Systematix. Shaily Engineering Plastics. Institutional Equities. A leader in precision injection moulding INITIATING COVERAGE.

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1 Systematix Institutional Equities Sector: Plastics CMP: Rs540 INITIATING COVERAGE Rating: Buy Target Price: Rs680 Stock Info Sensex/Nifty 26,725/ 8,178 Bloomberg SHEP IN Equity shares (mn) wk High/Low Rs704/ 300 Face value Rs10 M-Cap Rs4.5bn/ $68mn 3-m Avg volume $0.1mn Financial Snapshot (Rs mn) Y/E Mar FY16 FY17e FY18e Net sales 2,255 2,760 3,449 EBITDA PAT EPS (Rs) PE (x) EV/EBITDA (x) P/B (x) RoE (%) RoCE (%) D/E (x) Shareholding pattern (%) Mar 16 Dec 15 Sep 15 Promoter Pledged FII DII Others Stock Performance (1-year) Ankit Gor ankitgor@systematixshares.com Rahul Khandelwal rahul@systematixgroup.in May, 2016 A leader in precision injection moulding Ltd (SHEP) is a leading manufacturer of high precision injection moulded plastic components and assemblies. SHEP s five plants at Vadodara, with 104 injection moulding machines, operate within the three business segments: home furnishing (58% of revenue), healthcare (8% of revenue) and FMCG/others (34% of revenue). With an expertise in designing, developing and manufacturing, SHEP is a reliable and consistent supplier to Swedish home furnishing giant since 12 years. Its India foray will propel SHEP s growth prospects (30% local sourcing). SHEP s recent investment (March 2015) of Rs300mn in pharma packaging (CR caps and HDPE bottles) presents ample opportunity to scale up. We expect it to post a revenue/pat CAGR of 24/43% during FY16-18e, with steady margin expansion on the back of: 1) focus on high-margin CR caps and insulin pens business from pharma clients, 2) incremental business from Swedish furniture major, post its foray into India by 2017 and 3) expertise in plastic engineering along with strong clientele. We initiate coverage on SHEP with a Buy rating and a target price of Rs680 (18x FY18e EPS of Rs38), due to its global positioning among key industry players despite a smaller size, expertise in engineering plastic which enables it to innovate and make import substitute products, and healthy financials. India s largest supplier to Swedish home furnishing leader, India foray plan to boost revenue SHEP is India s largest supplier of plastic components and assemblies to Swedish furniture major. From the dedicated plant at Rania, Gujarat it manages ~20SKUs and the entire supply chain from the factory to its stores globally. Home furnishing revenue posted a CAGR of 23% during FY12-16 due to SHEP s operational efficiencies along with consistent/reliable supplies. Presently, Swedish furniture major sources ~Euro300mn products from India and this is expected to double (30% local sourcing as per government requirement) post its India foray in Swedish furniture major has already acquired land for its first store in Hyderabad and construction is in full swing. It has plans to open 25 home furnishing stores in India by Post it s entry in India; we expect significant increase in business to its current suppliers in India. We estimate SHEP s revenue to post a CAGR of 20% during FY16-18e to Rs1.9bn. Sole supplier of AllStar insulin pens to Sanofi; pharma packaging to aid growth SHEP s healthcare division includes medical devices and pharma packaging. It manufactures insulin pens for Sanofi and Wockhardt and asthma inhaler body for Sun Pharma and Zydus. In March 2015, SHEP had set up a pharma packaging plant at Rania, Gujrat (outlay Rs300mn) to manufacture child-resistant (CR) caps and HDPE bottles. As many Indian generic pharma companies are validating these products, we expect revenue generation to start from 1QFY17. We estimate the revenue from healthcare division to post a CAGR of 75% during FY16-18e to Rs562mn due to: 1) SHEP being the sole supplier of AllStar insulin pens to Sanofi and 2) pick-up in volume of import substitute CR caps and HDPE bottles. Expertise in plastic engineering along with strong clientele Over the years, SHEP has gained the expertise to convert critical components used in complex processes to engineered plastic. For Honeywell, it has replaced the metal rods with plastic for turbo chargers being supplied to major OEMs, including BMW. SHEP has also replaced the metal bearing cage for Fag Bearing, which supplies to Maruti Suzuki. SHEP s niche in plastic and consistency has gained customers trust over the years. It maintains long-term relationships with many Fortune 100 companies across the globe. Investors are advised to refer through disclosures made at the end of the research report. 1

2 FINANCIALS Profit & Loss Statement YE: Mar (Rs mn) FY14 FY15 FY16 FY17e FY18e Net revenues 1,508 1,797 2,255 2,760 3,449 Revenue growth (%) Op. expenses 1,267 1,532 1,865 2,259 2,791 EBIDTA EBITDA margins (%) Interest expenses Depreciation Other income Tax Effective tax rate (%) Reported PAT /- Extraordinary items /- Minority interest PAT EPS (Rs/share) Cash EPS (Rs/share) Balance sheet YE: Mar (Rs mn) FY14 FY15 FY16 FY17e FY18e Share capital Reserves & Surplus ,218 Networth ,061 1,301 Minority interest Total Debt ,063 Def. tax liab. (net) Capital employed 1,130 1,685 1,622 2,057 2,427 Net Fixed assets ,175 1,367 Investments of which liquid Net Working capital Cash and bank balance Capital deployed 1,130 1,685 1,622 2,057 2,427 Net debt ,002 WC (days) Book value (Rs/sh) Cash flow YE: Mar (Rs mn) FY14 FY15 FY16 FY17e FY18e PAT n cash items Cash profit Incr/(Decr) in WC (61) Operating cash flow Capex Free cash flow 42 (271) (1) (68) (18) - Dividend Equity raised Debt raised (192) Investments - - (254) Misc. items Net cash flow 181 (181) 22 (86) 38 + Opening cash Closing cash Ratios YE: Mar FY14 FY15 FY16 FY17e FY18e P/E (x) P/BV (x) EV/EBITDA (x) RoE (%) RoCE (%) Fixed Asset turnover (x) Dividend (%) Dividend yield (%) Dividend payout (%) Debtors days Creditor days Inventory days D/E ratio PAT growth (%) EBITDA growth (%)

3 Charting the story Chart 1: Revenue to post a CAGR of 24% over FY16-18e Chart 2: Margins to expand with better realisations in pharma Chart 3: Debt/equity ratio to remain under 1x Chart 4: Return ratios to expand due to higher OPM and ATR Chart 5: Home furnishing segment is highest grosser in FY16 Chart 6: Revenue from healthcare and other segments to rise 3

4 Home furnishing segment contributes more than 50% of revenue, to remain in focus SHEP began its business association with Swedish home furnishing major in During this 12-year period, SHEP managed the entire supply chain of around 20 SKUs right from its dedicated factory (100% EOU facility at Rania, Gujarat) to its stores worldwide. World over this Swedish company sources various product worth 10.5bn Euro, of which plastic products accounts for 11%. From India it sources about 40mn Euro of plastic products. Swedish furniture maker sources 25% of global need from China The world s largest furniture retailer is engaged in selling ready-to-assemble furniture, appliances and home accessories. It is known for its cost-effective, convenient-to-use, trend setting and eco-friendly furniture and home accessories. The company had a turnover of Euro31.9bn in 2015, with 361 stores in 45 countries and over 1,000 suppliers from 51 countries. It sources Euro10.5bn worth of products and product categories mainly from China, followed by Poland and other countries. Chart 7: India is in top 10 suppliers list Source: The Economic Times, magazine Sourcing from India to double from Euro315mn, post setting up of first store in 2017 by Swedish company In late 1980s, the global home furnishing player set up the first office in India mainly to source textiles, carpets and rugs for its stores across world. Currently, it sources many products (worth Euro315mn) including rugs, towels, bed linen, carpets, textile items, plastic products and lighting equipment (lamps) from ~50 suppliers in India. Over the years, it has helped suppliers to build strength, expand/diversify the product portfolio and train their employees. Table 1: Suppliers list of various product categories from India Product Home furnishing Home Lighting Products Plastic home furnishing Floral décor Garments Source: Panjiva.com Suppliers Asian Fabricx, Welspun, Trident, Jawandsons, Innotech Fitness Systems Neokraft, Associated Lighting company Shaily Engg, All Time plastics, Fancy fittings, Pyramid plastics Ramesh Flower Pvt ltd, Sibaflor Natural decorations Alok Industries, Shrilakshmi Cotsyn 4

5 Home furnishing products The company has ambitious plans for India and sees the country as the thirdmost important market, buoyed by an expanding middle class, desire for higher standard of living and willingness pay premium for quality products. In 2013, it received the Indian government s approval for its Rs105bn proposal to open 25 retail stores (in 9 cities by 2025) under 100% FDI route. The first store in India is expected to come up in Hyderabad in 2HCY17, followed by Mumbai (three stores) and NCR. To fulfill the government s 30% local sourcing criteria, the home furnishing player will have to ramp up it sourcing from India. To adhere to the local sourcing guideline, it would bring its key global supplier to India or scout for new suppliers in India or increase the sourcing from existing Indian suppliers. Of these, increased sourcing from local suppliers is the preferred option, in our view. Table 2: India vision of the Swedish furniture retailer Stores - 25 Employees ,000 Visitors - 100,000,000 Distribution Centers - 3 % of locally sourced Products 3% 30% Product Categories 5 10 Source: Poster at Make in India event, BKC Revenue from home furnishing to clock CAGR of 20% during FY16-18e SHEP s home furnishing segment revenues have grown at a CAGR of 23% over FY12-16 to Rs1.3bn, we expect revenue to post a CAGR of 20% during FY16-18e, on the back of record of consistent supply, increasing usage of plastic in home furnishing and decreasing sourcing from China. Chart 8: Home furnishing revenue to post a CAGR of 20% over FY16-18e 5

6 Chart 9: CRC caps and HDPE bottles manufactured by SHEP Pharma segment to be growth driver; set up plant for CRC caps to reduce imports by bigger Indian generic players To package tablets, drugs and syrups, pharmaceutical companies use glass bottles, HDPE bottles and blister flexible films. Regulated markets like the US have mandatory requirement to pack certain drugs in child-resistant packaging. It consists of HDPE bottle and Child Resistant Caps (CRC) on it. CRC caped bottles are difficult to open and it gives a loud and bit annoying sound. Why CR caps are compulsory in the US In the US, CR packaging is the result of the Poison Prevention Act (PPA) passed by the US Congress in The purpose of the law is to decrease the opportunity of children to gain access to substances, resulting in accidental poisoning. In addition, PPA extends to all states or localities in the US and is an uniform standard applied for all applicable products. The European standard only covers packages containing paracetamol, aspirin and medicines with 24mg of iron. How CR caps fare better compared to forms of packaging The pharma industry requires reliable and speedy packaging solutions that can deliver a combination of product protection, quality, tamper evidence, patient comfort and security requirements. Meeting all these challenges, CR packaging is designed or constructed to be significantly difficult for children under five years of age to open within a reasonable time but not difficult for adults. SHEP has set up a dedicated Rs300mn CRC plant at Rania, Gujarat In India, three to four reliable companies (including Triveni Polymer, Shriji Polymer and Gopaldas) make HDPE bottles, while majority of CRC caps used by all generic pharma players in India are imported due to the absence of credible suppliers. To bridge this gap, SHEP has set up a CR cap and HDPE bottle plant, with a total outlay of Rs300mn at Rania, Gujarat. This dedicated plant has a manufacturing capacity of 100mn CRC caps and bottles. SHEP has tied up with Global System Closure (GSC) to manufacture and market (royalty of 2.5%) these caps in India and South East Asia. Presently, these bottles and caps are under validation process with many Indian generic pharma players, while some companies have started supply. SHEP s production will ramp up in a year s time as most pharma companies will include the products in their commercial production 6

7 Wockhardt Insulin pen by SHEP Sanofi Insulin pen by SHEP Sole supplier to Sanofi for AllStar insulin pen SHEP started manufacturing insulin pens for Wockhardt in 2004 and the response was lukewarm. Revenue from Wockhardt stood at Rs20mn in FY16 and is expected to remain at this level over next few years. In 2011, it commenced production of Allstar re-usable insulin pen for Sanofi and the response is encouraging. FY16 revenue from Sanofi stood at Rs180mn. Globally, Sanofi distributes ~345mn insulin pens, 320mn disposable and 25mn re-usable (of which SHEP supplies ~1.5mn re-usable pens). Currently, healthcare division contributes 8% (Rs184mn) to overall sales. We conservatively estimate healthcare division s revenue to post a CAGR of 75% over FY15-18e and contribute 16% to overall sales by FY18e, on the back of consistent supply to one of the world s largest insulin pen maker and ramp up of CR plant capacity Chart 10: Revenue contribution from healthcare to increase in FY18 7

8 Auto, FMCG and Others products Metal-to-Plastic rod for Honeywell Expertise in plastic engineering enables conversion of critical metal components Over the years, SHEP has gained the expertise to convert critical components used in complex processes to engineered plastic. It has mastered to manufacture high precision components using high-performance engineering polymers. The company has a fully equipped tool room for mold maintenance, including manufacturing of spares, and core and cavity inserts, with years of experience in handling complex moulds. An intensive fail-proof maintenance program helps extend the tools life by 4x, thus helping to keep costs low without disregard for quality. This helps the company to provide end-to-end services from conceptualising to commercialised production, which includes design, prototyping, testing, validations, compliance (in case of healthcare) to the final manufacture of components and assemblies. For Honeywell, it has replaced the metal rods with plastic for turbo chargers being supplied to major OEMs, including BMW. SHEP has also replaced the metal bearing cage for Fag Bearing, which supplies to Maruti Suzuki. SHEP provides vital parts in automotive seat-making to Amvian India (Camaco Group, US), which supplies to GM plants across the US. Currently, SHEP is working with OEMs on similar product requirements in India and abroad. It has also developed insulin pens for Sanofi having 14 parts, ranging from 0.3bm to 300gms. Table 3: Few success stories Honeywell Wockhardt Product Rod for turbo charger Insulin Pen Application Automobile Healthcare Previous component Shaily s role Details Metal - Metal to plastic rod Single component injection moulded rod Productivity increased by 300x Cost reduced by 40% Replacement of metal rods in BMW, Audi, MERC, Hyundai, Ford and Tata From design to development using 100% plastic components Shaily engineered a mechanism that uses 100% plastic components, the world's first Patented the design and all IPRs transferred to Wockhardt on project completion 2008 IDEA Innovation award winner Pens are designed to meet UL & FDA approvals & ISO ,2&3 certification Shaily is one of the eight manufacturers of insulin pens in the world now 8

9 Chart 11: Strong customer base Company background commenced operation in 1987, with two moulding machines at Halol, Gujarat, primarily to cater to OEMs requirements. Currently, it has five plants across Halol and Rania in Gujarat, with more than a hundred injection moulding machines. These plants cater to the home furnishing, pharmaceutical industry and others (such as home appliances, automobile and FMCG industry). Chart 12: SHEP s business centres Headquarter Export unit Tool room Assembly 9

10 Key concerns Delay in production rampup of CR caps may slow down revenue from the healthcare segment. Setting up of a plant by Swedish furniture makers global supplier in India to cater to its India demand. Around 50% of the revenue comes from a single customer. Higher dependency may be a risk to overall business. As 75% of the revenue comes from export, currency volatility may impact revenue. Valuation and view Since inception, SHEP has specialised in manufacturing high precision components using high-performance engineering polymers. With constant innovations and investments in new technologies, it is one of the world s few plastic companies that have gained expertise in converting metal components to plastic. After becoming a dependable supplier to Swedish furniture maker, the company has set up a plant (outlay of Rs300mn) for import substitute CR caps. At full capacity, revenue from this plant can go up to Rs550mn. With no major players in India, CR caps will be key revenue driver for the company in FY With strong expected from home furnishing segment, SHEP plans to invest over Rs500mn during FY17-18 (leading to negative FCF) towards the segment which is expected to drive sales from FY19 onwards. Given the above positives, we estimate its revenue/pat to clock a CAGR of 24/43% during FY16-18e. We initiate coverage on SHEP with a Buy rating and a target price of Rs680 (18x FY18e EPS of Rs38), due to its global positioning with key industry players despite a smaller size, expertise in engineering plastic which enables it to innovate and make import substitute products, and healthy financials. Chart 13: PE band Key management team Mahendra Sanghvi (Executive Chairman): He is a chemical engineer from Wayne State University USA, plastics technologist. He was working in rth America in the plastics industry before coming to India and setting up Shaily Engineering. He has 32 years of experience in plastics industry in India as well as in rth America. Amit Sanghvi (Management Director): Son of Mahendra Sanghvi, he has six years of experience in Project management, Marketing & Strategy. He has done MSc in supply Chain & Manufacturing and BASc in Electrical Engineering. Sanjay Shah (CFO & VP-Finance): He has done his Bachelors of Commerce from HSM. He is with the company since 22 years. 10

11 Institutional Equities Team Nikhil Khandelwal Managing Director Equity Research Analysts Industry Sectors Desk-Phone Jaspreet Singh Arora - Head of Research Cement, Building Material, Construction jaspreet@systematixshares.com Rahul Jain IT, E-commerce rahuljain@systematixshares.com Priya Ranjan Auto & Auto Ancs priyaranjan@systematixshares.com Salil Utagi Capital Goods, Engineering, Consumer Durables salilutagi@systematixshares.com T. Ranvir Singh Pharma, Healthcare, Agrochem ranvirsingh@systematixshares.com Clyton Fernandes BFSI clytonfernandes@systematixshares.com Ankit Gor Mid Caps ankitgor@systematixshares.com Divyata Dalal Construction, Infra divyatadalal@systematixshares.com Gurpreet Kaur Cement, Building Material gurpreetkaur@systematixshares.com Bibhishan Jagtap Auto & Auto Ancs bibhishanj@systematixshares.com Rahul Khandelwal Mid Caps rahul@systematixshares.com Birendrakumar Singh Technical Research birendrasingh@systematixshares.com Equity Sales & Trading Name Desk-Phone Pankaj Karde Head - Institutional Sales & Sales Trading pankajkarde@systematixshares.com Jitendra Marchino, CFA Asia Sales jitendramarchino@systematixshares.com Dhanesh Padhya Sales dhaneshp@systematixshares.com Dinesh Bajaj Sales dineshbajaj@systematixshares.com Jigar Kamdar Sales jigarkamdar@systematixshares.com Bhavik Shah Sales Trading bhavikshah@systematixshares.com Vinod Bhuwad Sales Trading vinodbhuwad@systematixshares.com Amit Sawant Dealer amitsawant@systematixshares.com Vahila Thoomu Assistant Manager vahila@systematixshares.com Sugandha Rane Assistant Manager sugandha@systematixshares.com Corporate Access Shaheen Chamadia Manager shaheenc@systematixshares.com Production Ramesh Nair Editor rameshnair@systematixshares.com Mrunali Pagdhare Production mrunalip@systematixshares.com 11

12 DISCLOSURES/ APPENDIX I. ANALYST CERTIFICATION I, Ankit Gor, Rahul Khandelwal; hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report, (2) part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this research report by Systematix Shares & Stocks (I) Limited or its Group/associates companies. (3) has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. Disclosure of Interest Statement Analyst holding in the stock Served as an officer, director or employee Update II. ISSUER SPECIFIC REGULATORY DISCLOSURES, Unless specifically mentioned in Point. 9 below: 1. The Research Analyst(s), Systematix Shares & Stocks(I) Limited (SSSIL), Associate of Analyst or his relative does not have any financial interest in the company(ies) covered in this report. 2. The Research Analyst, SSSIL or its associates or relatives of the Research Analyst affiliates collectively do not hold more than 1% of the securities of the company (ies) covered in this report as of the end of the month immediately preceding the distribution of the research report. 3. The Research Analyst, his associate, his relative and SSSIL do not have any other material conflict of interest at the time of publication of this research report. 4. The Research Analyst, SSSIL and its associates have not received compensation for investment banking or merchant banking or brokerage services or for any other products or services from the company(ies) covered in this report, in the past twelve months. 5. 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