CD Equisearch Pvt Ltd

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1 August 16, 2016 Huhtamaki PPL ltd. No. of shares (m) 72.7 Mkt cap (Rs crs/$m) 2057/307.9 Current price (Rs/$) 283/4.2 Price target (Rs/$) 327/ W H/L (Rs.) 326/176 Book Value (Rs/$) 60/0.9 Beta 1.0 Daily volume (avg. monthly) P/BV (CY16e/17e) 4.6/3.8 EV/EBITDA (CY16e/17e) 8.8/7.8 P/E (CY16e/17e) 22.5/18.2 EPS growth (CY15/16e/17e) 11.9/18.8/23.6 OPM (CY15/16e/17e) 11.4/11.3/11.5 ROE (CY15/16e/17e) 16.8/22.1/23.0 ROCE (CY15/16e/17e) 13.9/12.6/14.6 D/E ratio (CY15/16e/17e) 1.3/0.9/0.7 BSE Code NSE Code PAPERPROD Bloomberg HPPL IN Reuters HUHT.BO Shareholding pattern % Promoters 68.8 MFs / Banks / FIs 6.1 Foreign 0.8 Govt. Holding 0.0 Public & Others 24.3 Total As on June 30, 2016 Recommendation ACCUMULATE Phone: + 91 (33) E- mail: research@cdequi.com Company Brief Huhtamaki PPL is a leader in the flexible consumer packaging sector serving various large and mid corporate players in the FMCG business. HPPL offers a wide portfolio of packaging solutions that include flexible packaging, labeling technologies and specialized films for high barrier. Quarterly Highlights Unexpected slowdown in export sales of Positive Packaging led to a mere growth of 5% (y-o-y) in HPPL consolidated revenues in Q2CY16 (Rs crs/$85.6m vs Rs crs/$81.5m). Good monsoons leading to good demand from the health and pharma sector boosted Webtech s business (20% growth y-o-y). Though the volume grew by 11.5% (q-o-q) in Q2, the moderation in the realizations due to passing on the benefits of the lower raw material prices in Q1CY16 to the customers was the argument for the tepid growth in revenues. The disproportionate increase in the raw material prices (raw material to sales ratio at 68.4% in Q2CY16 vs 64.3% in Q1CY16), lower selling prices and poor product mix led to the shrinkage in the operating margins to 10.4%, a fall of 472 bps from the previous quarter. Lower capacity utilization at Positive Packaging along with sharp decline in standalone margins largely explains the drop in the operating profit. HPPL s steadfast ability to repay its debts prompted a reduction of interest expenses in Q2CY16 by 28.7% which guarded the profitability of the company to some extent. Profit before tax grew by 5.6% last quarter to Rs crs ($4.9m). Higher tax expenses in the last quarter led to slump in PAT before MI by 3.2% (Rs crs/$3.0m vs Rs crs/$3.1m). The stock currently trades at 22.5x CY16e EPS of Rs and 18.2x CY17e EPS of Rs Fortified by 10-12% sales growth, earnings would rise by 21.2% on average over the next two years. Integration benefits would help sustain the margins at %. Yet, HPPL is barely impervious to fluctuations in crude oil prices making prophecy a tad challenging. Predilection on the FMCG sector is nauseating too. On balance, we assign accumulate rating on the stock with a target of Rs 327 (previous target: Rs 281) based on 21x CY17 earnings (peg ratio retained at 1) over a period of 9-12 months. Figures (Rs crs) CY13 CY14 CY15 CY16e CY17e Income from Operations Other Income EBITDA (other income included) Net Profit after MI and EO item EPS (Rs) EPS growth (%) Equity

2 [ CD Equisearch Pvt Ltd Outlook & Recommendation Industry Overview Flexible packaging market has been driving the packaging industry to new heights. Buttressed by development across consumer and industrial market that uses flexible films, improvements in manufacturing practices, and continued technological innovations, the packaging market has been able to grow and evolve thereby shaping the packaging industry trends. Globally, the flexible packaging market is forecasted to grow at an annual rate of 3.4% during the period to US$248 billion (Source: FICCI). The food packaging which occupies over 70% of the global consumer flexible packaging market is growing by 4% on average in volume terms and reached over 18.8 million tons in 2015 (Source: smitherspira). Whilst Asia-Pacific and Western Europe have enjoyed the largest areas of growth over the period , sales of consumer flexible packaging have been growing now at a rapid pace in Asia-Pacific and Eastern Europe. The Indian packaging industry which constitutes about 4% of the global packaging industry is expected to reach $72.6 billion in 2020 from $31.7 billion in 2015 (see chart). In the coming years, the packaging industry is anticipated to register 18% annual growth rate, with the flexible packaging and rigid packaging expected to grow annually at 25% and 15% respectively (Source: FICCI). If we look at the per capita packaging consumption in India, it is quite low at 4.3 kgs compared to countries like Germany and Taiwan where it is 42 kgs and 19 kgs respectively. However, organized retail and boom in e-commerce, which offer huge potential for future growth of retailing, is giving a boost to the packaging sector. Source: FICCI Source: FICCI Source: IBEF Plastics packaging segment is poised to grow at a good rate with the major applications being in food, beverage and consumer goods. The biggest end users of packaging, the food and beverages will help to drive the packaging demand, by growing at a CAGR of 25% in the period (Source: FICCI). Beside food & beverages, the pharmaceuticals is another major user of packaging which has become the major part of the drug delivery system. With the overall drug approvals given by the USFDA to Indian companies doubling in FY16, the Indian pharma market is expected to grow 13-15% annually in the period to $55 billion from $30 billion (2015). The flexible packaging market tends to be highly competitive at both the national and regional levels, often with narrow margin. The global flexible packaging industry continues to be highly fragmented although a small but growing number of multinational converters are adopting a global strategy to grow their major brand owner customers who are expanding their manufacturing footprint in emerging markets in Eastern Europe, Asia, Africa and Latin America. There is an increasing preference among consumers for environmentally sustainable packaging solutions that has made R&D towards light weighting of substrates rather ubiquitous. Converters are confronted with the daunting task of coming up with solutions that leave lesser waste and thus lower carbon foot print. 2 2

3 Financials and Valuations The mere value growth of 1.5% combined with a volume growth of 6.5% last fiscal (standalone business) was influenced by the disruptive rains that affected south India based customers; the sluggishness in the urban demand for FMCG products along with US FDA warnings to the pharma customers also impacted the business last year. Huhtamaki expects to consummate a good market in the consumer packaging sector in the wider Asia-Pacific African region by increasing its export revenues (25% in CY15) in the Middle East and African countries through Positive Packaging. Source: HPPL, CD Equisearch Source: HPPL, CD Equisearch Source: HPPL, CD Equisearch Though the trading conditions have not improved absolutely to ones expectations with the oil prices coming down and currency fluctuation issues in these export countries, the positive momentum in the FMCG sector this year (the subsidiary business seeing a good turnaround in some of the cost and sales factor) will help the revenues to grow at a CAGR of 11.1% in the next two years to Rs crs ($336.0m) and Rs crs ($376.3m) in CY16 and CY17 respectively. Despite drop in selling prices, margins improved last year due to benign raw material prices and better product mix. The reduction in the raw material to sales ratio at 67% in Q4CY15 driven by the continuous slide in crude oil prices helped Huhtamaki to expand its margins to 10.4% last year (standalone)- an increase of 150 bps (9.0% in CY14). Sharp fluctuations in the raw material prices in first half of the current year have slowed down the profit growth last quarter. Going ahead, with the acquisition synergies kicking this year and the BOPP capacity coming on stream will assist HPPL to sustain the margins at % in the next two years. Source: HPPL, CD Equisearch Source: HPPL, CD Equisearch Source: HPPL, CD Equisearch 3 3

4 In CY15, the company did not go into any major expansion; it did a maintenance capex of Rs crs ($6.8m) on a consolidated basis. In the year 2016, it plans to spend around crs ($ m) on the expansion of its existing product capacity which will be utilized at 85% in the current year. The acquisition of Positive Packaging succored Huhtamaki to report an EBITDA of Rs crs ($36.9m) in CY15, growth of 93.3%. The interest expense of Rs crs ($3.7m) on the debt issue of Rs 385 crs ($57.6m) for the acquisition impacted the bottom-line to grow at just 22.6% to Rs crs ($11.5m) last year (excluding extraordinary items). Despite synergies coming into play from the acquisition, the net profit margin remained at the lowest level in last four years at 3.9%-down by 142 bps (5.3% in CY14). The debt-equity ratio of HPPL increased to 1.3 in CY15 from 0.08 in CY14 which was mainly due to the additional debt to fund the acquisition. The company plans to continue the repayment of its debt which will reduce its interest expenses certainly. We expect HPPL to bring its gross debt-equity to in the next two years. The growth in the high end sensitive label for the pharmaceutical sector coupled with the demand from the export market will add on to the standalone business for Huhtamaki. Going ahead, we expect the net profit margins to move to % and help HPPL to post profit growth of 21.2% CAGR in the next two years to Rs crs ($13.7m) and Rs crs ($16.9m) in CY16 and CY17 respectively. Source: HPPL, CD Equisearch Source: HPPL, CD Equisearch Source: HPPL, CD Equisearch The stock currently trades at 22.5x CY16e EPS of Rs and 18.2x CY17e EPS of Rs Fortified by 10-12% sales growth, earnings would rise by 21.2% on average over the next two years. Integration benefits would help sustain the margins at %. Yet, HPPL is barely impervious to fluctuations in crude oil prices making prophecy a tad challenging. Predilection on the FMCG sector is nauseating too. On balance, we assign accumulate rating on the stock with a target of Rs 327 (previous target: Rs 281) based on 21x CY17 earnings (peg ratio retained at 1) over a period of 9-12 months. For more info refer to our March report. 4 4

5 Risks and Concerns Volatility in raw materials At present raw material costs constitute 68% of HPPL s revenues. Considering the outlook of petrochemicals, there is a risk of high volatility. The high volatility in the raw material prices caused by sharp fluctuations in the crude oil prices may make operating profits highly vulnerable. Client Concentration Risk Huhtamaki top clients include Costco, Kraft, McDonald s Unilever, Coca Cola, Cadbury, Nestle, Glaxo Smithkline, Perfetti, Marico and P&G which together account for almost 60-65% of its revenue. Thus HPPL is prone to client concentration risk and their retention is extremely important in order to maintain the market share in the business. Other Factors Since a large portion of its revenue is derived from the FMCG sector, any slowdown in this sector due to higher inflation can hit the revenue growth. Rural distress, arising due to vagaries of monsoon can also fetter the company s revenue as it will have an impact on the demand of consumer goods. Flexible packaging industry being a fragmented market can put HPPL into severe competition with other packaging companies like Uflex, Essel Propack and TCPL Packaging (TCPL forayed into flexible packaging business recently). Cross Sectional Analysis Company Equity CMP MCAP* Sales* Profit* Essel Propack Huhtamaki PPL Jindal Poly Film Uflex Calculations on ttm basis, * figures in crores OPM (%) NPM (%) Int Cov ROE (%) Mcap/ Sales P/BV P/E Source: HPPL, CD Equisearch Source: HPPL, CD Equisearch Source: HPPL, CD Equisearch CY for Huhtamaki PPL. Note: All $ values in the write-up are expressed at current exchange rate. 5 5

6 Financials Consolidated Quarterly Results Figures in Rs crores Q2CY15 Q2CY14 % chg H1CY16 H1CY15 % chg Income From Operations Other Income Total Income Total Expenditure EBITDA (other income included) Interest Depreciation PBT Tax PAT Minority Interest PAT after MI Extraordinary Item Net Profit EPS(Rs) Consolidated Income Statement Figures in Rs crores CY13 CY14 CY15 CY16e CY17e Income From Operations Growth (%) Other Income Total Income Total Expenditure EBITDA (other income included) Interest Depreciation PBT Tax PAT Minority Interest PAT after MI Extraordinary Item Net Profit EPS (Rs)

7 Balance Sheet Figures in Rs crores CY13 CY14 CY15 CY16e CY17e Sources of Funds Share Capital Reserves Total Shareholders' Funds Minority Interest Long Term Debt Total Liabilities Application of Funds Gross Block Less: Accumulated Depreciation Less: Impairment Net Block Capital Work in Progress Investments Current Assets, Loans & Advances Inventory Trade Receivables Cash and Bank Short term loans Other Assets Total CA & LA Current Liabilities Provisions-Short term Total Current Liabilities Net Current Assets Net Deferred Tax Net long term assets Total Assets

8 Key Financial Ratios CY13 CY14 CY15 CY16e CY17e Growth Ratios (%) Revenue EBITDA Net Profit EPS Margins (%) Operating Profit Margin Gross profit Margin Net Profit Margin Return (%) ROCE RONW Operating return on assets Valuations Market Cap/ Sales EV/EBITDA P/E P/BV Other Ratios Interest Coverage Debt Equity Current Ratio Dividend Payout Ratio Turnover Ratios Fixed Asset Turnover Total Asset Turnover Debtors Turnover Inventory Turnover Creditor Turnover WC Ratios Debtor Days Inventory Days Creditor Days Cash Conversion Cycle

9 Cumulative Financial Data Rs crs CY12-13 CY14-15 CY16-17 Income from operations Operating profit EBIT PBT PAT after MI Dividends OPM (%) NPM (%) Interest coverage Debt-equity* ROE (%) ROCE (%) Fixed asset turnover Debtors turnover Creditors Turnover Inventory turnover Debtor days Inventory Days Creditor Days Cash Conversion Dividend payout ratio (%) CY12-13 implies two year ending CY13.*terminal year The acquisition of Positive Packaging in CY15 largely explains the 2.4x increase in income from operations that HPPL will see in CY16-17 of Rs 4760 crs ($712.3m) from Rs 1986 crs ($297.2m) in CY The benefits of the raw material supply from the integration can be seen in the operating margins in CY Promising sector trends will increase the profits by 1.5x in the period CY16-17 from CY14-15 (Rs 205 crs/$30.7m vs Rs 140 crs/$21.0m) which will also drive the return ratios- ROE is expected to jump to 22.3% in the period CY16-17 and ROCE is expected to remain to move up to 13.3% in the same period. The decline in interest coverage ratio to 5.5 in CY14-15 from the massive 32.2 in CY12-13 is on account of increase in interest expenses in CY15 on the debentures issued for the acquisition. Minimal capex in CY16 and CY17 will push up the fixed asset turnover ratio to 4.9 in the two year period from 4.5 in CY The cash conversion cycle is expected to remain at the same level of days. 9 9

10 Financial Summary US dollar denominated CY13 CY14 CY15 CY16e CY17e Equity capital Shareholders funds Total debt Net fixed assets (inc CWIP) Investments Net current assets Total assets Revenues EBITDA EBDT PBT Profit after minority & extraordinary items EPS ($) Book Value ($) *income statement figures translated at average rates; balance sheet at year end rates; projections at current rates All dollar denominated figures are adjusted for extraordinary items

11 Disclosure& Disclaimer CD Equisearch Private Limited (hereinafter referred to as CD Equi ) is a Member registered with National Stock Exchange of India Limited, Bombay Stock Exchange Limited and Metropolitan Stock Exchange of India Limited (Formerly known as MCX Stock Exchange Limited). CD Equi is also registered as Depository Participant with CDSL and AMFI registered Mutual Fund Advisor. The associates of CD Equi are engaged in activities relating to NBFC-ND - Financing and Investment, Commodity Broking, Real Estate, etc. CD Equi is registered under SEBI (Research Analysts) Regulations, 2014 with SEBI Registration no INH Further, CD Equi hereby declares that No disciplinary action has been taken against CD Equi by any of the regulatory authorities. CD Equi/its associates/research analysts do not have any financial interest/beneficial interest of more than one percent/material conflict of interest in the subject company(s) (kindly disclose if otherwise). CD Equi/its associates/research analysts have not received any compensation from the subject company(s) during the past twelve months. CD Equi/its research analysts has not served as an officer, director or employee of company covered by analysts and has not been engaged in market making activity of the company covered by analysts. This document is solely for the personal information of the recipient and must not be singularly used as the basis of any investment decision. Nothing in this document should be construed as investment or financial advice. Each recipient of this document should make such investigations as they deem necessary to arrive at an independent evaluation of an investment in the securities of the companies referred to in this document (including the merits and risks involved) and should consult their own advisors to determine the merits and risks of such an investment. Reports based on technical and derivative analysis center on studying charts of a stock's price movement, outstanding positions and trading volume, as opposed to focusing on a company's fundamentals and as such, may not match with a report on a company's fundamentals. The information in this document has been printed on the basis of publicly available information, internal data and other reliable sources believed to be true but we do not represent that it is accurate or complete and it should not be relied on as such, as this document is for general guidance only. CD Equi or any of its affiliates/group companies shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. CD Equi has not independently verified all the information contained within this document. Accordingly, we cannot testify nor make any representation or warranty, express or implied, to the accuracy, contents or data contained within this document. While, CD Equi endeavors to update on a reasonable basis the information discussed in this material, there may be regulatory compliance or other reasons that prevent us from doing so. This document is being supplied to you solely for your information and its contents, information or data may not be reproduced, redistributed or passed on, directly or indirectly. Neither, CD Equi nor its directors, employees or affiliates shall be liable for any loss or damage that may arise from or in connection with the use of this information. CD Equisearch Private Limited (CIN: U67120WB1995PTC071521) Registered Office: 37, Shakespeare Sarani, 1st Floor, Kolkata ; Phone: +91(33) ; Fax: +91(33) Corporate Office: 10, Vasawani Mansion, 2nd Floor, Dinshaw Wachha Road, Churchgate, Mumbai Phone: +91(22) /0653; Fax: +91(22) 2283, 2276 Website: research@cdequi.com buy: >20% accumulate: >10% to 20% hold: -10% to 10% reduce: -20% to <-10% sell: <-20% 11 11