Management Meet Update Institutional Equities Reuters: HUHT.BO; Bloomberg: HPPL IN We met the management of (formerly Paper Products). After announcement of the acquisition of Positive Packaging by two months ago (likely to be EPS-accretive) and the acquisition likely to be completed in the next six months, the latter will emerge as the largest player in the flexible packaging segment. Slowdown in the FMCG sector, high crude oil prices, rupee depreciation and high power and fuel costs had impacted top-line and margins in the past few years, leading to flat EPS growth over CY11-CY13. The outlook is attractive on these fronts over the medium term. Unlocking of potential synergy from the acquisition of Positive Packaging in terms of economies of scale, production, purchasing power for raw materials, geographical spread and additional customers makes a potential long-term bet. The stock trades at 23x CY13 earnings. We do not have a rating on the stock currently. Positive Packaging deal: is a part of Huhtamaki Oyj, which currently has ~69% stake in the company. is mainly into flexible packaging and labeling and also has a small value-added carton segment with revenue of Rs200mn- Rs250mn, or ~2% of sales. Until two months ago, was the secondlargest player in the flexible packaging business in India with revenue of Rs10.8bn in CY13 (likely to be above Rs12bn in CY14E). What has changed is that the parent acquired the global business of Positive Packaging for around Rs 21bn and the Indian operations (registering revenue of ~Rs10bn) were acquired by for around Rs8,180mn. Positive s operations in India had equity of Rs3.5bn-Rs 4.0bn and debt of Rs 2.7bn. was a net cash company before the planned acquisition. The company has already raised Rs1.34bn from fresh equity issue to the parent at Rs134 per share (much higher than the six-month average prior to the issue, the number of shares increased from 62.68mn shares to 72.71mn shares and the parent s stake in increased from 63.78% to 68.77%) and will raise the remaining sum through domestic non-convertible debenture issue (coupon of less than ~10.5%, tenure of five years) which is likely to be completed by 4QCY14, with the transaction itself expected to be completed by 1QCY15. Industry and company details: Despite consolidation, the flexible packaging business in India is highly fragmented in nature. Total domestic market size is ~Rs 240bn (~1.2mt-1.4mt) and thus the top two players put together account for less than 16% of the industry. As much as 50% of the industry is still unorganised. Flexible packaging largely caters to FMCG companies and growth has been 12%-13% in the past few years with the unorganised segment also growing at a decent pace. has all the top FMCG companies in India (in food and personal care segments) as its customers, including Hindustan Unilever or HUL, Colgate-Palmolive (India), Britannia Industries and ITC. Large FMCG customers typically work with five-six suppliers of flexible packaging and buys on the spot with no advance commitment. The company also procures raw materials on spot basis. Building efficiencies: As the margins are lower and FMCG companies demand credit of two months (largely flattish across the past 10 years), has done well to reduce its inventory days (from 40 days a few years ago to 30 days), increase creditor days marginally (from 40 days earlier to mid-40s in recent years) and increase fixed asset turnover from 2.5-3.0 days to 4.5 days in recent years (new products, value addition and moderate capex investment, as per demand outlook). The company reckons that it can still bring down inventory days further. Top 10 customers of account for 60%-65% of its sales with the number 1 customer accounting for less than 20% of sales. The barriers to entry that the company has is scale, understanding customers requirement, efficiency and timeliness as the customers usually require quick delivery (maximum period of two-three weeks). 16 September 2014 NOT RATED CMP: Rs186 Sector: Packaging Krishnan Sambamoorthy krishnan.s@nirmalbang.com +91-22-3926 8033 Key Data Current Shares O/S (mn) 72.7 Mkt Cap (Rsbn/US$mn) 13.5/221 52 Wk H / L (Rs) 194/60 Daily Vol. (3M NSE Avg.) 146,902 One-Year Indexed Stock Performance 350 320 290 260 230 200 170 140 110 80 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Price Performance (%) 1 M 6 M 1 Yr 14.9 106.7 203.5 Nifty Index 3.1 23.5 37.5 Source: Bloomberg NSE CNX NIFTY INDEX Please refer to the disclaimer towards the end of the document.
Company background is a part of Huhtamaki Oyj which owns ~69% stake in the Indian entity. The company has been in operations for more than six decades and was set up by the Talwar family. In 1999, through a new equity issue, Van Leer of Netherlands acquired a 51% stake in the company. Revenues then were around Rs2bn and have jumped five-fold since then. Van Leer was in turn acquired by Finland-based Huhtamaki, one of the top 10 global players in the flexible packaging segment. The Talwar family has completely exited the company. is mainly into flexible packaging and labeling and also has a small value-added carton segment which posts revenue of Rs200mn-Rs250mn, or ~2% of sales. Positive Packaging acquisition Until two months ago, was the second-largest player in the flexible packaging business in India with revenue of Rs10.8bn in CY13 (likely to be more than Rs12bn in CY14E). What has changed since two months is the parent acquiring the global business of Positive Packaging for around Rs 21bn and the Indian operations (registering revenue of ~Rs10bn) acquired by for around Rs8,180 mn. Positive s operations in India had equity of Rs3.5bn-Rs 4.0bn and debt of Rs2.7bn. was a net cash company before the acquisition. The combined revenues put the consolidated entity at the top of flexible packaging business in India, marginally ahead of Uflex, the erstwhile largest player in the business. The company has already raised Rs 1.34bn from a fresh equity issue to the parent at Rs134 per share (much higher than the six-month average prior to the issue, the number of shares increasing from 62.68mn shares to 72.71mn shares and the parent s stake rising from 63.78% to 68.77%) and will garner the remaining sum through a domestic debenture issue (coupon of less than ~10.5%, tenure of five years) which is likely to be completed by 4QCY14, with the transaction itself expected to get completed by 1QCY15. Synergies could take 1.5 to 2 years to unlock. The synergies will be in terms of economies of scale in production and purchasing power for raw materials, geographical spread, additional customers etc. s margins were affected in the past 18 months by higher crude oil prices (a large portion of raw materials required is crude-oil linked), rupee depreciation and higher power and fuel costs (up 26% CAGR in the past 2 years). The company was not able to pass this on entirely to its customers because of competitive and fragmented nature of the industry. With crude oil prices declining sharply and rupee depreciation no longer a big worry, there is some respite on the raw material costs front as well as fuel costs, but high electricity costs are still a cause for concern. The typical volume growth for the company is ~6%-7% and price hikes are around 4%- 5%. The relative slowdown in the domestic FMCG segment has hurt volume growth in the past two years. As of now, the company has only shared revenue, debt and equity of Positive Packaging. Industry and The flexible packaging business in India is highly fragmented in nature. Total market size in India is ~Rs 240bn (~1.2mt-1.4mt) and thus the top two players put together (after Positive Packaging acquisition) account for less than 16% of the industry. As much as 50% of the industry is still unorganised. Flexible packaging largely caters to FMCG companies (mainly in F&B and personal care) and growth has been 12%-13% in the past few years with the unorganised segment also growing at a decent pace. Huhtamaki PPL has all the top FMCG companies in India (in food and personal care segments) as its customers including HUL, Colgate-Palmolive (India), Britannia Industries etc. Incidentally, ITC is a customer despite having its own flexible packaging business (albeit much smaller at less than 10% of post consolidation) as a part of its paper and paperboard business. Large FMCG customers typically work with five-six suppliers of flexible packaging and buy on the spot with no advance commitment. Similarly, the company also buys raw materials on spot basis. The barriers to entry that the company creates is in terms of scale, understanding customer requirements, efficiency and timeliness as the customers usually require quick delivery (maximum of two-three weeks). Top 10 customers of account for 60%-65% of its sales with the number 1 customer accounts for less than 20% of sales. Current capacity is 50,000tn and Positive Packaging also has a similar capacity. s plants are located at Silvassa, Rudrapur, Hyderabad and Thane with roughly similar capacity. Positive Packaging has plants in western and southern regions with capacities at Ahmedabad, Belapur, Khopoli 2
and Bangalore. Capacity utilisation level in the industry is typically 75-85% as the industry is wary of diluting margins because of excess capacity. Capex is usually limited to ~40% of EBITDA. The company has a small subsidiary called Webtech Labels which registers sales of Rs 850mn-Rs 950 mn, accounting for less than 8% of total sales. This subsidiary is 51% owned by and 49% by the erstwhile promoters. Financials EBITDA margin been in the 10%-14% range in the past 10 years and have been at the lower end of this range in the past few years because of the factors stated above. Gross margin slipped from 32%-34% to ~29% in 1HCY14. As margins are low and FMCG companies demand credit of two months (largely flattish across the past 10 years), the company has done well to reduce its inventory days (from 40 days a few years ago to 30 days), increase creditor days marginally from 40 days earlier to mid-40s in recent years) and increase fixed asset turnover from 2.5-3.0 days to 4.5 days in recent years (new products, value addition and moderate capex investment, as per likely demand outlook). The company reckons that it can bring down inventory days further. This enables double-digit RoE and RoCE as well as a net cash position (as of now, debt will be raised for the acquisition). ERP has been implemented a few years ago. has a program called NASP (New applications, services, structures and procedures) which has been in place for a decade and contributes ~30% to revenue. The company has been consistently free cash positive. Tax rate at ~30% is close to the peak level. Despite only a 34% dividend payout, dividend yield (trailing) is healthy at 1.5%. Other highlights Other large global flexible packaging players like Amcor (Revenues ~3bn in India) and Constantia (which acquired Parikh Packaging) are also present in India, but their scale of operations is much smaller than Uflex and Positive Packaging combined. There is no ESOPs at, but senior employees have been granted ESOPs at the parent level. The parent is not yet involved in day-to-day operations, but has two members on the company s board and also appoints senior management personnel. The parent does not charge any royalty. 3
Financials Exhibit 1: Income statement Net sales 5,831 7,101 8,039 9,006 10,855 % growth (5.8) 21.8 13.2 12.0 20.5 Raw material costs 3,825 4,966 5,637 6,249 7,523 Staff costs 493 591 643 710 841 Other expenses 731 774 879 1,150 1,345 Total expenditure 5,049 6,331 7,159 8,109 9,709 EBITDA 782 771 880 897 1,146 % growth 13.0 (1.5) 14.3 1.9 27.7 EBITDA margin (%) 13.4 10.9 11.0 10.0 10.6 Other income 12.9 4.6 27.1 24.4 14 Net Interest (12.3) (11.6) (37.6) (52.4) 2 Depreciation 311.5 324.0 320.5 356.5 420 Profit before tax 495.8 462.7 624.6 617.3 737 % growth 15.4 (6.7) 35.0 (1.2) 19.4 Tax 122.0 134.8 128.1 166.1 229 Effective tax rate (%) 24.6 29.1 20.5 26.9 31.1 Net profit 373.8 327.9 496.5 451.2 508 % growth 8.4 (12.3) 51.4 (9.1) 12.5 Adjusted net profit 373.8 327.9 496.5 450.7 492 % growth 8.4 (12.3) 51.4 (9.2) 9.1 Extraordinary items 0 153.3 29.4 0 71 Reported net profit 373.8 481.2 525.9 450.7 562 % growth 75.6 28.7 9.3 (14.3) 24.7 Exhibit 3: Balance sheet Equity 125 125 125 125 125 Reserves 2,490 2,811 3,163 3,424 3,783 Net worth 2,616 2,937 3,288 3,550 3,908 Long-term loans 225 225 222 378 456 Total loans 239 225 222 519 462 Deferred tax liability 68 53 25 7 10 Liabilities 2,923 3,215 3,535 4,260 4,582 Gross block 4,514 4,367 4,759 2,746 4,454 Depreciation 2,558 2,645 2,944 965 3,046 Net block 1,956 1,723 1,816 1,781 1,408 Capital work-in-progress 77 64 82 694 1,020 Inventories 759 892 844 886 935 Debtors 972 1,188 1,296 1,589 2,087 Cash 2 307 469 280 235 Liquid investments 349 196 387 471 471 Other current assets 322 325 329 338 470 Total current assets 2,404 2,909 3,325 3,565 4,197 Creditors 815 941 1,054 1,283 1,486 Other current liabilities 701 540 634 496 558 Total current liabilities 1,515 1,481 1,688 1,779 2,044 Net current assets 889 1,428 1,637 1,786 2,154 Total assets 2,923 3,215 3,535 4,260 4,582 Exhibit 2: Cash flow EBIT 471 447 560 541 725 (Inc.)/Dec in working capital 89 (387) 144 (254) (413) Cash flow from operations 560 60 704 287 312 Other income 13 5 27 24 14 Depreciation 312 324 321 357 420 Deferred tax liability (1) (15) (27) (18) 3 Interest paid (-) 12 12 38 52 (2) Tax paid (-) (122) (135) (128) (166) (229) Dividends paid (-) (125) (138) (150) (163) (204) Minority interest & ass.cos. - - - 185 - Extraordinary items - 153 29-71 Net cash from operations 648 265 813 557 385 Capital expenditure (-) (240) (77) (431) (933) (374) Net cash after capex 409 188 382 (376) 11 Cash from financial activities 31 153 (196) 73 78 Others (95) (22) (24) (26) (0) Opening cash (356) 2 307 469 280 Closing cash 2 307 469 280 235 Change in cash 358 305 162 (189) (45) Exhibit 4: Key ratios Y/E December CY09 CY10 CY11 CY12 CY13 Per share (Rs) EPS 6.0 5.2 7.9 7.2 8.1 DPS 2.0 2.2 2.4 2.6 2.8 Book value 41.7 46.8 52.5 56.6 62.3 Valuation (x) P/E 31.2 35.6 23.5 25.9 23.0 P/BV 4.5 4.0 3.6 3.3 3.0 EV/EBITDA 14.8 14.8 12.5 12.8 10.0 EV/sales 2.0 1.6 1.4 1.3 1.1 Return ratios (%) RoCE 12.8 10.8 14.7 11.2 11.2 RoE 14.7 11.8 16.0 13.2 13.2 Margins (%) Gross margin 34.4 30.1 29.9 30.6 30.7 EBITDA margin 13.4 10.9 11.0 10.0 10.6 PBT margin 8.5 6.5 7.8 6.9 6.8 PAT margin 6.4 6.8 6.5 5.0 5.2 Turnover ratio Asset turnover ratio (x) 2.0 2.3 2.4 2.3 2.5 Avg. inventory period (days) 43 42 39 35 31 Avg. collection period (days) 60 56 56 58 62 Avg. payment period (days) 46 45 45 47 47 Solvency ratios (x) Debt(cash)-equity (0.0) (0.1) (0.2) (0.1) (0.1) Interest coverage (0.0) (0.0) (0.1) (0.1) 0.0 Dividend yield (%) 1.1 1.2 1.3 1.4 1.5 Growth (%) Sales (5.8) 21.8 13.2 12.0 20.5 EBITDA 13.0 (1.5) 14.3 1.9 27.7 PAT 8.4 (12.3) 51.4 (9.2) 9.1 4
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