| Summary of Contents STOCK IDEA Supreme Industries
Recommendation: Buy
Price target: Rs570
Current market price: Rs420 Reigns supreme Key points -
Supremacy in all aspects: Supreme Industries Ltd (Supreme) is the leading manufacturer of plastic products with a significant presence across segments including plastic piping, industrial products, consumer products and packing materials. In spite of difficult business conditions, Supreme has proven its mettle by more than doubling its revenues and more than tripling its earnings in the last four years. What's more, the company has managed its working capital effectively and utilised its assets well which has been reflected in its consistently low leverage (it has a debt-equity [D/E] ratio of 0.5x despite regular capacity expansion) and high return on capital employed (RoCE) of over 30% for many years. -
Comfortably placed to exploit growing demand through aggressive capacity expansion: Given the relatively low per capita consumption of plastic products in India and the company's focus on introducing new products (high-margin products), Supreme has envisaged a capital outlay of Rs750 crore to expand its manufacturing capacities across product lines. The capital expenditure (capex) spread over the next three years would be funded by largely internal accruals (including the monetisation of its real estate in Mumbai) and partly debt. A lower dependence on debt for expansion would enable the company to keep leverage at comfortable level and return ratios healthy. -
Product innovation to support margins and add to growth momentum: Supreme has managed to keep its operating profit margin (OPM; on an annual basis) within a tight range of 14.5-16.0% despite wide fluctuations in the raw material prices over the last few years. This reflects its pricing power in a highly competitive market and ability to protect margins using a better revenue mix. The revenue share of high-margin value-added products increased from 23.3% in FY2010 to 31.7% in FY2013 and Supreme is planning to raise the contribution to 35% by FY2016. It has also increased its presence in chlorinated polyvinyl chloride (CPVC) products used in building and household segment. Moreover, there are many other products such as composite gas cylinders where regulatory approvals could open up a huge new market segment and take the company to a new growth orbit. We expect the margins to stay in the range of 15.5-16.0% over the next couple of years. We estimate a compounded annual growth rate (CAGR) of close to 20% in the earnings during FY2013-16. -
Valuation-recommend Buy with price target of Rs570: We are optimistic about the company's fundamentals on a long-term structural basis. We believe its leadership position, ongoing expansion plan, constant efforts to launch innovative and value-added products, and focus on enhancing its distribution reach with brand awareness would ensure consistently high growth. In addition, consistency in its financial performance, its higher returns and ratios, strong management team and best corporate governance practices give us confidence to look for an investment opportunity at the current level. Historically, the stock traded in the broad range of 10-20x one-year forward estimated earnings. Our price target of Rs570 is based on 16x FY2016 estimated earnings which is in line with its average multiple for the last three years; we have not considered the value of the company's 29.88% stake in Supreme Petrochem, as it is a strategic investment. We initiate coverage on Supreme with a Buy recommendation.
SHAREKHAN SPECIAL
Q3FY2014 earnings preview
Double-digit growth in earnings of Sensex companies aided by currency benefits Revenue growth sustains though largely driven by external sectors: For Q3FY2014 the revenue growth of the Sensex companies on an aggregate basis is expected to be 13.4% (ex energy), slightly better quarter on quarter (QoQ) and significantly better compared with the 7-8% growth seen in the previous quarters. But a large part of this growth is expected to be driven by the exporting companies in the technology and pharmaceutical (pharma) sectors where the growth momentum is aided by a weak local currency. Even in case of the automobile (auto) sector, the strong traction in the volumes of overseas subsidiaries (in case of Tata Motors) is likely to drive the growth in the revenues. On the other hand, the revenue growth in the domestic focused sectors like capital goods, infrastructure and cement remains anaemic. What's more, some of the consumer-focussed companies are also witnessing moderation in revenue growth. OPM-again currency gains skew the picture: The earnings before interest, tax, depreciation and amortisation (EBITDA) margin of the Sensex companies (ex banks) on an aggregate basis is expected to expand by 72 basis points year on year (YoY) to 18.8% (up 40 basis points QoQ). The rupee's appreciation (from the Q2FY2014 levels) is positive from the margin's point of view. Earnings growth outlook improves-IT, pharma, auto the key drivers of earnings growth: On an aggregate basis, the Sensex companies are expected to show an earnings growth of 11.6% YoY. The bulk of the earnings growth during Q3FY2014 is expected to be driven by sectors like information technology (IT), pharma and auto. Sectors like capital goods and power as well as Reliance Industries are likely to report a decline in their earnings on a year-on-year (Y-o-Y) basis. In case of banks, private banks may witness a moderation in growth while the public sector banks (PSBs) may continue to report a decline in earnings YoY. In terms of breadth, nine out of 30 companies in the Sensex are expected to report a decline in earnings YoY. Therefore, a broader revival in the economy remains the key to improvement in the earnings breadth. Downgrades take a breather, upgrades meekly catching up: Led by an improving global economy, the easing of the macro-economic concerns and expectations of a decisive outcome of the forthcoming general election, there have been modest upgrades in the FY2014 and FY2015 consensus earnings estimates for the Sensex (to 3.5% and 7% respectively) since October 2013. While this cannot be taken as an outright end of the downgrades, the upgrades are likely to outpace the downgrades in the earnings estimates. Sectors such as telecommunications (telecom), private banks and auto could see upgrades in the coming quarters. Going ahead, any significant improvement in the economic growth or a favourable outcome of the general election will be a key catalyst for earnings upgrades. Key risk: In case inflation continues to spiral up, the Reserve Bank of India (RBI) may raise the policy rates further which could constrain the recovery in the economy. |