Ambit SupremeInd Initiation 16Aug2013

8/17/2019 Ambit SupremeInd Initiation 16Aug2013

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Industrials August 16, 2013

Supreme IndustriesBloomberg: SI IN EQUITYReuters: SUPI NS

Accounting: GREENPredictability: GREENEarnings momentum: GREEN

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit

Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Please refer to the Disclaimers at the end of this Report.

BU

Key consolidated financials ( mn, unless specified)

Year to June FY12 FY13 FY14E FY15E FY16E

Operating income 29,279 34,040 40,413 48,758 56,288

EBITDA 4,719 5,356 6,408 8,291 9,273

EBITDA (%) 16.1% 15.7% 15.9% 17.0% 16.5%

Adjusted EPS ( ` ) 16.6 22.3 26.7 32.3 39.2RoE (%) 33.9% 36.0% 34.3% 32.8% 31.5%

RoCE excluding real estate (%) 22.8% 25.6% 24.7% 24.6% 24.7%

P/E (x) 21.0 15.6 13.0 10.8 8.9

Source: Company, Ambit Capital research

INITIATING COVERAGE

Nitin Bhasin

Tel: +91 22 3043 [email protected]

Tanuj Mukhija

Tel: +91 22 3043 [email protected]

Recommendation

CMP: ` 350

Target Price (12 Months): 442

Upside (%) 27

EPS (FY14): ` 28.1

Variance from consensus (%) 6.1

Stock Information

Mkt cap: ` 44bn/US$721mn

52-wk H/L: ` 380/264

3M ADV: ` 19mn/US$0.3mn

Beta: 1.2

BSE Sensex: 19,368

Nifty: 5,742

Stock Performance (%)

1M 3M 12M YTD

Absolute 1 (1) 27 17

Rel. to Sensex 4 1 18 18

Shareholding pattern (%)

Promoters

, 50%

FII, 10%

DII, 10%

Others,

30%

Source: BSE, Ambit Capital research

One-year forward P/E chart

579

111315

A u g

- 1 1

D e c -

1 1

A p r -

1 2

A u g

- 1 2

D e c -

1 2

A p r -

1 3

A u g

- 1 3

1 year forward PE Ave rage 1 ye a r fw d PE (x)

Source: Bloomberg, Ambit Capital research

he snowball…

Supreme’s competitive advantages in the fast-growing plastic pipingand packaging industry stem from its unmatched manufacturing anddistribution reach, consistent new product launches (including value-added products) and technological tie-ups. This is validated by its FCFgeneration and increasing RoCEs (FY13: 26% vs FY11: 20%). Itscompetitive advantages and surging CFO (36% CAGR in FY10-13) willprovide further support to this platform (

9bn capex in FY13-16) which will in turn lead to higher volume/revenue growth (14%/17% CAGR inFY13-16) and higher CFO for further product/capacity expansions.Current valuations (13x FY14E EPS) do not reflect its superior plasticsbusiness, unrivaled financial profile and top-quality management. Weinitiate coverage with a BUY and a TP of 442 (

420 for core business).

Competitive position: STRONG Change to this position: POSITIVE

Well-built competitive advantages key: Supreme has delivered superlativeadjusted RoCEs (average 22.3% in FY09-13) in a capital-intensive industry,owing to its strong competitive advantages built through: (a) unmatchedmanufacturing (22 manufacturing plants) and distribution reach, (b)technology tie-ups with renowned international players (Wavin, RPDRasmussen), and (c) diverse products servicing multiple industries. Theseadvantages are helping it gain market share from unorganised players.

Snowball gathering momentum on a solid platform: Supreme hascreated a solid platform (sales of ` 34bn in FY13 vs ` 13bn in FY08) by: (a)consistent modifications in its product portfolio mix to increase VAP share

(31.7% in FY13 vs 22% in FY09), and (b) capacity expansion without puttingstress on the balance sheet. Supreme is well placed to increase its reach andsize in the fast-growing piping and packaging segments through mega capex( ` 12.3bn in FY13-16) funded by internal accruals ( ` 21.2bn in FY13-16).

Strong operating cash flow generation to fund mega capex: RevenueCAGR of 17% in FY13-16 would be due to capacity additions in the piping andpackaging segment. Adjusted RoCEs of ~25% would sustain thanks to thestrong 14% volume CAGR in FY13-16 and stable EBIT margins of ~13%.Operating working capital will deteriorate by 5 days in FY14 due to highersundry creditors. Overall, Supreme will generate CFO of ` 21.2bn in FY13-16(~10% FY14E CFO yield), which would be sufficient to fund its growth plans.

Attractive valuation with limited downside risks, BUY, TP 442: We use

the SOTP method for our target price of ` 442—Plastic business: ` 420 (DCF),implying 16.8X FY14E EPS and 13.7X FY15E EPS; real estate and SupremePetrochem: ` 22. Current valuations at 13.1x FY14E core EPS are notrepresentative of its superior competitive advantages, balance sheet capacityand high return ratios. The stock trades at an unjustified 10% discount to Astral despite its larger size, higher RoEs and better liquidity. Key risks: Entryof large global players and lower-than-expected volume growth.


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Ambit Capital Pvt Ltd 2

CONTENTS

Supreme Industries: Multi-industry plastic processing leader……..……….. 3

Indian plastics sector: Poised for growth……………………………………..… 5

Mapping Supreme’s well-built competitive advantages………………………7

Snowball effect to gain momentum…………………………………………… 15

Mega capex to drive growth with stable RoCEs……………………………… 19

Valuations not reflective of supreme plastic business……………………… 22

Accounting analysis: Clean chit……………………………………………….. 29


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Supreme Industries: Multi-industryplastic processing leader

Exhibit 1: Business overview - multi-industry servicing business segments

FY13

Segments Sub-segments/ Products Application/customers Sales volumes(MT)

Revenueshare

Revenuegrowth

EBITshare

Share of VAP in

segment

Plasticspipingsystem

uPVC Pipes, injection moulded fittings &handmade fittings, polypropylene randomcopolymer pipes & fittings, HDPE and CPVCPipes Systems, LLDPE Tube and InspectionChambers, manholes

Potable water supply,irrigation, drainage andsanitation, housing

180,74652% 29% 52% 24%

Packaging films

Protective packaging products: Non-cross-linked foam packaging, cross-linked PEfoam packaging

Packagingproducts

Cross laminated films

Construction,automobiles and otherindustries for insulationapplications; CLF filmsfor covering purposes inmultiple sectors

41,30721% -2% 27% 53%

Industrial components: Customised plastic

parts for the automobile sector (e.g. cockpitassembly) and the consumer durable sector(plastic body for washing machines)

Auto sector, consumer

durable products, waterpurification

Composite products: Cylinders and pipes(under development)

Casing pipes for oil andgas industry, cylindersfor household use

Industrialproducts

Material handling: Heavy duty industrialcrates, fabrication facility to manufacturecustomised crates, roto moulded items,plastic pallets

Soft drink companies,agriculture and fisheries

40,03318% 12% 14% ~16%

Consumerproducts

Furniture (tested for ergonomic comfort,resilience and environmental resistance)

Retail stores,educational institutions 19,366

9% -3% 7% ~40%

Total 281,452 100% 17% 100% 31.0%

Source: Company, Ambit Capital research, Note: VAP= Value added products.

Technological collaborations across segmentsSupreme Industries does not have its own R&D division to create new products.Hence, it has entered into technological tie-ups with renowned internationalplayers across all product categories at very low royalty and license fees. Throughtechnological collaborations, the company has launched new products whilstkeeping product quality ahead of unorganised players. Supreme would not havecreated products such as Silpaulin and CPVC pipes without technologicalassistance from other players. It is creating a new segment (composite products) with the help of European and South African technology (Lomold) partners.

Exhibit 2: Technology partnerships

Segments Sub-segments/ Products Technology partner/ collaborator

uPVC pipes and fittings, PPRC Pipes & Fittings Wavin Overseas B.V., Netherlands is a subsidiary of Mexichem. It is aleading player in above and below ground pipe systems for hot andcold water applications in Europe.

Plastics pipingsystem

CPVC pipes (currently, a ` 8bn-10bn market)The technology partner is not known but competitors highlightthat it is a European company. Raw material sourced from Kaneka.

Protective packaging (two-stage cross link foam forinsulation purposes)

Sanwa Kako of Japan, the largest makers and patent holders ofpolyethylene block foam in the world.

Packagingproducts

Cross laminated films (cross line bonded film andcross plastics film, the next generation withsuperior properties)

RPD Rasmussen Polymer Development AG, Switzerland, is the patentholder of cross-laminated film. Supreme’s patent is valid until 2023.

Composite LPG cylindersNames not disclosed. Supreme currently has a tie up with aGerman Equipment manufacturer. Apart from this German company,there are two other companies which provide the technology.Industrial

products

Composite drill pipes

Lomold, South Africa is the first company to manufacture plastic

commingled with long glass-fiber into a closed mould in a costeffective way.



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SWOT analysisExhibit 3: SWOT analysis of Supreme Industries

Strengths Weaknesses

Diversified product portfolio across segments such as pipes,packaging and industrial products.

An unmatched distribution and production network—22

manufacturing plants and more than 1,250 dealers acrossIndia, with a strong presence in south and east India.

Market leader in the fast growing PVC pipes segment for

buildings and has a monopoly in cross-laminated films in India.

Technical tie-ups in all segments with reputed international

players.

Higher EBIT margins through focus on value-added products(VAP) such as pipe fittings and its cross laminated film,Silpaulin, (22% in FY09 vs 31.7% in FY13).

Strong balance sheet (FY13 gross debt:equity of 0.5x) vs otherorganised competitors like Jain Irrigation (1.6x) and FinolexIndustries (0.99x).

Our primary checks suggest that Supreme’s products are not

available due to capacity constraints especially in Chennai. Webelieve this is a lost opportunity for Supreme.

PVC pipes of any company are easily replaceable by a competitordue to the standard nature of the product.

The company has to continuously update technology throughinternational collaborations.

The business is capital-intensive and requires continuousreinvestment in gross block.

Opportunities Threats

Organised PVC pipes account for only 50% of the market.Supreme, with a better quality product and a renowned brand,is well placed to capture the structural shift to organisedplayers.

Per capita plastic consumption of India is only 7kg, significantlybelow the global average (of 28kg) especially in the agricultureand infrastructure sector.

Higher plastic pipe demand through PVC (replacement of GI)and better technology pipes such as CPVC

Supreme’s technology tie-ups with global players provides anopportunity to add new products.

Recent entry into composite products especially compositecylinder can be huge opportunity in India and the Middle East.

Increase in competition from international players: For example: theBelgian firm, Aliaxis, acquired a majority stake in the unlisted,

Ashirvad Pipes. Other large international players like TessenderloGroup and JM Eagle may also follow Aliaxis’ example.

Weak monsoon and low GDP growth may affect PVC pipe demandfrom agriculture (30% of total PVC pipe sales for Supreme).

Unavailability of raw material for PVC pipes and CPVC pipes canprobably reduce growth.

Supreme’s competitive advantage would be reduced if competitors

start innovating new products or improve distribution reach.

INR depreciation can increase the product price, thereby reducingdemand.



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Indian plastics sector: Poised for growthPlastics industry: Fastest-growing industry in India

The plastics industry has expanded at a volume CAGR of 9.2% over the last sixyears to reach 8.5mn tonnes by FY12. Plastics can be classified based ascommodity, engineering and specialty products. Commodity products such as

Polyethylene (PE), Polypropylene (PP), and Poly Vinyl Chloride (PVC) account for thebulk of plastic demand. Engineered and specialty plastics are derivatives of styrene which exhibits superior mechanical and thermal properties. Further, plastics canalso be classified on the basis of the manufacturing process (as shown below).

Exhibit 4: FY11 demand break-up of plastics by type

Marketshare

Consumption volume

(mn tonnes)

FY06-11CAGR growth

Polyethylene (PE) 36% 2.8 8%

Polypropylene (PP) 34% 2.6 12%

Poly Vinyl Chloride (PVC) 24% 1.9 10%

Others 6% 0.6 3%

Total 7.9 9.2%

Source: Report of the Sub-group on Petrochemicals

Exhibit 5: Classification of plastics by manufacturingprocess

MouldingMarketshare

Products

Extrusion 68%Films and sheets, fibre and filaments pipes,conduits and profiles, miscellaneousapplications

Injection 25%Industrial injection moulding, householdinjection moulding and thermoware/moulded luggage

Blow 5% Bottles, containers, toys and houseware

Roto 1% Large circular tanks such as water tanks

Source: CIPET

The Department of Chemicals and Petrochemicals, India expects a more than 10%demand CAGR for commodity plastics and 10.7% demand CAGR for PVC pipes inFY12-17. The competitive intensity is very high in the plastic processing industry,due to the existence of more than 23,000 plastic processing units in India. Theindustry is highly fragmented and has a large number of unorganised players. InFY06-11, plastic processing capacity in India increased at a CAGR of 15%. TheDepartment of Chemicals and Petrochemicals expects capacity addition of 8.25mt

by FY17. We believe a large portion of this capacity addition will be fromorganised players which will have better technology and higher applications.

Exhibit 6: Supreme’s key competitors in plastic processing industry

Segment Companies

Plastic piping systemSupreme, Finolex Industries, Jain Irrigation, Astral Polytechnik, Ashirvad Pipes,Prince

Packaging products Supreme, Polyplex, Jindal Poly, Uflex ltd, SKF

Consumer products Supreme, Neelkamal Plastics, National Plastics

Industrial products Supreme, Motherson Sumi, Tata Autocomp, Sintex Industries, Time Technoplast


Key demand drivers for plastic productsLow per capita consumption of plastics in India (7kg vs global average of 28kg),increase in disposable income and urbanisation will lead to higher demand forplastics in healthcare, packaging, consumer durables, automobiles, retail etc.Plastics have several advantages over other competing materials in:

Packaged goods: Consumption of packaged goods is increasing due tolifestyle changes, price advantage of plastic vs competing packaging materialand wide use in segments like drinking water and milk supply.

Construction sector: Plastic PVC pipes are replacing galvanised pipes, as PVC

pipes are easy to install and have a longer life.

Agriculture sector: Use of plastics in agriculture (like surface cover cultivationusing plastic films) can conserve soil moisture and a provide favourable microclimate, leading to improvements in crop yields.


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Auto industry: Replacement of iron and steel parts by relatively lower weightplastics helps to improve fuel efficiency of the automobile.

We expect blue-collar wage growth in rural India to drive demand for entry-levelconsumption products like PVC pipes for housing, plastic furniture etc. The wagesof blue-collar workers have recorded a 15% CAGR in FY10-12 despite GDP growthslowing down by 550bps due to reverse migration, pursuit of education and withdrawal of women from the labour force.

PVC pipes industry: Replacing the traditional metal

Plastic pipes are the second-highest selling plastic product in India. Further, PVCpipes are the largest-selling plastic pipes in the world. PVC pipes have replacedgalvanised steel pipes, as PVC pipes are easy to install and have a longer life.Supreme is a market leader in PVC pipes followed by Finolex Industries. The PVCpipes industry is highly competitive and dominated by unorganised players.Industry participants estimate total PVC pipes demand in India is 1.6mn tonnes.Supreme’s main target segment is the plumbing and sewage sector unlike thegeneral industry.

Growth avenues for Indian plastic piping sector We believe that there is a strong growth potential for plastic pipes in the housingsector due to housing shortage and strong replacement demand for galvanisediron (GI) pipes. In India, there is shortage of 22 million urban units and 54 millionrural units. The penetration of PVC pipes in industrial and sanitation applications islow. Thus, we believe that the plastic piping industry will upgrade to highertechnology, and HDPE, PP-R and PE pipes will be used in underpenetrated sectors.

Continuing shift to PVC from GI; absorption of new technology: In India,galvanised iron (GI) pipes were mainly used for hot and cold water applications inagriculture and construction. However, in the last 15 years, PVC pipes aresubstituting GI pipes because PVC pipes are easy to install, have longer life andare one-fifth the weight of GI pipes at similar costs. We expect this trend ofadopting new plastic pipe technology to continue, such as CPVC pipes in housingand other upcoming new technologies such as HDPE and composite pipes.

The developed countries in Europe have started adopting more advancedtechnologies such as PP-R pipes and HDPE pipes. The advantage of PP-R over PVCpipes is that they are environmentally friendly, as they do not contain chlorine.HDPE pipes have higher tensile strength, and thus they can remain bent for alonger period of time. Also, HDPE pipes unlike PVC pipes do not crack near plasticand steel joints. The next generation of pipes after HDPE pipes is polystyrenepipes. Polystyrene pipes have superior tensile strength than other common plasticpipes. However, their use in India is limited, as they are expensive. The keydemand driver for PVC pipes is superior performance at a lower price as compared

to GI pipes.Higher demand in underpenetrated industrial and sanitation sector: Indiahas adopted PVC pipes at a rapid pace in the housing and agriculture sector (as asubstitution for GI pipes). However, the penetration of plastic pipes is low in thesanitation industry owing to low government spending. Thus, an increase ingovernment spending to improve India’s sanitation could lead to strong demandfor PVC pipes. In the developed European and North American markets, PVC pipesare extensively used in various industries such as chemical processing, textiles,pharmaceutical, paper mills, steel wire plants and battery manufacturing. Thisshows that there is a large untapped opportunity for PVC pipes and newertechnologies in the Indian industrial sector.

If the price differential between PVC pipes and other superior

plastic pipes were to decreasethen demand for newtechnologies would increase

ccording to UNICEF, India’surban sanitation penetration is50% and rural penetration iseven lower at 21%

PVC applications by sector(%)

Water

Supply,

29

Irrigation

, 45

Sewage

, 12

Plumbing

, 10

Others,

1

Flexible

, 4 Water

Supply,

29

Irrigation

, 45

Sewage

, 12

Plumbing

, 10

Others,

1

Flexible

, 4

Source: Finolex Industries


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Mapping Supreme’s well-builtcompetitive advantagesThe plastic processing industry is generally viewed as a commodity industry.However, in our opinion, Supreme Industries has built strong competitive

advantages through an extensive manufacturing and distribution network, creatinga unique feedback loop that allows the company to consistently modify its productsto meet consumer needs. Supreme has consistently increased its plastic pipingproduct portfolio to 5,682 products through an unmatched distribution network which translates into higher-than-industry growth and margins. In cross-laminatedfilms, Supreme has a monopoly by creating a new segment in tarpaulins. In ouropinion, Supreme is an average player in the other two existing segments—Industrial and Consumer products segments.

We have done a competitive mapping of Supreme’s segments namely:(a) Plastic pipe segment—PVC pipes and CPVC pipes

(b) Packaging segment

(c) Industrial segment

(d) Consumer products segment

(e) Composites segment

(a) Plastic pipe: Supreme is the best placed

The PVC pipes industry has consistently recorded 14% sales CAGR in FY06-11especially for housing applications. The penetration of PVC pipes has increaseddue to the replacement of galvanised pipes, urbanisation and growth in theconstruction sector. In our opinion, the industry faces stiff competition fromunorganised players

Exhibit 7: Porter’s five forces analysis for the PVC pipes industry


Bargaining power of suppliers HIGH

The main raw material for PVC pipes isPVC resin which is in shortage in India.PVC prices are positively correlated tocrude prices. So, all PVC pipemanufactures are price takers for PVCresin.

The raw material for CPVC is supplied byonly two companies—Lubrizol andKaneka. The demand for raw materials ishigher than supply, consequently

increasing the bargaining power of CPVCresin suppliers.

Competition HIGH

More than 25,000 plasticpipe processing companies inIndia, leading to stiffcompetition in commodityplastics industry

Organised players are betterplaced than unorganisedplayers in the VAP segmentdue to better product qualityand better brand recognition.

Since VAP demand is high,organised players are notfocusing on market sharegain

Shortage of CPVC pipes inthe market implies that eachplayer has the potential tofully utilize capacity without

worrying about competition.

Barriers to entry MEDIUM

Whilst it may be easy to set up a PVC pipemanufacturing plant, we believe it isdifficult for a new player to set up adistribution network.

In case of CPVC pipes, shortage of rawmaterial is a major entry barrier for anynew entrant.

Bargaining power of buyers

MEDIUM

The company and its peers passthrough raw material costincrease to customers within 2-5days. This highlights strongdemand for PVC pipes and highbargaining power of theindustry.

However, consumers can easilyswitch between companies

(brands), thereby limiting thebargaining power of individualcompanies.

Threat of substitution LOW

Threat of PVC pipe substitutionby other product like galvanisedsteel is low because PVC pipesare easy to install and have alonger life. New technologyproducts will substitute but willtake time

Improving

Unchanged

Deteriorating


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Supreme: Know your plastic pipe competitors

Supreme is a market leader in the highly fragmented PVC pipes industrydominated by unorganised players. Supreme’s closest pan-India competitor isFinolex in the PVC pipes segment and Astral Pipes is the largest competitor in theCPVC pipes segment. Although Jain Irrigation is a large company, it caters largelyto the agricultural segment. We have identified four other important unlisted

players in the PVC pipes industry—Ashirvad Pipes, Ajay Pipes, Nandi Pipes andPrince Pipes.

Exhibit 8: Know your competitors in the plastic piping business segment

CompaniesMcap

(US$mn)

PVC pipe andrelated segment

revenues(

mn)

Pipe volume

sales(MT)

Segment EBITmargin

Brief business description and products

SupremeIndustries

71516,502

(50% of companyrevenues)

180,74516%

Supreme manufactures a number of plastic compound pipes(PPRC, PPR, HDPE, LLDPE). The company has recentlylaunched products like CPVC pipe systems, Nu Drainsystems which are finding increasing acceptance amongstinstitutional buyers (infra, residential developers). Nearly 20-25% of this segment’s sales come from plastic pipe fittings.

Jain Irrigation 40611,300

NAEBIT margin of 8%

for PVC pipe

With a market share of 15%, it is one of the three major PVC

players in the organised market and a leader in the rural water & irrigation markets, but lagging in the building &construction sector. It sells PE pipes in the gas and cable ductsegments and for sewage & effluent disposal. This segment

will be a major beneficiary of infra capex spending. It isdeveloping its CPVC pipe offering.

FinolexIndustries

27313,778


170,0005.2%

Finolex is the largest pan-India competitor of SupremeIndustries. Finolex’s main target segment is the agriculturesector which accounts for 70% of its PVC pipes sales. Finolexhas in-house manufacturing of PVC yet its margins are morethan 900bps below Supreme’s. We believe this is due to twofactors: (1) focus on highly competitive irrigation pipessegment vs fast-growing housing segment and (2) highmargin fittings as a percentage of PVC pipe sales are lessthan 10%, whereas fittings account for more than 20% ofSupreme’s sales. Finolex mainly has a presence in west and

south India.

Astral Poly 2088,254


49,495 12%

One of the fastest-growing pipe companies in India (~44%CAGR over last four years) with the highest realisation. Thecompany manufactures PVC and CPVC pipe systems. Thecompany has increased focus on CPVC pipes (60% of FY13sales) as their margins are better than PVC pipes. Thecompany has a tie-up with Lubrizol for CPVC raw materialsourcing. Astral’s distribution network is mainly in west Indiaand is now building in South India.

Ashirvad Pipes Unlisted 6,759* NA NA

Four-decade-old firm (mainly present in South/West India)manufacturing UPVC, CPVC, SWR pipes/fittings. One of thethree Indian partners of Lubrizol for FlowGuard pipes.Leading player in the Borewell segment (a ` 8bn market).

Aliaxis, a large global plastic pipes company, acquireda majority stake in Ashirvad Pipes for US$150mn in Feb,

2013.

Ajay Pipes Unlisted NA NA 12.5%

Ajay Group is a diversified engineered plastic productsmanufacturer with a presence across refrigeration sealing,

water/irrigation, automotive parts and extruded products. Apart from UPVC pipes, the company also manufacturesCPVC pipe systems using the technology of Lubrizol.

Nandi Pipes Unlisted NA NA NA

Company manufactures PVC, HDPE, UPVC pipes sells acrossirrigation, construction and infra segments. It offers CPVCpipe systems in a technological collaboration with SekusuiChemical Ltd, a Japanese chemical company.

Prince Pipes Unlisted 5,190* NA NA

Prince pipes established in 1973 manufactures uPVC, CPVCpipes and fittings catering to housing, agricultural andinfrastructure clients. Based on our dealer checks, Prince hasa strong presence in western India.

Source: Company, Industry, Ambit Capital research; Note: * FY12 revenues for Ashirvad Pipes and Prince Pipes


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(1) PVC pipes - competitive mapping scorecard

We have built a scorecard to evaluate the competitive positioning of six largeorganised PVC pipe players in India. We have selected five parameters that webelieve are the key to their performance—three-year average RoIC, revenue sizeand growth, financial leverage, product diversity, and distribution network. Basedon our scorecard, Supreme is the best player in the industry followed by

Astral Polytechnik. In our opinion, Jain Irrigation and Prince Pipes are laggards.

Exhibit 9: Supreme best ranked amongst peers (based on Exhibit 10)

3-yearaverage

RoIC

Pipingrevenue sizeand growth

FinancialLeverage

Productdiversity

Distributionnetwork

OverallRank

Supreme 2 1 2 1 1 1

Astral Polytechnik 3 2 1 2 2 2

Finolex 4 3 3 5 4 4

Jain Irrigation 5 5 5 6 5 6

Ashirvad Pipes 1 4 4 4 6 3

Prince Pipes 6 6 6 3 3 5

Source: Company, Ambit Capital research; Note: Rank 1 indicates the best player on each parameter in theindustry whilst rank 6 implies the worst-placed player. We have assigned equal weightages to each of the five parameters.

Exhibit 10: Numbers behind our scorecard

Companyname

3-yearaverage

RoIC

FY13 piperevenue

(

bn)

3-year pipesrevenue

CAGR

FY13 Netdebt/Equity

(x)

Product Linebeyond uPVC

Most importantclient

Pipemanufacturingplants

Distributors

Supreme 23.5 16.9 24.7% 0.44CPVC, PE, PP-Rpipes and fittings

HousingNorth, Centraland West India

700+

Astral 18.0 8.3 41.2% 0.22CPVC pipes andfittings

HousingNorth and WestIndia

400+

Finolex 8.6 13.8 18.4% 0.65 Fittings Agriculture West India 500+

JainIrrigation

8.4 11.3 10.0% 1.48PE pipes and 2fitting products

Agriculture West and SouthIndia

3000+

AshirvadPipes

31.8* 6.7* 39.3%* 0.84* CPVC and fittings Housing South India 4000retailers

Prince Pipes 7.0* 5.2* 16.4%* 2.37*CPVC, PP-R andfittings

Housing andagriculture

West and NorthIndia

Source: Company, Industry, Ambit Capital research; Note: *For the unlisted players, Ashirvad Pipes and Prince Pipes, we have taken only FY12numbers from the Ministry of Corporate Affairs’ website to evaluate financial performance.

Result: Domestic PVC pipe players are not a threat to Supreme

Our competitive mapping report card implies that there is no material threat toSupreme’s market leadership in PVC pipes from domestic players. Finolex isfocusing on the agriculture sector, which accounts for 70% of its PVC pipes sales. Astral Polytechnik is building its distribution reach in the niche CPVC product. Jain

Irrigation is not in direct competition with Supreme Industries as it sells entireirrigation systems wherein PVC pipe is a component. Other organised players likePrince Pipes and Ajay Group are currently too small in size to compete on a pan-India scale.

Now, a large global player with deep pockets like Aliaxis (acquired a majoritystake in Ashirvad Pipes) can be a strong competitor by quickly scaling up itscapacity and distribution reach. We believe that several other large internationalplayers like Huliot plastic pipes and the Tessenderlo Group would like to enter thefast-growing Indian markets. In fact, Huliot conducted a feasibility study to enterthe Indian markets in 2009.

Three-year average Return on Invested Capital: Supreme has the second-highest three-year average RoIC due to efficient capital allocation in fast-growing products. Finolex and Jain Irrigation despite larger turnover thanSupreme have allocated capital in the less-profitable agriculture and micro


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irrigation sector, resulting in lower RoIC. Astral Polytechnik has improved itsRoIC on a small base due to strong demand of CPVC pipes. Ashirvad Pipes hasthe highest RoIC on a small base whereas Prince Pipes is the worst placed.

Piping revenue size and growth: In our opinion, growth on a large basecreates a platform for growth through internal accruals. Our rank is based onthe average of piping revenue size and piping revenue growth. Thus, Supreme with market leadership and second-best growth is ranked 1. Astral has the

highest growth but due to its smaller size, it is ranked 3.

Financial leverage: We believe stronger balance sheet will enable thecompany to expand through capacity expansion and acquisitions. Astral hasthe best net debt:equity (0.22x) whilst Jain Irrigation (net debt:equity of 1.5x)and Price Pipes (net debt/equity of 2.3x) are highly leveraged.

Product diversity: In our opinion, products catering to multiple industriesprovide numerous growth avenues in the fast-penetrating engineered plasticssegment. Fittings account for 20-25% of sales for Supreme vs 35% for Astraland only 10% for Finolex. We rank Supreme as rank 1 because it has a largestproduct portfolio with 5,682 products in the plastic piping segments alone. Also, Supreme has consistently increased its VAP contribution to the plastic

piping segment revenues in the past six years by launching new fittings andPVC pipe products like CPVC, leading to higher-than-peer EBIT margin.Supreme has products for multiple industries such as building, agriculture andinfrastructure.

Exhibit 11: VAP drives plastic piping revenue growth

20

70

120

170

220

FY07 FY08 FY09 FY10 FY11 FY12 FY13

10%

15%

20%

25%

30%

Pipe mtrs sold (metres)

VAP % share in piping revenues (RHS)


Exhibit 12: Fittings growth driven by consistent newlaunches

4,600

4,800

5,000

5,200

5,400

5,600

5,800

FY10 FY11 FY12 FY13

50

75

100

125

150

175

200

Pipe products (nos)

Pipe fittings (mn pcs, RHS)


Distribution network: A strong distribution network allows a company toincrease the penetration of its products. Supreme has 22 manufacturing plantsspread across India whereas other players are concentrated in west and southIndia. As a result, Supreme has developed a strong presence in the less-competitive north and east India markets with minimum delivery time and without additional freight charges.

(2) CPVC: Prime example of Supreme’s product launches strategy

Supreme launched CPVC pipes (used for hot and cold water applications) in 2008, with a modest capacity. The demand for CPVC pipes has recorded a CAGR ofmore than 40% in the last four years. In our opinion, raw material sourcing forCPVC is the main barrier for new entrants, as there are only two manufactures of

CPVC resin in the world—Lubrizol and Kaneka. Supreme has an exclusive tie-up with Kaneka for CPVC resin supply in India. Lubrizol supplies CPVC resin to three

Fast growing CPVC pipes

0

2

4

6

FY11 FY12 FY13

Astral (Rs.bn) Supreme (Rs.bn)

Source: Com an


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Supreme Industries


players in India—Astral, Ajay Pipes and Ashirvad Pipes. Supreme is planning tolaunch CPVC pipes for industrial and fire sprinkler applications and so is Astral.

Comparing Supreme’s cost structure with Astral Polytechnik

Supreme has higher gross margins as compared to Astral Polytechnik becauseSupreme gets cash discount on purchase of PVC resin from domesticmanufacturers and better product mix (high margin Silpaulin and fittings products).

Supreme has higher power and fuel cost due to use of expensive captive power inSouthern states such as Tamil Nadu. Further, Astral has higher advertising costsbecause of its national media advertising v/s low cost local media marketingstrategy of Supreme Industries. Hence, Supreme has higher EBITDA/EBIT margins. Whilst Astral has significantly reduced its net-debt-to-equity in FY13 (0.22x v/s0.85x in FY12) resulting in lower interest costs, Astral’s interest expense as % ofsales are still higher than Supreme. However, Supreme’s PAT margins are similarto Astral due to higher tax expense as Astral got MAT credit entitlement in FY13.

Exhibit 13: Comparison of Supreme cost structure with Astral Polytechnik

FY11 FY12 FY13% of revenues unless otherwise specified

Supreme Astral Supreme Astral Supreme Astral

Net Income ( mn) 24,297 4,113 28,587 5,827 33,880 8,254

Cost of materials consumed 67.0% 71.7% 67.8% 71.7% 67.7% 71.5%

Gross margin 33.0% 28.3% 32.2% 28.3% 32.3% 28.5%

Employee cost 4.0% 2.6% 3.9% 2.6% 3.8% 2.5%

Power and Fuel cost 4.2% 2.4% 4.1% 2.5% 4.1% 2.3%

Freight and Forwarding charges 1.7% 2.5% 1.5% 1.5% 1.4% 1.6%

Commissions and discounts 3.1% 2.7% 1.7% 3.3% 1.3% 2.9%

Advertising and Publicity Expense 0.7% 1.4% 0.7% 1.0% 0.6% 2.0%

Labour charges 2.1% 0.0% 2.2% 0.0% 2.3% 0.0%

Repair Expenses 0.7% 0.7% 0.5% 0.5% 0.5% 0.3%

Other SG&A 2.9% 2.5% 2.7% 2.7% 2.7% 2.9%

EBITDA margin 13.7% 13.4% 14.9% 14.2% 15.5% 14.0%

Depreciation 2.5% 2.6% 2.5% 2.4% 2.4% 2.2%

EBIT margin 11.1% 10.8% 12.4% 11.8% 13.1% 11.8%

Interest Expense 1.8% 1.1% 2.0% 3.9% 1.6% 2.3%

Interest received 0.1% 0.1% 0.1% 0.1% 0.1% 0.0%

Other income 0.2% 0.2% 0.1% 0.5% 0.0% 0.2%

PBT margin 9.6% 10.1% 10.5% 8.6% 11.6% 9.7%

Tax expense 3.3% 2.1% 3.5% 1.8% 3.8% 2.3%

PAT margin 6.3% 8.0% 7.0% 6.8% 7.7% 7.4%


(b) Packaging: Silpaulin created new segment

Supreme Industries has created a new segment in the tarpaulin industry throughits highly successful product, Silpaulin. The company has an exclusive patent withRPD Rasmussen Polymer for selling it in India and SAARC countries until 2023.Supreme got this patent through the merger of group company Siltap Chemicals in2003. We believe Silpaulin’s product placement is perfect between HDPE andNylon.


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Supreme Industries


Exhibit 14: Silpaulin has a unique positioning - high quality and value for money

Nylon

SilpaulinPE films

Cotton

Low Quality

High Price

Low Price

High Quality


Silpaulin is three times cheaper than nylon films, thus limiting competition fromnylon films from price-sensitive buyers. Although Silpaulin is twice as expensive asHDPE films, Silpaulin’s price range for small-ticket buyers like farmers is between ` 150- ` 500, making it highly affordable. Also, Silpaulin has a longer life thanHDPE. Overall, our dealer checks also suggest that Supreme has created a brandfor Silpaulin and the demand is quite strong in India, except in/near Chennai

(c) Industrial: Supreme is an average player

The industrial segment services the auto industry, bottling crates and consumerdurable appliances. Competition in the industrial products segment is intense andfragmented. Supreme has the lowest three-year revenue CAGR amongst peersand its three-year average EBIT margins at 12.7% are above Machino Plastics andPlastiblend but below Time Technoplast. In our opinion, the advantage ofoperating in this segment is sales visibility but the disadvantage is limited pricingpower and client concentration risk. Overall, our analysis suggests that Supremedoes not have a competitive advantage over its peers.

Exhibit 15: Industrial plastic products overview

IndustryImportantClients

% ofsales

Key Competitors

AutoTata Motors,Maruti Suzuki,Piaggio

30%

Motherson Sumi, MachinoPlastics, Sintex Industries,Precision Pipes, TimeTechnoplast

ConsumerDurables

Whirlpool 30% Precision Pipes, Plastiblends

BottlingCrates

Coca Cola,Pepsi

40%Nilkamal, Time Technoplast,Tulsi Extrusions


Exhibit 16: Supreme is an average player in theindustrial segment

0%

5%

10%

15%

20%

25%

30%

Supreme:

Industrial

Machino

Plastics

Time

Technoplast

Plastiblend0%

5%

10%

15%

20%

3 year CAGR sales growth

3 year average EBIT margin (RHS)



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Supreme Industries


(d) Supreme shedding consumer products weight

Over the last decade, Supreme Industries has exited several low-margin consumerplastic products like mats (FY11-12), food serviceware and embossed sheets inFY07. As a result, the revenue contribution of consumer products to overallrevenues has more than halved from 21% in FY04 vs 8.4% in FY13. The plasticfurniture industry has high competition intensity from unorganised players. We

have compared Supreme with Nilkamal (largest plastic furniture manufacturer) toidentify Supreme’s competitive positioning in this segment. Nilkamal, althoughlarger in size, has lower margins than Supreme. Supreme is focusing on VAPproducts for higher margins at the expense of lower topline growth. AlthoughSupreme has increased its VAP share in the consumer segment to 40% vs 31.6%,yet the margins are lower than the overall company margins. This discrepancyhighlights that the standard furniture business is not very profitable.

(e) Composites: High potential, high uncertainty

Supreme will create a new segment in FY15 through composite products such ascomposite cylinders, composite pipes, composite pallet and composite autocomponents. To start off, the company will focus on export of composite cylindersto the Middle East. We believe the market has underestimated the risks involved inthe composite products of Supreme Industries. We agree that composite cylinders(the main focus in Supreme’s composite portfolio) have a large untapped potentialmarket in the Middle East and India. However, it will not be easy for Supreme toenter the composites cylinder market because:

Supreme is a step behind competitors in product development: Supreme

has not yet developed composite cylinders whereas large international playerssuch as Hexagon Composites and Luxfer Gas Cylinders have been sellingcomposite cylinders for more than a decade. Even the local competitor, TimeTechoplast, has access to the composite cylinder product through theacquisition of Kompozit-Praha for US$5.2mn in 2009.

Composite cylinders to be priced more than twice as much as currentsteel LPG cylinders: Supreme’s composite cylinders will be priced around ` 3,000/cylinder. In our opinion, the end consumer will have to bear the extracost of replacing the steel cylinder. Thus, price-sensitive consumers couldpotentially avoid the lightweight advanced composite cylinders.

Composite drill pipes can be used in short radius oil drilling applications.

Their main advantage over steel pipes is that they can remain bent for a longtime without stress fatigue and can be used in multiple drills. However, the useof composite drill pipes has been limited, as they break near the plastic andsteel joints due to stress. We are not very bullish on composite drill pipes dueto limited success of this product in other regions.

In order to account for the risks involved in the composite business, we expectcomposite revenues of only ` 750mn in FY15 vs management guidance of ` 2bn.Further, we have estimated long-term gross block turnover of 1.0x-1.5x forcomposites, significantly below the gross block turnover of Supreme’s other plasticproducts (2.3x-2.5x). In our opinion, EBIT margins will consistently increase from15% in FY15 to 18% in FY17 due to economies of scale.

Exiting competitive consumerproducts

0

5

1015

20

FY10 FY11 FY12 FY13

0%

5%

10%15%

20%

Supreme Sales (Rs. bn)Nilkamal Sales (Rs. bn)Supreme EBIT margin(RHS)Nilkamal EBIT margin(RHS)

Source: Company


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Supreme Industries


Competitive advantages verified through dealerchecks

We conducted dealer checks across India to understand: (1) why customers buySupreme’s products, and (2) the competitive advantage of Supreme in PVC pipes,CPVC pipes and cross-laminated films.

PVC pipes: Supreme has unmatched reach across India

Customers and dealers believe that Supreme has built a moderate brand through a better quality product and hence it charges a marginal premiumto its competitors. The product quality of organised players is better thanunorganised players wherein some sell their products without ISI approval.

A dealer mentioned that customers can compromise on outside drainage pipes

but the customers are not price sensitive for bathroom fittings as theyare visible and used every day. Supreme has the widest range of fittingsproducts and this makes Supreme popular with customers.

There are no supply-side constraints in the PVC pipes market. Also, thePVC pipes of one company can be easily substituted by those of any othercompany, reducing the pricing power of the PVC pipe manufacturer.

The dealer margins are almost the same for each company.

CPVC pipes: Strong demand but capacity constraints

The demand for CPVC pipes is very strong across India. Astral and Supreme

have better quality products than Prince and other unorganised players.

According to the dealers in Mumbai, Supreme’s products are not easilyavailable as compared to those of Prince and Astral. The managementconfirmed that they are not very strong in Mumbai but they have a good

network in the rest of Maharashtra.

The dealers have to pay for Supreme’s products in advance in Chennai,

as there are only two distributors in Chennai.

Silpaulin: Created a unique segment with a strong brand name

Silpaulin has been available in the Indian market for the last 27 years. The

buyers of Silpaulin can be classified into three segments—industries, truckowners and farmers.

Silpaulin is placed between competitive tarpaulin products made from nylon

and HDPE. Silpaulin is sold at about ` 300/kg whereas HDPE is sold at ` 120/kg. Nylon is more than three times more expensive than Silpaulin. Also,Silpaulin’s product life is 2-3 years which is in the middle range of the productlife of nylon (10-15 years) and HDPE (1 year).

It has built a strong brand name in the market due to its value-for-money

product positioning and good product quality.

Competitive edge over peers: Supreme has a presence in all the regions: south, north, east, west andcentral, whilst its competitorsdo not have national reach

Competitive advantage of Silpaulin: Cheaper than nylonand can substitute nylontarpaulin applications; better

quality than HDPE films but Silpaulin is not very expensiveas compared to HDPE


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Supreme Industries


Snowball effect to gain momentum We analysed Supreme’s business performance over the last 15 years and foundthree markedly different phases of evolution. The next phase from hereon will be ahigh-growth phase (on a high revenue base) driven by mega capex plans.

Exhibit 17: Evolution to a great business model – part 1

0

10

20

30

40

50

60

70

80

F Y

9 8

F Y

9 9

F Y

0 0

F Y

0 1

F Y

0 2

F Y

0 3

F Y

0 4

F Y

0 5

F Y

0 6

F Y

0 7

F Y

0 8

F Y

0 9

F Y

1 0

F Y

1 1

F Y

1 2

F Y

1 3

F Y 1

4 E

F Y 1

5 E

F Y 1

6 E

R e v e n u e s ( R s .

b n )

5%

7%

9%

11%

13%

15%

17%

19%Total Revenue

Composites

Consumer

Industrial

Packaging

Plastic Piping

EBIT margin

Phase4: Mega Capex

to drive growth with

stable RoCE

Phase2: Planted seeds for

high growth and RoE

Phase1: First

failed attempt to

improve business

model

Phase3: Bore fruit from

ideal product placement

strategy


Exhibit 18: Evolution to a great business model – part 2

0%

10%

20%

30%

40%

50%

60%

F Y 9 8

F Y 9 9

F Y 0 0

F Y 0 1

F Y 0 2

F Y 0 3

F Y 0 4

F Y 0 5

F Y 0 6

F Y 0 7

F Y 0 8

F Y 0 9

F Y 1 0

F Y 1 1

F Y 1 2

F Y 1 3

F Y 1 4 E

F Y 1 5 E

F Y 1 6 E

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

RoE

(LHS,%)

Capex-

to-CFO

(x) (RHS)

Debt-to-

Equity (x)

(RHS)

Phase3: Bore fruit

from ideal product

placement strategy

Phase4:

MegaCapex to

drive grow th

w ith stable RoE

Phase2: Planted seeds

for high grow th and

RoE

Phase1:

First failed

attempt to

improve


Phase 1 (FY1998-FY2001): First attempt (failed) to improve business model

In FY98, Supreme’s interest cost was 10% of turnover, leading to lower RoE.Hence, the new strategy by the management in FY98 was to achieve pre-taxRoE of 20% by reducing interest costs to 5% of turnover by repaying debt.This was the first signal by the management for improving returns forshareholders. During this period, the management not only restructured thegroup but also reduced capex to repay debt.

Exhibit 19: Restructuring measures during phase 1 to improve RoE

Year Disposal/restructuring loss-making asset/subsidiary

FY2000 Disposed off loss-making Premier Lighting Industries

FY2000 Turnaround of Supreme Vinyl Films Limited from loss-making

FY2001 Closed down Supreme Capital Management

FY2001 Shut down Huntsman Supreme



16/34

Supreme Industries


However, the company failed to deliver on its promises. Supreme’s RoEsdid not improve in FY1998-FY2001. To add to its troubles, Supreme had ahuge capital expenditure in FY01 (2.2x of CFO) which it funded throughborrowings, leading to an increase in the gross debt:equity again to 2.0x inFY2001 from 1.5x in FY2000. At the end of FY2001, the company againtargeted a debt-to-equity ratio of 1.0x by FY04 through consolidation of itsexisting business and sale of idle assets.

Phase 2 (FY01-06): Planted seeds for high growth and RoEs throughdeleveraging and product mix change

Over FY01-04, Supreme Industries reduced its debt by ` 720m through

operating cash flow and cutback on expansion capital expenditure in consumerproducts segment. The company achieved its targeted D/E of 1.0x in FY04.

After deleveraging, Supreme changed its product mix (increased exposure to

cross-laminated films and pipes at the expense of consumer products), whichlaid the foundation for a fourfold jump in the phase 3 post-tax RoE (10.6% inFY06 vs 41.7% in FY12).

In FY03, Supreme Industries merged Siltap Chemicals to get exclusive patent

rights of its future blockbuster product—cross-laminated film. Also, in FY04-06,Supreme had a cumulative capital expenditure of more than ` 1,491mn,mainly to increase the capacity of PVC pipes and fittings, thereby laying thefoundation for a strong revenue CAGR of 19% in phase 3.

Phase 3 (FY07-12): Bore fruits of the ideal product placement strategy

The management’s product placement strategy to avoid competition with

exports and to focus on fast-growing freight-intensive plastic products such asPVC pipes and Silpaulin paid rich dividends in phase 3. The company recordedsales CAGR of 19% in FY06-12.

Their VAP focused product strategy led to improvement in EBIT margins

(782bps during FY06-12) and debt reduction resulted in lower interest costs.

As a result, RoCEs improved from 8.0% in FY06 to 23.4% in FY12.

Strong revenue growth and lower raw material prices due to decline in crude

prices led to 33% EBIT CAGR. This along with an improvement in workingcapital days (31 days in FY12 vs 52 days in FY08) helped the companygenerate a cumulative operating cash flow of ` 11.4bn.

Supreme reduced its gross debt:equity from 1.1x in FY06 to 0.5x in FY12 and

tripled its capital expenditure ( ` 8.1bn in FY07-12 vs ` 2.4bn in FY01-06)through internal accruals.

Phase 4 (FY13-FY16E): Mega capex to drive growth with stable RoCEs

In our opinion, Supreme got its product portfolio right in the previous phase.

Now, we expect Supreme to increase the capacity of its high-demandproducts, such as PVC, CPVC pipes and Silpaulin, through a capex of ` 13.0bnin FY13-16 vs ` 5.9bn in FY09-12. The company plans to increase the PVCpipes capacity from 200,000 tonnes in FY12 to 325,000 tonnes by FY15.

We believe Supreme’s strong EBIT CAGR of 17% in FY12-17 will generate acumulative operating cash flow of ` 20.9bn in FY13-16, which would besufficient to fund its mega capex plans and repay debt of ` 1.0bn by FY16.

Also, during this phase, the company will introduce a new product segment—composite products (such as composite cylinders and composite pipes).Composite products have a huge potential but with business risks.

Overall, we believe the RoCEs, excluding real estate assets, at ~25% and EBITmargins of 13-14% will remain stable in FY13-17 as capex in the existingproducts will supplement revenue growth.


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Supreme Industries


Reaping rewards of efficient capital allocation We believe efficient capital allocation is the crux to building a successful plasticprocessing business. Supreme’s management has thoughtfully designed its productmix over the last 10 years by exiting commodity plastics and increasing its share of VAP (31.7% as on June 2013 vs 22% in FY09). During this period, Supreme hasconsistently increased the capacity of high demand products like plastic pipes and

cross-laminated films without losing balance sheet strength. Supreme is reapingthe benefits of efficient capital allocation in the following two areas:

(1) Expansion of the distribution feedback loop: Supreme has strategicallybuilt 22 manufacturing plants to penetrate all the five regions in India. As a result,Supreme has the most cost-efficient distribution network in the industry. Thecompany has built a successful feedback loop system through distributors tounderstand the customer’s needs and the structural changes in the industry. Thisunique feedback loop has helped Supreme make minor modifications to itsexisting product line without significant additional freight costs. As a result, value-added products (with EBIT margins higher than 17%) constitute 31.7% of totalsales, leading to higher-than-industry-average EBIT margins.

An example of gains from the distribution feedback loop is consistent new

launches in high-margin fittings products. The company plans to launch 30 newfitting products in the next quarter alone. According to the management, fittingproducts account for more than 20% of its plastic piping segment vs 10% for itslargest peer, Finolex Industries. In sync with its product modification strategy,Supreme plans to launch a new CPVC product for industrial applications andnoise-free PVC pipes for high-rise towers.

Exhibit 20: Rising share of VAP in piping andpackaging system led to….

-

5

10

15

20

25

30

35

F Y 0 9

F Y 1 0

F Y 1 1

F Y 1 2

F Y 1 3

Rsbn

10%

20%

30%

40%

Consumer

durables

Industrial

products

Packaging

products

Plastic piping

VAP revenue

share (RHS)


Exhibit 21: … consistently high revenue growth andsteadily increasing RoCE

0%

5%

10%

15%

20%

25%

30%

F Y 0 9

F Y 1 0

F Y 1 1

F Y 1 2

F Y 1 3

0%

5%

10%

15%

20%

25%

30%

EBITmargin(RHS)

RoCE(RHS)

RevenueGrowth


(2) Achievement of an ideal product portfolio: In the last decade, Supremehas moved out of low-margin commodity products such as food serviceware andBOPP film. Supreme shut down its two consumer product manufacturing plants inMalanpur and Daman. On the other hand, the company has pro-activelyincreased its focus on PVC pipes and cross-laminated films (as can be seen fromthe table below). It has launched highly successful products in the piping segmentsuch as CPVC, fittings products, and uPVC pipes. Supreme added its blockbusterproduct—cross-laminated films—through a merger of Siltap Chemicals in 2003.


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Supreme Industries


Exhibit 22: Changes in product/ revenue mix towards piping and packaging systems

Year Plastic Piping System Consumer Products Industrial products Packaging Products

2002(+) Rigid PVC film and BOPPfilm.

2003(+) Cross laminated film, Wide

Width film

2004(+) Polypropylene random Co-polymerpipes and fittings

(-) BOPP Film

2006 (-) Wide width film

2007(-) Food Service ware andembossed sheets

(+) material handlingpallets

2008(+) HDPE Pipe Systems, CPVC Pipesystems

2009(+) uPVC Pipes, LLDPE Tube andInspection Chambers

2012 (+) Manholes (-) Mats

Source: Company, Ambit Capital research, Note: (+): new product addition, (-) product deletion from portfolio

Rewards of efficient capital allocation: Supreme has recorded revenue CAGRof 21% in FY08-13 and its EBIT margins have increased by 820bps in FY08-13. Asa result, Supreme has the highest RoIC amongst the listed plastic pipemanufacturers. RoICs above 25% and efficient working capital management havemeant that Supreme has generated strong operating cash flows which are againreinvested in the business, thereby creating a snowball effect. As a result, Supremehas funded its capacity expansions without stretching its balance sheet.

Exhibit 23: Supreme has the highest RoIC amongstpeers

0

5

10

15

20

25

30

FY10 FY11 FY12 FY13

R o I

C ( % )

Supreme Industries Finolex

Jain Irrigation Astral Polytechnik


Exhibit 24: Supreme achieved 25% sales CAGR inFY09-13 without stretching its balance sheet

-10%

0%

10%

20%30%

40%

50%

60%

FY10 FY11 FY12 FY13

Supreme Industries Finolex

Jain Irrigation Astral Polytechnik



19/34

Supreme Industries


Mega capex to drive growth withstable RoCEs We expect Supreme to increase the capacity of high-demand products such asPVC, CPVC pipes and Silpaulin through a capex of ` 13.0bn in FY13-16 vs ` 5.9bn

in FY09-12. Supreme has already incurred a capex of ` 3.75bn in FY13. Thecompany plans to further increase the PVC pipes capacity to 325,000 tonnes byFY15. We believe that Supreme will generate cumulative operating cash flow of ` 20.9bn, which would be sufficient to fund its mega capex plans and repay debt of ` 1.0bn in FY13-16. Overall, we believe the RoCEs, excluding real estate, ~25%and EBIT margins (between 13% and 14%) will remain stable in FY13-17 as capex will supplement revenue growth.

Exhibit 25: Key assumptions (

mn, unless specified)

Particulars FY12 FY13 FY14E FY15E FY16E Comments

Revenues 29,279 34,040 40,413 48,758 56,288

YoY growth (%) 19% 16% 19% 21% 15%

Plastic Piping Segment 13,148 16,910 20,909 25,872 31,139

YoY growth (%) 25% 29% 24% 24% 20%

Packaging Products 7,146 7,000 8,478 9,787 11,073

YoY growth (%) 24% -2% 21% 15% 13%

Industrial products 5,431 6,070 6,501 7,232 8,504

YoY growth (%) 8% 12% 7% 11% 18%

Consumer products 2,858 2,760 2,985 3,228 3,491

YoY growth (%) 8% -3% 8% 8% 8%

Revenue CAGR of 18% in FY13-16 to be driven by

mega capex plans in plastic piping and packagingproducts segments.

The company plans to increase PVC pipes capacitycumulatively by 47% in the next three years.

Also, Supreme has increased capacity of Silpaulin by40% in FY13.

In our opinion, high-potential composites segment willcontribute only 2% of overall sales in FY16.

Adjusted plastics EBIT 3,532 4,439 5,119 6,096 7,277

Adjusted plastics EBIT margin 12.4% 13.1% 12.8% 12.9% 13.1%

Plastic Piping Segment 13.0% 16.0% 14.7% 14.2% 14.0%

Packaging Products 20.0% 20.0% 20.0% 20.0% 20.0%

Industrial products 13.0% 12.0% 10.0% 11.0% 12.0%

Consumer products 14.0% 12.4% 12.8% 11.5% 11.5%

We expect margins to remain steady at ~13.0% inFY13-16, as increase in the share of the high-margin

piping segment will be offset by a decline in margins inthe consumer and piping segment.

We believe the piping segment’s EBIT margin of 16% inFY13 are unsustainable and will decline to 14.7% inFY14.

Net depreciation 725 817 1,021 1,190 1,366

Net Interest Expense 548 523 452 382 283Net interest expense to decrease due to decrease indebt.

Average interest rate 13.2% 14.5% 11.5% 11.0% 10.5%

PBT before EO 3,474 4,014 4,965 6,751 7,657

Adjusted consolidated PAT 2,107 2,834 3,394 4,108 4,980

Consolidated PAT margin 7.4% 8.4% 8.5% 8.7% 9.0%

Strong 14% volume CAGR in FY13-16 will drive growthin net profit. Lower interest costs will lead to marginalimprovement in margins.

Adjusted plastic business EPS(

.)15.9 20.6 25.0 30.5 37.3

Average Working capital daysexcluding cash & real estate

31 19 24 26 28 We expect working capital cycle days to increase dueto decline in trade payables.

Capital Employed turnoverexcluding real estate

2.76 2.92 2.86 2.83 2.78Capital employed turnover to remain steady as megacapex will be complemented by sales growth.

CFO 3,519 4,046 4,365 6,102 6,448

Capex (762) (3,698) (2,500) (3,250) (3,500)

Free Cash Flow 2,736 561 1,865 2,852 2,948

Net Debt to Equity 0.48 0.44 0.33 0.17 0.09

Strong operating free cash will be sufficient to fundcapex and repay debt, producing surplus cash forreinvestment in business. Hence, net debt to equity willreduce to 0.1x by FY16E.



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Supreme Industries


Financial performance—‘greatness’ depicted

Exhibit 26: Mega capex of 13.0bn in FY13-16 to driverevenue growth, resulting in steady capital turnover

1.5

2.0

2.5

3.0

3.5

4.0

F Y 1 1

F Y 1 2

F Y 1 3

F Y 1 4 E

F Y 1 5 E

F Y 1 6 E

05001,0001,5002,0002,5003,0003,5004,000

Capex (Rsmn, RHS)

Capital employed turnover ex. real estate (x) (LHS)


Exhibit 27: Product portfolio shift towards piping andpackaging segment at the expense of consumers

0

10

20

30

40

50

60

F Y 1 1

F Y 1 2

F Y 1 3

F Y 1 4 E

F Y 1 5 E

F Y 1 6 E

Rsbn

0%

6%

12%

18%

24%

30%

Consumer durables

Industrialproducts

Packagingproducts

Plastic pipingsystems

Total salesgrowth (RHS)


Exhibit 28: We expect 17% revenue CAGR in FY13-16 atsteady EBIT margins of ~13%

6%

12%

18%

24%

F Y 1 1

F Y 1 2

F Y 1 3

F Y 1 4 E

F Y 1 5 E

F Y 1 6 E

6%8%

10%

12%

14%

16%

18%

Revenue growth EBITDA margin(RHS)

EBIT margin (RHS)


Exhibit 29: Rising share of EBITDA from the Piping andPackaging products segment

0

1,000

2,0003,000

4,000

5,000

6,000

7,000

8,000

9,000

F Y 1 1

F Y 1 2

F Y 1 3

F Y 1 4 E

F Y 1 5 E

F Y 1 6 E

Rsmn

13%

14%

15%

16%

Consumer durables

Industrialproducts

Packagingproducts

Plastic PipingSystems

Total EBITmargin(RHS)


Exhibit 30: High growth on a large base will lowerfinancial gearing

10

12

14

16

18

20

FY11 FY12 FY13 FY14E FY15E FY16E

-

0.2

0.4

0.6

0.8

1.0

Working capital turnover excl. real estate (X) (LHS)

D/E (x) (RHS)


Exhibit 31: High RoCEs leading to sufficient CFO to fundcapex and repay debt

(1)

-

1

2

3

4

FY11 FY12 FY13 FY14E FY15E FY16E

0%

10%

20%

30%

40%

CFO (Rsbn) FCF (Rsbn)

RoCE (RHS) RoE (RHS)



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Supreme Industries


Ambit vs Consensus

Exhibit 32: Ambit vs consensus estimates

Consensus Ambit Divergence Comments

Revenue (

mn)

FY2014 40,842 40,413 -1.1%

FY2015 47,837 48,758 1.9%

Our FY14 revenue estimates are in line withconsensus and management guidance of 19%

YoY revenue growth

Reported EBIT (

mn)

FY2014 5,081 5,387 6.0%

FY2015 6,117 7,101 16.1%

Our EBIT margin forecasts are higher thanconsensus estimates because we assume anincrease in the percentage of high-marginSilpaulin and CPVC pipes to overall EBIT.

Reported Cons. EPS (

)

FY2014 26.5 28.1 6.2%

FY2015 31.3 37.7 20.4%

Above consensus mainly due to higher EBITestimates

Source: Company, Bloomberg, Ambit Capital research

Quarterly performance

Exhibit 33: Quarterly performance of the company (

mn, unless specified)

1QFY12 2QFY12 3QFY12 4QFY12 1QFY13 2QFY13 3QFY13 4QFY13

Volumes sold (tonnes)

Plastic piping segment 26,290 41,067 39,948 43,959 36,972 40,935 47,500 54,105

Packaging products 8,481 9,979 9,557 9,360 9,572 10,417 11,117 9,635

Industrial products 7,949 8,870 11,589 9,917 9,487 10,373 10,952 11,346

Consumer products 4,041 4,778 4,890 5,025 3,981 4,862 4,947 4,944

Net realisation per kg (

) 100 109 114 133 101 120 120 127

Net Sales 5,012 7,697 7,685 9,263 6,176 8,150 9,177 10,362

YoY growth (%) 6% 32% 16% 24% 23% 6% 19% 12%

Total operating expenditure 4,301 6,494 6,637 7,507 5,329 6,956 7,833 8,644

% of net sales 86% 84% 86% 81% 86% 85% 85% 83%

EBITDA 711 1,203 1,048 1,756 848 1,194 1,344 1,718

YoY growth (%) -9% 48% 25% 54% 19% -1% 28% -2%

EBITDA margin (%) 14.2 15.6 13.6 19.0 13.7 14.7 14.6 16.6

Depreciation 172 171 172 211 186 190 197 291

EBIT 549 1,044 880 1,549 663 1,004 1,147 1,454

EBIT margin 11.1% 13.7% 11.6% 16.9% 10.9% 12.5% 12.7% 14.3%

YoY growth (%) -18% 57% 31% 56% 21% -4% 30% -6%

Interest 133 142 152 121 115 138 137 147

Profit before tax 416 902 728 1,428 548 866 1,010 1,335

YoY growth (%) -31% 61% 34% 65% 32% -4% 39% -7%

Tax 138 288 235 490 178 283 330 413

Adjusted net profit 326 593 548 950 390 664 758 995

YoY growth (%) -29% 43% 13% 58% 20% 12% 38% 5%

Net profit margin (%) 6.5 7.7 7.1 10.3 6.3 8.1 8.3 9.6

EPS 2.6 4.7 4.3 7.5 3.1 5.2 6.0 7.8

Source: Company


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Supreme Industries


Valuations not reflective of supremeplastics business We have used SOTP valuation for Supreme Industries—DCF valuation for theplastic processing business, market value of the real estate assets and current

trading share price of Supreme Petrochem, resulting in a target price of ` 442 forSupreme Industries. We prefer a DCF-based valuation for Supreme’s plasticbusiness, because we believe that this is the best way to value a company that iscapital-intensive and on a high-growth trajectory. Our DCF-based valuation of ` 420 for the plastic processing business implies 16.8x FY14E EPS and 13.7x FY15EEPS (adjusted EPS for the plastics business). Supreme deserves premium valuationsto its peers due to its superior revenue growth and profitability ratios.

Exhibit 34: SOTP valuation per share (

, unless specified)

Segment Equity value per share

Plastic Processing 420

Real Estate 13

Supreme Petrochem 9

Supreme Industries Target Price 442

Current Share Price 348

Upside Potential 27%

Implied Plastic processing business FY14E P/E 16.8

Implied Plastic processing business FY15E P/E 13.7

Implied Plastic processing business FY14E EV ( ` mn) 55,807

Implied Plastic processing business FY15E EV ( ` mn) 62,270

Implied Plastic processing business FY14E EV/EBITDA 9.1

Implied Plastic processing business FY15E EV/EBITDA 8.5

Source: Company, Ambit Capital research, Bloomberg

DCF-based valuation of 420/share

We believe that DCF is the best method to value plastic processing companies,because the key value drivers will be free cash flows based on revenue growth,profitability (RoIC and EBIT), working capital turnover and capital employedturnover. Our DCF-based valuation drivers/determinants are as follows:

Snowball effect from increasing revenue size: As mentioned earlier,Supreme’s perfect product portfolio positioning in the last five years created asnowball effect for operating cash flow generation. We expect Supreme’s snowballto gain momentum over the next five years (FY13-16), generating operating cash

flow of ` 20.9bn, which would be sufficient to fund capital expenditure and repaydebt. The key determinants of our FCF are:

a) Near-term and long-term revenue growth estimates: Our 18% revenueCAGR forecasts for FY13-16 are based on capacity expansion done bySupreme in high-demand PVC pipes and Silpaulin. We believe main growthdriver of 14% volume CAGR in FY13-16 would be increasing penetration ofengineered plastic products as Supreme has moderate pricing power (4% priceincrease CAGR in FY13-16) in its existing products. After FY16, our revenuegrowth assumptions are more moderate than FY13-16, because we expectgrowth to taper off to ~10% for its existing product portfolio. Our five-yearrevenue CAGR over FY12-17E is at 17% vs 11% over the next five years (FY17-22E). Our ten-year revenue CAGR over FY12-22E is at 13%.


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Supreme Industries


Exhibit 35: Capacity expansion in PVC pipes andSilpaulin will drive revenue growth…

0

10

20

30

40

50

60

F Y 1 1

F Y 1 2

F Y 1 3

F Y 1 4 E

F Y 1 5 E

F Y 1 6 E

Rsbn

0%

6%

12%

18%

24%

30%

Consumer durables

Industrialproducts

Packagingproducts


Total salesgrowth (RHS)


Exhibit 36: ..leading to higher contribution of plasticpiping and packaging products in total revenue

46% 52%54% 56% 57%

25% 21%22% 21% 20%

19% 19% 17%16% 16%

10% 8% 8% 7% 6%

0%

20%

40%

60%

80%

100%

F Y 1 2

F Y 1 3

F Y 1 4 E

F Y 1 5 E

F Y 1 6 E

Consumer durables

Industrialproducts

Packagingproducts



b)

EBIT margins to be range bound: We expect a marginal decline in EBITmargins in the industrial products and piping segment because pipingsegment’s FY13 EBIT margins of 16% are unsustainable. Overall, EBIT margins will remain steady at ~13% in FY13-16.

Exhibit 37: Total EBIT margin will marginally increasefrom higher proportion of piping, packaging products

0

1,000

2,000

3,000

4,000

5,0006,000

7,000

8,000

9,000

F Y 1 1

F Y 1 2

F Y 1 3

F Y 1 4 E

F Y 1 5 E

F Y 1 6 E

Rsmn

13%

14%

15%

16%

Consumer durables

Industrialproducts

Packagingproducts

Plastic PipingSystems

Total EBITmargin(RHS)


Exhibit 38: Segmental EBIT margins to remain steady

5%

10%

15%

20%

25%

F Y 1 0

F Y 1 1

F Y 1 2

F Y 1 3

F Y 1 4 E

F Y 1 5 E

F Y 1 6 E

Plastic Piping Systems Packaging products

Industrial products Consumer durables


c)

Operating cash flows: Supreme had an efficient working capital cycle,excluding real estate, of 19 days in FY13 due to an increase in sundry creditordays (68 days in FY13 vs 45 days in FY12). We believe FY13 sundry creditorsdays will decrease due to the current liquidity crunch market, leading to anincrease in working capital days (excluding cash and real estate) to 24 days inFY14.

d) Mega capex plans to increase size: Supreme has increased its capacity bymore than 40% in Silpaulin and PVC pipes in the last two years which will drivesales. Also, Supreme is investing to add high-potential new products incomposite plastics like composite cylinder. Overall, Supreme will incur a megacapex of ` 13.0bn in FY13-16.


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Supreme Industries


Terminal growth rate of 5%: We have taken a terminal growth rate of 5% forthe company post FY24 which is conservative in our opinion. Supreme’s revenueshave never declined on a YoY basis in the last 30 years and we do not think plasticpenetration will reach a level that will pull Supreme’s growth lower to 5%.

WACC of 14%: We assume Cost of Equity of 15% and take a WACC of 14%. Webelieve Supreme’s beta is understated due to lower liquidity. Hence, we haveassumed beta of 1.25x for Supreme.

Our 12-month DCF-based valuation of ` 420/share valuation implies 16.8x FY14adjusted plastics EPS and 13.7x FY15 adjusted plastics EPS.

Exhibit 39: FCF over FY14-24E

0

400

800

1,200

1,600

2,000

2,400

2,800

F Y 1 4 E

F Y 1 5 E

F Y 1 6 E

F Y 1 7 E

F Y 1 8 E

F Y 1 9 E

F Y 2 0 E

F Y 2 1 E

F Y 2 2 E

F Y 2 3 E

F Y 2 4 E

(Rs mn)

5%

10%

15%

20%

25%

30%

PV of FCFF WACC (RHS)RoCE excluding real estate (post tax) (RHS)


Exhibit 40: Terminal value forms 67% of the enterprise value

Particulars mn

PV of the forecasting period up to FY24E 22,900

Terminal value 32,907

Enterprise value 55,807

Less: net debt at June 2014 2,505

Implied equity value 53,302

Implied equity value (

per share) 420


Exhibit 41: Sensitivity to our WACC and terminal growth rate

Terminal growth rate

TP: 420 3.0% 4.0% 5.0% 6.0% 7.0%12% 484 525 578 648 747

13% 420 450 488 537 602

14% 368 391 420 455 500

15% 326 344 365 391 424

WACC

16% 291 305 321 341 365


Exhibit 42: Sensitivity to average capital employed turnover of plastic business

Average plastic business capital employed turnover Target Price

FY12 FY13 FY14E FY15E FY16E

Base 2.34 2.38 2.31 2.34 2.35 420

Bull 2.34 2.38 2.38 2.53 2.63 468

Bear 2.34 2.38 2.25 2.18 2.12 372


Commercial real estate - contributes only 3% to our target price: Supremehas ready-to-occupy commercial real estate space of 161,241 square feet in Andheri, Mumbai, with a value of ` 2.4bn. The property was developed in FY12 butdue to sluggish demand in commercial real estate, more than half of the area isunsold. Supreme is not in a cash-crunch situation and hence it has held on to itsprice of ` 15,000/sq ft. We have estimated that Supreme will be able to sell this byFY16.


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Supreme Industries


Supreme Petrochem - contributes only 2% to our target price: SupremeIndustries has a 30% stake in Supreme Petrochem. Supreme Petrochem is thedomestic market leader (with a market share in excess of 50%) in the polystyrenebusiness. It also exports to multiple countries in Europe and the Middle East. InIndia, 90% of polystyrene manufactured is used in consumer durable appliancessuch as refrigerators and water purifiers. The remaining 10% polystyrenemanufactured is used in the construction industry. Supreme Petrochem is a small

company with a market cap of ` 5.7bn and annual turnover of ` 22.7bn. Its netprofit for FY12 was ` 0.3bn. We apply a 30% holding company discount to market value of Supreme Petrochem, resulting in an additional contribution of ` 9/share(only 3% of Supreme Industries’ current market price).

Supreme deserves premium valuations to peers

Supreme is trading at 27%/23% premium to its plastic processing peers on FY14EP/E and FY14E EV/EBITDA. We believe Supreme deserves premium valuations toits peers due to the superior RoE and better EBITDA margins. We expect Supremeto record 18% revenue CAGR in FY13-15 vs 14% (consensus) for the industry.

Supreme’s adjusted PAT margins are 280bps above the industry average. As aresult, we expect Supreme’s adjusted RoE to be 34.5% in FY14, twice the industryaverage. Supreme’s direct peer in PVC pipes for the construction and buildingsector is Astral Polytechnik. Supreme is trading at a 10% discount to AstralPolytechnik on FY14E P/E and on FY14E EV/EBITDA. In our opinion, Supremedeserves a premium to Astral due to Supreme’s larger pipes business, multiplebusiness segments, larger balance sheet and higher RoEs.

Exhibit 43: Plastic processing relative valuation - Supreme deserves a premium due to its higher profitability

McapRevenue(US$mn)

RevenueCAGR

EBITDAmargin (%)

PAT margin(%)

RoE (%) P/E (x) EV/EBITDA (x)Companies

US$ mn FY13 FY13-15 FY14 FY14 FY14 FY14E FY15E FY14E FY15E

Supreme Ind* 719 627 18.0 15.3 8.4 34.3 13.1 10.7 7.5 5.6Motherson Sumi 2,258 4,655 14.6 8.4 2.8 30.4 17.0 12.9 7.5 6.1

Jain Irrigation 394 904 14.0 15.6 4.3 10.4 10.7 7.3 6.4 5.6

Sintex 122 934 9.2 15.1 6.8 9.9 2.3 2.0 4.0 3.5

Time Technoplast 121 331 17.7 16.3 6.1 13.7 5.9 4.7 4.1 3.6

Finolex Ind 237 391 9.5 10.7 7.8 22.0 18.6 14.6 7.8 6.9

Astral Polytechnik 202 152 18.3 12.9 8.8 25.7 14.5 11.9 10.3 8.4

Nilkamal 24 313 14.4 8.4 2.7 10.7 2.9 2.1 3.0 2.5

India Average 12.5 5.6 17.5 10.3 7.9 6.1 5.2

Global Players**

Aliaxis 1,342 3,057 N.A. N.A. N.A. N.A. N.A. N.A. N.A. N.A.

Tessenderlo Chemicals 881 2,738 (2.1) 9.8 2.9 14.3 13.4 11.1 5.8 5.1

China Liansu 1,848 1,726 14.8 17.9 11.7 21.5 8.6 7.6 4.7 4.2

Global Average 13.8 7.3 17.9 11.0 9.4 5.2 4.7

Source: Company, Bloomberg, Ambit Capital research; Note (a) * June-ending companies, rest are March-ending, (b) Market cap is as on 14 August 2013, (c) ** Global players are December-ending (d) We have used adjusted the financial performance of plastics of Supreme Industries to comparewith its peers.


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Supreme Industries


Relative valuation: Let’s think out of the (plastic)box

We have tried to think out of the plastic box to identify Supreme’s peers inindustries which have similar characteristics. We have selected five key plasticprocessing characteristics to identify Supreme’s peers in other industries:

Industry structure: The highly competitive and fragmented industry structureis the underlying reason behind Supreme’s limited pricing power.

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Ambit SupremeInd Initiation 16Aug2013

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