Accumulate Essel Propack – 3QFY2011 Result Update - Angel Broking

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Essel Propack – 3QFY2011 Result Update

Angel Broking recommends an Accumulate on Essel Propack with a Target Price of Rs. 58.

Essel Propack’s (EPP) 3QFY2011 results were below our expectations primarily

due to the lower EBITDA margin, which was impacted by the increase in raw

material costs, other expenses and higher tax rate. Overall however, EPP

continued to be profitable on the back of its robust re-structuring plan. We

recommend an Accumulate on the stock.

Profitable performance continues: EPP‘s core packaging business recorded strong

growth across regions. The AMESA region, primarily comprising India, recorded

robust growth of 23%, while the Americas business grew by 23%. However, EAP

(mainly China) posted growth of 14% to `76cr, while the key loss-making Europe

region posted growth of 3% only.

Europe widens loss: Most of the regions remained profitable. The key loss-making

European region, which had managed to curtail losses by 85% from peak loss of

`35cr in 3QCY2008 to `4crin 1QFY2011 and 2QFY2011, saw losses increasing

to `11cr in 3QCY2011.

Outlook and Valuation: We have revised downwards our FY2011 and FY2012

estimates to reflect the poor performance of 3QFY2011. At current levels, the

stock trades at 0.8x FY2012E EV/Sales and 0.9x FY2012E P/BV. We expect EPP to

ramp up operations going ahead. Hence, we recommend an Accumulate on the

stock, with a revised Target Price of `58 (`75).

Growth across geographies - Revenue below estimate

For 3QFY2011, EPP reported total revenues (excluding the medical business) of

`364.9cr in 3QFY2011 as against `306.2cr in 4QFY2010. EPP‘s core packaging

business witnessed strong growth across regions. The AMESA region primarily

comprising India recorded robust growth of 23.2%, while Americas grew 23.4%.

EAP (mainly China) registered growth of 14.2% during the quarter. However,

Europe grew by a mere 3.3% to `30cr due to lower utilisation levels on account of

holidays and disruptive weather conditions.

Cost-cutting measures restrict margin erosion

EPP’s (core packaging business) gross margins declined by 229bp to 51.7% from

53.9% in 4QFY2010, mainly on account of the rise in key raw material (like

polymer and polyester) prices during the quarter. The company also had to resort

to outsourcing as demand from India and China outstripped supply, which also

contributed to the increase in raw material costs.

OPM continued to be in the 16-18% band increasing by 20bp to 16.5% during the

quarter (compared to the lows of 7% and 4% hit in 3QCY2008 and 4QCY2008).

The cost-cutting initiatives undertaken by the company during the quarter at its

various manufacturing units arrested the decline in margins.

Europe has been biggest contributor to overall improvement in profitability of EPP,

as it reduced losses on a quarterly basis. However, during 3QFY2011, Europe

increased its losses to `11cr from 10cr in 4QFY2010 and `4cr in 2QFY2011.

Focused on improving profitability

The company is currently consolidating its operations wherein it is increasing focus

on the high-margin business of plasti-tubes. Hence, although the company may

report muted sales growth going ahead, the same will be compensated by better

profitability and earnings.

Investment arguments

Global leader, substantial market share to help garner more business: EPP is a

global leader in the tubes packaging business, with an estimated current market

share of 32%. Around 38% of the market is controlled by small regional players.

As economic recovery gets underway, further consolidation cannot be ruled out.

New business offers good opportunity: EPP is present in specialty packaging,

offering a solution to the food processing industry, which is recession-proof in

nature. Specialty packaging is a high-need requirement of consumers.

The domestic food processing industry is still at a nascent stage, but it is fast

gaining momentum. The market size of this segment is huge and offers the

company a chance to diversify its existing revenue mix, which is heavily dominated

by lamitubes.

Stabilisation in operations at subsidiary level: In CY2008, EPP posted losses on a

consolidated basis, due to deterioration in the performance of its key subsidiaries.

This was on account of the drying-up of orders, shifting of operations by one of the

company's key clients and teething problems at the new plant. We believe EPP has

been able to tackle most of the problems at its various plants and its operations

are now stable and profitable.

Outlook and valuation

We have revised our estimates downwards to reflect the poor 3QFY2011

performance.

EPP’s European operations increased its losses to `11cr in 3QFY2011, as against

`4cr in 2QFY2011, an increase of 170%. However, we expect the EU operations to

turn profitable by the end of 4QFY2011. EPP’s revenue mix is currently dominated

by lamitubes. However, this is set to change as the company has been aggressively

adding new customers from the cosmetic and pharma sectors, which consume the

higher-margin plasti tubes.

At current levels, the stock is trading at 0.8x FY2012E EV/Sales and 0.9x FY2012E

P/BV. We recommend an Accumulate on the stock, with a revised Target Price of

`58 (`75).