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Sintex (SINT)
Others
Increasing competition likely to erode margins. We expect a spurt in competition in
the market for monolithic and pre-fab construction to make it difficult for Sintex to
sustain its EBITDA margins. We are therefore cutting our margin estimates for both
businesses. We are also concerned about the declining capital efficiency of the business.
We prune estimates and downgrade the stock to SELL with a target price of Rs140 (10X
FY2012E EPS; fully diluted).
Monolithic construction – name is fancy but it is plain simple construction – problems lie ahead
We believe the company’s EBITDA margins at 18% are unsustainable on account of:
` Rising competition. Construction companies (like Ahluwalia Contracts, B.L Kashyap etc) which
bid against Sintex in the low cost housing contracts, work at EBITDA margins of ~10% (or
lower) in their business. In the absence of a significant competitive advantage, the margins in
this business could decline to as little as 10-12%.
` Entry barriers in the business by way of technology are very low. Every construction company in
India, from the smallest to the largest, would have experience executing projects using
monolithic construction techniques but with different formworks (wood, steel etc). So, from
pre-qualification criteria, every company would qualify for these projects on technical
parameters. The biggest evidence of this comes from the fact that Sintex uses a small local
contractor to execute the projects on the ground. The main advantage of monolithic
construction is that one can use unskilled labor as the level of skill required is lower than for
other construction projects.
` Aluminum/Plastic formwork availability has been increasing in India in the past 2-3 years. Any
company can import Aluminum/Plastic formwork with a lead time of two months. Also, three
companies (Nagarjuna, Mascon, Peri) have set up plants to manufacture Aluminum formwork in
India. Competition is growing in the low-cost housing segment with the increasing availability
of formwork in India. This is likely to shrink the price advantage Sintex enjoys in monolithic
construction.
We have always built declining EBITDA margins in our earning model. We used to model a 100
bps decline in EBITDA margins in FY2012E and FY2013E, from 18% levels in FY2011E. Based
on our current understanding, we believe the decline in margins could be much sharper.
Accordingly, we are building EBITDA margins at 18%, 16% and 14% in the monolithic
business in FY2011E, FY2012E and FY2013E, respectively.
We see similar risks in the pre-fabricated business
We see similar risks unfolding in the pre-fab business as:
1) In our opinion, a pre-fabricated structure is a low value-added product with very
low entry barriers by way of capital costs or manufacturing technology. We
encourage investors to visit the following link to gain an understanding of the very
competitive dynamics in this business.
Most of the companies competing in the segment appear to be SMEs, which could
lead to a fragmented market in the future and hence, lower margins.
2) As per our interaction, with the management of Sintex, it requires a total capital of
Rs500 mn (including land) to set up a plant for manufacturing of pre-fabricated
structures, which can generate a turnover of Rs2-2.5 bn. If one were to assume
EBIDTA margins of ~20% in this business, the payback period would range
between 2-3 years. Such a high return on invested capital is clearly unsustainable in
our opinion.
Accordingly, are building a declining margin (EBITDA) profile in this business going forward.
We are estimating EBITDA margins at 20.7%, 18.9%, and 17% for FY2011E, FY2012E and
FY2013E, respectively
. Margins in pre-fabs not sustainable; payback period for the capital investment is only 2-3
years
Economics of the pre-fab business, (Rs mn)
Capital required (incl. land) (a) 500
Working capital 1,000
Debt/Equity 70/30
Total debt required (incl working capital) 1,350
Tunover 2,200
EBITDA margin (%) 20
EBITDA (Rs mn) 440
Interest payment (at 11% interest rate) 149
Depreciation (at 5%) 25
PBT 267
Tax (at 33%) 88
PAT 179
Annual cash accretion (b) 204
Payback period (a)/(b) 2.5
Source: Company, Kotak Institutional Equities
Structural headwinds in the two businesses = low earning growth for the
company
The high growth in earnings being projected by the Street assumes margins in both these
businesses will sustain at current high levels till FY2013E. We believe the street is ignoring
the fact that very low entry barriers in these businesses could lead to a lot lower margins
than being projected right now.
Both businesses account for bulk of the earnings growth. If the scenario we project unfolds,
it would mean earnings growth of only 10% pa at the consolidated level for the next two
years.
Returns on incremental capital deployed are very low
In Exhibit 4, we have presented a few of the balance sheet and P&L items to evaluate the
efficiency of incremental capital deployed into the business by the company from FY2008-10.
In FY2008-10, the company increased its average gross block by Rs6.7 bn and the working
capital by Rs5 bn; which means the company deployed a total of Rs11.9 bn of capital into
the standalone business. The increase in sales and EBITDA in the same duration was Rs3.2
bn and Rs350 mn, respectively. This means that the return on incremental capital deployed
is, effectively, zero (adjusting for incremental depreciation of Rs320 mn) for the period under
consideration.
The numbers presented above point to the extremely poor allocation of incremental capital
by the company.
Also, while evaluating the increase in gross block, one needs to look at the sales number
excluding monolithic revenues as the monolithic business does not require much capital for
fixed assets though the requirement for working capital is high. On this metric, against an
increase of Rs6.7 bn in the gross block, sales (excluding the monolithic business) have
actually decreased by Rs1.88 bn.
Some investors might say that a comparison of FY2010 closing gross block with that of
FY2008 is not valid as the incremental capacity set up would have been used in FY2011E. In
our defense we offer two points:
` The incremental investment into fixed assets was only Rs940 mn in FY2010. So, even if
one takes the above view the capital deployed would decrease by only ~Rs1 bn which
doesn’t make the situation look any better.
` Also, if one annualizes the nine month SA sales of the company in FY2011E, we get a
number of Rs23.7 bn of sales and Rs4.76bn of EBITDA in FY2011E. We are assuming
incremental investment in to working capital in FY2011E at Rs1 bn (actual would be
more). On these metrics, against an investment of Rs12.90 bn (capex + working capital),
the increase in sales and EBITDA in FY2008-FY2011E would be Rs7 bn and Rs1.33 bn,
respectively, which also doesn’t project an encouraging picture. After adjusting for
depreciation expense of Rs350 mn (5% of incremental capex) and tax expense of ~Rs220
(tax rate at 22%), the return on incremental capital deployed is ~6%, which is suboptimal.
FCCBS are unlikely to be converted in to equity; not a near-term concern
In our opinion, FCCB of USD 225 mn is unlikely to be converted into equity as the stock
needs to appreciate by 150% in the next two years for conversion. The maturity date is
March 13, 2013. We don’t consider the issue of non-conversion of FCCBs as that big an
issue as the company has cash (at least as of now) to pay off the redemption amount. Still,
we thought we will bring it to the attention of the investors.
FCCBs are unlikely to be converted in to equity
Details of Sintex's FCCB, (Rs mn)
Face value (US $mn) 225
INR/US $ 45
Face value(Rs mn) 10,125
Premium on redemption (Rs mn) 2,630
Total redemtion amount (Rs mn) 12,755
No of shares on conversion (mn) 37
Conversion price (Rs) 345
Impact cost (%) 10
Conversion price inc impact cost (Rs) 379
Source: Company, Kotak Institutional Equities
We are reducing our earning estimates and valuation multiples
We have been valuing Sintex at 12X FY2012E PAT, which is in line with the average
multiples at which the stock has traded from March 2005. We think there is a case for using
lower multiples to value the company given the deteriorating return profile on incremental
capital deployed and the likely downside risk to margins in the monolithic and pre-fab
segment.
Accordingly, we are reducing the P/E multiple to 10X from 12X. Also, as explained before
we are reducing our earning estimates to factor in margin deterioration in monolithic and
pre-fab business.
We are downgrading the stock to SELL with a target price of Rs140 based on 10X FY2012E
EPS. We use fully diluted equity capital (310 mn O/S shares) to compute EPS for the purpose
of valuation. Our earning estimates are ~18% below consensus for FY2012E and FY2013E.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Sintex (SINT)
Others
Increasing competition likely to erode margins. We expect a spurt in competition in
the market for monolithic and pre-fab construction to make it difficult for Sintex to
sustain its EBITDA margins. We are therefore cutting our margin estimates for both
businesses. We are also concerned about the declining capital efficiency of the business.
We prune estimates and downgrade the stock to SELL with a target price of Rs140 (10X
FY2012E EPS; fully diluted).
Monolithic construction – name is fancy but it is plain simple construction – problems lie ahead
We believe the company’s EBITDA margins at 18% are unsustainable on account of:
` Rising competition. Construction companies (like Ahluwalia Contracts, B.L Kashyap etc) which
bid against Sintex in the low cost housing contracts, work at EBITDA margins of ~10% (or
lower) in their business. In the absence of a significant competitive advantage, the margins in
this business could decline to as little as 10-12%.
` Entry barriers in the business by way of technology are very low. Every construction company in
India, from the smallest to the largest, would have experience executing projects using
monolithic construction techniques but with different formworks (wood, steel etc). So, from
pre-qualification criteria, every company would qualify for these projects on technical
parameters. The biggest evidence of this comes from the fact that Sintex uses a small local
contractor to execute the projects on the ground. The main advantage of monolithic
construction is that one can use unskilled labor as the level of skill required is lower than for
other construction projects.
` Aluminum/Plastic formwork availability has been increasing in India in the past 2-3 years. Any
company can import Aluminum/Plastic formwork with a lead time of two months. Also, three
companies (Nagarjuna, Mascon, Peri) have set up plants to manufacture Aluminum formwork in
India. Competition is growing in the low-cost housing segment with the increasing availability
of formwork in India. This is likely to shrink the price advantage Sintex enjoys in monolithic
construction.
We have always built declining EBITDA margins in our earning model. We used to model a 100
bps decline in EBITDA margins in FY2012E and FY2013E, from 18% levels in FY2011E. Based
on our current understanding, we believe the decline in margins could be much sharper.
Accordingly, we are building EBITDA margins at 18%, 16% and 14% in the monolithic
business in FY2011E, FY2012E and FY2013E, respectively.
We see similar risks in the pre-fabricated business
We see similar risks unfolding in the pre-fab business as:
1) In our opinion, a pre-fabricated structure is a low value-added product with very
low entry barriers by way of capital costs or manufacturing technology. We
encourage investors to visit the following link to gain an understanding of the very
competitive dynamics in this business.
Most of the companies competing in the segment appear to be SMEs, which could
lead to a fragmented market in the future and hence, lower margins.
2) As per our interaction, with the management of Sintex, it requires a total capital of
Rs500 mn (including land) to set up a plant for manufacturing of pre-fabricated
structures, which can generate a turnover of Rs2-2.5 bn. If one were to assume
EBIDTA margins of ~20% in this business, the payback period would range
between 2-3 years. Such a high return on invested capital is clearly unsustainable in
our opinion.
Accordingly, are building a declining margin (EBITDA) profile in this business going forward.
We are estimating EBITDA margins at 20.7%, 18.9%, and 17% for FY2011E, FY2012E and
FY2013E, respectively
. Margins in pre-fabs not sustainable; payback period for the capital investment is only 2-3
years
Economics of the pre-fab business, (Rs mn)
Capital required (incl. land) (a) 500
Working capital 1,000
Debt/Equity 70/30
Total debt required (incl working capital) 1,350
Tunover 2,200
EBITDA margin (%) 20
EBITDA (Rs mn) 440
Interest payment (at 11% interest rate) 149
Depreciation (at 5%) 25
PBT 267
Tax (at 33%) 88
PAT 179
Annual cash accretion (b) 204
Payback period (a)/(b) 2.5
Source: Company, Kotak Institutional Equities
Structural headwinds in the two businesses = low earning growth for the
company
The high growth in earnings being projected by the Street assumes margins in both these
businesses will sustain at current high levels till FY2013E. We believe the street is ignoring
the fact that very low entry barriers in these businesses could lead to a lot lower margins
than being projected right now.
Both businesses account for bulk of the earnings growth. If the scenario we project unfolds,
it would mean earnings growth of only 10% pa at the consolidated level for the next two
years.
Returns on incremental capital deployed are very low
In Exhibit 4, we have presented a few of the balance sheet and P&L items to evaluate the
efficiency of incremental capital deployed into the business by the company from FY2008-10.
In FY2008-10, the company increased its average gross block by Rs6.7 bn and the working
capital by Rs5 bn; which means the company deployed a total of Rs11.9 bn of capital into
the standalone business. The increase in sales and EBITDA in the same duration was Rs3.2
bn and Rs350 mn, respectively. This means that the return on incremental capital deployed
is, effectively, zero (adjusting for incremental depreciation of Rs320 mn) for the period under
consideration.
The numbers presented above point to the extremely poor allocation of incremental capital
by the company.
Also, while evaluating the increase in gross block, one needs to look at the sales number
excluding monolithic revenues as the monolithic business does not require much capital for
fixed assets though the requirement for working capital is high. On this metric, against an
increase of Rs6.7 bn in the gross block, sales (excluding the monolithic business) have
actually decreased by Rs1.88 bn.
Some investors might say that a comparison of FY2010 closing gross block with that of
FY2008 is not valid as the incremental capacity set up would have been used in FY2011E. In
our defense we offer two points:
` The incremental investment into fixed assets was only Rs940 mn in FY2010. So, even if
one takes the above view the capital deployed would decrease by only ~Rs1 bn which
doesn’t make the situation look any better.
` Also, if one annualizes the nine month SA sales of the company in FY2011E, we get a
number of Rs23.7 bn of sales and Rs4.76bn of EBITDA in FY2011E. We are assuming
incremental investment in to working capital in FY2011E at Rs1 bn (actual would be
more). On these metrics, against an investment of Rs12.90 bn (capex + working capital),
the increase in sales and EBITDA in FY2008-FY2011E would be Rs7 bn and Rs1.33 bn,
respectively, which also doesn’t project an encouraging picture. After adjusting for
depreciation expense of Rs350 mn (5% of incremental capex) and tax expense of ~Rs220
(tax rate at 22%), the return on incremental capital deployed is ~6%, which is suboptimal.
FCCBS are unlikely to be converted in to equity; not a near-term concern
In our opinion, FCCB of USD 225 mn is unlikely to be converted into equity as the stock
needs to appreciate by 150% in the next two years for conversion. The maturity date is
March 13, 2013. We don’t consider the issue of non-conversion of FCCBs as that big an
issue as the company has cash (at least as of now) to pay off the redemption amount. Still,
we thought we will bring it to the attention of the investors.
FCCBs are unlikely to be converted in to equity
Details of Sintex's FCCB, (Rs mn)
Face value (US $mn) 225
INR/US $ 45
Face value(Rs mn) 10,125
Premium on redemption (Rs mn) 2,630
Total redemtion amount (Rs mn) 12,755
No of shares on conversion (mn) 37
Conversion price (Rs) 345
Impact cost (%) 10
Conversion price inc impact cost (Rs) 379
Source: Company, Kotak Institutional Equities
We are reducing our earning estimates and valuation multiples
We have been valuing Sintex at 12X FY2012E PAT, which is in line with the average
multiples at which the stock has traded from March 2005. We think there is a case for using
lower multiples to value the company given the deteriorating return profile on incremental
capital deployed and the likely downside risk to margins in the monolithic and pre-fab
segment.
Accordingly, we are reducing the P/E multiple to 10X from 12X. Also, as explained before
we are reducing our earning estimates to factor in margin deterioration in monolithic and
pre-fab business.
We are downgrading the stock to SELL with a target price of Rs140 based on 10X FY2012E
EPS. We use fully diluted equity capital (310 mn O/S shares) to compute EPS for the purpose
of valuation. Our earning estimates are ~18% below consensus for FY2012E and FY2013E.
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