Sintex Industries: Higher-than-anticipated capex implies depressed ROCE, could delay any re-rating of the name :: Nomura

Downgrade to Neutral, TP scaled back to INR39
We downgrade Sintex to Neutral, as we scale back average FY14-15F
EBITDA by ~16% and cut our target EV/EBITDA to 4.0x (vs 4.8x earlier).
We believe that incremental capex (partly related to the spindle project)
will lead to a 260bp y-y decline in FY14F pre-tax ROCE (vs our earlier
anticipated increase) and delay any re-rating of the stock. Current
valuation at FY14F EV/EBITDA of 4.9x is in line with the past one-year
average trading multiple of 4.8x

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Higher FY14F capex guidance of INR3.5-4.0bn and likely investment
in spindle project imply subdued returns and negative FCF
Sintex’s earlier plans to curtail capex and focus on FCF, debt reduction
and improved ROCE have been pushed back, with indications of higher
capex guidance of INR3.5-4.0bn for FY14F, vs our earlier expectation of
INR2.0-2.5bn. In addition, as per management, the company intends to
set up a spindle plant in Gujarat to manufacture cotton yarn which would
require capex of ~INR17bn over the next three years. As a result, we
expect the company to generate negative FCF, its debt level to increase
and its ROCE to decline over FY13-15F.
FY14F outlook more muted, consciously slowing execution in
monolithic to manage working capital
We estimate modest sales growth of ~4.9% in FY14F, as the company
plans to scale-back its monolithic business by 25-30% vs FY13. Although
we estimate its overseas custom moulding business will grow ~18% y-y in
FY14F driven by currency translation benefits and the Poschmann
acquisition, we expect domestic custom moulding business to be flat
owing to a slowdown in the auto sector.

Increased capex in FY14-15F, investment in spindle project,
and more subdued operating outcome to depress ROCE
We believe the company’s recent announcement of higher capex, especially its planned
investment in the spindle project is contrary to the discipline on returns metric that we
had anticipated from management. It may well be attributed to the fact that
management’s time horizon for any visible improvement in returns, free cash flows is
being much more backward loaded than our expectations. Apart from higher-thananticipated capex in FY13, the company now guides for higher capex in FY14 as well.
(The company’s actual capex for FY13 was INR4.4bn, including the Poschmann
acquisition and interest capitalisation, which was much more than its earlier capex
guidance of INR1.2bn.) It now expects capex of INR3.5-4.0bn in FY14F vs. its earlier
guidance of INR2.0-2.5bn. This, along with potential capex for setting up its spindle
project (mentioned in detail below) implies that its short- medium-term cashflows, return
metrics are likely to be significantly more subdued, in our view. Apart from the additional
capex, return ratios will also likely be impacted by operating outcome, we estimate, as
the company cuts back on its monolithic business and grapples with the current
slowdown in the auto sector which affects its domestic custom moulding business
As shown below, while we had earlier expected adjusted pre-tax ROCE to improve from
13.7% in FY12 to 15.1%/17.6% in FY14F/FY15F, we now expect adjusted ROCE to
deteriorate to 8.7%/9.9% in FY14F/15F which should delay any potential re-rating of this
name.
Similarly, earlier we had expected the company to generate positive FCF over FY13-
15F; however, we now expect FCF to remain negative in FY14-15F which implies its
net debt-equity ratio will likely remain at ~0.8-0.9 over FY13-15F vs. our earlier
expectation of a decline from 0.87 in FY12 to 0.27 by FY15F.

Intent to invest in spindle project – capex estimated at
INR17bn over next three years
During the 1QFY14 concall, management highlighted that it is evaluating to invest in a
spinning unit to manufacture cotton yarn with 0.3mn spindles which will be ramped-up to
1mn spindles in five years. As per management, setting up the unit with 0.3mn spindles
would entail a capex of INR17bn. As mentioned below, its intent to venture into the
spindle project has been driven by the various incentives provided by the state
government and the opportunity available in Gujarat. While we expect the project may be
positive for the company in the long-term, in the short- to medium-term it will likely have
a negative impact on key metrics such as ROCE, FCF and net D/E which we and
investors had expected to improve.
Rationale for the company’s venture into the spindle project:
• Easy access to raw material: Gujarat accounts for ~70% of cotton production in India
and India exports ~ 25%, which indicates abundant supply of raw material. India is the
third-largest producer of cotton in the world after China and the US (as per the
company). While acreage under cotton in India has been increasing every year, the
acreage under cotton has been on a downtrend in China owing to a focus on food
grains and other priority crops.
• Gujarat - New Textile Policy:
o State government to give 7% interest subsidy over and above the 4%
TUF (textile upgradation fund) subsidy offered by the central
government. This would imply nearly interest-free loan for Sintex’s
spindle project, on our reading.
o Gujarat has surplus power which would be available at a subsidised
rate (rate less by INR1/unit) to spinning units.
o VAT refund until project cost is recovered.
o Duty exemption ~15% on power tariff is also expected, as per the
company.
Monolithic business is being scaled back
The company now guides for FY14F sales at INR7.0-7.5bn for its monolithic business vs.
its earlier indication of 10-20% potential growth. This implies ~25-30% negative sales
growth for its monolithic business. We understand that its monolithic business is working
capital intensive and scaling back this business would release working capital. However,
this implies that overall consolidated sales growth will likely remain muted at ~4.9% in
FY14F, especially given the subdued outlook for its subsidiary Bright Autoplast which is
linked to the slowing domestic auto industry

Summary of our estimate changes
Apart from factoring in the knock-on impact actual outcome especially on cash flow for
FY13 and recently announced Q1 results, we have incorporated the following changes
for FY14-15 in our forecasts
• We have raised our FY14/15F gross capex estimate from INR2.0/2.0bn to
INR9.4/9.4bn. We now build in capex of INR3.75 for the prefab/custom moulding
business including maintenance capex and INR5.67bn capex for the spindle project
which has been highlighted earlier (we expect management to go ahead with the
project). This has also raised our estimate for depreciation in FY14/15F. The increased
capex will likely increase debt by INR3bn in FY15F.
• We have reduced our tax rate assumption to 20% (previously 30%), as guided by the
company during the 1QFY14 concall.
• For its textiles business, we build in sales contribution of INR2.6bn from the spindle
project from FY15F. Our sales assumption of INR2.6bn is based on our expectation of
96mn kg yarn production per spindle and realisation of USD3. We are not building in
any contribution in FY14F, as we expect production to start only in FY15F, post
evaluation of the spindle project and set-up.
• For its monolithic business, we now expect sales to decline ~25% in FY14F vs. our
earlier growth expectation of ~20%. Similarly, we have scaled back our sales growth
estimate from 20% to 0% for FY15F. Lower execution in the monolithic business would
also lead to lower margins, in our view. Accordingly, we have reduced our EBITDA
margin estimate for both FY14/15F by 300bp. This, however, will have a positive impact
on working capital. Hence, we have reduced receivable days by 20 days.
• We have also raised our sales growth estimate for its overseas custom moulding
business from 4% to 18% owing to recent depreciation of the INR vs. USD and EUR,
and our expectation of increased sales contribution from Poschmann. We have
reduced our EBITDA margin estimate for both FY14/15F from 9.9% to 8.1% on account
of lower capacity utilisation at Poschmann.
• For its domestic custom moulding business, we reduce our growth estimate from 6% to
0%, owing to negative sales growth of 16% in 1Q and our expectation of continued
weakness in the domestic auto sector.
• We have also captured the reported forex loss of INR37mn in 1QFY14F.
• Interest expense: we raise our interest expense estimate for FY14/15F, because earlier
we expected a reduction in debt vs. our current expectation of flat/increase in debt in
FY14/15F. Also, now the interest on the newly raised FCCB is being captured in the
P&L which would increase interest expenses. We have also assumed that the company
will raise debt for its spindle capex which will be interest-free, and re-pay part of the
interest-bearing debt in FY14/15F.
• The company has closed two water tank plants in Kutch and Bangalore and plans to
close another water tank plant at Daman. According to the company, this would entail
cash inflows of INR0.8-1.0bn from the sale of the closed plant and land. We have
captured INR684mn as exceptional gains in FY14F and assume INR116 as book value.

Valuation –Target price scaled back to INR39
We have updated our SOTP-based valuation (methodology unchanged) of Sintex to
arrive at a revised TP of INR39. Apart from changing our EBITDA estimate for its various
divisions and assuming higher net debt owing to the newly announced capex, we assign
a 15% discount to our earlier target multiple for each segment (given the pre-tax ROCE
decline vs. our earlier expectation of an increase), which drives a sharp reduction in our
target price
The stock currently trades at a one-year forward EV/EBITDA multiple of 4.6x (4.9x
FY14F and 4.4x FY15F), which is in line with the past one-year average trading multiple
of 4.8x. Our FY14F TP of INR39 implies an EV/EBITDA multiple of 4.1x FY15F and 5x
FY14F which we believe is fair given that we expect ROCE will likely decline over FY14-
15F and remain lower than WACC in both FY14-FY15F. This, we believe, should delay
any re-rating of the stock