Supreme Petrochem: Poorly managed bad business - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Supreme Petrochem: Poorly managed bad business

Mar 6, 2012

Taking the case of Supreme Petrochem, we would like to point out some very important lessons that value investors should keep in mind while investing in stocks.

The following is a brief financial snapshot of Supreme Petrochem Ltd (SPL) for the year ended June 2011. The company's sales and net profits grew by 20.6% (year-on-year) YoY and 44.8% YoY respectively. It reported a net profit margin of over 4%, its highest in the last decade. At 34%, the return on capital employed (ROCE) during the period was remarkable. It's debt to equity ratio stood at 0.6 times, which is a lifetime low. At the current price of Rs 48.5, the stock is trading at a trailing twelve month price to earnings (P/E) ratio of 7.9 times. The dividend yield at this price stands at 5.8%, which is pretty decent.

From the numbers, the company seems promising. But a deeper dig reveals something else altogether.

Is the business model sustainable?

Established in 1995, Supreme Petrochem is a joint venture between Supreme Industries Ltd and the Rajan Raheja Group. SPL is engaged in the business of manufacturing polystyrene, a thermoplastic polymer. Based on the grade of the polystyrene, it finds application in various things such as stationery, house ware, cosmetics, packaging, insulation, wall clocks, computer accessories, refrigerator components, washing machines, televisions sets and so on. The company has a leadership position in the Indian polystyrene market with a 50% market share. Some of its marquee clients include Haier, LG, Videocon, Godrej, etc.

But, the question is whether the business model is sustainable or not?

The Porter's five forces analysis is a very powerful tool to evaluate the fundamental strength of a business. Here is a brief analysis of SPL based on the Porter's model:

  1. Entry barriers- Low. It is easy to enter this business as it is neither capital intensive nor technologically advanced.
  2. Bargaining power of buyers- High. Polystyrene is a low value commodity. It is difficult to pass on price hikes fully.
  3. Bargaining power of suppliers- High. Styrene monomer, which is the raw material for polystyrene, is a derivate of crude oil. Hence, the company has no control on raw material costs.
  4. Intensity of competition- High. It is a supply-driven market with high overcapacity.
  5. Threat of substitutes- High. Polystyrene can be easily substituted by other materials.
The business of SPL fares badly on all of Porter's five forces. It is a clear indication that it is not a great business to invest in.

Management lacks a clear vision

SPL is the market leader in the domestic polystyrene business with a capacity of 272,000 tonnes per annum (TPA). But this is nothing to cheer about. The total domestic market is even less than that, at about 250,000 TPA. In addition, there are two other major players, LG Polymers Pvt Ltd and BASF Styrenics Pvt Ltd, both of which have a capacity of 100,000 TPA each. Because of the excess capacity, the company had no choice but to export its products abroad. But even then, the company operates at just about 60% of its full capacity.

The company is trying to reduce its exposure to the export market, while aiming to expand the share of domestic sales. The reason the margins on export sales are very thin. The management is optimistic that one day in the future they will be able to operate at higher capacities. They are relying on customer education for this. This means that they would educate their customers into buying more of their products.

This is a perfect example of how a management with a poor vision can drive the company in a very wrong direction. The company's management went on an expansion spree believing that they would be able to create a market for their products. But they were extremely wrong in their calculations. Now, the company has little choice but to sit with a lot of idle capacity.

Lesson for investors

The case of Supreme Petrochem clearly shows that you should never judge a company based on the financial data of just a year or two. A long term financial history of at least 5-10 years should be analysed. Secondly, if a company chalks out big expansion plans and makes big promises about future growth prospects, do not give in to over-optimism. Equally important is the industry in which the company operates. If the market for a product does not already exist, there are sure reasons to be skeptical.

Equitymaster requests your view! Post a comment on "Supreme Petrochem: Poorly managed bad business". Click here!

  

More Views on News

Top Indian Drone Companies to Watch Out for in 2022 (Views On News)

Jan 21, 2022

Several companies are adopting drone technology for regular business operations.

Insiders are Buying into these 6 Stocks Aggressively. More Details here... (Views On News)

Jan 19, 2022

While promoter holding is an important parameter, it should not be the sole reason for buying a stock.

These Penny Stocks Started 2022 with a Bang. This is what You Need to Know... (Views On News)

Jan 19, 2022

These penny stocks are up more than 30% already since the beginning of the year.

The Glitter is Returning to Bullion (Fast Profits Daily)

Jan 27, 2022

This is why gold and silver will go up in 2022.

Freefall: Paytm, Zomato, Nykaa Shares Drop to Record Low. Is the 'Unicorn' Craze Over? (Views On News)

Jan 27, 2022

New-age Indian tech stocks suffer in the market meltdown. Are any of these stocks still in your portfolio?

More Views on News

Most Popular

SWOT Analysis for Stocks

SWOT analysis guide for investors in the Indian share market.

These 5 Penny Stocks are Held by Rakesh Jhunjhunwala. Worth a Look? (Views On News)

Jan 18, 2022

Rakesh Jhunjhunwala is holding these penny stocks in his portfolio for several years now.

Time to Buy Energy Stocks (Fast Profits Daily)

Jan 14, 2022

Energy is a sector that looks set to take off. It's time to get in.

Tech Mahindra's CTC Acquisition: Too Expensive? (Views On News)

Jan 18, 2022

Tech Mahindra's acquisition of European IT-company fails to excite investors.

5 Hidden Tata Group Companies to Add to Your Watchlist (Views On News)

Jan 18, 2022

Here's all you need to know about these five Tata group stocks that aren't as popular as the others.

More

Become A Smarter Investor
In Just 5 Minutes

Multibagger Stock Guide 2022
Get our special report Multibagger Stocks Guide (2022 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Jan 27, 2022 (Close)

MARKET STATS