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Ess Dee Aluminium: Generating long term value
Apr 6, 2009

In the previous article we gave an overview of Ess Dee Aluminium's (EDAL) earnings profile and scope of growth in its revenues. In this article we delve further into the balance sheet strength and competitive evaluation of the company. Debt: EDAL has done well to reduce its debt equity ratio from 6.6 in FY05 to 0.3 in FY08. The company had raised funds through an initial public offering in 2006 to the tune of Rs 1.4 bn and used the same for its expansion projects. Going forward, the debt to equity ratio is expected to go higher to an average of 0.7 times in the next three years due to the Indian Foils acquisition.

Working capital: The business of EDAL is working capital intensive. Its debtor days have increased from 133 days in FY05 to 170 days in FY08. The company has big clients in the pharma and FMCG space (Cipla, Glenmark Pharma, ITC, Wrigley India etc) which makes it very difficult to bargain. Also, competition from organised and unorganised sector adds to the difficulty. While the inventory days have reduced from 160 days to 48 days, on account of dependence on only one supplier for its key raw material, the company does not have any bargaining power.

Return ratios: EDAL has done well to improve its return ratios in the last three years. The return on net worth (RONW) has improved from 6% in FY05 to 25% last year. Return on invested capital (ROIC) too has gone up from 5% to 17% during the same period. Higher sales and better margins led to the improvement. While the return ratios will remain at decent levels, going forward we expect them to be lower than the current levels due to pricing pressure, as revenues are slated to grow at a slower rate. Low bargaining power against strong and established clients and price sensitiveness of markets would also limit the realisation growth.

IFL acquisition – boon or bane? In the case of IFL acquisition, till the time the new capacity is fully utilised, EDAL will have to bear higher expenses in terms of interest costs as well as depreciation charges. Also the prices of aluminium foil stock (the major raw material accounting for 63% of sales) are determined by LME prices and this can impact the overall raw material costs for the company. Though the aluminium prices have reduced in recent times, once the demand picks up, the company’s costs would go up.

Though in the short term, the acquisition would dampen EDAL’s return ratios, we believe that the company stands to gain in the longer run on account of increased capacity, access to IFL’ s client base and lower tax liability, in the event of IFL being merged.

Comparison with peers: Paper Products and Essel Propack are existing players in the FMCG packaging space. Though not direct competitors to EDAL as the former use polymers for their products, we have made a competitive analysis of the three companies. EDAL fares better on account of its non dependence on the crude prices and better margins derived from the pharma segment as compared to the FMCG segment. Further, its hub and spoke model is also saving EDAL considerable operating costs.

Comparison with peers
(%) EDAL Essel Propack* Paper Products*
Operating margins 22.3 18.6 11.0
Net margins 15.4 5.0 5.7
Return on assets 14.0 2.9 7.9
Return on invested capital 16.0 6.2 8.4
Return on net worth 33.2 5.4 13.1
D/E 2.2 0.5 0.2
All figures are avg of 4 years * Essel Propack and Paper Product numbers are forCY05 to CY08UA

Going forward
At the current price of Rs 160, the stock is trading at 5 times our FY11 estimates. While the performance of the company would be muted till the acquisition of IFL gets fully integrated, things will improve going forward. Higher capacity, larger client base, entry into FMCG segment and introduction of new products will aid the company’s growth prospects. We remain positive on the stock.

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