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Essel Propack: In the seed phase - Views on News from Equitymaster

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Essel Propack: In the seed phase

Jul 27, 2006

Performance Summary
Laminated tubes major, Essel Propack, has announced results for the second quarter and half year ended June 2006 (December-ending fiscal). On a consolidated basis, while the topline has grown by 18% YoY and 15% YoY for 2QCY06 and 1HCY06 respectively, both operating and net margins have declined. However despite the margin decline, lower tax expenses have resulted in bottomline growing at a faster clip than operating profits during the quarter.

Consolidated picture
(Rs m) 2QCY05 2QCY06 % change 1HCY05 1HCY06 % change
Net sales 1,969 2,316 17.6% 3,874 4,437 14.5%
Expenditure 1,480 1,774 19.9% 2,890 3,383 17.1%
Operating profit (EBDITA) 489 542 10.8% 984 1,054 7.1%
EBDITA margin (%) 24.8% 23.4%   25.4% 23.8%  
Other income 22 26 18.2% 28 27 -3.6%
Interest 36 71 97.2% 58 117 101.7%
Depreciation 196 212 8.2% 372 420 12.9%
Profit before tax 279 285 2.2% 582 544 -6.5%
Tax 76 55 -27.6% 183 127 -30.6%
Profit after tax/(loss) 203 230 13.3% 399 417 4.5%
Net profit margin (%) 10.3% 9.9%   10.3% 9.4%  
No. of shares (m) 31.3 156.5   31.3 156.5  
Diluted earnings per share (Rs)*         5.5  
Price to earnings ratio (x)*         12.3  
* On a 12-month trailing basis
The face value is changed to Rs 2 from Rs 10 from CY06.

What is the company’s business?
Essel Propack is the largest laminated tubes supplier in the world. The company's global sales stand at around 4.5 bn tubes per annum, which is 30% of the global laminated tubes market. Over the years, Essel has acquired a global status, with presence in China, Egypt, Colombia, Venezuela, Mexico, the US, Germany, India, Nepal, the Philippines and Indonesia. A large part of this global stature has been possible due to the merger with Propack in 2001. The demand for its products closely tracks the growth of the oral care industry, which again depends on economic growth. In early 2003, the company commissioned a plant in Virginia, US, to cater solely to P&G's laminated tube needs in the US and Mexico. In August 2004, Essel acquired Arista Tubes of UK and then went on to acquire Telcon Packaging in April 2005, in order to increase its presence in the EU and UK. The company recently acquired an 85% stake in Tacpro Inc. (USA) and Avalon Medical Services (Singapore).

What has driven performance in 2QCY07?
India – Improved show: Essel Propack have yet again registered a decline in its net profits from the Indian operations. The extent of decline is however much lesser than what was seen in 1QCY06 (when Indian net profits declined by 19% YoY). The company’s Indian operations contributed to around 29% of consolidated revenues during 1HCY06 (31% in 1HCY05). Net profits also witnessed a decline in their contribution to consolidated bottomline (from 53% to 45% in 1HCY06). The management has indicated of better times for the Indian operations in the future. In order to enhance its domestic performance, the company is focussing on mini tubes in the pharmaceutical sector and, as per the management, this is a big growth opportunity.

India operations
(Rs m) 2QCY05 2QCY06 % change 1HCY05 1HCY06 % change
Net sales 570 629 10.4% 1,194 1,265 5.9%
Expenditure 408 469 15.0% 831 920 10.7%
Operating profit (EBDITA) 162 160 -1.2% 363 345 -5.0%
EBDITA margin (%) 28.4% 25.4%   30.4% 27.3%  
Other income 25 44 76.0% 41 46 12.2%
Interest -4 14   -12 18  
Depreciation 50 51 2.0% 96 101 5.2%
Profit before tax 141 139 -1.4% 320 272 -15.0%
Tax 43 42 -2.3% 107 83 -22.4%
Profit after tax/(loss) 98 97 -1.0% 213 189 -11.3%
Net profit margin (%) 17.2% 15.4%   17.8% 14.9%  

International operations: Revenues from Essel’s international operations grew at a strong rate of 21% YoY during the second quarter. Also, on the back of lower tax outgo, net profit growth (27% YoY) has outperformed growth in the topline. The aim to be a manufacturer of every second laminated tube is very much visible from the company’s expansion plans. In the laminated tube plant at Danville, US, the capacity expansion is complete and it will start yielding results during 4QCY06. Also, the recently initiated set-up of plastic tubes manufacturing unit of Arista Tubes at Danville is expected to become operational during fourth quarter. The Mexican and Colombian operations have also reported improved profitability during the quarter.

The operations at Arista Tubes, UK, achieved break-even in this quarter while, Essel Propack (UK), formerly Telcon Packaging, is expected to achieve break-even in July 2006. To accelerate growth in China, the company is rolling out mini-tubes technology. The capacities are in place to tap the pharma market of China and significant results will be seen during the 2QCY07.

Consolidated cost break-up
As a % of net sales 2QCY05 2QCY06 1HCY05 1HCY06
Total Cost of goods 44.5% 39.8% 44.9% 41.1%
Staff Cost 16.6% 19.1% 15.8% 18.1%
Other Expenditure 14.1% 17.7% 13.9% 17.1%

Lower margins: Inspite of lower cost of goods (as a percentage of sales), margins declined by 140 and 160 basis points in 2QCY06 and 1HCY06. Higher staff costs and other expenditure affected the company’s operating margins during both the periods under review. The staff costs have increased due to the expansion plans taken by the company. However, on the domestic front due to lesser competition the Indian operations margins are better than the group. In our view, as the new capacities gain scale, the cost heads will be spread over a wider base, resulting in operating margin expansion.

What to expect?
At the current price of Rs 67, the stock is trading at a price-earning multiple of 12.3 times its 12 months trailing earnings. In the long-term, we do expect volumes to drive the topline growth. The global operations will remain the key growth driver. Once the company makes proper use of Arista’s competencies in the plastic tubes segment, growth will accelerate at a much faster clip. We have a positive view on the stock from a long-term standpoint.

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