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Essel Propack: PIPL acquisition - Views on News from Equitymaster

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Essel Propack: PIPL acquisition

Sep 6, 2006

Last week, packaging major Essel Propack (EPL) acquired 100% stake in Packaging India (PIPL). PIPL is a manufacturer of specialty packaging materials and is a part of FMCG major CavinKare group. It is the third-largest producer of specialty packaging materials in India and enjoys a leading market position in the southern part of the country. EPL acquired the company for Rs 875 m in an all-cash deal. The equity component is Rs 635 m with the balance being debt. The rationale for the acquisition...
The deal will consolidate EPLís position as the leader in the domestic packaging industry. The Chennai-based PIPL provides packaging solutions to the confectionery, cosmetics, detergent/soap, food and beverage industries and has a production capacity of 6,000 tonnes per year. The acquisition, will add new areas to EPLís laminated and seamless tubes business catering to the oral care, cosmetics, pharmaceutical and industrial sectors.

Specialty packaging is required for pharma and FMCG sector. This acquisition marks EPLís entry into the specialty-packaging segment, which is a Rs 25 bn market and growing at over 15 % per annum.

Pharma sector: Indian pharma is moving up the value chain (bulk to generics to formulations). The size of the Indian pharma industry is US$ 6 bn as compared to global size of US$ 552 bn. It is only 1% of the global sales (in value terms). Also, the penetration of the modern medicines in the country is only 30%.

Packaging material/year 2005 2009E
Volume (MT) 26,398 47,461
Value (Rs bn) 4.6 8.1
Source:EPL presentation

As seen from the table, the potential of specialty packaging is huge and will give EPL leverage its global presence and de -risks its tube business.

Food industry: FMCG sector is also a major growth driver for the packaging industry. Packaging attractiveness help to drive brand strategy. India is the largest producer of fruits and vegetable but only 2% is processed. Semi processed foods and ready-to-eat category is growing at 33% per annum. Also, with organised retail expected to grow at 8% over next five years, it is a boom for the packaging industry.

Greenfield option or acquisition: The company had the option of setting up a greenfield capacity or buying PIPL. Due to long gestation period, initial losses till the business would break-even and stringent DMF approvals, the company decided to eliminate the earlier option. The cost of setting up a greenfield capacity would be around Rs 600 m while EPL bought PIPL for Rs 635 m. This will help the company move up the value chain, offer significant growth potential in the specialty packaging materials market and overcome risks involved in the greenfield option.

How the numbers of PIPL stack up?

(Rs m) FY06 as a % of EPL
Revenues 989 12.1%
Expenditure 847 13.6%
Operating Profit 142 7.4%
EBDITA margins (%) 14.4% 25.0%
Profit after Tax 39 4.3%
PAT margins % 3.9% 11.0%
ROE 21.7% 12.8%

Financials: PIPL reported net sales of Rs 989 m for FY06 and as per EPL, is expected to touch Rs 1,150 m in FY07. EPL has paid 1.1 times PIPLís FY06 sales as consideration. The margins of EPL are going to decline in the coming future, as PIPLís operating margins are only 14% as compared to 25% for EPL. However, its overall ROE is 21.7% as compared to EPLís 12.8%. Due to the asset intensive nature of the business, this acquisition balances well.

What to expect?
At the current price of Rs 85, the stock is trading at a price to earnings multiple of 10.4 times our CY08 earnings estimates. In our view, the current acquisition is a positive for Essel, as it will help the company move up the value chain. Though the margins will get affected in the near term, from a long term perspective we have a positive view on the stock.

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