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Research meeting excerpts: Essel Propack - Views on News from Equitymaster
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Research meeting excerpts: Essel Propack
Sep 17, 2004

The following are the key highlights of our management meeting with laminated tubes major, Essel Propack. The focus of the discussion was on the laminated tubes industry, Esselís strengths and the managementís outlook. But first a brief background.

Company background
Essel Propack is the largest laminated tubes supplier in the world. The company's global sales stand at around 4.5 bn tubes, 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, USA, Germany, India, Nepal, 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 is highly linked to the growth of oral care industry, which again depends on economic growth. In early 2003, the company commissioned a plant in Virginia, USA, to cater solely to P&G's laminated tube needs in the US and Mexico. Going forward, Essel will cater to 55% of P&G's global tube requirements, including China. In 2003, 40% of Essel's revenues came from India, 28% from China and 16% from the US.

Essel through Porterís eye
Industry structure:† Laminated tubes is a niche product. Tube making is capital intensive with low asset turnover ratio. Hence, internal efficiency is very important. Essel scores high on this aspect.

Suppliers:† The company uses special resins (plastic resins) and aluminium foils. The material is not very sensitive to oil prices, but does follow oil prices with a lag. Essel has a better bargaining power with suppliers, as it has complete control over its value chain.

Buyers:† The users of laminated tubes are predominantly oral care players. Globally, there are 5 to 6 key companies in the oral care business. Consequently, they have some amount of bargaining power over companies like Essel. Pharma and cosmetics industries continue to be small contributors to laminated tubes demand.

Competition:† Essel is the largest player in laminated tubes globally (about 4.5 bn tubes). France based Cebal and UK based Betts are the other two big players. The industry continues to be in the throes of consolidation. Competitive skills are determined by how integrated a company is, because that ultimately determines profitability.

Substitution:† The laminated tubes are better than the aluminium versions owing to their hygiene and high quality of decoration capability. However, if there is a ground-breaking innovation going forward that is even more competitive, it could pose a threat to Essel Propack (for now it does not seem to be the case).

Growth prospects
The management expressed confidence of growing the companyís consolidated revenues at 14% to 15% CAGR over the next three years. The company expects China and USA to power this growth. Over the past few years, the share of India to the companyís revenues has declined to 40% in 2003. Owing to the continued outperformance of China and the US, Indiaís contribution is likely to shrink even further (32% by 2006 as per our estimates).

Further, the company has recently acquired Arista Tubes, UK, which manufactures plastic seamless tubes for cosmetics, personal care, toiletries and pharmaceutical segments. The company has revenues of nearly US$ 20 m (approximately 16% of Esselís 2003 consolidated revenues). Arista has 30% market share in UK and Ireland. Though the company has not disclosed the terms of the deal, the acquisition looks positive for the company, as it gives it an entry into new markets and product offerings.

In our view, the company must have paid around US$ 8 m to US$ 10 m for the said acquisition. Since the company has about Rs 320 m as cash in its books at the end of 2003, the company may not have to take on much debt to fund this acquisition. However, we do expect its interest burden to rise on account of working capital needs. Arista has a small debt of around US$ 1 m (Rs 46 m) on its books.

Aristaís EBITDA margins are much lower than Essel at around 12%. The management expects to improve these margins to around 18% by 2006.

US operations:† Though the management did not disclose how many tubes they were selling to P&G USA, our estimates suggest that almost 20% of the total 4.5 bn tubes are supplied to P&G. We believe that the margins are also on the lower side as compared to the Indian operations, which stood at 37.5% in the first half of 2004. The company is now looking at expanding its relationships beyond P&G in the US.

Valuations
At Rs 220, the stock trades at a P/E multiple of 9 times our expected 2004 consolidated earnings and market cap to sales of 1.1 times. The companyís valuations are at the lower end of the FMCG spectrum. Essel has set itself an ambitious target to increase its share in the global laminated industry to 50% in the next few years. It is also looking at growing by making 'caps' for tubes for the global FMCG players.

However, among the key concerns, the company has still to receive over Rs 600 m from the promoters, which was given as a loan to them. Also, when the company took over Propack, it provided for goodwill to the tune of Rs 2.7 bn (over 40% of 2003 networth). This amounts to almost Rs 88 per share. The company has still to write off this amount.

We believe that Esselís strategy of straddling the global tubes market is encouraging and in the long run will prove beneficial.

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