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Essel Propack: High costs continue to haunt
Oct 18, 2007

Performance summary
  • Consolidated revenue grows by 13.4% YoY for 3QCY08, dampened to an extent by the rising rupee.

  • Indian operations contribution to the total sales for 3QFY07 fell to 24% from 27% in 3QCY06.

  • Steep escalation in raw material prices and cost of ramping new facility erodes the operating margins by 850 basis points on a consolidated basis during the quarter.

  • Lower operating income, combined with higher interest costs leads to the bottomline decline of 55% YoY.

Consolidated picture
(Rs m) 3QCY06 3QCY07 % change 9mCY06 9mCY07 % change
Net sales 2,769 3,141 13.4% 7,206 8,953 24.2%
Expenditure 2,140 2,696 26.0% 5,523 7,406 34.1%
Operating profit (EBDITA) 629 445 -29.3% 1,683 1,547 -8.1%
EBDITA margin (%) 22.7% 14.2% 23.4% 17.3%
Other income 35 45 28.6% 62 115 85.5%
Interest 66 94 42.4% 183 279 52.5%
Depreciation 221 233 5.4% 641 669 4.4%
Profit before tax 377 163 -56.8% 921 714 -22.5%
Extraordinary item - - - 7
Tax 110 42 -61.8% 237 185 -21.9%
Profit after tax/(loss) 267 121 -54.7% 684 522 -23.7%
Net profit margin (%) 9.6% 3.9% 9.5% 5.8%
No. of shares (m) 156.5 156.5 156.5 156.5
Diluted earnings per share (Rs)* 5.25
Price to earnings ratio (x)* 11.02
* On a 12-month trailing basis

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 3QCY07?
Transition phase: Essel Propack posted a YoY growth of 13% and 24% in the consolidated revenues for 3QCY07 and 9mCY07. The growth was driven by contributions from USA, Europe and China. However, the growth was dented due to rupee appreciation. The translation of other currencies into rupees adversely affected the sales of the company. The rupee has appreciated 13% against the dollar in the last one year.

The consolidated revenue in dollar terms grew 34% YoY for 9mCY07, with the core tubing business registering around 21% growth led by strong sales in Europe and the Americas. The Medical Devices and Specialty Packaging segments have performed as per the management expectations. However, their contribution to total revenue as yet is small at about 18%. The sales in the core tubing business have grown strongly (21% in US$ terms). The company’s expansion plans in US fell short from expected due to longer than expected customer development lead time and the myriads of trial / approval processes, which hampered the growth.

India accounted for 24% of the 3QCY07 revenues, down from 27% in 3QCY06. The international operations have been witnessing faster growth than the domestic operations. The company is currently in a transition phase from single product to multi product company. Plastic tubes, specialty packaging, medical devices along with lamitubes would be the next growth drivers. Though the near term catalysts are limited, the new businesses hold a huge potential going forward.

For the tubing business, the company has planned filling the capacity and price revisions in the near term. The migration of the plastic tube manufacturing in Europe will, however, continue through 4QCY07. The capacity expansion at the Medical Devices unit at Singapore has been completed and the plant is currently being ramped up. The new unit for specialty packaging at Uttarakhand, has already gone on stream from September ‘07. Though the near term catalysts are limited, the new businesses hold huge potential going forward.

India operations
(Rs m) 3QCY06 3QCY07 % change 9mCY06 9mCY07 % change
Net sales 744 742 -0.3% 2,009 2,171 8.1%
Expenditure 538 567 5.4% 1,460 1,670 14.4%
Operating profit (EBDITA) 206 175 -15.0% 549 501 -8.7%
EBDITA margin (%) 27.7% 23.6% 27.3% 23.1%
Other income 21 81 285.7% 67 168 150.7%
Interest 15 48 220.0% 31 131 322.6%
Depreciation 52 52 0.0% 154 149 -3.2%
Profit before tax 160 156 -2.5% 431 389 -9.7%
Extraordinary item 12 12
Tax 47 51 8.5% 130 129 -0.8%
Profit after tax/(loss) 101 105 4.0% 289 260 -10.0%
Net profit margin (%) 13.6% 14.2% 14.4% 12.0%

Dented margins: On a consolidated basis, the operating profits fell by 29% YoY for 3QCY07. Raw material prices (linked to crude prices) increased from 42% of sales in 3QCY06 to 48% in this quarter. Sharp escalation in polyethylene prices since mid 2007 has impacted the margins on account of the normal time lag in the pass through to the customer. Staff costs were also higher by 22% YoY due to new capacities created in USA and Poland. The company is also ramping up its facilities in Poland and USA and hence the other expenses increased from 17.7% of sales in 3QCY06 to 19% in this quarter. On a nine-month basis, the margins have declined by 610 basis points.

On the domestic front too, the company’s margins declined by 4.1%. Lower sales and higher operating expenses led to the operating profits fall of 15% YoY during the quarter. The margins are below our estimates. We will have to revise figures, taking into account the higher crude prices.

Consolidated cost break-up
As a % of net sales 3QCY06 3QCY07 9mCY06 9mCY07
Total Cost of goods 42.4% 48.4% 41.6% 46.3%
Staff Cost 17.3% 18.6% 17.8% 18.1%
Other Expenditure 17.7% 18.9% 17.3% 18.3%

Bottomline declines: On a consolidated basis, bottomline has declined by 55% YoY in 3QCY07. Lower operating income and higher interest cost due to its expansion plans has led to the fall.The translation loss impact was Rs 15 m. Lower tax outgo helped stem the decline in profits to an extent. For 9mCY07, the profits declined 24% YoY. Excluding the extraordinary item however, (one time closure expense of an overseas plant) the fall in net profits stood at 22.7% YoY.

The contribution of the domestic operations to the consolidated profits increased to 87% and 50% in 3QCY07 and 9mCY07 respectively. For 3QCY07, the domestic bottomline is up 4% mainly due to higher other income. However, in 9mCY07, it is down by 10% YoY. The net margins are below our expectations.

What to expect?
At the current price of Rs 60, the stock is trading at a price to earnings multiple of 11.0 times its trailing 12 month earnings and 5.6 times our estimated CY09E earnings. We need to revisit our numbers due to the not so good performance of the company, especially at the margin levels.The company has also taken efforts to reduce the dependence on single customers. Currently not even a single customer contributes more than 15% of the revenue. It has also managed to turn both the UK and the Mexican businesses profitable. While new businesses would help diversify its revenues, polymers and polymer processing would continue to remain the core business.The US markets would also continue to pose a challenge, as the business development activity would continue taking longer time due to the clients needs.The margins are likely to remain under pressure due to rising crude prices and ramping up of facilities.

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