Recently did some analysis of Masterbatch/Pigment industry, which provides colour to plastics. Master batches are used not only to provide colour to plastic but also provide additional properties such as strength and making the surface smoother. The plastic packaging industry is the major user of masterbatches, accounting for 50-60% of total production, followed by plastic products [Source company annual reports]. We can see use of plastic everywhere and its quite likely that going forward use of plastic will increase manifold providing huge opportunity to the company. So growth perse is not the problem. There are three main listed players in this segment. 1) Plastiblends 2) Poddar Pigments 3) Sudarshan Chemical Industries. I did not like last two for various reasons [Historically low ROE/ROCE, low capacity additions, management issues, no consistent dividend payout, marginal players in a highly unorganised market etc.]. Number wise Plastiblends appear to be better placed than the rest of the two.
Plastiblends [BSE code: PLASTIBL]
Plastiblends India Ltd (Plastiblends) is the largest domestic manufacturer of masterbatches; with an installed capacity of 50,000 TPA, it commands ~60% share [Source: Crisil report on Plastiblends, 2010] of the organised segment. During the last six years it has almost doubled its capacity and sales have grown at a CAGR of 24%. Currently it is trading 20% discount to book value and TTM PE of 5.4x and debt equity is quite reasonable at 0.5x and it provides dividend yield of more than 5%. [Reason for decline in price is decline in reported profits in last five out of six quarters, though sales have increased]. It has been a consistent dividend payer for last 10 years and disclosures are quite reasonable in MD&A. Still it’s featuring in my rejection list. In single word reason is Low [or No] entry barriers. I am unable to visualise whether company will continue to to enjoy the sales growth, though profitability should pick up if recent correction in crude oil prices sustain at current level.
Low entry barriers: The process of manufacturing masterbatches is less capital intensive and less technology intensive. This is reflected in the fact that almost 75% of the market is controlled by unorganised segment. That itself is not a problem, but I do not see any catalyst, which will result in increase in share of organised segment.
No pricing power: During the last ten years price of its main raw material polymer [> 50% of its RM cost] increased at a CAGR of 7% whereas its ASP increased only at a CAGR of 2.5%. This is reflected in structural decline in operating margins [EBITDA] from 18% in 2002 to 9% in 2012. One can argue that from now on crude oil prices expected to remain flat or decline. Even if it declines, I think Plastiblends may have to pass on the benefit to customers because of the presence of large unorganised segments.
Deteriorating working capital situation: Though sales had grown at 24% CAGR during last six years, net working capital increased at 40% CAGR. Average collection period had increased from average of 45 days during 2005-09 to more than 64 days during last two years. On average more than 40% of incremental sales during 2010-12 got tied up in working capital. Debt which on average was 10crs during 1998-2009 has increased steeply and now stands at 50crs as on Mar-12.
Low post tax ROCE: ROCE [pre-tax] which averaged more than 32% during 1998-2007 had declined to just 19% during 2008-12. Taking normalised tax @ 33%, this implies post tax ROCE of 12-13%. [Though reported tax rate is 10%, which might be due to some temporary tax concessions, I will prefer to take normalised tax rate].
Negative FCF: Company has reported FCF [post tax] of almost 9% as % of sales during 1998-2006. But during the last six years, it had reported positive cash flows only in two years. Ofcourse, company had incurred massive capex during last six years, but if working capital had not deteriorated, FCF would have been better.
Conclusion: All the above five points together indicates that companies in this industry do not enjoy any bargaining power with customers. Though working capital position of Poddar Pigments is much better than Plestiblends, but still the fact remains that there are no strong entry barriers. I do look for cheap stock, but that’s only the beginning. I also look for decent to strong entry barriers which ensure that company is able to enjoy growth whenever it picks up again. Here I will not be comfortable holding the stock for next 3-5 years if market goes into extended decline. I will give a pass to all the three players.
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