market share gains from better

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Market share gain from better ‘reach’ Availability is the underlying driver to build a strong brand in the plastic pipes business. Supreme’s distribution reach supported by its manufacturing network and innovativeness (wide product portfolio) make it the best plastic pipes player. Only, Astral, through its aggressive reach and product expansion plans, would challenge Supreme’s leadership by FY16. Branding is becoming increasingly important to distribution and top-3 have different promotion strategies to build brand—Astral: national, Supreme: local, Finolex: rural. Supreme and Astral’s one-year forward P/E multiples (presently, 16X and 19X, respectively) have scope of remaining rich as expanding reach and product portfolio support market share gains from unorganised players.

Availability is the key to building a brand

Our dealer checks across the urban and rural markets in west and south India reiterate that Finolex is the strongest brand in rural markets, Supreme is the most-popular PVC pipe brand in urban markets (especially south India) and Astral, an emerging PVC brand, is the best CPVC brand across India. The key driver for creating a strong brand is product availability, as dealers are reluctant to push products with limited availability to customers like institutional clients.

Advertising strategy: Astral-National; Supreme-Local; Finolex-Rural

Each of the organised PVC pipe players has an active promotional strategy to build a brand in a seemingly commoditised industry. Astral uses a smart cost-effective national promotional campaign through cricket and tie-ups with movies of Mr. Salman Khan, a leading Indian actor. Supreme and Finolex prefer joint advertising with distributors in local newspapers. Also, organised PVC pipe manufacturers have built a relationship with plumbers through training sessions.

Supreme: the leader, Astral: the challenger, Finolex: the laggard

Supreme continues to be the market leader but Astral is challenging former in west and south India. Organised players such as Supreme, Astral and Finolex are increasing their manufacturing and distribution reach to increase availability and gain market share from unorganised players. Alongside, Supreme and Astral are continuously adding new products, another key competitive advantage driver. Astral is the most-aggressive player, having already bought land for capacity expansions and identified new products for launch over FY13-16.

Valuation multiples—set to remain rich

Supreme and Astral have displayed strong growth alongside high RoCEs; we expect this to sustain and thus the rich P/E multiples. Expansion of valuations multiples will be a function of growth from shift in market share from unorganised to organised players, which will be driven by structural changes such as (1) adoption of plastic pipes across uses; (b) higher-quality construction and (c) regulation for quality control. Organised players sell superior-quality PVC pipes and are investing in newer products used for multiple applications. We expect both Supreme and Astral to generate sufficient cash flows to invest in capacities and product innovation for expanding leadership.

Relative valuation of organised PVC pipe manufacturers

Companies Mcap

(US$ mn) Revenues (US$mn)

Revenues CAGR

EBITDA margin

(%)

PAT margin

(%)

RoE (%) PE (x)

FY14 FY13-15 FY14 FY14 FY14 FY14E FY15E

Supreme Ind 930 627 16.2 14.7 7.2 29.1 19.3 15.3

Finolex In 371 394 11.7 13.0 6.6 21.0 14.3 11.4

Astral Poly 347 152 27.9 14.0 6.7 26.9 28.9 18.9

Source: Bloomberg, Ambit Capital research

Industrials POSITIVE

THEMATIC March 05, 2014

Key Recommendations

Supreme Industries BUY

Target Price: 480 Upside : 6%

Astral PolyTechnik Not Rated

Target Price: NA Upside : NA

Finolex Industries Not Rated

Target Price: NA Upside : NA

Astral vs Supreme FY15E P/E

Source: Bloomberg

Analyst Details

Nitin Bhasin +91 22 3043 3241 [email protected]

Tanuj Mukhija, CFA +91 22 3043 3203 [email protected]

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Supreme 1-year forward P/E

Industrials

March 05, 2014 Ambit Capital Pvt. Ltd.

Plastic pipe industry landscape Supreme is the market leader in the highly fragmented PVC pipes industry which is dominated by unorganised players. Supreme’s closest pan-India competitor is Finolex in the PVC pipes segment and Astral Pipes is the largest competitor in the CPVC pipes segment. Although Jain Irrigation is a large company, it caters largely to the agricultural segment. We have identified four other important unlisted players in the PVC pipes industry—Ashirvad Pipes, Ajay Pipes, Nandi Pipes and Prince Pipes.

Exhibit 1: Indian PVC pipe industry landscape

Companies Mcap (US$mn) FY13 piping

segment sales (` mn)

FY13 Pipe volume sales

(MT)

FY13 Segment EBIT margin Brief business description and products

Supreme Industries 699 16,502

(50% of company revenues)

180,745

16%

Supreme, the market leader in PVC pipes, manufactures a number of plastic compound pipes (PVC, CPVC, PPRC, PPR, HDPE, LLDPE). The company has recently launched products like CPVC pipe systems and Nu Drain systems which are finding increasing acceptance amongst institutional buyers (infra, residential developers). Nearly 20-25% of this segment’s sales come from plastic pipe fittings.

Jain Irrigation 429 11,300

NA

8%

With a market share of 15%, it is one of the three major PVC players in the organised market and a leader in the rural water and irrigation markets, but it lags behind in the building and construction sector. It sells PE pipes in the gas and cable duct segments and for sewage and effluent disposal. This segment will be a major beneficiary of infra capex spending. It is developing its CPVC pipe offering.

Finolex Industries 228 13,778


170,000

5.2%

Finolex is the largest pan-India competitor of Supreme Industries. Finolex’s main target segment is the agriculture sector which accounts for 70% of its PVC pipes sales. Finolex has in-house manufacturing of PVC, yet its margins are more than 900bps below Supreme’s. We believe this is due to two factors: (1) focus on highly competitive irrigation pipes segment vs fast-growing housing segment and (2) high-margin fittings as a percentage of PVC pipe sales are less than 10%, whereas fittings account for more than 20% of Supreme’s sales. Finolex mainly has a presence in west and south India.

Astral Poly 190 8,254


49,495 12%

One of the fastest-growing pipe companies in India (~44% CAGR over the last four years) with the highest realisation. The company manufactures PVC and CPVC pipe systems. The company has increased focus on CPVC pipes (60% of FY13 sales) as their margins are better than PVC pipes. The company has a tie-up with Lubrizol for CPVC raw material sourcing. Astral’s distribution network is mainly in west India and the company is now building its network in south India.

Ashirvad Pipes Unlisted 6,759* NA NA

Four-decade-old firm (mainly present in south/west India) manufacturing UPVC, CPVC, SWR pipes/fittings. One of the three Indian partners of Lubrizol for FlowGuard pipes. Leading player in the borewell segment (a`8bn market). Aliaxis, a large global plastic pipes company, acquired a majority stake in Ashirvad Pipes for US$150mn in February 2013.

Ajay Pipes Unlisted NA NA 12.5%

Ajay Group is a diversified engineered plastic products manufacturer with a presence across refrigeration sealing, water/irrigation, automotive parts and extruded products. Apart from UPVC pipes, the company also manufactures CPVC pipe systems using the technology of Lubrizol.

Nandi Pipes Unlisted NA NA NA

The company manufactures PVC, HDPE, and UPVC pipes and sells it across the irrigation, construction and infra segments. It offers CPVC pipe systems in a technological collaboration with Sekusui Chemical Ltd, a Japanese chemical company.

Prince Pipes Unlisted 5,190* NA NA

Prince Pipes, established in 1973, manufactures uPVC, CPVC pipes and fittings catering to housing, agricultural and infrastructure clients. Based on our dealer checks, Prince has a strong presence in western India.

Source: Company, Ambit Capital research. Note: * We have used FY12 numbers for unlisted firms such as Ashirvad pipes and Prince Pipes

Industrials


IBAS framework: Supreme is the leader We have used the IBAS framework to rank the organised plastic piping companies. The IBAS framework is based on four key parameters: (a) innovation, (b) brand, (c) architecture, and (d) strategic assets. Supreme is the highest-ranked company amongst organised players, owing to superior architecture, strong brand recall and diversified product portfolio.

Astral and Supreme leaders in innovation: Astral was the first company to introduce CPVC pipes in India and they have recently introduced new products such as composite column pipes, blazemaster and bendable pipes. Supreme Industries has more than 5,800 products in pipes and fittings developed through feedback from distributors. Further, Supreme has plans to launch composite cylinders after getting approval from PESO. In addition, the company would launch other composite products such as pipes and pallets and fire resistant pipes.

Brand equity: Supreme has the strongest brand in urban cities for PVC pipes. Astral also has high brand equity for CPVC pipes in urban cities. Finolex Industries has the highest brand equity in rural markets.

Supreme has superior architecture: Supreme has pan-India manufacturing reach through 22 manufacturing plants across India not only for PVC pipes but also for other products such as protective packaging. Finolex’s manufacturing plants are mainly located in west India. Astral is expanding its reach through a new plant at Hosur, Karnataka in south India.

Strategic asset: Astral’s tie-up with Lubrizol is a source of key competitive advantage. In our opinion, Supreme’s unmatched pan-India distribution reach and its patent license for cross laminated film product are its strategic assets.

Exhibit 2: IBAS framework for organised PVC pipe players

Innovation Brand Architecture Strategic

asset Overall

rank

Rural Urban Manufacturing

reach Distribution

reach

Supreme Industries

Astral PolyTechnik

Finolex Industries

Source: Ambit Capital research;

Note : - Strong; - Relatively Strong; - Average; - Relatively weak.

Competitive mapping scorecard We have built a scorecard to evaluate the competitive positioning of the six large organised PVC pipe players in India. We have selected five parameters that we believe are important for their performance—three-year average RoIC, revenue size and growth, financial leverage, product diversity, and distribution network. Based on our scorecard, Supreme is the best player in the industry followed by Astral PolyTechnik. In our opinion, Jain Irrigation and Prince Pipes are laggards. For more details on the competitive mapping scorecard, please refer to our initiation note on Supreme Industries, ‘The Snowball’.

http://webambit.ambit.co/reports/Ambit_SupremeInd_Initiation_16Aug2013.pdf

Industrials


Exhibit 3: Competitive mapping of PVC pipe manufacturers

Company name 3-year

average RoIC

FY13 pipe revenue

(` bn)

3-year pipes

revenue CAGR

FY13 Net debt/ Equity

(x)

Product line beyond uPVC Key client

Pipe manufacturing plants

Distributors Overall rank

Supreme 23.5 16.9 24.7% 0.44 CPVC, PE, PP-R pipes and fittings Housing North, Central and

West India 700+ 1

Astral 18.0 8.3 41.2% 0.22 CPVC pipes and fittings Housing

North and West India 400+ 2

Finolex 8.6 13.8 18.4% 0.65 Fittings Agriculture West India 500+ 4

Jain Irrigation 8.4 11.3 10.0% 1.48 PE pipes and 2 fitting products Agriculture

West and South India 3000+ 6

Ashirvad Pipes 31.8* 6.7* 39.3%* 0.84* CPVC and fittings Housing South India 4000 retailers 3

Prince Pipes 7.0* 5.2* 16.4%* 2.37* CPVC, PP-R and fittings

Housing and agriculture

West and North India 5

Source: Company, Ambit Capital research; Note: Rank 1 indicates the best player on each parameter in the industry whilst rank 6 implies the worst-placed player. We have assigned equal weightages to each of the five parameters.

PVC pipes: Structural long-term growth drivers The FY13 sales of PVC pipe industry were 1.5 million tonnes wherein the organised sector accounted for 60% of FY13 sales. We expect PVC pipe volume growth to be supported by growth in the individual home builder (IHB) segment. In our opinion, the key driver for organised PVC pipe manufacturers would be market share gain from unorganised players. Organised players, over the next 4-5 years, would gain market share due to the following factors:

Introduction of goods & service tax (GST) would reduce the price differential between unorganised and organised players, as several unorganised players evade the 12% excise duty.

Unorganised players cannot match the product portfolio of organised players. For example, Supreme has more than 5,800 products in PVC pipes and fittings.

Increase in retail distribution reach and brand equity through advertising and promotion by organised players would increase the market share gain from unorganised players.

Further, the organised players would benefit from improving construction quality standards in India. We believe reputed developers would prefer the superior-quality PVC pipes of organised players as compared to the lower-quality pipes by unorganised players.

Industrials


Availability is the key for building a brand We had extensive discussions with dealers across metro cities and tier-3 and tier-4 cities in west India and south India to understand the customer perception of organised PVC pipe brands. Our discussions confirm that Astral has a strong CPVC brand in urban India but it is not a significant player in rural India. Supreme has a strong PVC brand across west and south India especially in Bangalore and Maharashtra (ex-Mumbai). Finolex’s high-quality pipes have a very strong brand recall in rural India but a weak brand in urban India. In our opinion, the key driver for creating a strong brand and increase sales is product availability. Dealers are hesitant to push products with limited availability. For instance, dealers in Chennai believe that Supreme has the best PVC pipes but they do not recommend Supreme to customers as its PVC pipes have limited availability.

Exhibit 4: Customer perception of PVC pipe brands across west and south India – Consistent availability is the key

Astral Supreme Finolex West India

Urban

Astral is clearly the #1 CPVC brand and its PVC pipes are comparable to Supreme in Mumbai and Pune

Astral has a very strong brand name in both PVC and CPVC in Ahmedabad

Supreme is not widely present in Mumbai; Prince is the most popular PVC pipe brand in Mumbai

Supreme along with Prince has a strong presence in Pune

Supreme has a strong brand name in Ahmedabad

Whilst Finolex is the #3 brand in Pune and Ahmedabad, its sales are lower due to availability issues; Finolex sells at a premium to Supreme and Astral in Mumbai but it does not have a strong brand

Rural Not a significant player Supreme’s brand recall is lower than

Finolex’s and Jain Irrigation’s Finolex is the clear market leader and

has a very high brand recall

South India

Urban Astral has a strong CPVC brand name

However, PVC pipes brand is materially weaker than Supreme

Supreme is market leader in Bangalore and has the highest brand recall; in fact customers enquire about Supreme's pipes.

Supreme's PVC pipes are not available in Chennai due to supply constraints

Good quality pipes and good brand but pipes are not available

Rural Several dealers have not even heard about Astral

According to multiple dealers, Supreme’s sales for agriculture use have declined in the last two years due to availability issues

Finolex is the market leader followed by Jain Irrigation and Kisan

Source: Ambit Capital research

West India: Astral - CPVC leader; Supreme - Urban PVC; Finolex - Rural PVC

Astral PolyTechnik (Astral) has the best brand in CPVC pipes in urban cities such as Mumbai, Ahmedabad and Pune but several rural dealers have not even heard about Astral PolyTechnik pipes.

Supreme is a strong brand in urban cities in west India (except Mumbai) and has moderate brand recall in rural India.

Whilst Finolex has the strongest brand in rural markets, its brand recall is very weak in urban markets.

South India: Astral - average pipes, Supreme - very strong brand and Finolex - rural market leader

Surprisingly, urban dealers believed that Astral’s CPVC and PVC pipes are not as good as Supreme’s and Astral is an average brand. We were under the impression that Astral is the best CPVC brand and Astral’s PVC pipes were comparable to Supreme’s.

Supreme has a very strong brand perception despite availability issues in and around Chennai.

Industrials


Finolex is the clear market leader in rural markets followed by Jain Irrigation, Supreme Industries and Kisan pipes

Hence, organised players are increasing capacity and reach In the last two weeks, we had detailed discussions with the managements of leading PVC pipe organised players such as Supreme, Astral and Finolex Industries. All the three managements were confident of outperforming the strong PVC pipe industry growth of 10% CAGR in FY13-16. The managements of the three companies reiterated that the key to volume growth and strong band perception is consistent product availability. Hence, these three companies have plans to substantially increase capacity and dealer network across India to increase manufacturing and distribution reach.

Astral: most aggressive; Finolex: laggard

Astral is the most aggressive company amongst the three organised PVC pipe players in terms of capacity addition and new product launches.

Exhibit 5: Astral - most-aggressive plastic piping player

Particulars FY11 FY12 FY13

Volumes (tonnes)

Finolex 138,322 150,730 170,000

Supreme 133,143 151,264 180,746

Astral PolyTechnik 28,289 38,824 49,495

Realisation (`/kg)

Finolex 73 80 81

Supreme 79 87 94

Astral PolyTechnik 145 149 166

Sales (` mn) Finolex 10,083 12,074 13,778

Supreme 10,544 13,148 16,910

Astral PolyTechnik 4,108 5,793 8,211

EBIT margin (%) Finolex 7.2% 5.8% 7.2%

Supreme 12.5% 13.0% 16.0%

Astral PolyTechnik 11.3% 12.5% 11.7%

Source: Company

Astral plans to increase its PVC pipe capacity from ~85,000 tonnes in FY14 to 130,000 tonnes by FY16 (14% CAGR) and also increase the contribution from new products such as column pipes, fire sprinkler system and bendable pipes. On the other hand, Finolex Industries would focus on reducing its relatively high debt:equity (0.86x in 1HFY14) during FY13-16. Hence, it plans to increase capacity after FY16 but it has no active plans to launch new products. Supreme would continue with its asset optimisation strategy by judiciously increasing capacity in its fast-growing plastic piping and packaging segments. Hence, we project that Supreme’s revenue growth would be lower than Astral’s but higher than Finolex’s.

Exhibit 6: Evaluating the snowball effect momentum

FY13-15 revenue

growth (%)

FY13-15 capital

expenditure (` mn)

FY13-15 EBITDA (` mn)

1HFY14 Debt:Equity

1HFY14 Asset turnover (x)

Supreme Industries 17.8% 5,600 14,213 0.78 2.00 Astral PolyTechnik 29.9% 1,400 3,422 0.34 2.75 Finolex Industries 9.5% N.A. 10,577 0.86 2.24

Source: Industry, Ambit Capital research

Industrials


Dealer checks suggest Astral would continue to outperform Astral reported yet another strong quarter in Oct-Dec 2013. The PVC pipe volumes of Astral increased by 24% YoY as compared to a 2.6% YoY increase for Supreme and a 7.6% decline for Finolex Industries. Finolex Industries’ PVC pipe volumes declined due to elongated monsoon and lacklustre demand from the agriculture sector. The key reasons for Astral’s outperformance were: (a) higher share of CPVC pipes at 58% of revenues and (b) more than 30% YoY growth in recently launched products such as bendable pipes and composite column pipes.

Exhibit 7: Summary of Oct-Dec 2013 quarter performance of plastic pipe players

Particulars Oct-Dec

2013 Oct-Dec

2012 Jul-Sep

2012 YoY

growth QoQ

growth

Volumes (tons) Finolex 42,974 46,399 29,489 -7.4% 45.7%

Supreme 42,388 41,304 32,337 2.6% 31.1%

Astral PolyTechnik 15,349 12,378 13,822 24.0% 11.0%

Total 100,711 100,081 75,648 0.6% 33.1%

Realisation (`/kg)

Finolex 89 77 94 15.9% -5.7%

Supreme 108 93 113 16.0% -5.0%

Astral PolyTechnik 173 167 185 3.5% -6.7%

Total 110 95 119 15.9% -7.9%

Sales (` mn)

Finolex 3,819 3,558 2,779 7.3% 37.4%

Supreme 4,570 3,840 3,670 19.0% 24.5%

Astral PolyTechnik 2,651 2,065 2,558 28.4% 3.6%

Total 11,040 9,463 9,007 16.7% 22.6%

EBIT (` mn)

Finolex 340 123 238 176.4% 42.9%

Supreme 617 557 562 10.8% 9.9%

Astral PolyTechnik 394 197 371 100.0% 6.2%

Total 1,351 877 1,171 54.1% 15.4%

EBIT margin (%)

Finolex 8.9% 3.5% 8.6% 545 bps 34 bps

Supreme 13.5% 14.5% 15.3% -100 bps -180 bps

Astral PolyTechnik 14.9% 9.5% 14.5% 532 bps 36 bps

Total 12.2% 9.3% 13.0% 297 bps -76 bps

Source: Company, Ambit Capital research. Note: (a) * Total is the sum of the three listed plastic piping players: Finolex Industries, Supreme and Astral, (b) Supreme is June-ending

Strong demand for Astral in south India supported by higher credit period and smarter ad-spend

Our dealer checks suggest that the demand for Astral is very strong in south India especially from real estate developers. The demand is equally strong for PVC and CPVC pipes of Astral PolyTechnik. Astral’s higher growth is supported by higher credit period to distributors of 60 days as compared to peers. Astral also offers 2% cash discount to dealers. Supreme provides 14 days of credit for both PVC and CPVC pipes. Finolex Industries does not provide credit to dealers/distributors for PVC pipes. .

Industrials


Advertising strategy: Astral-National; Supreme-Local; Finolex-Rural Each of the organised PVC pipe players (Supreme, Finolex Industries and Astral) has consistently gained market share from unorganised players. However, each organised PVC pipe manufacturer has a very different marketing and promotion strategy to build a brand in a seemingly commoditised industry.

Supreme Industries advertises in partnership with distributors in local newspapers, as shown below. The distributors of Supreme PVC pipes are not offered promotion incentives by the company and the distributors have to share the print advertising cost with Supreme Industries. We believe that Supreme Industries would increase national advertising to increase brand visibility given the recent national campaigns from its competitor Astral.

Exhibit 8: Supreme’s local print advertisement for PVC pipes

Source: Company, Ambit Capital research

Exhibit 9: Supreme’s local print advertisement for industrial crates


Astral PolyTechnik: Whilst Astral’s revenues are the lowest amongst Supreme and Finolex Industries, Astral has a very smart national media marketing and promotion strategy. For example, Astral had done a promotional tie-up with the production house for the movie, Dabangg 2. Through this tie-up, Astral used Mr. Salman Khan, one of the most popular Indian actors, to advertise Astral’s pipes at a cost of less than `10mn. The average fee charged by Mr. Salman Khan to become a brand ambassador is `70mn-80mn. Thus, Astral used Mr. Salman Khan to promote Astral Pipes at a fraction of his brand ambassador fees. The company has again tied-up for a joint marketing of Kick, a movie of Mr. Salman Khan. In addition, Astral has used comparatively lower-cost cricket stadium advertising to create a strong retail brand. Astral’s efforts have yielded results, as the share of retail customers has increased from 25% in FY11 to 35% in FY13.

Industrials


Exhibit 10: Astral advertisements in cricket stadium


Exhibit 11: Astral co-branding advertisement with Dabangg-2


Finolex Industries: The agriculture sector accounts for 70% of Finolex Industries’ sales and 20% of its sales are derived from rural housing. Hence, Finolex Industries advertises in regional newspapers in partnership with local distributors.

Exhibit 12: Finolex local newspaper print advertisement


Industrials


Relative valuation In our opinion, Supreme’s and Astral’s valuation premiums to many of their smaller peers are justified owing to their higher than industry average RoCEs/ RoEs, expected higher FY13-15 sales growth and PAT margins. However, Supreme is trading at a 9% discount to Astral, which is unjustified given Supreme’s larger size, higher RoE and diverse product portfolio; whilst Astral is growing fast and could soon become an equally large pipe player, Astral’s relatively lower RoE should restrict multiple expansion from hereon. Finolex is trading at a discount to Astral/Supreme owing to lower RoCE/RoE, lower asset turnover and limited product portfolio (mainly for the agriculture industry).

Exhibit 13: Relative valuation summary

Companies Mcap

Rev (US$mn) Rev

EBITDA margin (%)

PAT margin (%) RoE (%) PE (x) EV/EBITDA (x)

US$ mn FY14 CAGR FY13-15 FY14 FY14 FY14 FY14E FY15E FY14E FY15E

Supreme Industries* 930 627 16.2 14.7 7.2 29.1 19.3 15.3 10.1 7.6

Motherson Sumi 3,338 4,655 17.2 9.0 2.9 33.9 22.2 16.8 9.1 7.3

Jain Irrigation 423 923 15.1 14.0 2.7 6.9 16.0 9.1 7.8 6.7

Sintex Industries 185 934 8.7 16.0 6.1 9.8 3.6 3.5 4.5 4.0

Time Technoplast 115 331 17.5 14.3 4.5 11.1 7.4 5.8 4.5 3.8

Finolex Industries 371 394 11.7 13.0 6.6 21.0 14.3 11.4 9.3 7.2

Astral PolyTechnik 347 152 27.9 14.0 6.7 26.9 28.9 18.9 14.8 11.8

Average 13.6 5.2 19.8 16.0 11.5 8.6 6.9

Global Players Aliaxis 1,524 3,057 N.A. N.A. N.A. N.A. N.A. N.A. N.A. N.A. Tessenderlo Chemicals

871 2,738 2.3 6.2 0.5 (3.8) 103.8 19.9 9.9 6.9

China Liansu 1,826 1,726 14.3 18.6 12.0 22.1 8.0 7.0 4.8 4.2

Global Average 12.4 6.2 9.2 55.9 13.4 7.4 5.5

Source: Company, Bloomberg, Ambit Capital research; Note (a) * June-ending companies, rest are March-ending, (b) Market cap is as on 03rd March 2014, (c) ** Global players are December-ending (d) We have adjusted the financial performance of plastics of Supreme Industries for comparison with its peers.

Cross-cycle valuations: Trading near all-time high Astral and Supreme are currently trading near their all-time high valuations on FY15E EPS and FY15E EBITDA supported by strong revenue growth, improving capital employed turnovers and improving RoEs.

Exhibit 14: Astral trading near its all-time high one-year forward P/E (x)


Exhibit 15: Supreme trading near its all-time high one-year forward P/E (x)


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Industrials


Key catalysts: Whilst all the three organised PVC pipe manufacturers would benefit from a shift from unorganised to organised players, each company has unique catalysts:

Supreme Industries: The key catalysts for Supreme would be increase in geographic reach in east India through the Kharagpur plant and sale of composite cylinders.

Astral PolyTechnik: Capacity expansion and increase in retail counters at its Hosur plant and economies of scale in new products such as composite column pipes, bendable pipes and Blazemaster are key catalysts.

Finolex Industries: The main catalyst for Finolex would be a transformation to an integrated PVC pipe manufacturer and reduction in debt. After Finolex has transformed its business model, it would expand its capacity and distribution reach. Another catalyst could be the launch of new products to leverage its strong brand image.

Key risks In our opinion, the key risk for all three organised PVC pipe players is increase in competition from large global players such as Aliaxis, which recently acquired a majority stake in Ashirvad Pipes. In addition to the above risk, the individual risks for the companies are:

Supreme Industries: Delay in approval for composite cylinders or lower-than-expected acceptance of composite cylinders.

Astral PolyTechnik: Slowdown in institutional construction spending could lead to lower than management guidance of 20% volume CAGR in FY14-16.

Finolex Industries: We believe it would be difficult for Finolex Industries to increase the share of fittings given that 70% of its sales are derived from the agriculture sector. Further, it would be difficult for Finolex Industries to replicate its strong rural brand in urban markets.


The leader Supreme would continue expanding reach and product portfolio; alongside we expect exports (Silpaulin and Composite Cylinders) to increase. We believe composite cylinders ramp-up could be a positive surprise, as Time Technoplast indicates strong traction and a possible OMC tender in the near-term. Lastly, we believe Supreme will also invest in national advertising for augmenting its brand awareness and volume growth over FY13-16. We estimate revenue growth of 20% YoY in 2HFY14E (due to volume growth of 12% YoY) but 170bps lower EBIT margins of 15.2%. EBIT margins would decline YoY due to lower margins in industrial and consumer but gradually increase with volumes. We retain our BUY stance.

Competitive position: STRONG Changes to this position: POSITIVE

Supreme expects 20% FY13-16 sales CAGR; higher than our estimate The management expects 11% volume CAGR in FY13-16 (in line with our est) driven by all the segments (except industrial products). In order to combat the domestic slowdown, Supreme would increase exports (mainly Silpaulin) to 5% of sales (from 2.5%). Supreme would increase national advertising spend to gain market share from unorganised players. Further, the company expects 20% revenue CAGR in FY13-16, implying 8% realisation CAGR. We believe Supreme would not be able to increase the prices of its products more than the PVC resin price increase, leading to stable EBIT margins of 13%.

Composite cylinders could turn out to be the joker in the pack We expect moderate revenue of `2bn in composite cylinder in FY13-16, below the management’s expectations of `2.5bn-3.0bn. Time Technoplast has received an order from Reliance Gujarat for 50,000 10kg LPG composite cylinders priced only 20% higher than steel cylinders. The customer response has been very positive to these composite cylinders in Gujarat. Supreme has already got an export order from South Korea and if Indian OMCs were to re-launch tenders, that could be a positive surprise.

Packaging and piping to lead volume growth recovery in 2HFY14 In 2HFY14, we expect revenue growth of 20% YoY, volume growth of 12% YoY and realisation growth of 7% YoY. The volume growth would be led by the packaging segment (28% YoY) and the plastic piping segment (17.7% YoY). The company has passed through the increase in PVC prices in the piping and packaging segment but not in the consumer and industrial segments. Hence, we estimate adjusted plastic EBIT margins to decline.

Reasonable valuation with limited downside risks, BUY, TP 480 We use the SOTP method for our TP of `480, implying 17.0x FY15E core EPS. Whilst the upside is 6%, we believe there are multiple upside catalysts to our estimates, such as visibility in composite cylinder revenues. Hence, we will revisit our estimates after we get more clarity from the management. Valuation of 15.8x FY15E core EPS is not representative of its superior competitive advantages, balance sheet capacity and high return ratios.

Supreme Industries BUY

COMPANY UPDATE SI IN EQUITY March 05, 2014

Key financials(` mn, unless specified)

Year to June FY12 FY13 FY14E FY15E FY16E

Operating income 29,279 34,040 39,172 46,531 54,302

EBITDA 4,719 5,356 5,974 7,796 8,840

EBITDA (%) 16.1% 15.7% 15.2% 16.8% 16.3%

Adjusted EPS (`) 16.6 22.3 22.3 28.1 35.2

RoE (%) 33.9% 36.0% 29.1% 29.8% 30.1%

P/E (x) 21.0 15.6 19.3 15.8 11.8


Industrials

Recommendation Mcap (bn): `57/US$0.9 6M ADV (mn): `39/US$0.6 CMP: ` 454 TP (12 mths): ` 480 Upside (%): 6

Flags Accounting: GREEN Predictability: GREEN Earnings Momentum: GREEN

Catalyst

Strong volume growth in PVC pipes and Silpaulin

Acceptance of composite cylinders

Wider manufacturing and distribution reach

Performance (%)


Analyst Details



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Supreme BSE Sensex (RHS)

Supreme


Balance sheet

Year to June (` mn) FY13 FY14E FY15E FY16E

Total Networth 8,790 10,611 13,309 16,459

Loans 4,089 5,439 4,939 4,439

Sources of funds 13,785 16,956 19,154 21,804

Net block 10,277 11,626 13,714 15,857

Investments 1,098 1,098 1,098 1,098

Cash and bank balances 239 1,148 1,545 1,792

Sundry debtors 2,031 2,657 2,961 3,508

Inventories 4,668 5,183 5,306 5,729

Loans and advances 1,660 1,965 2,282 2,703

Total Current Assets 8,617 10,973 12,113 13,752

Current liabilities and provisions 6,538 7,091 8,121 9,103

Net current assets 2,079 3,882 3,992 4,649


Income statement


Operating Income 34,040 39,172 46,531 54,302

% growth 16.3% 15.1% 18.8% 16.7%

EBITDA 5,356 5,974 7,796 8,840

EBITDA margin 15.7% 15.2% 16.8% 16.3%

EBIT 4,539 4,991 6,635 7,483

Interest Expense/(income) 523 704 529 409

PAT 2,617 2,740 3,464 4,365

Share of associates 217 87 100 110

Consolidated PAT 2,834 2,827 3,564 4,475

Consolidated EPS (`.) 22.3 22.3 28.1 35.2


Cash flow statement


PBT 4,014 4,318 6,137 7,107

Change in working capital (198) (1,006) (575) (941)

CFO (before exceptional) 4,046 3,779 5,825 6,016

Purchase of fixed assets (3,698) (2,350) (3,250) (3,350)

CFI (3,627) (2,320) (3,219) (3,317)

Net borrowings 1,187 1,350 (500) (500)

CFF (324) (550) (2,210) (2,452)


Ratio analysis / Valuation parameters


Net debt/Equity 0.4 0.4 0.3 0.2

Working capital turnover (x) 18.5 15.0 13.3 12.9

Gross block turnover (x) 2.9 2.7 2.6 2.6

ROCE 25.6% 22.1% 21.7% 22.7%

ROE 36.0% 29.1% 29.8% 30.1%

P/E (x) 20.2 20.2 15.8 11.8

EV/EBITDA (x) 11.4 10.3 7.8 6.8



The challenger Astral is challenging Supreme’s PVC pipes leadership by expanding into regions and adding new product lines. The not-well-understood underlying reasons for Astral’s stellar 43% revenue CAGR in FY08-13 are: (a) increase in dealer network and (b) increase in share of retail customers through extensive brand building. In addition to the existing growth drivers, capacity and reach expansion (alongside brand investment) and higher penetration of new products (electrical conduits, column pipes and blazemaster) would be the key drivers of 30% revenue CAGR in FY13-16. Further, the management has a relentless focus to add new products and improve process efficiency.


What are the main underlying reasons for Astral’s stellar growth?

Astral’s revenue growth (43% CAGR in FY08-13) significantly exceeded its organised peers due to the outperformance of PVC pipes (40% revenue share in FY13 vs nil in FY04) and higher acceptance of CPVC pipes, which is well understood by investors. However, the underlying reasons for the outperformance are: (a) increase in dealer network from 7,000 counters to 14,000 counters, (b) increase in share of retail customers, and (c) high PVC and CPVC sales to organised real estate developers. Astral used aggressive promotional activities such as co-branding with Dabangg-2 and stadium sponsorships for Sachin Tendulkar’s last test match series to increase visibility with retail customers.

Do not underestimate the advantages of manufacturing expansion

Astral has set-up a greenfield plant at Hosur with an initial capacity of 9,000 tonnes which would be increased to 30,000 tonnes in just 18 months. It currently transports pipes and fittings manufactured in Gujarat to south India at a freight cost of 7-8% of total cost. Astral can undercut the competition and quickly gain market share in south India by passing on the freight cost savings to retail customers. In addition, the company would increase distribution reach in rural areas to derive sales from the agriculture sector.

Higher penetration of new products to drive volumes

Astral’s 15-20% revenue CAGR in FY13-16 would be driven by higher penetration of the recently launched products (such as bendable pipes and column pipes) and new product launches (such as electrical conduits and CPVC fire sprinkler systems). According to the management, there is a large opportunity worth `25bn-30bn in composite column pipes and Astral’s FY14 composite column pipe sales would be only `0.2bn. Astral would launch BlazeMaster, CPVC fire sprinkler systems wherein the estimated opportunity is `15bn. In addition, its is also planning to expand solvent cement capacities.

Relentless focus by management to increase volumes and reach

Despite 40% revenue CAGR revenue, the management is always on the lookout for new products and new technology tie-ups. Further, Astral has appointed an independent agency to identify weak distribution reach areas and then devise mechanism to set-up distributors and retail counters in these areas. Current valuations (18.9x FY15E EPS) are not expensive, considering its high RoEs (five-year average of 24%), strong competitive advantages in fast-growing engineered plastics and high-quality management. Reduction in working capital days and operating leverage should improve RoCEs.

Astral PolyTechnik NOT RATED

COMPANY UPDATE ASTRA IN EQUITY March 05, 2014

Industrials

Recommendation Mcap (bn): `22/US$0.3 6M ADV (mn): `8/US$0.1 CMP: ` 380

Flags Accounting: GREEN Predictability: GREEN

Earnings Momentum: GREEN

Catalyst

Higher acceptance of new products

Geographic and capacity expansion

New technology tie-up with reputed global firm

Performance (%)


Analyst Details



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Astral BSE Sensex (RHS)

Astral PolyTechnik


Income statement

Particulars (` mn) FY10 FY11 FY12 FY13


EBITDA 419 560 818 1,116

EBITDA margin 14.5% 13.6% 14.1% 13.6%

Net depreciation / amortisation 86 107 134 177

EBIT 386 465 723 960


Adjusted PBT 337 422 496 779

Adjusted PAT 281 334 383 595

EPS (Adjusted) (`.) 5.0 6.0 6.8 10.6


Balance Sheet


Total Networth 1,181 1,488 1,856 2,418

Loans 404 448 887 895

Sources of funds 1,602 1,953 2,760 3,401

Net block 878 1,040 1,551 2,055

Cash and bank balances 38 102 350 114

Sundry debtors 510 1,133 1,692 1,700

Inventories 697 862 1,255 1,481

Loans and advances 259 395 427 575


Current Liabilities 983 1,280 1,943 1,928

Provisions 23 32 48 75

Net current assets 662 831 1,067 1,214


Cash Flow statement


PBT 337 422 504 779

Change in working capital (122) (3) 66 (373)

CFO (post -exceptions) 255 461 841 688

Purchase of fixed assets (178) (335) (687) (681)

CFI (182) (328) (668) (717)

CFF (58) (70) 75 (207)

Free cash flow 77 126 154 7


Valuation metrics and ratios

Particulars FY10 FY11 FY12 FY13




ROCE 24.8% 21.4% 25.4% 23.6%

ROE 26.6% 25.1% 22.9% 27.8%

P/E (x) 76.1 63.9 55.8 35.9

P/B (x) 18.1 14.4 11.5 8.8



Turnaround - Challenges galore We appreciate Finolex Industries’ turnaround plan through: (a) no further investment in the PVC resin business, (b) increased share of the fittings business (from 8% in FY13 to 13% in FY16), and (c) increased distribution reach. But, this turnaround plan faces several challenges, as it is difficult to effectively increase: (a) the share of fittings without investing in own capacities, (b) distribution reach without investing in capacities and products and (c) increase PVC resin margin. The stock is trading at 11.4x FY15E EPS; eps estimate appears aggressive. Finolex should trade at a justified discount to Supreme and Astral, due to its lower RoCE even if it achieves the turnaround plan.


Turnaround journey to integrated PVC pipe manufacturer

Finolex Industries’ management has articulated a turnaround plan to become an integrated PVC pipe manufacturer. This turnaround strategy is based on: (a) efficient capital allocation (no further investment in the capital-intensive PVC resin business), (b) increased share of fittings (from 8% to 13%), and (c) increased distribution reach in urban cities and east India. At the analyst meet, the management showed its intent to monetise a land parcel worth ~`7bn.

Challenge 1: Why outsource production of higher-margin fittings?

The key challenge for Finolex’s turnaround is to increase the share of fittings from 8% to 13%, as 70% of its sales are derived from the agriculture sector. The increase in fittings would be driven by an increase in the share of urban sales. However, our dealer checks suggest that Finolex’s brand recall is weak in urban markets. Whilst the management is bullish on fittings, it continues to outsource almost 100% production of fittings. Since Finolex has a cash and carry policy, we believe it would be tough for Finolex Industries to increase the share of real estate developers and hence fittings.

Challenge 2: Increase distribution reach without expanding manufacturing reach

Finolex Industries has plans to increase its distribution reach in north India and east India. However, the company does not intend to increase its manufacturing reach. Its existing capacities in west India can be scaled up to 350,000 tonnes. PVC pipes and fittings are freight-intensive products. We understand that the freight cost from west India to south India is 7-8% of sales. Hence, Finolex Industries’ EBITDA margins could be below Supreme’s (FY14E: 14.8%) and Astral’s (FY13: 11.7%) if the company supplies to east and north India through its plants located in west India.

Challenge 3: Increase in PVC-EDC spread

The management believes that 2.0mn tonnes of additional global ethylene di-chloride (EDC) capacity would increase PVC-EDC spread as EDC prices drop. Finolex Industries has 130k tonnes of PVC resin capacity based on EDC. We believe it would be difficult to increase the PVC-EDC spread, as there is an excess global supply of 17mn tonnes PVC resin (16mn tonnes in China). Global demand for PVC resin is likely to increase 1.5% p.a for next few years, not reducing demand-supply imbalance.

Finolex Industries NOT RATED

COMPANY UPDATE FNXP IN EQUITY March 05, 2014

Industrials

Recommendation Mcap (bn/US$mn): `23/US$357 6M ADV (mn): `20/US$0.3 CMP: ` 187

Flags Accounting: GREEN Predictability: AMBER Earnings Momentum: GREEN

Catalyst

Pick-up in demand from agriculture sector

Increase in RoCE post debt repayment

Performance (%)


Analyst Details



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Finolex BSE Sensex (RHS)

Finolex Industries


Current valuations—to remain cheap for multiple reasons

We expect Finolex to grow behind Astral and Supreme over the next few years. Finolex is very thinly covered and hence we believe that the Bloomberg estimate of 26.3% YoY FY15 EPS growth derived from 240bps YoY increase in FY15 EBITDA margin to 15.4% is highly aggressive. Finolex is trading at 11.4x FY15E on this aggressive EPS; Finolex should trade at a justified discount to Supreme and Astral, due to its lower RoCE even if it achieves the turnaround plan. Finolex Industries’ RoCE would be lower post the turnaround also due to the lower share of fittings and the capital-intensive PVC resin capacity. Further, the management has not historically displayed any efficient capital allocation—high debt and cash, limited expansions, limited product line additions. Possible large land monetisation (`6-7bn market value) could be the key positive catalyst.

Finolex Industries


Income statement



Total expenses 11,921 17,580 18,830 18,822

EBITDA 2,628 2,197 2,168 2,627

EBITDA margin 18.1% 11.1% 10.3% 12.2%

Net depreciation / amortisation 617 744 755 544


Other income 195 294 305 334

Provision for taxation 416 388 216 540

Adjusted PAT 1,693 742 617 1,204

EPS (Adjusted) (`.) 13.7 6.0 5.0 9.7


Balance Sheet


Total Networth 5,877 6,203 6,621 7,212

Loans 8,335 7,467 10,423 8,395

Deferred Tax Liability 735 801 899 936

Sources of funds 14,946 14,471 17,943 16,543

Net block 8,356 7,925 7,840 8,795

Capital work-in-progress 664 722 854 506

Investments 3,264 2,080 4,932 3,596

Cash and bank balances 827 269 291 91

Sundry debtors 362 1,234 469 387

Inventories 3,398 4,013 3,263 4,828

Loans and advances 1,956 2,854 3,184 2,182


Current Liabilities 3,388 4,180 2,447 3,046

Provisions 493 446 444 797

Net current assets 2,663 3,745 4,317 3,645


Cash Flow statement


CFO (post -exceptions) 3,110 (942) 1,545 2,738

Purchase of fixed assets (999) (416) (676) (1,055)

CFI (1,509) 1,787 (3,235) 625

Net borrowings 111 (692) 2,800 (2,151)

CFF (1,061) (1,798) 1,712 (3,563)

Free cash flow 2,110 (1,358) 869 1,683


Valuation metrics and ratios

Particulars FY10 FY11 FY12 FY13




ROCE 12.4% 10.0% 8.4% 11.7%

ROE 24.3% 12.6% 11.4% 19.7%

P/E (x) 11.0 25.1 30.1 15.5


Finolex Industries


Institutional Equities Team

SaurabhMukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Aadesh Mehta Banking & Financial Services (022) 30433239 [email protected]

Achint Bhagat Cement / Infrastructure (022) 30433178 [email protected]

Aditya Khemka Healthcare (022) 30433272 [email protected]

Akshay Wadhwa Banking & Financial Services (022) 30433005 [email protected] Ankur Rudra, CFA Technology / Telecom / Media (022) 30433211 [email protected]

Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power / Capital Goods (022) 30433252 [email protected]

Dayanand Mittal, CFA Oil & Gas / Metals & Mining (022) 30433202 [email protected]

Deepesh Agarwal Power / Capital Goods (022) 30433275 [email protected] Dipti Abhyankar Economy (022) 30433229 [email protected] Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Krishnan ASV Banking & Financial Services (022) 30433205 [email protected]

Nitin Bhasin E&C / Infrastructure / Cement (022) 30433241 [email protected]

Nitin Jain Technology (022) 30433291 [email protected]

Pankaj Agarwal, CFA Banking & Financial Services (022) 30433206 [email protected]

Pratik Singhania Real Estate / Retail (022) 30433264 [email protected]

Parita Ashar Metals & Mining / Oil & Gas (022) 30433223 [email protected]

Rakshit Ranjan, CFA Consumer / Real Estate / Retail (022) 30433201 [email protected]

Ravi Singh Banking & Financial Services (022) 30433181 [email protected]

Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile (022) 30433292 [email protected]

Shariq Merchant Consumer (022) 30433246 [email protected]

Tanuj Mukhija, CFA E&C / Infrastructure (022) 30433203 [email protected]

Sales

Name Regions Desk-Phone E-mail

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA UK / USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Sarojini Ramachandran UK +44 (0) 20 7614 8374 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Sharoz G Hussain Production (022) 30433183 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]

E&C = Engineering & Construction

Finolex Industries


Explanation of Investment Rating Investment Rating Expected return

(over 12-month period from date of initial rating)

Buy >5%

Sell <5%

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