Sintex Plastics Technology Ltd (STPL) was spun-off from Sintex Industries in May 2017 and listed as an independent entity in August. As with any spin-off, the motivation was to unlock hidden value from the unrelated and capital intensive textile Business. Statistically spin-offs have proven to be value accretive in past, naturally a lot of hope was pinned on STPL as well.

Roughly one year since its listing on 8 Aug 2018, STPL fell from 124 rupees a share to a low of 30 rupees in July 2018, a massive drop of 75%. With the stock requiring 4x gain to scale back to its listing price from July lows, STPL has proven to be a multi-bagger in the reverse.

It is natural for Spinoffs to fall immediately after listing as shareholders who originally bought the pre-demerged entity with the intention owning the other (textile) business sells leading to a price drop. In the case of STPL this fall was intensified as convertible FCCBs worth 220M, issued prior to demerger were converted resulting in another 3crore+ shares being sold. However, when promoters announced their intention to increase stake by 10% over next 2 years, it looked like a classic spin-off scenario, where outsiders were selling and insiders buying.

But then the script deviated. In Q2 FY19 analysts’ meet, management announced their intent to scale down the government portion of the high margin prefab business, which contributed around 21% FY17 sales, to almost zero, on the argument that it lead to cash flow problems due to delayed collections and bank guarantees. This came as a huge surprise, as neither this issue was known to the analysts, nor the intent of closing down government business was clearly communicated in past (management cited compliance issues as reasons). This disrupted the PNL estimates completely leading to a free fall in the stock price.

As things stand now, the prefab business is expected to see continued decline over the next 2-3 quarters. The CM business however is growing at around 20% and company’s debt reduction plan appears to be well on track. Negative surprise from the management, combined with recent carnage in mid & small-cap stocks have already dragged the stock down to attractive valuation. Presently, STPL trades at significant discount to its peers, anywhere between 6 – 8x FY20 estimated earnings.

Plastic processing capacity in India is growing at around 13% CAGR. With per capita consumption among the lowest in the world, combined with sustained economic growth, this momentum is expected to stay. Introduction of GST is expected to benefit organized players like STPL to gain market share, as price differential with unorganized sector have fallen from 30% in past to around 10% now (as per an IDBI report)

Potential of sustained growth from the CM business, combined with strong domestic brand, and attractive valuation provides hope that the stock has potential to provide decent returns going forward.

In the midst of all these, what is interesting to note is that promoters have been converting debentures at around 90 rupees a share, which is around 3x the recent lows. In addition, promoters purchased around 1% from market in November 2017 at around 80 rupees average. These actions further boosts conviction on the story.

Cash flow estimates

Cash Flow estimates based on Q1FY19 conference call:

Notes:

1. FY18 CM revenue was 3818, including excise, which is expected to grow by 20% YoY. Estimated FY19 CM revenue will be (3818/1.125)x1.2 = 4072 Crores
2. Business from Government was 21% of FY17 top-line (5995 crore) = 5995×0.21/1.125 = 1119 Crs. Total contribution of prefab was 2053 Crs (34% of FY17 sale) = 1825 before excise. For Prefab, assuming 10% government business & 100% private business will be retained, FY19 estimated prefab revenue will be: 1825 – 1119 x0.1 = 818Crores
3. FY18 Prefab revenue was 1718, including excise, which is expected to come down to 850 Cr in FY19 & 750 Cr FY20. Aggressive FY19 revenue estimate 4072 + 850 = 4922 crores
4. Total revenue for FY19 will be 4072 + 818 = 4890 crores
5. FY18 combined topline estimated as 3818x(1/1.125)x1.2 + 850 = 4923.
6. Assumed 14.5% EBITDA margin for FY19 against management guidance of 16.5%, as it is not clear how margin expansion is planned ( If we assume 15.5% margin, then EBITDA comes to 763, which is closer to management estimates of EBITDA )
7. While CM has grown by 21% in Q1, margins have declined from 14% in FY18 to around 13% in Q1. Decline is due to increase in employee cost (unlikely to change) + potential increase in costs due to including certain items which technically qualify as capex, as opex. This component has to decline, plus some operative leverage has to kick in as utilization increases
8. Either the margins have to expand significantly from current levels or CM has to grow by more than 20% for the story to hold ground. Actually FY17 margins were around 16.9%, higher than the optimistic FY20 estimates here, so the feasibility of margin expansion cannot be ruled out

Industry Overview

The plastic and polymer industry is valued approximately 144,000 Crores, growing at an estimated 13% CAGR in terms of processing capacity.

India ranks among the lowest in terms of per capita consumption of plastic, at 11kg (lowest in Asia), compared to the world average of 28 kg, 38 kg for China, and 32 kgs for Brazil. The per capita consumption for The US, Germany, UK, Italy, Spain, Australia, Japan, Korea and Taiwan are more than 100 kg.

Domestic industry snapshot:

• Per capita consumption of virgin 11 kg and recycled 3.8 kg
• Virgin Polymer consumption in 2014-15 – 14 MMT
• Number of converting/processing units –30,000-plus (organised sector) and 20,000-plus (unorganized sector)
  Number of processing machines – 113,000-plus
• Processing capacity – 30 MMT
• Processing capacity growth – 13% (5-year CAGR)

By 2020, plastics consumption of India is set to increase from the current 12 million metric tonnes per annum to 20 million metric tonnes per annum. India is expected to deploy 180,000 machines by 2020 as compared to the current fleet of 113,000 machines. Exports of Plastics finished goods are set to nearly double from US$7.9 billion currently to about US$15 billion in next 5 years. The industry is determined to play a significant role in executing government’s vision of raising exports to US$900 billion by 2020
(IBEF Jan 2017 report, SPTL FY2017 AR)

Company overview

STPL was formed in 2017 through the demerger of the plastic business of Sintex Industries Ltd. The latter continued to manage the textile business, while the plastic business was spun-off into a new entity. Objective of the demerger was value creation for share-holders. In the pre-demerged entity, plastic business contributed to around 80-85% (TBC) of the sale: it was self-sustaining high return business, as opposed to capital intensive textile. General perception was, that the cash generated from the plastic business was getting drowned in the capital intensive textile business. Further, the combined entity was trading at 10x earnings before demerger, while most of the major plastic businesses were trading at over 20-30x earnings. Corporate structure of the new entity is as follows:

Product Mix

Raw material

Among the industry’s major strengths is the availability of raw materials in the country. Thus, plastic processors do not have to depend on imports. These raw materials, including polypropylene, high-density polyethylene, low-density polyethylene and PVC, are manufactured domestically.
(Source, IBEF, January 2017), AR FY17

Existing capacities, utilization and capex

STPL has 35 manufacturing facilities spread over 9 countries and 4 continents. Average utilization of Custom Moulding facilities is around 65-70% – no immediate capex is required. Prefab capacity is under-utilized.
STPL is positioning a new product in auto space – Urea Tank for BS-VI diesel vehicles. As per management, there are around 3-4 players in India, one being a manufacturer while rest importing from China & S. Korea. STPL expects additional revenue opportunity of 350/400 crs from this segment with peak demand coming from September, 2019

In view of company’s focus on reducing balance sheet, management is trying to keep capex to minimum (less than 200 crores per year, Q1DY19 capex was 21 crores). STPL is trying to tie up with local manufacturers to make its products available locally in new markets. 3 new plants signed up recently, taking capacity to 6 – company is targeting 12 such facilities. (Management spoke about using rented facilities to accommodate future growth)

Marketing & Sales

Contribution of domestic and international sales is more-or-less balanced at 50% currently. Management expects this to change to 60% domestic and 40% international in future.

In the domestic market, currently around 85% of the sale comes of the auto industry, which company is trying to reduce to 75% in the medium term and eventually 50% in the long term.

Management is trying to renew focus on retail business, and has recently reorganized corporate structure with separate CEOs for Retail & Institutional business.

STPL is trying to rebuild dealer-distributor network for retail. Currently company has around 260 active dealers and a strong presence in the west. Company is expanding operations in North India, and subsequently wants to extend to East & South. SPTL has introduced revamped distribution model in 2 regions – West & North, with 2 products – tanks & doors, and as per Q1FY19 concall, the traction received is positive. Company intends to introduce new products, such as kitchen cabinets, and extend to other regions subsequently.

Domestic CM business is expected to grow at around 20% and command margins of around 18-19% going forward.
In the International market, auto (22%, down from 70% in 2011), electrical (32-33%), aerospace (20%) industries contribute to more than 70% of the company’s revenues. Going forward, STPL intends to reduce contribution of auto (20%) and electrical segments marginally, and increase contribution of defence business. In FY19E, company expects international business to grow by 10% with around 12% margins (up 50-100bps from 11-11.5% currently)

Market share and competitors

STPL is currently available at more than 50% discount to its peers.

Corporate structure

The Company has two business operations – custom moulding (under its subsidiary Sintex-BAPL Ltd.) and EPC contracts for various infrastructure projects (under its subsidiary Sintex Prefab and Infra Ltd.). The custom moulding is further segregated into global operations (through its subsidiaries Sintex NP SAS (Europe) and Sintex Wausaukee Composites Inc. (the US)) and Indian operations being managed by Sintex-BAPL Ltd.

Company has 26 subsidiaries, of which, 25 are 100% owned, and one, BAPL Rototech, is 70% owned. Out of these, 3 entities are based in India, rest are international.

Debt outlook

Net debt (consolidated) as on June, 2018 was around 3164 crores. (Net debt was around 4000 crores at the time of demerger)

Free Cash Flow estimates are around 550 crores and 700 crores for FY19 and FY20. Additionally, 600 crore infusion from promoters through convertible warrants. Q1FY19 capex was around 21 crores, full year capex expected to be minimal (no guidance from management for FY19, but FY18 guidance was less than 200crores). STPL expects debt levels to come down to 2800 crores by FY19. Net Debt/ EBITDA target is 2.3 by 2020 (estimated net debt of 2200-2300 crores in FY20).

BAPL has refinanced debt worth Rs 1190 crores through KKR Private Equity. This is expected to result in savings of around 150bps. CoF is around 8.5% (TBC), for a tenure of 10 years, with part of interest payments are back ended. (KKR will be entitled to 4.8% premium on principal if BAPL achieves 25% CAGR for 3 years? TBC – IDBI report, P7, aside from board seat). As on June 2018 concall, entire money had been received from KKR and debt has been refinanced)

Liquidity
Receivable days have improved significantly to 58 days in FY18 from 76 days in FY17

Promoter holdings & recent actions

Promoter holding is 50.29% as of June, 2018, down 3.54% from 53.83% June, 2017. Promoters have reduced stake marginally every quarter in the past one year. No shares have been pledged.

Graphics Source: Value Research
On February 2018, STPL decided to increase authorized share capital from 65 crores to 76 crores. Company also issued warrants aggregating upto 600 crores, convertible at around 90 Rs within 18 months of issue. This is expected to add another 6.67cr shares, to 59.04 cr shares outstanding as on Dec 2017. Accordingly, in April 2018, promoters (Star Line Leasing Company) acquired around 2.04 crores of shares by converting warrants worth 184 crores at a conversion price of around 90 rupees per share. As of July 2018, 4.63 crores of warrants were outstanding for conversion.

Promoters also acquired around 0.6 crores of share from open market in Nov 2017, at an average acquisition price of around 80 rupees per share.

Spin off was executed in May 2017, and STPL listed on 8 Aug 2017 at around Rs 124/ share

Total # of shares outstanding at the time of listing was 55.5 crores (demerger was 52 crores per capitalmind.in).
Also outstanding was, FCCBs worth $110M, convertible at 92.16 rupees, at dollar price of 67.4463. This could add 8 crores of shares assuming entire issue is converted.

Allotment of shares against FCCB so far:
30/Nov/17 – 43.91L
21/Nov/17 – 29.27L
29/Sep/17 – 81.97L
30/Aug/17 – 155.88L
Total, around 311.03L
Additional estimated 90L FCCBs are expected to be converted in FY19.

Risk Analysis

1. As of June 2018, 73.52% of promoter’s shares are pledged. Promoters are raising debt by pledging shares to subscribe to warrants, and the pledge is unlikely to be released in the next 18-24 months.
2. Long term story of STPL is premised on the assumption that the CM business will be able to generate 20% growth compounded, or better. Q1FY19, CM grew by 21% and management expects to sustain or better this momentum going forward. However, any failure in sustaining segmental growth will disrupt the story
3. EPS guidance from management assumes EBITDA margin of around 16.5%. Q1FY19 margins were around 13%, down from 14% in FY18. Decline is due to increase in employee cost (unlikely to change) + potential increase in costs due to inclusion of certain items in PNL which technically qualify as capex as per management. This component has to decline, plus some operative leverage has to kick in as utilization increases. Management hasn’t elaborated on the details of margin expansion plans. Although, FY17 margins were around 16.9%, higher the guidance, so the feasibility of margin expansion cannot be ruled out.
4. Interest rate risk: as of end FY17, around 80% of STPL’s borrowings involved variable rates loans. As a result, company is exposed to interest rate changes (although borrowings at the end of FY18 is likely to have changed as bank debt worth at least 1190 crores was refinanced through KKR – latest numbers TBC)
5. STPL has significant operations outside India, particularly in the EU & US. Company undertakes transactions in foreign currency and as such is exposed to exchange rate risk. Although, STPL may not be involved in import or exports by any significant extent, the financials are consolidated in INR. Consequently, fluctuations in Euro with respect to INR has an impact on the consolidated numbers. In particular, company has significant ECB denominated in USD that is marginally hedged. Below table summarizes sensitivity to a 10% increase in INR against the respective foreign currencies:
6. As of end FY17, STPL had loans maturing in 1-5 years (ref. to table in appendix), although this may have changed now after KKR debt refinancing – TBC

One year historical price chart

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