Monday, 19 December 2011

Sintex Industries: Is Mr.Market Overreacting?

Sintex Industries is synonymous with water tanks, plastic door/windows and many plastic products for building material. It has 95% market share in water tank business and is a market leader in building products and custom moulding. It is also pioneer in developing new applications/products leveraging their know how on plastic technology. Since last 4 years company has developed niche application called monolithic construction technology using plastic moulds that reduces the cost and time of constructing building significantly. Company has capitalized on first mover's advantage in monolithic segment and has current order book of INR 3000 crores in this segment. Company has unmatched history of paying dividends for last 78 years! In last 10 years, Sintex has grown its top line and bottom line at CAGR 17% and 34% respectively.

Now let us look at what has transpired in the last six months for sintex. In June 2011, company was trading at market cap of 5000 crores at P/E of 8-9, while at yesterday's closing Sintex was available at market cap of 1720 crores. In other words, company has lost market cap of whooping 3300 crores. So where did things go wrong for Sintex? Well, the answer lies largely in the FCCB. 

Let me first give some basics of FCCBs and how and why Sintex issued FCCBs. FCCB is Foreign Currency Convertible Bonds, a quasi equity financing available in the market. A company issues bond to foreign investors in which has a very low coupon rate however at the time of bond maturity bond holders have an option to convert their bonds into equity at pre determined conversion price. The premise here is that at the time of conversion, stocks will be trading at premium to conversion price and hence bond holders can make returns from the capital gain. However, in case if the stock prices are trading at discount to conversion price, bond holders have an option to redeem bonds and receive bond redemption premium. Typically the premium for 5 years FCCBs was 25-40% at the time of maturity resulting into annual interest rate of 5%-7%, a fairly attractive proposition for Indian companies. 

Around 2007-08, custom moulding business of Sintex was witnessing a strong traction and a huge opportunity was waiting to be tapped as there were no major players in this segment. Sintex started consolidating this business and in the process realized that it can become a significant global player in the industry leveraging its understanding of plastics business. At that point of time it started scouting for acquisition of large custom moulding companies across the world with ticket size of USD 400-500 million. It had already identified some targets in US and Europe. Sintex, being a aggressive company, built a war chest to part finance a large acquisition by issuing FCCB worth USD 225 million. However that move was ill timed as world was engulfed by financial crisis in later half of 2008. Sintex had to abandon its plans of large acquisitions. However it did manage to acquire some smaller companies in US, Europe and India utilizing USD 115 million in the process. 

Circa June 2011, European crisis engulfed the world, and rupee started falling unabated. In last 6 months, rupee has depreciated by 20%. This has a big impact on FCCB as companies which have borrowed money in foreign currency through FCCB, they have to pay back in USD thus increasing the outflow of the company by 20%, in case if bond holders opt to redeem bonds!

Following are the facts for Sintex FCCBs

FCCB amount: Zero Coupon USD 225 million

FCCB amount utilized: USD 115 million

Conversion price: Rs. 246/share

Redemption Amount: 130% * FCCB amount (USD 292 million)

Maturity Date: March 2013

Currently Sintex stock is trading at Rs. 63 and conversion price for FCCB is 246. It is very unlikely that bondholders will choose to convert their bonds into equity shares. Hence Sintex will have to pay the redemption amount of USD 292 million in March 2013, i.e. 15 months from now.

Now considering USD/INR conversion of 53 (though i do not believe rupee can remain at 53 till March 2013, but let's do worst case analysis) Sintex will have to shell out approximately 1550 crores by March 2013. According to Mr.Market this poses such a huge risk for the company that it has taken off INR 3000 crores from its market cap! Is this reaction justified? Let's dig deeper.

- If you look at company's balance sheet for FY2010-2011, you will notice following things
   Cash and Cash Equivalents: 900 Crores
   Investments: 1123 Crores (281 crores in Mutual Funds, rest in subsidiaries)
  Net Current Assets (including cash): 1828 crores
  working capital loans: 570 crores
  Term loan: 321 crores

So if you look at it closely, Sintex has liquid cash and investment of around 1100-1200 crores, which it can any day use to make repayment. That leaves around 350-400 crores which can be either be repaid through free cash flow generated from operations or from borrowings.

Sintex generated FCF of approximately 80 crores in FY2010-2011. If company maintains its revenue, EBIDTA guidance for FY 2011-12, company is likely to generate FCF of 200-250 crores of FCF. Thus it may be possible for Sintex to pay up entire redemption amount by March 2013 with resorting to very little extra debt ot no debt at all.

Even if we consider that Sintex is going to borrow additional 400 crores,Sintex's D/E ratio will be around 1.1-1.2, not unmanageable by any means. Sintex should be very easily able to raise the money from lenders at prevailing interest rates. Hence in my opinion default for FCCB is not a credible possibility. Moreover redemption of FCCB means that there will be no equity dilution from conversion of FCCB!

Another overhang for the market has been that Sintex made a late disclosure about an order received for one of its subsidiary Sintex Infra fro building power plant from Shirpur Power (Sintex's promoters are co-promoters of this company). However Sintex management has clarified that there is no cross holdings in the companies and Sintex Infra has bagged the order through bidding process. Even though the whole matter is little discomforting, there is no gross violation of corporate governance as per my understanding (if someone has more details and throw more light on this, it will be useful).

Considering remote possibility of default from Sintex on FCCB and 20% sustained growth in top line and bottom line, it seems imprudent to  wipe off 3000 crores based on currency movement and fear of default,without any fundamental deterioration in business. It appears to me that market has overreacted and built extremely negative scenario in the stock price.

Currently Sintex trades at 4 times last years earnings and company has affirmed its guidance of 25% growth in top line and EBIDTA in FY 12. This may be a good opportunity for long term investors to buy into a decent business at very reasonable price.

Disclosure: Please do your due diligence and don't solely rely on the views expressed here. I hold Sintex shares in my portfolio.

1 comment:

  1. Good analysis. My dad is holding shares of Sintex for a long time now, it has become 10 bagger and even after FCCB issue, he said he will continue to hold as it has strong business and good prospects ahead. I didn't get to discuss much with him on how he sees the FCCB issue, nor did I looked deeply in it as I am not comfortable with debt to equity of more than 1, but now after reading your post my doubts are cleared. Keep it up!

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