Wednesday, 21 November 2012

Hyderabad Industries Ltd: A Mispriced Bet

I hope all of you had a fabulous time during Deepawali and are eager to make most of the new year that has begun. In last two months market has been topsy-turvy with undertone being on the optimistic side. Any good news on sector/stock specific front is followed by strong rally while bad news are considered to have been discounted. In last two months number of undervalued opportunities discussed on this blog and many other such blogs seems to have caught up and difference between price and value seems to have narrowed (though undervaluation still exists in quite a few). In such a stock specific market, it is generally difficult to spot opportunities which have under performed in spite of strong fundamentals and good performance. 

Hyderabad Industries Limited (HIL) is one such opportunity, which inspite of good fundamental, decent growth record in recent quarters, strong promoters and potential to grow at decent pace, is trading at very cheap valuations. It is  a story which in my opinion is slowly unfolding but is not perceived correctly by the market. It is still considered a cement sheet company which means slow growth and fluctuating margins and hence valued in line with other cement sheet companies at TTM P/E of 4-5. In short to me HIL seems a mispriced bet.

Business Overview: HIL is a CK Birla group company established in 1946 and was a pioneer in asbestos based cement sheet business.Even though fiber cement sheet business still constitutes 80% of the business, HIL has also entered into business of thermal insulation, accessories and recently green building products. It has 12 plants spread pan India covering length and breadth of the country. Following is the key snapshot for major businesses of HIL 

Fiber Cement Sheet Business: It has built formidable "Charminar" brand over the years and has developed extensive sales and distribution network covering even remotest rural areas in the country. It is the largest player in this segment with more than 20% market share. This business contributes around 80% towards revenue however its share in overall revenue mix is decreasing due to increased contribution from green building product division. A peculiarity of this business is that transportation cost is one of the major component of the cost structure. Thus producing end product near demand centers is critical for better margins and cost competitiveness. HIL scores very well on this front due to highest number of plants spread across different states of the country covering all the regions.Other players in the industry are Visaka Industries, Ramco Industries, Everest Industries etc.

Green building products: This business is marketed with the brand of "Aerocon" and has become very popular in recent times. It comprises of two products namely AAC blocks and Aerocon panels. 

AAC Blocks: Autoclaved aerated concrete blocks are made from mix of cement, fly ash, aluminium and other plasticizers. It has number of advantages over clay bricks such as more environmental friendly, much better thermal insulation property, very light in weight, less labor requirements. Even though AAC blocks are costlier than clay bricks on standalone basis, cumulative cost of construction is comparable due to number of advantages AAC blocks enjoy.  In time of increasing focus on climate change and government's focus on improving energy efficiency in building construction sector, green building products have huge potential. Moreover, in addition to "green" tag, ease of use, acute shortage of labor and rising prices of sand/cement and reduced construction time is motivating number of builders to shift to AAC blocks. In Ahmedabad area itself, I have seen many of the new apartment and commercial complexes  using AAC blocks instead of clay bricks.

HIL is one of the leaders in AAC blocks segment with close to 26% market share in southern and western market. Other large players include Siporex (Pune) and magicrete(Surat). It grew its AAC block business by 100% last year and is hoping to maintain good growth in coming years due to increasing demand, its focus on quality and its relationship with large real estate players.

Aerocon Panels: A panel made from recycled waste (fly ash) is a perfect replacement for plasterboard, plywood, particle board and brick wall. It is a green product certified by Indian Green Building Code (IGBC) and has huge number of applications including partition walls, office chambers, office partitioning, mezzanine floors and pre-fab structures. It has low weight, ductility, better thermal insulation and fire resistance. HIL is leader in this segment with 58% market share. Business in this segment grew at healthy 21% in FY 12.

Thermal Insulation Products: HIL is leader in calcium silicate based thermal insulation product. It markets its thermal insulation product in the name of "Hysil". It commands 65% market share in domestic industry. It has application across cement,power, petrochemical and fertilizer industry. Thermal insulation business is too small compared to its building product division. It also is a slow grower and HIL is looking to expand this business in international market by focusing on exports.

Financials and Fundamentals: 

Let me take this opportunity to express my gratitude to Ayush and Pratyush for creating wonderful site like It is fabulous and extremely useful  site for creating user defined screens without getting bogged down by only recent years numbers. Here is the snapshot of 10 year financials for HIL. 

Before I start analyzing the financials, I want to bring in an important perspective here. HIL till 2006-07 was predominantly a cement sheet manufacturing company with virtually no appetite for growth. It was operating in a mature industry and in tough competitive environment with focus on maintaining its market share instead of growing.Its growth rate hovered around the growth of industry as a whole or slightly better(7-8%). However, management decided to bring in new vigor to the company, HIL brought in Mr.Abhay Shankar as its MD and widened its focus from fiber cement sheet business to become a building product company. This key change is reflected in numbers as well.  Few things which are evident from the analysis of financial statements.

P & L:

  • HIL's top line grew 7% CAGR from FY 2003 to FY 2008 while it grew at CAGR 15% from FY 2008-2012.
  • HIL's net profit grew more than four fold from 14 crores in FY 2008 to 60.5 crores in FY 2012. This is CAGR 44% in four years. 
  • Over last 10 years profit margins have been all around the place and there is no consistency in the margin. However, it seems (may be too early to conclude) operating margins around 12-13% is a reasonable estimate considering improving product mix (higher contribution from green building products).
Balance Sheet: 

  • Key takeaway from balance sheet analysis is that HIL has deleveraged its balance sheet over last 10 years. HIL reduced its debt/equity from 1.9 in 2003 to 0.3 in 2012. 
  • HIL managed its working capital exceedingly well and improved over last 10 years. WC as % sales reduced from 24% to 12%. 
Cash Flow:

  • HIL has consistently generated positive operational cash flow and mostly in line with the profit generated by the company. 
Return Ratios:

  • Company's ROE has been fluctuating over the years ranging from   below 15% to above 40%. however in case of normalized margins for HIL, it has earned very decent ROE i.e. in excess of 20%. In FY 12, HIL earned ROE of close to 20%. 
  • ROE is contributed equally through margins, asset turnover and leverage. I have preference for businesses that are intrinsically asset light (or rather not asset heavy) and ROE is derived through balancing of all the three factors. HIL surely scores well on this front.
  • It has asset turnover ratio hovering around 2 in spite of continuous capacity addition and expansion. 
Key Drivers for HIL:

Even though many a times, history does give important clues to how future may pan out, it is not the case always. Things change, circumstances change, people change and organizations evolve. 

  • HIL management has become more proactive for last 4-5 years which is clearly reflected in the numbers. HIL management aims to more than double its top line from current 850 crores to 2000 crores by 2016-17. Please read following article.
  • Moreover HIL is slowly moving from being a pure fiber cement sheet  company to a building product company having larger number of products in its portfolio. Revenue mix is slowly but surely changing with contribution from green building products rising at fast clip. Management plans to change revenue mix of cement sheet/green building products to 50/50 by 2016-17 from current mix of 80/20. Typically green building products have higher margin than cement sheets and hence margin profile may improve further from current levels.
  • As I have been working in sustainability area, I see a clear focus by the government in promoting energy efficiency. Government is strongly promoting green and energy efficient buildings by bringing in new guidelines and building codes. Moreover, green buildings are economically  viable if one considers cost metrics in totality and hence no additional burden on stake holders for "green" tag. This makes me believe that there is huge opportunity waiting to be tapped and hence growth expectations of HIL are not misplaced.

HIL currently has market cap of 350 odd crores with PBDIT of 116 crores and has book value of 452. It is trading at TTM P/E of 5 and P/B of 1.05. 

Now there are two scenarios I would like to draw here. First one is the pessimistic scenario. If HIL does not do as well as management has indicated and just grows its top line at CAGR 10-12% for 4 years, it will end up with revenue of roughly 1400 crores. If I take normalized net profit margin of 7.5% (which I think is realistic considering changing revenue profile), it will mean NP of 104 crores and EPS of roughly 140. Even if I take P/E of 5 (which in my opinion very conservative), it will result into price of 700 i.e. CAGR 10%. It is reasonable to expect that company will at least continue to pay dividend equivalent to current dividend, it will add roughly 4% to returns. Thus total returns will be 14% post tax. Thus in worst case, I earn 14% post tax returns which is not bad at all.

However, if company grows in line with what management indicates, it will be earning EPS close to 200. Even if I assign modest P/E of 10 (for a 25%+ CAGR company) it will mean price of close to 2000. This will mean CAGR 40%.

Even though it is too early to conclude anything, HIL has reported excellent numbers in Q1 and Q2 showing 30% + growth in each of the quarters.

So it is one story where odds of losing reasonable returns is minimal while one can make good money without losing sleep!

Key Negatives:

So what all can go wrong in this story? 

  • Typically margins have been fluctuating widely and hence it is not unlikely that history repeats. However typically lower margins have been followed by above average margins in subsequent years. It is reasonable to assume that over a 5 year cycle, one would earn normalized margins.
  • Management may make pricey acquisitions (as it is mentioned as one of the possible strategies for growth) and not able to manage it well. It will also mean balance sheet may be leveraged and hence things go awry.
  • There are no major entry barriers to any of the segments of HIL (including green building products) and hence competitive landscape is going to be flooded with number of players resulting in moderating in margins or price war. This can result into lower margins that company commands today for green building products.
So what's the final verdict? HIL is a bet where odds of winning seems tilted in favor of investor while risk of loss is minuscule from this level.