Stock Idea: GRP - Recycling for Moollah!!

GRP (Formerly known as Gujarat Reclaim & Rubber Products Ltd)

Describe the business in a few sentences. What does the company do? Who are its primary customers?

GRP is in the reclaim rubber business. Reclaim rubber is basically recycled rubber from both natural and synthetic rubbers. They are also getting started in the thermoplastic elastomer area for industrial usage. Rubber consumption in India is steadily increasing. To meet this demand, both natural & synthetic rubber source will not be sufficient. There are predicted shortages in availability on account of climate change and shortages in key ingredients like butadiene (which is a key raw material for production of commodity rubbers such as PBR, SBR, among others). With no short term solutions, reclaim rubber, at approximately 30-50% of virgin rubber prices and with 50% rubber content, is the best alternative to counter the supply constraints of virgin rubbers. Reclaim rubber is preferred for both tyre & non-tyre industry. Non-tyre sectors include conveyer belt, automotive profile, hoses, mats & flooring, roofing applications, hot melt adhesives, civil engineering. While historically the usage of reclaim in India as a percentage of virgin rubbers has been around 8%, the penetration has been rising and the Company is aggressively developing new grades to increase the usage of reclaim. The Company’s industrial polymers business caters mainly to the demand in the automotive industry, with bulk of its customers in the plastics compounding and automotive products manufacturing. The company’s Custom die-forms business caters to the export markets of North America. It has been producing under collaboration, components for use in mats, carpets and agricultural equipment. The company has achieved strong export growth in the last decade and spread itself to over 45 countries across the globe. This presence has been achieved using a judicious mix of direct customers and dealers who represent our company to the local industry with relevant support.

Is the sector that the company is in growing? i.e. Is there a headwind or a tailwind present?

Overall rubber usage is growing at a moderate pace (3-5% per annum). Reclaim rubber consumption is increasing at a similar pace. Increasing adoption is likely to increase the growth of reclaim rubber usage in the future. Thermoplastic elastomers is a new field and has very good demand.

What is the current market share of the company? Can the market share be increased?

It is very difficult to get market share details for the reclaim rubber industry. However, GRP is the market leader in India and one of the largest producers of reclaim rubber in the world. There is a perception challenge in the end user industry where no major manufacturer wants to admit to using reclaim rubber. So, it is unlikely that reclaim rubber is going to expand such that it takes up a major percentage of raw materials for production.

Who are the primary competitors? Why is this company a better investment than them?

Elgi Rubber and Balaji Rubber (unlisted) are competitors.

What is the owners’ and managements’ stake in the company?

Promoter holding is 46.49%.

Are management's salaries too high?

Management salary is reasonable. The MD & VC gets a total compensation of 1.12 cr.

How much debt is there in the balance sheet? Is it increasing, decreasing or remaining constant?

Debt is increasing and is currently around 70 crs. D/E ratio is around 0.8

Is the debt level normal for the sector the company is operating in (i.e. how much is the debt-equity ratio of its nearest competitors)?

Difficult to say. Indag Rubber, although not a competitor nor directly in the same segment, has no debt.

How much cash is there on the BS? What is the cash per share?

15 cr of cash on the B/S, which is not a material amount based on the overall business.

Is the Networth rising over the years?

Networth has increased from 31.21 in 2008 to 87.9 in 2012, a growth of about 29.5% cagr.

Is the inventory/sales rising or more-or-less in the same range? [Rising ratio may mean company is not able to sell its products.]

Inventory / Sales ratio is very low (0.09) so does not really makes a difference.

Is the debtors/sales rising or more-or-less in the same range? [Rising ratio may mean company is not able to collect payment.]

Debtors / Sales has reduced from 0.2 to 0.17 in the last 5 years.

Has the company increased its sale, net profit, operating margins and net margins over the years?

The company has increased its sale, profit and net margins over the years. Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Sales 110.74 132.19 144.82 187.35 240.28 Net profit 9.12 13.54 13.81 17.62 25.72 EPS 71.32 101.33 103.56 132.16 192.91 OPM 17.99% 18.45% 18.88% 16.53% 16.87% NPM 8.24% 10.24% 9.54% 9.40% 10.70% Dividend Payout 19.74% 17.21% 19.33% 17.42% 17.11%

Has the company increased it RoE, RoCE, (RoA for financial companies) over the years or atleast maintained it? How does it compare to its competitors?

Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 RoE 29% 32% 26% 26% 29% RoCE 22% 25% 24% 19% 21% RoE has been around 26-29% and ROCE around 20-22% over time.

Has the EPS growth over the years kept pace with sales/profit growth? (Impact of dilution)

There has been no dilution in the stock and EPS growth is in line with sales and profit growth.

Is the company operating cashflow positive? Is the operating – investment cashflow positive? Is the company net free cashflow positive? Is the Operating cash flow higher than earnings per share?

Cash flows are good for the company.

Does the company pay tax, dividends every year?

The company pays out between 15-20% of its income as dividend and pays out tax at the full rate.

Is the Free Cash Flow per share higher than dividends paid?

Yes.

Is the business capital intensive?

Working capital requirements are reasonably high. It is close to operating income of the company.

What is the expected valuation?

I expect the company to have a bad year this year in terms of growth and to be able to barely be able to manage last year’s earnings. Conservatively, I am assuming a FY13E EPS of 180-190 and FY14E of 220-240. The real kicker for this stock will be its foray in TPE (thermoplastic elastomers) which will probably take another 3-4 years to really produce results. At a PE band of 8-12, the stock may be priced closer to 2400-2500 in 15 months timeframe which is reasonably higher from current levels. Investors who have a longer timeframe (4-5 years), can easily SIP into the company for steady compounding returns.

Is the PE ratio below 15? Is the PEG above 1.0?

PE is less than 10. With growth of about 22%-25% on a regular basis, the PEG is well below 0.5.

Why do you think the stock is under priced? Is there an expectation to double the investment in 2-3 year timeframe? If not, why bother?

With a 4 year horizon, I am expecting a 1000 cr topline and 4 times EPS from the current levels.

What has been the share price over the last 5 years? Has it matched the profit growth? If not, why not? Does the market know something I don’t?

The share price has steadily grown over the years. Over the last 10 years, the stock has gone up 8229% vs 571% of the Sensex.

What will happen if the interest rates go up (or down)?

There will be a moderately negative impact of increasing rates. With a possibility of reduced rates, the company’s cost is likely to reduce slightly. Nothing significant here.

What will happen if there is cheap import (from China or somewhere else)?

The company is a major exporter and a market leader in India. Also, the sector is relatively unattractive to prevent large scale business from setting up.

What will prompt you to sell (stop loss / book profit)? i.e. What is the exit strategy?

This stock is more a portfolio stabilizer. i.e. something to buy and hold on for the long term. This is not a glamorous Sachin Tendulkar like stock but more like a Rahul Dravid one – toiling at the back and putting up an impressive record when no one is looking. Major downside would be if the company starts looking at unwarranted diversifications, increases debt (especially foreign currency debts), starts punting on currency hedges. Valuation wise, if the stock goes above 15-18 range, then it is time to look for the exit door.