Jitendra Kumar Gupta
While markets appear to be in an overheated zone, smart investors are still picking up stocks selectively. Deal data seems to suggest that Porinju Veliyath of Equity Intelligence, who is better known for buying turnaround stories that are often neglected by the markets, has recently cornered close to 100,000 shares of Shalimar Paints at Rs 197.84 a share.
Shalimar Paints with a market share of close to 1.5 percent is one of the top 5 brands in India’s paint industry. In the past 10 years the company has lost market share on account of inadequate capacity, frequent management changes and lack of focus on marketing.
Is there a change on the cards?
Apparently, the company is turning a corner. Shalimar is restarting Nashik operations in the first quarter of FY18 (which was damaged due to a fire in November last year, which manufactures resin, packaging and aluminium. It has expanded capacity at its Chennai plant and recently announced plans to restart Howrah plant.
A new leadership team is in place, too. The new Managing Director and CEO Surender Kumar was appointed in 2015 and is an industry veteran and has worked with rival AkzoNobel.
The company is also beefing up its dealership base and has introduced several new products particularly in the premium and luxury categories. Besides, it is re-building its brand and ran an advertising campaign on radio covering 100 cities.
Can the balance sheet hold up?
In FY16, the company made Rs 23 crore in cash from its operations, which was not enough to service its debt of Rs 145 crore (equity Rs 66 crore) with interest cost of Rs 22 crore.
It recently approved a rights issue for an amount not exceeding Rs 50 crore and announced plans to raise an unsecured loan from promoters to the tune of Rs 20 crore.
It is interesting to note that Shalimar has a diversified promoter holding. So the promoters are more like financial investors and their objective could be to generate handsome returns on their investment. The financial commitment could be a first sign of the same.
Apart from concerns about dilution and pricing, the bigger issue that will have to be addressed by the company is how much of this funding will help in achieving a turnaround.
Are the numbers reflecting the change?
After losses for two consecutive years (FY14 and FY15), the company made a profit of Rs 5 crore in FY16. In the first three quarters of FY17, it has made a profit of Rs 2.93 crore.
Is there room for improvement?
Shalimar is still a smaller player. AkzoNobel, which has the lowest market share (11 percent) among the larger players, has got a sales turnover of Rs 2,700 crore. As against this Shalimar Paints, which has 10,000 dealers (similar to AkzoNobel), has sales turnover of only Rs 430 crore. Consequently, the operating margin in single-digits is also much lower than its peers.
In terms of valuations, earnings-based valuations may not paint an accurate picture because the company only recently became profitable. The stock is currently valued at 16 times enterprise value to operating profits, which is about half of Berger Paints and Asian Paints valuations and closer to Kansai Nerolac’s valuation of 18 times.
This is certainly not cheap, especially when viewed in the context of the superior return ratios of peers. For example, Kansai Nerolac enjoys 26 percent return on capital and 27 percent operating margins while the ratios for Shalimar work out to 13 percent and 7.3 percent, respectively. Only a meaningful turnaround can justify the valuation and is Porinju’s investment an indicator of the same?