Solar Power – The Next Big (PROFITABLE?) Thing

India is expected to add 90 GW of solar power in the next 5 years. The current cost of developing solar is approximately 4-4.5cr / MW. The costs have fallen by more than 70% in the last 5 years. Assuming the trend continues due to technological progress and increasing supply, lets say the average cost of solar for the next 5 years will be 3 cr / MW. The potential size of the solar market if the government reaches its target is 2700000000000 rupees only.

Now that you are done counting the number of zeroes, let me remind you that this is just the size of the Indian market. I have not even bothered calculating the size of the global market. Feel free to give it a shot and share it with me.

The BIGger question though is whether this growth comes with profitability for the players in this sector or not? Perceived growth in solar capacity has attracted a number of players from all over the globe in a sector with no barriers to entry. Excess competition is bound to drive down returns in the market. Additionally, increasing adoption of solar is also expected to impact other players in the industry value chain (Utilities, Thermal Power plants and Customers).

It is difficult to say how many players will emerge out as winners with the Governments push on solar. Given the commoditized nature of the offerings and significant risks it will be difficult for players to earn high Return on capital employed in the future.  What is clear though is that there will be many losers.

Before I dwell further, I will quickly give a brief overview of the participants in this sector (Power 101). The main participants in the sector are 1) Discoms (distribution companies) or state utilities which sell power to the customers and purchase power from IPPs 2) Independent Power Producers (IPPs) who own power generating assets 3) Customers that include both residential and industrial/commercial users that buy power for their daily needs and 4) Engineering Procurement and Construction (EPC) players that construct the asset for the IPPs and in many cases operate and maintain them throughout the lifecycle of the project. They however do not own the assets.

So here is how it works – State discoms or the Government entities (like NTPC and SECI) tender bids from various IPP developers to set up Solar power plants. These entities buy solar power from IPPs at a tariff rate and then sell it to customers based on that rate. IPPs bid based on competitive tariffs and the lowest bidder wins the project. The winner then gets into a Private Purchase Agreement (PPA) with the utility/discom to supply power for 25 years. The winning IPP(s) can then develop the project using its in house team or outsource to an EPC player which can build and operate it on IPPs behalf.

There are various sources of electricity which mainly include Solar, Wind, Hydro and Thermal (coal based). Thermal accounts for more than 65% of the country’s requirements right now while renewables which comprise of wind and solar account for just 15%. The Indian Government has set an ambitious (to put it subtly) target of installing 175 GW of renewables by 2022. The major thrust however is on solar. The Government through JNNSM scheme intends to set up 100 GW of solar power by 2022. This will include 40 GW of rooftop solar where customers will install rooftop solar panels and will not have to procure electricity from the grid/utilities as long as their needs are being met with the capacity installed. Essentially you pay for setting up the solar panels on your roof and then consume power for free all your life! This disruption will have serious implications on the sector as discussed later.

In the sections below, I briefly explore the risks in the sector and the impact on various players in the industry.


IPPs are primarily exposed to 3 key risks – Competition, Counterparty and Curtailment.

Competition Risk

Profitability in this segment is a function of the number of players in the market and the cost of modules. Low entry barriers in the business and no differentiation in terms of the offerings from IPP players has increased the level of competition and led to lower returns through extremely competitive bidding. This can be observed from the latest bidding in the REWA project where the tariff quoted was Rs. 2.97 per unit (3.3 levelized). This has reduced from Rs. 15/ unit in 2010. While decline in the costs of solar modules would account for most the difference, competitive bidding has only exacerbated the issue. Inflow of capital from countries with extremely low interest rates and therefore lower return requirement has not helped much either. The return on projects will reduce as more players enter the market.

There is generally a gap of 5-6 months from the date of bidding to procurement of modules. The reason for the same is that the winners need to arrange for financing after signing the PPA, post which the construction begins. Module prices have been reducing at an extremely fast pace and hence the developers speculate on the prices of modules at the time of bidding. Their IRR requirements are based on the assumption of module prices which account for more than 50% of the cost of the project. Given the trend in decline of prices, the bidders make extremely aggressive assumptions in their models which leads to competitive bidding. The problem with this approach obviously is that the module prices cannot keep falling forever and a material difference in price assumed vs actual price has the potential to make the project unviable. Add to this, the other two risks mentioned and the situation starts looking even worse.

Counterparty Risk

The off takers of power from these IPPs are Discoms or Central government backed entities like NTPC. While NTPC is a good counter party, the real problem arises when the counterparty is a State Electricity Board/Discom. All Disoms are burdened by debt and under a lot of financial pressure which hampers their ability to make payments and honor their contracts. They had Rs. 4.3 lakh crore of debt outstanding as on December 2015. The main reasons for the same are high operational inefficiencies, commercial losses during transmission of power due to theft, poor meter readings, low transmission network etc. and cross subsidization where in to garner votes power is given to rezidential consumers at subsidized rates while higher rates are charged from the industrial and commercial users. Discoms face the heat when they have to keep supplying power at subsidized rates even when the industrial demand is low.

The Government has recently implemented the UDAY scheme. Under this scheme, the state government will take on 75% of the debt burden of the state electricity board and issue it to the public. While this measure does give temporary financial respite to the discoms, it still falls short on tackling the structural issues of the industry mentioned above. A key case in point is Jharkhand. It was the first state to sign UDAY in 2015. Despite that it has piled up debt and its revenue gap (difference between cost of supply and revenue per unit) has increased from 0.90 per unit to more than Rs.2 / unit (

While I am in no way writing off UDAY-in fact it is far better than the previous schemes to turnaround the sector, I do believe that more focus should be given on giving autonomy to the electricity boards and reducing commercial losses.

Curtailment Risk

Curtailment risk arises when the counterparty stops buying power generated from IPPs. This could be because of two reasons – a) Poor financial condition of the Discoms or b) Inadequate transmission infrastructure to offtake power. We have already looked at a) above. In case of b) the discoms stop buying power if there is excess load on the transmission network. This can happen when the production is at its peak however there is lack of grid availability or demad to offtake the power.  What happens when the discoms stop purchasing while the plants are still running? All numbers in the models prepared by IPPs at the time of bidding go for a toss. With increasing generation of power not being matched with increase in transmission, curtailment from counterparties can pose a serious threat to the players in the industry.


Generally EPC players take 6-8 months to set up a solar project. In case of EPC, the companies do not own the assets- they construct the asset and in many cases operate and maintain them for the life of the asset. Operating and Maintenance revenues are generally 1-2% of the capex costs with escalation of 5% every year.

Two trends have been emerging in the EPC segment – increasing competition leading to declining margins and developers increasingly doing EPC in house. EPC companies compete only and only on the basis of prices (bids). On top of that setting up solar plants is not nearly as complicated as other EPC projects like thermal, road, wind etc. as a result of which there are many EPC players in the industry. Due to aggressive bids EPC companies have seen their project level EBITDA margins decreasing. And lets not underestimate the price of declining capital costs of solar plants here. 5 years back when the capital cost was 10 – 12 cr/MW, EPC companies could earn decent revenue along with good margins. Now with capital cost of approx. 4 cr/MW and increasing competition, companies are not only earning lower  margins – they are earning it on lower revenue!

Secondly, since bids even in case of IPPs are getting competitive, most of them have started doing EPC in house rather than outsourcing it in order to keep costs under control. Self EPC has increased from 31% in 2015 to almost 50% in 2016.

Rooftop Solar

Rooftop Solar is so disruptive that it deserves a separate section. Rooftop will have implications both on the consumers (including industrial and commercial) and discoms. Currently there is only 1 GW of rooftop capacity installed in India. Rooftop is likely to see increasing adoption as the capital costs decline and tariffs become extremely attractive for residential consumers who currently pay lower tariffs due to subsidized rates. For Industrial and commercial users rooftop makes complete sense as shown in the graph below which compares the current rates vs rooftop rates. (y axis shows the tariff rates per KWh).

tariff comp

As more consumers start adopting rooftop, we are likely to see significant push back from the discoms. Why? Well its simple – discoms will lose their customers if they stop buying power from them and net metering will only make things worse.

Under net metering policy, users of solar can sell excess/unused electricity back to the grid and be compensated for that. What this essentially means is that even though discoms will lose consumers and therefore revenue, their costs would not reduce as they will still have to spend money on maintaining the grids and transmission assets to transfer power from excess capacity to areas/users in need of power. This has the potential to dent a bigger hole in their pockets. They may try to recover these costs by charging extra money from non-solar users which will encourage even a higher adoption of solar.

There have been cases in the developed countries where the state utilities have revolted against the use of net metering and discouraged solar rooftop adoption. The most prominent example is Nevada where NV Energy (owned by Warren Buffet) and Nevada regulators colluded to get rid of net metering and increased fees for solar rooftop installations.

And while all this is happening, lets not forget the impact on coal based plants. Their plant utilization factor will only see one direction with adoption of solar. No prizes for guessing! There is one small problem though – what happens when power is not being generated from solar? The utilization factor for solar is 19% as compared to 70%+ for thermal. All solar power is generated during the day. To meet electricity requirements while solar is not being generated, the state utilities will have to resort to other sources like thermal. The only fly in the ointment is that thermal power plants are not nearly as flexible when it comes to generation like other sources and hence the maintenance costs will be extremely high. Low PLFs (plant load factor) with rising costs – need I say more?


Solar is clearly a force to reckon with. It is disruptive and the growth in adoption of solar will be unparalleled in the coming years. We will see electric cars on the road sooner than we expect. In fact I will not even be surprised if a few decades down the line, oil & gas reserves would even count for anything. Solar might be just become the new oil and given India has 300 sunny days a year, it might emerge as a super power in the future!! Notice how I get carried away?

Coming back to the point – There will be a large inflow of capital given the growth in the industry. In a highly commoditized sector with no entry barrier, there will be no dearth of players in the sector going forward. Everyone would want a piece of it. This is expected to drive down the returns and lead to a lot of irrational bidding and competition. It is essential that the companies have a strict control over costs,  and find innovative ways of execution which is easier said than done. Adoption of solar is also expected to adversely impact the utilities and thermal power plants. The only clear winner as of today, seem to be the consumers of solar power.

Key Takeaways

Key takeways

Apar Industries

Apar Industries is a play on large scale investments of more than 2.5 trillion rupees in the Transmission and Distribution (T&D) space in India which is almost 50% more than what the Government spent in the last 5 years. While the power generation capacity has increased by 50% in the past 5 years, T&D capacity has not matched up with 30% increase.  This despite the fact that India added approximately 68,000 MVA of substation capacity in 2016 which is the highest ever addition in any given year and launched projects over 1,00,000 crores in T&D.  Apar is expected to be a key beneficiary of Government’s capex on the ailing T&D space owing to its leadership position in both the conductors and transformer oils segment. Besides, Apar is the leading cables manufacturer in the booming renewable segment in India. As per JNNSM, the government intends to target 175 GW of renewables capacity in 2022 from 45 GW currently.

Sectoral tailwinds, formidable leadership along with Apar’s intense focus on value added products in all three segments augurs well for the company going forward.

Conductors Business – Apar is the largest manufacturer of conductors in India with 23% market share. It generates 50% of its revenues from this segment. Focus on high margin products backed by Government’s focus on reducing Discom losses will be the key driver for this segment going forward.

  • Apar is one of the top 5 manufacturers of conductors in the world and is the largest exporter from India. Exports accounted for 35% of revenues in 2016. It is the lowest cost manufacturer of conductors in the world.
  • The tenders in this segment work on raw material + x gross margin. Being the lowest cost manufacturer enables Apar to bid at competitive rates.
  • The company has now executed its low margin legacy orders and is witnessing expanding EBITDA margins lately due to execution of new high margin orders especially from the value added segment. The current order book stands at 1524 cr.
  • Apar was the pioneer in Aluminum alloy conductors in India and was the first player to introduce High Efficiency Conductors(HEC) in India also known as High Temperature Low Sag (HTLS). It is the only company to have passed the technical tender for the product and is only one of the two manufacturers of HTLS (Sterlite being the other manufacturer) in India.
    • Commercial losses while transmission of power has been one of the major reasons for the dismal financial health of the electricity boards/discoms. Whiles schemes like UDAY do give financial respite to discoms, transmission loss is a structural issue with the sector and is a longer term solution. HTLS conductors reduce transmission losses by as much as 30% and transmit 2 times more power than normal conductors. Reducing AT&C (Aggregate technical and Commercial losses) losses is one of the key area to turnaround the financial health of discoms.
    • This is a high margin product and is witnessing increasing demand from both private EPC players and Power Grid in the market. It now accounts for 12% of total conductor’s revenues, the effect of which can be seen in the expanding EBITDA margin of the business. The EBITDA/ton adjusted for forex costs has increased from 4700 in Q4 15 to 10,944 / ton in Q2 FY 17. The management expects the share of HEC to improve to 15% next year and has given an EBITDA/MT guidance of 11,500-12000 (additional 1000/MT if GST is passed).


  • Demand from higher KV transmission lines (765 KV) bodes well for HEC conductors. There is high capex planned on high voltage lines in the 13th plan as shown later.
  • Apar collaboratetd with CTC Global , US develop HTLS conductors. This arrangement also enables Apar to expand its global footprint through exports.
  • The company has a capacity of 150,000 MT and has been operating at full capacity since the past 2 years. It closest peer is Sterlite which has a capacity of 170,000 MT. However, Sterlite uses 50% of the capacity for captive use.
    • The company has spent 35cr on capacity expansion and has increased it by 30000 MT. With current EBITDA/MT of 11000, this expansion has the capability to add 33 cr to operating profits. The management expects the additional capacity to be utilized fully by the end of next fiscal year.
    • Given Governments impetus on building grid connectivity, there is a huge amount of capital expenditure lined up on transmission lines going forward. As per the 13th plan INR 2.6 trillion will be spent on transmission. Out of this 50% will be spent on inter state transmission which requires a network of 400Kv and above, hence improving demand for its HTLS conductor which is used for high voltage transmission lines.transmission-linesconductors-numbers

Specialty Oils Business – Apar is the largest manufacturer of transformer oils in India with 45% market share. It generates 35% of its revenues from this segment. Focus on specialty transformer oils with limited competition, increasing distribution network of auto lubricants will be the key drivers in this segment.

  • Apar is the fourth largest manufacturer of transformer oils in the world and has 45% market share in the domestic market. It exports its oil to more than 100 countries globally.
  • Besides transformer oils, the segment also comprises of white oils and auto lubricants. While white oils(commodity) has been witnessing a lot of competition, auto lubricants has gradually been gaining traction. Apar has a manufacturing license agreement with ENI S.P.A which is the eight largest manufacturer of auto oils globally. It caters to the premium market and has 450 distributors and 15000 stockists across India. Automotive oils have the highest margin in this segment and has been gradually increasing its share in the segment. Although Auto lubes account for 15 % of revenue in H1 17 as shown below, it only accounts for 5% of overall volumes in the segment.


  • Transformer oils accounts for 60% revenues in this segment while auto accounts for 15%. Like the conductors segment, the absolute revenue is a function of raw materials (crude).
  • Pricing of oils is based on per KL fixed realizations and the contracts with customers protects the company reasonably from gradual increase in crude oil prices. Adjustment of realizations can be problematic when there are sudden changes in crude prices and the company’s products may get less competitive as compared to other players when the spot price goes lower than contract price. This is specifically true for commodity oils like white oils. Value added transformer oils are relatively protected from such volatility. Oils account for just 5% of the cost of transformers and hence the eventual customers are not price sensitive.
  • The company gets 15% of its revenue from recurring use of transformer oils every year and 85% from customer additions.
  • Apar is only one of the two supplier of 765 Kv transformer oils (High Voltage Direct Current oils-HVDC) in India. The other player is Savita Oils. 765 KV transformers are used as power transformers (mostly interstate connectivity) and Apar enjoys higher margin in this category due to limited competition.
  • The company also expects increasing demand from distribution transformers which are used for intra state transmission (220 Kv). This is a lower margin business are compared to power transformers. Currently 35% of the revenues come from 220Kv and above transformers and 25% from 400 Kv and above. The company has a lot of scope for further margin expansion by increasing share from higher value added products.
  • Just like the conductors segment, transformer oils is expected to witness growth going forward owing to increasing demand from high Kv transformers. In anticipation of the demand, Apar has increased HVDC (765 Kv and 800 Kv) transformer oils capacity. Besides Apar is the only company in India which is undergoing testing for 1200 Kv transformer oil for Power Grid. During the 13th plan period, about 1,28,000 MVA of transformation capacity of 400 Kv and above voltage level and 15000 MW of HVDC capacity is planned to be added which can further improve margins of the segment. Besides in the near term, there are 50000 cr of inter and intra state transmission corridors up for bidding in this fiscal year.
  • With increasing share of value added and automotive oils in the overall revenue, Apar has witnessed gradual increase in margin. The company has doubled automotive blending and automated packing capacity in anticipation of more revenue from the segment. The EBITDA margin has increased from 6% in Q2 15 to 10% in Q2 17.


  • The current capacity is 144,000 KL. The company spent 100 crore to set up a 100,000 KL plant in Sharjah which will open new opportunities for bulk exports to Middle Eastern markets. About 50,000 KL of products are exported out of India which will be shifted to the facility in Sharjah which will leave room for expansion both in the Indian and the overseas facilities.


Cables Business – This segment has shown a good turnaround owing to managements conscious efforts to shift focus from commoditized cables to specialty cables. This has led to EBITDA expansion and the improvement is expected to be sustainable with strong sectoral tailwinds in the end consumer markets. Apar generates 15% revenues from this segment.

  • Apar entered the cables segment with the acquisition of Uniflex in 2008. Due to oversupply situation in High tension/ Low tension power cables, Apar witnessed extreme pricing pressure in its cables business and was incurring losses in this segment.
  • The management changed its focus from HT/LT cables to high margin Optical Fiber Cable (used in telecom to set up national fiber network), Elastomeric cables (high flexibility cables primarily used in railways, defense and solar/wind) and E beam technology. HT/LT cables which accounted for 75% of the revenues in 2014 now account for 45%.
  • Shift to valued added cables has improved the EBITDA margin to 9% in Q2 17 vs 2 % in Q3 FY 15. The management expects the margin to increase to double digits going forward.


  • India has only 5 E-beam facilities and Apar has the highest voltage capability of 3 MeV. E-Beam technology protects cables from short circuits and improves the physical properties of cables like stress resistance and abrasion resistance. Ebeam finds application in defense and solar sector. The company is the largest supplier of cables to the renewables space especially solar which is growing at a scorching pace given the Government’s target to install 100 GW of solar capacity by 2022. The current installed capacity of solar is just 10 GW in India.



Based on these estimates, Apar is valued at 13 times PE. This is a company available with satisfactory Margin of safety with hopefully a long tunnel of growth ahead of it. Apar has already achieved 75% of last years profits in H1 17 and has shown increasing trend of capital efficiency since the past 4 years. The company has a low float with 86% of the shares held by the promoter and other long term institutional investors and fund managers.


Key Takeaways

  • Leader in all its operating segments
  • Sectoral tailwinds and capacity expansion in all the segments to aid future growth
  • Specialty products with limited competition leave scope for margin expansion
  • With capex cycle behind them, ROCE is expected to improve going forward
  • Transparency in information available to the shareholders making it easier to track key numbers
  • Large room to grow and available at good Margin of Safety with forward PEG of less than 0.5

7 reasons why GHCL could be a good bet

Gujarat Heavy Chemicals Limited has two segments – Soda Ash and Textiles. Soda ash finds applications in Glass and detergents. The company’s main customers include HUL, P&G, St. Gobain etc. Soda ash accounts for 57% of sales of the company. It’s a cash pumping machine with 450 cr of cash flows every year. The capacity of the company is 8.5 mn tpa. It has 23% market share in the domestic market. Nirma is the market leader with 25% share followed by Tata Chemicals with 24% share. Imports account for 24% share too.

It is also a backward integrated textiles player from yarn to textiles. The company has an installed capacity of 175,000 spindles in TN and home textiles manufacturing happens in Gujarat. Spinning accounts for 30% of the revenue in this segment while home textiles accounts for the rest.

Inr cr 2014 2015 2016
Total Sales 2248 2373 2559
Soda Ash Sales 1230 1416 1450
Textiles Sales 1017 957 1063
EBIT 355 448 551
EBIT Margin 15.79% 18.88% 21.53%
PAT 108 182 258
PAT Margin 4.80% 7.67% 10.08%
ROE 25% 32% 31%
ROCE 17% 21% 24%
CFO 343 467 507
CFO/Net profit 3.2 2.6 2.0
FCF 288 323 281
FCF/Sales 13% 14% 11%

If you are aware of the promoter history of this company, then I am sure the name GHCL will send shivers down your spine. I do not blame you. That is the reason for the shear undervaluation even while other stocks are hitting the roof (Sugar speculation anyone?). While the promoter issues are legitimate, I believe the market will not ignore the positive changes in the underlying business for too long and hence this could be a good opportunistic bet for a potential re rating. Below are the 7 reasons why I like GHCL-

  1. Lowest cost manufacturer of soda ash – There are three main players in the domestic market – Tata Chemicals, Nirma and GHCL. GHCL is the lowest cost manufacturer of soda ash with EBITDA margins ranging from 28% to 33% over the last 10 years which is 3-4% more than its competitors.

There are two types of Soda Ash – Synthetic soda ash and Natural Soda Ash. Synthetic soda ash is made from salt, limestone, lignite and met coke. It accounts for 75% of the soda ash globally. Natural soda ash is made from large trona deposits which has lower processing cost. The only fly in the ointment is that there is only a limited amount of trona deposits in US and Turkey and hence it’s a natural advantage that these geographies have. This has had implications on the supply dynamics as explained later.

The reason for GHCL being the lowest cost producer is that it’s the only player in India with access to its own lignite mines (20% captive). It also has access to other raw materials like salt (55% captive) and limestone (30% captive). Further it uses briquette coke instead of met coke which is cheaper and on which they have a process patent (for the sceptics – These raw materials account for more than 50% of the total cost. The company also has the highest capacity utilization in the industry (88%). In the last 5 years the average EBIT margin of Tata Chemicals has been 21% as compared to GHCL’s 25%.

The question then is this- Can anyone else do it? The answer is yes BUT (there is always a but) the entrant will need its own supply of raw materials and scale to match the cost competitiveness. There is only limited supply of raw materials and that is mostly available in Gujarat. Each tonne of soda ash requires 5 tonne of raw material and being in close proximity to raw materials is the key. Also, the logistics cost of soda ash is really high and hence it can’t be transported cheaply. A player in South will find it immensely difficult to supply soda ash to customers in North India due to high costs of transportation and no access to raw materials. Power and fuel account for 20% of the total costs. This is also the reason why domestic companies (96% of production happens in Gujarat) are not able to cater to the markets in South and East India where the gap is filled in by imports (24% market share).

So what if one wants to set up a plant in Gujarat? Well there are only limited amount of natural resources. Even the plants located in Gujarat do not have enough resources to cater to their own needs. The government has not issued limestone mining licenses since many years due to strict regulations. Also the capital turnover ratio is unfavorable as 1 tonne of production requires Rs. 50,000 while it generates only Rs. 20000 of sales. Hence the entrant would require a large scale to remain profitable (60% of the costs are fixed).

This is the reason why the industry is oligopolistic in nature with 3 players accounting for more than 75% market share.

  1. Supply side dynamics

The soda ash industry supply cycle is extremely favorable. As mentioned, EBITDA margins for GHCL have been relatively stable in the last ten years despite soda ash being a ‘commodity’. This is because supply has always followed demand. In fact in India the demand has always been higher than the supply (see below).


There are two processes for manufacturing soda ash – Solvay process and Hou process (mostly used in China). Both these processes use raw materials like limestone, salt and coke. The biggest threat to these processes is natural soda ash. Trona is 70% soda ash and can be refined at a much lower cost. It is a natural mineral which is geographically restricted to US and Turkey. Turkey has reserves for about 40 years. Due to the cost advantage enjoyed by companies in these markets there have been many plant closures of companies employing Solvay or Hou process in other countries like Japan, South Korea, Taiwan etc. which have been a victim of cheaper imports.  There have been 4 closures recently in other regions (shown below). Since 2009, more than 2.5 million ton of capacity has been shut down. In Feb 2016, the largest plant in China with 3 million ton capacity was shut down for a period of 6 months ( All these factors have led to increase in realizations of soda ash globally and favorable supply dynamics.


Natural soda ash is a legitimate threat but India is relatively protected from it for a while. Companies in US have been exporting most of their produce to South America and Africa while companies in Turkey are focusing on European countries.


There are two reasons for that – Anti dumping duty(ADD) and as mentioned earlier high logistics costs.

The GOI imposed ADD on soda ash imports in 2012. The duty on US imports is $30 / tonne and Chinese imports is $36 / tonne. Also the freight cost from US is $56/ tonne while from Europe its $40/tonne. However, one must be cognizant of the fact the ADD will be reconsidered in July 2017. As per the management, there will be 5% reduction in price if the ADD is removed.  Removal of ADD is not expected to have an extremely significant impact as even in the current market the cost of domestic produce is Rs.20000/tonne as compared to 17000 a tonne from imports. The fact is that there is just not enough supply currently in the market.

  1. Management efforts of improving Corporate Governance

For those of you who are not aware – type Sanjay Dalmia on google and you will realize the gravity of the situation. This is potentially one of the primary reason why the stock is undervalued.

However, GHCL is run by a professional management and Dalmia has no say in the day to day operations of the business. Mr. RS Jalan is the MD of the business and I couldn’t find any dirt on him. Lately, the management has been taking important steps to improve the confidence of the investors which I believe is critical. They have started doing concalls and are more transparent about their business. They have also formulated a dividend policy for the shareholders in FY 2016. Add to this the appointment of E&Y as its auditors. These are steps in the right direction. Second chance anyone? (Never ask this to your wife or girlfriend)

     4. Improving margins in the textiles sector                


Textiles is a sunrise sector in India. Textile companies have been showing great numbers too. GHCL made a late foray in the home textiles segment. It has been working hard to change its customer mix the result of which can be seen above.

The company operates at a lower capacity as compared to its peers. This company has enough room to grow in this segment. The margins will improve as the company utilizes more capacity and as home textiles starts accounting for more revenues in this segment. The management is targeting EBITDA margin of 16% in the next FY as compared to 13% in FY 16.

    5. Improving debt situation


GHCL has been working on reducing its debt. The company had loss making subsidiaries and it had to write off substantial amounts thereby eroding its net worth. It has now shut down all its loss making businesses abroad (more than 15 subsidiaries). The company structure too looks a lot cleaner now. The management targets to get D/E ratio below 1 and looks on track given their cash flows

  1. Capex using internal accruals

The company is increasing its soda ash capacity by 1 million tpa. It will be spending 375 crore and it will get commissioned by 2017. This should further enhance the margins. The company will also spend 50 crores on debottlenecking its plant and another 50 on windmill capacity will increase margins by 1% as per the management- All this with no additional debt or equity dilution.

  1. Compelling valuations

The soda ash division did revenue of 1450 cr in FY 16 with EBITDA margin of 32%. Average EV/EBITDA of commodity chemicals companies is 9.

For valuation purposes let’s assume EBITDA margin of 30% and EV/EBITDA of 6.5.


Current Market cap of the company is 1700 crore. Essentially one is getting the textile business with 1000 crore topline for just 80 crore at conservative valuation. This looks gravely undervalued if we consider the expected improvement in margins, reduction in debt and strong free cash flows.

7 Reasons why I like Vinati Organics

Vinati Organics (VOL) is a specialty chemicals player. Although it has a portfolio of 14 products, it derives 87% of its revenues from 3 products namely – IBB , ATBS and IB. IBB is the primary raw material for ibuprofen. ATBS has diverse applications in oil and gas, texitles, paints, construction etc. IB is a raw material for ATBS and is also used in agrochemicals. The company uses 40% of IB for captive consumption. Below are the seven reasons why I like VOL-

1. Sectoral Tailwinds – The chemicals sector in India is at a strong inflexion point. Since chemicals find application in a lot of sectors, the Government’s thrust on manufacturing will increase the domestic consumption of chemicals. This was proven by the increase in manufacturing and consumption of chemicals in China when it was going through its speculative growth phase.

Lately, a lot of business has been shifting to India due to de growth in China. The chemical companies in China overleveraged their balance sheets which has impacted them adversely. The India Government has also allowed 100% FDI in the chemicals sector. India has a large pool of cheap labour and has strong R&D capabilities. Hence, chemical companies in India should see demand for customised products going forward.

2. Industry Structure – Chemicals are of two types- commodity and specialty. Commodity chemicals are low value high volume products. Competition is mostly based on pricing rather than value addition.

Specialty chemicals on the other hand are low volume high value products. There are limited competitors and the nature of the industry is oligopolistic. Hence, these companies enjoy higher pricing power than commodity chemicals manufacturers. VOL is a specialty chemicals player and hence has a favorable industry structure. It has niche offerings with limited competition to deal with globally.

3. Leader in its core offerings– As mentioned, VOL derives 87% of its revenues from IBB (30%), ATBS (45%) and IB (12%).

VOL has 65% global share in IBB and gets 70% of its revenues from exports in this segment. It was the first company in India to manufacture IBB which used to be imported earlier. It collaborated with Institut Francais du Petrole (IFP), France for the same. Other players in the market are IOL Chemicals , India which uses its production for captive use and SI Group.

It is also the largest manufacturer of ATBS (26,000 tpa) globally and has 45% market share.  VOL started manufacturing ATBS in 2006 by partnering up with National Chemical Laboratories (NCL), Pune and now derives 90% of its revenues from exports in this segment.  It has two competitors in this segment – Lubrizol (14,000 tpa) and Taogosei, Japan (6,000 tpa). Lubrizol uses most of its production for captive use and it is not a key product for Taogosei.

VOL backward integrated to manufacture IB in 2010 to reduce its dependency on suppliers. It now has 70% domestic market share in IB.

4. R&D intensive – Specialty chemicals are knowledge driven. It requires high R&D to create niche products and meet international standards.  The fact that VOL derives majority of its revenues from exports prove the global competitiveness of its products.

VOL started as a single product company. It started selling IBB in 1992. The international standards demand purity levels of 99.5%. VOL beats the industry standard with purity levels of 99.8%.

Until 2002, IBB accounted for 100% of VOL’s revenues. Since then the company has diversified its offerings to 14 products through intensive R&D and now IBB accounts for 30% of the revenues. It commenced manufacturing of ATBS in 2002 and it took them 4 years to manufacture a globally accepted product with the help of NCL, Pune. VOL is the lowest cost manufacturer of ATBS and its process is patented. Its third main product IB has purity level of 99.85% which is the highest in the world.

VOL has now also started making customized products for its clients which will contribute significantly to its revenues in the coming years.

5. Protected from volatility in crude price– Most of VOL’s raw materials are derivatives of crude. VOL is immune to changes in price of crude price since its contracts are based on fixed realizations per kg. Hence, it automatically passes the risk of crude price increases to its customers. This also means that all the benefits are passed on too.

6. Entry barriers – VOL is the lowest cost manufacturer of ATBS in the world owing to its patented process. It is the only backward integrated plant globally as it manufactures its own IB which is used as a raw material for ATBS further aiding its margins.

VOL also enjoys the highest market share in a few of its offerings. Its customers do not switch suppliers easily as these chemicals form a small portion of their costs yet form a very critical component of their products. Hence quality is of vital importance and as mentioned earlier VOL’s product quality surpasses international standards. They also get into long term contracts with their customers which acts as a strong barrier to entry.

7. Management – The company is promoted by Mr. Vinod Saraf who is a first gen entrepreneur. Mr. Saraf has always emphasized on manufacturing niche products with limited competition. The company has followed synergistic integration as its strategy for growth- focusing on products that are interlinked in the manufacturing process. This keeps a tight control on costs. For example, VOL started manufacturing TBA (a specialty monomer used in water treatment and personal care products) which has the same raw materials as ATBS. It started manufacturing IB in 2010 which is used as a raw material for ATBS. It then started manufacturing HP-MTBE which uses MTBE as a raw material which is also a raw material for producing IB.

The management has shown prudent capital allocation skills with 10 year ROCE of more than 25%. After payout of dividends, the management has generated 28% return on every rupee retained in the business. The company is debt free on a net basis as of March 2016.

Under the leadership of Mr. Saraf, VOL has grown at a CAGR of more than 30% in the last 10 years and as shown this growth has not come at the expense of profitability.  The management expects ATBS to grow at 15% in the next 2-3 years. The growth outlook looks bright owing to the capacity and product additions by the management. The company is spending 150 cr on capacity expansion. Part of it will be used to increase capacity of IB from 12000tpa to 15000tpa. The remaining will be used to introduce new products like IBAP which is an intermediate between IBB and ibuprofen.  Tanfac industries is the only other competitor that manufactures IBAP in the domestic market.

The company is also introducing a couple of IB derivatives with applications in the perfume industry that will be sold in the domestic market thus sticking to its strategy of strategic integration. Last year VOL entered into a long term contract with US and Japanese based chemical companies for manufacturing customized products which is a testament of the quality and standards that VOL brings to the table. All these products are expected to add 200 cr to the topline in the next 2 years. It is also setting up a co-generation plant which will save 8cr annually.

The promoter will be buying 9 lakh shares from the open market in the next 6 months at a price of 500 or below and increase their stake to 74%.



Take Solutions – A small company pursuing a huge opportunity CMP: 150

Take Solutions (“TS”) is technology solutions and service provider primarily in Life Sciences(“LS”) and Supply Chain(“SCM”). It started as a Supply Chain software provider and later ventured in to Life Sciences through smart acquisitions at fair prices. From being a software provider in Life Sciences, Take started providing services too thereby taking advantage of the emerging trend in Clinical data management outsourcing. Due to commoditization of its supply chain offerings (which had lower margins), Take further decided to cut its focus on supply chain and shift its management bandwidth to the high margin Life Sciences business. It has now hired bankers to sell off its supply chain division completely. If that’s not all, Take also acquired Ecron Acunova- a Clinical Research Organization(“CRO”) in the booming Biosimilars market. What was the result of all this? – Not only did TS increase its margins, it also expanded its opportunity size to 30 billion USD.

Since my investment thesis is based on LS, I will focus on it in this report. If I have to summarize my thesis in one sentence two sentences– Take Solutions is a USD 300 million company pursuing a USD 30 billion opportunity, backed by a solid management which does not shy away from taking tough but value accretive decisions. Add to that a strong niche , a bunch of domain experts (“Nerds”) and a patented product.

Before we move on, below is a brief explanation of a few important terms

Clinical Research Organization – The R&D division of Pharma companies needs to carry out tests on patients to monitor the efficacy of drugs. The clinical trials take place through mainly 4 phases after which the drug is approved by the regulators and launched in the market. Pharma companies can outsource the tedious work of finding clinical subjects, monitoring their progress and providing feedback to CROs. CROs carry out the tests on behalf of the Pharma companies who can focus on their core work.

Clinical Data Management – During trials, the Pharma company has loads of data to work with which in most cases can be as long as 100 thousand pages. Clinical data management comprises of taking this data, standardising it, interpreting it and communicating it to the companies and regulators.

Pharmacovigilance – Once a drug is launched in the market, it needs further monitoring to make sure it is performing as expected. In case there is a discrepancy in its performance, the same needs to be reported to the regulators, company and necessary adjustments have to be made in labelling of the drug.

CDISC –  It is a collaboration of various authorities, pharma companies and IT firms to improve data standards. CDISC is a global, open, multidisciplinary, non-profit organization that has established standards to support the acquisition, exchange, submission and archive of clinical research data and metadata. The CDISC mission is to develop and support global, platform-independent data standards that enable information system interoperability to improve medical research and related areas of healthcare.

Why do Pharma Companies need Take Solutions?

There are more than USD 80b worth of drugs coming off patent in the next few years. For this reason, it has become imperative for Pharma companies to focus on R&D and expedite drug discovery process. TS enables these companies to channelize their resources on R&D while it takes care of clinical trials, regulatory submissions, drug monitoring and labelling. Through its services, Take Solutions helps Pharma companies in reducing the time to market by 50% while reducing the costs by as much as 30%. As shown below- TS is present across the entire value chain.



Take is not like other IT offshoring companies. TS is a specialized service company which requires high level of expertise. It hires people with vast experience in the field. It launched TAKE Academy of Life Sciences and Leadership in February 2015 to create a pool of highly qualified individuals with the required expertise. Any IT company cannot cater to these requirements by just hiring a bunch of engineers or software programmers.

TS serves 9 of the top 10 Pharma companies. However, the real target market for TS’ offerings are small and mid sized pharma companies that do not have the capital and bandwidth to carry out such activities.


Earlier TS was only involved in design of clinical trials and data analysis. However, with the acquisition of Ecron Acunova(CRO) for 115 crores in the last FY, TS also entered into data collection by carrying out the trials for the companies. EA has a strong niche as it is one of the few CROs that focuses on Biosimilars.

TS is also unlike other offshoring businesses since it has a list of IPs for each of its services as seen below.


TS is the only Indian technology firm that is a part of CDISC. This gives TS first hand information on the data standards and requirements in the industry. It has set up accelerators that fasten the process of data standardization and management. TS was awarded a patent by the United States Patent and Trademark Office (USPTO) for its “Method for Optimizing Clinical Data Standardization”. This process leverages TAKE Solutions’ Clinical Accelerators to reduce the time taken to standardize trial data by over 50% (when compared to standardization without the accelerators), thus reducing time to market.

PharmaReady is a proprietary software that finds applications in statistical analysis and regulatory submissions. The company has also set up ‘nets’ which are forums for professionals, regulators, marketers, safety heads of life sciences companies etc. These forums provide key insights to TS and help them better their offerings. This gives TS a unique advantage and helps them especially with their pharmacovigilance offerings. Infact these professionals and companies pay subscription fees to TS to be a part of the forums.


How much can their business grow?

Outsourcing in the Pharma Industry is increasing at a frantic space. The Life sciences BPO market consists of Contract Manufacturing Outsourcing(CMO), Contract Research Outsourcing(CRO) and Clinical Sales Outsourcing(CSO). (see below) The BPO market in Pharma is expected to grow at a CAGR of 22% and will be valued at USD 596 billion by 2019.


TS comes under CRO which is currently valued at 34b USD and is expected to reach 60b USD by 2020. In terms of the service that TS provided before acquisition, the market size is given below


Global IT spends by pharmaceutical sector is estimated at 3.4% of their annual revenue. The Life Sciences data management market is valued at USD 15.9 billion, which is expected to grow at annual rate of 12% in the medium term. TAKE addresses three segments of this market; namely Clinical, Regulatory and Safety, which are valued at USD 8.2 billion and expected to grow at a CAGR of 15.9% till 2020. As per the management, post-acquisition of EA, the target market will now increase to 30b USD by 2019.

Outsourcing by the Pharma Companies (“sponsors”) is a relatively new practice and currently only 20-25% of the market is outsourced. All these factors added up, leave TS with a long runway.

Is the management capable of growing this business?

The company is led by Mr. Srinivasan H. R. who is the founder of TS. He worked with the Singapore Government’s investment arm Temasek before setting up TS in 2001 with the help of seed money from R. Thyagarajan of Shriram Group.  I like management that lacks institutional imperative and is not afraid to make tough decisions.

TS started as a product company only in the supply chain space. After working with a few Pharma clients, it realized the potential of outsourcing in Pharma products through value added products. It started as a software provider company and then later ventured into services along with software to increase customer stickiness. Due to limited competition and high value addition, Life Sciences business was showing good traction while the supply chain division was getting more commoditized. The EBITDA for the SCM division reduced from 23% in 2010 to 15% in 2013. The management took a tough decision to restructure its business by focusing more on its life sciences business. It reduced its capital employed in the supply chain division . They walked away from more than 220 crores worth of revenue. In today’s world where the management is obsessed with legacy businesses and topline growth- Mr. Srinivasan clearly stands out from the crowd. For him the focus was on profitability and Return on capital employed and not topline growth at the expense of profitability. They even rebranded their Life Sciences business to ‘Navitas’ and repositioned its offerings ( In the latest concall, the management said that they have hired bankers to completely divest their supply chain division.

The management also has its skin in the game with 57.89% stake. The Shriram Venture has also shown confidence in the prospects of the business with increase in its stake from 2.3% in 2012 to 10% currently.

Inorganic growth has been a key strategy at TS. This can often be dangerous as the management may overpay for an acquisition in anticipation of high “synergies”. TS, however has been a smart buyer at conservative prices historically. Below is the list of key acquisitions in the life sciences space-.


EA’s closest comparable like Quintiles and Parexel are trading at EV/Sales of 1.8.

As can be seen from the table above, the management has acquired businesses which have been critical in the growth of their Life Sciences business.  All of them were cash transactions. They got their biggest clients and domain expertise through ACI, access to PharmaReady through OnSphere and access to consulting and a great leader in Jim Tazzard through WCI who is now heading Navitas and is the key guy behind high marketing spends and increasing traction. In one of the interviews, Mr. Srinivasan highlighted his approach on acquisitions –

“Sometimes, when we examine a company, we may like the company, but we don’t like the (asking) price. If we like the price, there is something in the company that you don’t like at all. If both are okay, then you still have to look at the cultural aspect of whether it’s going to be a fit or not. So, as a small company, we have our own challenges of making acquisitions work. We’ve done a few in the past. The last one we did was in January 2011, more than four years ago. While we are keen on inorganic opportunities, everything has to be right. Organically itself we will grow easily by 18-20 per cent every year. The focus, however, is on profitable growth.”  

Recent acquisition of EA is a potential game changer for TS which can take it to the next orbit. Firstly, it doubles Take’s addressable market to USD 30b. It increases subject matter experts by 30% and LS workforce by 50%.

It provides TS with an opportunity to cross sell its products. EA has a list of formidable clients and the client overlap is not more than 20%.


EA has a strong presence in Eu

rope which accounts for 50% of its revenues. TS on the other hand derives more than 70% of its revenues from US. Hence, this acquisition gives TS a chance to expand its share in the European markets.

Most importantly, TS will now enter the CRO market. Earlier , TS was only into management and analysis  of the data that was collected by CROs and had no role to play in carrying out the trials. Acquisition of EA makes it a complete player in the outsourcing market. By the looks of it, it seems that management has made another smart acquisition at a conservative price.

Only a few right decisions can make all the difference and based on the discussion above, the management seems capable of growing the business. Add to this their integrity. In 2009, when the global market was witnessing a slowdown,, the management took a voluntary cut in its salary to control expenses.

How does TS stand against its peers?

As mentioned earlier, unlike other offshoring companies that pride themselves on cheap labor and mostly mundane work, TS prides itself on domain expertise. Hence it is unfair to compare TS with other IT players in India. A vendor assessment test carried out by IDC in 2011 and 2013 ranks TS right at the top.


TS has no competitor in India. It is the only Indian IT firm which is a member of CDISC. It has an inherent stickiness in its model due to the criticality of its work and has been able to retain its top customers. It faces competition from firms in US like Parexel, Quintiles, Medidata and Medidata. TS is the only player with a patent on its standardizing process of data which is FDA approved. Even on a global scale, TS is one of the few fully integrated companies post the acquisition of EA. Quintiles in fact is a customer of TS for regulatory submissions while Medidata focuses only on providing technology solutions for better handling of the clinical trial process. The company also faces competition from a few unlisted players which mostly get acquired by the bigger players. This makes TS a potential acquisition target too given its small size.

What gives TS a significant advantage as compared to its global peers is ‘nets’. It gives them a strong network effect as more professionals pay to join the forum. It also creates a strong feedback loop which helps to better its offerings and remain up to date.

There has been a heavy consolidation going on in the industry. Large players have been acquiring small companies for either new technology or to enter new geographies. This could make TS a potential target too.

How do the numbers stack up?


The Revenue from LS has grown at a CAGR of 26% from 2011. The share of LS has increased from 47% to 72% in 2016. In 2013, the company decided to focus away from SCM which was facing stiff competition. Also, the management believed that LS has better growth prospects and hence wanted to increase its capital employed on the LS division. The segments that TS exited were inventory tracking solutions, low end support services and LS staffing business. All of them had lower EBITDA margins of 15% and below. Therefore, the company took a hit on its top line in 2014 and 2015 and the effort is now bearing fruits with higher turnover from LS which grew by 59% to 742 cr from 2015.

The management also decided to increase sales and marketing in the LS division and has been participating and organizing various events to increase visibility. It more than tripled its marketing expenditure in 4 years (2% of sales in 2011 to 6% of sales in 2015). TS also hired more domain experts thereby incurring higher employment benefit expenses. These expenses should be looked as long term investments by the company. They have a slightly negative effect on margins in the short term, however can be value accretive in the long term.


In fact, the company has won its first ever USD 10mm+ contract which will run till 2024 with an annual increment of 15%. As on Mar 2016, the order book too stood at its highest ever level at USD 103 million(90 million excluding EA) compared to USD 69mn last year. Therefore, the marketing efforts will show up in the future revenues.

The organic growth (excl. EA) was 50% in 2016. It started consolidating numbers for EA from Q4 FY16. EA accounted for 42 cr of revenue in FY 2016. The core LS business has EBITDA margins of around 23% while EA has EBITDA margin of 10%. In the latest interview, Mr. Srinivasan has given guidance of 20-22% organic growth with improving EBITDA margins for EA to 12-13% through use of its in house technology.


The company has been generating Cash flow from operations and its average 5 year Net Profit to CFO conversion is 1.16. It has also been generating FCF consistently, however FCF as a % of sales is a little below mark. This is due to heavy expenditure on software and building IPs. The company on an average has invested 7% of revenues in software development and has made investments into its subsidiaries too. One will need to monitor the FCF closely in future.

TS has also reduced its DSO considerably in the last year. The ROE seems to be back on track too. With the divestment of the SCM division completely, the return ratios are bound to increase.

Is the price reasonable?

TS currently trades at a PE of 15 which is at a discount to its “closest” IT peers in India of 20(industry) even though it has better growth prospects. TS also trades at a discount to its comparable in US .


What are the risks?

  1. Acquisitions can go wrong
  2. Significant amount of goodwill on the balance sheet
  3. Since company has discretion in amortization of software costs, it may use it to its advantage to smoothen out earnings
  4. Execution risk on projects (specifically for CRO)
  5. The company has been paying low taxes. When questioned in the concall, the management said that its due to differential tax rates from multiple locations and also because its Chennai office is located in SEZ. They have guided a tax outgo of 15-16% for the next year. I get comfort from the fact that the company has been paying dividends.
  6. Many step down subsidiaries and a complicated cross holding structure.

Below is the summary of why TS is a part of my portfolio

  1. A company with a strong niche. It is a good pick and shovel play on the booming pharma sector.
  2. A vertically integrated player after the acquisition of EA which provides value addition at every stage of clinical trials and pharmacovigilance. Entry into big data can be a game changer too.
  3. Management which is not afraid to take tough decisions which are focused on long term earnings rather than short term gyrations. Focus on LS will lead to higher margins and ROCE. Management also expects to expand the EBITDA margins of EA from 10% to 13-14% using its in house technology.
  4. Patented process for standardization which makes the life of Pharma companies a lot easier.
  5. Domain expertise which can analyze tons of complex data. Expertise is also required in regulatory submissions which are becoming increasingly complicated.
  6. Network effect and strong feedback loop from ‘nets’.
  7. Customer stickiness in the model. Pharma companies will not be willing to switch to a different vendor just on the basis of costs. It is a critical activity and therefore they would stick to service providers who have shown their expertise successfully in the past.
  8. Triggers in place in the form of higher outsourcing in future. Recent FDA inspections in India, patent expiration of drugs globally, heavy penalties for incomplete/wrong labelling, increasing complexity in regulatory submissions, need for big data in pharma etc. all point in the direction of bright future in outsourcing which save both time and costs.
  9. Increase in stake by Shriram Venture shows their confidence in the business.
  10. Huge market size compared to the market cap of the company.
  11. Available at a fair price.
  12. Heavy consolidation in the industry can make TS an acquisition target.

Pokarna – Turning around in a fast growing market CMP:700

The market does not pay an investor for the company’s past. It pays for the future. Many would pass on Pokarna for its messy past. Like many other companies it over leveraged its Balance sheet and got into trouble. The company is now shifting gears and showing signs of turnaround. Having paid off its FCCBs, Pokarna is on the highway of fast expansion in the growing natural and engineered stones market.


Company Description

Set up in 1991, Pokarna Ltd. is into three divisions-

1.Granite – This accounts for 45% of the revenues. Pokarna is the largest exporter of finished granite in India. It sources 80% of its materials from its own quarries and processes them in its state-of-the-art manufacturing facilities in Andhra Pradesh and Telangana. Finished granite by the company finds primary application in flooring and kitchen countertops. It is also used for gravestone segment.

Exports account for approximately 75% share in this segment while USA alone accounts for 31%. The company has a capacity of around 6 lakh square feet per annum and was operating at 70% utilization in FY 2015. This division has grown at a CAGR of 12%. Some of the projects that the company has supplied to are: Reliant NFL Stadium, Houston, USA, Radisson Hotel, Flint, Michigan, USA; Buckhead Village, Atlanta, Georgia, USA, Tidel Park, Chennai, India and Amaravathi Buddhist Museum, Guntur, India.

12. Quartz- What led to the mess is now the shining knight in the company. Operated under the wholly owned subsidiary Pokarna Engineered Stone Limited (PESL), the company entered into manufacturing quartz in 2006. In order to set up the manufacturing plant, the company issued FCCBs worth USD 12 million in 2007 which were to be redeemed on March 29 March 2012. The FCCBs were convertible at the price of Rs.294. Quartz, like Granite finds primary application in kitchen countertops and is also used for bathroom countertops, bar, floor and exterior walls and so on. The fate of this segment is dependent on the housing market and since US accounts for more than 70% of export revenues, the company suffered in the downturn after the financial crisis and defaulted on its payment.

The company started selling quartz under the brand name ‘Quantra’ and it took a while for the company to enter the US market which was dominated by Caesarstone and Cambria. Owing to its quality products, problems faced by its main competitor-Caesarstone and turnaround in the US housing market, this division started gaining fast traction and acceptance in the US market. The quartz segment has grown at a 5 year CAGR of 70% and is showing no signs of stopping. The company redeemed all its FCCBs in 2015 and reduced its debt burden. This segment now accounts for 51% revenues of the company (as per the latest quarterly numbers Q3FY16). The company has a capacity of 6 lakh square feet/annum and was operating at around 50% utilization in FY 2015.

PESL is the only company in India using patented Bretonstone Technology from Italy to manufacture quartz surfaces. This technology is a testament to quality and is considered as an important parameter by the buyers of the product. Breton is the world leader in the stone industry for its technology and has patents globally. There are only a few manufacturers globally with this technology. The company sells its products to dealers who sell it to fabricators some of which are on an exclusive basis. As per the director of Breton, Mr. Dario Toncelli, ”Among the many brands in quartz, Quantra is one of the best quality brands”.

Some of the projects the company has supplied to are: Mumbai International Airport (T2), Continental Hospitals – Hyderabad, Dew Flower, Sobha Developers – Bengaluru, Arlington Downs – USA, Marriott Irvine – USA Amli Ballard – USA, Amway Specialty Suites – USA.

23. Apparel – Although it accounts for only 4% of the revenues, this division is a drain on the company’s resources. Pokarna sells apparels in the brand name ‘Stanza’. It has been continuously making losses and sooner or later I expect the management to be wiser and get rid of this division. Last year the apparel segment did sales of 7 cr with EBIT of -10 cr.

To know more about the business and please watch this video-

Industry  :Tailwind in the construction and renovation market supplemented by high demand for stones especially quartz is driving growth for ‘Quantra’ and granite slabs by Pokarna

As the disposable income of consumers increases, so does their appetite for luxury consumption. We have seen how the likes of Cera and Kajaria have performed over the past few years due to the same reason. Granite and quartz take aesthetics a notch higher. Although the trend is yet to pick up in residential market in India, it is growing rapidly in the developed markets especially US which is one of the major market that Pokarna caters to. In India, the demand is mostly from non-residential market.

Since Pokarna’s products are primarily used for flooring and countertops, the fate of the company is closely linked to the construction activities in its target market. The demand is dependent on new construction and renovation projects. Construction is US has been picking up since 2014 after 5 years of stagnation. This year construction is expected to increase by 6.5% mostly led by the residential market according to Contruction Market Data’s (CMD) latest forecast.

By 2018, demand for floor coverings will be the fastest in North America led by recovery in the housing sector in US. The housing sector in US is expected to grow at 6.2%. Although granite flooring currently accounts for a small portion in residential flooring, it is picking up pace and is expected to grow most rapidly in US overtaking porcelain and is expected to be the second largest type in area demand terms by 2017.

Second use of Pokarna’s products is for countertops which is growing faster than flooring. The global market for countertops is estimated at USD 81b. Until recently, natural stone was mainly used in luxury homes in US. However, with cheaper imports the availability has been extended to the mass market.

Currently in US, Laminates account for a high portion of countertops market. However, natural stone and engineered stoned (Quartz) are rapidly eating into the market share as can be seen below.


The share of engineered stones has doubled in a matter of 5 years. As per a study of countertops by the Freedonia Group by 2017, “the annual installations of natural-stone tops will hit 130 million ft²”. Demand for natural-stone countertops will increase at 7.6% annually- the highest among standard materials. It is will be closely followed by quartz surfaces at 7.4%.

While the usage of natural stones like granite, marble, soapstone for countertops were dominant in the past, there has been a visible shift in favor of quartz over the past decade. The migration has resulted in the product becoming the fastest growing material to be used in the countertop industry, gradually eating into the share of other materials, such as granite, manufactured solid surfaces and laminate.


As compared to 4.4% 15 years CAGR growth in countertop market globally, quartz alone has grown at a CAGR of 16% over the same period. The use of quartz as a countertop still has a long runway for growth in the US market where the penetration is just 8%


‘Quantra’ is known for its quality and price and hence is showing high growth. Pokarna’s exports are facing stiff competition from Brazil in the granite segment. As per the CS, Brazil has an upper hand in terms of colours and currency depreciation.

A deeper look into revenue distribution in terms of geography reveals more insights. The distribution of granite is varied across geographies with US accounting for the highest share closely followed by India. India accounts for 20% of the world resources in granite and exports more than 200 varieties. Although, around 80% of granite in India is used for exports, the demand is increasing in India due to uptick in non-residential construction and renovation like malls, hotel and airports. The demand for countertop is the highest in Asia Pacific and hence a lot of company’s granite is also exported there.

Most of the company’s manufactured quartz is being exported to US and is highly dependent on the fortunes of the US construction market. The company is slowly but surely expanding its geographical distribution by targeting Europe. Last year, it entered into an exclusive contract with Dekker Zevenhuizen B V in Netherlands to sell its products under the brand name ‘Quantra’.


Since my investment thesis is based on the Quartz segment, I will mainly focus on it in this report.

Quartz imports to US is growing at a scorching pace. It has been setting records consistently since the past year due to high demand by fabricators who in turn sell it to eventual consumers. The growth rate of imports from India have shown a YOY increase of 219%.


As per the latest monthly data available (November 2015), India again showed high growth rate of above 250%. In October, imports from India witnessed a growth of 478% YOY.


Financials : Pokarna is showing turnaround in its numbers aided by fast growth and repayment of debt


As mentioned, the company had a torrid time pre 2014. The housing market in US started picking up in 2014 and it also led to a revival in the company. Quartz segment picked up majorly in FY 2015 with 120% increase in revenue YOY. Due to operating leverage coming into play the company also improved its operating margin from 2% in 2010 to 19% in 2015.

The company redeemed all its outstanding FCCBs in mid-2014 and therefore improved its net profit margins too. Since the company procures its own raw materials from quarries, it has high gross margins. The total revenue (incl. scrap/other income) has grown at a CAGR of 18 % over the past 5 years.

The growth in the quartz segment continues in FY 16. The consolidated 9 months revenues are up 31% while the PAT has increased by 3 times over the same period in FY 15. The granite division has witnessed a marginal decline due to competition but that has been compensated by 75% increase in quartz surfaces in 9M FY 16. The EBIT margins of the company has improved to 30.4% during the same time. The ROCE on the Quartz segment stands at 30% while it amounts to 35% in the granite division.


Due to this transformation, the ROE of the company is close to 50%. Since the company has been reducing debt, the increase in ROE is mainly on account of increasing net profit margin and asset turnover.


The company also declared a dividend of Rs.3/share in FY 2015. The company needs to stop reinvesting in its apparel division and I am hoping sanity will prevail. That said, the company is slowly shifting its focus away from the apparel segment and has not increased the capital employed on the division. Quartz now accounts for more than 50% of the revenues (9mFY16). It accounted for 31% in FY 15.


With FCCBs out of the way, the company intends to use its cash to pay down the debt. The D/E ratio of the company is still very high. However, the ratio is also higher due to equity erosion in the past. In HY16 the company’s equity has already increased to 78 cr and the LT debt to equity has come down to 2.5.


Out of the 200 cr long term debt, 110cr amounts to loan taken from banks while the remaining amount is the loan given by the promoters. Below is the debt maturity profile of the term loans-


The company has consistently generated positive CFO except in 2014 when the receivables increased. Pokarna generated good free cash flows last year and since it does not have major capex planned, we can expect the company to generate FCF going forward too. As per the CS, the company may incur capex in the quartz division, however the amount will not be high since the company already has a provision for a second line in its Vizag plant.

Given the strong cash flow generation, low capex planned in future and strong bottom line growth, it is reasonable to assume that the company should not have much problems in paying down the debt.

Competition : Although the company faces stiff competition from across the globe, it is making a mark in the market as a result of its relationships with the dealers and adverse situation of one of its major competitors in US.

Pokarna Ltd. has been exporting finished and processed granite which is facing stiff competition from Brazilian manufacturers who have better colours and their currency has depreciated recently which enables them to sell cheaper.

As per the National Kitchen and Bath Association (US), “While both quartz and granite countertops were specified by more than 80% of respondents in 2014, only quartz is expected to increase, while NKBA designers expect fewer granite countertops in 2015”. US has also witnessed decline in granite imports recently from India. Hence, the real differentiator is ‘Quantra’ which is renowned for its quality. The company does not face any competition from India due to its use of patented Breton technology. There are players like Asian Granito which have inferior products in terms of mix(marble + quartz) and no access to Breton technology. Breton is an important technology for countertops as the manufacturing process is “Eco-friendly” and the finished product is free from micro porosities.

Pokarna’s main competitors in US are Caesarstone (Israel), Cambria (Minnesota), Silestone (Spain) and Dupoint (Canada). They all use Breton for manufacturing. All quartz manufacturers use the 93/7 formula (93% quartz and 7% polymer). Cambria is the only company that manufactures in USA. Caesarstone as per their latest AR have also set up a manufacturing plant in US. There are Chinese imports too but they use a lot of chemicals and hence their colours fade easily.

Pokarna Ltd. sells its products to third party dealers who in turn sell it to fabricators. The fabricators then sell products to contractors, developers and customers. Caesarstone is the only company in US which has both direct and indirect sales channels. It spends 60% of it expenses on advertising.

The market is very competitive and the main determinant for the brands would be the tie ups with the dealers.

Caesarstone has exclusive tie-ups with IKEA US and Canada, Silestone sells exclusively through Home Depot, DuPoint sells through Lowes and Pokarna sells exclusively to Daltile, Oregon Tile and Marble and IGM.

Caesarstone claims to have 19% market share in US. However, a recent ‘short’ report by Spruce Point Capital( ) not only questions these claims but also questions the quality of the product. As per their lab tests, Caesarstone had only 88% quartz and 12% polymer as compared to industry benchmark of 93% quartz and 7% polymer. The feedback of customers on and is not very encouraging and people have been complaining about stains and warranty on the product. Due to these reasons, Caesarstone has just shown 11% increase in revenues last year as compared to its previous 5 years average of 25%. The decrease is also due to stiff competition from cheaper imports as mentioned in the report and also by Caesarstone in their 2014 AR-


We face competition in all of our key markets, primarily from manufacturers located in the Asia-Pacific region and in Europe that market quartz surface products at lower price points, including quartz surface products which imitate our products and designs. Manufacturers in China, Vietnam and other countries in the Asia-Pacific region frequently benefit from labor and energy costs that are significantly lower than our costs and enable them to price their products lower than our products. Under these circumstances, we can face direct competition that significantly undercuts the prices that we are able to charge and that we seek to charge our customers, as well as the prices that our distributors and fabricators are able to charge consumers. Even if we seek to lower the prices that we charge for our products in certain markets, we may be unable to achieve the same labor and energy costs in order to maintain current margins on our products

As per the CS, Daltile- a big retailer of wall and flooring products which used to sell Caesarstone’s products, cancelled its contract with them recently and is now selling Pokarna’s quartz surfaces on an exclusive basis under the brand name One Quartz.

Caesarstone mentions labour being a primary reason for cheaper imports from Asia Pacific. Recent wage hikes in China has increased the labour cost by as much as 5 times (incl. social security costs) as compared to India. Labor accounts for 20% of the operating costs for Pokarna. This gives another opportunity to Pokarna Ltd. to increase its share in the US market.

To increase market its market presence, Pokarna has been displaying its products at various exhibitions and its marketing team is closing relationships with the dealers in the target market.  Although there are many competitors, the market is large enough to accommodate all.


Voice of the dealers

I called up a few dealers of Quantra to understand the product, competition and what influences a customer’s decisions. Pokarna Ltd. is currently a B2B business. I spoke to dealers in US since that is the main market that Pokarna caters to.

Bedrosian, which used to exclusively sell Quantra until recently has discontinued the product. Instead they have started selling their own brand (Sequel Quartz) seeing the growth in the market. While one of the dealers cited quality as an issue, others said that there was no particular reason for them to discontinue the product. Most Bedrosian dealers mentioned that the management saw more potential in their own brand.

Oregon Marble and Tile has 5 dealers and sell Quantra only. They spoke highly of the quality of the product and said that they have been getting good feedback from the customers. There are two things that stood out for Quantra- range of exclusive colours and price. Average price for Quantra is around $25/sqf for 3 cm thickness as compared to $28-30 for Cambria. Caesarstone sells its product at an average price of $30-35/sqf since it has positioned itself as a premium brand. While only one dealer gave me a quote for the slabs, all others mentioned that the price depends mainly on the fabricators that are selling the product which includes the cost of installation.

Daltile, another dealer who buys exclusively from Pokarna sells its products under the brand- One Quartz. Again the feedback was good from dealers. They told me that Chinese quartz does not find application in kitchen countertops due to their inferior quality. They also told me that they are witnessing an increasing demand for quartz and have been increasing their inventory.

In terms of quality, all dealers said that the brands are on par with each other as long as they use Breton technology. The main criteria for decision making for the consumers are the fabricators and colours. As per a fabricator, “For a consumer- a quartz is a quartz” and hence brand does not play a significant role. The fabricators quote prices including their cost of installation which plays a major factor. In some cases cost of installation goes beyond the price of the slab itself. Some fabricators quoted as high as $70/sqf. The consumers have faced problems with installation in the past and hence they need to be wary of the skill level of the fabricator.

One of the fabricators also mentioned that the likes of Caesarstone and Silestone are giving high discounts on their products due to availability of cheaper products with the same quality. In some cases the discounts are as high as 40%. This will impact the margins of these companies and it will be interesting to see for how long  they can maintain it.

I learnt from the conversations that every brand is on a level playing field. The real differentiator would be exclusivity with the dealers and the fabricators who in turn sell it to the eventual consumers. The market is very competitive and I believe that expecting a 50% growth YoY is unreasonable. As the base effect narrows and more competition enters the market, the growth rate would be more realistic. As per Daltile, it is reasonable to assume 20% growth rate for the next few years.

ValuationPokarna Ltd. is trading cheap on relative valuation and DCF based on conservative estimates


The closest listed comparable for Pokarna Ltd. is Caesarstone in US. Caesarstone’s stock took a beating recently after the report. Even though Pokarna has far better growth prospects than Caesarstone, it still looks cheap on a relative basis.


Based on conservative growth estimates, the company is trading at a discount to its PV of cash flows.

The company has very low institutional holding and is yet to be fully discovered by the market. It has no analyst following.

Why Pokarna Ltd.?

  • Tailwinds– Pickup in both residential and non-residential construction market in US along with high demand for granite and quartz is a big positive for this company. The construction market witnessed it best growth in almost a decade in 2015 led by residential market. It is expected to grow 3.1% annually in real terms from current 1.7%.

Quartz is expected to be the fastest growing stone in the market. Residential market in US performed better than commercial last year and it accounts for 80% of the quartz countertop demand. Quartz penetration in US is increasing at a fast rate. Quartz growth has outperformed the industry growth in the past and is expected to continue on the same trajectory


Despite, increasing usage, Quartz accounts for just 8% of all countertops in America, resulting in one of the least penetrated developed markets in the world. The figure pales when compared with Australia and Europe wherein the share of the product ranges from 30% to 50%.

Quartz seems to be following the same growth story that granite countertops witnessed in the 90s in US when there was so much demand that the companies couldn’t even cater to it. As per NKBA, Quartz is the next big thing. The reason for the same is its uniform appearance, higher hardness rating as compared to other materials and its non-porous nature. Natural granite on the other hand needs to be sealed twice a year and its shine wears over time. The demand for quartz is high in both remodelling and new construction market.

Added to this, fed rate hike and interest rate cuts in India are dollar bullish which should benefit the company since it earns 70% of its revenues from exports.

Polymer which is expensive and comprises of 7% of slab material is dependent on the price of crude. Falling crude should further help company to expand margins.

  • Growth- Pokarna Ltd. has a long runway for growth. ‘Quantra’ has just started picking up in US and is slowly entering other markets. It recently entered Netherlands through an exclusive tie up with Dekker Zevenhuizen which will sell its products under the brand name EQ by Quantra. Pokarna also entered Greece and Middle East. The company is making efforts on marketing and distribution. It showcased its ‘Ganges collection’ range by Quantra at Marmomacc event in Italy which is considered the biggest annual event in the stone industry. This was the biggest product launch in company’s history. The company was also awarded Kosher certification for its products. Kosher means proper or acceptable by Jewish traditions. This confirms that the product adheres to the highest quality of Kashrut(Jewish dietary laws) and allows the Kosher consumers to use Quantra in their kitchens. As per Mr. Gautam Chand, “This certification besides enabling us to expand our market presence will also help us meet the growing demand for products conforming with Kashrus principles. Equally important, it will help us strengthen the trust for our products in the Jewish market”. Caesarstone is the only other competitor with the same certification.

Pokarna has also made a mark in the domestic market by executing lucrative projects in the non-residential market like Taj hotel, Mumbai Airport etc. With disposable income rising, consumers will gradually shift to granite and quartz in the residential market too.

The company upgraded its plant to manufacture jumbo slabs this year due to their high demand in the US market.

As mentioned, maintaining and developing relationships with the dealers is key. In the construction market they would also need to work on creating awareness amongst the developers. In renovation market, I believe fabricators will play a major role in influencing a customer’s decisions. Since Pokarna enjoys better margins than its competitors, they can give more dealer commissions thereby penetrating the market. Caesarstone, in particular has been witnessing margin compression due to supply problems and also discounting being given to fabricators as a result of competition from cheaper imports.

  • Improving financials – Pokarna ltd. is showing improvement in its numbers with increasing margins and ROE. The company is paying down debt and increasing top line which is always a good sign. As per the CS, the company intends to use excess cash flows for repayment of debt and will be wary of capacity expansion in case it puts more strain on the balance sheet. The company reported net profit margin of 20% in Q3FY16. Since it’s a capex heavy business, operating leverage will come into play with increasing sales which will further enhance the margins. Quartz division EBITDA increased by 228% YoY in 9mFY16. The company is also available at a good valuation with protected downside.
  • Competitive edge – Pokarna is the only company in India with Breton technology. Bretonstone System follows an eco-friendly friendly manufacturing process and the final product guarantees an optimum “indoor life quality”. It also has an advantage of cheap labour when compared to its global peers. It takes about 2 years to set up a plant using this technology.

When it comes to granite, Pokarna Ltd. has its own quarries for raw materials. Getting a license for the quarry is a very difficult process and takes at least 2-3 years. There is abundant supply of raw materials in Andhra and Telangana where the company is located. Pokarna Ltd. has a head start in the market and has an opportunity to establish solid dealer networks before more competition enters the market.


  • Supply of quartz– As per the CS, Pokarna Ltd. has been sourcing quartz from quarry owned by the Chettinad family. The company has applied for licenses but is yet to be granted one. The management is optimistic about getting it soon. They only have verbal agreement with the supplier. A quick look at the Government data for quartz mining lease shows that Pokarna has 20 hectares which is not operational(expires on March 2018) while Chettinad has another 20 hectares. There is lack of transparency in the deal between the two entities and the CS was not willing to answer the question.

  • Slowdown in the construction market– Any slowdown in the construction market will impact the demand for Pokarna’s products.
  • Apparel segment – The management has been destroying value on this segment. Although the company is shifting its focus away from this division, it still remains a drain on Pokarna’s profitability
  • Inability to pay debt– If the company fails to generate cash flows due to slowdown in the sector or intense competition, the company may default on its debt.
  • Corporate Governance– The company has material related party transactions and an investor needs to be cognizant of these transactions and the risks that come with them. Also the promoter took more salary in 2009 than what is permitted.


V-Mart:Big where it matters CMP: 520

Most retailers in India have destroyed shareholder value due to aggressive expansion, over leveraged balance sheets and low cost efficiency. In an industry dominated by players with abysmally low Return on Invested Capital, V-Mart clearly stands out. Backed by an ethical and transparent management with strong focus on costs, conservative financing, regional economies of scale and the best operating margins in the industry, V- Mart provides an opportunity for investors to participate in a profitable growth story.

Company Description
V-Mart is a fashion focused retailer with 109 stores across 12 states in India. While all its competitors are focusing on Tier 1 market, V-Mart is the only retailer focusing on Tier 2 and Tier 3 markets. The company got listed in 2013 and was oversubscribed at 1.2 times.


Founded in 2002, it is primarily engaged in ‘value retailing’. V-Mart prides itself on its low prices and all its discount stores proclaim the slogan “Priceless Fashion”. They focus on providing quality merchandise to their aspirational customers at discounted prices. As a matter of fact, the prices offered by V-Mart are comparable to road side vendors in the cities they operate; the differentiating factors being quality, variety and the experience of air conditioned shopping to its customers. The majority of its growth comes from Tier 3 cities where people are fascinated by such experiences and there is limited scope for other big retail outlets to establish themselves due to limited infrastructure availability and the size of the towns they operate in. This gives an advantage to V-Mart since it eats up into a large portion of the market which was earlier being served by road side vendors.
The company sources its supplies from its network of 2,000 vendors which are then shifted to a distribution centre in Delhi. The supplies are then dispatched to its stores. The company has a team of 35 people that focus only on procurement.

Through its stores, the company sells apparels, general merchandise and FMCG products (Kirana Bazaar). The management has shifted focus from low margin Kirana Bazaar to high margin Fashion segment over the years as can be seen below.

Capture2Capacity to Reinvest
With the company having tapped less than 10% of its target market, there is enough room left for growth

A term made famous by the global value investor, Thomas Russo, capacity to reinvest looks at the runway for growth. A company which can reinvest its profits at a higher Return on Invested Capital (ROIC) than cost of capital, creates value for its shareholders.
Since its listing, the topline of the company has increased at a CAGR of 37%. While this in itself is a phenomenal feat, the company still has a huge scope of growth in future. The map above shows that the company has most of its stores in UP and Bihar. There are still a lot of untapped markets which it is expanding into gradually.

Added to this, shift from unorganized retail to organized retail and rising income in Tier 2 and Tier 3 cities will aid to the growth of this company. Consumers in these markets are becoming more brand conscious which bodes well for V-Mart.


The company intends to add 20-25 stores every year going forward using their cluttered growth strategy. Unlike other companies, this growth has not come at the expense of its profitability.

Highest operating margins in the industry and conservative financing has enabled the company to grow without compromising on ROIC


It is uncommon to see a retail company generating higher profits with increasing top line in India. The reason for the same is high debt and fixed costs accompanied by aggressive growth strategy pursued by the management. V-Mart on the other hand has grown consistently without adversely impacting its margins. The gross profit margins of the company have remained stable. Due to their scale, even though the company is
procuring its materials at a lower cost from suppliers, V-Mart passes all the benefits to its customers. This way it stays true to its concept of ‘value retailing’ (see below).


With expansion of sales through new stores, the company has maintained its EBITDA margins and increased its Net profit margins through debt repayment. V-Mart has also shown strong Same Store Sales Growth (SSSG).


The reasons for decline in SSSG last year was due to (a) Bihar elections where the company has large presence (b) low monsoon and (c) In 2014 most of the growth in stores was skewed in the second half during festival season. New stores enjoy 2-3 months of honeymoon period and this was coupled with high demand during the Q3. In terms of seasonality, Q1 accounts for approx. 20-25% of bottom-line, Q4 accounts for around 15%; the rest divided between Q2 and Q3 wherein the third quarter accounts for 45%.


This is one of the most conservatively financed company in the sector. It used the IPO proceeds to pay down its debt and has since been using the remaining proceeds and internal accruals to expand. The company has no long term debt (on net basis). It only takes short term debt for financing working capital which is seasonal in nature. As a result its interest coverage ratio has also increased from 2.94 to 13.84 since FY 11. Inventory management is one of the biggest challenges in retail. The management seems to be heading in the right direction with decrease in DIO. Last year the company consolidated its warehouse operations from two to one. The company retained the services of APL Logistics to plan the layout of the warehouse so that goods move efficiently and the company could focus on its core competencies. The warehouse is now more centrally located to serve the stores and thereby reducing transportation costs too. V-Mart also commissioned an online vendor portal in January 2015 to engage with vendors on realtime sales of their stock and necessary replenishments, shrinking process time lag; the portal also showcased vendor performance (orders placed, supply responsiveness, product quality, returns percentage, inventory status and profits generated), extending to repeat orders. The company has a network of 2,000 vendors and given its scale, it is taking advantage by getting better
credit terms as can be seen from increasing Days of Payables outstanding. The company has very low DSO as it collects cash at the time of purchase. With decreasing DIO and increasing DPO the company has improved it Cash Conversion Cycle from 76 days in 2011 to 46 days in 2015.


The company has grown the number of stores at a CAGR of 24% which required reinvestments into capex. The company requires around 1cr of capex to open a new store along with another 1cr. on orking capital. Despite growing the number stores by 27% last year, the company reported FCF. As mentioned earlier this expansion has not come at the expense of profitability as the company has redeployed capital at high ROIC.


V-Mart is head and shoulders above its competition in terms of return ratios and enjoys competitive advantage of being the lowest cost operator

V-Mart, in its markets is an elephant amongst an army of ants. All other listed players and closest comparable like Trent, Shoppers Stop and Future Retail operate in Tier 1 markets. This gives V-Mart a big advantage as the local vendors lack capital to compete against the company. Despite having mere monopoly in most of the market it operates, V-Mart has not increased its prices even though it can afford to. It has in fact reduced its prices and passed on its advantage of bargaining power with suppliers to its customers. V-Mart understands that its target market wants quality at a very reasonable price which works differently from the consumer market in Tier 1. My father works in Haridwar. V-Mart store is a kilo metre away from where he stays. There are numerous other high end branded apparel outlets on the same lane like Levis, Blackberry’s, Peter England, Louis Philippe etc. Whenever I crossed that lane, I always noticed these EBOs were empty while V-Mart was always buzzing with crowd. That is a testament to the value V-Mart brings to its
customers in terms of variety, quality and price. This is one of the reasons why V-Mart has the highest Sales/sqft. Per month (Rs. 792) amongst its peers (Shoppers stop ~ Rs.670, Future Retail ~ Rs.550) Even though V-Mart has the lowest gross margins in the industry, the competitive advantage of V-Mart stems from being the lowest cost operator in the industry as can be seen from Operating(EBIT) and Net profit margins. The reasons for the same is controlled concentrated growth along with low debt.


As mentioned, V-Mart passes all its supplier cost advantages to its customers. Also, V-Mart has lower number of private label brands accounting for 25% of the revenue.


The presence of V-Mart’s moat is proven by the fact that it consistently has higher ROIC as compared to its peers.


This competitive advantage can be attributed to the expansion strategy followed by the management. Unlike its peers, V-Mart has not spread itself too thin by expanding aggressively. The company has followed a cluttered growth strategy which has enabled it to capture a high market share in the areas it operates thereby spreading its fixed costs over a large number of sales. For a retailer, economies of scale is not the number or size of the outlets it has; it is the market share in the relevant market it operates. Therefore, the advantage of economies of scale is very regional in nature. Most of its peers expanded
without consolidating their position in a particular region and hence never gained any significant market share. What has also helped V-Mart retail is that they have the first mover advantage in an untapped market. They have had very limited competition to deal with of similar size. Apart from this, the small cities they operate in do not have enough infrastructure and space to deal with a lot of retailers. This has enabled V-Mart to capture a good portion of the market and spread its fixed costs like advertising (which
is fixed for a region regardless of the number of customers), employees, rent etc. over its sales. Its stores are located 150 km within each other which also saves the transport costs since trucks don’t have to travel long distances from the centralised warehouse and helps in better inventory management. This is the reason why the profits have grown along with higher sales – a rare feat in the retail industry in India. Even if a competitor enters V-Mart’s markets, it will be unable to compete on price due to the high fixed costs prevalent in the business.


The model followed by V-Mart is very similar to the one followed by Walmart as can be seen in this link – ttp://


Starting from Arkansas, Walmart expanded slowly to areas around it. Walmart too had the lowest gross margins in the industry as they passed on the advantage to its consumers. However, it had the highest operating margins and return on capital employed in the industry even though it was smaller than its peers initially in terms of revenues(Between 1970 to 1985, Walmart averaged 24% ROCE and its operating margins peaked at 8%) . Kmart, which was a lot bigger in size tried to enter Walmart’s territory and started competing by lowering prices. Since Walmart had regional economies of scale, it slashed its prices even lower and was still profitable. Kmart didn’t have the same privilege as its sales were too low relative to the fixed costs in areas where Walmart enjoyed significant competitive advantage. Therefore, economies of scale became an entry barrier for Walmart’s competitors and it thrived. It is good to know that V-Mart is implementing a tried and tested model in India. It will be important for the management to remain focused in order to continue the company’s sustained growth.

Backed by an intelligent fanatic, Mr. Lalit Agarwal is an owner operator with substantial experience in retail and high focus on shareholder value

Mr. Lalit Agarwal, founder and MD of the company will fit into William Throndike’s (author of ‘The Outsiders’) definition of an ‘iconoclast’. While every retailer was chasing growth in Tier 1 cities and overleveraging their Balance sheets for the same, Mr.Lalit Agarwal went for the smaller cities – but with a bigger pie of the market. He did the same with conservative financing and truly understanding the market. V-Mart’s growth has been controlled and driven by the return on capital employed rather than the top line.
One can gauge the Management’s high focus on costs, profitability and ROIC in their Annual Reports and Con Calls. There are a few things worth mentioning which give us a good idea of how the management thinks.
Focus on Shareholder Value
“At V-Mart, we expect that our business model will generate a 35-40% revenue growth and project to add about 25 stores in 2013-14, with a higher percentage growth in our post-tax bottomline, enhancing value in the hands of the shareholders” – Conference Call Transcript 2013
Focus on FCFF and ROI
“We should keep targeting all the numbers in a better way because I feel the glass is hall full everywhere, so we should be able to see, the core target be return on capital employed and the free cash flow generation, so we have to work similarly parallelly on both the areas, top two KPI that we take for ourselves and the CFO takes for himself”- Con Call Transcript Q4 FY15
When asked about how he makes decisions on opening or closing the stores, this is what Mr. Lalit Agarwal had to say “Whether what kind of ROI I will be able to derive out of the expected sales that I would be able to generate out of these areas.” – Con Call Transcript
Focus on controlled growth with conservative financing and low costs
“At V-Mart, we believe that it is possible to create a robust and profitable retail business that benefits all stakeholders, does not have an excessive dependence on debt, is not governed by aggressive store rollout, does not entail large advertising budgets and does not depend on prominent urban locations.” – AR FY 13
“At V-Mart, we would rather grow 30% compounded across ten years supported by revenue growth in every single year as opposed to 50% compounded with three down years in ten.” – Conference Call Transcript Q3 FY13
“We embrace financial conservatism in a working capital-intensive business, growing our business out of accruals over debt.”- Con Call Transcript/AR
“Instead of rolling out stores at random across the vast geographical arena, we have selected to position each store 150-kms from the other, leveraging efficiencies in brand spending, procurement, supply chain, logistics and inventory management. At our Company, this priority has been extended to our selection of locations; all our stores are in downtown locations as opposed to the prevailing attitude of locating them in high-end malls.” – AR FY 13
“At V-Mart, we believe that even in an extensively under-penetrated Indian retail sector, a business model that generates controlled but sustainable growth works the best.”- AR FY 13
“At V-Mart, the ongoing challenge is not the absence of size or scope of the marketplace; the challenge lies in managing our ambitions so that all the growth that we generate is controlled, profitable and sustainable” – AR FY 14
Focus on Inventory management as its key parameter along with other stakeholders like customers, employees and vendors

“The vendors play a key role in providing affordable fashion to our customers and as such the Company has started actively engaging with them. We have started an annual event, Sahyog, as a forum to engage vendors wherein we invited a select group of 200, shortlisted on the basis of performance predetermined parameters. The forum was utilised to communicate the way forward of the Company and also our expectations from them.”- AR FY 15
“What do I mean business fundamentals is that my inventory and my customer base needs to be intact.” – Con Call Transcript Q4 FY15
“Weekly catch-ups with employees has helped the business to grow. Without good employees it is difficult to sustain a business. For the past year, I have devised a system by which I meet a junior employee for 20 minutes every day. He or she can come to my room and speak on anything they wish to.” – Article
The management focuses on all its stakeholders of the business including vendors, employees, customers and investors. It is not afraid of making bold decisions and close its unproductive stores quickly like it has many times in the past. It also removed focus from ‘Kinara Bazaar’ as it was a drag on the ROI. Mr. Lalit Aggarwal is not too fond of debt fuelled expansion and the company has an internal strategy in place to make sure D/E does not exceed 0.75.
It is a result of Mr. Lalit Agarwal’s focus and integrity that V-Mart has leading return on capital employed in the industry by a fair distance. With all due respect to Warren Buffet, sometimes a good jockey on a bad horse can make all the difference.



The PEG ratio of the company is less than 1 based on TTM profit growth of 42%. It scores high on Magic Formula. Earnings expansion and PE re rating are key components of a multibagger and this company seems to be heading that way.


E-Commerce threat- It is true e-commerce is a legitimate threat to offline retail. However, the scenario in Tier 2 and Tier 3 is not the same as metro cities. I realised this after talking to a few customers at the outlet
o Firstly, consumers there enjoy the experience of shopping in big outlets since it’s still a fresh experience for them. Tier 1 has already transitioned from this phase. For most of the customers I spoke to, it is their getaway spot as there are not many places to go to otherwise.

o Secondly, the buyers in this market are not as impulsive. It is very important for them to look and feel before making a purchase. For many, it is a luxury and they don’t buy as frequently as customers in Tier 1
o Thirdly, pricing which has contributed significantly to the growth of e-commerce in metros and Tier 1 will not be a threat to V-mart as their merchandise are already priced at very reasonable rates with scope of more reduction as they further squeeze in margins from the suppliers

Inventory management – Management has specifically said that it considers inventory as its only asset and has been taking steps to reduce the days of inventory outstanding. This is challenging but management has lived up to it so far. Warren Buffet has often said that retail is not the sort of business where one has to be smart just once; one has to be smart every day. This is a key variable to track in this business

Increased competition – As mentioned the company enjoys regional economies of scale. For a competitor to come in and start competing on price will not be a good idea since fixed costs account for a large portion of the business. Since V-Mart spreads its fixed costs over a larger number of sales, it has the ability to slash prices even lower than the competitor and still be profitable. This gives an entry barrier to the areas where V-Mart operates

Slowdown in same store sales growth- This is another key variable to be monitored. Since, V-Mart is heavily concentrated in a region, any slowdown in those areas may impact the business

Ability to self fund / maintain target D/E– V-Mart requires around 1 cr of capex to set up a new store. On an average the store breaks even in 3 months. To achieve its target of 30% CAGR by 2018 and assuming 7% CAGR in revenue/store (past 3 year CAGR of 9.2%), the company will need approximately 194 stores which is what the management has planned. This means they will have to spend approx. 85 cr on capex by 2018. They will use up the IPO proceeds by the time they reach 125 stores. This leaves them with 70 cr to spend on capex. The company generated 40cr of CFO last year. Assuming they generate the same amount for the next three years, the company should be able to grow using internal accruals. If things do not work out as planned then they have scope for additional debt while maintaining its D/E ratio <0.75

Low monsoon- This has played a spoil sport to many rural stories and V-Mart could be no different.

All in all V-Mart seems to be good company trading at a fair price. The management is competent and is more than capable to replicating its success in the past. At the same time it is highly transparent. Last year it changed its internal auditor to E&Y and also changed the composition of its board to accommodate more independent directors to earn investors trust. With a long runway ahead of them and backed by a passionate entrepreneur , V-Mart is a story to watch out for.