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Thursday, September 27, 2012

Indag Rubber - Investment Returns of 105% in 8 months

Hidden Gem - Jan 2012 research article shared by Saral Gyan Equity Analysts:

Indag Rubber Ltd (BSE Code: 509162) - Date: 29th Jan 2012
Recommended Price: 154.70 Target Price: 320

Company Background

Indag Rubber Ltd (IRL) was incorporated in 1978 in collaboration with Bandag USA who provided technical assistance to the company till H1FY07, when the promoters bought back Bandag’s 38.3% holding. The company is in the business of manufacturing precured tread rubber, un-vulcanized rubber strip gum, universal spray cement and tyre envelopes. IRL sells its products through its own depots/franchisees (C&F agents) appointed all over the country while the actual retreading operation is carried out by the retreaders. The company provides the franchisees not only with the retreading material but also with support services and training. The company is concentrating on utilizing the full potential of the existing depots/franchisees and setting up new depots/franchisees in unrepresented areas so as to have a larger and more efficient network.

Indag Rubber Ltd has two plants, one at Bhiwadi (Rajasthan), which is shut since 2006 due to labour problems, and the other at Baddi (Himachal Pradesh) with a capacity of 13,800 MT for tread rubber, 1,800 MT for rubber strip gums and 300 KL for rubber cement. Close to 90% of the company’s revenue is generated from the sale of precured tread rubber. The company has ~25 depots pan India, which sell to retreaders. Some of these depots are owned and operated by IRL while the rest are operated by franchisees.

Investment Rationale

1. Increase in capacity in FY10 and possible further expansion:

Indag Rubber increased its capacities in FY10. Precured tread rubber capacity was increased from 8950 MT to 13800 MT and bond repair & extrusion gums capacity was increased from 1150 MT to 1800 MT. The company is operating at similar utilization levels as before the increase in capacity resulting in an increase in volumes. However, the company has not exploited the increase in capacity to its full potential and further scale-up of utilization could increase volumes going ahead.

2. Increase in realization:

Rubber prices rose in FY09 then went flat in FY10 and later rose in FY11. This led to OPM of IRL falling y-o-y from 14.6% in FY08 to 13.3% in FY09 to 11.8% in FY10 to 10.6% in FY11. However in HY12 so far the OPM have jumped smartly by about 350 bps y-o-y. This is the result of higher volumes and passing on of the effect of higher rubber prices, which have now stabilised. Further its R&D efforts and efforts to improve productivity seem to have been paying off.

3. Replacement tyre demand to remain high till FY13:

Replacement tyre demand grew at 22.7% in FY10 and ~6.0% in FY11 and is expected to grow at ~14% in FY12 and ~10% in FY13. A healthy growth in OEM tyre demand in FY10 and FY11 due to an increase in sales of vehicles will lead to an increase in replacement demand in FY12 and FY13. Replacement tyre demand is expected to account for ~70% of the total tyre demand in these two years. Levels of radialization, increase in transport and replacement cycles affect the growth in replacement demand. The growth in replacement tyre demand will lead to higher demand for retreads as well.

4. Land at Bhiwadi, Rajasthan:

Indag Rubber Ltd Bhiwadi plant located near Alwar in Rajasthan is shut since 2006 when the Himachal Pradesh (HP) plant went on stream. All workers at Bhiwadi have been relieved. The Plant & Machinery has been shifted to the HP plant and there are no plans of restarting this plant. The possible sale of this land or putting it to alternative use could unlock value going forward though the timing of this is uncertain at this point.

5. Tax advantage:

Till FY10, Indag Rubber enjoyed 100% income tax and excise exemption. Starting FY11, the company’s effective corporate tax rate has increased to ~22% as 30% of its profits are exempt till FY15.

6. Attractive valuation considering growth in top and bottom line:

The company is trading at 4.0x FY12 (E) EPS and 3.3x FY13 (E) EPS. P/BV for FY11 was 1.6 vs 2.0 in FY10 while expected P/BV for FY12 and FY13 is 1.3 and 0.9. With good operating (11.8% in FY10, 10.6% in FY11 and 13.3% in H1FY12) and net margins (10.4% in FY10, 7.2% in FY11 and 8.9% in H1FY12), the company has high Return on Assets (32.4% in FY10 and 22.4% in FY11), Return on Capital Employed (65.1% in FY10 and 47.9% in FY11) and Return on Equity (32.1% in FY10 and 24.2% in FY11).

7. Excellent Performance in first 3 Quarters of FY 2012:

Net profit of Indag Rubber rose almost 100% to Rs. 14 crores in 9 months ended December 2011 as against Rs. 7 crores during the same period previous year - March 10 to Dec 2010. Sales rose 47% to Rs. 160 crore in first 9 monhs of FY 2012 against Rs. 109 crore during the same period last year.

Saral Gyan Recommendation

Saral Gyan equity analysts recommend Buy on Indag Rubber at current market price of Rs. 154.70 for target price of Rs. 320 in time period of 12-18 months.

Buying Strategy for Indag Rubber:

50% at CMP of Rs. 154.70
50% at Price Range of Rs. 125-135

Note: As target price is achieved, we suggest our Hidden Gems members to book partial profit by selling 50% of their holding in Indag Rubber at current market price and holding the rest for long term.