While a part of the weakness in results is transitory in nature, higher costs owing to employee benefits could be a new normal in R&D intensive industry.
Arrow Greentech has recently declared a weak set of quarterly numbers, marked by higher operating costs. While a part of the weakness in results is transitory in nature, higher costs owing to employee benefits could be a new normal in R&D intensive industry. However, we take note of the business growth in different product segments and remain enthused about their growing patent repertoire.
Q1 2018 results
Arrow Greentech’s consolidated net sales were up by a meagre 2 percent YoY wherein healthy standalone sales numbers (+27 percent YoY) were offset by weak operating performance from subsidiaries. Gross margin contracted primarily due to a sharp increase in the purchase of stock-in-trade, which should be transitory in nature. But what could be structural is the higher employee cost (+92 percent) owing to the requirement of high skilled work force that impacted operating margins. Further, higher depreciation expense and other expenses (possibly higher patent filing cost) weighed on profitability (- 42 percent YoY).
Business progress: across all segments
Company’s annual report (FY17) provides some new updates on the existing businesses.
A. Increased production of water soluable films (Watersol) by three times
As we noted in our earlier article, the company has completed capacity expansion that has augmented its capacity by three times, which they are targeting for agrochemical and health/hygiene sectors. Given the business traction, the company might go for further capacity expansion.
In the agrochemical space, the company sees a good opportunity as various Indian companies exporting agrochemicals are required to use such films for packaging harmful chemicals as mandated by various environmental agencies.
B. Klenz Pro: Hygiene chemicals in a water soluble film
Klenz Pro is a concentrated range of hygiene chemicals developed with technical support from Proquimia - a leading Spanish manufacturer of hygiene chemicals. Currently, this product is available in all major cities in West and South India (25+ distributors) with major end clients as hotels, pharmaceutical plants, automobile industry, facility management companies, etc. At present, the company has a product range of 59 and plans to expand the range to about 90 products by 2018.
C. Security products: protecting grey marketing of FMCG products
Arrow has scores of patents in the field of security used for brand protection and is catering to high-end security products like passports, bank notes and security paper. Arrow Greentech is especially targeting the area of protecting and controlling of grey marketing in FMCG products. The company says that track and trace solutions embedded in printed water soluble film for detergent pods or dishwasher tablets are some of the products it is looking to commercialise in the near-term.
New patent approval opens a new opportunity for monetization
Recently, the company said that it has received the patent rights from the Indian Patents authority for their patent – “Biodegradable smart cards”. As per the Intellectual Property cell, this invention provides a bio-compostable smart card comprising biodegradable magnetic stripe as one of its components. The cell further qualifies that percentage of biodegradation in the card shall be at least 90 percent within a maximum period of six months.
Given the big opportunity of smart cards as well as environmental concerns, this could turn out to be a big opportunity if the company is able to monetise this.
Valuation & recommendation
We take note of a new set of information coming from its new patent approval but look forward to further visibility from the management in terms of its monetization in the near term.
In light of the poor financial results, we have tweaked our financial projections, particularly for employee cost.
Stock has rallied about 10 percent since the time we initiated the coverage on Arrow Greentech on July 5, 2017. It is currently trading at 17.1x 2019E earnings which is at par with its global peers. Further, we maintain that company is at an early stage of growth (revenue CAGR of 16 percent for 2017-19E); a valuation re-rating is possible due to the array of patents (higher share of royalty income), potential for monetization and the recent capacity expansion.
In our view, stock decline post quarterly result provides investors an opportunity to take exposure to this high-beta growth stock.
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