Shaily Engineering Plastics: A disappointing Q3, but don’t overlook its long-term prospects

Q3 analysis

Positives - Gross margin expanded because of pass-through of raw material costs, which were on an upmove in Q2 in tandem with crude prices

Negatives - Sales growth was slower year-on-year (YoY) because of delayed orders and change in inventory policies by the Swedish home furnishing major (SHFM)
- EBITDA margin contracted due to lack of operating leverage and higher investments for bagging new orders. Net profit margin dipped because of lower other income and a significantly higher tax rate
- Finance costs increased YoY since debt was taken for funding land acquisition and other capex
- The target to achieve $100 million in revenue has been postponed by a year to FY21-end

Result snapshot

Observations

Swedish home furnishing major’s expansion plans in India SHFM is the world’s largest designer-cum-retailer of ready-to-assemble furniture and home/kitchen accessories. It plans to invest Rs 10,000 crore in India over the next 5-6 years. One of its outlets at Hyderabad is already functional, whereas two more will begin operations over the next two fiscals.

This development assumes importance for Shaily for the following reasons:
- 50-60 percent of its revenue is attributable to the SHFM
- It is associated with SHFM for over a decade
- It possesses technical know-how to manufacture products in accordance with the SHFM’s strict standards. So, there are high entry barriers in this category.

Shaily will commence supplies of ‘carbon steel’ furniture to the SHFM from October 2019. The management expects sales of Rs 100-120 crore from this project (involving a capital outlay of Rs 50 crore) by FY21.

Client additions in home furnishing are underway Starting Q4 FY19, Shaily will begin supplying products to another large Europe-based global department store, whose yearly sales are close to $100 billion and network spans 10,000 stores across countries. Going forward, the order size has the potential to increase substantially.

Demand for medical packages will help derive operating leverage The healthcare segment is divided into two sub-segments -- devices (insulin pens, dermatological pens) and CRC (child-resistant closures and bottles) packaging. Since compliance costs are steep and clients (i.e. pharmaceutical companies) are intolerant towards errors, there are not too many players in this space.

Utilisation rates at the package manufacturing facilities will pick up only when new orders are secured from domestic pharma clients. The CRC facility, at optimum utilisation levels, can add Rs 55-60 crore to Shaily’s top-line. For now, visibility is to the tune of Rs 20-25 crore only.

Higher use of plastics in auto, FMCG and lighting In the automobile segment, the use of plastics for manufacturing critical components is on the rise within and outside India. The domestic FMCG industry is steadily growing, which results in higher demand for packages. Increasing electrification coverage has helped boost demand for LED lighting. Shaily has business associations with leading brands in these industries.

Cost rationalisation Labour and power expenses, which rose sharply in 9M FY19, are expected to normalise over the next 2-3 quarters. Consequently, the strain on margin should reduce.

Key risks

- Delays in project implementation from the clients’ end may restrict top-line growth
- Raw material price hikes are passed on the customers, but the amount is received after a lag of 3-6 months. This impacts short-term cash flows

Outlook

- After a poor Q3 performance, the stock is close to its 52-week low
- FY19 will end on a subdued note because of sluggish sale volumes
- The stock trades at 20.2 times its FY20 projected earnings
- Any meaningful uptrend in valuation multiples may be visible only from H2 FY20 (i.e. when incremental orders in home furnishing start translating into revenue)

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Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here