J. P Morgan - Pidilite Industries

Asia Pacific Equity Research 03 May 2014

Initiation

Overweight

Pidilite Industries

PIDI.NS, PIDI IN Price: Rs315.00

A stock to bond with; initiate with Overweight

Price Target: Rs375.00

Pidilite Industrie Industriess (PIDI) (PIDI) is Initiate Initiate with with Overweight Overweight and and Mar-15 Mar-15 PT of Rs375 Rs375. Pidilite a leading adhesive & construction chemical manufacturer in India and holds a near-monopolistic share (50-70%) across its key brands (Fevicol/M Seal/Dr Fixit). PIDI has delivered delivered revenue revenue and and EPS growth growth of 17% 17% over the last last three three years years despite challenging fundamentals for discretionary and construction spends. We expe expect ct grow growth th to be sust sustai ained ned,, espe especi cial ally ly give given n expe expect ctat atio ions ns of of a mac macro ro improvement and a pick-up in industrial industrial activity in 2H. Recent improvement improvement in its underperforming international portfolio should also aid growth. growth. Valuation Valuation of 27.7x FY15 FY15E E P/E is at a premiu premium m to its trading trading history history,, but this should should contin continue ue given its increasing FCF generation, strong ROE profile, profile, and overall valuation valuation rerating seen across the building products space. 

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long-standing track record record of delivering delivering Glued to steady growth: PIDI has a long-standing steady revenue and earnings growth growth with minimal minimal volatility, volatility, especially in its consumer-facing business. business. New product launches and increasing growth in tier2 towns have been aided aided by a strong brand equity equity and widespread distribution distribution network (1MM+ points of presence). Also notwithstanding cost pressures in key RM (VAM, Oil derivatives) and expected ad rate inflation, we think PIDI can hold on to margins given its improving contribution mix and ability to pass on costs via price rises (consistent history history of over 10 years). We model revenue growth of 15-16% in FY15/16, similar to FY14’s. FY14’s. Improvement in discretionary discretionary spending or industrial activity activity in 2H could provide upside to growth trends. trends. International business now nearing a turnaround after being a drag on financials since FY08. FY08. We are encouraged by growth and margin improvement seen over over 9M FY14 FY14 driven driven by price price increase increasess and cost cost control control along along with initiative initiativess taken to strengthe strengthen n local managem management ent and marketing marketing teams. teams. In Brazil (one of the biggest markets in the international international portfolio) PIDI’s PIDI’s losses shrank significantly in 9M and and it is targeting cash cash breakeven over the next year.

India Building Materials Gunjan Prithyani

AC

(91-22) 6157-3593 [email protected] Bloomberg JPMA PRITHYANI J.P. Morgan India Private Limited

Saurabh Kumar (91-22) 6157-3590 [email protected] J.P. Morgan India Private Limited

Leon Chik, CFA (852) 2800-8590 [email protected] J.P. Morgan Securities (Asia Pacific) Limited Price Performance 340 300 Rs 260 220 May-13

Aug-13

Nov-13

Feb-14

May-14

PIDI.NS share price (Rs) NIFTY (rebased)

Abs Rel

Y TD 10.1% 3.9%

1m 2.1% 3.0%

3m 14.0% 2.5%

12m 25.9% 14.3%

Earnings and valuations: Our expected EPS growth for the business over the next two years is 19%. Our DCF valuation valuation imputes a COE of 12.5% and and longterm growth growth of 6%. PIDI’s PIDI’s close closest st compet competitors itors in the the Paints Paints space space – APNT (UW, (UW, cove covere red d by by Lat Latik ikaa Cho Chopr pra) a) and Berg Berger er (Not (Not Cove Covere red) d) – trad tradee at at comparable comparable or higher higher multiples multiples and have have similar similar industry industry structur structure, e, business business model, demand fundamentals fundamentals (home improvement), improvement), and cost and margin profile. profile.

Pidilite Industries (Reuters: PIDI.NS, Bloomberg: PIDI IN)

Rs in mn, year-end Mar Revenue (Rs mn) Revenue growth (%) EBITDA (Rs mn) EBITDA Margin Net Profit (Rs mn) EPS (Rs) DPS (Rs) P/E(x) EV/EBITDA (x)

FY12A 31,097 17.6% 4,926 15.8% 3,244 6.39 1.90 49.3 32.7

Source: Company data, Bloomberg, J.P. Morgan estimates.

FY13A 36,579 17.6% 5,990 16.4% 4,221 8.23 2.60 38.3 26.8

FY14E 42,395 15.9% 7,327 17.3% 4,863 9.49 3.32 33.2 21.9

FY15E 48,993 15.6% 8,606 17.6% 5,837 11.39 3.99 27.7 18.4

FY16E 57,101 16.5% 10,128 17.7% 6,876 13.41 4.69 23.5 15.5

Company Data Shares O/S (mn) Market Cap (Rs mn) Market Cap ($ mn) Price (Rs) Date Of Price 3M - Avg daily vol (mn) 3M - Av Avg daily val (Rs mn) 3M - Avg daily val ($ mn) NIFTY Exchange Rate Price Target End Date

508 159,909 2,650 315.00 02 May 14 0.22 65.77 1 .1 6694.80 60.33 31-Mar-15

See page 33 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.jpmorganmarkets.com


Gunjan Prithyani (91-22) 6157-3593 [email protected]

Key catalysts or the stock price:

Upside risks to our view:

Downside risks to our view:

- Pick-up in growth trends as macro

- Higher-than-expected Higher-than-expected growth trends

- Cash deployment in non-core acquisition or Elastomer project

improves and industrial activity revives - Faster-than-expected Faster-than-expected cash breakeven breakeven in international operations

- Trends in international international business business especially Brazil

- Sharp decline in VAM prices and consequent consequent margin improvement

- Increase in dividend dividend payout payout given strong FCF generation and net cash balance sheet

- Delay in international international cash breakeven breakeven - Sustained weak weak macro impacting the growth growth trends

- Stake sale sale in Elastomer Elastomer project

Key financial metrics Revenues (Rs M)

FY13A 36,579

FY14E 42,395

FY15E 48,993

FY16E 57,101

Revenue growth (%)

17.6%

15.9%

15.6%

16.5%

EBITDA (Rs M)

5,990

7,327

8,606

10,128

EBITDA margin (%)

16.4%

17.3%

17.6%

17.7%

Tax rate (%)

27.5%

27.5%

28.0%

29.0%

Net profit (Rs M)

4,239

4,863

5,837

6,876

EPS (Rs / share)

8. 2

9. 5

11.4

13.4

28.9%

15.2%

20.0%

17.8%

32

38

45

52

Operating cash flow (Rs mn)

5,175

3,654

5,510

6,277

Net margin (%)

11.6%

11.5%

11.9%

12.0%

2. 0 (0.2) 28%

2. 1 (0.2) 2 7%

2. 1 (0.2) 28%

2. 1 (0.3) 2 8%

EPS growth (%) BVPS (Rs / share)

Sales/assets (X) Net debt/equity (%) ROE (%) Key model assumptions Consumer & Bazaar growth Industrial segment growth International growth

FY13A

FY14E

20.7% 8. 5% 11.6%

FY15E

Valuation and price target basis

Our Mar-15 price target target of Rs375 is based based on DCF, DCF, actoring in a COE of 12.5% and long-term long-term growth of 6%. This implies a 28x forward P/E, P/E, which is 1SD above PIDI's mean valuation valuation for the last two years and at a ~20% discount to ANPT’s ANPT’s average average trading multiple for the last last two years.

FY16E

15.1% 14.5% 22.0%

15.2% 12.6% 18.0%

16.2% 14.8% 18.0%

Source: Bloomberg, Company and J.P. Morgan estimates.

Sensitivity analysis Sensitivity to 5% change in Domestic growth rates

EBITDA FY14E

FY15E

EPS FY14E

FY15E

-1.0%

-1.9%

-1.0%

-1.9%

+1% change in EBITDA margin

-5.4%

-5.5%

-5.4%

-5.5%

JPMe vs. consensus, change in estimates EPS JPMe old JPMe new % chg

Consensus Source: J.P. Morgan estimates.

FY15E

FY16E

NA 11.4

NA 13.4

NA

NA

11.5

13.6

Source: Bloomberg, J.P. Morgan.

Pidilite: Comparative analysis with other building product companies 5 year Revenue CAGR (FY09-14) EBIT margin (avg 5 year) ROE (avg 5 year) Net D/E Dividend payout Earnings growth P/ E EV/EBIT Source: Company

2

Pidilite

Asian Paints

Kajaria Ceramics

1 7% 16.4% 3 0% (0.2) 30%+ 3 4% 27.7 20.3

18% 16.3% 36.0% (0.2) ~40% 25% 34.6 22.5

23% 12.5% 28.3% 0. 5 ~20% 68.4% 22.6 12.2

Hindustan Sanitary-ware 2 5% 11.3% 10.0% 0. 9 15-20% 3 .8 % 15.6 10.6

Greenply 22% 7 .7 % 18.6% 1. 2 15% 15.6% 6. 8 5. 3



Table of Contents Investment Summary ....................... ................................................ ........................................4 ...............4 Initiate with Overweight Overweight and Mar-15 Mar-15 PT of Rs375 Rs375 .......................... ............. .......................... ......................... ............ 5 DCF valuation: what is the stock pricing in?............................................................6 Stock price performance and key catalysts...............................................................6

Investment Positives Positives........................ ................................................. ........................................7 ...............7 Industry leader in adhesives space; Diversification into non adhesive segments has also yielded positive results.....................................................................................7 Strong connect with demand influencers influencers has helped build build brand equity ....................8 ............. .......8 Multiple growth drivers...........................................................................................9 Growth has moderated but still strong at 15%+......................................................10

Key segments ........................... .................................................... ..............................................11 .....................11 Consumer & Bazaar: Retail products driving the growth........................................11 Industrial Chemicals: Chemicals: Weak domestic trends offset by pick-up in exports on rupee depreciat depreciation ion ...................... ................................. ...................... ...................... ...................... ...................... ...................... ...................... ..................13 .......13 Others: Specialty acetates......................................................................................14 International business witnessing improving trends; Brazil cash break-even likely in the next year..........................................................................................................15 Strong FCF generation and net cash balance sheet provides scope for higher dividend payout................... payout...... ........................... ........................... .......................... .......................... .......................... ........................... ........................... ................17 ...17 Expect margins to stay firm...................................................................................18

Investment risks ........................... .................................................... ..........................................19 .................19 Spike in VAM prices or FX depreciation could lead to margin volatility in the near term… ...................... ................................. ...................... ...................... ...................... ...................... ...................... ...................... ...................... ...............19 ....19 Cash deployment in non-core business remains a risk risk ......................... ............ ........................... ................... .....20 20 Elastomer project remains a drag on returns; strategic tie-up could remove an overhang overhang ..................... ................................ ...................... ...................... ...................... ...................... ...................... ...................... ...................... .............20 ..20 Lower-than-expected domestic growth trends .......................... ............. ........................... ........................... ................20 ...20

Pidilite Industries: Comparative analysis ......................... .............................22 ....22 PIDI vs. Paints companies (Asian Paints)...............................................................22 PIDI vs. Building product companies.....................................................................25 PIDI vs. Global chemical companies .......................... ............. .......................... ........................... ........................... ................26 ...26

Financials................................................................................28 Company profile ........................... .................................................... ..........................................30 .................30

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Investment Summary Established in 1959, Pidilite is a pioneer in consumer and industrial specialty chemicals. The company company is a market leader in most categories and has a strong brand portfolio. Its flagship flagship brands, i.e. Fevicol, Feviquick, Feviquick, and and M- Seal, Seal, command 70%+ market share in their respective categories From being a pure adhesive player, co has diversified into construction chemicals and art material segment over the last decade Further, the company has made a foray in international international market market since 2005 via acquisition of brands and companies in the US, Brazil, Southeast Asia and the Middle East

Pidilite: Key brand portfolio Category

Major Brands

Adhesives & Sealants

Fevicol, M- Seal (leakage (leakage in pipes), Feviquick (instant adhesive), Fevimarine (sticking marine products)

Constructi on Chemicals

Dr. FIXIT (leakage in walls), Roff (Tiling solution)

Art Materials

Ranipal, Fevicol Hobby Ideas, Motomax, Cyclo

Source: Company, J.P. Morgan

We initiate coverage on PIDI with an Overweight rating rating and price target of Rs375, implying upside of ~20% from the current share price. price. PIDI holds a near-monopolistic position position in the adhesive and sealants sealants industry in India. India. The company company has a strong strong portfolio portfolio of brands, brands, with with its flagship flagship product productss such as Fevicol and M Seal commanding a 70%+ market share in their respective respective categories. The company’s company’s diversification diversification in non-adhesive segments over the past decade, i.e. construction construction chemicals chemicals and art materials, materials, has also met with with good success. Its key construction chemical brand brand Dr Fixit commands commands a 50% market share in the retail waterproofing segment. PIDI has a long-standing track record of delivering steady revenue and earnings growth with minimal volatility especially in its consumer facing business. This as new product launches, increasing growth in tier-2 towns have been aided by its strong brand equity and widespread distribution distribution network (1MM+ points of presence). presence). 9M revenue growth was 16% driven by steady growth of consumer / retail adhesives which has helped offset weak trends in discretionary and industrial segments. We expect the growth trends for the company to sustain, given expectation of an improved macro & pick up in industrial activity in 2H. Recent improvement in its international portfolio portfolio is also encouraging and should aid revenue/ earnings growth. PIDI’s stock price has seen a significant re-rating over the last five five years, and valuations at 27.7x FY15E P/E are at a premium to its trading history. history. This is not at odds with the valuation up-move seen across the entire building product space (paints, ceramics etc) and is supported by its steady growth trends, strong ROE profile, and increasing FCF generation, generation, in our view. view. Increase in dividend dividend payout, international business turnaround, turnaround, and clarity around tie-up tie-up for Elastomer project are some key stock catalysts catalysts ahead. We view paints companies companies as the closest comparables for PIDI PIDI given their similar similar industry structure, demand demand fundamentals (home repair / renovation/ renovation/ new home furnishing), cost structure (high reliance reliance on crude derivatives/ imports), good pricing power, and similar margin margin profile. Looking Looking at the last last 10 years, the performance performance of PIDI and and Asian Asian Paints Paints has been been fairly fairly comparable comparable acros acrosss most key financial financial metri metrics. cs. Compared to to other building products companies (tiles, plywood, sanitary ware) and chemical companies, PIDI is trading trading at a premium. This in our view is justified given PIDI’s dominant position (high pricing pricing power), better ROE and earnings growth profile and strong strong BS.

Table 1: Pidilite: Comparative analyses with building product companies

5 year Revenue CAGR (F09-14) EBIT margin (avg 5 year) ROE (avg 5 year) Net D/E Dividend payout Earnings growth P/ E EV/EBIT

Pidilite

Asian Paints

Kajaria Ceramics

1 7% 16.4% 3 0% (0.2) 30%+ 3 4% 27.7 20.3

18% 16.3% 36.0% (0.2) ~40% 25% 34.6 22.5

23% 12.5% 28.3% 0. 5 ~20 % 68.4% 22.6 12.2

Source: Company reports and J.P. Morgan estimates. For non covered companies we use Bloomberg consensus estimates 4

Hindustan Sanitary-ware 2 5% 11.3% 10.0% 0. 9 15-20% 3 .8 % 15.6 10.6

Greenply 22% 7 .7 % 18.6% 1. 2 15% 15.6% 6. 8 5. 3



Initiate Initi ate with Overweight Overweight and Mar-15 PT of Rs375 Our Mar-15 price target of Rs375 is based on DCF factoring in a COE of 12.5% and long-term growth growth of 6%. This implies a 28x forward forward P/E which1SD above PIDI’s PIDI’s mean valuatio valuations ns for the last two two years and at a ~20% discount discount to ANPT’s ANPT’s average average trading multiple for the last two two years. Key risks to our price target include: include: a) usage of surplus cash to diversify diversify into noncore segments/ brands; b) delay in cash break-even for international international operations; c) sustained macro weakness and consequently moderation in growth trends. Figure 1: Pidilite: P/E trading trading range over the last two years 32 30 28 26 24 22 20 18

2 1 r p A

2 2 1 - 1 y n a u M J

2 1 l u J

2 1 g u A

2 1 p e S

2 1 t c O

2 2 1 - 1 v c o e N D

3 1 n a J

3 1 b e F

3 3 1 - 1 r r a p M A

3 3 1 - 1 y n a u M J

3 1 l u J

3 1 g u A

3 1 p e S

3 1 t c O

3 1 g u A

3 1 p e S

3 1 t c O

3 3 1 - 1 v c o e N D

4 1 n a J

4 1 b e F

4 4 1 - 1 r r a M A

Source: Company reports and J.P. Morgan estimates.

Figure 2: PIDI valuation discount to Asian Paints (on P/E basis) 45% 40% 35% 30% 25% 20% 15%

2 1 y a M

2 1 n u J

2 1 l u J

2 1 g u A

2 1 p e S

2 1 t c O

2 1 v o N

2 1 c e D

3 1 n a J

3 1 b e F

3 1 r a M

3 1 r p A

3 1 y a M

3 1 n u J

3 1 l u J

3 1 v o N

3 1 c e D

4 1 n a J

4 1 b e F

4 1 r a M


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DCF valuation: what is the stock pricing in? In this section, we also look at DCF valuations and growth rates that the market is implying currently. In our DCF analysis, analysis, we use a WACC of 12.5% and mediumterm revenue/ EBITDA CAGR of 16%. The current stock price seems to be implying 3-4% long-term (terminal) (terminal) growth, which which in our view in not demanding. Our PT assumes a 6% terminal growth which we think think is achievable factoring the price inflation in in the business (4-5% (4-5% pa price increase achieved over past decade) and also given linkages to real estate estate demand and increasing retail/ consumer consumer usage of the products. Table 2: DCF sensitivity to long-term growth rates and WACC 11.5% 359 383 416 460 523 623

3.0% 4.0% 5.0% 6.0% 7.0% 8.0%

12.0% 332 352 379 414 463 537

12.5% 308 325 347 376 414 470

13.0% 287 302 320 343 374 418

14.0% 252 262 275 291 312 339

15.0% 223 231 240 251 265 284


Stock price performance and key catalysts Key catalysts catalysts for stock, in our view, are 1.

overhang of further further Stake Stake sale sale in in Elas Elastom tomer er projec projectt – This will remove an overhang investment for completion of the project.

2.

Cash Cash break break-e -even ven for for Brazi Brazill opera operati tions ons which have been a drag on financial financialss over the last few years. Recent Recent revenue/ma revenue/margin rgin trends trends on this biz. have been encouragin encouraging. g.

3.

capex needs and increasing Incr Increa ease se in divi divide dend nd payo payout ut – given limited capex FCF generation.

4.

Improv Improveme ement nt in in domest domestic ic growt growth h trend trendss – driven by expectation of macro environment and pick up industrial activity in 2H.

Figure 3: PIDI: Share price performance 360 330 300 270 240 210 180 150

2 1 r p A

2 2 1 - 1 y n a u J M

Source: Bloomberg

6

2 1 l u J

2 1 g u A

2 1 p e S

2 2 2 1 - 1 - 1 t v c c o e O N D

3 1 n a J

3 3 3 1 - 1 - 1 r b r e a p F M A

3 3 1 - 1 y n a u J M

3 1 l u J

3 1 g u A

3 1 p e S

3 3 3 1 - 1 - 1 t v c c o e O N D

4 1 n a J

4 4 4 1 - 1 - 1 r b r e a p F M A



Investment Positives Industry leader in adhesives space; Diversification into non adhesive adhesi ve segments has also yielded posit positive ive results PIDI is market leader is adhesive adhesive and sealants and construction construction chemicals space in India. PIDI has a strong portfolio of brands with key products like Fevicol, M-Seal and M-Seal commanding 70%+ market share in their respective categories. Even the relatively newer newer brand Dr Fixit Fixit (under its construction construction chemical segment) has a 50% market share in retail water proofing segment. Company’s flagship brand “Fevicol” is synonymous with adhesives in India and is largest selling adhesive in Asia. Brand extensions to introduce new variants (of Fevicol i.e. marine/ speedx), product innovation, creative creative marketing, and product offerings offerings across price points (especially (especially its Rs5 packages) to capture retail consumer demand have enabled company company to maintain its market share in the adhesives space. Further, the company’s strategy to replicate Fevicol success in non-adhesive non-adhesive segments, i.e. construction chemicals chemicals / art materials is also yielding positive results and these segments have been key driver of growth over the last few years. Table 3: Pidilite: Key brand portfolio Category Adhesives & Sealants

Major Brands Fevicol, M- Seal (leakage in pipes), Feviquick (instant adhesive), Fevimarine (bonding products with water exposure)

Construction Chemicals Art Materials

Dr. FIXIT (l(leakage in walls), Roff (T (Tiling solution) Ranipal, Fevicol Hobby Ideas, Motomax, Cyclo

Source: Company, J.P. Morgan

Figure 4: Pidili Pidilite te – Segment Segmental al breakdo breakdown wn (F13)

Source: Company

7



Strong connect with demand influencers has helped build brand equity PIDI has very strong brand equity across its users; built on the back of significant investments in advertising and publicity and relationship building with key demand influencers (carpenters, architects, plumbers etc). PIDI’s innovative advertisements have resulted in mass appeal and high high brand recall. The company has created a fairly fairly strong connect with the demand influencers and customers for its products. Its brand “Fevicol” is synonymous with adhesive in India. PIDI undertakes relationship building activities with its key users or demand influencers i.e. carpenters, plumbers and architects. Some of the key initiatives taken by the company include: include: a) Fevicol champions club which is a community of 5060K carpenters for networking; b) number of publications for carpenters (furniture book highlighting highlighting new trends and designs) designs) and artists artists (fabric designs, designs, Paint designs etc); etc); and c) Dr Fixit Knowledge Center –for correct understanding and application application of water proofing solutions for architects and civil engineers. Figure 5: Pidilite Industries: Industries: Advertiseme Advertisement nt and Publicity spend - Rs B and as % of sales 3.0

4.5%

2.5 2.0

4.0%

3.7%

1.5 1.0

4.3%

4.1%

4.3% 4.0% 3.5%

3.5% 3.3%

3.0%

0.5 0.0

2.5% FY10

FY11

FY12

FY13

A&P spend (Rs B) Source: Company reports and J.P. Morgan estimates.

8

F Y14E

FY15E

A&P as as % of sales

FY16E



Multiple Multi ple growth drive drivers rs Below we highlight the key growth drivers drivers for PIDI’s products range. range. Diversified user base

PIDI has a diversified user base ranging from carpenters/ architects (furniture (furniture industry), plumbers, art professionals, retail consumers, electricians and various industries (paints/ footwear/ leather). This helps company offset growth pressures in case of demand weakness in a particular particular user industry. For instance, instance, demand for discretionary products (new furniture) furniture) was slow in FY14, although this was offset by steady retail demand (Feviquick, Fabricare etc). Large distribution base with widespread geographic presence

PIDI has one of the largest distribution distribution networks networks within the building products products space. The company has a separate distribution network for each of its segments. Overall it it has 1000 distributors across segments and 60K dealers. For its retail products (such as Feviquick), the company has 1MM 1MM points of presence (200K direct and 800K indirect). This is the highest in the building products industry and comparable to FMCG companies. PIDI’s PIDI’s target is to reach 3MM touch points over the medium term, which will continue to drive demand for the retail-led retail-led products. Home repair / renovation renovation a key home driver, which is more stable than new home home construc construction tion

A large part of the demand for the company’s products comes from home repair & renovation work and retail usage of adhesives (Feviquick). Renovation demand has a shorter cycle of 4-5 years vs. new home construction and hence demand is relatively more stable vs. new home construction. Further, the the number of old buildings in large (like Mumbai/ Delhi) as well as tier tier 2/3 cities, which can potentially potentially go under renovation, is fairly high high and these provide a large opportunity opportunity for its construction construction chemical segment segment (water proofing). Dominant presence presence and low cost of usage (as % of overall spend on home renovation/ furnishing) provides company pricing power

PIDI has fairly strong pricing power given its brand equity and dominant market share. Further, Further, spending on PIDI’s products as percentage percentage of total spending spending on renovation / new home furnishing is fairly low. This makes demand relatively relatively priceinsensitive and perceived perceived quality usually takes takes precedence over cost.

9



Growth has moderate moderated d but still strong at 15%+ 15%+ PIDI has been able able to register healthy growth trend (16% in 9M), despite despite overall weak macro and slowing discretionary discretionary spending, given the company’s company’s strong brand portfolio, extensive extensive distribution distribution network, diversified diversified user base, base, and higher replacement demand (vs. new homes). While there has been some moderation in FY14, we think the overall overall growth trend is fairly healthy healthy at 15%+. For FY15/16, we are modeling in largely stable stable growth of 15%/16%, primarily primarily driven by steady growth growth trends in the consumer segment, while we do not factor factor a revival in industrial demand into our assumptions. assumptions. Any improvement in overall macro and industrial industrial activity activity will will likely provide upside to growth forecasts. forecasts. Long-term prospects for the adhesives industry remain strong, given rising income levels across rural/ urban areas, low per-capita consumption of adhesives offers potential headroom for growth, increasing increasing the desire desire to renovate/ refurbish homes (shorter cycle) and higher awareness of branded products. Figure 6: Pidilite: Standalone (domestic business) revenue growth trend 55 50 45 40 35 30 25 20 15 10

52 23%

44

19%

18% 33

38

20% 15%

15%

16% 15%

28 10%

24

5% 0% FY11

FY12

F Y13 Revenues ( R s B)


10

25%

FY14E

F Y15E

Growth % Yo Y oY

FY16E



Key segments Consumer & Bazaar: Retail products driving the growth Consumer and Bazaar segment segment accounts for 80% of the overall revenues revenues and 90% of the segmental profits. This segment has continued to register steady growth given its diverse product portfolio catering to different end users. Hence, demand moderation in the furniture industry over the last year has been offset by steady consumer demand (retail usage for Feviquick, M-Seal etc) and strong growth in the art / stationary segment. Consequently, a large part of incremental growth in this segment is coming from non-Fevicol non -Fevicol products. Figure 7: PIDI: Consumer and Bazaar segment growth trends 45 40 35 30 25 20 15 10 5 0

Figure 8: PIDI: FY13 Breakdown Breakdown of Consumer & Bazaar segment segment 25%

22.3%

Art Material & Others 12%

22.3% 20.7%

20%

15.1%

15.2%

16.2% 15%

Construction / Paint Chemicals 25%

10% FY11

FY12

F Y13

FY14E

R evenues (R s B) Source: Company reports and J.P. Morgan estimates.

FY15E

F Y16E

Adhesives & Sealants 63%

Grow th (%) Source: Company

The share of Consumer & Bazaar segment has been increasing over the last few years due to weak per formance of industrial segment. Within Consumer Consumer and Bazaar, the company operates under three segments a) Adhesive & Sealants (51% of revenues): Key brands in this segment segment include its flagship Fevicol, M-Seal which are used for wood work, plumbing, electrical electrical purposes etc. Most Most brands in this this segment command a 70%+ market share and face limited competition. competition. Huntman’s products such as Carpenter/ Araldite Araldite are the the key competition, competition, while others others are primarily primarily from smaller regional players. This segment has registered a 21% CAGR growth over FY10-13. Growth over the recent past, though, has been led by non-fevicol brands.

11



Figure 9: Adhesive and Sealants: Revenue growth trends 30

25%

23.7%

25

22.3%

20%

20

18.2%

15

15.0% 15% 13.0%

13.0%

10

10%

5 0

5% FY11

F Y12

FY13

FY14E

R evenues ( R s B)

F Y15E

FY16E

Grow th (%)


b)

wide Construction and Paint Paint Chemicals (20% of revenues): revenues): PIDI has a wide product range in this segment. Key brands include include ROFF ROFF and Dr Fixit which are essentially used for waterproofing, tile fixing, floor hardening etc. PIDI’s brands are market market leaders in their categories and the the company benefits from a first-mover first-mover advantage advantage in this segment. However, However, it has seen competition increasing from paint companies in this space. The segment is as yet fairly nascent and penetration levels are very low, so it offers a strong growth potential. This segment registered a 25% CAGR growth over FY1013 given the relatively low base, PIDI’s strong brands, brands, and high industry growth.

Figure 10: PIDI: Construction Chemicals and Paints 12

35%

10

30%

8

29.1%

25.1%

25%

6

20.6%

4

18.0%

18.0%

20% 17.0%

2 0

15% 10%

FY11

F Y12

FY13 R evenues ( R s B)

FY14E

F Y15E

FY16E

Grow th (%)


c)

12

revenues) – The company company has an Art Materials and Stationary (10% of revenues) extensive range of art materials materials for education, hobby, and fine art segments. Key brands in the segment include fabric glue, Ranipal, Fevicare, Fevicraft etc. This segment has has seen sharp growth growth over the last two years, aided aided by product refresh, new launches, and a marketing push by the company. This segment is growing off a low base and, given retail oriented products, products, it should continue to drive growth growth over the next few years years..



Figure 11: Art & Material: Revenue growth trends 6 36.1%

5 4 3

20. 0%

20.0%

2 1

8.9%

10.2%

0 F Y11

FY12

FY13

FY14E

R evenues ( R s B)

F Y15E

40% 35% 30% 25% 20.0% 20% 15% 10% 5% 0% F Y16E

Grow th (%)


Industrial Chemicals: Industrial Chemicals: Weak domest domestic ic trends offset by pickup in exports on rupee depreciation PIDI’s industrial segment has seen an impressive revival over the last few quarters, after a fairly slow FY12/13. This has primarily been aided by a pick-up in exports on the back of a weak rupee, while domestic market performance performance remains fairly fairly subdued due to weak industrial activity (IIP trends) in India. Key export markets for the company are the the Middle East, East, Africa and emerging markets markets in the U.S. U.S. 9M industrial segment growth stood at 14% as against FY12/13 sales growth of 7-8%. We are modeling growth of 13-14% over FY15/16. A favorable election outcome will be the key to a revival in in industrial activity and hence could meaningfully aid the growth trends in this segment. Within industrial, company has three sub segments: a)

Industrial Adhesives – PIDI is a market leader in this segment with extensive range of products catering to packaging, cigarettes, stickers, labeling, footwear, book binding etc.

b)

chemicals for industries industries such as paints, nonIndustrial Resins – Specialty chemicals woven and flocked fabrics and leather catering to domestic and export market. This is used as an intermediate product by paper, leather and paint companies.

c)

dispersions for Organic pigments – PIDI is a market leader in pigment dispersions textile segment. Also caters to paint and plastic companies

Of the above segments, industrial resins and pigments have a high contribution from exports, while the industrial adhesives segment segment is primarily domestic-market-driven. domestic-market-driven.

13



Figure 12: PIDI – Industr Industrial ial busines businesss growth trend trend

Figure 13: PIDI: Industrial segment – FY13 revenue breakdown

10 9

25.0% 22.3% 20.0%

8 14.5%

7 5

7.2%

14.8%15.0%

12.6%

6

Organic Pigments and Preparations 32%

10.0%

8.5%

Industrial Resins 31%

5.0%

4 3

Industrial Adhesives 37%

0.0% F Y11

F Y12

FY13

FY14E

Revenues

FY15E

F Y16E

Grow t h (%)

Source: Companyreports and J.P. Morgan estimates.

Source: Company

Figure 14: Industrial production production trends in India (YoY) 40

%

30 20 10 0 (10) (20) Jan 10

J ul 10 IIP

J an 11

Jul 11

Capital goods

J an 12

Ju l 12

Consumer durable

Jan 13

J ul 13

Jan 14

Consumer non-durable

Source: Bloomberg

Others: Specialty acetates The Others segment is primarily Vinyl Acetate Monomer (VAM) plant operations. VAM is the largest raw material for PIDI. However, the company is importing VAM currently as the price of bought out VAM is lower than in-house production cost. PIDI is now evaluating the possibility of utilizing the VAM plant for other specialty acetates. As of now trials are underway and the company is marketing the products to clients. The company expects the revenue contribution from this segment to increase to Rs1-2B+ over the next 2-3 years, once the product gets acceptance, as against FY13 revenues of Rs200MM (9MF14 – Rs240MM). Rs240MM). This could could result in a positive positive EBIT contribution from this segment as capacity utilization picks up, compared to the loss in in FY13. FY13.

14



International business International business witnessing improving improving trends; Brazil cash break-even likely in the next year PIDI’s international operations operations have shown a meaningful improvement over the last few quarters, after being a drag on the company’s consolidated financials since FY07. This has been primarily driven by improving trends in Brazil operations and margin improvement seen across geographies aided by both price increases taken and cost controls. A near-term focus for the company is reaching cash breakeven for Brazil operations, operations, and trends over the last few Qs have been encouraging. encouraging. Specifically for South Americas Americas business (key to international turnaround), turnaround), PIDI has taken a number number of measures to improve the performance, performance, i.e. strengthening strengthening the management (appointed CEO) and marketing / sales team on the ground. These measures have yielded positive positive results, and consequently losses in Brazil Brazil have reduced significantly. significantly. Overseas subsidiaries registered registered a 14% growth (constant currency basis) in 9M and margins improved across all businesses. Table 4: Pidilite: International revenues and profitability for key markets Rs MM International revenues North America South America Middle East South & South East Asia

FY12

FY13

9MFY13

9MFY14

% ch Y/Y

1,276 1,260 291 422

1,574 1,225 289 595

1,238 941 227 433

1,401 1,168 239 613

13% 24% 5% 42%

International EBITDA North America South America Middle East South & South East Asia

62 (94) (50) 45

55 (150) (21) 93

56 (119) (10) 76

104 (29) (36) 116

84% -76% 244% 52%

5% -7% -17% 1 1%

4% -12% -7% 16%

5% -13% -5 % 18%

7% -2 % -15% 19%

3% 10% -10% 1%

International EBITDA margin North America South America Middle East South & South East Asia Source: Company reports

PIDI’s international presence has primarily been been building through acquisitions acquisitions done over 2005-07. The company has operations in the US, Brazil, Bangladesh, Egypt and Thailand, Dubai and Singapore. Below we highlight the trends in key marketsa)

businesses here are Sargent Sargent Arts and Cycle. Sargent (art (art USA – Key businesses material) registered registered 5.5% Y/Y revenue growth and Cycle (car care) grew by 3% Y/Y in 9M. Margins although expanded meaningfully (by 200-500bp Y/Y) for the both the segments segments aided by price increases implemented implemented by the company.

b)

management changes (CEO) done and the South America – With management strengthening of the on-the-ground on-the-ground sales & marketing team, team, business seems to seeing good traction and losses have come down significantly. Revenue growth for 9M stood at 24% and losses have come down to a marginal Rs30MM Rs30MM (vs. a 9M loss loss of Rs119MM Rs119MM last year). year).

15



c)

stood at 29% in 9M South and Southeast Asian – Revenue growth stood (constant currency) and EBITDA was almost 1.5x last year. Near-term growth in Bangladesh has been impacted due to political issues; although company remains positive positive on long term demand outlook outlook in Bangladesh.

d)

Middle East and Africa – Revenue growth has been healthy, despite difficult market conditions in Egypt.

Table 5: Pidilit Pidilitee – Interna International tional Acquisition Acquisition History International foray in Singapore, Dubai

Pidilite acquired Chemson Asia Pvt. Ltd, a Singapore-based brand that manufactured waterproof coating and emulsion paints. Pidilite took over Jupiter Chemicals in Dubai. Furthering its international operations, the company incorporates two more subsidiaries in Brazil and Middle East.

Sargen Sargentt Art (USA) (USA)

Pidili Pidilite t e USA USA Inc. Inc. acquir acquired ed Sarge Sargent nt Art Art brand brand & busi busines nesss in June June 2006. 2006. Base Basedd in Pennsylvania, Sargent Art sells art materials in USA for over 50 years. The product range includes crayons, tempera colours, acrylic colours, markers and modelling clay.

Cycl Cycloo (USA) (USA)

Base Basedd in in Flor Florid ida, a, USA USA,, Cycl Cycloo was was acq acqui uire redd in in June June 200 20066 by by Pidi Pidililite te.. The The pro produ duct ct ran range ge includes maintenance, performance and appearance products for DIY (Do it Yourself) and professional car care segment. Co sells products in the United States and 50 other countries.

PULVITEC PULVITEC (Brazil) (Brazil)

Pidilite Pidilite Brazil Brazil Ltd. acquire acquiredd Pulvitec Pulvitec in June June 2007. 2007. Pulvitec Pulvitec has been been in the busines businesss of developing adhesives, sealants and construction chemicals since a very long time. The acquisition helped Pidilite tap the large Latin American market.

Source: Company reports

16



Strong FCF generation and net cash balance sheet provides scope for higher dividend payout PIDI’s domestic business is generating strong cash flows given healthy growth trends, stable working capital, and limited capex commitments. Further, Further, co's international operations operations are also improving and should contribute positively to the cash flows over F15/16. We expect the company to generate free cash flows of Rs3.8B/Rs4.6B over the FY15/16 respectively. PIDI has a consistent dividend payout history and has maintained its dividend payout at 30%+. Given the strong cash generation generation and net cash balance sheet (Rs3B+), (Rs3B+), there is a possibility of a higher dividend payout ahead. Table 6: Pidilite Industries: Cash flows Rs MM EBITDA Less: Tax Paid Change in working capital Operating cash flows

FY14E 7,327 (1,835) (1,838) 3,654

FY15E 8,606 (2,259) (837) 5,510

FY16E 10,128 (2,795) (1,056) 6,277

Capex Change in investments Net finance charges Free cash flow

(1,500) 0 170 2,324

(2,100) 0 343 3,753

(2,100) 0 453 4,630

Dividend paid Net cash flows

(2,000) 340

(2,400) 1,380

(2,828) 1,835

Source: J.P. Morgan estimates.

17



Expect margins to stay firm PIDI’s margins have been improving over the last few years despite RM increases and sharp rupee depreciation seen over the last year. We expect the margins to stay firm on the back of company’s strong pricing pricing power, improving sales mix mix and improvement in profitability of international operations. a)

sales mix with with higher contribution contribution coming Favorable value mix – Shift in sales from better-margin Consumer Consumer & Bazaar segment, segment, while growth growth for relatively low-margin low-margin industrial segment has been subdued.

b)

Strong pricing power – Given PIDI’s strong brand equity and dominant market share, the company has been able to effect price increases increases to offset any cost pressures due to RM cost increase / rupee depreciation.

c)

last few years, International businesses – After being a drag for the last international business should start to contribute positively to the consolidated financials ahead. This is being driven by cash breakeven at Brazil and improving margin trends across other markets (cost controls)

Table 7: Pidilite: Sales and EBIT mix % of sales Consumer & Bazaar Industrial % of EBIT Consumer & Bazaar Industrial

F10 77% 23% F10 81% 19%

F11 7 7% 2 3% F11 8 2% 1 8%

F12 79 21 F12 86 14

F13 8 1% 1 9% F13 8 9% 1 1%

F14E 81% 19% F14E 91% 9%


Figure 15: Pidilite – Margins improving on improved mix and pricing power 16.5%

16.1% 15.8%

16.0% 15.3%

15.5% 15.0%

14.5%

14.5% 14.0%

13.8%

13.5% 13.0% 12.5% FY12

F Y13

Source: Company Company data, J.P. Morgan estimates

18

FY14E

F Y15E

FY16E



Investment risks Spike in VAM prices or FX depreciation could lead to margin volatility in the near term… PIDI’s key raw material VAM (Vinyl (Vinyl Acetate Monomer) as well as other monomers, are largely imported or linked to crude oil oil prices (~50%+ of RM RM cost). For VAM, India is dependent on imports imports from countries such as Singapore, Taiwan, Taiwan, and Saudi Arabia. VAM prices have increased significantly significantly over the last 3-4 months due to supply constraints on account of large plant closures in Europe late last year and planned turnarounds in in US plants. VAM VAM prices have increased to US$1,300+ US$1,300+ per per ton, after being rangebound at US$950-1000/ton US$950-1000/ton for the last three three years. The recent surge in VAM prices is likely to impact the gross margins in the near term, although this should should normalize as the company implements implements price increases to offset the cost increase. However, we note that price increases increases come through with a lag of 1-2 quarters, with the consumer segment seeing faster pass-through (given market dominance) than the industrial segment. PIDI has fairly high pricing power for its key products across segments given its dominant market share and strong brand equity. equity. Further, Further, given that the spending spending on PIDI’s product is fairly low as a proportion of total home repair/ renovation, demand is not very price price sensitive. Therefore, Therefore, the company has been able to to implement price increases to offset any cost pressures coming from rupee depreciation as well as any RM appreciation in the past. Figure 16: VAM prices – Recent surge in prices likely to impact margins in the near near term

Source: Company Company data, J.P. Morgan calculations ations

19



Cash deployment in non-core business remains a risk In its recent analyst calls, management indicated that once the Brazil operation reaches cash break-even, break-even, it will evaluate acquisition acquisition opportunities opportunities in international markets, primarily focused on strong strong local brands in emerging emerging markets. The company company has not done any internatio international nal acquisiti acquisitions ons since since 2007, as the focus had been on integrating integrating the earlier acquisitions acquisitions and improving improving the profitability profitability of international subsidiaries. The price paid for any international acquisition and correspondingly integration issues for big acquisitions remain the key risks, given that the past experience of international acquisitions acquisitions has not been very encouraging. Further, cash deployment in the non-core business is also a risk (as seen in Elastomer acquisition acquisition earlier).

Elastomer project remains a drag on returns; strategic tieup could remove an overhang PIDI has stalled work for for the last two two years on its Elastomer Elastomer project project in Gujarat (Dahej). The company is now looking for a strategic partner partner for the project. Overall it has invested around Rs3.6B Rs3.6B to date, and completion of the project would would entail an additional Rs3.5B in capex. Given significant pending capex, non-core operations operations and changes changes in the demand demand environment, PIDI PIDI is evaluating a tie-up with with a strategic partner or a stake sale in the project. Any progress on this this could remove an overhang on the stock. PIDI’s PIDI’s reported ROEs ROEs have been adversely adversely affected affected by this investment. investment. Just to recap, recap, PIDI had acquired the plant, machinery, machinery, technology, technology, patent and trademark of the synthetic elastomer project in June 2007 from Polymeri Europa Elastomers. The production (25000 tonnes pa) from the plant was to be exported to Europe and Amercia. This acquisition is completely unrelated to its core business of primarily consumer-driven consumer-driven adhesives business. business. Consequently, Consequently, the acquisition acquisition was not taken well by the market.

Lower-than-expected domestic growth trends Sustained macro weakness and deferment of discretionary spending could further adversely affect the growth trends for the company. This, in our view, is the key risk to earnings and stock performance. Consensus estimates for PIDI have come down marginally over the past quarter due to moderation in growth trends. This is primarily due to a slowdown in discretionary segments (home furnishing/ renovation) over the past year. Growth in consumer/ retail products (Feviquick/ M Seal) and art materials, materials, though, has helped offset the weakness in the repair/ renovation segment, thereby keeping overall growth growth healthy at 15%+.

20



Figure 17: Pidilite: Consolidated consensus estimates

Source: Company Company reports and J.P. Morgan estimates estimates

21



Pidilite Industries: Comparative analysis Given no direct comparable, we benchmark Pidilite’s financial metrics and valuations to building product companies as well as global chemical companies in the sections below. Figure 18: 18: PIDI PIDI – Porters model

Source: JP Morgan

PIDI vs. Paints companies (Asian Paints) The closest comparables comparables to PIDI in the listed space space are paint companies. Both have a similar industry structure (concentrated (concentrated market share), share), demand fundamentals (home repair / renovation/ home furnishing), cost structure (high reliance on crude derivatives/ imports) imports) and good pricing pricing power. In terms of demand mix, both sectors sectors have a high share of replacement demand vs. new home completions. PIDI, however, also has a retail product portfolio portfolio in the adhesive and sealant space which has helped offset growth weakness in the discretionary segment segment (renovation) over the last year. Further, Further, PIDI has been an early entrant in the construction construction chemical space (25% of revenues), while paint companies companies are now aggressively aggressively building up a presence presence in this segment. Below we compare industry leader Asian Paints (APNT, covered by Latika Chopra) and PIDI across various metrics. We note APNT is much bigger in scale than PIDI PIDI given the large industry industry size. Both companies companies have a dominant position position in their respective industries, industries, Paints and Adhesives/ sealants. APNT has a 50% share in the decorative paints paints business, while PIDI has a 70%+ share in in its core segment of adhesives. Given the leadership position and strong brand, both companies have 22



good pricing power and have been able to offset cost pressures through price increases. Table 8: Asian Paints and Pidilite: Key metrics (FY14) Rs B Revenue EBIT EBIT margin Net profit ROE

Asian Paints 124.0 18.4 14.9% 12.0 32%

Pidilite 42.6 6. 5 15.3% 4. 9 27%

491 (10.5) 480

162 (3.6) 158

Mcap Net cash EV Source: Company reports and J.P. Morgan estimates.

Table 9: Asian Paints and Pidilite: Du Pont analysis Asian Paints Profit margin Asset Turnover Leverage ROE Pidilite Profit margin Asset Turnover Leverage ROE

FY10

FY11

FY12

FY13

FY14E

FY15E

FY16E

1 3% 5.2 0. 7 49.1%

11% 5.8 0.6 38.5%

10% 5.1 0.7 36.0%

1 0% 4.4 0. 7 32.9%

10% 5.0 0.6 29.9%

10% 5.5 0.5 29.6%

10% 6.0 0 .5 29.0%

12.3% 2.6 1. 0 31.0%

11.7% 2.9 0. 8 28.4%

10.4% 3.1 0 .8 24.3%

11.5% 3.4 0. 7 25.4%

11.4% 3.7 0. 6 25.0%

11.9% 3.9 0 .6 25.5%

12.0% 4.1 0. 5 25.5%

Source: Company reports and J.P. Morgan estimates

1.

Growth trends have been similar similar and highly correlated to GDP growth: Growth trends for both companies have been fairly similar and strongly correlated to GDP growth. Typically Typically paint industry volume volume growth has been 1.5-2x GDP growth, while PIDI’s PIDI’s volume volume growth has been 2x (avg) (avg) GDP growth. Weak macro and slowing discretionary consumption have moderated the growth trends for both APNT and PIDI over the last year. However, PIDI’s growth trends have been relatively more steady due to healthy demand for retail products like Feviquick / M Seal.

Figure 19: PIDI and Asian Paints: Sales growth trends and correlation with GDP 35%

12.0%

30%

10.0%

25% 20%

8.0%

15%

6.0%

10% 4.0%

5% 0%

2.0% FY04

FY 05 05

FY 0 6

FY 0 7

FY08

Asian Paints (LHS)

FY09

FY 1 0

F Y1 Y11

Pidilite (LHS)

F Y1 Y12

F Y1 Y13

FY14E

GDP (RHS )


2.

Margin Marginss – Key raw material for both the companies are crude derivatives (Ti02 for paint companies and VAM for Pidilite) and hence the margin trends have also been similar. We note that even though PIDI’s gross 23



margins are higher than APNT; EBIT margins are largely similar probably explained by APNT’s scale. Also PIDI’s PIDI’s international business business is a drag on consolidated financials, financials, which should should improve. Figure 20: Asian Paints and PIDI: Gross margin trends

Figure 21: Asian Pain s and PIDI: EBIT margin margin trends

52% 50% 48% 46% 44% 42% 40% 38% 36%

20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% FY04 FY05 F Y0 Y06 F Y07 F Y0 Y08 FY09 FY10 FY11 F Y1 Y12 F Y13 Asian Paints

Pidilite

Asian Paints


Pidilite


3.

APNT has been very very strong strong at at 30%+, 30%+, while while ROE comparison- ROEs for APNT for PIDI it has been been improving improving consiste consistently ntly and is currentl currently y at 25%. APNT’s higher ROEs are primarily primarily explained by high asset turnover. turnover. However, we note that the gap between the two has narrowed.

Figure 22: Asian Paints and PIDI: ROE trends 45% 40% 35% 30% 25% 20% 15% 10% 5% 0%

40%

36% 27%

FY12

32%

28%

32% 27%

FY13

FY14E Asian Paints

28%

FY15E

31%

28%

F Y16E

PIDI


4.

24

healthy FCF generation in the business and net Dividend payout- Given healthy strong balance sheet (net cash), the dividend track record for both companies has been consistent.



Figure 23: Dividend payout 45.0%

42%

40%

40.0%

40%

35.0%

31%

30.0%

26%

31%

30%

29%

28%

40%

39%

36%

25.0% 20.0% 15.0% FY08

FY09

FY10

F Y11

APNT

F Y12

FY13

PIDI

Source: Company

5.

Valuat Valuation ionss – PIDI PIDI vs. paint paint compan companies ies

Valuations for PIDI PIDI are at a 20% discount to APNT’s APNT’s (industry leader) leader) and in a similar range to other paint companies’. The paint industry is oligopolistic oligopolistic with with four large players (APNT has the highest share at 50%) and the industry size is fairly large; adhesives is a smaller, niche segment with only one large organized player (PIDI) and competition is primarily smaller regional players. Table 10: Valuations: Pidilite vs. paint companies Market Cap Pidilite

P/E (x)

EV/EBITDA (x)

ROE (%)

EBITDA margin

EPS growth

(US$MM)

FY15E

FY16E

FY15E

FY16E

FY15E

FY16E

FY15E

FY16E

FY15E

FY16E

2,689

27.7

23.5

18.6

15.4

27.7%

27.7%

17.5%

17.6%

20.0%

17.8%

Asian Paints

8,170

34.6

30.0

20.6

17.7

29.6%

29.0%

16.2%

16.2%

17.6%

15.6%

Berger Paints

1,399

28.0

23.5

15.9

13.1

23.9%

25.0%

11.9%

11.6%

19.9%

19.3%

689

18.2

19.9

14.2

12.8

16.1%

14.7%

8.1%

8.1%

37.9%

-8.8%

1,104

24.8

21.7

13.5

11.8

16.9%

18.2%

12.3%

12.2%

19.0%

14.1%

Akzo Nobel Kansai Nerolac

Source: Company reports and J.P. Morgan estimates. Bloomberg consensus estimates used for non-covered companies

PIDI vs. Building Building product product compa companies nies Below we compare PIDI with other building product companies in tiles (Kajaria), (Kajaria), sanitary ware ware (HSIL), and plywood segments (Greenply). (Greenply). 1.

Demand driver: Repair/ renovation vs. new home construction: In terms of mix, replacement demand demand is higher for PIDI’s PIDI’s products, while new construction drives 70-80% of demand for tiles/ sanitary/ plywood companies. Further, PIDI’s PIDI’s products also have retail usage (Feviquick/ M Seal) which is independent of discretionary demand for home furnishing.

2.

Growth trends have moderated across all companies given slowdown in discretionary spending. However, overall growth trends remain healthy (in the 15-20% range) given increasing penetration into tier 2/3 cities and shift to organized segment (vs. unorganized).

3.

PIDI as a near-monopoly near-monopoly in the adhesive adhesive space and Market dominance: PIDI faces very limited competition, competition, while market share is fairly fragmented fragmented in other building product segments with the industry leader commanding 1030% market share. The unorganized market is fairly big in other segments. 25



4.

spending on adhesives, strong strong brand equity and Pricing power – Smaller spending dominant market share give good market share to PIDI. PIDI. Among others, sanitary ware companies and Greenply have decent pricing power given brands, while tiles players’ pricing pricing power is lower lower due to competition competition from the unorganized segment.

On valuations, PIDI is trading at a premium to these building product companies. PIDI has a better better ROE profile, stronger FCF generation, higher dividend dividend payout, payout, and a net cash balance sheet (vs. 0.5-1x Net Net D/E for other companies) companies) which should support the premium valuation. valuation. Other building building product companies have have also witnessed a sharp re-rating re-rating over the past 2-3 years given steady steady growth trends and improving ROEs. However, FCF generation and dividend payout is low in these companies given capex needs. Table 11: PIDI – Compara Comparative tive analys analysis is with building product product companies companies PIDI 17% 16.4% 30% (0.2) 30%+ 34%

5 year Revenue CAGR (F09-14) EBIT margin (avg 5 year) ROE (avg 5 year) Net D/E Dividend payout Earnings growth

KJC 23% 12.5% 28.3% 0.5 ~20% 68.4%

HSIL 2 5% 11.3% 10.0% 0.9 15-20% 3 .8 %

Greenply 22% 7 .7 % 18.6% 1 .2 15% 15.6%


Table 12: Pidilite vs. other building product companies Mkt Cap $ MM Pidilite Havells Kajaria HSIL Greenply Industries

2,689 1912 574 185 163

P/E (x) FY15

FY16

27.7 19.7 23.3 15.6 7. 4

23.5 17.1 17.9 9. 4 5. 8

EV/EBITDA (x) FY15 FY16 18.6 12.0 13.8 6. 9 5. 3

15.4 10.5 11.2 5.1 4 .3

Earnings growth FY15 FY16 20% 21 % 31 % 70 % 28 %

1 8% 15% 26% 65% 28%

ROE (%) FY15 FY16 27.7 28.9 25.5 7. 5 21.5

27.7 27.1 25.4 11.5 22.9

Source: Company reports and J.P. Morgan estimates. Bloomberg estimates have been used for non covered companies

PIDI vs. Global chemical companies As compared to global peers in the construction chemical space, PIDI is trading at a premium. We note that PIDI PIDI has a much large retail retail / consumer portfolio primarily primarily in India, while global peers have high/ concentrated exposure to industrial industrial segments across countries. On financials, PIDI PIDI has a better growth profile and ROE and has been less affected affected by the weak macro environment environment over the last few years. PIDI is also scaling up its international presence both via exports and its subsidiaries in Brazil and North America. International subsidiaries have seen a pick-up in growth and margin improvement over the recent past. This should help improve consolidated profitability, profitability, after being a drag over the last few years. Importantly, we note that PIDI’s international business and strategy is to scale up its presence in emerging emerging markets which which offer strong growth potential and niche segments (care care/art material in the US).

26



Table 13: Pidilite vs. Global chemical companies Currency Pidilite Industries Ltd Clariant Ag-Reg Sumitomo Chemical Co Ltd H.B. Fuller Co. Du Pont (E.I.) De Nemours Huntsman Corp Eastman Chemical Co Shin-Etsu Chemical Co Ltd BASF SE Celanese Corp-Series A

IN CHF JPY US US US US JPY EUR US

Mkt Cap $ MM 2,689 6,732 6,230 2,307 61,309 6,094 12,918 25,433 106,394 9,545

P/E (x) FY14 27.7 14.8 18.8 15.0 15.5 11.9 12.3 19.5 14.1 12.0

FY15 23.5 12.5 11.2 12.6 13.7 9. 3 11.1 17.8 13.0 11.5

EV/EBITDA (x) FY14 FY15 18.6 15.4 8. 0 6 .9 7. 2 6 .9 8. 9 7 .6 9. 2 8 .5 6. 3 5 .7 8. 1 7 .3 7. 1 6 .5 8. 3 7 .6 7. 7 7 .4

ROE (%) FY14 FY15 27.7 27.7 12.6 14.6 6. 3 9. 8 15.7 16.9 24.4 24.9 24.1 24.6 25.4 25.4 7. 4 7. 7 19.2 19.4 25.9 23.5

Earnings growth FY14 FY15 20.0% 17.8% 18.2% 10.8% 68.2% 30.8% 18.9% 5 .3 % 13.2% 11.6% 27.0% 16.0% 11.7% 9 .6 % 9 .1 % 12.9% 8 .9 % 9 .9 % 4 .6 % 9 .6 %

Source: Company reports, Bloomberg consensus estimates

27



Financials 1.

consolidated revenue revenue growth of 15-16% Y/Y, Revenue growth – We model consolidated primarily driven driven by steady growth growth in Consumer and Bazaar Bazaar segment and improvement in international growth trends. Industrial segment growth could see a pick-up as macro improves improves and the capex cycle revives in 2H, 2H, though we are not building in any material improvement in our assumptions

2.

margins to improve improve marginally marginally given increasing Margins – We expect margins contribution from the better-margin Consumer & Bazaar segment and improved profitability at the international operations.

3.

Dec-Q). Net cash balance sheet – PIDI has a net cash BS (Rs3B as of Dec-Q). Further, we expect the company to generate Rs3.8B/Rs4.6B of FCF over FY15/16.

4.

Return ratios – Return ratios ratios for the company have been improving and fairly strong. ROCE is 25%, and adjusted ROCE (adjusted for Elastomer Elastomer plant investment) investment) is even higher at 30%+. ROEs are in the range of 27-28% aided by better better asset turn and steady steady margin margins. s.

Consolidated dated income statement statement Table 14: Pidilite – Consoli Rs MM, YE Mar.

FY12

FY13

FY14E

FY15E

FY16E

Revenues

31,266

36,781

42,616

49,237

57,370

Cost of Goods sold (COGS) Gross Profit Gross Margin

17,403 13,862 44.6%

20,081 16,700 45.7%

22,996 19,620 46.3%

26,501 22,736 46.4%

31,101 26,268 46.0%

Staff Cost Advertising & Publicity Other Expenditure Total Expenses

3,262 1,074 4,599 26,339

3,746 1,473 5,492 30,791

4,195 1,738 6,359 35,289

4,699 2,082 7,349 40,631

5,263 2,427 8,451 47,242

EBITDA % Growth EBITDA Margin

4,926 5.0% 15.8%

5,990 21.6% 16.3%

7,327 22.3% 17.2%

8,606 17.5% 17.5%

10,128 17.7% 17.7%

Depreciation EBIT EBIT Margin

637 4,289 13.7%

686 5,304 14.4%

823 6,504 15.3%

881 7,726 15.7%

942 9,186 16.0%

Interest Other income Profit Before Tax Total Tax Tax rate Profit after tax Growth (%) Net Margin

397 435 4,327 1,100 25.4% 3,244 4.6% 10.4%

214 704 5,794 1,595 27.5% 4,239 30.7% 11.6%

180 350 6,674 1,835 27.5% 4,863 14.7% 11.5%

60 403 8,068 2,259 28.0% 5,837 20.0% 11.9%

50 503 9,639 2,795 29.0% 6,876 17.8% 12.0%


28



Table 15: Pidilite: Balance sheet Rs MM, YE Mar Net Fixed Assets Capital WIP Total Fixed Assets

FY12 6,177 3,938 10,115

FY13 6,467 4,280 10,747

FY14E 6,544 4,880 11,424

FY15E 7,164 5,480 12,644

FY16E 7,721 6,080 13,802

983

2,931

2,931

2,931

2,931

4,541 3,952 2,732 1,261 115 12,601

5,236 4,305 1,506 914 113 12,074

6,156 5,048 1,246 2,093 250 14,794

7,131 5,848 2,426 2,425 250 18,080

8,331 6,832 4,061 2,833 250 22,306

5,285 1,466 6,751

5,808 1,786 7,595

6,772 1,965 8,737

7,845 2,161 10,006

9,164 2,377 11,542

Net Current Assets Total Assets Debt

5,850 16,947 3,213

4,479 18,158 1,134

6,057 20,413 534

8,074 23,649 334

10,765 27,497 134

Net Deferred Tax Liabilities / (Assets) Share Capital Reserves and Surplus Shareholders' Funds

468 508 12,754 13,261

499 513 16,003 16,515

500 513 18,866 19,378

500 513 22,302 22,815

500 513 26,350 26,863

Investments Current Assets Inventories Sundry Debtors Cash & Bank balances Loans & Advances Other Current Assets Total Current Assets Current Liabilities Provisions Current Liabilities and Provisions


29



Company profile PIDI was established as a partnership firm firm by the Parekh Parekh family, which which commissioned a plant for the Acron brand of pigment emulsion in 1959. PIDI was acquired by Parekh Dyechem Industries Pvt Ltd in 1969 and was renamed PDI Chemicals Pvt Ltd in 1986. The company went public in 1988, acquired its present name in 1990, and made an IPO in 1993. PIDI is a pioneer in consumer and industrial industrial specialty chemicals. chemicals. The company is a market leader in most categories categories and has a strong brand portfolio. portfolio. Its flagship brands Fevicol, Feviquick, and M- Seal command a 70%+ market share in their respective respective categories. The company has a strong and diversified portfolio portfolio of brands. From being a pure adhesive player, PIDI has diversified into construction construction chemicals and art material segment over the last decade. PIDI’s foray in these newer niche segments has met with good success and its construction chemical flagship brand Dr Fixit commands a 50%+ market share share in its categroy. categroy. The company has also diversified into the international market since 2005 via th eacquisition of brands and companies in the US, Brazil, Southeast Asia and the Middle East. The consumer segment accounts for 81% of total revenues (90% of EBIT), EBIT), while the remainder comes from from the industrial segment. PIDI has a wide geographical spread with 1MM+ points of presence for its retail brands (in town with 50K+ population). It also has a well established R&D team and has been consistently innovating innovating new products. Figure 24: Pidilite Industries: Key milestones

Source: Company presentation

30



Figure 25: Shareholding structure

Source: BSE

Table 16: Pidilit Pidilite: e: Product range – Key brands brands and their usage usage Product range Fevicol SH, Fevicol Speedx, Fevicol Marine, Fevicol WRA etc Woodgrip M Seal Fevitite range Dr. FIXIT sealants range Terminator wood preservative Showcase range ROFF Raincoat Pidilite Di Dist em empers/ Em Emulsion/ Co Colors Steel Grip Fevicol Foamfix

Description and use Synthetic Resin Adhesive. Usage primarily wood work. Variants for different requirement like fast bonding, water exposure etc Synthetic Resin Adhesive. High viscosity adhesive Liquid pipe sealnt - Used for joining & leakage plugging For bonding of metals, ceramix, marble, granite, plastics, glass etc For sealing gap between glass, Ceramic, Aluminium, etc For protection from termites / borers and increases life of the wood For wood finishing/ polishing New construction Tile Adhesive For Decorative exterior waterproofing coating F or or wh whit e wash of ho houses , off ice etc. Bi Binds lime/ di distemper on on wa wall. Pr Prevents Cr Cracks PVC electrical insulator

For Sofa, Chaits Mattresses

Source: Company

31



Pidilite Industries: Summary of Financials Profit and Loss Statement Rs in millions, year end Mar Revenues % change Y/Y E BIT % change Y/Y EBIT margin (%) Net Interest Earnings before tax % change Y/Y T ax as % of EBT Core net profit % change Y/Y Shares outstanding EPS (reported) % change Y/Y

Cash flow statement FY12 FY13 FY14E FY15E FY16E Rs in millions, year end Mar 31,097 36,579 42,395 48,993 57,101 EBIT 17.6% 17.6% 15.9% 15.6% 16.5% De Depr. & amortization 4,289 5,304 6,504 7,726 9,186 Ch Change in working capital 4.6% 23.7% 22.6% 18.8% 18.9% Others 13.8% 14.5% 15.3% 15.8% 16.1% Cash flow from operations (397) (214) (180) (60) (50) 4,327 5,794 6,674 8,068 9,639 Ca Capex 7.4% 33.9% 15.2% 20.9% 19.5% Disposal/(purchase) (1,100) (1,595) (1,835) (2,259) (2,795) Net Interest 25.4% 27.5% 27.5% 28.0% 29.0% Fr Free cash flow 3,244 4,221 4,863 5,837 6,876 4.6% 30.1% 15.2% 20.0% 17.8% Equity raised/(repaid) 508 513 513 513 513 De Debt raised/(repaid) 6.39 8.23 9.49 11.39 13.41 Other 4.3% 28.9% 15.2% 20.0% 17.8% Di D ividends paid Beginning cash Ending cash Balance sheet Ratio Analysis Rs in millions, year end Mar FY12 FY13 FY14E FY15E FY16E Rs in millions, year end Mar Cash and cash eq equivalents 2,732 1,506 1,246 2,426 4,061 EB E BIT margin Accounts receivable 3,952 4,305 5,048 5,848 6,832 Net margin Inventories 4,541 5,236 6,156 7,131 8,331 a Others 1,376 1,027 2,343 2,675 3,083 a Current assets 12,601 12,074 14,794 18,080 22,306 Sa S ales growth a Core Net profit growth Investments 983 2,931 2,931 2,931 2,931 EPS growth Net fixed assets 10,115 10,747 11,424 12,644 13,802 a Total Assets 23,699 25,752 29,150 33,655 39,039 In I nterest coverage (x) a Net debt to total capital Liabilities Net debt to equity Accounts payables 2,058 2,501 2,955 3,423 3,999 Sales/assets Others 3,227 3,307 3,817 4,421 5,165 Assets/equity Total current liabilities 5,285 5,808 6,772 7,845 9,164 RO ROE Total debt 3,213 1,134 534 334 134 ROCE Other liabilities 473 509 500 500 500 a Total Liabilities 10,437 9,237 9,771 10,840 12,176 a Shareholder's eq e quity 13,261 16,515 19,378 22,815 26,863 a BVPS 26.12 32.22 37.80 44.50 52.40 a Source: Company reports and J.P. Morgan estimates.

32

FY12 4,289 637 (306) 3,670

FY13 FY14E 5,304 6,504 686 823 145 (1,838) 5,175 3,654

FY15E 7,726 881 (837) 5,510

FY16E 9,186 942 (1,056) 6,277

(1,554) (1,460) (1,500) 2,413 3,870 2,285

(2,100) 3,453

(2,100) 4,213

0 0 0 (147) (2,078) (600) (4) (284) 6 (1,030) (1,121) (2,000) 1,038 2,732 1,506 2,732 1,506 1,246

0 (200) 27 (2,400) 1,246 2,426

0 (200) 29 (2,828) 2,426 4,061

FY12 13.8% 10.4%

FY13 FY14E 14.5% 15.3% 11.5% 11.5%

FY15E 15.8% 11.9%

FY16E 16.1% 12.0%

17.6% 4 .6 % 4 .3 %

17.6% 30.1% 28.9%

15.9% 15.2% 15.2%

15.6% 20.0% 20.0%

16.5% 17.8% 17.8%

12.4 3 .5 % 3 .6 % 1.4 1. 8 26.9% 20.8%

28.0 (2.3%) (2.3%) 1.5 1. 7 28.3% 22.5%

40.7 (3.8%) (3.7%) 1.5 1. 5 27.1% 25.1%

143.4 202.6 (10.1%) (17.1%) (9.2%) (14.6%) 1.6 1.6 1 .5 1. 5 27.7% 27.7% 25.8% 26.0%



Other Companies Discussed in This Report (all prices in this report as of market close on 02 May 2014) Asian Paints Limited (ASPN.NS/Rs511.45/Underwe (ASPN.NS/Rs511.45/Underweight) ight) Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. For all Korea-based research analysts analysts listed on the front cover, they also certify, as per KOFIA requirements, that their analysis was made in good faith and that the views reflect their own opinion, without undue influence or intervention.

Important Disclosures  Client: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients: Pidilite Industries, Asian Paints Limited.

Company-Specific Disclosures: Important disclosures, including price charts, are available for compendium reports and all J.P. Morgan– covered companies by visiting https://jpmm.com/research/disclosures , calling 1-800-477-0406, or e-mailing [email protected] with your request. J.P. Morgan’s Strategy, Technical, and Quantitative Research teams may screen companies not covered by J.P. Morgan. For important disclosures for these companies, please call 1-800-477-0406 or e-mail [email protected] . Pidilite Industries (PIDI.NS, PIDI IN) Price Chart

546

468

390

Price(Rs)

312

234

156

78

0 Mar 11

Jun 11

Sep 11

Dec 11

Mar 12

Jun 12

Sep 12

Dec 12

Mar 13

Jun 13

Sep 13

Dec 13

Mar 14

Jun 14

Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.

33



Asian Paints Limited (ASPN.NS, APNT IN) Price Chart

854 732 610

UW Rs445

Price(Rs) 488

Date

Rating Share Price Price Target (Rs) (Rs)

06-Oct-13

UW

366

463.50

445.00

244 122 0 Oct 10

Jul 11

Apr 12

Jan 13

Oct 13

Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends. Initiated coverage Oct 06, 2013.

The chart(s) show J.P. Morgan's continuing coverage of the stocks; the current analysts may or may not have covered it over the entire period. J.P. Morgan ratings or designations: OW = Overweight, N= Neutral, UW = Underweight, NR = Not Rated Explanation of Equity Research Ratings, Designations and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Not Rated (NR): J.P. Morgan has removed the rating and, if applicable, the price target, for this stock because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating and, if applicable, the price target, no longer should be relied upon. An NR designation is not a recommendation recommendation or a rating. In our Asia (ex-Australia) (ex-Australia) and U.K. small- and mid-cap equity research, research, each stock’s expected total return is compared to the expected total return of a benchmark country market index, not to those analysts’ coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying certifying analyst’s coverage universe can be found on J.P. Morgan’s research website, www.jpmorganmarkets.com. Coverage Universe: Prithyani, Gunjan: Godrej Properties (GODR.NS), Havells India Ltd (HVEL.NS), Phoenix Mills (PHOE.BO), Sobha Developers (SOBH.BO) J.P. Morgan Equity Research Ratings Distribution, as of March 31, 2014

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