Grande Cold Brew Valuations: Pidilite Industries

I wrote this back in October. I might do this once a week, where I dive deep into a company. Please find my disclosures related to finance articles here.


Pidilite Industries

Business Quality:

Company’s main product segments are:

1. Adhesive and sealants: 55% of revenue

2. Construction and paints: 20% of revenue

Adhesive and Sealant segment is growing by 15% and Construction and paints are growing at 14.6%.

The company has a huge brand moat around it. Household recognizable names like Fevicol, Fevilkwik, M-Seal.

Because of such strong brand name they are bound to have repeat customers.

The products they make are simple, the company does not need to innovate itself every year.

Products need frequent replacement since most of to have a short shelf life.

They are the market leader with a 70% market share in the organized sector.

Red Flags:

Fevicol has great viral ads but that costs them. Their EBIDTA has been shrinking because of promotional cost.

Their input cost has also been rising leading to impact their profit margin.

I like companies that do not require huge CapEx to expand internationally. Pidilite does not qualify. They have been able to maintain some international presence through acquisitions but in order to be a dominant player internationally, they will need significant investment.

International Scalability is an issue.

Fraud Detection:

Let’s see if the company has any potential frauds.

The gatekeepers to the land of fraud are the Auditors.

B. P. Shroff partner at Delloite is the recent auditor for Pidilite. Did not find any negative reports of the B. P. Shroff.

There is also a high correlation between frauds and the duration of the auditor with the company. Higher the duration, higher is the chance of cooking books because auditors might develop more than a “professional” relationship with the company. Pidilite has appointed Delloite less than 5 years ago as their auditors, which is a good sign!

Did not find any red flags regarding auditors so let’s look at the numbers.

Modified C Score is 5 on a scale of 9. A lower number is better than a higher one. Pidilite scored poorly on this.

Let’s look at another ratio called Sloan ratio. Sloan ratio measures the quality of earnings. If the company’s Sloan ratio is between 10% and -10% quality of earnings are good. Anything above 10% and lower than -10% raises red flags. I like to look at the correlation between Sloan ratio and Earnings.

There have been 4 times in the last 10 years that the company’s Sloan ratio has crossed over 10%. This indicates poor earnings strength.

Debt Doctor:

Their Debt to Equity ratio is pretty awesome at 0!

I also look at how the management is managing the capital.

Pidilite has a very good Return on Invested Capital at an average of 32% over the last 9 years.

Management also scores high on ROE with an average of 25% over the last 9 years. On looking closer I found that the management increased ROE by reducing the financial leverage and improving the net profit margin. Extra points for that!

Valuation:

Since the business is more predictable and products do not change dramatically year to year basis. I decided to use the Discounted Cashflow model. I used 13% growth in revenues that was given to us as a guidance by management. My model estimates fair value around Rs500. It’s trading at Rs. 933 as of 11th October 2018. It’s certainly overvalued from a value perspective.

Let’s look at it relative to its own history.

Pidilite’s 5 years Median PE is 47. It currently trades at PE of 50.

Pidilite’s 5 years Median PB is 11. It currently trades at PB of 13.

Pidilite seems to be fairly valued with respect to its own history.

Bottom Line:

– Pidilite is a market leader.

– The company is growing at double digits. It does have some headwinds with respect to increase in input costs.

– No Debt

– The company has a great brand moat.

– Short-term indicators are mildly positive. There is a good support around Rs 870 level.

Pidilite is a not a value play but it’s brand familiarity and consistently strong financial performance, makes it an 8-80 stock. Buy on dips.

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