By Baniya Beast,
What beats superior business which can provide higher returns is commodity business caught at the bottom of the cycle and the cycle begins to turn on upwards. – Anonymous
Cosmo Films Overview (it’s not an entertainment company)
It was founded by Mr. Ashok Jaipuria in 1981 and it is the 5th largest and one of the low cost manufacturer of Biaxially Oriented Polypropylene (BOPP) films globally. It is also India’s largest BOPP film exporter.
Cosmo Films offers wide range of BOPP films for flexible packaging, labeling, lamination and industrial applications including films such as high barrier films, direct thermal printable films and velvet thermal lamination films.
Plant, customer and others
Cosmo Films has 3 plants in India (2 in Maharashtra and 1 in Gujarat) and 2 plants located internationally (1 in Korea and 1 in USA).
Cosmo Films exports in 80 countries. Its customer base includes leading global flexible packaging and label face stock manufactures like Amcor, Constantia, Huhtamaki, Avery Dennison etc. It services brands like Pepsi Co, Coca Cola, Reckitt Benckiser, Nestle, Unilever, P&G, Colgate, Mars etc.
BOPP = Commodity = Low margin business (but totally acceptable to me)
BOPP film is pure commodity film which results in low margin business. While the company has entered the specialty films space some years back where it manufactures thermal films, wet lamination, synthetic paper, high barrier films and coated films which finds applications in packaging sector.
If we look at product mix then both traditional and specialty films contribute 50/50 to the topline (varies every quarter).
Cosmo Films enjoys ~20% market share in the BOPP film sector and 2/3rd market share in specialty films space.
Key impacting metrics
Cosmo Films has two major impacting variables-
- Crude oil prices (raw material accounts for 63-70% of the cost of production)
- Currency movement (Major debt in form of ECB which is partly naturally hedged from exports)
Exports contribute 45% of the topline. Key raw material is polypropylene which is the 2nd derivative of crude oil.
Sustainable demand growth
Industry is growing at 8-12% per annum for past many years and it is expected to grow at least at nominal GDP rate i.e. 8-9%. This is supported by the growth in packaging appetite of the FMCG companies and innovative packaging solutions.
Industry capacity of 600,000 MTPA is almost fully utilized. Industry exports are down in past 2 quarters which is putting some pressure on the supply side in domestic markets. Within next 12 months total supply should be around ~10,000 MT (that too coming from Cosmo Films). This is 1.6% of the total domestic production. Competitor capex is NIL.
After 3 years the demand-supply is finally in the favor of manufacturers. The producers were adding capacity for past many years to match the demand and gain market share. This scenario has finally changed.
For FY21, around 40,000 MT of capacity is to be added. This should be absorbed by the markets because it replicates the growth rate of 8-12%.
The sanity of the demand-supply has brought cheers to the gross margins.
Commodity gross margins in domestic market improved from Rs.2-5/Kg (Q3FY19) to Rs.10-15/Kg (Q4 FY19).
Margins improved after 2 years due to no capacity addition in domestic market leading to better utilization of lines and increasing contribution of specialty films. Normalized margins are Rs.20/Kg.
Above chart will give a perspective of the gross margins that can be generated. Margins are at the bottom of the cycle. It has just started to pick up. I expect the margins to go up substantially from current level of 30%.
Below is the gross spreads for past few quarters. It gives us good understanding on the way forward.
Turnaround in US business
US Subsidiary was making loss of $4-5Mn per year (past 3-4 years) and now the management has turned it to EBITDA positive of $0.5Mn on a sale of $33Mn (but still negative at PAT level). This turnaround was possible by bringing the production back to India and making it cost competitive.
US business to make much better EBITDA in next 2 years. This business should breakeven on PAT level by end of H1 FY20 (management guidance).
Debt pare down
The management expects to reduce debt by Rs.100-150 crore in FY20. Net debt as on March 2019 is Rs.643 crore and current Debt to Equity is 1:1.
I would typically value this kind of commodity business at a forward multiple of 6-7x EV/EBITDA.
Below is my conservative assumption for the year FY20.
The return typically should be around 40-60% in next 6-12 months depending on the exit multiple you provide.
Key risks and their probability of occurring
You can watch the video on cyclical investing – Mastering Market Cycles.
This article was originally published by author Baniya Beast. Views are personal and not a recommendation.