This article provides in-depth fundamental analysis of Sarla Performance Fibers Ltd, a manufacturer of specialized polyester and nylon yarn.
Sarla Performance Fibers Ltd Research Report by Reader
Q: Hi Dr. Vijay, I wanted to understand your views on Sarla Performance Fibers Ltd (SPF) – I am presenting my views below –
- Sarla Performance Fibers Ltd has been able to grow its sales at modest pace of 15% over 7 years.
- SPF being a fiber manufacturer, raw material price volatility has affected its operating profit margin – OPM went as high as 20% and fell to lows of 14% as well.
- In line with OPM, NPM has also been volatile, in range of 12% to 9%. NPM has been impacted by tax rate and interest payout as well.
- Over FY2009 to FY2014, SPF’s cumulative cash flow from operations (cCFO) has been INR 113 cr. and cumulative profit after tax (cPAT) has been INR 131 cr. This gap is just due to one year’s dismal CFO performance in FY2012 when CFO was INR (1) cr. and PAT was INR 19 cr. Baring this year, cCFO > cPAT
- Sarla Performance Fibers Ltd’s asset turnover has been steady at ~2.5x until FY2013.
- In FY2014, Sarla Performance Fibers Ltd expanded in the USA. The expansion was funded by debt. Because of this expansion, asset turnover dipped to 1.3x and debt surged from 105 cr. to 163 cr.
- Though debt increased, interest coverage has been under check as it is dollar debt and the interest cost is low.
- Moreover, the sales have increased by 21% in FY2015 – although USA plant is operating at 25% utilization levels only currently. USA plant expected to operate at 100% utilization level during this year (source: company website and investor presentation).
- As production from USA plant will be sold to USA clients only, working capital cycle is expected to reduce – releasing cash at a rate higher than existing rate.
- Due to CAFTA and NAFTA laws under USA, Sarla Performance Fibers Ltd has tax incentive on sales coming from USA plant. Sales capacity is expected to double from 9000 TPA to 18000 TPA due to USA plant.
- Moreover, SPF has launched Nylon 66 (high value added product – hence high margin).
- At current MCap of INR 358 cr., P/E is 12.8x which offers some comfort in backdrop of expansion underway.
- Sarla Performance Fibers Ltd’s SSGR has been greater than sales growth rate over FY2013 and FY2014 – due to improved operating profit margin (and hence improved NPM).
Dr Vijay Malik’s Response
Thanks for writing to me! I appreciate the time and effort put by you in analysis of Sarla Performance Fibers Ltd. You have highlighted most of the important operating efficiency parameters in your analysis. I thank you on behalf of all the readers for sharing your work on Sarla Performance Fibers Ltd with us.
Let us analyse the consolidated financial performance of Sarla Performance Fibers Ltd over the years.
Financial Analysis of Sarla Performance Fibers Ltd:
You have rightly pointed out that Sarla Performance Fibers Ltd has been growing its sales at a moderate pace of about 15% year on year since last 8 years (FY2008-15). However, profitability margins (both OPM & NPM) have been fluctuating in a wide range. Operating profit margins (OPM) have been varying from 14-20% and net profit margins (NPM) have been fluctuating from 8-12% over the years.
Such fluctuating margins are characteristic of companies, which have low bargaining power with their customers. In such businesses, companies find it difficult to pass on the increase in raw material costs to their customers quickly and thus take a hit on their profitability margins. However, despite fluctuations, the profitability margins are at descent levels of 17% OPM and 9% NPM in FY2015.
Over the years, the tax payout ratio of Sarla Performance Fibers Ltd has been fluctuating from 20% to 30%. An investor should study it in detail to understand whether Sarla Performance Fibers Ltd has received any tax concessions etc. from govt.
Operating Efficiency Analysis of Sarla Performance Fibers Ltd:
Operating efficiency parameters of Sarla Performance Fibers Ltd reflect that operating efficiency levels are deteriorating over the years. Net fixed assets turnover has declined from 4.7 in FY2008 to 1.8 in FY2014. Similarly, inventory turnover ratio of Sarla Performance Fibers Ltd has also declined from 5.2 in FY2011 to 4.0 in FY2014.
You have rightly pointed out that Sarla Performance Fibers Ltd has not been able to convert its profits in to cash flow from operations. PAT for last 7 years (FY2008-14) is INR 146 cr. whereas the CFO over the similar period is INR 114 cr. Receivables days, though deteriorating, but are nearly stable at 90 days.
Deteriorating operating performance in terms of declining fixed asset turnover has necessitated infusion from additional sources of capital like debt to sustain the growth rate of Sarla Performance Fibers Ltd. Moreover, the deteriorating working capital management has led to tying up of funds in inventory and receivables. These factors are the major reasons, which have led Sarla Performance Fibers Ltd to rely on debt as additional source of funds to meet the growth requirements.
Debt levels of Sarla Performance Fibers Ltd have been increasing year on year. Total debt of Sarla Performance Fibers Ltd has increased from INR 43 cr. in FY2008 to INR 203 cr. in FY2014. Increasing debt levels with growing business are the features of companies operating in capital-intensive businesses.
Margin of Safety in the Business of Sarla Performance Fibers Ltd:
i) Self-Sustainable Growth Rate (SSGR):
Self-Sustainable Growth Rate (SSGR) of Sarla Performance Fibers Ltd is about 14-15%. As mentioned in the article on Self-Sustainable Growth Rate, SSGR does not factor in working capital changes. However, we can estimate whether funds are being tied up in working capital by comparing cPAT with cCFO.
Analysis of SSGR indicates that if Sarla Performance Fibers Ltd can manage its working capital management and operating efficiency properly, then it can grow continuously at about 15% growth rate without creating additional debt burden on the balance sheet. However, if net fixed asset turnover, inventory turnover, receivables days and profitability margins deteriorate further in future, then we might see increasingly high debt levels.
Investors should be cautious of investing in companies, which have continuously increasing debt levels, as high debt has the potential of increasing the risk of bankruptcy and reduced profitability under tough business conditions.
You should read the analysis of two other companies: Ahmednagar Forgings Ltd and Amtek India Ltd, to understand the impact low fixed asset turnover can have on the debt levels of companies. You may read their analysis here:
As mentioned by you, USA plant seems to be operating at suboptimal capacity currently. An investor should keep a close watch on the performance levels of USA plant, its various expected incentives in USA and performance of Nylon 66. Less than expected performance on these parameters might lead to the Sarla Performance Fibers Ltd sagging with burgeoning debt levels.
Margin of Safety in the market price of Sarla Performance Fibers Ltd:
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.
In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
Overall, Sarla Performance Fibers Ltd seems to be a company growing at a moderate pace but unable to maintain its profitability margins due to low bargaining power with its customers. Sarla Performance Fibers Ltd has been witnessing deteriorating operating efficiency in a capital-intensive business over the years and therefore, has witnessed increasing debt levels. An investor should keep a close watch on its debt levels. Investors should analyse Sarla Performance Fibers Ltd futher to understand the reasons for fluctuating tax payout ratios.
These are my views about Sarla Performance Fibers Ltd. However, you should do your own analysis before taking any investment related decision about Sarla Performance Fibers Ltd.
You may use the following steps to analyse the company: “How to do Detailed Analysis of a Company“
Hope it helps!
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- The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
- I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
- Currently, I do not own stocks of the companies mentioned above in my portfolio.