Analysis: Supreme Industries Limited

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This article provides in-depth fundamental analysis of Supreme Industries Ltd, a leading player in Indian plastics industry, modular furniture, pipes, packaging etc.

 

Supreme Industries Ltd

Q: Hi Dr Vijay, I was tracking Supreme Industries Ltd for some time. Basis the fundamental data from screener.in, I noticed that:

  • Operating profit margin (OPM) of Supreme Industries Ltd is ranging between 11-15%.
  • Sales growth is again in the 15-20% range.
  • Price to earning is also good.
  • ROE is also quite high in the range of 30%.
  • Debt is high but the D/E ratio is below 1.
  • Interest coverage is good.

From fundamental point of view things, look ok, if not great. However, I wanted to check with you on couple of things:

  • While going through the annual report, I found that the owners are blaming Macro factor for recent slowness in progress. How do I verify this claim, which looks more to me as incapability of the management?
  • 50% of the revenue comes from Pipes & product and I see lot of constructors/builder using Supreme Pipes. I might be biased; but is it something similar to Peter Lynch’s strategy that we can apply here in terms of sustainable demand for the product of this company, given its “brand” value.
  • Supreme chairs and furniture are also quite good. Good product.
  • Apart from this, I had read couple of industry reports, which features Supreme Industries Ltd as one of the better manufactures; but the competition is stiff.
  • I know Supreme Industries Ltd does not offer margin of safety (MOS) but given that it is a growth area, is the company, which qualifies the criterion “Good Company at fair price”?

I did go through the articles on your website and tried to grasp as much as possible in last 6 days. Here is my understanding:

I compared Supreme Industries Ltd with the following companies such as Astral Poly Technik Ltd, Finolex Industries Ltd, Responsive Industries Ltd and Sintex Industries Ltd:

  • All the peers have shown slowdown in the growth (by sales and net profit margin) in recent time frame. Astral Poly Technik Ltd was able to maintain high growth rate though the increase is lesser compared to earlier years.
  • OPM is in the range of 14%. Now ROE, as I understand, is quite high for both the companies (Supreme and Astral) ~30%.
  • Promoter for Supreme Industries Ltd seem to be some organization.

The more I read, the more I get perplexed and more ideas I am getting in both the directions (purchase v/s no purchase). It will be great if you can mentor/guide me towards next set of things, which I should check to make up my mind:

  • As an investor what are the things that I should be focusing on and giving importance to.
  • Should I not be happy with high ROE given that other things are more or less ok?
  • How do i know if this company (or companies) is going to maintain this growth rate in the future or not?
  • Seeing that Supreme Industries Ltd’s products are widespread in the market, how do I figure out the “premium” for this brand, if I decide to buy the stock?
  • How to invert and think of the reasons not to buy this stock

These are some of the things, which I am able to write down; however, there are hundreds other things, which are going in my mind but I am afraid to ask.

Can you help me to get into the right mind set for the stock selection? I read a lot about having a investment thesis or logic but I have no clue how to create one and more importantly, feel to a certain extent confident about the decision. Currently, I have neither thesis nor logic to accept or reject this stock.

I am attaching my understanding on the Supreme Industries Ltd using the data from Screenr.in and combining that with the information from internet. I request you to go through the list, to see if it covers important points and anything that needs to be covered.

Parameter

Observation

Criterion satisfied/

My stand

Notes

Financial Analysis

Sales Growth

Sales growth is close to 19% in last ten years

Yes

Profitability

OPM 15% and has been consistent, NPM is ~7%

Yes

Tax payout

Its >30%, except for one interim year

Yes

Interest coverage Ratio

High 8-10 times

Yes

Debt/Equity

It is low <0.5 and decreased in recent times

Yes

Current ratio

0.7 to 1.08

Yes

CFO

Net Cash flow is overall positive in last 5 years

Yes

PAT v/s CFO

CFO is higher than PAT by about 1.38 times

Yes

Valuation Analysis

P/E

~20 Not theoretically MOS in another website ~30

No

Should we take into account the growth?

P/Growth

Did not calculate/Was not comfortable with the formula

Earning yield

Did not calculate/Was not comfortable with the formula

P/B ratio

~ 8.20

No

P/S

2.16

Neutral

Sales per share source equitymaster

DY

>0

Yes

Business Analysis

Peer comparison

Max India : Sales growth high ~30% similar to SI but OPM low

Yes

Astral Poly : This company is growing higher than SI but the net cash flow is negative so did not further study on this company

What could be the reason for negative net cash flow? This requires further research

Sintex: Sales growth Average OPM high but very high negative Net cash flow, so rejected

Jain Irrigation: Last 3 years sales growth is 12%

Responsive : D/E above 1

Production capacity increase

It is opening new production capacity in Kgp, WB and upgrading Hosur facility

Neutral

Not sure on the impact of these improvements

Sales growth into Profit

Consistently NPM of 7%

Yes

Profit into Cash

Already checked

Yes

Management Analysis

Background check of Promoter

Could not find anything significant against Mr MP and BP Taparia

Yes

Promoter shareholding

~49%

Yes

Salary Promoter

Could not find any verifiable source but in one of the articles found that salary is not too high

Neutral

Succession plan

Could not get any idea directionally

Neutral

Shareholding

No FII investment

Yes

Product

After reading AR figured out that they get away from high competitive markets and focus on niche areas. Which is good

Neutral

Inputs are 40% imports not much bargain as a buyer but as seller looks like a price setter as NPM remained more or less constant

Pros

Cons

Good Financials

Dependency on imports and crude price, not much bargaining strength here

Innovative and variety of products

High P/E ratio, Increase in domestic competition

Overall, Supreme Industries looks in good shape given the financials and its position in the market. However, this is already reflected in its high P/E.

It has some moat as compared to some of its competitors but how do I check if this is sustainable or not. Any idea from you in this direction would be great; moreover, if I have missed anything important in the analysis. Let me know what other factors to consider for further analysis are.

In addition, any additional thoughts or points that I should consider and how do I screen stocks.

Thanks again for your help.

Regards,

Author’s Response

Thanks for writing to me! I am happy that you have done your own stock analysis and have pointed out the important parameters for analysis of Supreme Industries Ltd.

Let us analyse the consolidated financials of Supreme Industries Ltd. The company seems to follows a financial year from July to June. However, from long-term financial analysis perspective, it should not pose any problem.

 

Financial Analysis of Supreme Industries Ltd:

Supreme Industries Ltd equity analysis research report

Supreme Industries Ltd has been growing its sales at a decent pace of about 16-19% year on year since last 10 years (FY2006-15). Moreover, this sales growth has been accompanied by sustained profitability. Operating profit margins (OPM) of Supreme Industries Ltd have been stable in the range of 15-16% and net profit margins (NPM) have been stable in the range of 7-9% over the years. Sales growth with sustained profitability is a good sign for any investment opportunity.

Supreme Industries Ltd has been paying taxes at 33-34% rate, which equals the standard corporate tax rate in India. This is another good sign.

(Read: How to do Financial Analysis of a Company)

 

Operating Efficiency Analysis of Supreme Industries Ltd:

Over the years, Supreme Industries Ltd has been maintaining its operating efficiency.

(Read: 5 Simple Steps to Analyse Operating Performance of Companies)

Net fixed assets turnover (NFAT) of Supreme Industries Ltd has been stable in the range of 3.7-4.0. However, in recent years the company has witnessed a decline in net fixed asset turnover from 4.0 in FY2012 to 3.7 in FY2014. Therefore, an investor should keep a close watch on the net fixed asset turnover of Supreme Industries Ltd. Any further deterioration in the operating efficiency might result in high debt on the books of Supreme Industries Ltd.

Inventory turnover ratio is also reflecting the similar trend. Over the years, it has been stable in the range of 7.7-8.2. However, in recent years the company has witnessed a decline in inventory turnover ratio from 9.0 in FY2012 to 8.2 in FY2014. An investor should keep a close watch on the inventory turnover of Supreme Industries Ltd. Any decline in inventory turnover can lead to funds being tied up in working capital and thereby shortage of funds for maintenance & capacity expansion capex.

Receivables days are stable at 20 days, indicating that the credit terms with customers are stable over the years

Supreme Industries Ltd has been able to convert its profits in to cash flow from operations. PAT for last 9 years (FY2006-14) is INR 1,410 cr. whereas the CFO over the similar period is INR 1,886 cr. This is a good sign. However, any deterioration of working capital management, to be reflected by declining inventory turnover and increasing receivables days, might lead to profits being stuck in working capital. Such a situation would reflect as cumulative CFO over the years being less than cumulative PAT over the same period. An investor should constantly check her stocks on this parameter.

Sustained profitability, maintained operating & working capital efficiency has led to good amount of cash generation from its inherent operations. This cash has been primarily utilized for funding capacity expansion as reflected by increasing net fixed assets (NFA) from INR 324 cr. in FY2006 to INR 1,088 cr. in FY2014.

Most of the funds requirements for capex have been met by profits of Supreme Industries Ltd. However, the balance funds have been raised by debt. Total debt of Supreme Industries Ltd has increased from INR 237 cr. to FY2006 to INR 385 cr. in FY2014.

 

Margin of Safety in the Business of Supreme Industries Ltd:

Self-Sustainable Growth Rate (SSGR):

Increase in debt has been marginal over last 9 year as Supreme Industries Ltd has been growing at a rate, which is not much higher than its Self-Sustainable Growth Rate (SSGR).

(Read: Self-Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company)

SSGR of Supreme Industries Ltd is about 11-13%, whereas it is growing at a rate of 16-19% over the years. The extra growth of 5-6% over and above SSGR has been funded by incremental debt.

The net fixed asset turnover (NFAT) and net profit margin (NPM), which are key determinants of SSGR, have been stable over the years. However, if we see closely, in last 2-3 years, both NFAT and NPM have witnessed decline, though marginal. The impact of recent decline in NFAT & NPM is not visible in SSGR as I have used the average values of last 3 years of these parameters while calculating SSGR, as mentioned in the article cited above.

An investor should note that if the declining trend of NPM and NFAT continues in future, then SSGR of Supreme Industries Ltd would decline. Resultant decline in SSGR would make it necessary for Supreme Industries Ltd to fund its growth by additional sources of funds like debt & equity. Therefore, an investor should keep a close watch on the NFAT and NPM levels of Supreme Industries Ltd, in future.

Supreme Industries Ltd has been paying 30-35% of its earnings as regular dividend to its shareholders. It amounts to sharing the fruits of growth with shareholders. These are signs of a shareholders’ friendly management.

Share market too seems to have recognized it. The market capitalization of the Supreme Industries Ltd has increased by about INR 8,000 cr. against retained earnings of INR 950 cr. over last 9 years (2006-14). Management has created a value of about INR 8.5 for the shareholders from every INR 1 of earnings retained & not distributed to shareholders.

 

Margin of Safety in the market price of Supreme Industries Ltd:

Supreme Industries Ltd is currently available at a P/E ratio of 29, which does not offer any margin of safety as described by Benjamin Graham in his book The Intelligent Investor.

Read: 3 Simple Ways to assess the Margin of Safety in a Stock

Also Read: Hidden Risks of Investing in High P/E Stocks

 

Conclusion:

Overall, Supreme Industries Ltd appears to be a company growing at a decent pace, with stable profitability margins & operating efficiency. However, its net fixed asset turnover, inventory turnover and NPM have been declining in last 2-3 years, which can limit its inherent growth potential. An investor should keep a close watch on NFAT, inventory turnover and NPM levels of Supreme Industries Ltd so she can notice the signs of weakening strength of company’s business model/advantage at the earliest and take steps accordingly.

These are my views about Supreme Industries Ltd. However, you should do your own analysis before taking any investment related decision about Supreme Industries Ltd.

Let us now focus on the other queries asked by you:

 

Additional aspects of Supreme Industries Ltd:

1) While going thru the Annual report, I found that the owners are blaming Macro factor for recent slowness in progress. How do I verify this claim, which looks more to me as incapability of the management?

If any company cites external factors like macroeconomic factors for their good/poor performance, then a good method to verify its claim is to compare its performance with its industry peers. If most of its peers have shown similar kind of performance, then the management is probably right.

As you have also found while comparing Supreme Industries Ltd with its peers that most of the peers have also witnessed slowdown of growth during this period, it seems that the promoters might be right in highlighting the challenging macroeconomic environment to shareholders.

 

2) Is it something similar to Peter Lynch’s strategy that we can apply here in terms of sustainable demand for the product of this company, given its “brand” value?

And

Seeing that Supreme Industries Ltd’s products are widespread in the market, how do I figure out the “premium” for this brand, if i decide to buy the stock?

Having good brand names in the portfolio, is a plus for any investment worthy company. However, an investor needs to verify whether the “brands” are benefiting the company in terms of higher margins than competition on a consistent basis year on year. An investor may do the comparison with peers to see whether Supreme Industries Ltd is able to get superior and consistent margins than its competitors.

 

3) I know Supreme Industries Ltd does not offer margin of safety (MOS). However, given that it is a growth area, is the company, which qualifies the criterion “Good Company at fair price”?

You are right that Supreme Industries Ltd at P/E ratio of 29 does not offer any margin of safety as described by Benjamin Graham. However, as far as buying price of Supreme Industries Ltd or any other stock is concerned, every investor has a different take on it. I would be happy to elaborate on my purchase price criterion.

I believe in following the criterion set by Benjamin Graham in his book Intelligent Investor. Graham defines margin of safety (MoS) as the difference by which the earnings yield of a stock is higher than the long-term treasury rate. As the Government Securities (G-sec) or comparative Bank FD rates in India are currently about 9-10%, therefore the maximum P/E that I feel comfortable buying a stock is about 10-11.

The P/E criteria would keep getting a bit relaxed as the interest rates fall. However, the lower the P/E ratio is the better.

Many readers have commented that I might be missing many potential growth opportunities by the strict P/E criterion. Many other investors have recommended paying for growth upfront in terms of higher P/E. However, as I mentioned previously, every investor has her own criteria for deciding the purchase price.

I have made a checklist for buying stocks, which I follow before deciding to invest in a stock. You may read about this checklist in the following article:

Read: Final Checklist for Buying Stock

Hope it clarifies my criteria for deciding the buying price level of Supreme Industries Ltd or any other such stock. I advise the investor to keep waiting until she finds the fundamentally sound stock trading at attractive valuations. She should not become impatient and buy stocks without margin of safety.

 

4) As an investor what are the things that I should be focusing on and giving importance to.

And

If I have missed anything important in the analysis. Let me know what other factors to consider for further analysis are.

Stocks analysis is a never-ending exercise. Therefore, an investor needs to define her priorities on which she should focus while doing the analysis. These criteria might vary from one investor to another and for each investor from one industry to another.

I would be able to tell you the approach that I follow, which I advise to investors as a general approach. I have mentioned my stock picking approach in the following article:

Read: Selecting Top Stock to Buy: A Step-by-Step Process of Finding Multibagger Stocks

I divide the stock analysis into Financial, Business, Management and Valuation aspects. I analyse each stock from these aspects and if any stock impresses me on all these criteria, then I add it to my portfolio. An investor may find the features that I advise looking for each of these parameters in the article link shared above.

 

5) Should I not be happy with high ROE given that other things are more or less ok?

Return on Equity (ROE) is a composite parameter, which combines results of profitability, operating efficiency (asset turnover) and leverage. High ROE is not enough in itself. I prefer stocks that have high profitability, high asset turnover and low leverage.

You may read more about my views on ROE in the following article:         

Read: Why Return on Equity (ROE) is not meaningful for Stock Market Investors!

 

6) How do i know if this company (or companies) is going to maintain the growth rate in the future or not?

I believe that no investor can know for sure whether any company is going to maintain its growth rate in future. If I could do that, then I would sell all my assets, borrow money from anywhere I can and then buy all the stocks of the company that I can. Nevertheless, it is a sense of conviction that I as an investor, try to draw from the inputs that I get.

An investor should analyse the past financial data and compare it with peers to see if the company is able to grow more than its peers while maintaining its margins and applying little leverage. If an investor is able to establish it from past financial performance, then she should investigate further about the sources of this performance. She can read about the information available on public media about its products, go to marketplaces and talk to its customers etc. or interact with management via analyst calls or otherwise.

All these activities would give the investor the information that would help her decide about potential of future growth. However, whether the assumptions of the investor would hold good in future, is never certain. Therefore, continuous monitoring of the stocks in the portfolio is required.

I have elaborated about the monitoring framework that an investor should apply for monitoring stocks in her portfolio in the following article:

Read: How To Monitor Stocks In Your Portfolio?

 

7) How to invert and think of the reasons not to buy this stock?

I believe that an investor should have a checklist for buying stocks. If a stock does not meet the criteria for the checklist, then it automatically get filtered out.

You may read my stocks buying checklist here:

Read: Final Checklist for Buying Stocks

I have found that not many stocks pass a soundly devised checklist. Therefore, if any stock, which passes the checklist and impresses the investor on the parameters discussed above, then it becomes a strong buying candidate.

As we are aware that equity investing involves the risk of loss of capital, which get compensated by way of higher expected returns. An investor may think of this risk of loss of capital, as the reason for not buying a stock. However, I would suggest that strict screening and in-depth analysis should filter out most of fundamentally unsound stocks. Therefore, the selected stocks become strong investment candidates.

 

8) How do i screen stocks?

You are right that an investor should have a stocks screening criterion for shortlisting stocks for detailed analysis. As on date, there are more than 5,000 stocks available for investment on Indian stock exchanges. Due to limitations of time, it becomes difficult for any investor to analyse each of these stocks to find out investment worthy opportunities.

Therefore, if an investor has certain stock screening criteria which can help her narrow down the number of stocks to Ltd few, where she can spend her Ltd time judiciously, then she can use her efforts efficiently in stock investing.

I have elaborated the guidelines/processes for screening of stocks in a dedicated article. You may gain more information about screening stocks in the following article:

Read: Shortlisting Companies for Detailed Analysis

 

9) Salary of promoters:

You may get the idea about salary of promoters from the annual reports of the company. Promoters’ remuneration would be part of details under corporate governance as well as related party transactions.

 

10) Succession Plan:

You may get the idea about the succession planning by analyzing the board/senior management composition, time since the potential successors are working with the company and their remuneration. All this information would be available in the annual reports of the company.

I hope that my responses would help you arrive at solutions to your queries. However, in case you believe that I have missed something, anything requires further clarification or you have any additional queries, then I suggest that you write the same in the comments below or at the dedicated page for asking queries: “Ask Your Queries”.

Regards,

P.S.

 

DISCLAIMER

  • 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.

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