This article provides in-depth fundamental analysis of Ultramarine & Pigments Ltd (Ultramarine Pigments), a leading Indian manufacturer of inorganic pigments and surfactants including “OOB” brand of dish-washing liquid & bars, liquid detergents & bars and scouring powder.
Ultramarine & Pigments Ltd Research Report by Reader
Hello Dr Vijay Malik,
Congratulations and thank you for a wonderful blog on fundamental analysis.
Can you please give your insights on Ultramarine & Pigments Ltd? I have attached my analysis, checklist summary, pros and cons.
Details of Ultramarine & Pigments Ltd:
Business segments – pigments, surfactants, detergents, BPO
- Market cap = 400 cr approx.
- P/e = 14
- Debt free
- Sales growth 5y ~ 13% CAGR
- Profit growth 5y ~ 12% CAGR
Financial Analysis Checklist of Ultramarine & Pigments Ltd:
- Sales growth: 13%
- Profitability: 12%
- Tax payout: 30%
- Interest coverage: Debt Free
- Debt to Equity ratio: Debt Free
- Current ratio: Debt Free
- Cash flow (CFO > 0): YES (10Y CFO=175CR, 10YCPAT=165CR)
- Cumulative PAT vs. CFO (cPAT ~ cCFO): YES
Business & Industry Analysis Checklist of Ultramarine & Pigments Ltd:
- Comparison with industry peers: Rank #2 Or #3
- Increase in production capacity and sales volume: Not Checked
- Conversion of sales growth into profits: Yes
- Conversion of profits into cash: Yes
- Creation of value for shareholders from the profits retained: Yes (2.4x)
Management Analysis Checklist of Ultramarine & Pigments Ltd:
- Background check of promoters & directors: Refer Pros/Cons listed below
- Management succession plans: Nothing clear from annual report
- Salary of promoters vs. net profits: 20%
- Project execution skills: Has Some Trouble In Gujarat Due To Macro Factors
- Consistent increase in dividend payments: Consistent
- Promoter shareholding: 52%
- Promoter buying the shares: No Idea
- FII shareholding: 0
Other Business Parameters of Ultramarine & Pigments Ltd:
- Product diversification: Di”Worsified” Into IT
- Govt. influence: Nothing So Far
Margin of Safety (MoS) Analysis of Ultramarine & Pigments Ltd:
- MoS in Purchase Price (Earnings Yield (EY) EY > 10 Yr G-Sec Yield): Yes
- MoS in Business Model:
- Self-Sustainable Growth Rate (SSGR) (SSGR > Achieved Sales Growth Rate): Not Able To Calculate
- Free Cash Flow (FCF) (FCF/CFO >> 0): 50% Over 10y
Valuation Analysis Checklist of Ultramarine & Pigments Ltd:
- P/E ratio: 14
- P/E to Growth ratio: 1.1
- Earnings Yield (EY): 10.73
- P/B ratio: NA
- Price to Sales ratio (P/S ratio): 1.8
- Dividend Yield (DY): 2.50%
- Chemical sector expected to be upbeat
- 50+ year old company, well-known name in the sector
- Products used in basic laundry detergents
- Consistent dividend payer (ref fig below)
- Company just made all-time best performance
- Asset turnover, inventory turnover, fixed asset turnover all improving every year
- Days sales outstanding, inventory days and cash conversion days all decreasing for past 5 years
- Gross margin – 50%, OPM 17%, NPM 12%
- DuPont ROE – 25% largely driven by high net margin and asset turnover and not leverage
- Major COGS is raw material – heavily dependent on crude, price and availability volatile
- Shrinking demand for laundry products
- Di”Worsified into BPO – 33cr revenue out of 220 cr
- Directors too old, JMD is 31 yrs.?
- Promoters salary too high at the max limit
- MD, JMD raises > 50% for the current year! While employees increase was 10%, sales increased only 25%
- Violated SEBI rules on MD extension – a managing director could not be appointed or continued after he had attained the age of 70 years.
- Disputes pending on income tax from 2006 for even ₹50,000!
- Changed auditors recently – not sure if important
It seems to be a good company based on recent performance but can the management be trusted?
Also can you please do the SSGR calculation? I am not able to do like you do. Request your inputs on this.
Dr Vijay Malik’s Response
Thanks for writing to me! I appreciate the time & effort put in by you in analyzing Ultramarine & Pigments Ltd and sharing your analysis for the benefit of author and readers of www.drvijaymalik.com
Let us first analyse the financial performance of Ultramarine & Pigments Ltd over last 10 years.
Financial Analysis of Ultramarine Pigments:
Ultramarine & Pigments Ltd has been growing its sales consistently at a good pace of 10-15% year on year since last 10 years (FY2007-16). It is important to note that this sales growth has been accompanied by sustained profitability. Operating profit margins (OPM) of Ultramarine & Pigments Ltd has been consistent at 15-18% throughout last decade. Similarly, net profit margins (NPM) have also been consistent at 9-10% in last 10 years barring the first 2 year, when the scale of the company’s operations was quite small as compared to current levels. Sales growth with sustained profitability margins is the first sign of any exciting investment opportunity.
Ultramarine & Pigments Ltd has been paying taxes at 30-32% rate, which is similar to the standard corporate tax rate in India. This is another good sign.
Also Read: How to do Financial Analysis of a Company
Similarly, net profit margins (NPM) of Ultramarine & Pigments Ltd has been consistent at 9-12% throughout most of the last decade. The profitability margins have witnessed improvement in the recent years, which as per management is the result of better working capital management and increasing focus on the usage of own sales channels bypassing the intermediaries.
Management’s focus on these parameters becomes clear when the investor reads through the management and discussion analysis (MDA) section of the annual report for the year FY2016, page 12:
While crude prices remained volatile this year, we were able to achieve much faster turnaround on production cycles. This, along with our working capital management, helped curtail major inventory losses. We focused on driving sales through our own channels, and reduced our reliance on processing for third parties: this has impacted our profit margins positively
The management has been candid about sharing the details of performance of different segments in the management & discussion analysis of FY2016 annual report. For example, the performance of the wind power division at page 12:
The total revenue of the windmills is Rs.122 lacs, a reduction of 38% as compared to the previous year resulting in a decline of 49 % in profit. The reduction in Units generated is on account of low wind season & evacuation constraints faced by the Company due to State grid capacity.
The management has indicated that the reduction in the performance of the wind energy division of the company has been due to low wind season and due to issues related to power offtake/evacuation by the Tamil Nadu state grid.
The management is right in explaining the reasons to the shareholders, as upon analysis of other companies, which have wind power plants in Tamil Nadu, like Ambika Cotton Mills Ltd, have also faced the similar challenges. The below excerpt from the FY2016 annual report of Ambika Cotton Mills Ltd, page 24, also highlights the similar reasons for reduced performance of wind power and resultant reduction in profitability:
The performance in FY 2015-16 in spinning segment was maintained at the same level without much impact. However the captive power for spinning segment was affected on account of low wind and further evacuation issues to the State Grid . This has necessitated outsourcing of power at a higher cost impacting the overall performance.
Operating Efficiency Analysis of Ultramarine Pigments:
Over the years, Ultramarine & Pigments Ltd has been reflecting improved operating efficiency.
The company has been doing capex after every 3-4 years as has been visible from the year on year capital expenditure data. Ultramarine & Pigments Ltd has done major capex in the years FY2009, FY2011-12 and FY2016.
Net fixed assets turnover (NFAT) witnessed a decline after the initial years of capex until the capacity utilization reached optimal levels as a result, the NFAT reduced from 4.08 in FY2007 to 3.34 in FY2013. However, once the capacity utilization reached optimal levels in the later years, the NFAT has started increasing consistently and has improved from 3.34 in FY2013 to 4.86 in FY2016.
The management has disclosed these developments in the MDA section of FY2016 annual report, page 11:
Revenues improved by 28% to Rs.220.23 crores, and the profit before tax by 42% to Rs.39.04 crores. This marks an all-time high in the history of the Company. These improvements are due to a continuous upgradation of our technical capabilities with a sizeable investment in plant & machinery at both manufacturing facilities. The manufacturing operations have also achieved better capacity utilization & have focused this year on an optimal product mix.
Inventory turnover ratio of Ultramarine & Pigments Ltd has improved from 7.0 in FY2008 to 11 in FY2016. Improving asset and inventory turnover indicate that Ultramarine & Pigments Ltd is able to use its capital more efficiently and generate higher sales from same level of assets.
Receivables days of Ultramarine & Pigments Ltd have improved from 55 days in FY2008 to 40 days in FY2016. Moreover, the company has been able to bring the receivables days, which during the last decade seemed to go out of control to 58 days in FY2013, which might be a result of aggressive sales push. However, in recent 3-4 years, the receivables days have improved to 40 days.
Improvement in receivables days indicates that the company has been able to collect the money from its customers faster, indicating its growing influence in the market. Improved collection practices lead to lower working capital finance requirements and thereby lower interest costs and improved profitability.
Ultramarine & Pigments Ltd has PAT for last 10 years (FY2007-16) of ₹163 cr. whereas the CFO over the similar period is ₹176 cr. indicating that PAT has been converted into CFO, which is a good sign.
Margin of Safety in the Business of Ultramarine Pigments:
i) Self-Sustainable Growth Rate (SSGR):
Self-Sustainable Growth Rate (SSGR) of Ultramarine & Pigments Ltd used to be about 4-6%, however, it has improved to 17% in the recent years.
The improvement in SSGR in recent years has resulted from improvement in profitability margins, reduction in the dividend payout ratio as well as the improvement in the net fixed assets turnover ratio in the recent years. Analysis of the dividend payout ratio will reflect that the dividend payout ratio has come down from 64% of net profits in FY2012 to 37% of net profits in FY2016.
Moreover, 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. In case of Ultramarine & Pigments Ltd, the cCFO is higher than cPAT, which indicates that the funds are not getting stuck in the working capital.
Analysis of SSGR indicates that if Ultramarine & Pigments Ltd can manage its working capital management and operating efficiency properly, then it can grow continuously at about 15-17% growth rate without creating additional debt burden on the balance sheet. As Ultramarine & Pigments Ltd has been growing at a rate of 10-15%, it has been able to manage its growth story without leveraging its balance sheet.
These findings of SSGR get re-affirmed when an investor analyses the cash flow from operations (CFO) of Ultramarine & Pigments Ltd with its capital expenditure (Capex) requirements over last 10 years (FY2007-16).
ii) Free Cash Flow Analysis of Ultramarine Pigments:
During FY2007-16, Ultramarine & Pigments Ltd realized total CFO of ₹176 cr. and out of it Ultramarine & Pigments Ltd to spend ₹71 cr. into capital expenditure, thereby releasing free cash flow (FCF) of ₹105 cr. as surplus for shareholders.
This data indicates that Ultramarine & Pigments Ltd is a good example of efficient capital utilization. Despite meeting its entire capex requirements, Ultramarine & Pigments Ltd was able to generate FCF of ₹105 cr. out of which it distributed ₹84 cr. as dividend to shareholders.
The ability of Ultramarine & Pigments Ltd to grow its sales with Ltd capex from its CFO and generating good amount of free cash flow (FCF) indicates that the company has a good advantageous business model.
Advised reading: Free Cash Flow: A Complete Guide to Understanding FCF
The investors would agree that a company which generates good amount of free cash flow (FCF) post meeting entire capex requirement from its operating cash flow (CFO) would not need any debt or equity dilution. The same is true for Ultramarine & Pigments Ltd; it is almost a debt free company with no history of equity raising over last 10 years.
I advise investors to put a lot of focus on the free cash flow (FCF) generating ability of the company as it is only the free cash flow, which is the real value generating ability of the company for its shareholders. FCF is like the net savings of a salaried person after deducting all the expenses and constitute the disposable income. If a company does not have positive FCF, then the company might turn out to be a permanent cash flow drain for the shareholders, which is continuously asking for more and more funds to be deployed in either working capital or plant & machinery.
FCF is one of the key parameters to determine the margin of safety present in the business of any company. You may read the following article to understand more about the margin of safety in the purchase price and business.
Ultramarine & Pigments Ltd has been paying regular dividend to its shareholders though the payout ratio has been witnessing a decline as the company is retaining funds to invest in its expansion projects. Paying regular dividends amounts to sharing the fruits of growth with shareholders.
Dear Srivatsan, I appreciate that you have gone through the annual report of Ultramarine & Pigments Ltd in depth and have brought forward quite a few points related to the management actions.
Let’s analyse some of the issues, which become glaring upon reading FY2016 annual report of the company:
Additional aspects and annual report analysis of Ultramarine Pigments:
1) Management remuneration higher than the statutory limit:
The regulatory cap on the salary to all the directors is 10% of net profits. The act states that:
“A director who is in whole time employment of the company or a managing director may be paid remuneration either by way of a monthly payment or at a specified percentage of net profits of the company or partly by one and partly by the other. Such remuneration cannot exceed 5 % of the net profits of the company, except with the approval of the Central Government in the case of one director and 10 % for all such directors.”
However, if an investor analyses the remuneration of whole time/executive directors of Ultramarine & Pigments Ltd, then she would notice that the remuneration of each of the two of the directors is more than 5% of net profits of the company for FY2016 and the sum of the remuneration of all the whole time directors (WTD) is 16.7% of the FY2016 net profits of the company, which is more than the regulatory cap of 10% of net profits of the company.
To pay the remuneration to the WTDs, which is more than the regulatory cap, a company needs to take the central government approval. Therefore, an investor should analyse whether Ultramarine & Pigments Ltd has taken the central government approval for giving such remuneration to its whole time directors.
There is no doubt that Ultramarine & Pigments Ltd has shown good business performance over the years and the senior management has been a key factor to achieve such growth. However, a comparative assessment of the sharing of rewards with the junior management/employees brings the following picture:
“Average percentage increase made in the salaries of Employees other than the managerial personnel in the financial year is 14.32% whereas the increase in the managerial remuneration was 57.77%.”
2) Sourcing of Raw Material:
You have rightly pointed out that procuring some of the raw materials of Ultramarine & Pigments Ltd are presenting a challenge to the company. The supply, as well as the price of these raw material, is very volatile and erratic. E.g. Alpha Olefin, which is a key imported raw-material of Sulphonation as well as the crude oil prices.
FY2016 annual report, page 13:
Availability of Alpha Olefin, a key imported raw-material of Sulphonation division continues to be erratic & volatility in crude price may result in inventory loss; these are beyond our control. Any increase in sales volume through traders impacts the collection cycle & debtors outstanding
However, the sustained profitability of Ultramarine & Pigments Ltd over the years indicates that the company has been managing such raw material related issues quite well and may continue with the same performance in future unless the management and outside environment changes drastically.
3) Diversification in IT industry/BPO:
The commencement of the IT/BPO unit by a pigment/chemical company seems quite odd as it falls outside the purview of the management competence. As rightly pointed out by you, this diversification may very well turn out to be a “Diworsification”. Therefore, an investor should keep an eye on developments related to the IT division as part of her monitoring exercise so that she is able to detect any adverse changes soon and is able to take appropriate decision about her investments.
You may read a case of repeated diversification attempts ending in “Diworsification” here: Analysis: Bodal Chemicals Ltd
- Further advised reading: Information Technology (IT) Services Companies: Analysis Guide
- Further advised reading: How to Identify if Management is Misallocating Capital
4) Change in auditor:
Change/rotation of auditor after a few years should be seen as a positive development unless the change is too frequent/every year. Change in auditor bring in a new outside perspective to audit and is expected to increase the independence of the audit process.
5) Inter-corporate deposits and writing off bad debts:
Ultramarine & Pigments Ltd has been giving inter-corporate deposits to other parties, which are visible upon analysis of the notes to financial statements to the annual report of FY2016:
An investor would notice that the amount of inter corporate deposits has come down in FY2016, however, it is essential that the investor keeps an eye on the level of inter-corporate deposits continuously, as it is one of the key ways used by smart managements to take the money out of the companies.
In the FY2016 annual report of Ultramarine & Pigments Ltd, an investor would also notice that the company has written off bad debts to the tune of ₹1.5 cr. These are the dues, which the company thought that the counterparties would pay to it, however, now the company feels that there is no possibility of these dues being recovered from the counterparties:
An investor should focus on bad debt being written off, as this can be one of the ways, which smart managements deploy to take advantage of minority investors. Smart management may first offer inter-corporate deposits to others and then write off such advances in the “other expenses”. Therefore, it becomes imperative that the investor be vigilant when reading the annual reports and while monitoring the company.
6) Greenfield plant in Gujarat:
The company has been facing issues related to its expansion project in Dahej, Gujarat. The company is facing penalty by the Gujarat Govt for delays in project completion, which Ultramarine & Pigments Ltd is contesting on account of delays in the handover of the land by the govt. All these details are available in the contingent liability section of the annual report for FY2016 of the company:
However, as per the management disclosure in the management discussion & analysis (MDA) section in the FY2016 annual report, page 12, the management is having second thoughts about this plant:
There has been a change in the demand – supply scenario for the products planned to be manufactured in the proposed plant at Dahej, Gujarat (Western India). In light of this, we are re-evaluating our strategy of investment in this green field project with respect to the product mix.
Therefore, an investor should keep a constant vigil on the developments related to the Dahej, Gujarat plant of the company and the enforcement of the penalty by the Gujarat Govt, if any.
Margin of Safety in the market price of Ultramarine Pigments:
Ultramarine & Pigments Ltd is currently available at a P/E ratio of about 16.55, which does not offer any margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor. However, the FCF analysis of the company indicates that the company has some margin of safety built in its business model.
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, Ultramarine & Pigments Ltd appears to be a company growing at a descent pace, with sustained profitability margins & operating efficiency. It has been able to meet its capex requirements from its cash flow from operations and able to generate free cash flows and generate surplus distributable funds for its shareholders.
These are my views about Ultramarine & Pigments Ltd. However, you should do your own analysis before taking any investment related decision about Ultramarine & Pigments Ltd.
You may use the following steps to analyse the company: “How to do Detailed Analysis of a Company“
Additionally, the investor should keep track of the future performance of the company for signs of improvement or worsening as part of their monitoring exercise. She may use the steps explained in the following article for monitoring stocks in her portfolio.
Also Read: How to Monitor Stocks in your Portfolio
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.
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