Analysis: National Peroxide Ltd

The current section of the “Analysis” series covers National Peroxide Ltd, a Wadia Group company and the largest manufacturer of hydrogen peroxide (H2O2) in India.

“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

National Peroxide Ltd Research Report by Reader

Hello Sir

I would like to submit my analysis of National Peroxide Ltd to you for your insights. The key triggers for the same could be anti-dumping duty and expansion of production capacity, which could lead to a growth in profitability in the future. However, there are some aspects while studying the business, which gives me the clues that business performance can significantly deteriorate going forward.

I have updated the report as per your guidance.

Thank you, Sir!

Gurjeev Singh Anand

About the Business of National Peroxide Ltd:

National Peroxide Ltd (NPL) is an establishment, which was listed on the BSE in 1954. A company, which belongs to Wadia Group (having an interest in several businesses from Airlines to FMCG) of companies.

NPL is in the business of peroxide chemicals and is the largest manufacturer of hydrogen peroxide in India. Besides hydrogen peroxide, they also manufacture compressed hydrogen gas, and peracetic acid. Hydrogen peroxide is used in several industries which are non – edible oil refining, water and effluent treatment, paper – pulp bleaching, chemical synthesis, textile bleaching industry, sugar belching industry, metallurgy industry.

The Single most active constituent of Hydrogen Peroxide is “Active Oxygen” which is obtained by controlling the decomposition of Hydrogen Peroxide with water. Hence, it is a clean process, which does not generate harmful or environmentally unsafe products while bleaching, or chemical synthesis.

(Source: Company Website)

History/Overview of National Peroxide Ltd:

National Peroxide Limited (NPL) was started and jointly promoted by The Bombay Dyeing & Manufacturing Company and Laporte Industries, UK. The peroxygens division of the company manufactures hydrogen peroxide and persalts.

The first plant, manufacturing hydrogen peroxide using the electrolytic process, was set up in 1956. In 1972, NPL adopted the latest auto-oxidation technology. A captive hydrogen gas plant was set up in 1987. After a series of expansions, the capacity of the hydrogen peroxide plant increased to 15,000 TPA.

In 1970, Laporte joined hands with Solvay, Belgium, and formed a joint venture known as Interox Coordination. In 1992, Solvay took over Interox Coordination and became a shareholder of NPL with a 25.10% stake. It established an integrated R&D center in Kalyan in 1979 to promote the applications of Hydrogen Peroxide and Persalts in various industries and to carry out process development.

The Company manufactures hydrogen peroxide with a current installed capacity of 95,000 metric tons per annum (MTPA) on 50% weight per weight (w/w) basis. National Peroxide Ltd.’s integrated manufacturing site for hydrogen peroxide is located at Kalyan in Maharashtra (India). The Company manufactures hydrogen peroxide in approximately four different forms, which include 50% w/w (Concentrated), 60% w/w (Concentrated), 35% w/w (Concentrated) and 70% w/w (Distillate).

Uses of Hydrogen Peroxide:

Hydrogen peroxide is a pale blue clear liquid slightly more viscous than water. Hydrogen Peroxide is mainly used as a non-polluting oxidizing agent and is used as an oxidizer, bleaching agent and disinfectant. It is used for refining non-edible oil, water, and effluent treatment, paper pulp bleaching, chemical synthesis, textile bleaching industry, sugar bleaching industry and metallurgy industry. Hydrogen peroxide is the simplest form of peroxide constitute only hydrogen and oxygen in the world, which has application in almost all types of food and beverages. Hydrogen peroxide is used to make sodium perborate and sodium percarbonate, which are further utilized as a bleaching agent in detergents.

Industrial Hydrogen Peroxide market is expected to witness an escalating demand among the consumers because of its broad use and increasing presence paper and pulp industry throughout the world. The industrial Hydrogen Peroxide market is driven by the growing adaptation in paper and pulp industry. Companies all around the world are getting attracted towards Industrial Hydrogen Peroxide because of easy to use features and great usage, which is driving the market. Use in making detergent bleaches, textile bleaching and purification of water are giving a push to the Industrial Hydrogen Peroxide market. Countries like India and China are the manufacturing hub for Industrial Hydrogen Peroxide and thus a promising market for Industrial Hydrogen Peroxide.

(Source: HDFC Retail Research)

Financial Analysis of National Peroxide Limited:

a) Sales:

NPL sales have grown from 122 Cr in 2010 to 402 Cr in 2019. That is a CAGR growth of 14%. However, NPL does not have a smooth trend of growth in its topline. Sales have shown a fluctuating trend. After approx. every 2 years, there has been a sales drop. NPL gets 100% of its revenue contribution from domestic sales and 98.5% revenue is generated by the selling of Hydrogen Peroxide.

b) Profitability:

The operating margins have shown a similar kind of fluctuating trend as the sales over the years. The OPM margins from 27% in 2010 were to fall to 9% in 2015 to rise to 56% in 2019, which is a wild swing. The high volatility in the operating margins shows that the business is a commodity business where the changes in prices of raw material costs effects the profitability to a major extent.

The management has stated the reason for the swings in the operating margins in their reports.

The company has a long-term contract with GAIL India for the supply of GAS (which is their RM) which is based on an average of 60 Months crude oil price. The agreement is valid until April 30, 2028. The sudden price decline in crude prices did not help them due to the average price clause in their contract. Thereby the companies cost was higher than the prevalent spot prices during that time which caused the reduction in operating profit margins.

The management has repeatedly articulated its raw material linkages to crude oil prices and the effects it might have on the operating margins of the business.

Even after the drastic fall in crude oil prices, the operating margins in 2015 have dropped drastically. This is explained by the management in their average price of 60 Months clause with GAIL India.

In 2019, the business has shown excellent operating margins, which might not sustain going forward as if crude prices rise drastically and stay on elevated levels that will hit the margins for National Peroxide Ltd. Another risk is if the long term contract with GAIL comes to an end and is not renewed (in such a scenario the management will have to look for other sources for their supply which might also hurt the profitability) or the same contract with GAIL is renewed on new terms which might prove adverse for NPL in future.

The management has repeatedly articulated its raw material linkages to crude oil prices and the effects it might have on the operating margins of the business.

The Net profit margins have shown a similar trend as the Operating Profit margins. This is because there is hardly any Interest cost/depreciation, which the company has paid in the last 10 years. National Peroxide Ltd is a net cash positive company.

c) Interest Costs / Coverage of National Peroxide Ltd:

NPL has FCCB loans to the tune of 70 Cr, which is payable in 16 equal installments starting 6th June 2020 of 6.25 lac USD each. They also have a term loan of 10 Cr from the bank, which is short term in nature. The interest rate for this short-term loan is 9.5%. Since the nature of the loans is FCCB, the interest cost is minor where the company does not face issues to pay the same on time because of its strong liquidity position.

Both types of loans are secured in nature. National Peroxide Ltd has used a negligible amount of limits sanctioned to it thus showing good liquidity strength in the business.

d) Value Creation:

The management has shown track of creating more than 1 rupee for every rupee they have retained in the business over the years.

e) Taxes:

The company pays taxes in line with the standard tax rates in India Prevalent during the time. The Current reduction in taxes by Honorable Finance Minister to the net of 25.17% for all corporates (22% + surcharge) will help the growth in the bottom line as the savings from taxes will be added to the bottom line directly.

f) Conversion of profits to Cash:

National Peroxide Ltd has earned Rs 495 Cr profits cumulative in the last 10 years whereas the Cumulative cash flow from operation is Rs 535/- Cr, which shows that the company has been able to convert its profits to cash.

Credit Rating Reports of National Peroxide Ltd:

While going through the credit rating reports it comes to the light that the capacity utilization levels of NPL plants (Previously 95000 MTPA 50%w/w) were above 100% in many months. NPL Term loans were utilized within group companies (as NPL is one of the companies of Wadia Group) which is quite evident from the related party transactions over the years. However, with the strong cash flows and good liquidity position of the business the management has been able to pay off the term loans and working capital loans in due course of time.

Before CY 2016 National Peroxide Ltd was largely exposed to RM risks. To mitigate the risks of RM price volatility the company entered into such contracts, which had a floor and a cap price protection. Natural gas prices dropped significantly below the floor prices (as a drastic drop in crude oil prices during that time) and NPL had to procure Natural Gas at the contractual floor price hence giving a hit to their margins.

Thereby in Jan 2016, the company changed its contractual terms for the natural gas prices to be in line with the spot prices. This helped the company reduce volatility in its raw material prices to a great extent and helped them to improve/recover their lost margins.

After the imposition of anti-dumping duty in 2017, the realizations of Hydrogen Peroxide increased hence. The price of natural gas remained stable during that period hence giving good profits to the business. The expansion from 95000 MTA to 150000 MTA is currently undergoing, which should enhance the profitability going forward (subjected to the volatility of natural gas (crude oil) prices. For which the company has a contract with GAIL, which has an exclusive clause for price discovery at the average of 60 Months).

Operating Efficiency Analysis of National Peroxide Ltd:

a) Receivables days (Terms of Trade):

The receivables days of the company were 45 days in 2011 which dropped to 65 days in 2015 and thereby slowly improved year over year to 38 days in 2019. It seems that the company has been able to get good controls over its receivables.

b) Net Fixed Asset Turnover (NFAT) of National Peroxide Ltd:

The fixed asset turnover from 2.32 has dropped to 1.27 in 2016 again to rise to 2.4 in 2019. This was because form 2010 the assets/net block of the business was increased from 75-80 crore to 187 cr. After which the company has not done any major expansion until 2019. All though in 2019, the capital work in progress is 75 Cr.

The company is undergoing an expansion of its capacity from 95000 tons per annum to 150000 per annum for 50% w/w basis. As per the company’s BSE filing, it has taken a temporary shutdown of its plant for expansion.

The company will be spending Rs 200 Cr for the said expansion. Two other companies in the same line of business are also expanding their facilities to the tune of 32000 MT.

c) Inventory Turnover Ratio of National Peroxide Ltd:

National Peroxide Ltd has high inventory turns (although fluctuating) in the last 10 years. The same has been in the 12.7 down to 9.8 in 2015 and again rising to 17.3 in 2019. 2015 was the year when crude prices dropped significantly but the company did not get the benefits due to an average price of 60 months clause with their long-term contract with GAIL. On the contrary, this clause will also protect the margins (only for few months though) if the crude oil prices rise suddenly and remain at elevated levels.

The addition of new capacity should give growth to the business going forward as the management has shown good capabilities to sell their inventory and collect their receivables on quickly.

Free Cash Flows Analysis of National Peroxide Ltd:

The business has generated 495 Cr as Cumulative Profits in the last 10 years whereas the cumulative cash flows are 535 Cr. This gives one the sense that the company has been able to manage its finances/working capital well. This also coincides with the improvement in the trend of the receivable days in the last 4 years where the company has been able to collect faster.

The management had to spend Rs 240 Cr as capex to increase the business from 120 Cr topline to 400 Cr topline. This has helped them to generate 296 Free Cash Flow. Out of this 296 Cr of free cash flow, the company has paid dividends to its shareholders to the tune of 140 Cr and kept the balance for its future growth/investments (cross-holdings).

Self-Sustainable Growth Rate of National Peroxide Ltd:

The SSGR for National Peroxide Ltd has increased from 2% 3 years back to 27% with the strong performance of the business. This is mainly due to the rise of the Net Profit margins (As per earlier discussion the profits are linked to the volatility of crude oil prices, which does affect the RM costs of the business. Hence SSGR could drop in future with volatility in crude prices). The company is growing well below its current SSGR rate, which is also evident from the fact that they do not need to rely on external borrowings to grow their business.

Peer Comparisons:

Other major business houses running in this segment are

a) Hindustan Organic Chemicals Limited (HOCL) (http://www.hoclindia.com/ ) (a GOI undertaking): Hindustan Organic Chemicals Limited (HOCL) is the Government of India owned company based in Mumbai, Maharashtra.[5] It was established in 1960 to indigenise the manufacture of basic chemicals and to reduce the country’s dependence on the import of vital organic chemicals. Its products are Phenol, Acetone, Nitrobenzene, Aniline, Nitrotoluenes, Chlorobenzenes & Nitrochlorobenzenes. Basic Organic Chemicals includes Pesticides, Drugs & Pharmaceuticals, Dyes & Dyestuffs, Plastics, Resins & Laminates, Rubber Chemicals, Paints, Textile Auxiliaries & Explosives.[6][7][8] Source (Wikipedia)

HOCL is a government of India undertaking mainly in the business of Phenol, Acetone, 50% w/w Hydrogen Peroxide. HOCL has an installed capacity of 10,450 MT and the company gets only 7% of its revenue from selling H2O2 (Hydrogen Peroxide). The actual production in 2017-18 was 9008 MT and 2018-2019 6789 MT, which shows that the capacity utilization of the company for the H2O2 plant is 65% odd. The major revenue contribution and focus of the management are on Phenol and Acetone.

b) Asian Peroxides Limited (APL) (unlisted private player established in 1987) is the third-largest hydrogen peroxide (HPO) player in India. It was incorporated in 1986 by NRI promoter and Managing Director Mr. Shiv K. Dewan, as a 100% export-oriented unit (EOU) in technical and financial collaboration with Peroxygen Technologies Limited, UK. Having commenced operations with an installed capacity of 5,000 metric tonnes per annum (MTPA) at Sullurpet (Andhra Pradesh), 80 km north of Chennai, it has gradually expanded its capacity to 18,000 MTPA (100% w/w basis) now.

APL debonded its EOU status in two stages in 1995 and 2005 and currently caters to the domestic demand of HPO, largely to the paper and textile industries for bleaching applications. The company is looking to expand its capacity to 38,000 MTPA with the commissioning of the Gwalior plant, and further to 45,000 MTPA by debottlenecking the Sullurpet plant. The company procures its feedstock (naphtha) and fuel (furnace oil) from Indian Oil Corporation Limited (IOCL), while the solvents are imported.

Source (Chemical Industry Reports)

c) Gujarat Alkalis and Chemicals Ltd (GACL) (a Government of Gujrat Undertaking): Gujrat Alkali has diverse business it would not be viable to compare the operating metrics of Gujrat Alkali with National Peroxide Ltd. Gujrat Alkali has a production capacity of 53080 MTA as per their Investor Presentation.

It seems there is a trend in the industry that all the players working in the Hydrogen Peroxide industry have high capacity utilization levels.

Gujrat Alkali has little export presence for Hydrogen Peroxide also which National Peroxide Ltd does lack.

d) Indian Peroxide (unlisted private player) (http://www.indianperoxide.com/index.html): Indian Peroxide is a private company having a setup capacity of 45,000 MTA in 2018. They produce Hydrogen Peroxide in 3 grades namely 35% w/w, 50% w/w, 60% w/w.

(Source: worldwide.com)

Management Analysis & Additional aspects of National Peroxide Ltd:

a) Management Background:

Wadia Group has a big diverse business conglomerate. Where the highly successful companies Britannia Industries are also in their basket of holdings. Ness Wadia is the MD of National Peroxide Ltd. Mr. Ness Wadia holds several directorships in several other group businesses also enclosed.

b) Remuneration:

The combined remuneration of the top-level management is 4 Cr which when compared with the average last 3 years (96 Cr average profits) profits of the company is about 4%. It looks decent with the trend and increment of profitably of the company in last 3 years.

In 2019 there were 123 employees working in the company. There was a median 24.4% increase in the remuneration of the employees from 2018, which gives a sense that there are cordial relations of the top-level management with the employees of the company. Regular increments in employee remuneration keep them motivated to utilize the assets of the company and work more efficiently for better outputs.

From the structure of the directors of National Peroxide Ltd, it seems that after MR Ness Wadia steps down it will be a professionally managed company. As management succession information is not given.

c) Fraudulent Cheques of National Peroxide Ltd:

Hundreds of fraudulent Cheques were issued from the bank accounts of NPL totally Rs 37 Crores. The company in their 2018 annual report had stated about this in the Director’s Report.

The company has stated that they have further strengthened their controls so such a kind of action does not take place in the future.

The management has filed a police FIR (Criminal Proceedings) against the same with the Joint Commissioner of Police.

MD has been asked to resign due to Rs.36 Cr embezzlement: On November 07, 2017, National Peroxide Ltd informed that funds of the Company have been embezzled by an employee of the Company Mr. Nipul S. Trivedi and others if any, who are yet to be identified and there might be a potential loss to the Company of approx. Rs.36 cr. On Dec 15, 2017, as per the management, the earlier MD Mr. S R Lohokare had to resign due to his careless manner, wherein, he signed a large number of bearer cheques. In addition, he did not follow the procedures laid down due to which he was found guilty. While this loss may have to be written off (subject to any insurance claim and/or recoveries if any made), it will be considered an extraordinary loss.

d) Cross Holdings by National Peroxide Ltd:

NPL holds a 1.7% stake in The Bombay Burmah Trading Corporation and a 0.7% stake in Bombay Dyeing and Manufacturing Company. The company gets dividend income from Bombay Burmah Trading Corporation.

e) Related Party Transactions and CSR Spends:

The company engages in several related party transactions with members and other corporations of Wadia Group.

Any significant advances to group companies and heavy debt-ridden capex can hinder the performance/liquidity position of the company.

National Peroxide Ltd engages in lots of related party transactions due to its linkage with Wadia Group.

• A note on the ICD deposit given: The Company has, during the year, given Intercorporate Deposits (ICDs) to certain parties covered under section 189 of the Companies Act, 2013, viz. Nowrosjee Wadia and Sons Limited ₹ Nil (Previous Year ₹ 3,000 Lakhs), Wadia Techno-Engineering Services Limited ₹ 350 Lakhs (Previous Year ₹ 500 Lakhs), Bombay Dyeing Limited ₹ 10,000 Lakhs (Previous Year ₹ Nil) and Go Airlines (India) Limited ₹ 10,000 Lakhs (Previous Year ₹ Nil). These ICDs are for general business purposes and carry an interest rate of 10% p.a. (Previous Year 12.50% p.a.) and have tenure for less than a year

It is interesting to see that in 2019 the company sold its liquid investments in several mutual funds to the tune of 63 Cr. Also looking at the year-end cash and bank balances of the company, it is evident that the proceeds from this money were utilized to give the ICD loans to others. The company has stated this as general business purposes where National Peroxide Ltd is entitled to get an interest rate at 10% p.a (the previous year which was 12.5%). 10% is still good what the company can get from its liquid investments but the same coming down from 12.5% raises eyebrows that what was the need to sell the liquid investments and fund other (sister concern) company from the same.

f) Book Overdraft:

Seeing the liquidity stability of the company, it is contrarian that there is a Book Overdraft in liabilities. Book overdraft is when the cheques issued exceed the arrangements in the bank and the same have not been presented in the bank. The company gives huge intercorporate advances at one end and at the other end has to face issues with checks to honour. However, the amount is small Rs 1.48 Cr looking at the size of operations of the business.

g) Jump in Finished Goods:

It is evident from the communications from the company’s reports. The finished goods have gone up from 4 Cr to 22.2 Cr. This is in the plan of action that the company has kept fulfilling the demand from its customers during the time its plant is shut down for expansion process (which is currently going on) so they do not lose customers.

For the same expansion, the company has raised the capital advances from 6.36 Cr to 17.7 Cr for the purchase of equipment.

Capital work in progress as of March 31, 2019, of ₹7,540.39 lakhs (March 31, 2018 ₹ 563.98 lakhs) includes cost incurred towards the expansion of the existing plant of 95 KTPA to 150 KTPA located at the Company’s property in Mohone, Kalyan. Additions to Capital work in progress during the year include ₹ 43.93 lakhs (March 31, 2018 Nil) being borrowing cost capitalised in accordance with Indian Accounting Standards (Ind AS) 23 on “Borrowing costs”.

Business & Industry Analysis:

There are 3 other producers of Hydrogen Peroxide besides National Peroxide Ltd (one of which is Hindustan Organic Chemicals {A Government of India Undertaking}) in the country and the combined production is 210000 MT. NPL holds 33-35% (which has fallen by 3-5 % in the last 2-3 years) of market share. With the eco-friendly nature of the product (stringent environment pollution norms, rising awareness) the demand in the market is expected to grow by 7-10%. Due to continuous surplus in other Asian Countries, there has been continued import of Hydrogen Peroxide in India. The growth of pulp/paper, Textile (the focus of the Government of India to further boost the growth of the textile sector) industry with its large size and new capacity expansion of several companies in these segments will rip up demand for Hydrogen Peroxide in future. The demand from oil refineries will also grow as India needs to process approx. double quantities of crude oil to cope with the rising demand.

a) Raw Material Threats:

National Peroxide Ltd needs Hydrogen Gas as a key raw material. Steam reforming of natural gas is done to get hydrogen gas. India imports (India imports LNG through Petronet (Dahej), Shell (Hazira) and Ratnagiri Gas and Power Pvt. Ltd. (Dabhol) half of its natural gas requirements. Forex (US $ / Rupee) and price of natural gas (Crude oil-related) fluctuations affect the prices of raw material for the company to a great extent. In addition, natural gas does not fall under the limits of GST and the VAT paid on the same is not allowed to be claimed under input tax credit, which further puts pressure on increasing the raw material costs for the business.

National Peroxide Ltd has a long-term contract from GAIL (which has a clause for the price for the same at an average of 60 months).

Significant imports of Hydrogen Peroxide have taken place from Thailand, Bangladesh, and South Korea. The imports from these neighbouring countries were significantly at low prices than Indian domestic companies selling prices. The Government of India has imposed an anti-dumping duty to protect the domestic industry. The same has been imposed from Bangladesh, Taiwan, South Korea, Pakistan and Thailand. From some ASEAN and SAARC countries, there is still “zero” customs duty, which will distort the business economics. It is mainly because of the protection from this anti-dumping duty that domestic companies are increasing their production capacities to fulfil the demand. They are working to become an import substitute for their B2B relations.

As per the 2016 annual report, the company starts that GAIL (India) has entered into a long-term contract. This should give some sense that the NPL contract with GAIL will be honoured for the long term as they state.

b) Other Risks of National Peroxide Ltd:

b. i) Single Product Risk:

98.5% of the business revenues come from a single product that is Hydrogen Peroxide and a single location of production facility might hamper the revenues in adverse times. The size of the industry is small for National Peroxide Ltd to grow its revenue exponentially.

b. ii) Large Scale Imports:

Large-scale imports from countries like Thailand, Pakistan, and Bangladesh were always a threat to the Hydrogen Peroxide industry. However, after the imposition of anti-dumping duty these risks are mitigated to some good extent.

Valuation Analysis of National Peroxide Ltd:

NPL currently trades at a P/E of 8.34, which does offer some margin of safety. However, the protection of anti-dumping duty and capacity expansion of the plant can give growth going forward. Here important aspect to take note of is there are a lot of moving parts in this business being fluctuations in crude oil (natural gas) prices, forex fluctuations, cheaper imports, (long term contract with an average of 60 months with GAIL might lead to very different RM prices than current prevalent prices).

Conclusion:

National Peroxide Ltd is the largest producer of Hydrogen Peroxide in India with a 35% market share. They sell domestically with zero exports but have to bear the forex fluctuations for their raw materials, which acts as a risk to their profitability. The products it makes are used by several B2B players in their industry from Pulp / Paper, textile to oil refineries.

The key raw material for the company is Hydrogen Gas, which is made from steam reforming of Natural Gas, which is linked to crude oil. The fluctuations in crude oil prices affect the prices of the raw material for the company. To protect from the same, the company has entered into a long-term contract with GAIL India, which has a special clause to account for crude oil prices on an average of 60 Months. This clause has shown adverse effects in 2015 when the prices of crude oil dropped drastically and stayed at lower levels. Due to the average, the net costs for the company were much higher than the spot prices in the market during that time.

Recently the company is expanding its production capacity from 95,000 MT to 150,000 MT, which will be operational in CY 19-20. The company has taken a plant shut down for the same. It expects to cater to the demand from the customers from the Inventory it holds in hand. Other players also in the industry are expanding their capacities. This is mainly because of the imposition of anti-dumping duties from the Government of India to protect the domestic industry.

The size and demand for the Pulp/paper industry are growing and the Government of India has a key focus on the development of the Textile industry. This leads to the visibility of the demand for Hydrogen Peroxide (coupled with the benefits from Anti-Dumping Duty).

National Peroxide Ltd is a commodity business in nature, which has to rely on several aspects like crude oil, forex, anti-dumping, constant supply of raw materials for uninterrupted production. Commodity business moves in cycles and past excellent performance in profitability may not sustain going forward.

Looking forward to your input!

Regards,

Gurjeev Singh Anand

Dr Vijay Malik’s Response

Hi Gurjeev,

Thanks for sharing the analysis of National Peroxide Ltd with us! We appreciate the time & effort put in by you in the analysis.

While analyzing the past financial performance data of National Peroxide Ltd, an investor would notice that the company has one wholly-owned subsidiary company, Naperol Investments Limited (NIL). As a result, National Peroxide Ltd provides both standalone financials as well as consolidated financials in its annual reports.

Ideally, we believe that while analysing any company, the investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire group. Consolidated financials of any company present such a picture. Therefore, we prefer to analyse the consolidated financials of companies.

Further advised reading: Standalone vs Consolidated Financials: A Complete Guide

Nevertheless, in the case of National Peroxide Ltd, an investor notices that the only business activity of the subsidiary company, Naperol Investments Limited (NIL) is to hold investments in shares and mutual funds. NIL holds primarily holds shares of two of the Wadia group companies, Bombay Burmah Trading Corporation Limited (BBTCL) and Bombay Dyeing & Manufacturing Company Limited (BDMCL). The rest of the investments are comparatively smaller holdings in other stocks.

NIL generates a very low income via dividends receipts on its investments in comparison to the overall revenue of the parent company; National Peroxide Ltd. NIL does not have any operating assets or any debt. Therefore, the addition of financials of NIL to National Peroxide Ltd primarily leads to cash & investments in the balance sheet.

As a result, if an investor wishes to analyse only the operating performance and efficiency of the manufacturing operations of National Peroxide Ltd, then she may analyse the standalone financials of the company. However, as mentioned above, we prefer to analyse the overall financial standing of the company including the investment position of the company. Therefore, we have analysed the consolidated financials of the company.

Nevertheless, an investor should note that the primary difference in standalone and consolidated financials for National Peroxide Ltd is the cash & investments held by the subsidiary company, Naperol Investments Limited (NIL).

Let us analyse the financial and business performance of the company over the last 10 years.

Financial and business analysis of National Peroxide Ltd:

While analyzing the financials of National Peroxide Ltd, an investor would note that in the past, the company has been able to grow its sales at a rate of 15% year on year. Sales of the company increased from ₹122 cr. in FY2010 to ₹402 cr in FY2019. However, the sales have declined sharply to ₹279 cr in the 12 months ending Sept. 2019 (i.e. Oct. 2018-Sept. 2019).

While analysing the sales of the company over the last 10 years, an investor would notice that the growth rate of the company has not been consistent. National Peroxide Ltd has had periods of negative growth in the past as well. In FY2012, the sales declined by 15% to ₹155 cr from ₹182 cr FY2011. Thereafter, in FY2015, the sales declined by 16% to ₹197 cr from ₹236 cr in FY2014.

Therefore, an investor realizes that the sharp decline of sales in the last 12 months (Oct. 2018-Sept. 2019) is not an isolated incidence. The company has seen periods of sales decline frequently in the past.

Similarly, when an investor analyses the operating profit margin (OPM) of National Peroxide Ltd over the last 10 years, then she notices that the OPM has fluctuated by a huge margin from 11% to 56% over the years. Over the past, the OPM has behaved in a cyclical manner. It increased from 27% in FY2010 to 51% in FY2011. Thereafter, the OPM declined first to 31% in FY2012 and then to 11% in FY2015. OPM then increased consistently to 56% in FY2019 and then once again declined to 37% in the last 12 months (Oct. 2018-Sept. 2019).

An investor needs to analyse the financial performance of National Peroxide Ltd in detail to understand the reasons for such fluctuating and cyclical performance. The company has provided annual reports from FY2009 on its website, which are a good resource to understand the business dynamics of the company.

Further advised reading: Understanding the Annual Report of a Company

Broadly, an investor would appreciate that a business performance characterized by fluctuating sales growth and fluctuating profit margins indicates a commodity business with high competition. In such businesses, the companies hardly have any competitive advantage. Their product (e.g. hydrogen peroxide, H2O2 in the case of National Peroxide Ltd) is usually indistinguishable from the product of their competitors. Therefore, the customer is indifferent in buying the product from one source or another. Such commodity businesses are highly impacted by economic cycles and commodity/raw material cycles.

Companies producing commodity products find it difficult to increase the prices of their products when the raw material prices increase because the customer can buy the product from its competitors. As a result, the companies end up taking a hit on their profit margins.

On the contrary, when the demand for the product increases and/or raw material prices go down and the companies start to make good profits, then the supply of the product in the market also increases. The supply increases by the way of increase in manufacturing capacity and by the way of low priced imports. The increased supply increases the competition, which drives down the price of the product. As a result, the price of the product and the profit margins decline.

Therefore, in such commodity businesses, high growth rates and high-profit margins are difficult to sustain over a long period. The competition from other manufacturers and imports ensures that profit margins come down over time. Similarly, the downturns of the economic cycles ensure that the demand for the product declines, leading to a sharp fall in the sale of the quantity of the product as well as its price. It results in a decline in sales revenue.

Read: How to do Business & Industry Analysis of a Company

With this understanding of commodity businesses, when an investor analyses the first year of sales decline of National Peroxide Ltd, FY2012, then she notices that the business was impacted by:

• Declining demand for hydrogen peroxide (H2O2) due to the economic downturn as well as
• Declining prices of H2O2 due to competition from low priced imports and
• Lower production due to the shutdown for capacity expansion,

FY2012 annual report, page 5:

The decline in the sales volume during the year was partially due to the shutdown and sluggish market conditions. The decline in profit was due to lower sales realization arising from higher imports at lower prices.

The Company sold 61,240 MT of H 2 O 2 during the year under review, as against 66,806 MT during the previous year. The lower demand in the market led to a decrease in prices of H 2 O 2 , resulting in lower profit for the year. The Company, however, continues to maintain its prime position in the market and held 40% market share during the year.

The company highlighted the threat from surplus manufacturing capacity of hydrogen peroxide in neighbouring countries, Thailand, Pakistan and Bangladesh as well as increasing manufacturing capacity within India.

FY2012 annual report, page 13:

The outlook for the industry in the near term can only be viewed with cautious optimism due to the surplus capacity in Thailand, Pakistan and Bangladesh. A mega plant was commissioned in Thailand in 2011 by Solvay and is expected to increase the availability from Thailand which has a limited domestic demand. On the other hand, the domestic availability has improved as a result of increased capacity of the Company and the new Plant set up by a Competitor. This will put pressure on the Hydrogen Peroxide prices in the coming years.

The company also highlighted that its profit margins were impacted as the cost of raw materials (natural gas) was high.

FY2012 annual report, page 6:

The price of crude oil and consequently Natural Gas had risen significantly by the end of the year thereby impacting the cost of production.

An investor can understand that the company could not pass on the impact of the increase in natural gas prices to its customers as in FY2012, there was a lower demand for hydrogen peroxide in India and there was high competition from lower-priced imports. As a result, the company witnessed its profit margins decline from 51% in FY2011 to 31% in FY2012.

Similarly, in FY2014, the company could not pass the increase in the cost of natural gas to its customers and in turn had to take a hit on its profit margins. The OPM in FY2014 declined to 26% from 32% in FY2013. The credit rating agency, India Ratings, highlighted this aspect in its report for National Peroxide Ltd on Oct. 17, 2014.

EBIDTA margins for FY14 declined to 26.3% (FY13: 31.5%) due to an increase in the cost of production driven mainly by a growth in the price of natural gas

While analysing the second period of decline in the sales of National Peroxide Ltd (FY2015), an investor notices an almost similar unfolding of events like FY2012. There is a market slowdown, a shutdown of the plant and a decline in prices of hydrogen peroxide due to intense competition (low priced imports).

FY2015 annual report, page 12:

The decline in sales volume during the year was partially due to the shutdown and sluggish market conditions. The decline in profit was due to lower sales realization arising from higher imports at lower prices and intense domestic competition.

The Company views its future prospects with cautious optimism. Due to surplus in the neighbouring countries such as Pakistan, Bangladesh and in Thailand and domestic competition there is intense pressure on the domestic prices.

When an investor reads the above disclosure by the management in FY2015, then she is reminded of the exactly similar situation faced by National Peroxide Ltd three years back in FY2012.

However, there was one factor affecting the company that was different in FY2015 from FY2012. It was crude oil prices.

As per the above discussion, an investor would notice that in FY2012, National Peroxide Ltd faced an increase in raw material prices (natural gas) because the crude oil prices were high. However, in FY2015, the crude oil prices were significantly lower than FY2012. In addition, crude oil prices have witnessed a sharp decline from Oct. 2014 onwards.

However, still, the company could not benefit from lower crude oil prices. It was due to a long-term natural gas supply contract entered by National Peroxide Ltd with GAIL India Ltd. As per the contract, GAIL would charge the price of the natural gas to the company linked to a 60-months average of crude oil prices. In addition, the price of natural gas in the contract also had a floor price. It meant that if the crude oil price declined to very low levels, even then the price of natural gas paid by National Peroxide Ltd will not fall to very low levels. Instead, National Peroxide Ltd will have to pay the floor price of the natural gas as per the contract to GAIL.

FY2015 annual report, page 12:

The crude oil prices dropped significantly leading to sharp decline in liquid fuels such as naphtha and furnace oil during the year. The Company has a long term gas contract with GAIL India Ltd. The said contract is based on 60 months average of crude oil prices with a cap and floor price. As a result the long term contract prices of natural gas were higher than the spot prices. The company’s cost therefore has not come down inspite of lower crude oil prices.

As a result, in FY2015, due to the combined impact of lower demand from the market, lower prices of hydrogen peroxide, intense competition from low-priced imports and other Indian manufacturers and high contractual natural gas prices, the operating profit margin of the company declined to the low of 11%.

National Peroxide Ltd realized the problem of the pricing mechanism of the contract with GAIL in FY2015. As a result, the next year, in January 2016, the company revised its pricing mechanism in the contract with GAIL. The credit rating agency, India Ratings, highlighted this development in its report for National Peroxide Ltd in March 2017.

Improved EBITDA Margins; Revenue to Remain Stable in FY17: NPL’s EBITDA margins improved significantly to 28% in 9MFY17 (FY16: 15.4%, FY15: 11.4%) owing to a revised pricing mechanism for its key raw material, natural gas. The earlier pricing had a floor and a cap. The natural gas spot prices fell below floor following the drop in crude prices in FY15 and FY16. However, NPL had to buy natural gas at the floor price. The pricing mechanism was changed in January 2016; natural gas prices are now aligned in line with its spot price. This has resulted in reduced input cost and the consequent improvement in the profitability margins.

Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

Because of the change in pricing mechanism with GAIL, the cost of natural gas for National Peroxide Ltd declined and its profit margins improved significantly in FY2017 to 28%.

However, the problem of low priced imports of hydrogen peroxide from other countries has been a persistent problem for National Peroxide Ltd.

In FY2018, the company requested the govt. for imposing anti-dumping duty on the import of hydrogen peroxide from Bangladesh, Taiwan, South Korea, Pakistan, and Thailand. The govt. approved its request and an anti-dumping duty was imposed on the import of hydrogen peroxide from these countries.

FY2018 annual report, page 16:

Significant imports continued to take place from Thailand, Bangladesh and South Korea during the FY 2017-18. These imports have been at low prices due to surplus capacities in originating countries. Government of India has imposed Anti-dumping Duty on imports from Bangladesh, Taiwan, Korea RP, Pakistan and Thailand.

The anti-dumping duty on low priced imports has led to increased sales of Indian manufacturers of H2O2 like National Peroxide Ltd at higher prices. It has resulted in higher sales and significantly improved profit margins for the company. In FY2019, National Peroxide Ltd reported all-time high sales of ₹402 cr and an all-time high operating profit margin of 56%.

The credit rating agency, India Ratings, highlighted the impact of anti-dumping duty on the business performance of National Peroxide Ltd in its report for the company in July 2018.

NPL’s revenue grew 18.6% yoy to INR3,112 million in FY18 and EBITDA margins rose to 49.9% (FY17: 26.9%), backed by higher realisation and stable natural gas prices. The average realisation increased due to a sharp increase in hydrogen peroxide prices since June 2017 because the Indian government imposed an anti-dumping duty on the import of the hydrogen peroxide from six nations.

The company has benefited from the imposition of anti-dumping duty on the competing supply of low-priced imports in the past as well. In 2009, the company along with other Indian manufacturers of hydrogen peroxide had requested the govt. to put an anti-dumping duty on imports from competing countries. Their request was approved and anti-dumping duty was put on import of hydrogen peroxide from the European Union, China, Korea, Indonesia and Turkey.

FY2009 annual report, page 7:

The Company along with other Indian producers of Hydrogen Peroxide, took steps for levy of anti-dumping duty on imports of Hydrogen Peroxide from European Union, China, Korea, Indonesia and Turkey. These efforts were successful and anti-dumping duty was levied on August 8, 2008, on imports from these countries. This would help in reducing low priced imports into the country and result in realistic price realization for the Company.

As a result, the competition from imports was reduced in FY2009.

However, an investor should note that the impact of barriers like anti-dumping duty is only temporary. This is because they tend to act against the nature of the market forces. Over time, the market dynamics of price and supply take over and the prices decline to reflect the true market situation.

In 2009, the prices of hydrogen peroxide initially increased after the imposition of anti-dumping duty. However, within a few months of the imposition of anti-dumping duty, the prices declined due to market slowdown/lower demand and intense domestic competition. As a result, the prices soon fell below the price of imports.

FY2009 annual report, page 7:

The prices of Hydrogen Peroxide continued to increase in line with the Naphtha prices, during the first half of the year. In the later half of the year, the lower demand resulted in intense domestic competition leading to prices below the landed cost of imports.

Similarly, in 2018-2019 as well, initially the anti-dumping duty reduced the international competition and resulted in all-time high profits for National Peroxide Ltd. However, soon the intense domestic competition and the lower demand resulted in a decline in prices of hydrogen peroxide and a decline in the profit margin of National Peroxide Ltd. (India Ratings credit rating report, Oct 2019):

Healthy Revenue, Margins Growth: NPL clocked 27.8% growth in revenue to INR4,023 million in FY19 (FY18: INR3,149 million) due to higher realisation over FY17-FY19 (FY17: INR26/kg; FY19: INR43/kg) backed by antidumping duty over the imports of hydrogen peroxide. Resultantly, EBITDA margin expanded to 56.4% in FY19 (FY18: 46.2%).

However, 3QFY19 onwards the prices have corrected and realisations have normalised. In 1QFY20, NPL achieved sales of INR571 million with EBITDA margin of 32%.

As a result, it does not come as a surprise to the investor when she notices that in the last 12 months ended Sept 2019 (i.e. Oct. 2018-Sept 2019), the sale of National Peroxide Ltd has declined to ₹279 cr and OPM has declined to 37%. An investor should note that it is difficult for the barriers like an anti-dumping duty to distort market prices/dynamics for a long period. In most cases of anti-dumping duty imposition, either the domestic supply increases or the imports find alternate locations/countries outside the purview of anti-dumping duty and in turn increase the supply in the market and increase the competition.

While looking at the financial performance of National Peroxide Ltd over the years, an investor would note that despite being a commodity business exposed to economic downturns, commodity cycles, and low priced imports, the company has still managed to report intermittent periods of high sales growth and high-profit margins. This seems primarily because the current domestic manufacturing of hydrogen peroxide is less than domestic demand.

As a result, whenever, there is reduced supply due to restrictions on imports, the Indian customers do not have any other place to go other than Indian manufacturers. This results in high sales volume and high prices of hydrogen peroxide for Indian manufacturers leading to high sales growth and high-profit margins.

An investor would notice that the Indian manufacturers are continuously adding to their production capacity of hydrogen peroxide year after year. Once, India has a surplus production capacity of hydrogen peroxide, then the market may witness intense competition from suppliers to sell their products. This competition may lower the prices and take away the negotiating power from H2O2 manufacturers. It may happen that once India has a surplus capacity of H2O2 production, thereafter, the sales growth rate, as well as profit margins of Indian manufacturers, come down.

Further advised reading: How to do Business Analysis of Chemical Companies

The credit rating agency, India Ratings, has highlighted the domestic production and demand situation in its Oct. 2019 report for National Peroxide Ltd.

Additional Capacities to Change Demand-Supply Scenario: Estimated domestic production of hydrogen peroxide in FY19 was 156453 tones and import stood at 84261 tones thus taking total consumption to 240714 tones. A substantial addition- over 145,000 tpa – to hydrogen peroxide capacity will take place in India by FY21, resulting in surplus capacity, which will restrict imports. This capacity addition can also impact profitability of the companies due to higher competition; NPL has a market share of 32% in the domestic market in FY19.

Therefore, going ahead, an investor should keep a close watch on the market dynamics of hydrogen peroxide in India in terms of domestic manufacturing capacity, removal/reduction of anti-dumping duty, and increase in imports from other countries that are outside the purview of current anti-dumping duty so that they may anticipate the upcoming saturation in the Indian market. Such a situation may lead to a period of lower sales growth with lower profit margins for Indian hydrogen peroxide manufacturers including National Peroxide Ltd.

In addition, it is advised that investors may read the analysis of the following companies in order to understand more about the impact industry/commodity cycles may have on companies:

• Analysis: HEG Ltd
• Analysis: Escorts Ltd
• Analysis: Gandhi Special Tubes Ltd

While analysing the tax payout ratio of the company, an investor notices that National Peroxide Ltd has been paying taxes at a rate of 30%-35% on its profit before tax (PBT), which is in line with the standard corporate tax rate prevalent in India.

Operating Efficiency Analysis of National Peroxide Ltd:

a) Net fixed asset turnover (NFAT) of National Peroxide Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of National Peroxide Ltd in the past years (FY2010-19), then she notices that the NFAT of the company has varied significantly from 1.27 to 2.40 over the years. The periods of low NFAT e.g. FY2012, FY2015-FY2016 coincide with the years when National Peroxide Ltd witnessed a decline in sales due to shutdown, low demand for H2O2 in the market resulting in low prices. In the later years when the demand situation of H2O2 improved and the prices of H2O2 increased due to high demand and anti-dumping duty on imports, then the NFAT of the company also improved accordingly.

Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors

b) Inventory turnover ratio of National Peroxide Ltd:

While analyzing the inventory turnover ratios (ITR) of National Peroxide Ltd, an investor would note that during FY2010-2019, the ITR has mostly been in the range of 14 and above. ITR has come down primarily during two periods, FY2012 (10.1) and FY2014-2015 (9.8). These years represent those periods when the company had shut down its plants to integrate expanded production capacity. During these periods, National Peroxide Ltd had accumulated a lot of stock of ready hydrogen peroxide to supply to customers during the period of shutdown.

FY2012 annual report, page 5:

An inventory of 5,422 MT of Hydrogen Peroxide (H 2 O 2 ) was available for the Plant shutdown taken from 11th April to 21st June, 2011 to implement the 84,000 MTPA Expansion Project. However, due to the extension of shutdown and the prevailing market conditions, there was a loss of 1,500 MT of H2O2 by way of sales. The plant started commercial production from 1st September, 2011.

FY2014 annual report, page 11:

The Company sold 78,295 MT of Hydrogen Peroxide during the year under review, as against 80,334 MT during the previous year, due to restricted sales to build inventory for the expansion shutdown.

The excess inventory (finished goods) resulted in low inventory turnover during FY2012 and FY2014-2015. In later periods, when the shutdown was over and the plant started functioning normally, then there was no need for keeping higher inventory. As a result, the inventory turnover ratio improved.

In FY2020, while expanding its capacity from 95,000 MTPA to 150,000 MTPA, the company has shut its plant down from Sept 30, 2019. In order to serve its customers during the shutdown period, the company has accumulated excess inventory.

BSE corporate announcement, Sept 30, 2019:

This is to inform you that the Company ’s plant located at Kalyan, Maharashtra, has been temporarily shutdown from today i.e. , September 30 , 2019 , for carrying out expansion of production capacity from 95,000 MT per annum (50% w/w) to 150,000 MT per annum (50% w/w). The increased capacity will help the Company to improve its market share and overall performance . The plant will remain under shutdown for an approximate period of 90 days .

During the aforesaid period the Company will continue to service the key customers uninterruptedly from the inventory of finished goods accumulated for the purpose .

Advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of National Peroxide Ltd:

An investor would notice that the receivables days of National Peroxide Ltd were 45 days in FY2010, which deteriorated in two particular years: FY2012 (61 days) and FY2015 (65 days). As per the above discussion, an investor would notice that FY2012 and FY2015 are the periods when there was low demand for hydrogen peroxide (H2O2) in India and the companies faced a lot of competition from Indian as well as international suppliers (low priced imports) and there was a decline in the prices of H2O2. It seems that in these tough times of the industry, the customers of the company in addition to negotiating lower prices of H2O2, also delayed payments/asked for a higher credit period from the company. As a result, the receivables days of National Peroxide Ltd increased in FY2012 and FY2015.

However, in the later years when the demand position of hydrogen peroxide improved, then the receivables days were brought under control. As a result, the receivables days of National Peroxide Ltd improved consistently from FY2016 onwards and have declined to 38 days from 65 days in FY2015.

Further Advised Reading: Receivable Days: A Complete Guide

An investor notices that over the years, National Peroxide Ltd has been able to control both its inventory as well as its receivables. As a result, the company has been able to manage its growth while keeping its working capital position under control. Therefore, the working capital of the company did not consume a lot of cash over the years.

This aspect of the business of National Peroxide Ltd gets established when an investor compares the cumulative net profit after tax (cPAT) of the company with the cumulative cash flow from operations (cCFO) for FY2010-19. She notices that the company has been able to convert its profits into cash flow from operations.

Over FY2010-19, National Peroxide Ltd has reported a total cumulative net profit after tax (cPAT) of ₹495 cr. whereas during the same period, it reported cumulative cash flow from operations (cCFO) of ₹535 cr.

It is advised that investors should read the article on CFO calculation mentioned below, which would help them understand the situations in which companies tend to have the CFO lower than their PAT and the situations when the companies tend to have CFO higher than their PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

Margin of Safety in the Business of National Peroxide Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Further advised reading: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

While analysing the SSGR of National Peroxide Ltd, an investor would notice that the company has consistently had a fluctuating SSGR. It used to be 25% in FY2013, which declined to 2% over the years and now has improved to 27% in FY2019.

While studying the formula for calculation of SSGR, an investor would understand that the SSGR directly depends on the NFAT and net profit margin (NPM) of a company.

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

• SSGR = Self Sustainable Growth Rate in %
• Dep = Depreciation rate as a % of net fixed assets
• NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
• NPM = Net profit margin as % of sales
• DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

An investor would notice that during FY2015-2016 when the industry faced poor market conditions and reduced demand & prices of hydrogen peroxide, then the NPM of National Peroxide Ltd declined significantly from 19% in FY2013 to 3% in FY2015. Similarly, during this period, the NFAT of the company declined to an all-time low of 1.27 in FY2016. This resulted in a significant decline in the SSGR. (Investors should note that we take an average of the last 3 years for all the parameters while calculating SSGR for any year).

In the later years, the SSGR has improved to 27% in FY2019 as the NPM and NFAT improved on the imposition of anti-dumping duty on low priced imports.

Therefore, an investor would notice that the improvement of SSGR is primarily because of reduced competition from lower-priced imports from international manufacturers. It seems that in the state of normal competition from all channels, both domestic and international, the ability of the company to generate higher profits will suffer.

It may happen that once the anti-dumping duty is removed or when the domestic manufacturing capacity of H2O2 exceeds domestic demand, then profits and NFAT of National Peroxide Ltd witness a decline leading to a reduction in SSGR.

b) Free Cash Flow Analysis of National Peroxide Ltd:

While looking at the cash flow performance of National Peroxide Ltd, an investor notices that during FY2010-19, the company had a cumulative cash flow from operations of ₹535 cr. However, during this period it did a capital expenditure (capex) of ₹240 cr. As a result, it had a free cash flow of ₹295 cr. (535 – 240).

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

While analysing the past annual reports of National Peroxide Ltd, an investor would notice that the company has used this FCF of ₹295 cr and incremental debt of ₹80 cr, total ₹375 cr (= 295 + 80) primarily in the following manners:

i) Intercorporate deposits to Wadia group companies: ₹238.5 cr. The breakup of intercorporate deposits on March 31, 2019, is given below:

1. Go Airlines (India) Limited: ₹100 cr
2. Bombay Dyeing Limited: ₹100 cr
3. Macrofil Investments Limited: ₹30 cr
4. Wadia Techno Engineering Limited: ₹8.5 cr

FY2019 annual report, page 122:

ii) Payment of dividend to shareholders: ₹140 cr excluding dividend distribution tax (FY2010-2019).

Investors would notice that most of the free cash flow generated by National Peroxide Ltd over the years, has been given by it to its group companies and the remaining amount has been used to pay dividends to the shareholders.

Nevertheless, the presence of free cash flow indicates that National Peroxide Ltd has been able to meet all its capital expenditure requirements from its cash flow from operations. As a result, the company could keep its debt level under check over the last 10 years.

Free cash flow (FCF) is one of the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

Additional aspects of National Peroxide Ltd:

On analysing National Peroxide Ltd and reading the annual reports since FY2011, an investor comes across certain other aspects of the company:

1) Management Succession of National Peroxide Ltd:

While analysing the leadership team of the company, an investor notices that currently, one member of the Wadia family, Mr. Ness Wadia (age 48 years) is the Chairman of the company. Mr. Ness Wadia has been with the company in the non-executive position since 1997.

FY2019 annual report, page 11:

Mr. Ness N. Wadia (48) is currently the Chairman of the Company and was inducted as a Non-Executive Director in March 1997.

Moreover, it seems that the executive day-to-day leadership of the company has been in the hands of professional managers.

Until Dec 14, 2017, the executive leadership was in the hands of Mr. Suhas Lohokare, who was the Managing Director of the company. Mr. Lohokare had been with National Peroxide Ltd since May 1997 (Source: LinkedIn).

From Dec 15, 2017, National Peroxide Ltd changed its senior leadership team and brought in a new Chief Executive Officer and Director, Mr. Suresh Khurana, who was holding the position of CEO-Polymer at Bombay Dyeing and Manufacturing Company Ltd. Mr. Khurana is currently holding positions at both the companies (Source: LinkedIn)

It looks like a situation where the promoter family is providing overall strategic guidance to the company whereas the day-to-day management and the execution of the strategy are left for professional managers.

Such a decentralized approach of giving execution authority to the professional management allows for freeing up of the time of promoter family. However, there have been a few incidents in recent times, which gain the attention of investors.

a) Financial fraud at National Peroxide Ltd with involvement of senior management:

In the FY2018 annual report, the company intimated to its shareholders that it has come across a financial fraud of about ₹37 cr. by its employees including senior management employees. The company terminated the services of these employees and filed criminal complaints with the police.

FY2018 annual report, page 116:

Embezzlement of funds of the Parent Company: 1. During the current financial year, the Parent Company’s management has identified instances of embezzlement of its funds by certain employees of the Parent Company, including senior management employees, whose services have since been terminated. Based on the management’s scrutiny and the forensic investigation report, the amount of the embezzlement is ₹3,702.98 lakhs. The Parent Company has initiated criminal proceedings against these employees including filing of FIR and application for other appropriate action with the Joint Commissioner of Police, Economic Offences Wing.

Later on, from media reports, an investor gets to know that the police had arrested Mr. Suhas Lohokare (ex. MD) and an accountant of the company, Mr. Nipul Trivedi. The media report mentioned that these suspects siphoned off money, which was for the payments of sales tax and value-added tax (VAT) for over 10 years, from 2008 to 2017 (Source: Times of India)

Suhas Lohkare, who was brought from Pune and arrested

EOW had earlier arrested Nipul Trivedi (40), an accountant with the firm

The suspects siphoned off money for payment as sales tax and Vat over 10 years, from 2008. They claimed the ST receipts were pending with the government and they would get them later,” added an officer

After this fraud, National Peroxide Ltd acknowledged that its internal processes needed strengthening. As a result, the company changed its senior management team including the MD and the VP-Finance as well as its internal auditors. The company mentioned that it is revisiting its key contracts as well as customer and vendor prices.

FY2018 annual report, page 116:

2. The Board has appointed Mr. Suresh Khurana as CEO and Director of the Parent Company and Mr. S. Raja as Vice President – Commercial and Finance of the Parent Company on December 15, 2017, immediately on termination of the earlier senior management team. The Board also appointed new internal auditors. The new Management, from January 2018, commenced by focusing on addressing gaps in entity level controls; identifying mitigating compensating controls for system gaps, revisiting the Chart of Authority, reviewing all the identified gaps in business processes, instituting new / compensating controls and maker checker controls more specifically in areas like review and approval of bank payments, journal entries, cost of goods sold ledger, reconciliation of direct and indirect taxes, re-performance of inventory valuation etc., and ensured design of controls was in place and gaps were remediated as at the beginning of January 2018. The new Management, assisted by the internal auditors subsequently tested all the controls for adequacy and operating effectiveness as on March 31, 2018.

3. Additionally, the new management has re-performed several procedures viz., reviewing sales and purchase price, analyzing customer / vendor wise sales / purchase price, reviewing scrap sales, reviewing key contracts entered into etc., to ensure that there were no transactions / account balances during the year ended and as at March 31, 2018 that were impacted by the embezzlement.

Such incidence indicates a lapse on the part of the company in its processes and systems. However, an investor may hope that these steps would help in preventing the relapse of such fraud.

Going ahead, an investor may keep a close watch on the financial performance of the company including signs of red flags, if any.

Further advised reading: Are professionally managed companies safer for shareholders?

b) Detention & suspended sentence of Mr. Ness Wadia for carrying drugs in Japan:

On March 3, 2019, the Chairman of National Peroxide Ltd, Mr. Ness Wadia was detained by the law enforcement authorities in Japan for carrying Cannabis. On April 22, 2019, Mr. Wadia was given a sentence of two years in jail that was suspended for five years. It indicates that the sentence will not be implemented in case he does not break the law again in Japan in the next five years.

BSE corporate announcement, May 20, 2019:

The Company is informed that its Director, Mr. Ness N. Wadia was detained on March 3, 2019 at Chitose Airport, Sapporo, Japan for alleged possession of Cannabis under the Cannabis Control Act and the Customs Act of Japan.

On April 22, 2019, Mr. Ness Wadia was given a suspended sentence of two years, which sentence is suspended for a period of five years.

Mr. Ness Wadia has since been available to the company and is performing his duties in accordance with his role.

As per the statements from the company, Chairman, Mr. Wadia is able to perform his duties for the company, as the sentence is a suspended sentence.

Many times, it becomes a reputation risk for companies when its promoter or senior management is involved in unlawful activities. As a result, investors should keep a close watch on the developments related to the promoters and senior management.

2) Project execution by National Peroxide Ltd:

While analysing the history of the company, an investor notices that the company has been able to increase its production capacity at frequent intervals.

• From 54,000 MTPA to 65,000 MTPA in FY2010
• From 65,000 MTPA to 84,000 MTPA in FY2012
• From 84,000 MTPA to 95,000 MTPA in FY2015
• From 95,000 MTPA to 150,000 MTPA in FY2020 (under construction).

Therefore, it seems that the project execution team of National Peroxide Ltd is able to complete the increase in the production capacity of the plants whenever required. As a result, the company is able to meet the growing demand for hydrogen peroxide in the country.

Currently, the expansion of the capacity from 95,000 MTPA to 150,000 MTPA is under construction. An investor may keep a close watch on the developments related to this expansion to monitor whether it is completed within the budgeted time and cost.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

3) Versatile nature of manufacturing plant of National Peroxide Ltd:

When an investor reads the FY2009 annual report, then she notices that the hydrogen peroxide (H2O2) manufacturing plant of the company is a versatile plant, which can produce H2O2 from natural gas as well as naphtha.

FY2009 annual report, page 7:

From October 2008 onwards, since the fall in prices of Naphtha was sharper than that of Natural Gas, making it more viable to use Naphtha, the Company switched over to use of Naphtha as a feedstock. Subsequently, with the fall in prices of Natural Gas, the Company switched back to Natural Gas in March 2009. This ability to operate the plant on either Naphtha or Natural Gas has been a significant contributor to the Company’s bottom-line.

Because of this versatility, the investor would appreciate that the company can switch over from natural gas to naphtha or vice versa whenever the price of any of these becomes comparatively cheaper. Such ability to switch over the feedstock provides a good option for the company to keep its costs under control.

However, since FY2009, there is no mention of such incidences of switching over of feedstock by the company in its annual reports.

An investor may contact the company directly to know whether the subsequent expansions of the manufacturing capacity including the under-construction expansion to 150,000 MTPA have this ability to switch over between natural gas and other feedstock like naphtha.

Further advised reading: How should investors contact Companies/Management for clarifications or additional information?

4) Use of resources of National Peroxide Ltd by Wadia group for its group companies:

While analysing the history of National Peroxide Ltd, an investor notices that there have been many instances when the company has used its resources/borrowed money to provide money to Wadia group companies.

a) National Peroxide Ltd took loans to give money to Wadia group companies (FY2015):

While analysing the financial position of National Peroxide Ltd over the years, an investor notices that in FY2015, the total debt of the company increased by ₹69 cr, from ₹4 cr in FY2014 to ₹73 cr in FY2015.

At the same time, in the FY2015 annual report, the investor notices that National Peroxide Ltd had given loans of ₹65 cr to different Wadia group companies, which had increased by ₹46 cr during the year from ₹19 cr in FY2014.

• Bombay Dyeing Real Estate Co. Ltd: ₹5 cr
• Archway Investments Ltd: ₹30 cr and
• Macrofil Investment Ltd: ₹30 cr

FY2015 annual report, page 86:

An investor may note that Archway Investments Ltd and Macrofil Investment Ltd are part of the companies through which the Wadia group owns its shareholding in National Peroxide Ltd.

FY2015 annual report, page 37:

As per the FY2015 annual report of Bombay Dyeing & Manufacturing Company Ltd (BDMCL), Bombay Dyeing Real Estate Co. Ltd (BDRECL) is its associate company where BDMCL holds a 40% stake.

FY2015 annual report of BDMCL, page 23:

This seems like an incidence where the promoter group is using National Peroxide Ltd as an avenue to raise loans from banks and then forward this money to its group companies for their benefit.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

The credit rating agency, India Ratings, highlighted this transaction in its report for National Peroxide Ltd in Feb 2016.

NPL borrowed INR500m long-term loans and INR150m working capital demand loan (WCDL) in FY15. While the latter was availed to fund incremental working capital requirements, the term loan was largely deployed in group entities.

b) National Peroxide Ltd again took loans to give money to Wadia group companies (FY2019):

While analysing the FY2019 annual report, an investor notices that at the end of National Peroxide Ltd had given loans of ₹238.5 cr to different Wadia group companies. These loans to the group companies had increased by ₹173 cr in FY2019; from ₹65 cr in FY2018 to ₹238 cr in FY2019.

FY2019 annual report of BDMCL, page 122:

An investor would also notice that in FY2019, National Peroxide Ltd took loans of ₹80 cr from its lenders. The company used to be a debt-free company in FY2018.

An investor may notice that in FY2019, the company did a capital expenditure of ₹75 cr on the capacity expansion project and the company may have taken the loan for usage in the expansion project. The credit rating report by India Ratings for the company in July 2018 mentioned that National Peroxide Ltd plans to take a loan of ₹125 cr to meet the total project cost of ₹200 cr.

NPL is undertaking a capex of INR2,000 million to increase its capacity to 1,50,000 metric tonnes per annum from 95,000 metric tonnes per annum. The debt of INR1,250 million undertaken to fund the capex and a decline in sales due to lower production will weaken the credit metrics in FY19; however, the ratios will remain commensurate with the ratings

However, an investor may appreciate that money is a fungible commodity. National Peroxide Ltd could have used its business profits to fund the capital expenditure instead of giving them as loans to group companies.

Therefore, a situation where a company takes loans to meet its capital expenditure and gives its cash reserves to group companies is no different from the situation where the company uses its cash reserves to meet the capital expenditure and takes loans to give money to the group companies.

National Peroxide Ltd could have avoided the debt and the interest cost if it used its business profits to meet the capital expenditure instead of giving this money to the group companies.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

c) National Peroxide Ltd gave ₹97 cr to Wadia group company by buying shares from it:

On Sept 3, 2019, National Peroxide Ltd submitted a corporate announcement to the Bombay Stock Exchange (BSE) in which it disclosed that National Peroxide Ltd along with its subsidiary, Naperol Investments Limited (NIL) has bought 1,110,017 shares of The Bombay Burmah Trading Corporation Limited (BBTCL).

While reading the details in the corporate announcement, an investor notes that on Sept 3, 2019, Bombay Dyeing and Manufacturing Company Ltd (BDMCL) had sold 1,788,208 shares of BBTCL. These shares were purchased by different Wadia group companies. The maximum amount of shares (1,110,017) was purchased by National Peroxide Ltd (1,054,384) and its subsidiary, Naperol Investments Limited (55,633).

BSE corporate announcement, Sept 3, 2019:

On Sept 3, 2019, the shares of The Bombay Burmah Trading Corporation Limited (BBTCL) closed at ₹873.55 on BSE. At this price, the 1,110,017 shares purchased by National Peroxide Ltd with its subsidiary are valued at about ₹97 cr.

If an investor views this transaction from the perspectives of the stake of the promoters, the Wadia group, in The Bombay Burmah Trading Corporation Limited (BBTCL), then she notices that for the promoters this transaction is immaterial. Because, both the seller, Bombay Dyeing and Manufacturing Company Ltd (BDMCL) and the buyers, National Peroxide Ltd along with its subsidiary, Naperol Investments Limited (NIL) are mentioned as promoters of The Bombay Burmah Trading Corporation Limited (BBTCL).

Promoters’ shareholding of The Bombay Burmah Trading Corporation Limited (BBTCL) at Sept 30, 2019 (Source: BSE)

Therefore, on an overall level, this transaction may amount to shifting of ₹97 cr from National Peroxide Ltd to the seller Bombay Dyeing and Manufacturing Company Ltd (BDMCL) via sales of shares of BBTCL. At the end of this transaction, BDMCL received ₹97 cr from National Peroxide Ltd and the promoters, the Wadia group, retained its stake in each of the companies at similar levels.

An investor would note that National Peroxide Ltd could have used this ₹97 cr to repay the debt that it has taken to fund the current ongoing capacity expansion project.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

The above transactions may indicate to an investor that the promoter group looks at all its group companies as entities where it moves money/resources from one company to another as it deems fit. Whenever it needs money in one of the group companies (say ABC Ltd), then it assesses which of its other group companies has the ability to take debt or has surplus cash. Once it has decided that a particular company (say XYZ Ltd) has the ability to take debt or has surplus cash, then the promoter group moves money from XYZ Ltd to ABC Ltd either by way of loans or by way of selling an asset from ABC Ltd to XYZ Ltd.

When looking at the perspective of the promoters, such a transaction may represent an efficient use of group resources. However, it remains true only when the promoters are the only shareholders of all the group companies. Things start to look different when the investor analyses it from the perspective of public/minority shareholders of these different group companies.

The minority shareholders own an economic interest in the money, which is moved by the promoter group from one company to another. The minority shareholders may prefer to get their share of the money themselves in the form of dividends etc. and may not want to be a party to such a transaction where one group company is supporting another group company. However, minority shareholders have no choice in such cases.

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

Moreover, many times such transactions of shifting money of the company to another group company may not generate any return for the minority shareholders.

Let us take the example of the shares of Bombay Dyeing and Manufacturing Company Ltd (BDMCL) owned by National Peroxide Ltd along with its subsidiary, Naperol Investments Limited (NIL) for more than a decade.

5) Shares of Bombay Dyeing and Manufacturing Company Ltd owned by National Peroxide Ltd:

The earliest available annual report of Bombay Dyeing and Manufacturing Company Ltd (BDMCL) on its website is for FY2006. This annual report mentions that on March 31, 2006, the Wadia group owns its shareholding in BDMCL via many companies, which include National Peroxide Ltd and its subsidiary.

FY2006 annual report of BDMCL, page 30:

Moreover, the earliest available shareholding disclosure of BDMCL at the BSE website, which has the details of the names of individual promoter companies is for June 2006. This disclosure shows that National Peroxide Ltd with its subsidiary, Naperol Investments Ltd (NIL) owned at a consolidated level 379,180 shares of BDMCL on June 30, 2006. National Peroxide Ltd owned 297,940 shares of BDMCL and Naperol Investments Ltd (NIL) owned 81,240 shares of BDMCL (379,180 = 297,940 + 81,240).

Promoters’ shareholding pattern BDMCL, June 30, 2006 (Source: BSE)

Both National Peroxide Ltd and Naperol Investments Ltd (NIL) had 379,180 shares until FY2013 when the shares of BDMCL were split from one share of the face value of ₹10 to five shares of the face value of ₹2.

FY2013 annual report of National Peroxide Ltd, page 58:

As a result, the total number of shares of BDMCL owned by National Peroxide Ltd and its subsidiary, Naperol Investments Ltd increased from 379,180 to 1,895,900.

As per the shareholding pattern of Bombay Dyeing and Manufacturing Company Ltd (BDMCL) at Sept 30, 2019, at BSE website, National Peroxide Ltd and its subsidiary, Naperol Investments Ltd continue to own 1,895,900 shares of BDMCL (=1,489,700 + 406,200)

Promoters’ shareholding pattern BDMCL, Sept 30, 2019 (Source: BSE)

Therefore, an investor would notice that National Peroxide Ltd and its subsidiary, Naperol Investments Ltd have continued to own their stake in BDMCL without any buy/sell transactions since at least June 30, 2006, until now, (January 2, 2020). We assume that there has not been any buy/sell of shares of BDMCL by National Peroxide Ltd and its subsidiary, Naperol Investments Ltd. This is because there has not been any disclosure by the promoters to the stock exchange in this regard unlike the case of The Bombay Burmah Trading Corporation Limited (BBTCL), discussed above, where there was a stock exchange disclosure on Sept 3, 2019, when there were changes in the shareholding.

Therefore, the shareholders of National Peroxide Ltd including the public/minority shareholders have been patiently holding split-adjusted 1,895,900 shares of BDMCL without any buy/sell transactions since at least June 30, 2006.

When an investor analyses the share price movement of BDMCL since June 30, 2006, up to January 2, 2020, then she notices that during this period the share price of BDMCL has declined by about 27% from ₹113.14 on June 30, 2006, to ₹83.00 at January 2, 2020.

Therefore, an investor would note that the decision of the promoters to shift money from National Peroxide Ltd to any other group company by selling shares of BDMCL to National Peroxide Ltd has not yielded any meaningful return to the public/minority shareholders of National Peroxide Ltd.

Moreover, the public/minority shareholders may have wanted to take this money to themselves as dividend/share buyback so that they can invest it as per their own choice. However, they do not seem to have any other option.

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

6) National Peroxide Ltd (NPL) gives loans to Macrofil Investment Ltd (MIL) and MIL buys shares of NPL:

While reading the FY2017 annual report, an investor notices that the promoter group company, Macrofil Investment Ltd (MIL), increased its stake in National Peroxide Ltd.

FY2017 annual report, page 36:

An investor notices that in FY2017, Macrofil Investments Ltd increased its stake in National Peroxide Ltd by 9,441 shares (=7311+2108+22) in FY2017.

Moreover, the investor notices that National Peroxide Ltd has given a loan of ₹30 cr to Marcofil Investments Ltd, which was yet to be repaid in FY2017.

FY2017 annual report, page 84:

[The Company has given Intercorporate Deposits (ICD) for general business purposes to Archway Investments Ltd. ₹ NIL (Previous Year: ₹ 1,400 Lakhs) and Macrofil Investment Ltd. ₹ 3,000 Lakhs (Previous Year: ₹ 3,000 Lakhs). The interest rate of the said ICDs is 12.50% p.a. and these are repayable on demand]

An investor would appreciate that money is a fungible commodity. Therefore, when National Peroxide Ltd (NPL) has given loans to Macrofil Investment Ltd (MIL) and later MIL buys shares of NPL, then it amounts to a situation where NPL itself has funded the acquisition of its shares by MIL.

Also read: How Promoters use Loopholes to Inflate their Shareholding

Due to the fungible nature of money, this amounts to a situation where the promoter group has borrowed money from National Peroxide Ltd (NPL) itself to increase their stake in the company.

7) Management of relationships with labour union of National Peroxide Ltd:

An investor would appreciate that the manufacturing business is a labour-intensive activity. As a result, companies need to be continuously in touch with the labour unions to meet their expectations.

While reading the annual reports of National Peroxide Ltd, an investor gets to know that the company manages its labour relations by way of long-term agreements with the union.

As per the publicly available annual reports since FY2009, one such agreement with the labour union expired in Sept 2009.

FY2010 annual report, page 4:

The settlement with the Union expired on 30th September, 2009. Negotiations are in progress and are expected to conclude shortly. Industrial relations continued to be cordial during the year.

The negotiations with the union concluded in FY2011 and the company entered into an agreement with the union in Nov. 2010.

FY2011 annual report, page 8:

The Company entered into a long term settlement with the Workmen’s Union on 3rd November, 2010 which will expire on 31st March, 2013. Industrial relations continued to be cordial during the year

This agreement expired in March 2013. Post this National Peroxide Ltd entered into another agreement until Sept 2016.

FY2014 annual report, page 19:

The Company signed a long term settlement with its recognized Union, Maharashtra Girni Kamgar Union (MGKU) on 2nd April, 2014. The said settlement will be valid upto 30th September, 2016.

In FY2018, the company intimated its shareholders that it has renewed its agreement with the labour union in March 2018. However, the disclosure did not mention the validity date of the renewed agreement.

FY2018 annual report, page 17:

The long-term settlement with the recognized Union, Maharashtra General Kamgar Union (MGKU) was renewed in March 2018. The Company is implementing employee engagement programs to promote a motivated work force.

An investor notes that the FY2019 annual report also does not mention the expiry date of the current agreement with the labour union.

An investor would note that in the case of manufacturing companies, it is very important to have cordial relationships with the labour union. This is because problems with the labour union can hamper the functioning of the manufacturing plant and in turn the business of the company. Therefore, it is advised that an investor may contact the company directly to know about the current state of its settlement agreement with the labour union along with its expiry date so that she may effectively monitor developments in the labour relations of the company.

Further advised reading: How should investors contact Companies/Management for clarifications or additional information?

8) Instances of excess remuneration paid to the directors of the company including the managing director:

While analysing the financial performance of National Peroxide Ltd, an investor notices that in the past on many occasions, the company paid remuneration to its managing director, which was higher than the statutory limit in the Companies Act.

In FY2015, the company paid a remuneration of ₹2.59 cr to its managing director whereas the statutory limit was ₹0.93 cr.

FY2015 annual report, page 41:

Similarly, in FY2016, the company paid a remuneration of ₹2.29 cr to its managing director whereas the statutory limit was ₹1.66 cr.

FY2016 annual report, page 38:

In the past, there have been many instances where National Peroxide Ltd initially paid a higher remuneration/commission to its directors that it had to recover later on.

In FY2012 and FY2013, the company had to recover excess commission paid to its directors.

FY2016 annual report, page 63:

The reversal of excess commission paid to the directors continued in FY2014 and FY2015.

FY2015 annual report, page 89:

The next instance of such a reversal of excess commission to the directors appeared in FY2017.

FY2017 annual report, page 87:

An investor may note that in the case of National Peroxide Ltd, there has been an instance of senior management of the company prioritizing its interest over the interest of the shareholders when the employees of the company engaged in financial fraud. The internal systems and processes were found lacking at that time. The company has mentioned that these processes have been strengthened thereafter. However, going ahead, an investor may keep a close watch on various parameters that may indicate that the management is prioritizing its interest over the shareholders.

Further advised reading: How to identify Promoters extracting Money via High Salaries

9) Instances of delays in meeting statutory requirements, payments and filings by National Peroxide Ltd:

While reading the past annual reports of National Peroxide Ltd, an investor comes across a few instances where the company did not meet the statutory requirements in time.

In FY2016, the company had a long delay of more than one year in payment of undisputed income tax dues to the department. The payment was due in April 2015. However, National Peroxide Ltd made this payment in May 2016.

FY2016 annual report, page 52:

Similarly, in FY2018, the company had delays in filing of Form MR-1 for the appointment of its Whole-Time Director.

FY2018 annual report, page 41:

During the period under review, the Company has complied with the provisions of the Act, Rules, Regulations, Guidelines, Standards etc., as mentioned above except filing of Form MR-1 for appointment of Whole-Time Director which was filed subsequently.

We believe that an investor should pay attention to such instances, which may give an idea about weakness in the processes or the lax attitude of the management towards compliances. In case an investor notices that there are many such instances, then it may serve as an early warning to the investor about the possibility of bigger issues, which may be discovered later.

Margin of Safety in the market price of National Peroxide Ltd:

Currently (January 2, 2020), National Peroxide Ltd is available at a price to earnings (PE) ratio of about 13.91 based on the last four quarters’ consolidated earnings from Oct. 2018 to Sept 2019. The PE ratio of 13.91 provides a small margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, taking 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, even 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.

• Further advised reading: 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
• Read: How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
• Further advised reading: Hidden Risk of Investing in High P/E Stocks

Analysis Summary

Overall, National Peroxide Ltd seems like a company, which has been able to grow its sales at a growth rate of 15% per annum over the last 10 years (FY2010-19). However, this growth journey has not been smooth. The company has witnessed periods of fast growth in sales as well as periods of declining sales. Similarly, in the last 10 years (FY2010-2019), National Peroxide Ltd has seen periods of high-profit margins as well as low-profit margins.

The reason for such wide fluctuations in the business performance is the commodity nature of its product, hydrogen peroxide (H2O2). The company faces intense competition from Indian as well as foreign competitors. Because of the competition, the company faces difficulties to pass on the increase in raw material costs (natural gas) to its customers. Low priced imports from other countries frequently push the price of H2O2 in India down to such a level that the company ends up facing a decline in its sales. These problems are accentuated by the cyclical nature of the demand for hydrogen peroxide, which depends primarily on the paper and textile industries where it is used in bleaching. Periods of the high demand for H2O2 result in high sales and high-profit margins whereas the periods of low demand for H2O2 result in declining sales and low-profit margins for National Peroxide Ltd.

The company attempts to reduce the competition from foreign manufacturers by regularly requesting govt. to impose anti-dumping duty on imports of hydrogen peroxide. It has succeeded twice in recent history and got the anti-dumping duty imposed on H2O2 imports from key countries; once in FY2009 and then in FY2018. However, the benefits of such barriers like anti-dumping duty, which interfere with the market forces of demand/supply and price, are short-lived. In FY2009, the H2O2 came to the level of imports within a few months. Similarly, in 2019 as well, after a few quarters of the imposition of anti-dumping duty, the high prices of H2O2 declined and the high sales and high-profit margins of National Peroxide Ltd witnessed a decline.

Nevertheless, India has a short domestic supply of hydrogen peroxide than its domestic demand. As a result, domestic manufacturers like National Peroxide Ltd are able to generate sufficient free cash flow after meeting the capital expenditure requirements. However, when an investor analyses the usage of the free cash flow by the company, then she notices that most of the free cash flow has been given by the company to the promoter group companies either by way of loans or by way of buying shares of group companies.

National Peroxide Ltd seems to follow a management style where the promoters make their presence as the head of the board of directors to give strategic direction whereas the day-to-day executive authority has been given to professional managers. This approach served well to the company for a long period until in FY2018 when it came to the notice that the senior management was siphoning off the money by way of fraudulent cheques. The company had to change the entire senior management team and internal auditor. The company has stated that it has strengthened its weakness in its systems and processes. However, it remains to be seen whether it is able to avoid such frauds in the future.

The company has been able to show good project execution until now when it has expanded the manufacturing capacity at regular intervals. In addition, the company seems to have managed its labour relationships well by way of regular settlement agreements with the labour union.

Going ahead, an investor should keep a close watch on the domestic demand-supply situation of hydrogen peroxide along with the removal or reduction of the anti-dumping duty. This is because if the current situation of the shortfall in domestic production changes to domestic surplus production, then the company may find it difficult to witness periods of high growth and high-profit margins. Thereafter, the hydrogen peroxide industry may enter into a phase of intense competition where manufacturers undercut each other to sell their products and in turn make it difficult for any producer to make a reasonable return on its investment.

Simultaneously, an investor should keep a close watch on the investments/loans given by National Peroxide Ltd to the promoter group companies so that she may ascertain whether the company is thinking about the interests of minority shareholders or it is solely working to the benefits of the promoter group.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on National Peroxide Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”

I hope it helps!

Regards,

Dr Vijay Malik

P.S.

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.