The current section of the “Analysis” series covers Supreme Industries Ltd a plastic goods manufacturer in India. The company manufactures plastic pipes, plastic furniture, cross-laminated films, protective packaging, composite LPG cylinders etc.
“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.
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.
Supreme Industries Ltd Research Report by Reader
I have attached analysis of Supreme Industries Ltd. Hope you find it worthy enough.
With best regards,
Business Analysis of Supreme Industries Ltd:
Supreme is the market leader in plastics industries. The company has exhibited consistent volume growth, profit growth, and sales growth.
The key raw material used by Supreme is PVC resin, which is a crude derivative. As we know, there has been a fall in crude prices and even after that, there has been an increase in realisation which shows pricing power.
The operating profit margin (OPM) in Screener has not seen wide fluctuations apart from 2-3%, which shows the stability of the business and non-cyclicality.
The company has generated positive free cash flows.
We see that the business has generated cash flows from its profit indicating the quality of profits.
Further, if we analyse the working capital of the business, then we find that Supreme Industries Ltd has maintained debtor days consistently.
We find that the return on capital employed (ROCE) of the business is above the cost of capital indicating competitive advantage. The question we should ask is why. We find that it is a mixture of high assets turnover and higher margins. This indicates that the company has a cost advantage as well as some pricing power.
Raw Material Analysis of Supreme Industries Ltd:
The snippets from the annual reports show that Supreme Industries Ltd may suffer from volatility in crude prices, and suffer inventory losses. However, with a time lag, it can manage its inventory. Also, it will always be dependent on imports and depreciation of rupee will have an adverse impact on its margins. If we see the various annual reports, then we will find that the foreign exchange used is significantly higher than the foreign exchange earned.
Now we analyse the pricing power and margin structure of various business segments.
Conference call 30.6.2011
Analyst: “Sir, if you could just explain how the pricing is done in your industry, in a sense that we are seeing runaway inflation in oil prices, so how easy is it to pass on the prices to the end customer; can you just take us through that in each of your segment?”
M. P. Taparia: Plastic piping, we pass on the price increase immediately. Because that is a low margin product, we immediately pass on. Similarly, on industrial products also we pass it on after one week’s time and furniture, protective packaging and material handling we give a time lag between two to three weeks to transfer the increased cost including our operating margin. On Cross-Laminated Films, where we enjoy a strong margin, we do not change the price every time, price go up or come down, we can maybe once in a quarter.”
Analyst: “Is there any margin structure for let us say for different segment?”
M. P. Taparia: Margin structure is highest in Cross-Laminated Films.
Parthiv Patel: Okay. Even on the broader level, let us say if we talk about Plastic Piping, what would be the margin structure there?
P.C. Somani: On margin structure, overall, if you look at in totality, the Plastics Piping system would be around 12-13%.
Parthiv Patel: You are talking about EBITDA level?
P.C. Somani: Yeah.
Parthiv Patel: Okay.
P.C. Somani: Whereas Industrial component, industrial product would be around 14%. In Packaging product, including Cross-Laminated Films would be around 19%, 20%.
Parthiv Patel: Okay. And what about Consumer?
P.C. Somani: Between 12% and 13%.”
Manoj Bahety: And sir, my last question is since in the current year the prices have fluctuated a lot. So is it possible to bifurcate our profitability in terms of normal operating profitability and the profitability just pertaining to inventory gains, because in a volatile year the inventory also gets repriced?
M. P. Taparia: After all, we make inventory gain and there is an inventory loss. As informed in the first ten months, there were inventory gain and in the month of May and June, the prices have fallen when the crude price has dropped suddenly by $15, so we made the inventory loss also. So for the whole year by and large they are canceling it out only to the extent whatever remains in the inventory, the loss on account of inventory is there, if there is a fall and gain, if there is an increase. However, in our case we do not keep much of the finished goods in our stock. So that will be a very small amount. Not a significant amount compared to our turnover and overall profit.”
It is self-explanatory about the margins enjoyed by various segments of the business. As far as the inventory gains/losses are concerned, it states that the volatility is a normal course and there is some loss and gain which average out each other.
The management is more inclined towards having margins and has pricing power in consumer products, which is a good sign. Moreover, the company is inclined towards selling more value-added products and enhancing its pricing power.
Industry Analysis for Supreme Industries Ltd:
Polymer growth is linked to GDP growth. Indian consumption of polymers is very low compared to the world in per capita terms. Further, there is a government initiative to build affordable housing, smart cities, which will be a demand driver for Plastic Pipes.
If we see the financials of its creditors, the industry enjoys decent returns on capital and margins. It means the industry is not entirely a commodity industry and has some brands- Astral/Finolex- Pipes, Nilkamal- Plastic chairs, Time Technoplast- Composite cylinders and Mox Films.
Further, this is a growing industry with less cyclicality as evidenced by volume growth of the company and industry.
Management Analysis of Supreme Industries Ltd:
The company is run by Taparia Family. Mr B L Taparia is chairman and M P Taparia, S J Taparia, and VK Taparia run the executive functions of the company. This indicates succession planning but may put the company in jeopardy if there is a difference in the family.
The promoter remuneration is ₹26 crores in 2019, on profit before tax (PBT) of ₹664 crores. This is within the restrictions of the Companies Act. However, the remuneration drawn by the family is almost the same. This indicates that there may be no mechanism to differentiate between the contributions of each member.
Self-sustainable Growth Rate (SSGR) of Supreme Industries Ltd:
The SSGR of the company has been roughly 7/8 %, which is in line with the sales growth of the company. Hence, the debt has neither reduced nor increased. In March 2016, it was roughly ₹400 crores and it remains the same now.
Real estate operations of Supreme Industries Ltd:
The company built supreme chambers in Andheri Mumbai in 2010-11. However, until FY2019, the entire area has not been sold.
If we track all the annual reports, we will find that the company has been eternally optimistic about selling the space. It is a call of judgment whether a plastic products company should enter into real estate and allocate ₹155 crores which could have been utilized in reducing debt.
Related party transactions of Supreme Industries Ltd:
There has been the consistent purchase of goods from Supreme Petrochem Ltd and sale of goods to Devvrat Impex Pvt Ltd. Given the large size of the company, these amounts do not appear to be substantial. Therefore, these can be considered in the regular course of business.
Valuations & likely prospects of Supreme Industries Ltd
The company trades at 30-35 times its earning, which is inherently expensive and discounts a very high growth rate for the company. This provides a low margin of safety for the purchase price.
Further, with the increasing prosperity of the country, the use of polymer products will increase. This will certainly drive growth for the company; however, it is a matter of judgment whether the historical growth can be repeated.
The only catalyst for growth is the composite cylinder business, which can be a game-changer. However, the LPG market is controlled by public sector units (PSUs) who prefer the status quo. Hence, we can assume moderate growth assumption for the company in future, at best at nominal GDP rate.
Hope this analysis can add some value to other investors.
Dr Vijay Malik’s Response
Thanks for sharing the analysis of Supreme Industries Ltd with us! We appreciate the time & effort put in by you in the analysis.
While analysing the history of Supreme Industries Ltd., an investor notices that the company has a wholly-owned subsidiary, Supreme Overseas FZE, and an associate company, Supreme Petrochem Ltd, where it owns about 30% stake. As a result, throughout the last 10 years (FY2011-2020), Supreme Industries Ltd has reported both standalone as well as consolidated financials.
We believe that while analysing any company, an investor should always look at the company as a whole and focus on the financials, which represent the business picture of the entire group. Consolidated financials of any company, whenever they are present, provide such a picture.
Further advised reading: Standalone vs Consolidated Financials: A Complete Guide
Therefore, in the analysis of Supreme Industries Ltd, we have used consolidated financials in the assessment.
In addition, an investor notices that until FY2015, the company used to follow a financial year from July to June. In FY2016, the company changed its financial year to end in March. As a result, in FY2016, the company covered only 9 months i.e. from July 2015 to March 2016. Therefore, all the financial data for FY2016 comprises the performance of only 9 months. In the years before FY2016 and FY2017 onwards, the reported performance is for 12 months.
FY2016 annual report, page 8:
Pursuant to section 2(41) of the Companies Act, 2013, the Company adopted April-March as its Financial Year & accordingly the year under review comprised of Nine months only from 1st July, 2015 to 31st March, 2016. From 2016-17 & onwards, the financial year of the Company shall be for a period of 12 months i.e. from 1st April to 31st March.
With this background, let us analyse the financial performance of the company.
Financial and Business Analysis of Supreme Industries Ltd:
While analyzing the financials of Supreme Industries Ltd, an investor notices that the sales of the company have grown at a pace of about 7-9% year on year from ₹2,469 cr in FY2011 to ₹5,511 cr in FY2020. During the 12-months ending June 2020, the sales of the company have declined to ₹5,129 cr.
An investor notices that the sales of the company have grown consistently over the last 10 years except FY2020 and the 12-months ending June 2020. The decline in the performance during this recent period is due to the lockdown and resultant slowdown due to coronavirus pandemic.
While looking at the profitability of the company, an investor notices that the operating profit margin (OPM) of Supreme Industries Ltd has been very stable during the last 10 years. The OPM has consistently been in the range of 14-16%.
Let us try to understand the key characteristic of the business model of Supreme Industries Ltd and the factors affecting its profitability.
i) Raw material volatility and the pricing power of Supreme Industries Ltd:
An investor would appreciate that companies would have stable profit margins only when they can pass on the increase in their costs to their customers. In such situations, when the raw material & other input costs increase, then the companies can increase the price of their products and maintain their profit margins. Such ability of the companies is known as pricing power and is very helpful to ensure consistent profitability.
In the case of Supreme Industries Ltd, the company has intimated to its shareholders over the years that it can pass on the increase in its raw material costs to its customers. The company passes on the increase in raw material costs to its customers with a gap of a few weeks.
FY2008 annual report, page 9:
In our Company’s product segments, the increase in raw material costs could be transferred to the product pricing within a time lag of 2 to 5 weeks.
However, the ability to pass on the increase in raw material costs also has its limitations. This is because when the raw material prices increase very sharply, then the company has to increase the prices gradually. Otherwise, the customers would stop buying its products, which would hurt the revenue.
Like in FY2013, when the raw material prices for Supreme Industries Ltd increased sharply, then it decided to increase the prices of its products gradually over a longer period.
FY2013 Chairman’s Speech, page 1:
As the price increase was steep, the Company has decided to transfer the increased cost over a longer time horizon on most of its products. The Company has now transferred the entire cost increase in all its products.
Therefore, an investor would appreciate that Supreme Industries Ltd can pass on the increase in its raw material costs to its customers; however, it is not unlimited power. This is because if there is a very sharp increase in the raw material prices and in turn, the company increases the prices of its products sharply, then the customer would feel that the products have become very costly and in turn, she would defer buying the products or would buy the products of other competitors.
In addition, an investor would also notice that the ability of the companies to increase prices when the raw material prices increase is not a one-way decision. It means that whenever the raw material prices decline, then the company has to pass on the same as well i.e. when raw material prices decrease, the Supreme Industries Ltd has to decrease prices of its products.
The company faced such a situation in FY2016 when the raw material prices declined and Supreme Industries Ltd had to pass on the benefit to its customers. Because of the decline in its product prices, the revenue growth of the company was lesser than the volume growth in the sale of its products.
The credit rating agency, CRISIL, highlighted this in its report for Supreme Industries Ltd in March 2016.
polymer prices declined by 10-15 percent during the six months ended December 31, 2015, due to drop in crude oil prices, impacting its revenue growth, as decline in prices were largely passed on to customers. Thus, despite registering a volume growth of 10 percent during the six months through December 2015 as compared to the previous year it reported flat revenue growth in the same period.
Therefore, an investor would appreciate that if the raw material prices of Supreme Industries Ltd increase, then it can increase the prices of its products to protect its profit margins. Moreover, if the raw material prices decrease, then it has to reduce the prices of its products, as the relationship between the raw material prices and the final product prices is a two-way mechanism.
However, an investor should not think that such kind of two way mechanism makes any company like Supreme Industries Ltd immune from the impact of changing raw material prices. This is because whenever the raw material prices decline and as a result, the prices of the final product declines. However, the products lying with the company as well as its dealers/shops are made from the plastic/raw material that was bought previously when the raw material prices were high. As a result, the company faces losses on the existing raw material already bought and the ready products already prepared from the costly raw material purchased previously. This is called inventory loss, which becomes very apparent when the raw material prices decline sharply.
In the case of Supreme Industries Ltd, the raw material used to make plastic products are crude oil derivatives. Therefore, their prices are dependent on crude oil prices.
An investor would appreciate that the crude oil prices are highly volatile. In the below chart from Macrotrends, covering the history of crude oil prices over the last 15 years, an investor would notice that the per barrel price of the crude oil in 2006 was about $60, which increased to about $140 in 2008. It declined sharply to $40 per barrel in 2009. It increased to about $120 in 2011 and then declined to $35 in 2016. The crude oil price again increased to $75 in 2018 and then declined to $20 in 2020.
Therefore, an investor would appreciate that the crude oil prices and in turn the raw material prices for Supreme Industries have been highly volatile over the last 15 years.
An investor would also appreciate that in the case of raw material dependent on crude oil, the prices are benchmarked in US Dollars. Therefore, to assess the final impact on any company in India, an investor needs to combine it with the impact of USD-INR exchange rate.
Over the last 15 years, an investor would notice that USD-INR exchange rate has been fluctuating wildly in the short-term cycles. In addition, over the long term, the INR is on a continuous decline against USD.
Therefore, an investor would appreciate that due to the combined impact of volatility in the crude oil prices and the volatility in the USD-INR exchange rate, any kind of prediction about the final cost of raw material to any company in India becomes very difficult.
The credit rating agency, CRISIL, highlighted the susceptibility of Supreme Industries Ltd to the volatility in crude oil prices and foreign exchange volatility in its report in March 2016.
Operating performance is susceptible to volatility in raw material (polyvinyl chloride resin, polyethylene, and polypropylene) prices given their linkages with crude oil prices and foreign exchange rates.
While analyzing Supreme Industries Ltd, an investor notices that the company faced sharp volatility in its raw material prices over the years.
During the periods of the sharp decline in the raw material prices, the company faced inventory losses. E.g. in FY2019 when the oil prices declined sharply, it faced inventory losses, which led to a reduction of its OPM from 16% in FY2018 to 14% in FY2019.
FY2019 annual report, page 36:
The PVC prices in the first ten months maintained upward bias. Suddenly the prices dropped in March by 12.5% in five week times. This resulted in steep inventory loss in the working of the Company for the year eroding its operating margin to some extent.
Therefore, in the industries facing sharp raw material price fluctuations, an investor needs to be aware of the inventory losses faced by the companies. In addition, the resultant sharp price fluctuations of the products affect customer behaviour as well. This in turn affects the business of the company.
Supreme Industries Ltd detailed this impact of fluctuating product prices on customer behaviour in its annual report for FY2009 (page 14).
The company highlighted that first, the raw material increased sharply and as a result, it increased product prices, then the customers refused to buy products at unaffordable prices.
From 1st July 2008, which is commencement of our New Financial Year 2008-2009, onwards the polymer prices reached a peak, probably the highest ever in the history of polymer Industries in India. As a result, there was a lot of resistance from the consumers to buy plastics products at such unaffordable prices.
Thereafter, when the raw material prices declined sharply, then the buyers stayed away from the market due to sharp volatility in prices and the companies faced large inventory losses.
within a span of 10 weeks, the raw material prices reached a level of between 40% to 60% of its peak level of 1st July’08. Such a vertical drop in raw material prices week after week forced the buyers to stay away from the market and plastics producers were left with heavy inventory losses.
Therefore, an investor would notice that whenever the prices fluctuate a lot, then the ability of the company to pass on the costs to its customers may not be the only factor that is at play. Sharp fluctuations in the prices affect customer behaviour as well.
The company faced a similar situation in FY2015 when once again the raw material prices fluctuated wildly. The raw material prices went up and down by 25-35% in quick succession.
FY2015 annual report, page 34:
Last year, the Company witnessed tremendous volatility in the Polymer Prices between July 14 to June 15.
PP Homopolymer prices came down from ₹109.20 per kg in July 2014 to ₹76.27 per kg by February 2015. It went up again to ₹100.77 per kg in the middle of May 2015 to come down to ₹92.77 per kg in June 2015 with a bearish trend.
Prices of PE have gone down from ₹113.92 per kg in July 2014 to ₹82.95 per kg by 1st Feb 2015 and went up to ₹103.72, by 7th May 2015. Prices have again has gone down to ₹98.72 the middle of June 2015 with a bearish trend.
Prices of PVC resin has gone down from ₹79.50 per kg during July 2014 to ₹58 per kg by middle of December 2014. Prices went up to ₹69.50 per kg by 1st June 2015 and again came down to ₹65.50 per kg during the month of June 2015 itself.
Such wild fluctuations in the prices affect the purchasing behaviour of the customers and as a result, the demand for the products go down. In FY2015, the sharp fluctuations of the prices affected the demand for plastic.
FY2015 annual report, page 34:
Thus, there was tremendous volatility in the Polymer prices during the preceding year. Such price fluctuations have affected the growth in the consumption of Plastics in country’s economy. It also has put pressure on operating profit margin.
Moreover, the company experienced that when the raw material prices go down, then the channel partners i.e. distributors, retailer etc. focus on selling their existing inventory fast and defer ordering more products from the manufacturers like Supreme Industries Ltd. This behaviour of the channel partners also affects the growth of the company when raw material prices go down.
FY2014 chairman’s speech, page 1:
There was downward revision in the prices of key raw materials consumed by the Company. Consequently, there was a trend of emptying the pipeline at the end of channel partners, which slowed the value growth in first two months.
Therefore, an investor would appreciate that even though a company may have the ability to pass on the changes in its raw material costs to its customers, still the sharp fluctuations in the prices affect it by reducing the demand from the customers and the inventory losses.
The credit rating agency, CRISIL has highlighted this aspect of the business model of Supreme Industries Ltd in its report in July 2020.
Supreme is susceptible to volatility in the prices of key raw materials, polyvinyl chloride, high-density polyethylene, and polypropylene, which are affected by change in crude oil prices and foreign exchange rates, albeit partly offset by its ability to pass on price fluctuations to the consumers. Furthermore, Supreme has to maintain large raw material (constituted 65% of the operating income in fiscal 2020) inventory, and volatility in input prices impacts working capital management.
Moreover, an investor should note that Supreme Industries Ltd is able to pass on the increase in the raw material cost to most of its customers. However, there are instances where the customers outrightly refused to accept any increase in product prices. Supreme Industries Ltd faced such a situation in its automobile business. An investor would appreciate that automobile original equipment manufacturers (OEMs) are much larger organizations than Supreme Industries Ltd and have many vendors willing to supply to them at their terms. As a result, when the raw material costs increased then the automobile OEMs did not agree to any price increase for Supreme Industries Ltd e.g. in FY2008.
FY2008 annual report, page 13:
Due to a very steep rise in prices of polymers in the last quarter of the financial year and the non acceptance of OE customers to accept any price increase, margins were under severe pressure.
In the automobile division (industrial segment), the company could increase prices only gradually over the years and that too only to a few customers every year after prolonged discussions and negotiations.
FY2012 annual report, page 11:
Company is also in discussion with its various customers for price corrections for the old continuing businesses.
Supreme Industries Ltd intimated its shareholders that it could get a price increase from the customers of industrial components (including automobile) in FY2013.
FY2013 annual report, page 13:
This year company has also managed to get price corrections from some of its customers.
In FY2014, the company could get price revisions from some more customers of the industrial component division (including automobile division). However, still, some customers were not paying the expected price to Supreme Industries Ltd.
FY2014 annual report, page 18:
During the year, Company has also managed to get price corrections from some of its customers. Efforts are on to get it from all the customers.
Therefore, an investor should not assume that Supreme Industries Ltd would always be able to pass on the increase in raw material costs to all its customers without challenges. At the end of the day every customer wishes to get its supplies at the lowest possible cost and to achieve this objective, they attempt to defer the price hike to their supplier to the extent possible.
Therefore, while understanding the business model of Supreme Industries Ltd, an investor needs to appreciate the impact fluctuating raw material prices have on its business, margins and customer behaviour.
An investor would notice that over the years, the company has focused on producing products that add a higher value to the customers and better customer loyalty. These products have a higher profit margin and further improve the company’s ability to pass on increases in input costs. Over the years, Supreme Industries Ltd has increased the share of value-added products with EBITDA (earnings before interest, tax, depreciation & amortization) margins exceeding 17%.
The share of value-added products was 29.83% of the total net turnover in FY2012 (Oct. 2013 presentation of the company, page 33), which has increased to 38.28% of total net turnover in FY2020 (May 2020 presentation of the company, page 36).
Another factor that investor need to focus on while analysing the business model of Supreme Industries Ltd is the amount of competition it faces. While reading the annual reports of the company, an investor comes across multiple instances where Supreme Industries Ltd highlighted the challenges it faced from the competition especially from the unorganised sector.
ii) Intense competition faced by Supreme Industries Ltd:
At many instances, Supreme Industries Ltd highlighted that the competition it faces is intense, which many times turns unhealthy where the competitors try every trick to take away market share. The company faces competitors that provide substandard and cheap material and even resort to supplying counterfeit products.
An investor finds the mention of intense competition in the annual reports of the company right from the oldest available annual report of the company (FY2006) on its website.
FY2006 annual report, page 11:
Several competitors of individual products have mushroomed over the last two years bringing unhealthy competition in the trade segment.
In FY2008 and FY2011, the packaging products division suffered due to intense competition from the unorganized segment.
FY2008 annual report, page 13:
Vanilla products such as EPE & Air bubble, suffered growth as competition from the unorganized sector was intense.
FY2011 annual report, page 11:
PACKAGING APPLICATION: The division is facing tough competition from the un-organized sector.
In FY2012, many new players entered the packaging films segment and the existing players increased their capacity. As a result, the business segment witnessed oversupply.
Also, all competitors expanded capacity. At the same time, several new players entered this field, rendering the business to be extremely competitive, capacity far outstripping demand.
In FY2014, more new players entered the packaging films business that already faced oversupply.
FY2014 annual report, page 19:
Few new players have entered this already overcrowded market. Oil Packaging films, which is highly competitive business; continued to be the major segment of sales of this division.
In FY2015, the increased competition in the packaging films division resulted in a price war.
FY2015 annual report, page 38:
Despite entry of new players in the market and resultant price war, Company’s regular customers continued their support to the Company.
By FY2016, the competition in the packaging business has increased to such an extent that the players started adopting unethical practices.
FY2016 annual report, page 37:
While most competitors, including several new ones, adopt unethical practices offering falsely certified products, denting the Company’s business in some of the price sensitive markets, thereby reducing its growth in those segments, your company continues to position itself to give all its products with the appropriate certification only.
FY2019, the competition in the packaging films division has increased to such an extent that the company witnessed a de-growth in this division.
FY2019 annual report, page 41:
The division has a slow-down in business owing to competitive pressure and increase in manufacturing capacity in the industry in the year under review.
Overall sale was 6703 tons as against 7454 tons in the previous year due to intense competition.
Exports were also lower at 1316 tons as against 1659 tons in the previous year. Here also the prices were under pressure due to stiff competition from Indian manufacturers.
The credit rating agency, CRISIL, in its report of April 2019, also highlighted that the decline in the operating profit margin (OPM) of Supreme Industries Ltd in FY2019 was primarily due to intense competition in the packaging business.
Operating profitability declined marginally to 13.2% due to intensifying competition in the packaging segment because of entry of new players offering lower prices.
The intense competition with unhealthy and unethical practices like sub-standard products is not limited to the packaging films division alone. The company faced such competition in the insulation division as well.
FY2015 annual report, page 39:
Competition in this range of products is now increasing and nonstandard products are being supplied by the competitors.
FY2016 annual report, page 37:
During the year, two more new manufacturers have entered in the markets, who have started diluting the quality standards of the product.
By the next year, FY2017, Supreme Industries Ltd realized that it is losing orders in the insulation division due to competition.
FY2017 annual report, page 40:
The division has lost orders in many projects due to lower price offered by competitors. New plants have come at several locations. Many of the competitors are supplying substandard products against declared tender documents and offering lower prices which are against the policy of your Company.
By FY2018, the company accepted that the business and profitability of insulation division are impacted due to competition.
FY2018 annual report, page 46:
As informed earlier, several new competitors entered the business simultaneously & dropped prices inappropriately while compromising on desired quality standards. This had severely impacted Company’s business & profitability.
Similarly, Supreme Industries Ltd faced intense competition in the cross-laminated films business.
FY2018 annual report, page 46:
Several new players have also entered this business in the country claiming to make similar products like our Company. Combination of these two factors have affected the volume & margins in this segment of business
In other divisions, like the furniture division, the competition became so severe that Supreme Industries Ltd started to make losses on some of the items.
FY2013 annual report, page 12:
The Company continues its strategy to minimize participation in commodity furniture business. Many of the commodity products were contributing negative margins.
The inability of the company to pass on the increase in raw material costs to the customers in the commodity furniture business was the key factor for losses in this segment.
FY2012 chairman’s speech, page 2:
Company is able to pass on the increased cost on all its products except commodity furniture.
The competition in the furniture division became so severe that some of the existing players shut down their business. As a result, the remaining players could expand their market share.
FY2014 annual report, page 16:
The number of all India branded players of quality Plastic Furniture has come down giving the Company more space to occupy such retail counters, fulfilling the aspirations from this segment of customers.
The competition faced by Supreme Industries Ltd is not limited to other players selling their goods cheaper. The company is facing competition from counterfeit products as well.
FY2015 annual report, page 35:
Several counterfeit products (specially in XF products and Pipe System) similar to the Company’s product are now available in the market. Company has taken several measures to address this menace.
The company decided to take legal recourse to remove counterfeit products from the market.
FY2019 annual report, page 37:
Company is also taking legal recourse to contain counterfeit products in Plastics pipe System, XF Products and Furniture. Company assiduously works to address this menace.
However, despite the efforts of the company, the problem of counterfeit products is continuing.
FY2020 annual report, page 31:
Company is quite active to seek legal remedy to contain counterfeit products in its range of products to protect consumers from getting cheated.
The impact of low priced, unbranded, substandard products from the competitors is that Supreme Industries Ltd has to develop products that are low priced and at times, the company had to dilute the quality of the product as well. E.g. in FY2013, the company produced lower grades for its construction division.
FY2013 annual report, page 15:
The division also introduced economical grades for those customers whose specification requirements are lower than our existing products.
In FY2015, when Supreme Industries Ltd started losing market share in the insulation division, then it introduced cheaper products for the customers to regain market share.
FY2015 annual report, page 39:
The division has worked to reduce product cost by manufacturing lighter materials while maintaining the properties as per specifications. The product is now ready and is being offered at competitive prices to counter the competition in the market. This will help the Company to regain some lost markets.
In FY2020, the company intimated the shareholders that it has produced low-priced products for the civil business division.
FY2020 annual report, page 36:
The Company’s technical team has developed low cost products to match the lower end product of competitors, with better properties.
Many times, the low-end products have worked for the company. However, at times, low-end products developed by the company did not get acceptance from the market year after year. For example, when Supreme Industries Ltd faced competition in the cross-laminated film business, then it developed a thinner film to reduce the cost and gain market share from the competitors. However, the market did not accept the thinner film, which was 35 GSM against the usual product of the company that used to be from 70-300 GSM.
In FY2014, the company could sell only 275 tons of 35-GSM film against its expectations of 3,000 tons as the customers were apprehensive of the quality of the film.
FY2014 Chairman’s speech, page 2:
The company expected 3000 Tons of business from its 35 GSM film in the previous year. However, it could sell only 275 tons in the year. Due to thinness of the film, the business did not take off at expected level as consumers were cautious about the durability of the product.
In FY2015, the company told the shareholders that the 35-GSM film is not doing well.
FY2015 annual report, page 40:
The 35GSM Silpoly Liner, which was introduced by the Company two years back, did not make much headway.
The situation did not change much even in FY2016.
FY2016 annual report, page 38:
The 35GSM Silpoly Liner has not made much progress since its introduction in the Indian market three years back. Though the 35GSM Silpoly Liner has not performed as expected, nevertheless, it has a bright future. The Company is trying hard to popularize this multiutility product through its dealer/ distributor network
As the market did not accept the thin cross-laminated film in the functions expected by the company, it tried to reposition the film as “mulching film” in FY2017.
FY2017 annual report, page 40-41:
The Company is planning to promote 35GSM in black color as Mulching film. Mulch film used to suppress weeds and conserve water in crop production are in good demand throughout the Country. There are newer applications being developed from 35GSM film which may reverse de-growth trend in the current year.
Therefore, an investor would appreciate that whenever a company tries to lower down the quality specifications of its products to match the price of the competition, then success is not guaranteed and at times, it may take many years for the customers to accept the low-end product from the company, if at all.
Therefore, an investor would appreciate that even though at the face, it may seem that Supreme Industries Ltd has grown its sales consistently for almost all of last 10 years (FY2011-2020) and has maintained a consistent profit margin, she should not assume that it has come without facing intense competition.
As per the company, it has decided to avoid competing in the segments that have a lot of competition from imports. The company also intends to avoid competing in segments where there is a heavy presence of the unorganized sector.
FY2011 annual report, page 8:
Your Company has selected its product portfolio in such a manner that it does not have to compete against imported plastics products.
The Company also avoids to remain in a line where it has to compete against unorganized sector. In certain products where the Company is making such products, the effort remains to have lower percentage of such business, within the overall turnover of that products, just to supply complete range to its distributors.
The strategy of the company to differentiate itself from the competition and the challenges that such a strategy brings has been highlighted by the credit rating agency, CRISIL, in its report for Supreme Industries Ltd in January 2014.
on account of the highly fragmented nature of the plastics industry with a sizeable unorganised segment, competitive intensity is very high especially in the commoditised products segment. This segment is highly price sensitive, which prevents timely passing on of any increase in input costs.
Supreme has historically sought to mitigate these competitive pressures by periodically introducing new products with a higher margin and discontinuing products that have become commoditised. However, this strategy translates into higher capex requirements. CRISIL therefore believes that the company’s ability to maintain a balance between managing margins and capex levels will be a key determinant of its business risk profile.
An investor would appreciate that any new product introduced in any industry will be commoditized after some time. As a result, to stay ahead of the competition, the companies need to continuously innovate or keep finding new products to supply to the market. Such steps need continuous investments. Therefore, it should not come as a surprise to the investor that Supreme Industries Ltd has been doing capital expenditure continuously over the years. The capital expenditure phase/cycle for the company does not seem to end.
From the above discussion about various factors influencing the business of Supreme Industries Ltd, an investor would notice that the company can pass on the increase in its raw material costs to most of its investors within a gap of a few weeks. However, for some of the large institutional customers, the price increase may be delayed. The ability to pass on the increased prices to its customers have helped the company maintain stable profit margins.
Nevertheless, the company faces intense competition in many of its business divisions. At times, the competition has led to a situation of oversupply in the market, leading to price wars and unethical practices of supplying substandard products. Supreme Industries Ltd has responded to such challenges by developing low-cost products with lower standards to meet the requirements of cost-conscious customers.
On its part, Supreme Industries Ltd has decided to avoid hypercompetitive segments where there is a lot of competition from imported products and the unorganized sector. This is because, in the low-tech commoditized products business, the company has faced negative profit margins. However, to continuously focus on high-tech advanced products, the company needs to keep doing large investments. As a result, an investor would notice that Supreme Industries Ltd has been investing large sums of money year after year.
Supreme Industries Ltd also faces threat from counterfeits for its products in the market. The company has taken legal steps to control counterfeit products. However, despite prolonged time, the fight against the counterfeit products is continuing.
Going ahead, an investor should keep a close watch on the increasing competition in the market segments of the company and the trend of its profit margins so that she may monitor the competitive standing of Supreme Industries Ltd in the business.
While looking at the tax payout ratio of Supreme Industries Ltd., an investor notices that in the last 10 years (FY2011-2020), the tax payout ratio of the company has been in line with the standard corporate tax rate prevalent in India. In FY2020, the tax payout of the company is lower at 27% due to the reduction in the standard corporate tax rate in India.
Further advised reading: How to do Financial Analysis of a Company
Operating Efficiency Analysis of Supreme Industries Ltd:
a) Net fixed asset turnover (NFAT) of Supreme Industries Ltd:
When an investor analyses the net fixed asset turnover (NFAT) of Supreme Industries Ltd in the past years (FY2011-20), then she notices that the NFAT of the company has been consistently in the range of 3.5-4.0. The NFAT was low at 2.7 in FY2016 because, as discussed above, the sales data in the year included the financial performance of 9 months from July 2015 to March 2016.
A consistent NFAT indicates that Supreme Industries Ltd has maintained the efficiency of utilization of its assets.
Moreover, when an investor reads the annual reports of the company, then she notices that in most of the instances, the company initiated capacity expansion when the existing capacity of the plant was fully utilized.
For examples in FY2008, the company decided to increase the manufacturing capacity of cross-laminated films when the existing capacity was fully used and it was losing additional business.
FY2008 annual report, page 13-14:
However, demand for the product outpaced the supply and the orders to the tune of Rs. 14 crores have been carried forward to the next year. Export increased to 1392 tons against 1072 tons of the previous year. The volume in export was restricted due to non-availability of the product.
Encouraged by the overwhelming demand for the product and to increase market share, the Company has decided to further increase the installed capacity by 4000 MT with capital outlay of Rs.25 Crores.
In FY2018, the company decided to increase the capacity of its Chennai plant when the existing plant was running at the full utilization levels and the company could not accept new business opportunities due to the inability to produce more goods.
FY2018 annual report, page 44:
Business opportunities are encouraging for Chennai Plant. Plant registered growth of only 4% as company couldn’t grab the business opportunities due to capacity constraints in the plant. Currently plant is running at its optimum capacity. Company is now in the process of acquiring land adjacent to its existing facility, which will be used for expanding the plant.
In addition, an investor notices that whenever the company put up an expansion project, then it tried to consolidate its nearby operations to a single plant so that it could derive efficiencies in the material movement etc.
In FY2006, when Supreme Industries Ltd made plans to make a large manufacturing complex in Gadegaon, which is about 15 km away from Jalgaon, where it had an existing plant, then it decided to shift the existing plant also to the new site at Gadegaon for better efficiencies.
FY2006 annual report, page 10:
The company has acquired 100 acres of land at Gadegaon, which is 15 km away from Jalgaon. The company is planning to create world-class production facility at this new site and intends to invest Rs.50 crores in the current year. The present manufacturing facilities at Jalgaon Unit are expected to be shifted to new site by August’2007.
In FY2009, when the company created additional capacity in Halol, Gujarat, for cross-laminated films, then in the light of new capacity, it closed down the existing manufacturing unit in Pondicherry.
The increased installed capacity of 17000 tons has become fully operational from June 2009. The Company also purchased a plot of land admeasuring 3280Sq. mtrs; along with structure adjacent to the plant at Halol. This structure after some modifications will be used for building additional fabrication capacity to match the increased installed capacity. With additional fabrication capacity available at Halol, the Company has decided to close down the fabrication site at Pondicherry.
Further, in FY2019, when the company expanded the capacity of its plant in Hosur, then it aggregated the operations of the old plant and the new plant in the new building to have better efficiencies and in turn, it sold the premises of the old plant.
FY2019 annual report, page 41:
The Two units at Hosur were merged into a single unit. This unit now has a total built up area of over 350000 sq ft. The modern layout ensures a smooth flow of material ensuring movement efficiencies. The vacated premise of Unit 1 has been sold.
An investor would appreciate that such steps by the company indicate that it focuses on the efficient utilization of its assets. As a result, it does not come as a surprise to the investor when she notices that the NFAT of the company has been stable during the last 10 years (FY2011-FY2020).
Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors
b) Inventory turnover ratio of Supreme Industries Ltd:
While analysing the efficiency of inventory utilization by Supreme Industries Ltd, an investor notices that the inventory turnover ratio (ITR) of the company has declined over the last decade from 8.9 in FY2012 to 6.7 in FY2020.
A decline in the inventory turnover ratio highlights that the operations of the company have become more working capital intensive.
While assessing the inventory turnover, an investor may also note that in the initial years of the previous decade, Supreme Industries Ltd had classified a significant portion of the commercial real estate building (Supreme Chambers), which was unsold, in the inventory. Gradually, over the years, as the area in the Supreme Chambers was sold, it was removed from the inventory. In FY2020, the entire area in the Supreme Chambers was sold and it was completely removed from the inventory.
The impact of the addition of the unsold real estate area in the inventory tends to bring down the inventory turnover ratio (ITR). An investor notices that in the initial part of the decade, the inventory had a large part of real estate (₹109 cr in FY2011 and ₹98 cr in FY2012), whereas in FY2020 when the real estate inventory was nil. The reported ITR was higher i.e. 8.9 in FY2012 whereas, then the reported ITR was lower at 6.7 in FY2020. Therefore, an investor may observe that if she excludes the real estate inventory, then the decline in the ITR representing only the plastic business, would be even higher.
The credit rating agency, CRISIL has also highlighted in its report in February 2017 that Supreme Industries Ltd has to maintain a large amount of inventory of its products.
Furthermore, Supreme also has to maintain large raw material inventory (raw materials constitute around 63% of operating income as of December 2016); hence, volatility in input prices also impacts working capital intensity.
Advised reading: Inventory Turnover Ratio: A Complete Guide
c) Analysis of receivables days of Supreme Industries Ltd:
While analysing the receivables position of the company, an investor notices that the receivables days of Supreme Industries Ltd have consistently been in the narrow range of 20-24 days. In FY2016, the company reported receivables days of 29; however, it was because the company reported only 9-months of sales in FY2016.
Stable receivables days over the period indicate that Supreme Industries Ltd has been able to collect money from its customers in time.
Further Advised Reading: Receivable Days: A Complete Guide
An investor gets the same observation when she compares the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of Supreme Industries Ltd for FY2011-20. She notices that the company has collected all the profits as cash flow from operating activities.
Over FY2011-20, Supreme Industries Ltd reported a total cumulative net profit after tax (cPAT) of ₹3,333 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹4,258 cr. (Please note that for this calculation, we have adjusted the CFO of the company for FY2011 by adding back the interest expense, which is otherwise deducted by the company from CFO. It is discussed in detail below in the article).
It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT. In addition, the investors would also understand the situations when the companies would have their CFO higher than the PAT.
Further advised reading: Understanding Cash Flow from Operations (CFO)
Learning from the article on CFO will indicate to an investor that the cCFO of Supreme Industries Ltd is higher than the cPAT due to following factors:
- Interest expense of ₹428 cr (a non-operating expense) over FY2011-FY2020, which is deducted while calculating PAT but is added back while calculating CFO.
- Depreciation expense of ₹1,272 cr (a non-cash expense) over FY2011-FY2020, which is deducted while calculating PAT but is added back while calculating CFO.
The Margin of Safety in the Business of Supreme Industries Ltd:
a) Self-Sustainable Growth Rate (SSGR):
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.
An investor may calculate the SSGR using the following formula:
SSGR = NFAT * NPM * (1-DPR) – Dep
- 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)
While analysing the SSGR of Supreme Industries Ltd, an investor would notice that the company has consistently had an SSGR of 7-8% over the years, which is almost similar to the sales growth achieved by the company over the last decade (FY2011-FY2020).
In light of the same, an investor notices that Supreme Industries Ltd has been able to achieve its growth without the need for any additional debt or equity dilution.
Over the last 10 years, the company has reduced its debt by ₹73 cr from ₹514 cr in FY2011 to ₹441 cr in FY2020.
An investor gets similar observations when she analyses the free cash flow position of Supreme Industries Ltd.
b) Free Cash Flow (FCF) Analysis of Supreme Industries Ltd:
While looking at the cash flow performance of Supreme Industries Ltd, an investor notices that during FY2011-2020, it generated cash flow from operations of ₹4,258 cr. However, during the same period, it did a capital expenditure of about ₹2,143 cr.
Therefore, during this period (FY2011-2020), Supreme Industries Ltd had a free cash flow (FCF) of ₹2,115 cr (=4,258 – 2,143).
In addition, during this period, the company had a non-operating income of ₹191 cr and an interest expense of ₹428 cr. As a result, the company total free surplus cash of ₹1,878 cr (=2,115 + 191 – 428). Please note that the capitalized interest is already factored in as a part of capex deducted earlier.
An investor notices that the company has used the surplus cash of ₹1,878 cr over FY2011-2020, in the following manner:
- Paid dividends excluding dividend distribution tax of about ₹1,223 cr during FY2011-2020. On this, the company would have paid about 20% (about ₹245 cr as the dividend distribution tax).
- The remaining amount seems to be present with the company as an increase in cash & investments of about ₹333 cr over FY2011-2020. The cash & investments balance of Supreme Industries Ltd increased from ₹106 cr in FY2011 to ₹439 cr in FY2020.
Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF
Self-Sustainable Growth Rate (SSGR) and free cash flow (FCF) are 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 Supreme Industries Ltd:
On analysing Supreme Industries Ltd and after reading its publicly available past annual reports since FY2006 and other public documents, an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.
1) Management Succession of Supreme Industries Ltd:
The company was established by the Modi family in 1942. In 1966, the Taparia family took over the company. Since then, the Taparia family is in the control of the company.
Currently, four members of the Taparia family are present on the board of directors of the company.
- Mr B. L. Taparia (age 86 years), Non-executive Chairman,
- Mr M. P. Taparia (age 83 years, brother of Mr B. L. Taparia), Managing Director,
- Mr S. J. Taparia (age 75 years, nephew of Shri B. L. Taparia and Shri M. P. Taparia), Executive Director
- Mr V. K. Taparia (age 65 years, son of Mr B. L. Taparia), Executive Director
An investor would notice that almost all the members of the Taparia family who are currently the part of the board of directors are above 65 years of age. As per the FY2020 annual report, page 105, Mr Vivek Taparia who is also part of the promoter family is working as the business development manager in the company.
Mr. Vivek Taparia, Business Development Manager (Relative of Director)
As per the Wall Street Journal, another person, Mr Viren Vivek Taparia having the age of 40 years is working as Senior Manager-Business Development at Supreme Industries Ltd (Source). However, we are not able to find any mention of Mr Viren Vivek Taparia in the annual reports of the company as a part of the management of the company. His name is present in the FY2020 annual report, page 22, as one of the promoter-shareholders of the company holding a 0.16% stake in the company.
It is advised that an investor may contact the company directly to understand the management and ownership succession planning of the company.
Further advised reading: Steps to Assess Management Quality before Buying Stocks
2) Strategy of Supreme Industries Ltd to close down units that do not make economic sense:
While analysing the annual reports of the company, an investor comes across many instances where Supreme Industries Ltd closed down its business units when did not perform satisfactorily. Such a strategy frees up resources to be used more efficiently in other business segments.
In FY2007, the company decided to shut down some of the business units where it was not performing well like the rigid PVC film and food service-ware (FSW) division.
FY2007 annual report, page 9:
The company has also decided to quit from those segments where their product range is not differentiated, viz. Rigid PVC film at Malanpur and FSW division at Daman.
In addition, the company highlighted that it is planning to sell other units as well where it is not making an adequate return.
FY2007 annual report, page 9:
The Company is also exploring the possibility of disposing off some other unit, which is not giving adequate return.
In FY2011, the company closed down its mats unit when its performance was not satisfactory.
FY2011 annual report, page 10:
Exports of Mats continue to be weak. Profit has also been severely affected on account of volatility of raw material prices and foreign exchange. The business volume is hovering under ₹15 crores annually in each of the last three years. In relation to the Company’s business, it is insignificant. The Company has, therefore, taken a decision to close this business….The written down value of the plant and machinery is under ₹50 lakhs. The Company would be able to sell the equipments at a higher price.
In FY2013, the company decided to shut down its division of trading of furniture as it was not deriving any meaningful value from the same.
FY2013 annual report, page 12:
The business of traded items has gone down from ₹10 crores to ₹3 crores. The Company has decided to discontinue this business.
In addition to the closing down of non-performing business divisions, as discussed above, Supreme Industries Ltd combined its manufacturing units at a single place to get better efficiencies and then sold off the spare assets to use its resources efficiently.
Such corporate decisions help any company in freeing up the resources to put into better use.
3) Project execution ability of Supreme Industries Ltd:
While assessing the business performance of the company over the years, an investor notices that Supreme Industries Ltd has continuously made investments in new manufacturing plants over the years. The number of plants has increased from 17 as per FY2006 annual report, page 1, to 25 as per FY2020 annual report, page 1.
The evidence of the regular addition of new manufacturing plants indicates that the project execution of the company is satisfactory.
However, it is not to assume that the company has not faced any hurdles in executing projects over the years. When an investor reads the annual reports of the company, then she notices that the company has faced challenges in the terms of getting land allotment etc.
In FY2012, the company abandoned its plans to establish a furniture manufacturing plant in Andhra Pradesh when it could not get the land registered in its name.
FY2012 annual report, page 10:
There has been a delay in getting the plot registered in the Company’s name at Andhra Pradesh even after allotment and making full payment to APIIC at Ongole Growth centre. This was due to their internal technical reasons with court. The Company has, therefore, abandoned the Andhra Project for Furniture manufacturing as of now.
Further advised reading: Steps to Assess Management Quality before Buying Stocks
4) Issues related to environmental/pollution control regulations faced by Supreme Industries Ltd:
While reading the historical performance of the company, an investor notices that at times, Supreme Industries Ltd faced problems in meeting the environmental and pollution control norms. As a result, either the company had to shift the plant to another location or it had to shut down the plant for some time.
The manufacturing plant of Supreme Industries Ltd at Urse, Maharashtra faced such problems many times.
In FY2008, the Urse plant did not receive the environmental approvals and as a result, the company had to shift this plant from Maharashtra to Madhya Pradesh to start production of the insulation material.
FY2008 annual report, page 13:
As certain environmental clearances were not received for our Urse plant, extruded cross linked foam could not be started on schedule. Due to further expected delay the division shifted this plant from Urse to Malanpur & commenced production by March 08.
The company got these approvals only after almost two years in FY2010 and the Urse plant could commence production of insulation material.
FY2010 annual report, page 15:
The revision of the pollution guidelines by the Government of Maharashtra has enabled to start the Urse plant, which was held up due to the pollution clearance. The commercial production of the unit has commenced from Sept. 2009 onward.
However, in FY2019, the pollution norms in the state of Maharashtra changed and the Urse plant had to shut down production once again.
FY2019 annual report, page 41:
Due to introduction of new pollution control norms in Maharashtra, production of Air bubble film line and lower thickness foam was stopped at Urse for two months, which has affected the business of west zone to some extent.
In light of the above information, it is advised that an investor should do deeper due diligence about the impact of plastic processing on the environment. This is because any adverse development on this front can make a plant non-functional overnight.
Investors would remember the incidence of Sterlite Copper Ltd.’s plant in Thoothukudi (Tuticorin), Tamil Nadu, which was closed by the govt. in May 2018 due to pollution-related concerns. This plant was functioning at the location since the early 1990s.
Therefore, it is advised that investors should do their due diligence in this regard.
5) Time taken to develop new products:
While reading about the business of the company, an investor notices that for many products, Supreme Industries Ltd and its collaborators have taken significant time to develop and perfect the technology of the products.
5.i) Composite LPG cylinders:
In one such incidence, an investor notices that it has taken the company about 10 years to experiment with the composite cylinders; however, still, the product has not picked up meaningfully. Investors notice that after many years of establishment, the product still faced quality deficiencies.
The first time, in FY2010, Supreme Industries Ltd mentioned its plans to manufacture domestic LPG composite cylinders.
FY2010 chairman’s speech, page 2:
This investment will include a sum of ₹50 crores allocated for the manufacture of domestic LPG composite cylinders. This product is a new product for the Country. Government of India has announced their decision to introduce usage of light weight explosion proof composite LPG cylinders… This project is coming in Western India and expected to start operation by October 2011. Initial capacity will be around 350,000 cylinders per year.
The company expected that it would start production of cylinders by Oct. 2011. However, the project was delayed and the company pushed the expected time for the production of cylinders to March 2013.
FY2012 annual report, page 14:
Company has committed to invest ₹70 Crores for production capacity of 5 lacs cylinders per annum. Equipments are expected to reach the plant site at Halol (Gujarat) by first week of Dec’2012. Trial runs are likely to commence from first week of Jan’2013 and Company hopes to commence production before end of March’2013.
In FY2015, Supreme Industries Ltd intimated the shareholders that the cylinder plant is ready but it is lying idle.
FY2015 chairman’s speech, page 3:
Company sees good prospects for its Composite LPG Cylinder business, which currently has the capacity to produce 4 lakh cylinders per annum. This capacity is currently lying idle.
The plant for manufacturing composite cylinders stayed under-utilized for such a long time that in FY2018, the auditor of the company also highlighted it in its report.
FY2018 annual report, page 69:
Without qualifying, we draw attention regarding the under utilization of capacity of the Company’s composite cylinder unit situated at Halol (Gujarat)
Finally, the company could get some exports order from South Korea and Bangladesh and a small trial order from HPCL. However, in FY2018, about 8 years after the initial plans of making cylinders, an investor gets to know that the cylinders are facing quality issues.
Supreme Industries Ltd intimated the shareholders in FY2018 annual report that the clients found some issues in the cylinders; however, the same has been resolved and the company expects repeat orders.
FY2018 annual report, page 47:
There were some minor technical issues on the cylinders supplied by the Company to Korea and Bangladesh. All those issues have been resolved and clients have started discussions for repeat orders.
However, the next year, in FY2019, the company intimated that the buyer in Bangladesh is not happy with the cylinders and in fact, the company expects that it would have to make additional compensations.
FY2019 chairman’s speech, page 3:
Supplies of Cylinders to Bangladesh customer received certain complaints arisen due to non- conformity of some bought out components. Till now Company’s efforts to rectify the same has not been fully acceptable to the customer. Efforts are on but likely to have more rejection/ replacement of goods than anticipated earlier.
In the conference call of the company in May 2020, Supreme Industries Ltd intimated the analysts that it had to pay a penalty of ₹12 cr to settle for the deficiencies in the quality of the cylinders supplied by it in Bangladesh.
you see the last year — ’18/’19, we supplied the material, which met with some technical problems. We had to compensate heavily for that and about INR 12 crores of compensation we provided back to the party.
In FY2020 annual report, the company intimated the shareholders that now the issues related to the cylinders are settled and they have perfected the design for the cylinders.
An investor would note that in its entirety, it took about 10 years for Supreme Industries Ltd to perfect the technology/design of the cylinders since it started its plans in FY2010 for the first time. This was even though Supreme Industries Ltd had taken the already developed technology from Kautex GMBH (Oct. 2013 presentation of Supreme Industries Ltd, page 19).
5.ii) Cross Plastic Film:
While assessing the annual reports of the company, an investor notices that in the case of another product, cross plastic film, the collaborators of the company has taken more than 10 years to perfect the technology.
For the first time, in FY2009, Supreme Industries Ltd intimated its shareholders that its collaborators are developing cross plastic film and the company has taken exclusive rights to produce and sell the same in identified geographies. The agreement with the collaborator mentioned about license income to Supreme Industries Ltd until December 2019.
FY2009 annual report, page 15:
The Company’s collaborators are in the advanced stage of developing Cross Plastic film, which has superior properties & wide newer applications. As per the agreement entered into by the Company, the Company enjoys an exclusive right to produce the same in India & SAARC Countries & export to all countries in the world except Portugal, Spain & Switzerland….Thereafter the Company will get 10% share in licence income upto 31st December 2019.
However, it was only after five years, in FY2014, that two of the other licensees of the collaborator started the production. However, the product still had the problems, which the company said that have been resolved.
FY2014 annual report, page 20:
The production of Cross Plastic Film has been started by two licensees of Company’s collaborator. The problem of shrinkage of film faced by these licensees have been overcome by the collaborator. They claim to have perfected the technology.
However, even after four more years, in FY2018, the collaborator was still working on developing the technology of the cross plastic film. Supreme Industries Ltd mentioned that it would put up a manufacturing plant after the technology becomes perfect.
FY2018 annual report, page 46
The technical collaborator of the company is working in tandem with the prospective customers of Cross Plastic Film to perfect the product in all respects. Once the product is perfected the company will be putting up plant to manufacture this product at its Muvala plant.
However, even at the end of FY2020, which is beyond the expiry of the originally envisaged license ending period of December 2019 as per FY2009 report, the work on the production plant is yet to commence.
FY2020 annual report, page 38:
The drawings of various equipment to put up Cross Plastic Film project at Get Muvala are under preparation in Romania and Switzerland. Due to Covid-19 lockdown the process is taking more time to finalise the drawings. The Company will move expeditiously after working drawings are frozen to put up the Plant.
Therefore, an investor would appreciate that in the case of Cross-Plastic Film, Supreme Industries Ltd started planning of production and sales in FY2009, which was much in advance of the perfection of technology of the product. The plant is yet to see the light of the day in FY2021.
While reading the annual reports of Supreme Industries Ltd, an investor notices that the company first developed the manhole product in FY2009.
FY2009 annual report, page 11:
The Company has also developed 1000 mm dia Inspection Chamber / Manhole, which is under final stage of testing. The Company expects to launch this product immediately after the monsoon is over.
However, upon reading the subsequent annual reports, an investor notices that the product was still under trials after 5-years, in FY2014.
FY2014 annual report, page 15:
The Company’s 1000 mm and 1200 mm dia Manhole products are installed at many places by various Municipal Corporations. They are under observation to evaluate the performance before the products are finally approved for installation under various schemes.
Therefore, an investor notices that in the case of manholes, the product took about 5-years and it was still under testing stage by the municipal corporations.
Similarly, in the case of composite LPG cylinders, Supreme Industries Ltd planned the plant in FY2010 whereas the company could perfect the quality/technology only in FY2020. In the case of Cross-Plastic Film, it started planning of production and sales in FY2009 whereas the plant is yet to see the light of the day in FY2021.
Therefore, an investor should note that whenever Supreme Industries Ltd or any other company in the plastics processing business mentions about any new product or new technology, then she should not go overboard with optimism. She should not start making projections of future profits and resultant gains for the shareholders. This is because, as seen in the above-discussed examples of composite LPG cylinders and cross plastic films, the actual acceptable product quality and meaningful sales may be more than a decade away.
Such kind of delay in the predictions by the management is not limited to the development of the plastic products. In the case of commercial building “Supreme Chambers” developed by the company in Mumbai, an investor notices that the sales of the building were highly delayed than the management estimates.
The company started the construction of the commercial building in FY2008 with an estimate to complete it by June 2009.
FY2008 annual report, page 6-7:
The construction of Commercial Complex at Corporate site is progressing smoothly. The P.T. slab of 4 th floor has been completed and Casting of slab of 5 th floor is in progress. The entire Complex is likely to be fully completed in April/June, 2009 quarter.
The company intimated its shareholders in the FY2010 annual report that the building, Supreme Chambers, is ready for occupation.
FY2010 annual report, page 16:
The swanky commercial complex “Supreme Chambers”, a Green Corporate Park, built by the Company is now ready for occupation.
In the next year, FY2011, the company estimated that it would sell the entire area in Supreme Chambers by June 2012.
FY2011 chairman’s speech, page 3:
Several serious enquiries are at discussion stage. The Company expects to sell remaining planned sale area by 30th June 2012.
However, Supreme Industries Ltd could sell its planned sale area completely only by FY2020, which is a delay of 8 years.
FY2020 annual report, page 38:
Consequent to the above sale, Inventory of the Commercial Premises has become NIL.
Therefore, an investor would notice that the company started the construction of the commercial building in FY2008 with an estimated completion time by FY2009. The construction was completed in FY2010 and the company estimated to sell all the area by FY2012. However, the company could sell the area only by FY2020.
Therefore, an investor would appreciate that whenever she comes across any claim by the management about expected turnout of events, then she should always take such claims with a pinch of salt. She should do her due diligence and arrive at her estimates before making any projections for future profits etc. This is because, many times, the actual turnout of the event takes much more time than what the management originally promises the shareholders.
6) Key risks faced by Supreme Industries Ltd:
While analysing the business of the company, an investor comes across various aspects of the company that represent key risks in its business.
6.i) Sourcing of CPVC resins for a single supplier:
One such risk is the sourcing of chlorinated polyvinyl chloride (CPVC) resin by Supreme Industries Ltd from a single supplier. CPVC resin is the key raw material to manufacture plastic pipes that constituted 63% of the overall sales of the company in FY2020 (FY2020 annual report, page 30).
As per the company, India has a lesser supply of CPVC resin than the demand. As a result, the company has to rely on imports to meet its CPVC resin requirements.
The situation of domestic shortage in CPVC resin is continuing for more than a decade since FY2010.
FY2010 annual report, page 10:
There has been addition to the resin production capacity of Chemplast Sanmar Ltd. taking total local production capacity to 1.2 million tons. However, the demand during the year 2009-2010 has reached 1.8 million tons, thus creating large dependence on imports.
FY2012 annual report, page 8:
There has been no addition to the capacity of local PVC resin producers. It clearly indicates that growth in this business may depend largely on the Imports.
The CPVC resin shortage has continued. In FY2018, the company intimated that the CPVC resin prices have increased, as there has not been any new manufacturing capacity for the resins.
FY2018 annual report, page 40:
Due to hardening of Polymer Prices and lack of new capacity build up of the PVC resin all around the world, the PVC prices have moved to higher band.
In light of the above discussion, an investor notices that the situation of CPVC resin in the world is of short supply. As a result, the manufacturers of plastic pipes face challenges to source CPVC resin to meet their requirements.
Further, an investor notices that Supreme Industries Ltd sources its CPVC requirements from a single company, Kaneka Corporation, Japan.
Conference Call, January 2020:
M. P. Taparia: We believe all the suppliers must have increased the price to their customer. We are buying only from one company, Kaneka.
In light of the above discussion, an investor would appreciate that Supreme Industries Ltd is dependent on a single supplier, Kaneka Corporation for the entire supply of CPVC resin, which in turn is the key raw material to manufacture plastic pipes that makeup 63% of sales of the company.
An investor would appreciate that a supplier can face any issue. Its production may shut down, or India-Japan diplomatic relationships may deteriorate, or Indian relationship may deteriorate with any other country that can influence Japan’s policies, or any fraud may appear in Kaneka, or any of the other numerous things can go wrong. If any such untoward event happens, then the plastic pipes division of Supreme Industries Ltd would be in a very precarious position.
An investor would remember that in the last 6 months, almost entire Indian pharmaceutical industry faced a sudden and severe shortage of their key raw material, active pharmaceutical ingredient (API) when diplomatic relationships of Indian and China deteriorated. (Source: India’s dependence on China for APIs exposes vulnerabilities in pharma: Jairam Ramesh)
An investor would notice that CPVC resin in the world is already in a short supply. In such a situation, to develop a new resin supplier for a large quantity would be highly challenging.
Therefore, an investor would appreciate that dependence of Supreme Industries Ltd on a single source for the raw material that is most critical for its business, is a key risk.
Going ahead, an investor should monitor the dependence of the company on Kaneka Corporation for CPVC resins. She should closely monitor whether the company is able to diversify its sources of CPVC resins.
6.ii) Competence of technology partners/collaborators:
Another aspect that an investor should be aware of is the competence of its technological partners/collaborators and the company’s relationship with them.
An investor would note that Supreme Industries Ltd licenses technology from its foreign collaborators. Thereafter, the company manufactures and sells the products in India and overseas. In such a business model, the company depends a lot on its foreign collaborators to develop the technology and then create a working manufacturing plant that produces the goods that meet the required standards.
From the above discussion, an investor would note that one collaborator of the company took almost 10 years to perfect the technology for cross-plastic films. Supreme Industries Ltd is yet to install the manufacturing plant of the same even after 10-years of its first planning in FY2010.
However, on another occasion, the company faced a situation where one of the collaborators could not provide a manufacturing plant that could produce composite pipes meeting required standards. The company invested in the manufacturing plant; however, as the composite pipes were not of good quality, the plant remained unutilized. It led to a dispute between Supreme Industries Ltd and its collaborator, which could not be resolved. Finally, the company had to write-off the money invested in the composite pipes manufacturing plant.
In FY2013, the company intimated the shareholders that the composite pipes plant is ready; however, there are some disputes with the collaborators.
FY2013 annual report, page 17:
Installation of Company’s small size plant was completed in the month of Feb’2013. Company encountered some technical problems during trial run, which has led to some difference of opinion with its technology provider M/s. NBL Corporation of Japan.
Even after 3-years of negotiations, the differences with the technical collaborator did not resolve and the company had to write-off the money invested in the manufacturing plant.
FY2016 annual report, page 7:
However, technical collaborator of the project could not enable the company to produce the specified product. As of now, management has decided to abandon the project and write-off the incurred cost of the project amounting to ₹768.90 lacs and the same has been shown as exceptional item during the year.
Therefore, an investor should be cautious with the foreign technical collaborations and do her deeper due diligence. She should not start projecting the potential profits the moment any company announces any technical tie-up with a foreign collaborator. She should keep in mind that the technology under consideration may be at an initial stage and may take even a decade to convert to a good working product and that at times, the product may never see the light of the day.
7) Regulatory challenges in launching new products:
An investor notices that Supreme Industries Ltd is facing numerous hurdles in selling its CPVC fire sprinkler system in the country.
The company planned to launch this system under the name “Supreme Flame Guard” in FY2016.
FY2016 annual report, page 34:
The Company has tied up with Spears Manufacturing Company; Los Angles. The Company started the manufacture of pipes from the imported compound from Spears. The fittings and the required solvent cement will be imported from Spears. The Company is authorized to use “FLAME GUARD” brand on its CPVC fire sprinkler system.
However, soon thereafter, in FY2017, the company realized that it faces huge regulatory hurdles in launching the CPVC fire sprinkler system.
FY2017 annual report, page 36:
In spite of all the advantages of CPVC Fire Sprinkler System over the conventional metal system, many regulatory hurdles need to overcome.
The FY2018 annual report gives an idea of the extent of regulatory challenges that a company needs to cross to launch the fire sprinkler system. It needed to get approval from every state govt. and then Fire Officers of every municipal corporation. This was despite the product already approved by Bureau of Indian Standards (BIS).
FY2018 annual report, page 42:
Although Company’s CPVC Fire Sprinkler System is approved by Bureau of Indian Standard (BIS) and is also Underwriters Laboratories (UL) listed, still the Company needs product approval to install in Residential /Commercial Buildings. There is no single authority to approve the product and every State Government has their own rules and regulations to be followed in their States. Certain states got Central Authority called “Director Fire Services” and the approval is acceptable to all the Fire Officers and Fire stations within their States. But in certain States the Company has to seek approval from every Chief Fire Officer of a city, which has status of Municipal Corporation. Seeking approval is a time consuming process.
In FY2020, after 4 years of licensing the technology from Spears and spending resources to get regulatory approvals, the company could get permission only from four states: Maharashtra, Gujarat, Karnataka and Uttar Pradesh; however, it still needs to take approvals from individual municipal corporations.
FY2020 annual report, page 32:
At present, the Company has approvals from Maharashtra, Gujarat, Karnataka and Uttar Pradesh fire departments. Apart from approvals from the regional heads, the Company is required to take the approvals from the individual Municipal Corporations.
Therefore, an investor would appreciate that in certain business segments, the regulatory approvals form a big challenge for Supreme Industries Ltd and an investor should keep a close watch on developments related to the regulatory approvals.
8) Non-conventional accounting policies followed by Supreme Industries Ltd:
While going through the annual reports of the company, an investor notices that the treatment of certain items by Supreme Industries Ltd in its cash flow statement did not conform to normal expectations of the investors.
8.i) Interest expense as outflow under cash flow from operations (CFO):
The first such incidence relates to the treatment of interest expense in the cash flow statement.
In the general practice, companies add the interest expense while calculating the cash flow from operations (CFO) and then show it as an outflow under cash flow from financing activities (CFF). This is to ensure that the interest related outflows are classified under the financing activities.
However, while reading the annual reports, an investor notices that until FY2012, Supreme Industries Ltd classified interest expense as an outflow under CFO instead of CFF.
FY2011 annual report, page 60:
While analysing Supreme Industries Ltd, we have added back the interest expense for FY2011 to the CFO for doing our calculations of cumulative CFO (cCFO) and free cash flow. For FY2012, even though in the FY2012 annual report, the company had deducted interest outflow from CFO; however, in the FY2013 annual report, the company rectified the same and as a result, the databases like Screener used the previous year data in the FY2013 annual report to rectify the FY2012 CFO data. Therefore, the FY2012 CFO data did not need any adjustment.
Further advised reading: Understanding Cash Flow from Operations (CFO)
8.ii) Buyback spending as outflow under cash flow from investing (CFI):
At another instance, in FY2009, Supreme Industries Ltd showed the money spent in buyback of shares as an outflow under cash flow from investing activities (CFI). This seems in contravention to the general practice of showing the spending on the buyback as an outflow under cash flow from financing activities (CFF).
FY2009 annual report, page 69:
Therefore, it is advised that an investor should always study the financial statements in detail from the annual report before taking any investment decision so that she knows what the individual items are under different headings.
9) Supreme Petrochem Ltd:
An investor notices that Supreme Petrochem Ltd (SPL) is an associate company of Supreme Industries Ltd where it holds 30.74% stake on June 30, 2020 (Source: BSE).
While analysing the annual reports of Supreme Industries Ltd, an investor notices that whenever SPL took debt from the lenders, then the lenders asked Supreme Industries Ltd to provide contractual comforts to them. Past annual reports of the company indicate that the lenders took a commitment from Supreme Industries Ltd that it would not sell its stake in SPL without the consent of the lenders.
FY2011 annual report, page 39:
The Company has given undertaking to IDBI Bank & ICICI Bank for non-disposal of its investments in Supreme Petrochem Ltd. (SPL) without the prior consent of the respective banks as long as any part of the loan facilities sanctioned by the Bank to SPL remains outstanding.
While analysing the credit rating report of Supreme Industries Ltd in January 2014, an investor notices that CRISIL had combined the risk of SPL with the company while assigning a credit rating to Supreme Industries Ltd.
For arriving at the ratings, CRISIL has combined the business and financial risk profiles of SIL, its wholly owned subsidiary Supreme Industries Overseas FZE, and its associate company Supreme Petrochem Ltd.
An investor would appreciate that the lenders have the habit of seeking contractual comforts from the promoters while lending to their subsidiary or associate companies. Therefore, an investor should always assess the contractual arrangements whenever the subsidiary or the associate, SPL, takes any debt. In many cases, the lenders may have contractually secured their payout from the parent company in the eventuality when the subsidiary or the associate company is unable to repay the debt.
The Margin of Safety in the market price of Supreme Industries Ltd:
Currently (Oct. 18, 2020), Supreme Industries Ltd is available at a price to earnings (PE) ratio of about 42.5 based on consolidated earnings for twelve months ending June 2020 (i.e. from July 2019-June 2020). The PE ratio of 42.5 does not offer any 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, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.
In the absence of any strength in the business model of the company, 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.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
Overall, Supreme Industries Ltd is a company that has been growing consistently at a rate of 7-9% year on year for the last 10 years (FY2011-2020). The company has been able to grow with stable operating margins in the range of 14-16% over the years. The company has been able to pass on the increase in the cost of its raw material to its customers to maintain its profit margins. However, still, the sharp volatilities in the prices due to fluctuations in the crude oil prices and foreign exchange rates hurt the business by inventory losses and subdued buyer sentiments.
Supreme Industries Ltd faces intense competition from the unorganized sector and counterfeit products in multiple business divisions. It has attempted to counter such competition by offering more value-adding products to the customers and by developing low-cost products for cost-conscious customers. At times, the low-cost products developed by the company like 35-GSM film failed to impress the customers and its sales did not pick up despite intense efforts by the company for many years. The company attempts to avoid competing in segments where a large number of products are imported.
Nevertheless, Supreme Industries Ltd has been able to grow its sales with sustained profit margins and asset utilization efficiencies. The company has maintained its asset turnover by frequently exiting the non-remunerative businesses, selling them using the resources in plants that are more remunerative. Even though the company has maintained its asset turnover ratio, still, its inventory utilization efficiency has declined over the years. The company has been able to create new manufacturing plants at a regular interval; thereby depicting good project execution skills.
The company has been able to add new products to its offerings. However, at times, some of the products have taken many years, even more than a decade, to achieve good quality standards. The company took almost 10 years to perfect the technology of composite LPG cylinders, and about 5 years for plastic manholes whereas the collaborator of the company is still working on cross-plastic film even after 10-years from the date of initial disclosure of the company to manufacture and sell the film.
At one occasion, the company even created a manufacturing plant for composite pipes. However, the technology partner/collaborator could not deliver on the acceptable product quality. As a result, the company had to write-off the investment done by it on the plant. It comes as an example of events where an investor should not become too much enthused when companies announce new technologies and products.
Supreme Industries Ltd has grown by using the cash flows generated by its business operations and as a result, over the years, it has been able to reduce its debt and reward the shareholders with continuous dividends.
The business strategy of the company exposes it to certain risks like sourcing of the main raw material CPVC resin, which is in short supply, from only one supplier. In addition, the company faces challenges like time taking regulatory approvals for its products, which further delays the meaningful addition to the revenue by new products and complying with environmental and pollution control regulations. Nevertheless, the company has been able to show consistent growth over the years.
Four members of the promoter family are a part of the board of directors. However, all of them are quite senior with age ranging from 65-86 years. Upon further analysis, an investor is able to find two more members of the promoter family as a part of the senior management of the company. However, to get a detailed idea about the management and ownership succession planning of the company, the investor needs to contact the company directly.
Going ahead, an investor should monitor the competitive intensity in the business segments served by the company and its profit margins, its dependence on a single supplier for CPVC resins, regulatory approvals for products, developments related to perfection of technology by collaborators so that she can have a view about the future growth prospects of the company.
Further advised reading: How to Monitor Stocks in your Portfolio
In case of any additional information and clarifications, an investor may contact the company directly.
These are our views on Supreme Industries Limited. 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!
Dr Vijay Malik
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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.