Vinyl Chemicals India Ltd. - A Pidilite Associate

                                           VCIL – A Pidilite Group Company

Usually Related Party Transactions of a listed entity with promoter group entities are done at highly favourable terms to the latter. Hence the minority shareholders are the losers in such transactions whereas the promoter group entities are the beneficiaries. But what if we get an option to be on the other side of the transaction by being shareholders in the entity that is in the winning side of the transaction.

Vinyl Chemicals India Ltd is a Pidilite group company incorporated on 15th May, 1986 with the object of manufacturing Vinyl Acetate Monomer (VAM).

The Company commissioned a 10,000 TPA, Vinyl Acetate Monomer(VAM) manufacturing plant in the Raigad district of Maharashtra, in technical collaboration with Uhde GmbH,Germany, on 25th October, 1990. 

Due to some reason, the VAM plant made continuous losses and was demerged into Pidilite Industries Ltd. (PIL) in FY08. Due to the demerger, the Share Capital of the co. reduced from Rs. 18.34Cr. in FY07 to Rs.1.84Cr. in FY08. Networth reduced from Rs.30.8Cr. to Rs.2.7Cr., Debt reduced from Rs.32.4Cr. to Nil and Total Assets reduced from Rs.63Cr. to Rs.2.7Cr.

The Net Fixed Assets were reduced from Rs.39Cr. to Rs.25 lakhs and the company ceased to be a manufacturing concern.

This demerger was a boon for VCIL shareholders since the VAM plant was a liability. Today, the VAM plant which is now a part of PIL, is inoperative. The VAM plant generated revenues of Rs.93Cr, Rs.15.7Cr. & Rs.2.1Cr. in FY09, FY10 & FY11 for PIL. Clearly, the demerger was a bail out of VCIL by PIL. This is highlighted by the Annual Report of PIL.

Excerpts from PIL annual report of FY10 :

VAM Division : This segment largely consists of the Vinyl Acetate Monomer manufacturing unit merged into the Company effective 1st April 2007.

Since the pricing of bought out VAM was more advantageous, the Company opted to import rather than operate the plant.

Consequently the revenue in this segment was only Rs 157 million as compared to Rs 932 million in the previous year. The Company is evaluating options to manufacture other products in the plant as in the near future import of VAM is likely to be more viable.

The Company is the only manufacturer of VAM in the

country with an installed capacity of 30,000 MT per annum.

As mentioned earlier, due to global demand supply situation

it was viable to import VAM rather than manufacture inhouse

and accordingly the plant remained shut last year.

Going forward, in the near future, import of VAM is likely to

remain more viable. The Company is exploring alternative

products which can be manufactured in the same plant.

Excerpts from PIL annual report of FY11 :

As mentioned earlier, due to global demand

supply situation it was viable to import VAM rather than

manufacture in-house and accordingly the plant remained

shut last year. Going forward, in the near future, import

of VAM is likely to remain more viable. The Company is

exploring alternate products which can be manufactured in

the same plant.

The Company continues to import rather than operate the VAM plant, as import price of VAM

continues to be more favourable. Consequently the revenue in this segment was only 21 million as compared to 157 million in the previous year. The Company is evaluating options to manufacture other products in the VAM plant.

Post demerger, VCIL started trading in VAM, which it imports from Singapore and sells in the domestic market, primarily to PIL.   

Thus, post FY08, the company started with a clean slate with no liabilities and a Networth & Total Assets of Rs.2.7Cr. and the backing of PIL.

Today, PIL holds 40% stake in VCIL and 10% stake is held by the promoters (Parikh family) directly.

VAM is a major Raw Material for PIL, amounting to approximately 15% of the latter’s total Raw Material expense. PIL sources all its VAM requirements from VCIL. PIL accounted for 97.5%, 86% & 80.5% of VCIL’s Sales during FY09, FY10 & FY11. Clearly, VCIL’s dependence on PIL is reducing with each passing year.

The company is looking out for opportunities in trading of other chemicals, apart from VAM. During FY11, VCIL started trading in Acetic Acid also.

Since even today 4/5^th of the sales are coming from PIL, VCIL is basically a Related Party Transaction Company. The Terms of Trade of VCIL with PIL are skewed in favour of the former. Hence VCIL needs to maintain little inventory & receives prompt payment from the parent. Therefore, it needs very limited working capital and its business is very scalable.

VCIL is being subsidized by PIL.

Moreover, since PIL sources all its VAM requirements from VCIL, VCIL is a proxy of PIL since its sales growth will track that of PIL. Also PIL is a full blooded blue chip FMCG stock trading at a PE of over 30x & P/BV of 7x whereas VCIL trades at a fraction of that. 

Also the management of Pidilite is known for its competence & integrity. Since VCIL is also under the same management, at least corporate governance is not an issue, unlike other micro caps of the same category.

VCIL, though a separate entity, for all practical purposes, operates as a division of PIL. It even operates out of the office of PIL.

VALUATION :

CMP = Rs.8.3/-

MCap = Rs.15.37Cr.

FY12 :

Sales = Rs.211 Cr. 

Operating Profit = Rs.11.10 Cr.

Exceptional Item (Forex loss) = Rs.3.88 Cr.

PAT = Rs.5 Cr.

PAT (excluding Extraordinary Item) = Rs.7.6Cr.

Debt = NIL

Networth = Rs.16 Cr.

PE = 3x

PE (excluding Extraordinary Items) = 2x

Sales / MCap = 13.72x

EV / EBITDA = 1.38x

P/BV = 0.96x

RoE = 36%

RoE (excluding Extraordinary Item) = 54%

Asset Turnover Ratio = 14.4x

OPM = 5.2%

NPM (excluding Extraordinary Items) = 2.36%

DPS = 0.6/-

Dividend Yield = 7.23%

Payout Ratio = 25%

CAGR : FY08 - FY12 ( n=3.5 years)

Sales = 23.4%

Operating Profit = 76%

Networth = 66%

Total Assets = 66%

The company has shown a volume CAGR of 16.5% during the 3 year period FY08 – FY11.

These miraculous nos. are the result of the Preferential Treatment VCIL gets from Pidilite. 

THREATS :

1.)   FOREX HIT : Since VCIL is a big Net Importer, and imports are more than 90% of the Sales, the company is susceptible to Forex Losses due to Currency Fluctuations.

Indeed, the company has faced frequent forex hits in the past regularly. Currency markets have also been extraordinarily volatile during the recent past and this trend might continue considering the global economic uncertainties.

2.)   RIL : Mukesh Ambani, in FY11 AGM of RIL, announced that RIL will set up a VAM plant in India. If & when this plant comes onstream, VAM imports might become unfeasible & VCIL might be driven out of business.

3.)   BULK DISCOUNTS : VCIL receives income in the form of “Bulk Discounts” during Q4 of every fiscal. This income contributes significantly to its Operating Profits. This income is shown as “Miscellaneous Income” in the schedule of “Other Income”.

Bulk Discounts                          Bulk Discounts / Net Sales                        

FY11 – Rs.5.75Cr.                                  3.78%

FY10 - Rs.6.85Cr                                   5.75%

FY09 - Rs.4.46Cr                                   6.12%

FY08 - Rs.31 lacs                                  0.34%

Although the Sales growth in terms of Volume & Value was 14% & 28% in FY11 yoy, the Bulk Discounts have reduced yoy in both % terms as well as in absolute terms.

This is unexplainable. If this declining trend continues, then it is a big negative for the company.  

What is Vinyl Acetate?

Vinyl acetate is a versatile and economically important chemical with a wide variety of industrial and commercial applications.

Uses

Vinyl acetate monomer is a chemical building block used to manufacture a wide variety of polymers including: polyvinyl acetate; polyvinyl alcohol; polyvinyl acetals; ethylene vinyl acetate copolymers, ethylene vinyl alcohol and several others shown in the table below. VAM-based polymers are commonly used in the production of:

·  plastics ·  films ·  lacquers ·  laminating adhesives ·  elastomers ·  inks ·  water-based emulsion paints ·  adhesives ·  finishing and impregnation materials

·  paper coatings ·  floor tiling ·  safety glass ·  building construction ·  acrylic fibers ·  glue ·  cosmetics and personal care products ·  textile finishing and non-wovens

The table shows several of the end uses for various VAM-based polymers. This information is based on the May 2008 draft EU human health risk assessment for VAM, Canada's May 2008 draft Screening Assessment for VAM, and the US Department of Human Health's Household Products Database.

Vinyl acetate monomer (VAM) is used to produce a wide variety of useful products.

Adhesives	VAM is a cost-effective raw material for a wide range of adhesive products. Polyvinyl acetate emulsions have excellent adhesion to a host of substrates, including metal, porcelain, wood and paper, and have advantages over butadiene-styrene latexes in being more color stable and odor-free.
Chemical Intermediates	VAM is widely used as molecular building blocks, or intermediates, due to its chemical structure and useful chemical functionality. It is also used as a monomer or co-monomer for a variety of polymers.
Coatings	VAM is used extensively in coating formulations and as a monomer in the production of copolymers in textile and adhesive resins, as well as surface coatings. It is also widely used in water-based coatings.
Food	VAM is a raw material used to make FDA compliant food-contact materials used in adhesives, printing inks, paper and paperboard coatings and can-end cements.
Plastics	VAM is used in the manufacture of plastics. For example, it is co-polymerized with ethylene to form polymers for use in flexible films, wire and cable insulation and moldings. VAM is used to form acrylic fibers and is also converted to polyvinyl acetals, which are used for magnetic wire and inter-layers for safety glass.
Textiles	Polymers made from VAM are used in fabric treatments, pigments and adhesives.