Ashish Chugh’s HIDDEN GEMS ……. in search of Market Beating Stocks E-Mail ID - email@example.com September 23, 2006 HIDDEN GEMS REPORT SENT TO PAID SUBSCRIBERS ON AUGUST 28, 2006 Shalimar Paints Ltd. CMP – Rs. 165 BSE Code –509874 Shalimar Paints Ltd. (Shalimar) was incorporated by British entrepreneurs under the name Shalimar Paint Colour & Varnish Company in 1902 to takeover the business of 'The Shalimar Works', a company which manufactured paints, colour and varnish from its factory at Shalimar and Goabaria in Bengal. Courtalds Coatings, UK was the holding company and it held majority shareholding through it's subsidiary International Paint Company, UK. It became a private limited company in 1956 and later on in 1961, it was converted into a public limited company. The company acquired its present name in 1963. Courtalds slowly started disinvesting since 1978 and finally in 1989, it fully disinvested its stake and maintained only its technical and marketing collaboration with the Indian company till 1994. The Courtald's stake was acquired by G irish Jhunjhunwala, a HongKong based NRI (20%) and the Delhi- based O P Jindal group (42%). Thereafter in October 2001, the Jindal Group diluted a part of its equity in favour of Girish Jhunjhunwala group and both the groups currently holds 31.18% each in the company, thereby making the promoters shareholding at around 63 %. Manufacturing Operations The company currently has its manufacturing plants located at Howrah (West Bengal), Nasik (Maharashtra) and Sikandrabad (Uttar Pradesh). Howrah Unit The Howrah plant was the first large scale paint manufacturing plant to be set up not only in India but in entire South East Asia. It has an installed capacity of 14204 MT per year. The Company's central Research and Development laboratory is located in the Howrah Plant. This state-of-the-art R&D unit was the first in-house paint R&D unit to be recognized by Dept. of Scientific and Industrial Research, Govt. of India. Nasik Unit The Nasik factory was set up in 1992 in western India in Nashik on Mumbai - Agra Highway . It was designed as a state-of-the-art-plant with installed capacity of 16000 MT per year. Sikandarabad Unit In 2003 the Company acquired the American Paints unit in Sikandrabad near Delhi, North India. The American Paints plant was set up in technical collaboration with Sherwin Williams of USA . The company acquired the unit spread over an area of 10 acres through an auction sale for a total consideration of around Rs.3.50 crores. The company is putting up a Greenfield facility at Tamil Nadu at a total cost of Rs.15 crores, is expected to go on stream over the next 6 months. With this, the company will have one unit each in East, West, North and South India. Product Portfolio The company caters primarily to the Decorative & Industrial Segments :- Decorative Segment The Company manufactures a wide range of decorative products- both for the exterior and interior segments. It has paint systems for every application - interior or exterior, every surface - concrete, plaster, metal or wood. Shalimar's premium acrylic emulsion is marketed under the Hussain Collection. Its Xtra and Shaktiman brands are for exteriors while for interiors it has S uperlac Acrylic emulsion and No.1 Silk emulsion. The company sells enamels under the Superlac Hi -Gloss enamel brand. The company has also set up colour dispensing stations at its retail outlets under the name Shalimar Color Space – where the customer can choose amongst over 5000 colours & shades for his rooms/ exteriors. Industrial Segment The Company has been a pioneer in the Industrial Paint Segment by virtue of its long association with multinational giants like Pinchin Johnson Co. and International Paints PLC of the U.K. coupled with its own R&D strengths. Shalimar Paints has built up considerable expertise in manufacturing and marketing of high performance industrial coatings, Aviation coatings, marine paints and coatings for metal decoration and food can lacquers. The company manufactures specialized coatings for Oil & Gas sector, Refining Petrochemical, Fertilizers, Hydro Power plants, Paper & Pulp, Sugar and Cement sectors. The company also manufactures specialized coatings for the Marine sector. Distribution Network The Company has a wide distribution network. The entire country is divided into 4 zones, each of which is headed by a Regional Business Manager. The Company has more than 45 branches and depots who service more than 6000 dealers all across the country. With its wide distribution network the Company is able to reach not only the urban market but also the rural and up-country markets. Financials The latest financials of the company are given as under :- QUARTERLY - LATEST RESULTS - Shalimar Paints Ltd (Curr: Rs in Cr.) Year Year Quarter Quarter Quarter Ended Ended Year Ended Ended Ended Ended (Mar (Mar (Jun (Jun (% 06) 05) Particulars 06) 05) Var) (12) (12) (%Var) Sales 53.45 50.7 5.4 217.04 189.99 14.2 Other Income 0.43 0.38 13.2 1.7 1.13 50.4 PBIDT 2.23 1.69 32 10.67 7.37 44.8 Interest 0.75 0.49 53.1 2.92 1.78 64 PBDT 1.48 1.2 23.3 7.75 5.59 38.6 Depreciation 0.73 0.63 15.9 2.75 2.53 8.7 PBT 0.75 0.57 31.6 5 3.06 63.4 Tax 0.28 0.22 27.3 1.59 1.08 47.2 Deferred Tax 0 0 - 0 0 - PAT 0.47 0.35 34.3 3.41 1.98 72.2 (Source : Capitaline) The company has a Equity Capital of Rs.3.79 crores with the promoters holding roughly 63%. The share price chart is given below :- (Source : Capitaline) Comparison with the Peer Group A comparison of the company with the peer group reveals that the valuation gap between the 3rd & 4th largest player in the sector –namely Berger Paints & ICI India and the 5th largest player – Shalimar Paints is Huge, even though the gap may not be that large in the size of their businesses. FY 05-06 PE Sales EPS Mkt.Cap Ratio Mkt. Cap (Rs.cr.) (Rs.) (Rs. cr.) to Sales Asian Paints 2441 20 6187 32 2.53 Kansai Nerolac 1061 36.4 2076 22.5 1.96 Berger Paints 980 3.3 1540 23 1.57 ICI India 955 13.9 1250 22 1.31 Shalimar Paints 217 9.3 60 16.5 0.28 Even though the Sales Revenues of Berger Paints & ICI India may be 4 to 5 times of the Sales revenues of Shalimar Paints, the market cap of these companies is 20 to 25 times more than Shalimar Paints. We believe that the valuation gap will narrow down. However, our major concern with Shalimar Paints is its low profit margins compared to the industry. For example – the Operating Profit margin for ICI is around 11% whereas Shalimar does and Operating margin which is less than half of ICI. The primary reason for the low margins is its scale of operations. There is however a realization towards this fact in the company and the company hopes to improve its margins through cost cutting initiatives and through increased scales of operations as its Greenfield facility being put up in Chennai will be operational after 6 months. Conclusion Shalimar Paints being a company over 100 years old has been si tting on assets which have been acquired at historical valuations and would have a valuation which would be many times over its market cap. Even the manufacturing facility spread over 10 acres in Sikandarabad in Uttar Pradesh, which the company acquired in 2003 for just Rs.3.50 crores would also be currently worth much more. The company expects to grow at 20% this year and expects to log higher margins compared to last year. Given the small Equity base of Rs.3.79 crores and a high Turnover to Equity, a small improvement in margins leads to a big increase in its Earnings per share. Most paint companies have a market cap which is more than its sales revenues as is evident from the table above, ranging from 2.53 for Asian Paints to 1.31 for ICI India, Shalimar Paints commands a Market Cap to Sales of just 0.28. We believe that the company is grossly undervalued compared to its peers and carries potential to reduce the huge valuation gap which exists currently. Ashish Chugh is an equity analyst and investment consultant based at New Delhi, INDIA. At the time of writing this article, he, his firm and dependent family members have a position in the stocks mentioned above. The author, his firm or any of his dependent family members may make purchases or sale of the securities mentioned in the report while the report is in circulation. The author invites readers to send him email and welcomes comments, feedback & queries at firstname.lastname@example.org. This report has been prepared solely for information purposes and the information contained herein may not be deemed to be an investment advice. Such information is impersonal and not tailored to the investment needs of any specific person. The information contained herein is not a complete analysis of every material fact representing any company, industry or security. The views expressed may change. While the information contained herein has been obtained from sources believed to be reliable, no responsibility (or liability) is accepted for the accuracy of its contents. Investors are advised to satisfy themselves before making any investments and should consult with and rely upon their own advisors whether and how to use such information in making any investment decision. 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