Business Overview: Confidence started as a cylinder manufacturer for the big three oil companies (BPCL, HPCL, IOCL) and diversified into a blending, and bottling services provider for the oil majors, into marketing and distribution of own brand LPG "GasPoint", and lately, into distribution of Auto LPG through owned dispensing centers (ALDS). The Company is going through a rapid business transformation leading to large shifts in relative contribution of each business (some growing at a good rate, others at great rate) to consolidated sales. The pie chart below shows the topline contribution of each business in FY10.
Sales Pie chart
LPG/ CNG Cylinder Manufacturing: The Company has a built-up capacity to manufacture 40lac LPG cylinders annually in sizes of 14.2kg, 19kg, 35kg, and 47.5kg. The Company's capacity utilization is 25% only as it sold 10lac cylinders in FY10. A cylinder costs Confidence Rs 925 (5% lower than global benchmark, Rs 970), allowing it to offer competitive pricing to the PSUs. The business has operating margins of 11-12%.
Gaseous fuels like LPG have considerable social benefits from a health oriented perspective. They possess a simple chemical structure, promoting clean burning, with greatly reduced levels of combustion by-products. Indian Government is focused on the increased rollout of new LPG connections – 5.5cr new connections till 2015 - while increasing its population coverage from 50% to 75% and raising the total number of LPG customers to 16cr. A majority of the new connections are to be distributed in rural areas under Rajiv Gandhi Gramin LPG Vitran Yojna (RGGLVY).
The Government initiatives for increased rollout of LPG Connections will create demand for an additional 8cr new cylinders over a period of 5 years, providing a 300%+ boost to the market. Since Confidence has spare capacity to the tune of 30lac cylinders per annum (current sales: 10lac cylinders), it is well positioned to exploit the opportunity without incurring any capital expenditure.
The Company’s CNG/hi-pressure cylinder unit at Vizag (annual capacity: 3lac cylinders, sales: minimal) has recently started operations and is also expected to have a better capacity utilization from increased auto demand (7lacs new gas based vehicles to come online in next three years, increasing gaseous vehicle base to 15lacs), and better penetration in medical oxygen, industrial gases, and nitrogen market.
Blending, Bottling and Transportation Services: India's LPG refining capacities are largely situated in coastal areas. The gas pipeline network is very limited. To add to these factors, India's dispersed geographies with low usage leads to high distribution costs for oil companies. Bottling is increasingly being considered a non-core activity by the oilcos, and they would prefer an external service provider, if a cost reduction can be achieved. At present, about 10% of bottling is outsourced by oilcos with Confidence enjoying 95% share in the market. It is the only player in LPG bottling and logistics business with MDRA rating-II required for tender qualification.
The Company had Rs179cr of sales in FY10 from 22 bottling plants (plus a fleet of 550 carriers: 55 owned and rest leased on a per-use basis). The Company has expanded to 51 bottling plants by the end of FY11 and is expected to more than triple its sales by FY12 end. The Company plans to add 100 bottling plants over a 5-year period.
A bottling plant typically takes about Rs 2cr to setup and the margins in bottling are 8-10% (a RoCE of 32%-40%). Confidence is expected to incur Rs 200cr capital expenditure in the next 5 years in this division.
GasPoint: The Company sells LPG (50TMT annualy) to time critical businesses such as hotels, restaurants, and industries, the segments which can be severely impacted by the unreliability of the PSUs. As Confidence needs to procure gas from the public sector undertakings and compete with them in end-product pricing, the margins are on the lower side in this segment: 6-8%. With rationalization of subsidy structure by Govt., Confidence expects to extract better profitability from this segment.
Auto LPG Dispensing Stations (ALDS): The Company started establishing ALDS's in Jan 2010, and as such have minuscule sales from this segment in FY10. In FY11, 150 operational ALDS's are expected to contribute Rs 1cr (Rs 2cr in stable state) each in sales on an average. The ALDS segment enjoys higher margins to the extent of 18%-20%. An ALDS takes about Rs 60-65lacs to setup and can generate sales to the tune of Rs2-2.25cr (Rs 1cr gas, rest value added sales), leading to a RoCE of up to 67%. The Company expects to setup 500 ALDS by 2012, though full benefits will only start accruing from FY14 onwards. The Company has already setup 250 dispensing centers, so there is fair visibility on revenues in this segment. The company will need an additional financing of Rs 150cr to set up the remaining ALDS's.
A look at the graph above clearly highlights Confidence's rapid growth in the last five years. From Rs 15cr of sales in FY06, company's sales grew at a CAGR of 134% to be within a touching distance of Rs 1100cr this fiscal. Operating margins have come down from 20% to 11% due to low margins in the Company's core bottling business, but when you are growing at 134%, who cares.
Internal Accruals have been the most prolific source of growth financing, while external equity to the tune of Rs 103cr was raised in FY08. Including Rs 78cr additional debt raised, and Rs 106cr of internal accruals, company has used up Rs 287cr to generate incremental sales of Rs 1077cr, transforming into an asset turnover of 3.75. Based on EBIT margins of 9%, the company is generating RoCE to the tune of 39%. Even ignoring its high growth trajectory, such high RoCE entitles the Company to a PE value better than 6.8x. (Note: Don't get confused with lower TTM sales and PAT than stated here. Company's TTM numbers are on a standalone basis, while its consolidated numbers are much better due to a healthy contribution from Auto LPG Dispensing Stations.)
Environment Management: The Company is in the business of manufacturing cylinders for the last 17 years, and the promoter is a first generation entrepreneur who familiarized himself with the ways of the industry for a decade before making a foray into blending, bottling, transportation, and distribution. He rapidly scaled up the new business using his established linkages, and strengthening company's balance sheet by raising equity to the tune of Rs 102cr. It is a virtual monopoly in bidding for rights of bottling for PSUs. The Company has managed working capital very efficiently - a difficult task when dealing with the public sector. The Company has shown good environment management capabilities and has the ability to come good on achieving planned growth.
Value Capture: A valid concern against Confidence is that existing shareholders can get diluted in a capital raising round (which it may need due to its high CapEx - ~Rs 350cr over 5 years). In 2007-08, when company raised equity, the scrip was ruling at an all time high with prospective growth built-in into the valuation. Hence, despite good growth, the shareholders did not gain anything in the two years. A closer examination reveals though that the Company was growing from a very small base in FY08 (Rs 72cr sales in FY07), which made it difficult to finance the growth through internal accruals. Now, however, the Company's large base is sufficient to execute planned growth through internal accruals. We have to note that in key segment, the Company is yet to achieve full sales or capacity utilization which will substantially add to the profits. Besides, the promoter has a 46% stake in the entity, and he will be extremely unwilling to further bring down his stake now, unlike back then, when he had a large majority stake. In any case, back then, the deal was excellently valued for the promoter who knew that growth comes with riders, but cash in hand has no riders. At current valuation, he is unlikely to be tempted, even if he has to sacrifice a little on the growth frontier.
Company Valuation: Since ALDS's are just in the startup phase of operations, and the Company's sales trajectory has a steep curve, any estimates will severely curtail probabilistic know-how of the upside, while leaving us clueless on the downside. So, we decided to go for Monte-Carlo simulations to value Confidence with any degree of confidence.
The graph above shows the probabilistic distribution of valuation of Confidence in 2015 that we got in a 1000-sample run of the dependent variable (valuation in 2015) on a host of independent variables, ranging from number of bottling plants, contribution per ALDS, margins, etc. The mean valuation is Rs 4023cr with a minimum valuation of Rs1970cr. We can say with a high degree of confidence that barring glaring loopholes in the Company's public disclosures, we can expect a minimum returns of 3.5x on our investment with an upside of up to 15x on our original investment, though a more likely outcome is returns in the range of 6x-8x. Please note that the valuation does not assume any earnings multiple arbitrage, earnings multiple has been assumed to be 12 for exit.
For the purists, we have also included a conservative sales estimate based valuation, as below:
The expected PAT in FY15 is Rs 260cr and a 12x multiple suggests a valuation of Rs3120cr, resulting in 6x returns over a 3-5 year horizon.
