Backward integration boosts Ess Dee

Ess Dee Aluminium, India’s largest manufacturer of aluminium foil and foil products, is well poised to benefit from its backward integration exercises along with rising demand for packaging products from pharmaceutical and FMCG sectors.

Business: Ess Dee Aluminium engages in the manufacturing and supply of primary packaging materials for the pharmaceutical, food, and FMCG industries in India and abroad.

The company specialises in providing aluminum foil based flexible packaging laminates and coatings for pharmaceutical products in strip or blister packs. Ess Dee also manufactures thermoforming poly vinyl chloride (PVC) films and PVdC coated PVC films for packaging high-moisture and oxygen-sensitive products.

The company sources aluminium foil stock from outside and converts it to packaging foils using cold rolling processes at its hubs in Daman and Kolkata. After cold rolling process, the packaging foils are sent to its printing units or ‘spokes’ which are located in close proximity to manufacturing plants of end users.

The company has current installed packaging capacity of 370,000 million tonnes per annum (mtpa). Also this acquisition helped Ess Dee to have its own caster plant with installed capacity of 11,000 mtpa. The caster plant provides backward integration as it converts aluminium ingots into aluminium foil sheets — the key raw material for packaging.

Investment rationale: The company having an expertise in aluminium foil packaging would be benefited from a steady growth in its user industries like pharma, food and FMCG. While pharma industry is expected to grow at 12-14% over the next five years driven by its ability to produce low cost generic products, the food and FMCG are expected to benefit from rising consumption driven by higher income across sectors.

Also food processing and FMCG companies are increasingly coming out with lower volume packs and innovative packaging to attract customers in semi urban and rural areas which will further drive up demand for packaging foils. As only half the demand for aluminium packaging is met locally with rest of requirement imported, Ess Dee with its strategically located plants in West and East India would be a prominent beneficiary of rising demand.

The company has over the years developed strong relationship with major pharma players and since the entry barriers in industry are high, it would continue to get incremental volumes.

The company has undertaken a capex plan to increase packaging capacity at its Daman unit by further 15,000 mtpa which is expected to be partially operating from FY13. The company has also successfully completed integration exercise at India Foils with caster plant now operational and this is likely to reduce its dependence on external sources for raw materials while increasing the operating margins.

Company expects to produce 9,000 mtpa of aluminium foils from this caster plant while the remaining foodgrade and FDA approved foils are sourced through its trusted supplier Gulf Aluminium Rolling Mill Co.

The company is also foraying into a new product targeted at household packaging needs through its consumer division. The company estimates the potential market for this product at Rs1,500-2,000 crore market and is planning to launch it by July 2011.

Concerns: Any significant increase in key raw material costs like aluminium may affect the margins though the company can easily pass through the hikes to its customers. Large dependence on GARMCO for raw materials exposes company to supply side risks. Any delays in adding new capacities or achieving higher capacity utilsations at its existing facilities may affect the revenues.

Valuations: Led by higher capacities and increased utilisations, the company’s revenues are expected to grow at a CAGR of 29% over FY11-FY13E while the net profits are likely to grow at a faster pace of 30% on back of higher operational efficiencies post the integration exercises. At current market price of `412.80, the stock of Ess Dee Aluminium is trading at 8.64 times its expected FY12 earnings and 6.63 times its FY13 earnings, respectively. Investors with a long-term view can consider buying the stock on declines.

Disclaimer: The writer does not hold any shares in the company.