ICI India

Profile

ICI (India) Ltd is one of India’s leading manufacturers of paints, specialty chemicals and industrial starch. It was set up in 1911, when its parent company, based in the UK opened a trading office in Kolkata. Till the year 2000, ICI expanded its horizons through mergers and acquisitions was well. Since 2001, it has been on a rationalisation exercise where it is looking to get out of small businesses and companies where it was not in a commanding position in the market. ICI’s mainstay business arm, the paints business, is well established, having well — popularised brands like Dulux and Duco.

Promoters
Imperial Chemical Industries was the parent company of ICI. It held a stake to the tune of 54 per cent in the subsidiary. However, the parent company itself was acquired by Azko Nobel NV of Netherlands in 2008. According to the company’s shareholding pattern for the Q1FY2010, promoter holdings are still at 54 per cent, while the other major stake holders are institutional investors, which hold 20 per cent and out of this insurance companies hold 12 per cent and foreign institutional investors (FIIs) hold 5 per cent.

Investment Rationale

• Improved Margins

As per ICI’s Q1FY2010 results, the company’s net sales grew by 5.6 per cent year-on-year (YoY) to Rs 240 crore. Though the company’s paints business, registered a moderate growth of 6.9 per cent during the same period, profit before interest and tax (PBIT) margins improved significantly by 9.4 per cent.

• Lower Costs

The primary reason behind the company’s improved margins is the lower raw material costs. This was due to a sharp correction in crude oil prices, from some of the highest points reached ever, and the consequential decline in crude derivative prices. The raw material cost as a percentage of sales slumped by 631 bps YoY to 51.7 per cent in Q1FY2010. The same stood at 53.8 per cent in Q4FY2009.

• Rising Profits

ICI has strategically increased its spending on brand building exercises, especially for its paints business. Due to this, the other expenditure as a percentage of sales surged by 428 bps and hence, negated the substantial gains from raw material cost savings. This has restrained operating profits rate at a 30.12 per cent growth to Rs 27.2 crore, which could have been higher, but for the expenses incurred. However, the spending exercise is likely to generate dividend in terms of rising demand in the foreseable future.

• High Cash Reserves

The pile of cash the company holds in its reserves amounts to Rs 1,000 crore. While the company is not really looking out for acquisitions, but when and if such an opportunity arises, this sum can be useful. It can always serve as a cushion in hard times and to fast track growth during spikes in demand.

Risks & Concerns

• The Slowdown Effect

The demand for paints is directly related to construction and housing development. If the demand for the construction space does not pick up then the company’s plans of expansion through means of new plants, if implemented, could become a liability.

• Rising Raw Material Prices

With oil prices being range bound for now between USD 60-70/barrel, if it moves up any further, the company runs the risk of hurting its operating profits. It cannot even look for alternatives as oil is an important constituent for paints. Hence any significant increase in prices can affect the overall performance adversely.

• Monsoon Effect

If monsoon is deficient, which increasingly is not looking a possibility, then it will affect rural demand (since the majority of the farm income is derived from monsoon-related agricultural produce, any lag in the weather will cut rural income hugely thereby affecting demand) and hence become a barrier in the company’s growth. If the scene does not improve, then cheaper alternatives like sand paints or wallpaper will become serious competitors. The increasing use of wall tiles could also pose a threat in this case.

Valuation

Although it has been reported that the industry could see a marginal correction of 1-2 per cent in prices across the board, but even after that, it is expected the industry will report overall growth.

At current market price, the stock trades at 12.0x and 10.6x its FY2010 and FY2011 expected earnings respectively and discounts its core earnings per share (EPS; i.e. earnings excluding the other income) of Rs 27 by 9.7x for FY2010