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Garware Hitech films - Attractive valuation, or a trap?

Garware hitech films is a leader in the manufacturing of polyester films. These films find their application mainly in sun-control films. The sun control films are used primarily in automobiles and architectural segment.


The company has also started manufacturing paint protection films. These are used to coat the exterior of cars to avoid any damage to the car paint. As per reviews from teambhp, the company seems to have hit the right spot. This market for paint protection films has been dominated by the likes of international brands like 3M. The prices of these international brands have been exorbitant and Garware is offering equally good products for a considerably lower price. As per some reviews, the delta between the prices of multinational giants and Garware is as high as 50%! Such a high price differential is enough reason for consumers to switch loyalty from the multinationals to Garware. Essentially, grabbing more market share in the paint protection business shouldn't be very difficult for the company. The quality of products offered by Garware is at par with the quality offered by giants (might be a debatable point, basis your experience. Would like to hear in comments).


The company had made a conscious attempt to move from commodity products like plain polyester films into value added specialty films. In 2017, the contribution from commodity products was 52%, whereas in FY23, this contribution has fallen significantly to 20%.


Owing to the change in product mix, EBITDA margins have improved from ~9% to ~18%. This improvement is significant considering the fact that commodity markets have been turbulent between 2020 and 2023.


The company is backward integrated and manufactures it own raw material for making the films. The process for manufacturing films is as follows:

crude oil --> basic petrochemicals --> raw material --> chips/ resins --> films.


Rising temperatures globally is a blessing in disguise for the solar control films business. Protection from UV ways is taken seriously by the public at large. The management on one of its analysts call indicated that rising temperatures and wrath of Sun has a positive correlation with their solar control films business. The company's PPF plant is not fully backward integrated at the moment. However, they expect the plant to be integrated soon. This integration is likely to further improve the margin profile. So how difficult will it be for competitors to achieve backward integration? Well, this is a capital intensive business with asset turnover ratio only around 0.95. By the time competitors reach the stage of backward integration, Garware might have penetrated the market and thereby created a name for itself in the paint protection segment. The company has already started Garware Application Studios (G.A.S as called by the company) at various locations in India. These studios help consumers in having a look and feel of the products. Being a dominant player in the sun protection films business gives them an early mover advantage in the paint protection films business.


How do the business prospects look like?

  1. Rising temperatures globally is a blessing in disguise for the solar control films business. Protection from UV ways is taken seriously by the public at large. The management on one of their analysts calls indicated that rising temperatures and the wrath of Sun has a positive correlation with their solar control films business.

  2. Luxury car sales in India is rising. Aspirational consumption is rising and this is indicated in the sales figures of SUVs and luxury cars. Paint protection films business mainly caters to aspirational cars. Someone who spends 20 lacs+ on a car may not hesitate to spend Rs. 1-2 lacs extra, and get their car protected. Needless to mention the anxiety that a driver has while driving his/ her brand-new car on crowded Indian roads!

As per industry data, number of luxury cars sold in FY2023 was 36,508. In the first half of calendar year 2023, around 21000 luxury cars were sold. The growth has been high in luxury products, not just cars, but many luxury products are selling record volumes in India despite the mixed economic data. Needless to mention the long queues outside Apple showrooms for buying every new iPhone! Cutting the long story short, luxury product sales is surely a long term trend in India.



Source of above image: Statista


Talking about the risks, fluctuating crude oil & its derivatives price is a big risk for every business that uses downstream products. In the case of Garware, this risk is partially mitigated because of the backward integration, however they are not completely insulated from the risk, because they have to procure the basic petrochemicals at market prices.


Corporate governance issues of the past:

Garware Hitech is a family business of Mr. Shashikant Garware. His three daughters namely Monika, Sarita and Sonia are actively involved in the business in the executive capacity. Having such a diverse representation within the family is not very comforting to minority shareholders.


In the year 2017-18, a few minority shareholders had filed a petition in NCLT Mumbai bench opposing the remuneration paid to the management. In that year, the Garware family paid itself close to Rs. 9 crores compensation. Back then, the net profit was Rs. 33 crores. Essentially, the family managed to withdraw a remuneration that is almost 27% of the total profits that year. To be noted here that as per Companies' act 2013, the maximum compensation that can be paid to the directors of a public company cannot exceed 11% of the net profits of the company. In the year 2023, the remuneration of promoter directors stood at 18.78 crores (on a base of Rs. 166 crores net profit). The percentage comes to 11.33%. Although they have brought down the compensation within acceptable limits, the market perhaps doesn't yet trust the company completely. And this is reflected in the valuation of the company (price to earnings ratio around 20 and price to book value ratio around 1.6). Let's get to this part a little later.


Over and above the remuneration, the company has paid Rs. 1.86 crores as rent to the Monika, Sarita and Sonia Garware during the year 2023. Also, Rs. 43.61 crores has been paid to Garware Industries Pvt Ltd. as processing fees. To be noted here that Garware Industries Pvt. Ltd is the 100% closely held entity by Garware family members.


In the recent analyst call, a question was asked to the management about the processing charges. The management gave a brief answer stating that Garware Industries owns a technology for deep-dying, which is not present anywhere else in India. This technology differentiates the product quality of sun control films from those of the competitors. While this may be true, it remains unclear why is Garware Hitech not merging the private company with itself? Rs. 43 crores is a significant expense for a company that declared Rs.166 crores net profit. Given the nature and quantum of expense, the minority shareholders deserve more clarity into this matter.


Valuation:

The stock trades at close to 20 times the trailing 12 months earnings per share. Considering the growth prospects this valuation appears attractive. The price to book value is around 1.6, which again is attractive in the current market conditions. However, the valuation in view of corporate governance track record may not be as attractive as it seems.


What's the verdict?

Valuation is surely attractive. The existing business fundamentals are good too. Future prospects are in-line with the long term trend of increasing luxury products sales and rising global temperatures. However, the related party transactions still give an impression that the management doesn't fully care about minority shareholder interest. In such situations, where there is lack of trust between minority shareholders and the management, share price may not perform well despite business booming. However, the sad reality is that many small and midcap Indian companies have this issue of promoters withdrawing hefty compensation in the name of rent, related party transactions etc. So can you really afford ignoring all such companies?


Positive triggers to watch:

Reduction in management payout, merger of the private company with the listed company. If the promoters take a few shareholder friendly steps like reducing their own compensation, the stock is likely to perform much better due to rerating of price to earnings and price to book value multiple.


Disclaimer: Tequity Ventures (SEBI RIA) does not hold any exposure to Garware Hitech Films at the time of writing this article. But we are tracking the company.

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