“We have invested for growth from the beginning using debt to conserve equity, but within judicious parameters, which could be sustained by our performance. Maybe our track record of 20+ years, duly adjusted for a conservative outlook, gave us the confidence to continue as in the past in this most capital intensive industry.

Unfortunately, and frankly unforeseen by us, our world of 22-25% EBIDTA margins with 20-25% sales growth, inflation of 7-8% in costs and 1-2% in prices, turned upside down.”

– Q&A with MD and CEO, Annual report 2013 -14

I am starting this post with those couple of lines posted in 2013 – 14 annual report. Asahi India Glass started its venture as a glass provider to Maruti Suzuki with Suzuki having a quarter of its own equity into the business. The whole business model in late 2008 was funded on debt with a very less shareholders equity.

Then came the financial crisis and they found the whole business under threat. 2013 -14 was the third consecutive year for them to report losses. I have taken this year as my base rate for my analysis and understanding of the business.

What attracted me to this business?

Higher return on equity and countries biggest supplier of glass as OEM to Auto industry. Supplier of 3 out of 4 new cars glass needs was and is the sweet spot. In other words, market leader and so far only competing in the market by importers and none of the manufacturer of their scale within country.

They also manufacture architectural glass and are involved into construction business. Half of their revenues from sale (46% in 2014) came from this business segment in 2013 -14 financial year. They also got involved with manufacturing solar panel glasses as their third biggest market segment now.

Return on equity is inflated due to the high debt driver. They infused 250 crore as fresh capital in 2014 to bring their debts down and they ended that year with consolidated net debt of Rs 1,079.73 crore. Keep this figure in mind. Their EBIDTA margin stood at 10.91% of sales and as mentioned earlier they reported losses for the year.

We never liked this business for two big reasons:

  1. Capital intensive manufacturing
  2. Highly in debt

These are the two biggest threat for this company to give consistent returns every year and add value to it. They need lot of cash every year to keep them running. Which means if they report any profits than big chunk of it has to be reinvested in the business. In 2017 dividend payout ratio was 11% and they cannot afford to give more than that as dividends to its shareholders. Hence, investors in this business can only expect to gain by capital gains.

Capital gains does not happen in vacuum. It all depends on management skills and knowledge of deploying that extra cash to generate higher returns (IROE). As business by itself is capital intensive, there is a good chance that certain year management won’t be able to allocate those surplus funds to generate higher returns.

2015

In 2015 annual report they openly came out showing concerns of debt on their book. They mentioned to cut down their debts by Rs 300 crore in the coming 2016 financial year. The net debt stood at Rs 1,096.86 crore. So debt rose by Rs 17 crore in 2015 and its EBIDTA was standing at 15.42%.

If we look closely to their 2015 operations, they reported negative sales growth and this was due to shutting down of one of their furnace of Taloja. This resulted in lower depreciation cost, and also other expenses like power, fuel and water resulting into higher EBIDTA margins.

The sales of architectural glass also fell down by almost 19% because of the shut down and now it was representing only 39% of the total sales of the company.

2016

Then in 2016 they came out with bigger profit figure and also paid of Rs 100 crore of their debt. They also reaffirmed that in the coming 2 -3 years they will keep doing this without compromising on any growth opportunities. It is fair enough if the opportunity could generate higher returns. Their net debt stood at Rs 1,014.44 crore, down by approximately Rs 80 crore from the last year.

The total sales revenues increased by 4.67% compare to last year and its EBIDTA margin stood at 17.96%. Looking at their operations more closely, we found again that Architectural glass business sales sliding down further by 3.31% and now represent only 36.15% of total sales. The margins improved because of less consumption of power, fuel and water expenses.

2017

Last financial year they have seen strong revenue growth of 9.72% to Rs 2,614.02 crore and their EBIDTA margin standing at 16.90%. This helped them to report profits of Rs 131.33 crore for the year. Again, net sales of Architectural business this time jumped up by marginally 1% and now it represents 31% of total sales revenue.

The net debt as of March 2017 for the business stand at Rs 1,032.51 crore.

Conclusion

We like the business and its operations and specially its monopoly in automotive glass manufacturing. But we don’t like the business model on what it is operating. With close to Rs 500 crore of shareholder equity and Rs 1,000 crore of debt on the book, its operations generated net profits of Rs 131 crore plus Rs 139 crore in payment of its interest cost.

It can become more attractive if they change this business model around. The management knows about this but the process of change is too slow. If another financial crisis hits the market, Asahi India Glass will find themselves back into the same 2010 – 11 situation.

There is a good scope for margins to improve but to do that it needs investments in the cost efficient technology in their plants. By closing down one old plant, even after denting its total revenue figures for the year, improved its efficiency in using all the resources and improving its margins. The resources used to manufacture Architectural Glass are chewing up its margins by extra operative cost and taxes. I think they should more concentrate on automotive glass business and turn this business model more profitable.

One of the analyst is expecting its revenues to grow by 5% in 2018 and report profits of Rs 235 crore for 2018 financial year. It looks achievable as we expect its margins to improve. If those analysts numbers looks real to you then Asahi India Glass is trading at little discount to its 2018 intrinsic value calculated by us.

Our investment conviction in this story is very low to 35%. This is mainly because of its high debt. Our allocation tool is pointing towards not to invest more than 11% of your individual stock allocation to this story. With our conviction level (35%) factor in, we are happy to not invest more than (35% * 11%) 3.85% of our individual stock allocation at current market price.

We own very few stocks of Asahi India Glass in our portfolio and will be re-looking at this investment story in coming quarters to upgrade/degrade our conviction level.

What is your conviction level on this story?