GMM Pfaudler Ltd(GMM) has been one of the stock getting lot of limelight due to the returns given by the stock amid the more than 2 years of market slump in India. Although I missed the early part of rally, learning what worked for the company will help us do better in the future. I will try to explain that in the blog “GMM Pfaudler Ltd- A proxy to pharma & chemical industry capex”
GMM Pfaudler Inc- Past 2 year share price movement
GMM Pfaudler Ltd- A proxy to pharma & chemical industry capex
GMM Pfaudler Inc- About the company
The company was setup in 1962 as 'Gujarat Machinery Manufacturers Private Limited' & got listed on BSE in 1963. The company started commercial production in 1965. In 1987 Pfaudler Inc., USA the world leader in Glass Lined equipment subscribed to 40% equity to form a joint venture. Pfaudler Inc. further increased their stake to 51% in 1999 and the name of the company was changed to GMM Pfaudler Limited(GMM).
The co. has a manufacturing facility spread over an areas of 20 acres at Karamsad in Gujarat. GMM manufactures engineered equipment and systems for critical applications in the chemical and pharmaceutical industries. They are the market leader in glass-lined equipment(GLE), other product portfolio includes Heavy Engineering, Mixing Systems, Engineered Systems and Filtration & Drying Equipment. The company is trying to grow revenue from the non GLE(NGL) segment and reduce the cyclical nature of the business. BUT AS OF NOW THE STORY REVOLVES AROUND THE GLASS-LINED BUSINESS.
About the parent: Pfaudler Inc was established in 1884, Pfaudler Inc. is a world leader in process solutions company, providing technologies, solutions, services and innovations to meet the specific requirements of its customers in the chemical, pharma and other process industries. THEY ARE THE ONE WHO INVENTED GLASS COATED STEEL EQUIPMENT.
The ownership of the parent Pfaudler Inc has changed hands several times and today is owned by a German private equity fund Deutsche Beteiligungs AG (DBAG).
GMM Pfaudler Ltd had 4 subsidiaries at the end of 2019 and all of them wholly owned (100%) by the parent.
1. Karamsad Holdings Limited– In the process of winding up
2. Karamsad Investments Limited– In the process of winding up
3. GMM Mavag AG- GMM Mavag AG was created only to act a vehicle to acquire the Swiss company ‘Mavag AG’
4. Mavag AG– Step down subsidiary i.e. subsidiary of GMM Mavag AG
A very lean structure. Going forward, the company will have only 2 subsidiaries.
In April 2019, the company Acquired Industrial Mixing Solutions Division(IMSD) of Sudarshan Chemical Industries Ltd, Pune. With this acquisition, GMM Pfaudler Ltd now have access more sectors such as minerals, metals, sugar, food etc
Pfaudler Inc is the largest player in the GLE segment with a market share of 35%. Pfaudler Inc receives 1% of glassline sales done by GMM.
GMM Pfaudler Ltd- Key Pointers
GMM Pfaudler Ltd- Acquisition of Mavag AG
GMM Pfaudler acquired Switzerland based Mavag AG in 2008.
Switzerland based subsidiary Mavag AG was setup in 1861 and is a leading supplier of highly engineered equipment for the pharma, bioengineering and fine chemical industries. Co. is technologically very strong but not run efficiently. Employee expenses contribute 53% of total costs.
The previous managing director of GMM ‘Ashok Patel’ stepped down in 2015 and is now serving as the executive chairman of Mavag AG. The idea is to focus on growing the business and enhance profitability. As a part of this strategy, basic work of Mavag is to be done in India by GMM and finishing is to be done by Mavag, thus lower cost of production.
Rationale for acquisition was to get presence in Europe, get access to latest technology for Indian market and use India as a low cost sourcing hub.
Also, Mavag is into non-GLE(NGL) segment and hence act as a vehicle for the management to diversify revenue.
GMM Pfaudler Ltd- A proxy to pharma & chemical industry capex
GMM Pfaudler Ltd- What has changed now?
Historically, GMM had been a mediocre company and has not been able to take advantages of change in cycles. Things started to change from 2015 onwards when Tarak Patel was made the Managing director that was coupled with change in ownership of the parent ‘Pfaudler Inc’.
Tarak Patel is the son of previous MD ‘Ashok Patel’. Tarak Patel joined the company in 2001 as sales executive and was made executive director in 2007 and MD in 2015.
He stepped up production, increased capacity, enhanced throughput, diversified to include heavy engineering as it is an unlimited market compared to small GLE market. He also has created milestones & other goal based documents and is pushing the entire team in achieving those targets.
With new focus, coupled with change in cycle in the end consumer sectors, the company has been trying to take maximum advantage of the ongoing tailwinds.
GMM Pfaudler Ltd- How are the product pricing decided?
The company will have inventory of several quarters worth of steel(raw material).
Based on the purchase price of raw material, the prices of equipment for the client to be made by GMM is decided. It usually cant be changed once the product price is finalized between the client & GMM.
If there is any increase or decrease in raw material prices, the price for next order is quoted with the new raw material prices. So, that protects margin from raw material price fluctuation but increases inventory costs. With new MD, the company is trying to do it more efficiently by managing inventory at an optimum level.
Raw material required is Carbon Steel(10-15%), Stainless Steel( 55%), Clad steel(25%), Exotic material-10%. Raw material is procured domestically.
GMM Pfaudler Ltd- Product Lines
1. Glass Lined Equipment (GLE):
The co. has more than 50% market share in glass lined equipment(GLE) in ₹500-600 cr Indian market. GLE is used mainly in pharmaceutical, agro-chemical and specialty chemicals.
Company’s GLE product is far more superior in a critical environment thus they charge 20% premium given than the parent is the inventor of GLE.
In FY19, 68% of the Company’s standalone revenue came from the GLE business. Good companies like Dr Reddy, Natco, Divis, wait for GMM equipment to install rather than get it earlier from competitors.
GLE is being the preferred choice of equipment for companies giving the benefits associated with GLE such as:
1. Glass is resistant to attack from chemicals (acids, alkalis, water and other chemical solutions)
2. Is smooth, anti-stick surface, easy to clean & does not introduce impurities to the process materials
In terms of export, the company needs to do that very specifically since the parent company is also into GLE and GMM does not want to create any areas of conflict. So, focus mostly on domestic demand(which is very strong now) and most of the export order are from the Pfaudler Inc itself to its subsidiary.
2. Heavy Engineering(HE):
Much more competitive segment but high volume but has very large market size. Therefore lower margins. In order to differentiate and have higher margins, the company is looking for established players who need strong engineering in terms of weightages & thickness of capacity much higher than offered by competitors.
Pfaudler Inc, the parent company are not into heavy engineering, so they are trying to get more orders from the parent’s network. Because of which higher percentage of export revenue comes from this segment.
Accounts for 13% of standalone revenue.
3. Proprietary Products:
Lot of metalwork is required in the below sub-segments. Contributed 19% of standalone revenue. The business acquired from Sudarshan Chemicals comes under this category.
Mixing Systems (MS)
Engineered Systems (ES)
Filtration & Drying (F&D)
GMM Pfaudler Ltd- Financial Analysis
GMM Pfaudler Ltd- Financial Analysis
The last few years have been exceptionally good for the company with the sales growing at a CAGR of 20% & PAT growing at a CAGR of 35% between 2016 & 2019. Two out of the 3 end industries i.e. Specialty chemicals & Agro chemicals have been doing very well since 2016-17 increasing their contribution from total sales from 30% to 50%. While pharma had been clouded with troubles such as strict FDA inspections and other similar issues had their total contribution to revenue drop from 50% to 20%, are seeing turnaround in their business environment. Pharma contribution has now increased to 30%.
The end customers prefer glass lined equipment compared to others equipment. And there is only a handful of them & quality is of prime importance. So, most of them wait to get it done from GMM. With the demand situation in favorable condition, the company has been able to charge little further premium(20% already due to superior product). \
Also, the company is debt free.
As you can see that the company has improved its return ratios, more so starting 2017 with the Chinese curb on chemical companies. GMM has substantially improved the cash conversion days from 172 in 2016 to 108 in 2019 by better management of inventory.
In 2018, the company changed the way of measuring output from number of count to the effort that goes on making one unit. Now, that on one hand makes measuring very difficult from tangible to intangible and on the other hand it makes sense as the equipment manufactured by the company are of different shapes and sizes, and the effort & time to make the smallest to largest would vary hugely along with the revenues earned from them. Had no option other than to trust management on this.
GMM Pfaudler Ltd- A proxy to pharma & chemical industry capex
GMM Pfaudler Ltd- Quarterly segment wise results
GMM Pfaudler Ltd- Growth Drivers
End consumer which are specialty chemicals & agro-chemicals are doing extremely well due to supply disruption in China. Now, the third customer segment which is Pharmaceuticals are also witnessing growth & hence expanding.
Increased focus on exports(HE) by creating agent networks in the Middle East, Africa, South East Asia and Eastern European markets. In GLE, for exports the margins are twice that of India.
Parent company Pfaudler Inc outsourcing order to the GMM Pfaudler
Telangana govt. decision to set up pharma city in Hyderabad.
Replacement demand in glass lined equipment
Current API disruption in China by Coronavirus can lead to capacity expansion by the Indian players
Entry into newer industries
Company has setup one more furnace in Jan 2020 and 2 more is going to come in June-July 2020. As of now the total furnace stands at 7. Since, the current capacity utilization stands at about 90%, the new furnace will be key in revenue growth.
All new furnace will be running on Natural gas than electricity, saving more than 50% in power cost
Clients wait for GMM Pfaudler to deliver them the product instead of importing them from Europe(much higher cost) and quality of Chinese companies can not be trusted.
GMM Pfaudler Ltd- Risks
GLE business which accounts for 68% of revenue is highly cyclical with its revenue depending on the end consumer. As of now things are going too good for the company with immense demand. But once the GLE order books start getting exhausted and start moving to normalization, the margins are going to see a dent. The life of a GLE is 7-10 years. Those clients will wait for 7-10 years for replacement once their current demand is met barring some maintenance & replacement in-between.
So these kind of business are good for investment with a horizon of 1-2 years and SHOULD NOT BE CONSIDERED FOR LONG TERM. A distribution led business is always better than order book based business for long term investment.
As of now they are getting few orders each worth ₹25-30 cr from 5-6 clients. Even if a couple of clients leaves or get done with, it can create sudden drop in revenue given the smaller size of the company.
GMM Pfaudler Ltd- A proxy to pharma & chemical industry capex
With the tailwinds with the company one can buy small amounts on dips and current economic situation enables to get to much more cheaper. Currently, the company looks quite expensive but a good correction will offer opportunities.
I was thinking on the line what made this stock a multibagger and the answer for me was ‘PRICING POWER’. If I compare to multibaggers of previous bull market such as HEG, GI, BEPL etc, they also had the benefit of end industry doing well(strong demand). Graphite electrode stocks were also benefited by supply side disruption as well. That brought pricing power to them. Such pricing power usually does not last long. So, one needs to regularly monitor the performance of the company.
Further reading:
Latest Interview: https://economictimes.indiatimes.com/markets/expert-view/strong-growth-in-chemicals-pharma-to-directly-benefit-gmm-pfaudler-md/articleshow/75158471.cms?from=mdr