Not a buy recommendation
Our investment case for Tarsons
The Indian plastic labware industry has undergone a rapid transformation over the last three decades from being dominated by imports from MNCs to now domestic players like Tarsons accounting for a significant part of the market. Among the top five leading players highlighted in the exhibit below, Tarsons accounted for nearly 44% of the cumulative operating profits over FY17-21 (despite having only 13% share of revenues) thanks to its significantly better operating margin. This share in profits is despite considering the entire operating profits of Thermo Fisher Scientific India which is also present in several non-plastic labware businesses like biotech, chemicals and wide-ranging diagnostics equipments.
Tarsons’ revenue and EBITDA growth over the FY16-21 period has somewhat lagged that of its peers – primarily on account of unprecedented revenue growth witnessed by some peers in FY21 like Genaxy Scientific (revenues up 210%) and Abdos Labtech (revenues up 57%) due to Covid-19 related demand. Tarsons whilst witnessing 30% YoY growth in FY21 couldn’t fully benefit due to capacity constraints (Tarsons has historically been operating at much higher utilisation levels vs peers). However, we believe this Covid-19 related spike witnessed in FY21 is unlikely to sustain going ahead as is also visible in significant tapering down of Covid-19 related test revenues reported by the listed diagnostic companies in the recent quarters. Hence, going forward, plastic labware industry revenue growth will be determined by conventional dynamics like quality, reliability and competitive pricing where Tarsons scores over peers.
Portfolio updates: Addition of Gujarat Ambuja Exports
We have made the following changes to portfolio in the month of March 2022:
Addition of Gujarat Ambuja Exports: Incorporated in 1991, Gujarat Ambuja Exports Limited (GAEL) is engaged in processing of Maize, Soya and Cotton and converting them into Starch & Starch derivatives, Soya meal & Soya oil and Cotton Yarns. Main customers for the company are from the FMCG, Pharma, Textile, Paper and Animal feed industries. Over the last 15 years, company has consciously diversified away from the low margin but highly volatile businesses viz. Soya and Cotton Processing with low barriers to entry. On the other hand, focus has been primarily on the Maize processing segment where the company has been successful in pulling away from competition in profitability, asset turns and return on capital. GAEL’s market leadership in the Maize processing business is underpinned by its efficient manufacturing operations (high level of plant automation, in-house power plants, raw material procurement/storage strategies etc). Furthermore, in the value-added product segments like starch derivatives, considering that products are sold to regulated industries like Pharma and FMCG, getting customer approval involves long gestation periods which acts as barrier to entry. Add to that, the extensive manufacturing footprint spread across India makes GAEL a preferable supplier to its customers. In the maize segment, the company has grown its revenue and EBIT at 11% CAGR and 20% CAGR respectively over the last 5 years (FY16-21) with average ROCE of 21%. With its two new manufacturing facilities coming in Malda (West Bengal) and Sitarganj (Uttarakhand), Gujarat Ambuja is expanding its capacities by 67% and is also entering some new product categories
Here are two examples of mistakes we have made around the assessment of capital allocation decisions in our portfolio companies:
1) Our position sizing in Page Industries until FY19 did not reflect the firm’s inadequate investments in technology when the going was good (i.e., prior to 2018): Page Industries reported one of the healthiest and most consistent growth in fundamentals until FY18. Over the five years of FY13-18, Page reported 24% revenue CAGR, 25% PAT CAGR, 57% FCFF CAGR and 60% average ROCE over FY13-18. Over the ten-year period of FY08-18, Page reported 30% revenue CAGR, 31% PAT CAGR and 55% average ROCE over FY08-18. These fundamental strengths were backed by exceptionally strong competitive advantages around the high quality of products offered at affordable prices due to its in-house manufacturing, a distributor-led approach to ensure product availability at MBOs, and an aspirational brand recall created by using European models (instead of Bollywood celebrities). Supporting the strong growth rates was the widening of its product portfolio, initially from men’s innerwear to women’s innerwear, and subsequently from innerwear to outerwear and loungewear. However, behind the scenes, the firm didn’t invest adequately enough in technology, systems & processes around its distribution and supply chain over the period 2014-2018. Our research carried out until FY19 did not pick up this lack of tech investments and hence the risk of operating inefficiencies in a business which was fast expanding its range of SKUs. This risk played out after GST introduction as working capital of the channel was adversely impacted and Page couldn’t resolve such challenges faced by their dealers and distributors. To make matters worse, some new competitors also capitalised on the opportunity to expand their distribution network by targeting disgruntled channel partners of Page Industries. By the time we became aware of the root cause of the problem (inadequate capital allocation towards systems and processes), the firm’s fundamental growth rates had started moderating significantly - 9% average annual revenue growth reported over the next six quarters (from 2QFY19 to 3QFY20).
Our mistake - The lack of granularity in our capital allocation framework prior to 2019 meant that we didn’t ask all the deep questions we should have asked during our primary data checks on Page. Hence, even though our investments team correctly identified the strengths of Page Industries’ business, the position sizing of the stock did NOT reflect the risks highlighted above. Page Industries was amongst the highest allocation stocks in Marcellus’ CCP portfolio in FY19.