Description

Investment Thesis

Vardhman Acrylics is a small-cap stock (market cap: US$55mm, EV: US$17mm) in India, that trades at a cheap 2.7x earnings ex-cash and a 35% free cash flow yield. The company is in a slow growth industry that not surprisingly generates an ick reaction from investors from doing work. The stock has largely been ignored and there is no sell-side coverage. At current valuations and the recent 20% stock decline in last 6 months, the stock is compelling for micro-cap investors presenting a 50% upside over the next 18-24 months.  

What caught my attention now is that management has aggressively bought back a significant $9.8mm in stock and cancelled shares during the year ended March 2017. This is meaningful at over 15% of Vardhman Acrylics market cap. Share buybacks have taken place in prior years too but particularly notable last year, as the company also cancelled shares. The company has generated FCF every year with minimal capex since 2003 and has been consistently profitable the last 10 years. Therefore, I expect buybacks to continue at these prices.

In addition to buybacks, Vard’hman Acrylics has initiated a dividend last year for the first time in its history. This is consistent with the aim of returning some of the excess cash pile on balance sheet to minority investors. Cash still represents nearly 2/3rds of market cap and the company has had a strong net cash balance sheet the last 8 years. Given management intention publicly in interviews to distribute excess cash, I expect capital management to attract investors and value unlocking of the stock presents a higher probability event to occur.

The company may benefit from new GST reform in India, which will streamline the Acrylic Fibre (AF) chain as the chain is currently distorted due to exemptions and duty structure. This may lead to lower costs and higher demand which given valuations would be gravy on top. Demand for AF is expected to be better than 2016 and at current prices at just 4x FCF plus significant share buybacks, the stock trades at compelling valuations. 

Business model

Vardhman Acrylics is engaged in manufacturing man-made fibers and operates through Acrylic Fibre & Tow segment. It is majority owned by a leading Indian brand, Vardhman Textiles which ventured into manufacture of Acrylic Fiber & Acrylic Tow in 1999. A modern plant (18000 TPA Acrylic Staple Fibre and Tow production) with technology from Japan Exlan was set-up as a JV with Japan Exlan Co. and Marubeni Corporation in the state of Gujarat in western India.

Vardhman Acrylics products in India are used for apparel use, including children clothes, sweater, muffler, t-shirts, scarf, socks, tie, underwear, shirting, track-suits, shalwar kamiz and jersey. The Company's products also are used for household use, including carpets, woven blanket (circular knit), blanket (tufting), rug-bed sheet, bunting, bath mat, towel and draperies. The end use list is here: https://www.vardhmanacrylics.com/end-use-list.php

Currently the top 5 customers account for 60% of the company’s revenue compared to nearly 75% 2 years ago. Dependence on Vardhman Textiles for Vardhman Acrylic has gone down over the last few years. 

Significant buybacks at INR 50 – over 15% of market cap. Current stock price is a discount to INR 44 current price. Dividends paid signal capital management to help unlock value 

As per the company’s 20-F “The Board of Directors of the Company in its meeting  held on 22nd October, 2016 approved the buyback of 1,38,00,000 fully paid up equity shares of INR 10/- each, at a price of INR 50/- payable in cash, through the Tender offer route, upto an aggregate amount not exceeding INR 69 crores. During the year, the Company had bought back and extinguished 12,644,090 Equity shares of INR 10/- each at a price of INR 50/- per share. The paid up capital of the Company post buyback is INR 80,36,37,460”

In the last 5 years, Vardhman has previously bought stock in 2012 and 2013 of about $2.4mm and $0.3m. Those prove to be timely and right decisions, as the stock has since been a multi-bagger.

In addition to share buybacks, management has clearly stated their intent to explore cash on its books in an interview: http://www.moneycontrol.com/news/business/companies/exploring-options-to-use-cashbooks-vardhman-acrylics-959177.cms

For an obscure stock like Vardhman, sitting in a boring industry, the key catalysts on the stock are the fact that management intend to return cash to shareholders through either share repurchases, dividends. It is also possible, that the parentco may decide to purchase the company altogether, although I place a lower probability on this happening.

Free cash flow generative

The company has historically generated significant cash flow (even in periods of financial crisis) . Cash flow exceeds accounting earnings historically, and so quality of earnings is good. Return on unlevered (no debt) tangible equity are nearly 15%.

The historical free cash flow below in US$mm; year ended March.

2017: $6.5mm

2016: $3.1mm

2015: $7.8mm

2014: $6.1mm

2013: $3.5mm

2012: $3.9mm

2011: $2.3mm

2010: $6.5mm

2009: $5.2mm

2008: $4.2mm

Given this, the cash pile on the balance sheet will continue to be deployed towards capital management. Insiders are fully aligned with minority investors.

Consistently profitable last 10 years

Vardhman Acrylics has been consistently profitable in the last 10 years. Return on unlevered (no debt) tangible equity are nearly 15%. The below are net margins historically:

2017: 12.2%

2016: 9.9%

2015: 6.7%

2014: 9.3%

2013: 5.6%

2012: 6.3%

2011: 9.4%

2010: 16.1%

2009: 1.8%

2008: 2.6%

2007: 6.1%

Risks to thesis

The key risks for AF industry in India are related to weather (hotter weather) and fashion.

Next, spike in crude oil prices can also impact Acrylic Fibre (AF) consumption as it may lead to large cost increase and make substitutes attractive. However, given the current position of major crude oil producing countries and shale oil economics, odds are not in favour of major increase in crude oil prices. AF is a petrochemical product and is a crude oil derivative.

Over the last few years, more and more capacities of producing Propylene, a main raw material for Acrylonitrile, from non-traditional routes are getting commissioned. This is an encouraging development as Acrylonitrile plants are no longer dependent upon a single route for their raw material.

The INR is a risk, if depreciates, as it could impact demand growth in AF.  

Catalyst

Management has aggressively bought back a significant $9.8mm in stock and cancelled shares during the year ended March 2017. This is meaningful at over 15% of Vardhman Acrylics market cap. In addition to buybacks, Vard’hman Acrylics has initiated a dividend last year. This is consistent with the aim of returning some of the excess cash pile on balance sheet to minority investors. Cash still represents nearly 2/3rds of market cap and the company has had a strong net cash balance sheet the last 8 years. Given management intention publicly in interviews to distribute excess cash, I expect capital management to attract investors and value unlocking of the stock presents a higher probability event to occur. GST reforms in India are a catalyst, as it could lead to lower costs and boost demand.