Solar Industries India Ltd (SIIL)

Stock Update
HDFC Sec Scrip code SOLEXPEQNR Industry Explosives CMP Rs. 743.10

CMP: Rs. 743.10

August 12, 2011
Recommended Action Buy at CMP and add on dips Average Band 656-700 Sequential Targets Rs. 805 and Rs. 864 Time Horizon 2-3 quarters

We had initiated coverage on Solar Industries India Ltd (SIIL) on 3 Nov 2010 at Rs. 555.40 with a recommendation to buy the stock at the current market price and to add on declines to the Rs. 510-530 price band for sequential price targets of Rs. 641 and Rs. 665 over the next 1 year. The stock touched a low of Rs 517 on Feb 30, 2011 thus entering our average band. The stock made a high of Rs. 675 and met its second target on 19th July 2011. It is currently trading at 743. We present an update on the company post the Q1FY12 results and interaction with the management.

Company Background
Founded in 1995, Solar Industries India Limited (SIIL), formerly known as Solar Explosives Limited, is one of the largest manufacturers and exporters of explosives in India. SIIL has a consolidated installed capacity of 3,31,700 MT of explosives (95,700 MT of cartridge explosives and 2,36,000 MT of bulk explosives), 175 mn detonators and 93 mn mtrs of detonating fuse, which is the highest installed capacity in India. SIIL supplies to the domestic market where it has a 23-24% market share spread across 16 locations in 8 states across India. It exports to more than 15 countries; key export markets include Africa, South East Asia, the Middle East and east European countries. SIIL has a 50% market share in exports of explosives and its accessories from India. SIIL is the largest supplier of packaged explosives to Coal India Limited, which consumes about 65-70% of the country's demand. Besides that, SIIL supplies to other major Public sector and Private sector companies in the steel industry, cement industry and various other companies in the infrastructure and construction sector.

Key Highlights(Consolidated) of Q1FY12 and FY11 Results

Particulars (Rs cr) Gross Sales Excise Duty Net Sales Other Operating Income Other Income Total Income Total Expenditure Raw Material Employee Costs Other Expenditure EBIDTA Interest PBDT Depreciation PBT Extraordinary item Tax PAT Less Minority Interest PAT after adjustments EPS Equity Face Value OPM % Q1FY12 258.0 15.6 242.4 2.0 6.4 250.8 205.1 151.0 10.2 43.9 45.7 3.7 42.0 2.9 39.2 0.0 12.6 26.6 1.6 25.0 14.4 17.32 10 16.1% Q1FY11 172.1 11.2 161.0 0.1 3.4 164.4 131.2 91.9 6.6 32.6 33.3 3.0 30.3 2.0 28.3 0.0 10.2 18.1 0.0 18.1 10.4 17.32 10 18.6% % chg 49.9% 39.4% 50.6% 1745.5% 89.9% 52.5% 56.4% 64.3% 53.8% 34.7% 37.4% 22.4% 38.8% 41.8% 38.6% NA 23.2% 47.3% NA 38.5% 38.5% Q4FY11 215.7 13.8 202.0 0.2 9.0 211.1 162.8 113.7 8.9 40.3 48.3 6.6 41.7 2.1 39.6 -0.8 14.0 26.5 5.5 21.0 12.1 17.32 10 19.4% % chg 19.6% 13.2% 20.0% 1253.3% -28.8% 18.8% 26.0% 32.9% 14.9% 9.0% -5.3% -44.3% 0.8% 38.3% -1.1% NA NA 0.5% NA 19.3% 19.3% FY11 722.9 43.4 679.4 0.4 26.6 706.5 558.0 385.0 31.3 141.7 148.5 12.8 135.7 8.5 127.2 -0.8 45.1 82.9 7.4 75.6 43.6 17.3 10.0 17.9% FY10 % Chg y-o-y 590.2 22.5% 32.8 32.5% 557.4 21.9% 3.1 -86.2% 22.9 15.9% 583.4 21.1% 471.4 18.4% 327.8 17.5% 21.8 43.5% 121.8 16.3% 112.0 32.5% 13.4 -4.5% 98.7 37.5% 7.9 8.3% 90.8 40.1% 0.0 NA 32.2 40.1% 58.6 41.5% 0.0 NA 58.6 28.9% 33.8 28.9% 17.3 10.0 15.9%
(Source: Company, HDFC Sec)

Segmental (Rs cr) Explosives Trading Others Total PBIT Explosives Trading Others Total PBIT % Explosives Trading

Q1FY12 207.4 34.5 2.55 244.5 36.02 0.44 0 36.46 17.4% 1.3%

Q1FY11 138.93 22.03 0.11 161.1 28.52 -0.63 0 27.89 20.5% -2.9%

% chg 49.3% 56.6% 2218.2% 51.8% 26.3% NA NA 30.7%

Q4FY11 163.66 14.28 24.19 202.1 38.39 -0.32 0 38.07 23.5% -2.2%

% chg 26.7% 141.6% NA 20.9% -6.2% -237.5% NA -4.2%

FY11 576.7 78.72 24.47 679.9 114.57 -0.35 0 114.2 19.9% -0.4%

FY10 % Chg y-o-y 435.4 32.5% 103.29 -23.8% 21.77 12.4% 560.5 21.3% 80.99 0.22 0 81.2 18.6% 0.2% 41.5% -259.1% 40.6%

Retail Research

Others Total Capital employed Explosives

0.0% 14.9% 522.09

0.0% 17.3% 401.62 30.0%

0.0% 18.8% 501.02 4.2%

0.0% 16.8% 501.02

0.0% 14.5% 372.69 34.4%

(Source: Company, HDFC Sec)

Q1FY12
In Q1FY12, SIIL recorded Net Sales of Rs 258 crs, up 50.6% y-o-y and 20% q-o-q buoyed by good performances in both the Explosives and Trading segment. Explosives segment witnessed 49.3% y-o-y and 26.7% q-o-q jump in revenues to Rs 207.4 cr with Zambia, Turkey and Nigerian operations kicking in revenues for the quarter. Supply to Coal India during the quarter was Rs 64 cr. Ammonium nitrate trading sales too recorded a good jump in the topline at 56.6% y-o-y to Rs. 34.5 cr. Sequentially, revenues in the segment has more than doubled. Other segment which mostly constitutes sale of scrap, return of raw material and packing material registered revenues of Rs 2.6 cr against Rs. 0.11 cr in Q1FY11 and Rs 24.2 cr in Q4FY11. Exports during the quarter were Rs 20 cr out of which Rs 9.2 crs pertains to subsidiaries. There was a 58.5% drop from Rs 31.6 cr in exports over corresponding quarter last year, largely due to shipment delays. Coming to overseas operations, Zambia posted revenues of Rs 12.5 cr, Nigeria Rs 14.6 cr and Turkey Rs 5.2 cr. Revenues from Nigeria and Turkey were from trading operations. Trial production in Nigeria has been done and manufacturing would start contributing from Q2FY12.
Particulars (Rs in crs.) Sales Zambia Nigeria Turkey 12.5 14.6 5.2 Q1FY12 PAT 2.7 1.5 0.3 Sales 71.8 14.8 9.6 FY11 PAT 10.9 1.8 0.3
(Source: Company, HDFC Sec)

Company posted lower operating margins of 16.1%, a drop of 250 bps y-o-y and 330 bps q-o-q because of higher input costs and lower exports. Exports traditionally give better margins. Raw material cost, on the other hand rose 64.3% and 32.9% over the said period. It was attributable to the change in product mix in Q1FY12 with increase in manufacture of bulk explosives. As a percentage to sales, raw material cost have risen to 61.8% in Q1FY12 from 57.1% in Q4FY11 and 56.2% in Q1FY11. Employee cost has been almost stable at 4.2% this quarter compared to 4.1% y-o-y and 4.4% q-o-q as a percentage cost to sales. Other expenses have actually fallen in Q1FY12 due to lower exports leading to lower selling & distribution expenses. Interest cost at Rs 3.6 cr increased by 22.4% y-o-y and decreased 44.3% q-o-q. Exchange gain of Rs 0.6 cr has been adjusted in interest cost as per new accounting policy adopted by the company. Depreciation costs were up 41.8% y-o-y and 33.8% q-o-q at Rs 2.9 cr in line with the capex carried out by the company. Other income jumped almost 90% to Rs. 6.4 cr mainly because of higher interest income. Minority interest (representing local partner stake in overseas subsidiaries) was Rs.1.59 cr during the quarter. SIIL reported a PAT of Rs 26.6 cr, a jump of 47.3% y-o-y and almost flat sequentially. Of these profits, Rs 4.5 cr came in from its African operations. Zambia posted a PAT of Rs 2.7 cr, Nigeria - Rs 1.5 cr and Turkey Rs - 0.30 cr. Tax rate for the quarter is lower at 32.1% from 36.1% in Q1FY11 and Q4FY11 as profits from Zambian operations do not attract any tax for five years.

FY11
For the full year ended FY11, company recorded Net Sales of 21.9% to Rs 679.4 cr over FY10. This came by with higher sales volumes in explosives which was up 15.9% to 1,29,854 tonnes and higher realizations of 17%. Realizations were better with higher exports of Rs 72.7 cr a jump of 75.8% over FY10. Revenues from Nigeria stood at Rs 72 cr, Rs 15 cr from Zambia and Rs 10 cr from Turkey. Explosives segment grew 32.5%; but for the degrowth of 23.8% in the trading segment overall sales growth was just 21.9%. Operating margins were up 200 bps to 17.9% mainly because of higher exports and lower dependence on Coal India. Revenues from Coal India have come down to 24.8% from 29.7% while exports have gone up from 10.4% to 23.5%. Operating margins of Nigerian operations are 22.5% while Zambia operates at 12.5% margins. Also, raw material cost and other expenses as a percentage cost to sales have come down 220 bps to 56.6% and 100 bps to 20.8% over the previous period resulting in less pressure on the operational front. Employee costs increased by 43.5% y-o-y on account of hiring in India and Africa. As a percentage cost to sales, it was up 70 bps to 4.6% over FY10. Interest costs have come down 4.5% to Rs 12.8 cr as company switched its loans from LIBOR rate to ECB rate. PAT rose 41.5% to Rs 82.9 crs. Profits from Zambia operations stood at Rs 1.8 cr, Nigeria Rs 11 cr and Turkey Rs 0.29 cr. Minority stake to subsidiaries stood at Rs 7.4 cr.
2

Retail Research

Other Updates
SIILs plant at Nigeria (manufacture bulk (10,000 MT) and cartridge (5,000 MT) explosives) has completed its trial run production in Q1FY12. Manufacturing could start from Q2FY12. In FY12, it expects trading sales to be about Rs. 75 cr and Rs. 20-25 cr from manufacturing. Trading mainly consists of detonators and detonating fuse (explosive initiation devices). So far investment of USD 3.5 mill have been made for the Nigerian plant with the total cost of plant being USD 4.2 mill. SIIL expects Zambia (bulk explosive capacity of 10,000 MT) to contribute Rs. 50 cr to top line in FY12. A cumulative investment of USD 1.1 million has been made for Zambia with total cost of plant being USD 2.1 million. The balance cost incurred is through loans given by JV partner. Facilities in Turkey are still to go onstream so activities carried out are mostly trading. Total plant cost of Turkey was USD 6.3 mill with an investment of USD 2.5 mill done so far. The Tanzania operations set up to manufacture bulk (5,000 MT) and cartridge (5,000 MT) explosives are likely to get delayed further. So far land has been acquired and civil construction has started. In the recent Coal India tender for bulk explosives, SIIL has won the contract to supply ~74,000 MT (up from 60,000 MT in the previous year) of explosives in FY12. In FY11, SIIL supplied explosives to the tune of Rs 179.2 cr to Coal India which is expected to go up to Rs 250 cr in FY12. Margins from Coal India supplies are typically lower. The management is confident of offsetting lower margins in bulk with higher margins from cartridge explosives and explosive initiating devices and components. SIIL had allocated Rs. 200 cr for its capacity expansion. In FY11, Rs 52 cr was spent on domestic and the remaining ~ Rs 38 cr on overseas capacity expansion. For FY12 & FY13, company has earmarked Rs 100 cr for its expansion plans. Besides internal accruals Company has taken an ECB amounting to USD 10 mill. We would like to highlight that H2 of the financial year is typically better than the first half. Q2 is also impacted due to the monsoon and closure of mining activity. Q3 and Q4 are expected to be good quarters for the company. No major developments have happened as far as companys mining ventures are concerned. SIIL had got stake in two coal blocks at Madanpur and Bhatgaon. SIIL is in the process of developing specific products for the Defence Sector using the expertise available with them.

Concerns
Fluctuation in raw material prices, mainly ammonium nitrate Unexpected increase in raw material costs (Esp. ammonium nitrate) could significantly impair SIILs operating profitability. Ammonium nitrate, accounts for more than around 60 per cent of the companys raw material costs for manufacturing explosives. It, is therefore, vulnerable to increasing prices of natural gas, a key input in the manufacture of ammonia. However, the risk is mitigated by the cost escalation clauses in its contracts with CIL and other major clients. Trading in ammonium nitrate SIIL trades in ammonium nitrate (due to importing in bulk & using major portion for own consumption) which adds to top line growth but the contribution to bottom line is minimal. Seasonality Due to monsoon, the sale of explosives during Q2 of the financial year is generally lower. This could result in some fluctuation from quarter to quarter. Slowdown in core infra growth SIILs fortunes are closely linked to the growth in mining activities, which in turn are dependent on growth in power, metals, cement and investment in road infrastructure. Slowdown in the overall economy could impact the demand for explosives negatively. Adverse regulatory changes - Warehousing, marketing and transportation of explosives is subject to government regulations. The company can sell the product only to licensed buyers. Also, to set up explosives plants a number of licenses and approvals are required. Dependency on Coal India SIIL is dependent on Coal India for about 25% of its revenues. If for any reason, CIL undergoes some financial trouble or a slowdown in mining activity in could impact SIIL adversely Execution risks and Venture into Africa SIIL is expanding operations in India and Africa. Any delay or hurdles along the way could reduce the companys growth prospects and also impact our estimates. In Africa the company faces execution, pricing and regulation risks among others. Competition in India and Africa SIIL faces competition from players such as Orica, Gulf Oil Corp, Premier Explosives etc in the domestic market and Orica, Sasol, BME etc in Africa. Increase in capacity of any existing player could lead to further price competition in the market. SIIL also faces competition from the unorganized market in India. Diversifying into coal SIIL has economic interest in two coalmines. Delay in start of operations due to regulatory reasons or otherwise could depress return ratios in the medium term. Forex risk SIIL is a net user of forex. Sharp fluctuations in the USDINR (depreciation of the INR) could impact the company negatively. Liquidity in the stock The free float of this stock is limited as 74.6% is held by the promoter and 15.49% by domestic institutional investors. As a result, the impact cost could be high and adversely impact returns. Hence, we suggest spacing out buying in the stock.

Retail Research

Conclusion:
SIIL is a Nagpur-based manufacturer of industrial explosives, which are mainly used for mining and infrastructure projects. SIIL, which is the market leader in India, is likely to benefit from growth in the countrys mining sector and several new infrastructure projects. The global explosive industry is USD 10 bn while the Indian explosive market is around Rs 24 bn. Increased investments into the mining sector over the years have fuelled demand for government outlay during the XI Plan stands at Rs. 6,00,000 cr for electricity production and Rs. 3,00,000 cr for roads and bridges. During the XI plan, 62,000 MW could be added to the existing power capacity of which about 70% is thermal. All the above will spurt demand for coal. Hydropower generation is set to increase by 17,000 MW requiring large scale excavations and tunneling operations. As a result of power, cement, steel and infra demand, the growth of explosives demand in the country could be about 10-12% p.a. SIIL will maintain robust growth over the medium term on the back of increasing demand from the energy and infrastructure sectors. Furthermore it could benefit from its enhanced presence in the international markets. Volatility in ammonium nitrate prices is a risk though partly offset by price escalation clauses with some customers. We like SIIL due to its strong market position, good operating efficiencies (backed by prudent raw material procurement policies and backward integration), and strong balance sheet. Further, SIIL has now expanded its geographical horizons to Zambia, Turkey and Nigeria where its manufacturing units are at different stages of development and operation. We expect SIILs African operations to grow in size over the next 2-3 years. In FY11, about 6% of revenues came from manufacturing sales in Africa while in FY12 this could go upto 17%. As per the company, the profitability of operations in Africa is better than India and hence we expect net profit margins in the 10-11% range for FY12. We are revising upwards our estimates for FY12 given the lower exposure to Coal India and higher contribution from overseas subsidiaries. Topline could be higher at Rs. 888.3 cr as against Rs.679.4 cr with manufacturing operations in Nigeria to start contributing from Q2FY12. Net Profit could be higher at Rs 103.2 cr with lower tax rate as Zambia operations are exempt from tax. At the CMP of Rs. 743, SIIL is quoting at 12.5 FY12 (E) EPS of Rs.59.6 respectively. Fresh investors could buy the stock at CMP and add on dips to Rs 656 - Rs 700 (11-11.75x FYE EPS) for sequential price targets of Rs. 805 and Rs.864 (13.5x and 14.5x FY12E EPS).

Financials
Consolidated (Rs in crs.) Net Sales Other Operating Income Other income Total Income Total Operating Expenditure EBITDA Margins % (without other income) Interest Depreciation & Non cash charges PBT Taxation Net Profit Less Minority Interest Net Profit after MI EPS FY08 281 0.8 10.9 292.7 221.6 71 21.3 10.6 5.5 54.9 18.8 36.1 0 36.1 20.9 FY09 487.8 10.3 15.7 513.8 418.1 95.7 16.1 23.5 6.2 66 21.9 44.1 0 44.1 25.5 FY10 557.4 3.1 22.9 583.4 471.4 112 15.9 13.4 7.9 90.8 32.2 58.6 0 58.6 33.8 FY11 (E) 658.6 1 22 681.6 547.5 134.1 17 9 9 116.1 39 77.1 3 74.1 42.8 FY11(A) 679.4 0.4 26.6 706.5 558.0 148.5 17.9 12.8 8.5 127.2 45.1 82.9 7.4 75.6 43.6 FY12 (OE) 828.1 1 18.5 847.6 685.5 162.1 17.3 15.8 12.4 133.9 45.5 88.4 6.1 82.3 47.5 FY12(RE) 888.3 1.0 25.5 914.8 727.3 185.4 18.0 15.8 12.4 157.2 44.8 112.4 9.2 103.2 59.6

(Source: Company, HDFC Sec, A- actual, OE original estimate, RE revised estimate)

Analyst: Ms Siji A. Philip (siji.philip@hdfcsec.com) RETAIL RESEARCH Fax: (022) 30753435 Corporate Office
HDFC Securities Limited, I Think Techno Campus, Building - B, "Alpha", Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Website: www.hdfcsec.com Email: hdfcsecretailresearch@hdfcsec.com Disclaimer: This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for Retail Clients only and not for any other category of clients, including, but not limited to, Institutional Clients

Retail Research