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DCW – Stock of the Month (March 2014)

26 February, 2014

Price: Rs. 10.60

INVESTMENT RATIONALE
 Strong Financial Position
 Over the last 5 years, DCW Limited (“DCW” or “Company”) sales and net profit have been consistently on the rise. In FY 2013, the Company’s top line grew by 12.13 % year-on-year to Rs. 1,327.80 Cr from Rs. 1,184.12 Cr. Growth in FY 13 was largely on account of higher price realization on Beneficiated Ilmenite (used in Welding electrodes, Paints, Titanium Sponge etc) which is an export oriented product, as a result exports were up 60 %, from Rs. 153.19 Cr. to Rs. 255.82 Cr.

DCW Stock Analysis

 The Company delivered a good performance for FY 2013 with revenues increasing by 12.13 % to Rs. 1,327.80 Cr. as compared to Rs. 1,184.12 Cr. in the corresponding previous year. The EBITDA grew by 99.11 % to Rs.  248.46 Cr. as against Rs. 124.78 Cr.

AT CMP OF Rs. 10.60 (26TH FEBRUARY, 2014), THE STOCK IS TRADING AT A PE OF 2.10X. WE BELIEVE THAT AT THIS PRICE, DCW OFFERS GREAT LONG TERM POTENTIAL.

Diversified Business Division

DCW  operates in three diversified business segments viz. Poly Vinyl Chloride (PVC), Chloro Alkali (Caustic Soda) and Soda Ash. Thus, the Company is reasonably protected from the fluctuations of individual business cycles of these products. Product diversification helps the company to maintain high margins at a consolidated level. The Company’s products are used by various industries like textiles, pulp & paper, soaps & detergents, alumina, water treatment, petroleum, fertilizers, pharmaceuticals, agrochemicals, plant protection, dyes & dyes intermediates, etc. and it has marked its presence across the globe even against stiff international competition by exporting its products.

DCW Stock Analysis

PVC Division

The Company, one of the country’s top five producers of PVC resin, has maintained its market share of nearly 7 %.  Over the last 5 years, PVC demand is growing at a CAGR of 10 %. The government has identified infrastructure, agriculture and water management as important areas for development. This provides the Company with an opportunity to increase its PVC capacity to meet demand-supply gap in future. Moreover, On 10th May’13, the government has increased import duty on PVC from 5% to 7.5%. This will reduce competition from imported PVC.

Caustic Soda Division

The Company continues to be a major player in South India with a market share of approximately 15 %.  The demand for caustic soda is expected to grow at a steady rate of 4% to 5%, especially with increased demand from alumina manufacturers.

Soda Ash Division

The Soda Ash Industry continues to grow at a compounded rate of 4 % to 5 % per annum and this trend is expected to continue due to strong demand from end user industries. Imposition of Antidumping duty (A protectionist tariff that a domestic government imposes on foreign imports that it believes are priced below fair market value) on import of Soda Ash from countries like Iran, Pakistan, China, Ukraine, Kenya, European Union and the U.S. by Government of India, will protect the industry against dumping of Soda Ash and will help the domestic industry.

Capacity Expansion

The Company signed Technology License agreement with Arkema France for putting up Chlorinated Poly Vinyl Chloride (C–PVC) Plant at its Shupuram Facility, in Tamil Nadu. The project will help the Company to manufacture value added product from its in house products PVC and Chlorine.

DCW is planning to increase its Trichloroethylene (used as a solvent to remove grease from metal parts; also found in some household products, including typewriter correction fluid, paint removers, adhesives) capacity by 5000 TPA which will replace the imports of Trichloroethylene. Currently, the Company has capacity to manufacture 7200 TPA Trichloroethylene. These initiatives will help DCW in increasing its captive consumption of Chlorine, reducing its dependence on sale of chlorine.

 INVESTMENT CONCERN

Rising raw material prices (Inflation) and currency volatility

In addition to the slowdown in industrial production and consumer spending, India has been suffering from a high rate of inflation for the past many months with the general level of prices for commodities and raw materials rising at an alarming rate. High inflation has also kept R.B.I. from cutting key interest rates.

The Company is exposed to volatility in the raw material prices. DCW imports a large part of its raw material for synthetic rutile and PVC. The average Indian rupee/U.S. dollar exchange rate was approximately 48.53 per $1.00 in FY 2012. For FY 2013, it has been in the range of 60 – 63 per $1.00. This volatility in currencies is likely to continue in future as well. Accordingly, the Company’s operating results have been and will continue to be impacted by higher raw material prices and fluctuations in the exchange rate.

Fragile state of economy

Besides the satate of high inflation in India, the company is suffering on account of a prolonged slowdown in the global economic conditions which continue to be somewhat challenging with tighter credit conditions and slower growth since the financial crisis which started in the middle of FY 2008. The recovery has been the slowest in recent times and even after 6 years, the economy is not yet back on track and many downside risks remain. Given that 32% of total sales of DCW are from exports, the state of global economic environment affects DCW in a material way.

DCW Stock AnalysisIn the United States, unemployment is still high but. In the Europe, sovereign debt problems continue to be a concern and may derail the recovery. Political turmoil in Middle East continues to threaten oil supply. India has been struggling with record high inflation numbers which has restricted the RBI from cutting key interest rates. Global economic conditions and confidence in recovery affect the Company’s clients’ businesses and the markets they serve. While we believe that we are nearing the end of a bad economic cycle any meaningful improvement in the economy will primarily depend upon progress on the following fronts:

♦    European sovereign debt crisis;

♦    The structural challenges which the US employment market is facing; and

♦    The state of high inflation in India.