The Hindu Business Line : Supreme Petrochem: Hold

Though valuations appear stretched, the expansion of the company's polystyrene capacity and diversification into expandable polystyrene are likely to result in earnings growth over the medium term.

Low operating margins are among the key dampers. Softening crude prices are, however, likely to improve the company's margins.

Existing Business

Supreme Petrochem is among the larger players in the polystyrene business, making a range of grades, including general-purpose polystyrene (GPPS) and high impact polystyrene (HIPS).

Apart from occupying a dominant position in the domestic market, the company is a sizeable global player. At about 40 per cent, exports contribute a chunk of the company's revenues.

In the recent past, exports have been the key revenue growth driver, registering a 39 per cent growth in the past five years. Mounting pressure from overseas competitors and a surge in freight rates appear to have dented Supreme Petrochem's margins.

Polystyrene is primarily used in cabinets for consumer durables, product casings, food packaging and toys. In 2005-06, the company's colour master batches business registered a commendable 25 per cent revenue growth. Its intense focus on this higher value-add segment is likely to improve margins and contribute to earnings growth.

Expandable Polystyrene

Supreme Petrochem has of late diversified into the expandable polystyrene business. In March 2006, it acquired a majority stake in Shin Ho Petrochemicals. With this acquisition, Supreme Petrochem has diversified into expandable polystyrene. The company plans to raise the capacity of Shin Ho Petrochemicals' facility at Chennai by 150 per cent to 15,000 tonnes. Supreme Petrochem plans to expand its presence in this segment by setting up a 60,000-tonne plant at its existing facility near Nagothane, Maharashtra.

The expandable polystyrene industry to a large extent depends on the white goods and industrial and commercial air-conditioning industries. Higher disposable incomes and strong industrial growth are expected to translate into volume growth. Under-utilised capacities in the Asean region and a reduction in import duties pose a threat to Supreme Petrochem's expandable polystyrene business. Low re-cyclability of expandable polystyrene and high level of concentration in this business, however, provide a cushion.

Concerns

A key concern is Supreme Petrochem's low margins. The polystyrene business is raw material-intensive with input costs, primarily styrene monomer, accounting for about 90 per cent of operating expenditure. In recent quarters, higher raw material prices have shrunk Supreme Petrochem's operating margin to as low as 3.5 per cent. Softening crude prices are likely to result in lower prices of styrene monomer which, in turn, is expected to boost Supreme Petrochem's margins. However, rising freight rates is of concern as Supreme Petrochem imports a chunk of its raw materials.

In October 2005, the company increased its polystyrene capacity by 33 per cent to 2.72 lakh tonnes. With scope for higher operating levels in its polystyrene business and diversification into the expandable polystyrene segment, Supreme Petrochem is likely to maintain a 20 per cent revenue growth in the medium term.

Plans

Supreme Petrochem plans to set up a private port to meet its overseas logistics requirements and an SEZ in Maharashtra to boost domestic consumption of polystyrene by downstream units.

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