Sheela Foam Limited (SFL) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the Q3 FY '21 Earnings Conference Call of Sheela Foam, hosted by Edelweiss Securities Limited. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Nihal Jham from Edelweiss Securities. Thank you, and over to you, sir.

Thank you, Margaret. On behalf of Edelweiss, I would like to welcome you all to the Q3 FY '21 Conference Call of Sheela Foam. From the management today, we have Mr. Rahul Gautam, Managing Director; Mr. Tushaar Gautam, Director; Mr. Rakesh Chahar, Director of Sales and Marketing; Mr. Dhruv Mathur, CFO; and Mr. Davinder Ahuja, VP, Finance. I would now like to hand over the call to Mr. Rahul Gautam for his opening remarks. Over to you, sir.

Thank you, Nihal. Thank you very much. And Margaret, thank you very much for starting this call. All our internal meetings, we generally start with our vision statement. And today, I consider all of you to be a part of our family. And therefore, I will start with our vision statement. [ We will continue to be recognized as a leading organization in quality comfort products while practicing values of ] integrity, reliability, proactivity and transparency; to do business with a smile for customer delight; and a commitment to society. Thank you very much. So I welcome you all to this meeting. And I understand that you are present here in large numbers and so thank you all once again for this. As we see, we are witnessing these times, which are -- which I can call them as the worst of times or the best of times. The world is changing, and changing extremely fast. We, at our end, are trying our best to keep pace with it. And we believe that this may not be a time to really drive any changes but a time to keep pace with the changes that are happening in the environment, to readjust, to negotiate with them, and in the process rebuild the company to face the new world as corona tends to fade away, and create those environment or circumstances which are very different from what they were before. So whether it is the health part that is becoming important or whether it's e-com for buying and purchasing that is becoming more important, those are changes that we have to deal with and we are trying our best, and we would continue to cope up with them. As far as corona is concerned, we are all aware that India is definitely experiencing the abatement of it, and most of the rural areas that I'm connected with have virtually no traces of corona. Even in the larger cities and bigger cities, it seems to be going down by itself. And I only hope and pray that there is no second wave or another mutant that comes about. And for Delhi, even the sero-survey states that about 56% or 57% people have antibodies and therefore somewhere or the other they have been sort of impacted by it, and now we are close to a herd immunity. So we don't know the exact reason, but it's definitely going down. When we look at 2 of our other geographies that we operate on, Australia had completely closed itself many months back. And just to narrate that a few days ago, they had 1 case in Perth and they locked down the city for 5 days. So that's the level to which they are controlling the connection with the outside world. Spain, on the other side where we operate in, is bad. It's part of the European Union. I think the people had a damn good time during the Christmas and New Year, and they were intermingling and now bringing out all the infections. In our small cities where we operate from in Spain, 4% of the population has been infected. Hospitals are under stress, et cetera. But vaccination has also started. And therefore we believe that soon the vaccination curve should take care of the corona part of it. The other big event that we had was, of course, the budget that was presented. Nirmalaji said -- in fact, she took the example of the cricket series that we won against Australia, and she said that that's the kind of new hope that that is emerging. Our thoughts on it are that definitely the budget was surprising. There were no disappointments at all. And I think she addressed all the required parts of the economy and probably much more than that. There was a lot for the future parts too. In the end, there was consistency as far as the budget was concerned. I think the basic change which we witnessed was that every time the country needs money for anything, the best thing to do is to increase tax or taxation, and I think that's a big change that is happening. On the other hand, if money is required or has already been spent on corona, the government is looking at disinvesting or is looking at raising funds elsewhere or looking at more compliance. And I hope that someday -- so today, of course, they have not laid any new taxes, but I hope that someday a situation also comes that reducing the taxes actually improves the compliance and there would be more money coming in. Simplifying the tax laws and simplifying the implementation of them would actually bring in more compliance and would improve the situation. The collections of the GST for January, which was INR 1,20,000 crore, it appears was like a premonition for this that the direction is right and it helped to probably change the starting sentiment of the budget. We've also witnessed the 15th Finance Commission and this report. And again, they have worked towards, let's say, for example, GST. They have suggested and recommended that there should be simplification, which means eventually to move to one rate of tax. But at the moment suggesting that [indiscernible]. So Simplification and Reduction, those are the mantras, I think, which are going to be there, and that feels very good as far as the industrial world is concerned. Nothing directly has impacted, whether in the direct taxes or the indirect taxes to Sheela Foam. But indirectly, there have been 3 areas where we believe that besides the good sentiment that the budget is setting, we believe that there would be impacts to Sheela Foam. Number one is the importance of railways and the extra budgets that have been given and the growth that will happen, and which means it's more business for us. Buses, similarly, where more cushioning is required, et cetera. And above all, is the affordable housing focus that the government has brought about. And we intend to work on all these 3 areas and to be there to support this direction that is there. So all in all, we look at FY '22 with immense amount of hope and enthusiasm and most definitely with new energy. There have popped up during these corona times, have been a lot of astrological predictions but one of the ones that I follow, not that I believe in it, but that I follow and who has been reasonably correct in the past in predicting the starting, et cetera, says that from April -- mid-April onwards everything will start normalizing and by the end of -- or middle of November corona will be history. And even the service industry and the hotel industry and the airline industry will come back to normalcy, and in fact come back with renewed energy. In our business, raw material is an important part. We all know that. And it's [ the least ] to say that in the previous 6 months it has been fluctuating like a wild wave that is still there. India rose -- the raw materials rose extremely high and then now are on the falling spree, except a minor aberration which has happened today morning or yesterday evening. In CDI, they've increased the price again by INR 6. But otherwise, by and large, the raw materials are reducing. Polyols are off the level of INR 200; TDI at level of INR 163 plus INR 6, let's say about INR 170. I think stabilizing around INR 170 level for both or INR 150 to INR 170 level for both will be something achievable by February end and we should be witnessing that. The other geographies, Australia has been steady. There is far more stability in that market, even for the raw materials. The same suppliers globally, but they look at Australia differently. Spain did not increase as much as India, but it appears that right through February it's on a bit of an increasing mode. All this converging to good, steady prices by end of February. That is how we look at it. There is one aspect which from -- the present government has been pushing hard and which is Aatmanirbharta. From our perspective, we -- whatever our imports were, we have looked at local replacement, especially in the textile area or the mattress picking area, and we can now say that we are absolutely indigenized under that. Not only that, for businesses like furniture business where imports from China or elsewhere, Middle East has -- sorry, Southeast has been coming in, we are doing our bit to ensure that the right grades of foam and the right grade of cushioning are available for that so that those imports into the country can be reduced. We're also working hard to support the furniture cluster that the Government of India wants to put in and preparing foams or making foams which will be completely compliant to what is needed in Europe and U.S. as far as the fire retardant is concerned and all the other general [ characteristics ]. On Aatmanirbharta side, we are doing our bit and more supporting the other segments so that we [indiscernible] the one change which we're noticing is on [indiscernible] And our presence -- I informed you last time last quarter that our presence was just beginning to happen. But now I can say we are reasonably present there and are increasing our presence and the market is also growing and we are getting a good foothold into that. And we are prepared to increase our initiatives on the e-commerce side. The 3 other areas which we have not forgotten in spite of whatever has been happening on the raw material side or the production side, but we have not forgotten, is the safety, health and the environment part of it. Safety, we look at the human safety first. In fact, have already made our application for getting vaccines, whenever if they become available, for our entire company manpower of the human resources. Health, we have -- it's a big change that has happened in the corona and the post-corona times. And we have offered our products, all our products come with Neem Fresche, which has been an antivirus up to almost 100%, of course we say 99.9. But that's a special innovation the company has done. It combines the natural products of India, neem, and it combines the technology from [ Australia ], the technology of Fresche. And that product is there in all the offerings that we make to consumers. On the environment front, we have been compliant for sure. In fact, Spain has recently been awarded a prize for doing their bit in reducing the carbon footprint, and they are going to the next levels of compliance. In India, we have embarked on a project of reducing plastic wastage completely. We do not believe in eliminating the plastics but definitely believe that there should not be any wastages from there, and that process is on. Our CSR activities also continue in spite of all the disruptions that happened of physically not being able to move around. And all our activities definitely required people to be present and to interact and take the programs forward. But we have found ways of connecting up online, teaching online and interacting with even the rural areas. So all activities have been -- have continued even during this period. In fact, we've learned a lot. And this will be a basis for even the future interactions when the corona goes away. And I'm hopeful that government will confirm to the vaccinating of people as a CSR activity, and we will be able to do it not only for the people but even for their immediate families. Another change that has happened, and I bring that to your knowledge, is on the export side. And this is the U.S. Bed in a Box program. Currently, the market is estimated to be about $600 million, primarily supplied by China as a bed in a box and exported to the U.S. But from the time that the sentiment has changed, they have been looking at elsewhere. I completely agree that actually competing with China or with the Chinese people, because those people have also moved their manufacturing bases to elsewhere, is tough and our country is also taking time to support the exports part of it. But let me just share with you that there are enough inquiries which are there. We are -- we have in fact begun already supplying to them some products from Spain which make it better and some products from India that make it better to go from here. Some challenges like the shipping disruptions and the container availability, but that we are expecting it to go away soon. Next financial year or the coming financial year, we are sure that this number would be past 3-figure mark in India, in crores of rupees. Financial results have already been shared with all of you. They have been good. I am not going to talk specifically about. I'm sure you people would have gone through it and would have your questions to clarify. Our team is here. But we are -- just on a quarter-on-quarter basis, the total consolidated top line has gone up by 25%, 26%. Even the EBITDA percentage has gone [ up ] and I hope that this becomes our normal, and we continue to improve from where we are. Mattresses, I would specifically want to spend a moment on that, in all the 3 geographies have come out as a big surprise. If we start from Australia, of course, they are big travelers and they have -- because there's no traveling, they have money in their pockets saved for the household product. Plus they have spent a lot of time at home and therefore recognize the mattress part of it. The government has also put money into their pockets. And above all is the factor, which is again the China factor, which is that the imports from China are getting restricted sentimentally and even from the government side a little bit. So all that is playing out and the mattress in Australia is growing, will continue to grow, and will be an important business segment for us to supply products into. [indiscernible] We are a very small part of the entire European Union market, but we -- and we have the U.S. program, this is just across the Atlantic, that will be there. And the mattresses, same reasons, similar reasons, have become important, and therefore the growth is there. In India, we're experiencing probably a little bit of a different factor, which is that 60%, 65% of the population doesn't sleep on any mattresses. So they are getting slowly converted to the unorganized part of the modern mattresses. And then there is a shift from the unorganized modern mattresses into the organized part and that's where we play. So mattresses will continue to play an important role in our lives. I know there is a constant pressure to always reduce the average selling price, but we work hard. And as we are now in the rebuilding mode, we're working hard to give more value to the consumer and in that process increase the ASP at a critical time. So with those words, I would thank you all once again and open the entire team for all the questions. Thank you very much.

[Operator Instructions] The first question is from the line of Sujit Jain from ASK Investment Managers.

Congratulations on a strong performance. I hope I'm audible. There's some disturbance.

Yes, you are audible. Members of the management, there’s some disturbance from your line.

There's a lot of disturbance in the line.

Ladies and gentlemen, we would request you to please stay connected while we reconnect the line of the management. [Operator Instructions] Ladies and gentlemen, thank you for patiently waiting. We have the line for the management reconnected. I would request Mr. Sujit Jain from ASK Investment Managers to start with your question.

Yes, Rahulji, our compliments for a very solid set of numbers. I have a few questions, sir, on the margins. First of all, I wanted to understand, let's say, if INR 100 is the selling price and, let's say, if INR 55 is the cost and gross margin is INR 45, of the INR 55, how much is TDI and how much is Polyol?

Okay. Dhruv, would you answer that question, please?

Yes, yes, yes. Of this INR 55, around -- in the current prices, around 30% is Polyol and 20% is TDI, on the net revenue.

On the net revenue, you are saying 30% is TDI and 20% is Polyol?

Correct, at the current prices.

That only leaves about 4%, 5% of the remaining cost, and that will be for what?

That will be -- because in mattresses the consumption of foam is very limited because like, cloth, spring, all those things are there.

Okay. So if I look, our gross margins have corrected but our other expenses there's a big saving of about close to 5%, 5.5%. How much of that will be retained because post-COVID travel conveyance, et cetera, will come back. So, A, what is the reason for this fall in other expenses? And how much of that can be retained?

These expenses are lower on 2 accounts, largely. One is on marketing expenses and selling expenses. And also based on operating leverages because the sales number is pretty good, fixed cost being fixed. That is the reason for this. And as far as going forward, it will be dynamic to the situation.

So if I quickly put it in terms of numbers, this OPM of 17.5% last 2 quarters versus of 14% in FY '20, so there is a rise of about 3%, 3.5%. How much of that can be retained because of operating leverage? Marketing and sales eventually will come back, like you said.

No, I never said that. I said it will be dynamic to the situation.

Okay. But I still want to know how much can be retained because of operating leverage? What will be the steady state operating margin?

So you are asking the steady EBITDA margin, probably that's your question?

Yes.

See, I will answer it is like this that if the sales remains the same, margin will be the same.

You can maintain this margin you're saying?

If the sales is like this.

Okay. Okay. And the other one...

And also one more caveat, and the raw material prices are the ones which we witnessed in Q3, because these things keep on changing. If you see the margin, gross margin has gone down from 49% to 43% because of the raw material price increase.

Yes, yes. And the other question is in terms of strategy to Rahulji. When you entered Spain and as well as Australia, of course, and like you said, there is a large untapped opportunity in India itself, how does Sheela Foam decide which geography to enter, et cetera? What were the strategic imperatives for you to decide about these 2 locations? And as well as I wanted to know also about Divya Software. Because it's a small company and there could -- that could require large outlays, how does one figure out what eventually the free cash flows over a sustained basis for Sheela Foam would be, because there will be a continuous need for capital investment in an entity like software? So these 2 entities, basically -- I mean, the business overseas and as well as the software company.

So let me first answer the software part of it. See, as far as Divya Software is concerned, that's a company that we bought. But of course, we don't do any software business in that. That only houses our corporate office at the moment. And in due course of time, probably, it will merge into the parent company. But we do have software business, name of Staqo [ a completely owned subsidiary ] of Sheela Foam. And that part of it, there is no capital outlay that is there. We do not deal in products. We are dealing only in the software part of it. And there the costs are more OpEx in nature where it's the people coming in and all the programs that are being made or developed, et cetera. So there is no big outlay of any CapEx or any funds as far as that is concerned. Coming to the other part where you said about Spain, Australia and India, yes, you're right that in India there is a large market and more -- and a lot of it has also changed post-corona. But each one of them, the Australian and the Spanish part, there were different reasons for it. Australia was 15 years back, and it was -- I mean reasons like it was a developed market, there would be a lot of cross-learning that would be there, there were raw material -- common raw material suppliers, and therefore you could leverage purchases, et cetera, which were there. And it was an English-speaking country. Management was -- they had a strong management and therefore that would not be a problem. We will be able to connect ourselves to ERPs, et cetera, which is all being done. As far as -- all being done and 15 years are a result of that that we see. As far as Spain is concerned, that happened only in 2019, October 2019. European Union is the biggest, largest world market of polyurethane foam in the world. And we needed a foothold there for reasons which are very similar to the Australian one. Plus, this company had only 1% share. Technology was something which was very common to all of us. In fact, exclusive to all of us that was there. And we just thought that we have -- and the company is in a low-cost area of Europe. And now, of course, what has opened up to this is also next or it is just one-off away from the East Coast of U.S. So keeping all these things in mind, we took and -- at the end of the day, let me just say there are 3 things which happened. Number one, that opportunity has to come, right, and it has to find fitness into our program. We should be able to have the capacity to bite into it and not really get choked with it. This means the size of the business has to be within our realm. We are conservative on that part. And the third is, I think, most of these things happen by chance here, by serendipity. So I would put it not to some great strategy which has been carved out. I know I'm probably lowering our standard by saying that there was no great strategy on that. But when things come around, you just make these -- few of these judgments and you take a call there.

Sure. These places, they have local plants, Spain and Australia?

Yes, yes. So foam generally is not -- cannot move too much distances too far because it's a voluminous product. So they have their own plants, they supply to their own geographies and completely independent from this, except the software part of it, which is the intellectual properties, the research and development or the learnings, et cetera. So including, I would say that what we did in Australia has helped us to improve our mattresses in India, has helped us to introduce mattresses in India the way we have done. I'm just giving you one example.

[Operator Instructions] The next question is from the line of SivaKumar from Unifi Capital.

Congrats for a great set of numbers, sir. Sir, my question is with regards to the revenue. We see that there is a strong traction in the mattresses segment and also the technical foam and foam core segments. So was this pent-up demand, marriages which were stalled for more than 6 months suddenly happened and then we saw some pent-up demand? Or do you see this as a secular trend in favor of the organized segment where you are the leader? And do you see the traction even in Q4?

Rakesh, you want to answer that?

Yes. Okay. So it was a mix of 2, 3 things. As far as mattress is concerned, you're right, it started with a pent-up demand. But then very quickly, we realized there is also a change in consumer behavior where staying at home people were able to kind of realize what their mattress condition is and therefore need for a change and so that was there. Then it was also the shift from unorganized to organized, wherein the unorganized was not able to kind of get its act together. So that advantage was also there. On the B2B side, I mean there are some industries, some segments which have performed well, especially the auto industry, where we are experiencing a good traction and we have a very high market share in that market. And this trend is going to continue because the consumer behavior is still the same, where the importance of sleep with relation to good health, these dots are getting connected in consumer’s mind.

Yes. And I just want to add to that. For mattresses, whenever an important sort of category increases, the importance of established brands increase. So people -- when a category -- fortunately people want to buy something which is branded, something which is established and that's where our role has increased.

It's good to hear that, that the traction is continuing in Q4. Sir, coming to the raw material prices, you said that TDI has cooled to INR 170 levels and Polyol to INR 100. Is that correct?

No, no. Polyol has not cooled to INR 100. Polyol is still at about INR 197, INR 198. It had gone up to INR 230. It is cooling down. And in fact, it's one of those few times when Polyol is actually above TDI. Generally, it's always – I mean from times immemorial I have always seen Polyol low. So it has to cool down further. TDI has cooled down. Also from a INR 230 level, it has cooled down to INR 170 level. But Polyol is taking a little more time to do that.

Sir, and the exports opportunity, obviously you have referred to that in your opening comments, can you quantify that in a more specific manner as to what that opportunity can be in size over the next 2, 3 years?

Sorry, I can't be more -- I mean, one is, of course the ambiguity of the situation and how does it pan out. But I would say close to INR 100 crores, yes, in the next couple of years -- next 1 or 2 years.

[Operator Instructions] The next question is from the line of Gaurav Jogani from Axis Capital.

Congratulations on the great set of numbers. Sir, my question is with regards to, again, the sharp decline in the other expenditure. So while I realize that there is an operating leverage benefit because of the higher sales, but if we see, the other expenditure has also come down on an absolute basis by 11%. So was it some one-off cost either on the base quarter or there is some cost that might come back from this quarter to the quarters ahead?

So can I answer that?

Yes. Yes.

See, as I have stated, the reduction largely was in marketing expense and selling expense. So it will all depend upon the strategy and at that point of time whether we have to increase expenses. We have to strike a balance between how much sales we have to achieve, how much expenditure on selling we have to do. So that will certainly change depending upon the times we are in. So we cannot say that this will continue like this only.

Okay. Sure, sir. And sir, my other question is with regards to the mattress realization. So if you see the volumes have grown sharply by around 16-odd-percent in the mattresses segment while the price increase is hardly around 2%. So is this a conscious strategy by the company to absorb the price increases and garner [indiscernible] lower mattresses segment?

Dhruv?

Yes. It's a function of 2 things. Number one, we do not pass on the entire cost to our customers because in a branded segment you cannot do that. Since we know that these prices are not going to be forever like this, so we do not pass the entire price increase. Secondly, this is also sometimes a function of product mix, what all you are selling and what you are selling at that point of time. These 2 factors impact that.

So sir, would it be right to say that the lower segment mattresses' growth would be higher versus the high-value mattresses and that would have affected the product mix?

I think because there is a shift from unorganized to organized, and unorganized was mostly in low price segment, that is very natural to happen.

The next question is from the line of Ritesh Shah from Investec.