Arrow Greentech: Production ramp-up reduces dependence on royalty income
Arrow Greentech’s recent Q2 results have come on the back of improvements it executed in commissioning and utilization of new capacity. While revenues from the sale of manufactured products in the topline increased, there have been incremental higher costs due to an increase in operating expenses.
Q2 2018 results: Increased share of manufactured products
Table: Consolidated financial statement
Consolidated Q2 results reflect sequential improvement in topline growth. Higher raw material costs and reduced EBITDA margin (-857 bps) suggest that contribution of royalty income has reduced and there has been a ramp-up in sale of products. Net profit was also impacted by reduced other income and higher taxes.
Standalone financial statement reiterates a similar observation. The company has completed its capacity expansion three times its earlier tonnage and the new capacity that has come on steam has partially been deployed. In this respect, higher employee cost (18 percent of sales vs 12 percent in Q2 2017) and raw material cost (11 percent of sales vs 6 percent in Q2 2017) seems to be the new normal. Infact, raw material cost is expected to rise even further as and when capacity utilization improves.
Table: Standalone financial statement
Also read: Arrow Greentech: Despite weak results, patent approval & business growth hold promise
Valuation and recommendation
Based on its recent financial results, we have made a few changes in our projections. While we expect a similar trajectory for the topline growth, we have lowered our assumptions for raw material costs but increased that for employee costs, depreciation expense and other expenses. This reduces our near-term earnings expectations.
However, stock has recently corrected and currently trades at 20.6x 2019E earnings which remains at par with its global peers.
Further, we maintain that the company is at an early stage of growth (revenue CAGR of 16 percent for 2017-19E) a valuation re-rating is possible due to an array of patents (higher share of royalty income), potential for monetization. And, therefore, the current correction provides investors an opportunity to take exposure to this high beta growth stock, in our view.