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Company Background

Linc Pen & Plastics Limited (Linc), promoted by Mr. Deepak Jalan, Managing Director, in 1994, is India’s leading manufacturer, marketer and exporter of a complete range of writing instruments, having presence in over 50 countries. Its state-of-the-art integrated manufacturing facilities are located at Falta SEZ and Sirakole in West Bengal and Umbergaon in Gujarat.

Mitsubishi Pencil Company, Japan, a global writing instruments giant, whose popular products like Uni-ball are being exclusively marketed in India by Linc for over a couple of decades, has a 13.45% stake in Linc’s equity capital. With an aim to further strengthen its product portfolio and leverage its distribution network, in 2018, Linc entered into a marketing tie-up with the Chinese stationery giant, Deli to market its products in India.

Investment Rationale

Improvement in performance with better off take

* During Q1FY22, Linc’s net sales witnessed a growth of ~101.1% y-o-y to ~Rs 551.3 mn on a lower base driven by focused initiatives to expand their reach with a wider range of products. However, Covid-19 second wave induced state wise curbs resulted in ~41% q-o-q de-growth in top line. Exports remained stable q-o-q with a mere growth of ~0.5% to ~Rs 124.2 mn. It accounted for ~80% of pre-Covid levels of Q1FY20 owing to continued weak global sentiments and subdued demand from Myanmar, one of its key markets because of the ongoing political disruptions in the country. Domestic sales witnessed a growth of ~116% y-o-y to ~Rs 427.1 mn during the quarter with better off take as a result of widened distribution network, though it de-grew sequentially by ~47%.

* Linc is undertaking pro-active steps to negate impact of demand slowdown as a result of sustained closure of educational institutions and commercial offices still operating with lower workforce by strengthening its distribution reach with new retailers. Linc has embarked on a rejig of its distribution model by undertaking remote engagement and non-facial contact to enhance product visibility, which is a potential game changer - helping it grow its network and making it more efficient, thereby, improving market share, revenue and profitability. It intends to increase its retail network from 1,48,000 in FY21 end to 2,00,000 by the FY22 end, which will deepen Linc’s presence into Tier-II+ markets and amongst non-conventional retailers. The management believes that with change in their business model by shifting towards a distribution driven Company, they will lay a foundation of a reinvented Linc.

* Demand momentum currently has been impeded with Covid-19 second wave induced lockdown in many states. Visibility of educational institutions opening up remains bleak in the near term, despite the increase in India’s vaccination pace. However, Linc’s effort to strengthen its retailer management through restructuring and digitalization along with improved customer sentiments is likely to act as a catalyst for increase in sales off take. We expect Linc’s top line to grow by ~14% y-o-y in FY22E (FY21 lower base) and reach FY20 levels by FY23E buoyed by a rise in economic activity and gradual resumption in educational institutions. However, our estimates are contingent upon future uncertainties of COVID19 disruptions, which might impact our forecasts.

EBITDA margins to remain subdued in FY22E

* During the quarter, EBITDA margins increased by 750 bps y-o-y to ~2.5%, however, it declined by 450 bps q-o-q due to increase in raw material (RM) costs driven by the surge in crude oil prices. RM costs as a percentage of sales increased by 302 bps y-o-y to ~64.6%. On the other hand, employee cost reduced by 459 bps y-o-y to ~13.3% and other expenses decreased by 593 bps y-o-y to ~19.6% as a result of improved operating efficiency and higher absorption of fixed expenses.

* Going forward, we expect margins to remain subdued in FY22E, stabilizing at ~9.7% in FY23E with a) increase in volume on the back of increase in distribution footprints, b) improvement in operating efficiency with equipment automation, c) improvement in average realization driven by rise in proportion of value added products, priced at Rs 10 and above and d) strengthened product portfolio with focus on non-stationery products.

* During Q1FY22, the Company reported PAT loss of ~Rs 12.2 mn against a loss of ~Rs 39.9 mn in Q1FY21. Interest cost decreased by ~69% y-o-y to ~Rs 3 mn on account of re-payment of long term loans during FY21 while other income increased by ~221.5% y-o-y to ~Rs 4 mn. Further, the Company reported a cash profit of ~Rs 14.7 mn during Q1FY22 v/s a cash loss of ~Rs 22.2 mn in Q1FY21,

* The Company is undertaking effective inventory management efforts in order to reduce its working capital requirement. Also, to conserve cash, Linc continues to keep on hold all major capex in anticipation of normalization in trade conditions.

‘Pentonic’ breaking the barrier

* During Q1FY19, the Company launched an innovative; new generation product i.e. ‘Pentonic’ accounting for ~37% of the total revenue and 68% of the products priced over Rs. 10 of the general trade business in Q1FY21. Linc is radically improving the ratio of value added products in the overall portfolio, which will not only help it to insulate margins from raw material price volatility but also secure top line, paving path for growth. Revenues from products priced at Rs. 10 and above stood at 54% in Q1FY22 v/s 46% in Q1FY21.

Valuation

Linc has consistently witnessed improving financial performance and strong brand equity in recent years. The recent blip is led by Covid-19 related demand destruction. The Company’s earnings are expected to witness a rebound by FY23E. We have valued the stock at 18x FY23E earnings of Rs 12.7/share and recommend a ‘BUY’ on the stock with a target price of Rs 229/share (upside of ~20%).

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