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Building capacity to seize the opportunity

In this report, we have analyzed SRF’s Packaging Films division. The company has aggressively expanded its capacity to capitalize on the impending opportunity in the Packaging Film industry, with a shift in consumer buying behavior. We have analyzed the Packaging Film industry and the competitive intensity of SRF. The key highlights are as follows:

* Over the last seven years, SRF aggressively incurred a cumulative capex of INR32.3b on building its Packaging Film division, resulting in an industry leading revenue/EBIDTA CAGR of 21%/39%, followed by Polyplex Corporation (PPC) at 11%/24%.

* Global demand for Packaging Films is expected to be driven by low penetration of packaged food, higher adaptability of Flexible Packaging, rising trend toward easily recyclable packaging solutions, innovative packaging, and e-commerce.

* However, higher competitive intensity and additional capacity build up in the industry may pressurize industry profitability in the short term.

SRF aggressively scales up its Packaging division to capitalize on industry opportunities

* Given the growing need for packaged products, the management has intensified its capex spend in the Packaging Film division since FY16, with a cumulative capex of INR32.3b in the last seven years (FY16-22), of which INR6.4b was incurred in FY22, taking its total capacity to 315,000MT as of Mar’22. It generated a cumulative EBITDA of INR40.5b over the same period, earning more than the capex incurred.

* Capital employed for SRF’s Packaging segment has clocked 19% CAGR over the last seven years (FY16-22), with the same standing at INR41.8b in FY22. It has generated a RoCE of 22.6% in FY22, which is much higher than its historical average of 18.1% over FY16-22.

* Currently, SRF has six manufacturing units, including international units in South Africa, Thailand, and Hungary. Recently, SRF commissioned a second BOPP Film line and Metallizer at Indore (Madhya Pradesh), with a capacity of 60,000mtpa, taking its total capacity to 375,000MT.

* The company is diversifying into the manufacture of aluminum foil and has allocated a capex of INR4.3b to set up a manufacturing facility in Madhya Pradesh.

* Revenue/EBIDTA contribution from the SRF's Packaging Film division has risen to 38%/35% in FY22 from 28%/25% in FY16.

* Over FY16-22, revenue/EBITDA for SRF’s Packaging Films division grew the fastest (at a CAGR of 21%/39%) among domestic players, followed by PPC (a CAGR of 11%/24%), Uflex - UFLX (a CAGR of 11%/17%), Cosmo First (Erstwhile Cosmo Films) - CFLM (a CAGR of 9%/27%), and Jindal Poly Films - JDPF (a CAGR of -4%/11%).

Growing demand for packaged food to drive growth in the Flexible Packaging industry

* As per CRISIL, the global Flexible Plastic Packaging market is estimated at USD194.4b in CY21 (of which, BOPP/BOPET is ~USD10b/~USD15.2b), and is expected to touch USD257.4b by CY27 (4.7% CAGR). The Indian Flexible Plastic Packaging market is estimated at USD19.3b in CY21 (of which, BOPP/BOPET is ~USD0.9b/~USD0.8b), which is expected to touch USD35.3b over CY27 (~10.2% CAGR).

* Of the global demand for BOPP Films, 60-70% is used by the Food Packaging industry, which is expected to grow by 5.5% over FY21-26 (as per Mordor Intelligence). Share of demand from industrial/non-food packaging stands ~17%/18% of global demand for BOPP Films.

* Out of the global demand for thick PET films, ~68% is used in the Electrical and Electronic industry. Around 75% of global thin PET film demand is used in the Packaging industry. As per Fortune Business Insights, the global Electrical and Electronic industry is projected to grow by 5.3% CAGR till FY27.

* Going forward, we expect a robust domestic demand for Packaging Films, supported by: a) low packaged food penetration and rising personal disposable income, b) Investment in the organized Retail industry, c) change in the pack format to flexible from rigid, d) the use of easily recyclable and sustainable packaging solutions.

* End-user industries like Pharmaceutical, Food Processing, and Personal Care is expanding with huge investments from large multinational corporations. This has resulted in the need for developing cheaper and sustainable packaging solutions, which is fueling expansion in the Packaging sector.

* Factors like an increase in the working population that requires instant food solutions, with a higher shelf-life, have forced companies to come up with innovative and durable packaging solutions.

* According to the Indian Institute of Packaging (IIP), consumption of packaging in India has increased by 200% in the past decade.

Innovative packaging and a rise in e-commerce to drive long-term demand

* Innovative Packaging: Key players in the industry are developing innovative packages that are aimed at attracting customers. Several global FMCG companies are giving their packaging designs a fresher look, keeping in mind the fact that a ‘good packaging protects your product, while great packaging protects your brand’.

* e-commerce: The e-commerce and the packaged food segment received a big boost due to the COVID-19 pandemic as consumers preferred to buy hygienically packaged products. A rise in e-commerce can place an intense focus on increased packaging requirements.

* Sustainable packaging solutions: Increasing awareness of sustainable packaging is a huge opportunity for the industry. Major industry players have partnered with some of the best global brands to offer rationalization of the packaging structure and recyclability solutions in categories such as biscuits, noodles, tea and coffee sachets, and soap wrapper. Industry continues to invest in R&D to offer sustainable solutions like Oxo Biodegradable Films for a better tomorrow and has increased the use of water-based coatings. With growing awareness, the requirement for ecofriendly and sustainable packaging is steadily on the rise.

Over-supply and sustainability are key challenges for the industry

* Recently, several new manufacturing lines of BOPET have been commissioned, with many more expected to turn operational in the coming months (majorly in India and China). This may create a demand-supply imbalance, resulting in an oversupplied market, which, in turn, will exert pressure on profitability of industry players.

* Macro headwinds in Europe are also dampening demand, which is expected to be short-lived. With the easing of headwinds in Europe, the demand-supply imbalance is expected to normalize in the medium term, driving growth in the global Packaging Film industry.

* Also, certain headwinds such as high logistics cost and supply-chain constraints will continue to weigh over margin in the near-term.

* Poor waste collection and the nascent stage of recycling facilities globally can be a significant threat to the industry in the long run, considering the growing demand for sustainability.

Valuation and view

* SRF’s Packaging business clocked a revenue/EBIDTA CAGR of 21%/39% over FY16-22 on the back of an aggressive capacity buildup and improvement in operating margin.

* Given the growing need for Packaging Films across Food, Electronics, and sustainable solutions, SRF’s strong capability will enable it to capitalize on the growth opportunity.

* We expect 17% revenue CAGR from the Packaging Films business over FY22-24, with EBIT margins to decline to 18.2%/18% in FY23/FY24 from 19.8% in FY22, due to an expected pressure on BOPET margin, with new capacities coming on stream.

* Going forward, we expect SRF to register a revenue/EBITDA/PAT CAGR of 18%/16%/20% over FY22-24.

* While we expect the management to cash-in on these opportunities, we maintain our Neutral rating, given to its rich valuation, which has been priced into its nearterm upside.

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