SHIL is currently involved in only the marketing and sales of building products while the manufacturing is done by the other group company HSIL leading to significant related party transactions. HSIL manufactures and transfers to SHIL at 4-5% operating profit margins, while SHIL owns the brand (Hindware) and sells in the market by marking up and earning about 15% operating profit margins. We had invested before the demerger, had to sell HSIL during Mar’20 rejig given it was a very small position but stayed invested in SHIL.

Ideally, they should have also de-merged the manufacturing assets into SHIL but they could not as that would have led to transfer of the title of some prime land parcels which would have involved significant cash outflows on account of stamp duty registration as well as capital gains taxes, given these were acquired in 1960s for pennies.

They have now found a middle ground by transferring all manufacturing assets other than these two land parcels. EY & Deloitte have been the advisors and valuers in this transaction.

The deal value is Rs 630 Cr, while the book value of assets being acquired is Rs 475 Cr. SHIL would be borrowing Rs 550 Cr to fund this acquisition. These manufacturing assets reported a turnover of Rs 593 Cr last year but at full utilisation can do over Rs 1,100 Cr. Had they included those prime land parcels, the deal value would have jumped meaningfully, leading to higher borrowings and inflated capital employed depressing the return ratios permanently for SHIL (our portfolio company).

The acquisition would be completed by March 2022. With effect from Q1FY23, the operating margins of SHIL would expand by 350-400 basis points due to this backward integration. On the flip side, it will add debt and interest burden for next 2-3 years.

Overall, on a net basis, we find this to be a very positive move. We now have one of India’s largest and fastest growing buildings material company with leadership position (top 3) in sanitaryware & faucets, and rapidly growing into pipes and other ancillaries. Being vertically integrated, with complete control over in-house manufacturing, will remove all investor concerns around transfer pricing and related party transactions once and for all. The business is on an attractive growth trajectory and this restructuring ideally paves way for some re-rating if they continue to deliver and execute well.