US has initiated inquiry into quartz imports coming from India and Turkey to determine if any duties are to be levied to protect domestic manufacturers from unfair competition. The preliminary inquiry is positive, while the final outcome will be known only by October 2019 and duties, if any, to be applicable with effect from June 2020.

Basis this news the stock has been falling continuously. Here’s how we think about this development:

1. Anti-dumping duty (ADD) is levied when one can prove if an exporter is dumping his goods into another market either by getting subsidies from his government or selling below cost just to kill competition in target market. In case of Pokarna, the product sells at a premium to similar quality products manufactured in the US, has a waiting period of up to three months while company makes 35-40% operating profit margins (audited results), which is phenomenal by any standard. All this while getting no subsidies from Indian government, except being located in a special economic zone enjoying certain tax exemptions. This is enough to prove that products aren’t being ‘dumped’ and there is no question of ADD as long as logic holds.

2. However, given there is a trade war going on and also elections are due in the US, there could still be some countervailing duty levied to protect US industry. Will that be 20% or 50%, we don’t know. If its reasonable, will Pokarna be able to pass it on to its customers? We would have to see.

3. The duty, if at all, will be effective from June 2020 and till then there could be a huge pre-buying to fill inventory implying Pokarna will be able to ramp up new capacity quickly (expected commissioning during Q4FY20). The new plant isn’t in the export oriented unit and can sell domestically (in India) too. Pokarna is IKEA’s exclusive supplier and as latter scales up in India, the off-take will keep improving.

4. US is a very big market for Quartz stones, and majority of the demand is met via imports. There was a 350% duty levied on Chinese imports during Dec 2018 which made those that much expensive. If India and Turkey are also levied duties, the cost will go up further for the consumers, in turn hurting the quartz demand. Some of it could shift back to natural stones, in which Pokarna is a meaningful player setting off some impact of Quartz.

5. Even if investigation’s final outcome is adverse and duty is levied, we believe it is already priced in. Pokarna is making quarterly net profit of Rs 25 Cr which translates into Rs 100 Cr annual profits (FY19 - Rs 81 Cr). At current market capitalization of Rs 400 Cr, it trades at 4x earnings. If decision is favorable, the stock could skyrocket one way up, else the downside seems limited.

6. We initially invested 3% of portfolio in this business. This has always been a tracking position and one in which a lot went wrong from company surrendering allotted land causing a two-year delay in new plant commissioning to going back on the decision to divest loss-making textile segment, which is why we never added to this position despite a significant price drop. The current model portfolio weightage is 1.5% (could be different for subscribers due to different entry timings) which is why either ways it is too small a position to make much difference at portfolio level.

7. Meanwhile, how would the stock behave? Like most things, the answer lies in expected demand-supply equation. Amidst this uncertainty, some existing shareholders are surely selling in panic; more than one lac shares being dumped every day. Market is shallow and there is hardly any appetite among investors for small and micro caps, which is why stock continues to tank. Where is the bottom and for how long will this continue, is hard to say.

For now, we continue to hold and will take a decision once there is clarity on duty investigations & its implications.