My notes on Tinna Rubber, a company that recycles tyres

When you come across a growth story with powerful powerful (yes used the word twice!) tailwinds, you may be inclined to overpay for growth. But then you hit on too many red flags relating to quality of reported financials — then you pause, you think shall I leave it and go find another company or am I overthinking? This is great industry to be in! Perhaps the red flag is really amber or could even be green if I give this company a chance!

Putting this gyan aside, I’d try to be objective in my short notes about this company. Again, these notes are more like my personal journal that I am making public.

Company Business

Tinna Rubber is witnessing strong circular economy tailwinds. The company sources End-of-Life (EOL) tyres and recycles them to make Crumb Rubber, Crumb Rubber Modifier, Reclaim Rubber and Steel (by-product). They are the largest EOL tyre recyclers in India.

Timeline:

• 1998: Company claims to have pioneered CRMB (Crumb Rubber Modifier for Bitumen) or rubberized asphalt, which are used to in road construction.
• 2010: Claims to become largest producer of CRMB. Commissioned bitumen emulsion plant
• 2014: Commissioned reclaim rubber plant. Reclaim rubber is sold to companies making tyres, conveyer belts and mats.
• 2017: Started exporting
• 2020: Set up organized collection and safe disposal of waste tyres in tie-up with Bridgestone
• 2021: Expanded capacity of micronized rubber (ultra fine crumb rubber) and reclaim rubber. Set up subsidiary in Netherlands.
• 2023: Set up ops in Oman by buying a rubber crumbing plant.

Infrastructure Segment:

Crumb Rubber and Crumb Rubber Modifier are sold to road builders. Crumb Rubber Modified Bitumen (vs virgin bitumen) is said to increase the life of roads and also reduces GHG emissions. There is a lot of government push to use CRMB for building roads.

Crumb Rubber Modifier is also sold to refineries like IOC. Petrochemical refineries, when they refine crude oil, a byproduct for them is bitumen / asphalt. IOC produces bitumen and blend it with the crumb rubber modifier for selling to road contracting community directly. Other refineries produce their own CRMB. They source the raw material – Crumb Rubber – from companies like Tinna.

Industrial Segment:

Crumb Rubber (specifically fine crumb rubber) and Reclaim Rubber is sold to Tyre and conveyor belt makers.

With Extended Producer Responsibility going into effect, the onus is on tyre makers to be more responsible for recycling their produce and use a portion of recycled rubber (from EOL tyres) instead of all new rubber. This is not only acting a strong tailwind for recycled rubber consumption, but also finally catalyzing the process of setting up an infrastructure for the disposal and collection of EOL tyres in India.

Tinna rubber has struggled with sourcing EOL tyres in the domestic market (despite there being abundance of EOL tyres in India). They currently import 60% of their EOL tyre requirement. This should reduce overtime.

Tyre companies have a long 2-3 year approval process for recycled raw materials (actually, tyre makers have a multi-year approval cycle for everything and not just recycled raw materials). Tinna is doing business with all leading tyre manufacturers in India and has now been approved to supply to two international players as well.

Consumer Segment:

This is the smallest segment for Tinna and is witnessing the highest growth rate both owing to low base and industry tailwinds.

Points of Caution

While there are strong tailwinds for the business segments they operate in – there is government push on circular economy i.e., using recycled material for roads (infra) and EPR regulation for tyre makers, which is going to drive decadal demand for this company, but there are quite a few points of caution I noticed when I delved into their financials. I have listed the key ones below:

1. Contingent liabilities (these are liabilities for which a company does not need make provisions; they lead to earning erosion if they materialize in the future):
   • corporate guarantee to credit facility taken by related parties – subsidiary Tinna Trade and associate company TP Buildtech – worth 86 Cr in FY23, 48 Cr in FY22
   • disputed tax litigations of Rs 11.5 Cr
2. Curious accounting: a tax dispute of 5.6 Cr from FY14 was not debited from P&L in FY21 when the matter resolved, but was debited only from equity. A CA could comment if accounting allows such a treatment, but logically speaking if this were allowed then companies would look more profitable than they really are.
3. Non-core investments of Rs 24 Cr: Good thing is that company recognizes these as non-core and is looking to liquidate them — this red flag changes to green when this happens!
4. Investments into associate company: Tinna Rubber has invested 7.4 Cr (of which 2 Cr were done in FY23) in an associate company TP Infratech. The promoters say that this associate company is into construction materials and hence has synergies with their core business. Not a whole lot about the business operations of this associate company is known.
5. Receivables from associate company: The holding company i.e., Tinna Rubber has receivables worth 2 Cr in FY23 (6% of overall) and 5 Cr in FY22 (15% of overall) from the associate company.
6. Loans to and from related parties: Many such transactions. A key one worth mentioning — promoter Bhupinder Sekhri gave a loan of 1.2 Cr and 1.6 Cr in FY23 and FY22 resp. He recovered these amounts from the company in the same year after charging interest. This is fine. Investors can live with it. However, he took a loan of 2 Cr from the company in FY22. There is a receivable of 1.2 Cr in FY23 i.e., he is yet to pay this amount to the company. Moreover, this seems to be an interest free loan (At the same time, his compensation from increased from 1.2 Cr in FY22 to 2.4 Cr in FY23). Case of promoter treating company as their personal bank offering their desired interest rate?
7. Related party transactions contd: Many purchase from sale to related parties transactions. Moreover, overall receivables from related parties far exceed payables to related parties — negatively impacting the working capital.
8. Discrepancy in numbers:
   • I wasn’t able to reconcile the reported sale volume numbers across the quarterly investor presentations in FY22 and FY23. An analyst did ask about this to the management during a concall. I wasn’t able to understand management’s explanation. Nor do I think the analyst did (unless the analyst emailed the management later and got justification for the anomaly).
   • Moreover, the capacity expansion communicated via investor presentation from FY24-Q2 does not exactly match with the plan communicated via concall. Anyways, this is not necessarily a red flag. This is me knit picking!
9. Volatility in sales and profits up until FY20: Management’s explanation “That was the phase when our multiple customer base between the road sector and non-road sector had not stabilized is achieved now. Therefore, going forward I feel we have better visibility, better ability to adjust to any down cycle in a particular sector. So, we feel more confident now of our revenue projections and our profitability”

Valuation

The company has a market cap of ~INR 1,000 Cr at 39x TTM earnings as of 1/12/2023.

Management expects sales to reach 900 Cr in FY27 (from 300 Cr in FY23) on the back of tyre crushing capacity increasing from 80,000 MT in FY23 to 250,000 MT in FY27.

Taking management’s guidance as inputs to my DCF model – after projecting the 3 financial statements – I find the fair market cap to be ~600 Cr i.e., 23x TTM earnings. At a market cap of 1,000 Cr, I find Tinna Rubber excessively overpriced. Future growth seems to have been priced in given the strong industry tailwinds.

There is subjectivity in valuations. Below are my key assumptions:

1. Sales Growth: Tinna Rubber grows 3x to 900 Cr in Sales by FY27 (as per management’s commentary). With strong recycling tailwinds, the company adds a whooping 2,000 Cr to Sales by FY38 i.e., Sales grow almost 10x from current over 15 years.
2. Capacity Expansion: Tyre crushing capacity grows 3x to 250,000 MT by FY27 (as per management’s commentary). Capacity further expands to 600,000 MT by FY38 i.e., Capacity expands almost 8x from current over 15 years.
3. Debt: Company raises debt of ~30 Cr in FY24 (as per management’s commentary). As per my model, the company will need to raise additional debt of ~50 Cr by FY30 i.e., 80 Cr debt to fund expansion. Internal accruals won’t suffice until then. However, post FY31, the company will generate sufficient cash flows and will be able pare down debt.
4. Margin: With operating leverage and reduced interest costs, PAT margin increases almost to 10% in FY38 from 7.5% currently
5. Cost of Equity: 14% as my bare minimum return expectation

Summary

The above assumptions need to be true to justify a price of INR 600 Cr (i.e., 23x earnings) today. I believe my base case assumptions paint quite an optimistic story.

Let’s say that the company walks the talk (and my optimistic assumptions start being true), market exuberance gradually fades away (i.e., sanity returns) and the stock trades at its fair multiple of 23x 3-4 years out.

“In the short run, the market is a voting machine but in the long run it is a weighing machine.” — Ben Graham.

As per FY27 projection, the company will do Sales and PAT of INR 900 Cr and ~80 Cr respectively. Assuming the company trades at 23x 3-4 years out, then the then market cap could increase to ~INR 1,800 Cr (from 1,000 Cr as of 1/12), which is 1.8x growth. While this is not a bad return at all. But, I wonder why should I put my capital in a this risky stock for slightly better returns vs the relatively low risk index.

Although, I like the strong strong tailwinds, but because there is good scope of improvement in earnings quality and corporate governance, and also because of ridiculously high valuations I’d give this company a pass.

I am yet to look into GRP and Elgi Rubber, which are trading at even higher P/E multiples.

PS: This is not a buy/sell recommendation.