Case 006Long pitches and valuationWarm up

Harvel Paints has revenue of Rs 2,400 crore and a 12% EBIT margin, with crude-linked raw materials at 55% of revenue. Your thesis is that raw material prices fall 10% and Harvel keeps half the saving. What happens to EBIT, and how much must it keep for a 15% upgrade?

Millennium ManagementNew York · 2024

The situation

Harvel Paints makes decorative paints and sells through dealers. Revenue is Rs 2,400 crore and EBIT is 12% of revenue, Rs 288 crore. Raw materials, mostly crude-linked solvents, resins and additives, cost 55% of revenue, Rs 1,320 crore.

You are pitching Harvel as a long. Your thesis: input prices fall 10% over the next year, and Harvel, as the brand leader, cuts its own prices by only enough to pass on half the saving. The portfolio manager's first question is how much that is worth to earnings.

Your task

What happens to EBIT under your thesis, and what share of the saving must Harvel keep to deliver a 15% EBIT upgrade?

Quick check

Raw materials fall 10% and Harvel keeps half the saving. Roughly how much does EBIT rise?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

EBIT rises from Rs 288 crore to Rs 354 crore, about 23%, and Harvel needs to keep only about a third of the saving for a 15% upgrade. A 10% fall in Rs 1,320 crore of raw materials saves Rs 132 crore; keeping half adds Rs 66 crore. A 15% upgrade needs Rs 43.2 crore, 32.7% of the saving. The pitch therefore rests on pricing power, not on the crude call.

Step 1Why does a 10% input fall move EBIT by so much more than 10%?

Compare the size of the cost line with the size of the profit. A tea stall that spends Rs 55 of every Rs 100 of sales on milk and sugar and keeps Rs 12 as profit gains a lot when milk gets cheaper, because the cost is more than four times the profit. Raw materials at Harvel are Rs 1,320 crore against EBIT of Rs 288 crore, so a 10% saving, Rs 132 crore, is 46% of EBIT before anything is passed on. That operating leverage on the cost side is what makes commodity-driven margin stories attractive to a long-short fund.

A 10% fall in raw materials lifts EBIT by more than a fifth, if Harvel keeps half288EBIT today12% of 2,400+132Gross saving10% of 1,320-66Passed onhalf the saving354EBIT afterup 22.9%The debateis not crude.It is how muchHarvel keeps.
Harvel's EBIT of Rs 288 crore gains a gross saving of Rs 132 crore from a 10% fall in raw materials; passing half to customers leaves EBIT at Rs 354 crore, up 22.9%.
Step 2How much of the saving must Harvel keep for a 15% upgrade?

Work backwards from the target. A 15% upgrade is Rs 43.2 crore of extra EBIT, which is 32.7% of the Rs 132 crore saving, so Harvel can pass on two thirds and still deliver it. Each tenth of the saving it keeps adds about 4.6 points to EBIT growth. If Harvel keeps half, revenue falls to about Rs 2,334 crore as prices come down and the EBIT margin rises from 12% to about 15.2%.

Every tenth of the saving Harvel keeps adds about 4.6 points to EBIT+10%+20%+30%+40%+50%0%25%50%75%100%Share of the Rs 132 crore saving that Harvel keepsEBIT upgrade+15% needs 32.7% keptHalf kept: +22.9%All kept: +45.8%
Harvel's EBIT upgrade rises in a straight line with the share of the Rs 132 crore saving it keeps, from nothing if it passes on everything to 45.8% if it keeps it all; a 15% upgrade needs 32.7% kept and half gives 22.9%.
Step 3What does the portfolio manager push on next?

The crude call is the part everyone in the market can see; the pass-through is where a variant viewA view that differs from what the market already expects and that you can defend with evidence; the source of any edge in a stock pitch. can live. Show the evidence for pass-through from the last time inputs fell: how gross margin moved over the following four quarters, and whether the leader cut prices first or last. Then give the timing. Harvel holds two to three months of inventory bought at old prices, so the saving shows up a quarter late, and dealers may push for discounts. Close with the risk: if a competitor cuts prices to gain share, Harvel keeps less than a third and the upgrade falls below 15%.

Where candidates lose it

Candidates apply the 10% input fall to EBIT directly and say earnings rise 10%, or apply it to the whole cost base. The saving is 10% of raw materials only, and it must be compared with EBIT, which is less than a quarter of that cost line.

The second is presenting the saving as if Harvel keeps all of it. Assuming full retention gives a {h_full*100:.0f}% upgrade and tells the portfolio manager you have not thought about competitors or customers.

What the interviewer asks next

  • Crude falls 10% but the rupee weakens 5% against the dollar. What happens to the saving?
  • How would you check Harvel's pass-through behaviour in past cycles from public data?
  • If the market already expects a 15% EBIT upgrade, what is your pitch?

Asked at Millennium Management, Investment Research, New York, 2024 (Wall Street Oasis): First round behavorial with a current Analyst, then a stock pitch case study

Company names and figures are illustrative.