Wednesday, 14 March 2012

Updates on Oriental Carbon Chemicals Limited

I am writing this post with respect to my earlier post on OCCL Oriental Carbon and Chemicals: Keeping a close eye. I was circumspect about the sustainability of NPM in the longer run and hence advised caution before taking a plunge. Today I have come across announcement from Schrader Duncan, a company promoted by Duncan group (promoters of OCCL) and Schrader Bridgeport International Inc. OCCL had 12.58% shares in Schrader Duncan. Now, OCCL is going to acquire 50% share from Schrader Bridgeport for roughly 14 crores (as per OCCL announcement on March 05). This will mean that Schrader Duncan will become subsidiary of OCCL.

Schrader Duncan has two divisions namely Tyre/tube valves and accessories and pneumatic products. Schrader Duncan is currently in shambles due to very many reasons but primarily due to lack of pricing power and cut-throat competition. The situation is so bad that company is not able to pass on increase in raw material and operating cost and is incurring operating losses for last 2 years. Company had a plant located in Mulund which has been shut down and land is sold in March 2011 for 42 crore. Company has received 20 crore proceeds from this sale till December 2011 while remaining 22 Crore  is yet to be received. Schrader Duncan incurred extraordinary expense of 15 crore for VRS of its employees at mulund plant which has eroded company's networth substantially. Moreover, in its AR in 2011, management specifically talks about intense competitive pressure and lack of pricing power for its products. Thus management does not expect substantial improvement in business economics.

I am not able to understand the rationale behind management's move.This move raises doubts about management's ability to protect interests of OCCL shareholders.
Based on this development, Schrader Duncan will become subsidiary of OCCL and on a consolidated basis and losses of Schrader Duncan will be offset by the very decent profit made by OCCL thus impacting net earnings of OCCL. In other words, OCCL will have to absorb the financial burden of Schrader Duncan and have impact on its return ratio as well.


OCCL operates in oligopoly world over and has substantial pricing power. OCCL seems to have very robust business economics while Schrader Duncan seems to be a downright mediocre business. Even if one considers basic management philosophy, two different businesses with different economics growth profile and scale should be kept separate and this philosophy has been driving force for so many demergers. In this case, management is taking exactly the opposite view and trying to bring a high quality business and mediocre business under one roof. In my view, this action by management raises serious doubts about management's attitude towards minority shareholders of OCCL as it will result into significant value destruction   for OCCL shareholders considering Schrader Ducan's present state of business and management's outlook on the business. 

I would not like to sail into such troubled waters unless management comes forward with strong rationale to dispel the doubts about its intentions.

so let's wait and watch how this story unravels!



13 comments:

  1. Hi Dhwanil,
    Really good observation and analysis.
    As Warren Buffett says - He invests in simple business with excellent management and he likes jumping over 1 footer than 7 footer.

    I have been following OCCL since few months. Had invested but came out with some loss.
    My reason for selling was this.

    For last few yrs, the management has reduced the debt. But to ramp up the production, they took debt.
    At first they said, they will take less debt ( around 25cr) and finance major portion from reserves.
    But they took larger debt of 76cr and laso gave interim dividend.
    This offended me. Say if I am owner of OCCL, will first of all take less debt and will not give any interim dividend. In case of dividend, once its paid, the money is gone from the company.
    These few things I didnt like so opted out of it with loss.
    btw, you are working as consultant in energy sector, can you please throw some light on SJVN.
    As per me its a good value buy for very long term.
    I think,it can give both capital appreciation and nice dividends.
    Do share your views.
    Regards,
    Vikas

    ReplyDelete
    Replies
    1. Hi Vikas,

      You are very right. Warren Buffet places highest importance to how management is allocating capital and how effectively it generates returns on invested capital. In my opinion, some of the decisions taken by management cast doubt on ability to carry out this responsibly. It may turn out to be a good example of a great business run by mediocre management will not be a great wealth creator. I would be very circumspect on this stock but will keep track of it for inherent strength of the business.

      Frankly, I have not studied SJVN and can comment after carrying out analysis. I will come back to you on SJVN shortly.

      Best Regards
      Dhwanil Desai

      Delete
    2. Waiting for your reply on SJVN
      Vikas

      Delete
    3. Hi Vikas,

      I have done preliminary analysis of SJVN and feel that it is a mediocre business due to following reasons.

      1) It is a regulated business with fixed ROE determined periodically by CERC. Currently, ROE prescribed by CERC is 15.5%. Typically, SJVN has been earning ROE in the range of 12-14% which is mediocre only.
      2) Low ROE is combined with highly capital intensive nature of the business which is not a great combination. Another negative in my view is that it is a regulated business and hence bears very high regulatory risk.

      3) Hydro power typically has lots of issues of displacement and relocation. This leads to very high gestation period and adds the risk on project implementation side. I have been involved in many projects and the whole procedure of getting environment clearance is extremely subjective and time consuming even if there is least environmental impact. So, I would imagine that if the issues of land displacement/relocation are involved, it would be very closely scrutinized and may take even longer than for a typical power project.

      4)SJVN has plans to add 4000 MW of additional capacity, however only 400 MW is likely to be commissioned by 2014. Rest is still at approval/planning stage. Moreover, once SJVN starts implementing projects, its balance sheet will look very different due to borrowing it will take. Generally power projects have 70% debt component. Hence cash sitting on balance sheet may no longer be available if actual implementation starts as planned.

      5)With current policies of government of exploiting PSU for government needs without caring for minority shareholder's interests and economic principles makes me wary of investing in PSUs.

      Best Regards
      Dhwanil Desai

      Delete
    4. Thanks a lot Dhwanil for the detailed and personal experienced view.
      Thanks a lot.
      I have one more request.
      As Charlie Munger & Warren Buffett say - ITS FAR BETTER TO BUY AN EXCELLENT BUSINESS AT FAIR VALUATION THAN TO BUY A FAIR BUSINESS AT EXCELLENT VALUATIONS.

      So can you please suggest few excellent business with wide moats available at fair prices.

      Regards,
      Vikas

      Delete
    5. Hi Vikas,

      It is indeed difficult to find great businesses at fair price as most of the great businesses are identified by the market and market starts paying high premium for it and hence in most of the cases great businesses do not to turn out to be great investments. Nestle and HUL/ITC are great companies but price that you pay for acquiring those business is so high that there is hardly any upside potential. excellent business has to have three things namely above-average business economics, capable and ethical management and slow changing nature of business with demand for the product/services for long time to come.

      In my opinion some of the following are wonderful businesses available at reasonable price. (some of them have already rose so one shall keep track of them and invest when price corrects)

      1) Amara Raja Batteries/Exide (may be on correction)
      2) Bajaj Corp
      3) FAG Bearings (may be on correction)
      4) Swaraj Engines
      5) Shriram Transport Finance

      Discl: I may be having position in some of these stocks.

      Delete
    6. Thanks a lot Dhwanil for detailed reply.
      Can one consider stock like NMDC as great business at cheap valuation.
      I know its commodity stock and capital intensive business.
      But financials are just great.
      Whats your opinion.

      Regards,
      Vikas

      Delete
    7. Hi Vikas,

      Sorry for a late reply. Yes, NMDC is a wonderful business and I don't have any doubt about business economics. It is also available at a very reasonable price. However, I myself is not very comfortable with PSU companies due to undue pressure and arm twisting that govt exerts to serve the interests of govt and completely ignore the economic interests of the company and minority shareholders. Moreover, even though it can be considered unregulated monopoly, it may be subject to policy uncertainty (in terms of iron ore export especially) which may undermine the interest of the company in future if there is drastic change in policy of GoI. And thirdly, it carries inherent cyclical risk due to commodity business.

      So, In my opinion barring management (i.e. government) I think it is a great business.

      Delete
  2. Hi,

    Completely agree with you on this.
    Just sold OCCL 3 days back for precisely the same reason that you pointed.

    ReplyDelete
    Replies
    1. Hi JK,

      I think you took a judicious decision. I went by my gut feel and adopted "wait and watch" approach even after Q3 results and had created a very small position.

      Best Regards
      Dhwanil Desai

      Delete
  3. Does NHPC also stands in the same boat or is there some difference with sjvn?which will be the topmost switching candidates from nhpc?
    Also what's your take on once, oil,rec,dcb,

    ReplyDelete
  4. What's your take on icici bank,bob,union bank,united bank,n what r your top picks.any views on liberty phosphates?

    ReplyDelete
    Replies
    1. Hi Vivek, truly speaking I have not looked at any of the stocks mentioned by you except cursory look at Liberty phosphate. However, I have not developed any conviction due to lack of proper research on the business of liberty phosphate.

      I will post my thoughts once any of the stocks are on my radar (based on my investment screening criteria).

      I try to limit my investment where leverage is low and ROE/ROCE are consistently high and company is trading at low P/E or it is a cash/NWC bargain. My top holdings are Cera Sanitaryware, Mayur Uniquoters, JB Chemicals, Piramal Healthcare, Shriram Transport, Mazda Limited, Narmada Gelatine, Gujarat Reclaim and Hindustan Zinc

      Delete