Saturday, 19 May 2012

Value Picks in Turbulent Times: Few Interesting Opportunities

Good times are back again! No, I am not kidding. If you are a value investor who wants to create disproportionate wealth over a long period of time, there can not be a better opportunity than a prolonged bear market. A prolonged bear market gives value investor to do a detailed analysis of interesting opportunities (and there are plenty!) and pick the best and to top it, average it over a period of time! Lots of investor (of course including me!), who were awestruck to see early 2012 rally, must be quite content that they are getting a similar opportunity again! 

Warren Buffet put very succinctly "cash in the time of crisis combined with courage is priceless". So, in this time of crisis, if you have plenty of cash to deploy and have courage to weather a feisty storm and conviction in your analysis, you have an opportunity that can generate phenomenal returns in next 3-5 years. So it's time to work hard and find out businesses that have strong economics, represent some barrier to entry/competitive advantage, have strong balance sheet and available at substantial discount to its intrinsic value. The best thing a value investor can get is business at a value where growth component is absolutely free!

I began with initial screening to identify such opportunities. I put following criteria to arrive at 69 companies with market cap ranging from 7 crores to 50, 000 crores. 

Average 3 year CAGR sales growth: 15%

Average 3 year CAGR net profit growth: 15% 

Debt to equity ratio: less than 0.5

Return on capital employed: 25%

P/E ratio: less than 12

However, list of 69 companies was just the starting point. My ultimate objective of the exercise is to find companies that have steady and sustainable businesses (reflected by consistent profit margins), scalable business models and reasonably good management. I am looking for businesses that are trading at at least 50% discount to conservatively calculated intrinsic value. I could eliminate some of them by cursorily looking at financials for last 5 years as many of them lacked consistency in performance over a period of time. For remaining in the list, I started digging deeper. Based on my initial review, I shortlisted 6 opportunities that seems attractive. Following is a synopsis of investment case for each opportunity. 

I would like to strongly emphasize here that, this list is still "work in progress" and not the final outcome and hence one should not jump to conclusions based on the  investment case outlined here. I have excluded two ideas Cera Sanitaryware and Mayur Uniquoters as I have covered them in separate posts.

1) Atul Auto: A three wheeler commercial vehicle manufacturer having strong brand of "Atul Shakti". Enjoys a very strong presence and brand recognition in the markets of Gujarat,Rajasthan and Andhra Pradesh. Debt free company. Last 5 years sales growth @ 26% CAGR and PAT @ CAGR 65%. Expanding distribution network into Kerala, Karnataka, Bihar and other states. Increasing profit margin and ROCE/ROE.  Available at P/E of 6 on TTM basis. Limited competition (Bajaj, Piaggio and M&M)

2)Amara Raja Batteries: Second largest automotive and industrial battery manufacturer and pioneer for VRLA technology in India. Jhonson's control, world's largest automotive battery manufacturer holds 26% in the company. Operates in a oligopoly market where only significant competition in branded battery market is from Exide.Last 5 year topline and bottom line growth of CAGR 22% and 25% respectively.Strong brand "Amaron" combined with well laid out distribution network.  Increasing demand for new automobiles  combined with increasingly higher replacement demand (every 3 years one has to change four wheeler battery and every two year a two wheeler battery!) is going to create very large replacement market, thus volume growth can be sustained. Nearly debt free company. Increasing ROCE/ROE trend. Even in worst years ROE/ROCE is above 20%. Available at TTM P/E of 11.6.

3) Fluidomat: Pioneer in indigenous manufacturing fluid couplings. It is a niche product having application in diverse sectors such as thermal and nuclear power, cement, steel, mining, paper, fertilizer and chemicals and ports. Marquee list of national and international clients for its products and company's products are approved by all major engineering consultants. Steady growth in sales and profit in last 5 years (CAGR 15% and 18% respectively). Consistently increasing ROCE/ROE (20% to 35%). debt free company and trading at market cap of 16 crores. 20% of market cap is available as cash and  cash equivalent. P/E of 5.45 on TTM basis.

4) Narmada Gelatines: One of the pioneers in manufacturing of gelatin in India and 50 year old company. Gelatin manufacturing is oligopoly with only handful (25-30) manufacturers all over the world. In India only 5-6 large units. Significant barrier to entry due to technology, quality, approval from pollution control and raw material procurement. Current market cap of 43 crores (in last week stock price has rose by more than 15%), 18 crores is cash + liquid investments. Company's sales and net profit has grown CAGR 10% and 32% respectively in last 5 years (indicating strong margin expansion). Increasing ROCE/ROE due to margin expansion. Net of cash, it is trading at P/E of less than 3. Dividend yield of 4%. High promoter holding of 75%. Current management may divest (shaw-wallace group) as many European majors are interested in buying operating unit in India which will a trigger for re-rating. Upward trend in gelatin price due to demand supply gap and capacity expansion (underway) may further increase company's margin and ROCE/ROE.

5) Swaraj Engines: Diesel engine manufacturer for tractors of "Swaraj" brand and high-tech engine component manufacturer for Swaraj Mazda (SML Isuzu now) commercial vehicles. "Swaraj" brand is taken over from Punjab Tractors Limited by M & M, India's largest tractor manufacturer. M & M and Kirloskar Oil Engine are major shareholders, 33.23% and 17.39% respectively. 5 year CAGR for sale and profit is 25% and 30% respectively. Pristine balance sheet. Consistently high and increasing ROE/ROCE. Cash + current investment is 140 crore i.e. 28% of market cap of 500 crores. It is in sweet spot due to free substantial cash flow generation combined with high ROE and debt free balance sheet. It has undertook capacity expansion which will drive top line/bottom line growth

6) Wim Plast: Manufactures plastic molded furniture with brand name "Cello". "Cello" is very popular brand in writing products (pen) and  kitchen products and hence strong brand association. One of the three major players in branded plastic molded furniture other two being Nilkamal Plastics and Supreme Industries. Top line and bottom line growth in last 5 years at CAGR 24% and 61% respectively. consistently improving margins and ROE/ROCE. Debt free company and trading at TTM P/E of 5.6. It is expanding capacity (Daman and Haridwar) and increasing its reach in eastern and southern (presently confined to northern and western market). Consistent dividend paying company since 1998. Promoters are buying consistently since September 2011 and bought shares close to current trading price. 

As I said before, this list is indicative of "work in progress" and I intend to study these opportunities closely before allocating substantial capital to any of the ideas. However, the objective of posting these ideas here is to receive critical opinion (a well researched negative opinion will be even more useful!) from readers. 

I look forward to your comments/suggestions.


29 comments:

  1. Nice shortlist to look. I have couple of questions:
    1. Atul auto: Its operating performance zoomed in the past 3 years. Excellent performance for sure. But between the period FY'06-09 it actually degrow. Why is that? Generally automobile company depends too much on single product and if it gets wrong, all the hell broke loose. Also they sector follows cyclical pattern and sometimes, for a cyclical company, low PE is actually a value trap and high PE would be right time to enter (converse of stable companies).
    2. Amara raja: Generally for battery manufactures, lead constitutes major bulk of the raw material cost. It does not have captive smelters like Exide batteries. In FY'11 its bottomline degrew due to the soaring lead prices. Also rupee depreciation will be major factor as they need to import lead. Its product mix is 50:50 between industrial (mainly telecom) and automotive. I think it should improve its product mix in favor of automotive to get better margins in consistent basis.
    Would love to hear your thoughts.

    Regards
    Jagadees

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    Replies
    1. Hi Jagadees,

      As I said in the post, this is just a shortlist and I am planning to dig deeper to unearth anomalies/spurts/inconsistencies in performance of the mentioned companies in the post.

      I will study Atul Auto in further detail and will get back to you on Atul Auto, mean while management has indicated why performance was sluggish from 2006-09. here is the link

      http://dalal-street.in/atul-automanagement-interview/

      Regarding Amara Raja, lead does constitute a major component and its prices does have impact on margins. However, operating in oligopoly and expanding market with moat of "brand" and "reach", in the longer term it shall be be able to maintain it's average margin. Amara Raja has set its sight on increasing sales in two wheeler segment which shall help improve its margin further.

      Best Regards
      Dhwanil Desai

      Delete
  2. nice post.........thanks

    Karun Sandha

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    Replies
    1. Thanks Karun.

      Best Regards
      Dhwanil Desai

      Delete
  3. Great Post Thanks for the effort

    Anoop

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  4. Nice post.

    Regarding Wimplast, I don't see any moat. Also margins are much less for Nilkamal.

    Do you think margins for WImplast will stay at current levels?
    If yes, why?

    ReplyDelete
    Replies
    1. Hi JK,
      I will try to answer you questions with small research that I have done for shortlisting Wim-Plast.

      I partially agree that Wim Plast doesn't have a very strong moat at this point of time, however, a strong brand of "Cello" definitely is a strength for the company. Moreover branded plastic molded furniture is not very competitive as only 3-4 major players are there. If wim plast is able to increase its reach and build upon a strong brand, it can convert "moderate moat" into strong moat.


      Regarding margin, I think in the longer term, Wim plast shall be able to maintain at least 10% NPM. My reasoning is simple that even Nilkamal earns 10% margin on plastic business (it also is into retail through @home stores) if you do not account for interest cost (which is substantial for Nilkamal). Nilkamal also has substantial presence in material handling, an inherently low margin business. Even after clubbing that low margin business, Nilkamal is able to maintain close to 10% margin for its plastic business (please refer to FY 11 Q3 segment wise results) Moreover, I do not see much leveraging happening in near future for wim plast hence not much of interest cost. RM price is dependent on Crude which is at USD 120. If I consider 5 year average price of crude, it is likely to be less than current price and hence impact of RM price on margin in next 3-4 years is going to be positive, if at all. Still, I think 10% is a fairly realistic expectation (considering FY 12 margin of 11.35%).

      I hope I have been able to put through my thought process clearly.

      Delete
    2. Hi Dhwanil

      I had looked at Wim Plast sometime back, but I had few concerns regarding sustainability of high returns.

      1. Wim Plast was a very poor business till 2008 with ROE of less than 6%. Then it suddenly turned around and main reason for this improvement was bubble guard technology.

      From MDA in 2006 AR
      “The Management is of the view that any further huge Investment in the form of expansion in the present line of moulded furniture business would not give adequate returns. Hence the management has decided to venture in a new line of Business of manufacturing Bubble Guard Sheet along with the current business i.e. Moulded furniture. “


      It seems like the bubbleguard product/ technology is patented with limited number of players, but I am still not convinced on whether others can replicate it. There certainly would be more players entering this domain if Wim Plast can maintain sustained profitability. Some old links:

      “Cello Bubble Guard” project is an Asia’s 1st plant and 3rd of its kind - http://www.indiapackagingshow.com/MMSAdmin/MMSTEST/htmlfiles/Wim%20Plast%20Ltd..html


      This is the first time plastic bubble-guard cartons have been introduced in the world
      “In Kashmir, apple farmers fetched Rs 600 for 20 kg-cartons, as compared with the traditional packing which fetched Rs 150 less
      http://www.business-standard.com/india/news/reliance-packs-in-appleshimachal/227497/


      2. I don't think Cello is a big brand in plastics. So comparing it with Nilkamal may not be the right thing. In the long term, can it scale up and become as popular as Nilkamal, I am not sure. But again, I rarely go to shop for plastic products and my views are based on very limited observations :)

      Delete
    3. Hi Rajat,

      Wim plast was not a very profitable company till 2007-08. However, management identified the problem and addressed it with adopting right strategies. In essence, Wim Plast shifted its focus on manufacturing and closed down low margin/loss making trading operations. This combined with cost cutting and improved capacity utilization boosted profits. Following link gives some insight on why returns/margins were lower for wimplast.

      http://www.katalystwealth.com/wim-plast-ltd-should-it-be-a-part-of-your-portfolio

      Wim Plast has ended FY 12 with 11.5% NPM, indicating margins seems to have stabilized around 10%.

      With regards to brands, my understanding is as good/bad as yours in plastic furniture. However, I do know that "Cello" is a very popular name for household items in Gujarat and evokes strong positive brand association. This, I think may be working in favor of the company.

      Again, I would strongly recommend that one needs to dig deeper before making investment decision as this research is still superficial. I am not too sure about management quality/integrity barring the fact that no major violation has been committed by them.

      Best Regards
      Dhwanil Desai

      Delete
  5. i think out of this list amara raja may give reasonable componding.it has been gaining market share and growing faster than exide.despite that its pe ratio is lower.however if india sinks due to fii money going out,this will also fall.autompbile sales could also fall if petrol prices rise substantially due to devaluation in rupee

    if fiis withdraw money,there would be nowhere to hide other than shorting the market

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  6. Hi Dhwanil,

    Narmada looks like a very good business. What are the -ves do u forsee in this business. Few which i can think of are
    1) Dependence on RM prices- What is the company policy here? Are they able to pass on the effect of increase in RM prices immediately
    2) Pollution- Cos AR says that few of its competitors suffered closures. Any idea where company is on pollution norms

    regards,
    saurabh

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  7. Hi Saurabh,

    Yes, dependence on RM prices is the single biggest risk that I foresee. In the past, many gelatine manufacturers have witnessed highly fluctuating margins due to increase in cost of RM. However narmada has been able to manage RM front well as company has maintained its margin in last 6 years. Moreover gelatin industry is facing RM shortage worldover and hence any increase in RM prices is likely to be passed on to the consumer with some lag considering oligopoly nature of gelatin industry.

    Gelatin manufacturing is a process where environmental risks are high but I do not envisage that as big threat for narmada considering their experience and track record in the industry.

    I feel there is strong underlying value in Narmada Gelatines Ltd.

    Best Regards
    Dhwanil Desai

    ReplyDelete
  8. Prakash p. Joshi23 August 2012 at 10:03

    Dear Dhwanil,

    Which "Screener" you have used to get a list of 69 companies as a starting point?

    ReplyDelete
    Replies
    1. A very useful website

      www.screener.in

      Delete
  9. GR8 Analytical tips / recommendation proving very profitable on both the blogs.. Try yourself. I am serious.

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  10. Nitta Gelatin is also in same sector as Narmada..Would like to request for comparison if possible

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  11. Hi Achin,

    Nitta is one of the larger ones and a japanese company however,its historical track record is highly fluctuating while that of narmada is very consistent. Also, in terms of valuation, narmada is available very cheap price while Nitta looks pricey with current earnings and price. So, odds of making significant returns remain in favour of Narmada.

    Best Regards
    Dhwanil Desai

    ReplyDelete
  12. Nice post. But how did you screen these companies.

    thanks

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  13. Dhwanil - are you still invested in Fluidomat? What do you think are the prospects going forward?

    What would be your estimate of the market size of fluid coupling products in India and abroad?

    ReplyDelete
    Replies
    1. Hi Anon,

      Sorry for late reply. I am invested in Fluidomat from the level of 28 and continue to remain invested. Though, I feel that in order to remain invested for long term, I would like to see decent topline growth as the margin expansion will eventually plateau out.

      What I understand from the market and interaction with few people in the industry is that domestic market size is of the order of 350-400 crores. International market is much larger than that.

      Best Regards
      Dhwanil Desai

      Delete
  14. Dhwanil, great picks! have looked at all these companies at different points of time. Regarding Wimplast, did you look at the corporate governance issue here? The promoter was involved with an operator (Linke here-http://www.moneylife.in/article/sanjay-dangi-another-barred-market-manipulator-still-pulling-strings/12075.html)

    I viewed this as more of a binary call and stayed away. Would like to have your thoughts on this. Thanks

    ReplyDelete
    Replies
    1. Hi Rohit,

      Though, I had looked at Wimplast as one of the potential investment opportunities, eventually decided not to invest for similar reasons as any doubt on Promoter integrity is a show stopper especially when the activity involves market manipulation. On the business & valuation front, it looked good and has performed well in last 3 years. But the returns are irrelevant as the risk involved is disproportionate.

      Delete
  15. Yes, I agree. Had similar concerns. I worked on Narmada Gelatines recently, and would like to exchange notes with you on the same. Would it be possible to discuss it over email/call? I can share my analysis with you over email?

    ReplyDelete
    Replies
    1. Hi Rohit,

      Sure, we can discuss and share the work and that is how we can get better insights or find areas where we have not done complete analysis.

      You can send the notes to my mail address. However, I will be able to revert only in next week as I am going on vacation from tomorrow.

      Look forward to be in touch with you.

      Best Regards
      Dhwanil Desai

      Delete