Monday, 16 July 2012

GSFC Ltd: A Peter Cundill Style Opportunity

I have completed reading "There is Always Something To Do: The Peter Cundill   Investment Approach" by Christopher Risso-Gill. Let me tell you, it is a remarkable book about a extra ordinary value investor. The book has been replete with "investment notes" maintained by Peter Cundill for his investment ideas.Investment rationale for many investment ideas is very succinctly presented with right perspective. Peter Cundill was one investor whose investment style largely resembled to the investing style of Benjamin Graham which relies heavily on tangible assets on book to ensure margin of safety in investment process. This analytical framework is the most conservative way of ensuring margin of safety as it ensures "safety of capital" in the worst case scenario, i.e. liquidation of a company. 

Before I start analyzing the company, let me give you some glimpse of Peter Cundill's investment style. Peter Cundill describes his investment style as "mostly Graham, slightly Buffet and little bit of Cundill". His investment thought process relied heavily on determining "liquidation value" of a company and if the company was trading below its liquidation value, he would seek to invest in a company. He would look for securities that were quoting below book value and carried assets on the books at substantial discount to its fair/market value. He would then determine the fair book value or liquidation value of a company and if the price is below "liquidation" value, he will seriously look at such companies for adding into his portfolio. In my opinion central premise on which Peter Cundill relied was that any business is worth more alive than dead. Based on this premise, if one buys into a business at price which is even lower than its liquidation value, it gives substantial margin of safety to investor. The only caveat here is that, business in which one is investing, should be a profit making venture and should not be burning cash. This approach worked so well for him that he generated 15.2% annual returns compounded over 33 years, a terrific record by any standards. Peter's focus on seeking margin of safety in tangible assets meant that he was insulated from vagaries of growth rates and free cash flows!

With this background, I will try to analyze GSFC Ltd and how it presents an opportunity that Peter Cundill would have surely looked at. GSFC limited is a public sector enterprise promoted by Goverment of Gujarat with the aim of producing complex fertilizers to meet the needs of agrarian economy. GSFC  mainly operates in two segments i.e. fertilizers and industrial chemicals. GSFC is the largest producer of Caprolactum (used for manufacturing of nylon), malamine and amonium sulfate in India. It is second largest producer of di-ammonium phosphate (DAP) in India. It also produces ammonia, nylon, ammonium phosphate sulfate, urea, argon gas and sulfuric acid. It has also entered into production of bio-fertilizers and water soluble fertilizers which is a value added product compared to normal fertilizers. 

I will do a very cursory analysis of P &L and return ratio here, as focus of the analysis is limited to ensure that GSFC's operation will not start burning cash fast enough to erode margin of safety. 

In Fy 2011-12, company reported revenue of 5680 crores and net profit of 758 crores. It increased its sales by 14% while its bottom line grew by 1% from FY 2010-11. In last 5 years company's sales has grown at CAGR 9% while its profit grew at CAGR 26% (mainly due to quantum leap in margins in last 2 years post nutrients based subsidy adopted from April 2010). GSFC's ROE has been oscillating between 17% to 30%. However post NBS, company is able to generate ROE that is much better than that of pre NBS era. It has very little debt on its books as per 2012 balance sheet. So essentially we are talking about a company that is practically debt free and generates reasonably good return on its equity. In each of the last 5 years, cash flow from operations has remained positive and generally in line with net profits. Thus, it is reasonable to conclude that GSFC is not going to be cash burning enterprise in near future. 

So now let give you a glimpse of key components of balance sheet for GSFC as on march 2012. 

Total Shareholder's Funds: 3517 Crores

Long term Debt              : 191   Crores

Total Liabilities              : 3708 Crores

Net Block                      : 1425  Crores

Capital work in progress  : 346   Crores

Investments                  : 433   Crores

Net Current Assets         : 1504  Crores
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Let us first look at assets that can be easily liquidated and price can be estimated with reasonable certainty. In the entire exercise, even though, I have taken some benchmarks to decide realistic value for various assets/investments, I have tried to remain conservatively realistic on valuation. 

Net Current Assets: based on balance sheet of FY 2011-12, 

Current Assets- Current Liabilities = (3104-1611) = 1493 crores. 

Now we have to determine realizable value of net current assets if these assets are to be liquidated/sold off to some other investor. 

If we break down current assets it comprises of following components, its book value and realizable value based on certain assumptions.  

Asset/Liability Class
Value on Books
Realizable Value
Cash
897 Crores
897 Crores
Accounts Receivables
1426 Crores
   1354 Crores (5% Write Off)
Inventory
642 Crores
515 Crores (80% of BV)
Other Current Assets
135 Crores
120 Crores (10% write off)
Short Term Loan
622 Crores
622 Crores
Accounts Payable
492 Crores
492 Crores
Other Current Liabilities
500 Crores
500 Crores

so realizable value of Net current Assets = (2886-1609) = 1277 crores

Now let's look at investments. 

Investments: 

Following link provides view of various short term/long term investments held by GSFC.
GSFC 2011 12 Investments


Non Current Quoted Investments:

Let us start with non current investment in quoted securities  and determine market value of non current quoted investments.

Security Name
No.Of Shares
Book Value (Cr)
Current Share Price
Market Value(Cr)
GNFC
3,07,79,167
 58.39
  84
  258.5
GIPCL
2,23,62,784
 36.50
  65.75
  147
GACL
16,55,040
 8.27
  122.95
  20.35
Total
 
    426         

Total market value of quoted security is roughly 426 Crores at current market price. 

Non Current Unquoted Equity investments:

I have done analysis of conservatively estimated value of GSFC's investment in Indian potash limited, bhavnagar energy company, GSPC and GSPC Gas. I have not analyzed other investments as either they are strategic in nature (Gujarat Chemical Port Trust) or enough financial information is not available with me.

1) Indian Potash Limited: GSFC holds roughly 7.87% stake in Indian potash i.e. 11,25,000 shares in IPL, a flagship company promoted by various fertilizer companies and ministry of commerce for importing, marketing and promoting potash in Indian market. According to 2010-11 P &L available on its website, company made profit of roughly 375 Crores on turn over of 20,750 crores. According to FY 10-11annual report, basic EPS is Rs.263 . Even if we assume 10% growth in FY 11-12 and assign P/E of 6 on 2011-12 earnings, it will mean share price of 1740. GSFC's investment of 11,25,000 shares can be valued at roughly 200 crores against book value of 0.61 crores.

2) Bhavnagar Energy Company Limited: It is a 500+ MW lignite based power plant put up near Bhavnagar in Gujarat. BECL is promoted by various state PSU such as GSFC, GNFC, Gujarat Power Corporation Limited, Gujarat Mineral Development Corporation, GIPCL and GACL. Lignite for the power plant is going to be available for GMDC mine near Bhavnagar. GSFC holds 4% share in the company. BECL is at advance stages of construction and project is likely to be commissioned by end 2012. A comparable company for valuation shall be Navyeli Lignite corporation which operates 2750 MW of lignite based capacity and has market cap of 13670 crore valuing company at 5 cr/MW of existing capacity. On a similar matrix, BECL can be valued at roughly 2500-2700 crores. However considering the fact that for BECL project is under implementation and there is no track record of operations, one should consider at least 25-30% discount to Navyeli's valuation. Thus we shall assume 4 Cr/MW for valuing BECL. Hence valuation of BECL shall be around 2000 crores. GSFC's share of 4% will mean value of 80 crores. 

3) GSPC Limited: GSFC holds 2.35 crores share of GSPC at average cost of 64 rs/share (face value of 1 Rs). Total value of GSPC holding is 150 crores. LIC, SBI and IDFC acquired shares in GSPC at 810 rs/share (FV of 10 Rs) so effectively they acquired stake in GSPC share (of Fv 1 ruppe) at roughly 81 rupees. However, to be conservative, let us value GSFC's investment in GSPC at the book value i.e. 64 Rs/share. This will mean valuation of 150 crores for GSPC investment (same as value carried on book). 

4)GSPC Gas Limited: GSPC gas is now the largest City gas distribution operator in India with its wings spread across number of cities in Gujarat. GSPC gas distributes CNG and PNG in many parts of the state catering to natural gas needs of industrial, residential and commercial customers. GSPC Gas is promoted by GSPC. It is currently not publicly listed company. GSFC holds 91,78,800 shares in GSPC gas. According to 2010-11 annual report of GSPC Gas, company reported net profit of 148 crores in 2010-11 registering more than 400% growth in PAT with respect to previous year. If I assume modest growth of 15% in PAT, 2011-12 PAT of GSPC Gas would be around 170 crores. Based on FY 2010-11 report GSPC has issued paid up shares of 5.92 crores in 2009-10 and was under process to issue shares of 10 crores. Hence total paid up shares is likely to be 15.92 crores. Thus EPS of the company would be 170/(15.92) = 10.7. In terms of valuation, GSPC gas valuation can be done based on it's listed peers Gujarat Gas and Indraprastha Gas. GGL and IGL trade at trailing P/E of 15 and 11 respectively. GSPC gas being the largest CGD company and also being fastest growing CGD company can very easily command P/E of 12. Considering this, valuation of GSPC Gas share will be around 129. So total value of GSFC holding in GSPC Gas is around 129 * 91,78,800 = 118 crores.

Joint Venture Company:
GSFC and Coromandel International Limited (CIL) has established joint venture with tunisian firms Groupe Chimique Tunisian (GCT) and Campagnie Des Phosphate De Gafsa (CPG) to establish 360,000 tons of phosphoric acid plant in tunisia.This company is known as Tunisia Indian Fertilizer Company Limited (TIFERT). GSFC and CIL each have agreed to offtake 180,000 TPA of phosphoric acid from this new facility. GSFC has signed 30 year supply agreement with TIFERT. GSFC holds 15% equity in the project. GSFC has invested INR 120 crores in the project and holds 33,75,000 shares of 10 tunisian dinars each. Total project cost of this project is likely to be roughly USD 600 million i.e. 3000 crores. 

Phosphoric acid is a key raw material for manufacturing di-ammonium phosphate (DAP) a very popular phosphatic fertilizer in India. Indian fertilizer companies are facing severe shortage of phosphoric acid and they have to rely on very tight international market for procuring phosphoric acid. Almost all DAP manufacturers have indicated that lower capacity utilization of DAP plants are due to non availability of phosphoric acid. In such situation having 30 years supply tied up is a big strategic advantage. However, it is difficult to quantify such advantage and hence, to be conservative let us assume zero value for this advantage. Hence, value of GSFC's share will be at least equivalent to its book value i.e.  120 crores. 

Equity Trade Investment:
In addition to non trade investment in GACL, GIPCL and GNFC, company also has some investment in following companies. Table below represents market value and book value of these equity investments. 


Security Name
No.Of Shares
Book Value (Cr)
Share Price
Market Value(Cr)
Gruh Finance
1,00,000
 .295
  777
  7.77
IDBI Bank
5,49,440
 4.46
  95
  5.22
Manglore chemical
5,79,000
 0.38
  51
  2.95
Total
 
    15.94         

Based on analysis of various type of current assets and investments,Following table summarizes and enlists realistic value of current assets and investments. 


Current Asset Name
    Value
Net Current Assets
     1277 Crores
Non-Current Quoted Investment
      426 Crores
Stake in Indian Potash Limited
      200 Crores
Bhavnagar Energy
         80 Crores
GSPC
       150 Crores
GSPC Gas
       118 Crores
Tunisian Indian Fertilizer
      120 Crores
Equity Trade Investments
       16 Crores
Total
       2387 Crores

GSFC's Current Valuation: At today's closing, GSFC's total market capitalization is roughly 2850 Crores. If we add long term debt of 190 crores, GSFC is available at 3040 Crores to a private investor. Out of 3040 crores, company has net current assets + investment of roughly 2400 crores. This implies that GSFC's fixed assets and future cash flow is available for 650 crores. 

Now fixed assets on depreciated basis is carried on company's books at 1425 crores while   capital work in progress is roughly 345 crores. So total fixed asset value on the books is 1800 crores. However, even if we only assign 650 crores ( roughly 35% of book value), investment made by a private investor at current marker price will break even. In my opinion, no sane person/entity will sell its assets at 1/3 of book value, unless company is under financial distress or assets on books are not likely to generate cash flow in future. In case of GSFC, neither of this is true. 

To put the things in perspective further more, if GSFC wishes to monetize only township land, (roughly 850,000 square yard and free hold of land is with the company) at prevailing market price (roughly 10,000/sq.yard)  it will fetch roughly 800 crores, far higher than value assigned to fixed assets of the entire company at current market price. This will leave Vadodara and Sikka plants available for free.

Thus there exist an opportunity to invest in one of India's largest complex fertilizer company at substantial discount to its liquidation value. I am sure, Peter Cundill would have grinned spotting such opportunities.

As icing on the cake, Fidelity Low priced stock fund holds 4.63% in GSFC. Fund manager of this scheme,Joel Tillinghast is noted value investor who follows investing style of Peter lynch and tries to buy "growth at reasonable price". He has achieved enviable record of generating compounded annual return of 14% for 23 years in Fidelity low price stock fund. Mr.Tillinghast has received best fund manager of the decade award in 2009 by highly prestigious Morningstar magazine. Fidelity low priced stock fund has increased its position in GSFC over last 3 years from nil to 4.63%. This further supports my hypothesis of GSFC's value proposition.

In all, I think, GSFC is a very good investment opportunity considering its leadership position in complex fertilizers, diversified product mix, very good return ratios, strong balance sheet and substantial margin of safety at current market price.

14 comments:

  1. Hi,

    Very interesting post. I was also evaluating this idea but was getting stuck as i was unable to predict what could be the worst case EPS of the company,by considering drop in DAP & Carb. prices. Idea was to understand how badly can EPS fall and if p/e remains same what will be the worst case scenario and thus find if Margin of Safety existed in present price.

    But, for a commodity play, this method of evaluation seems better, wherein rather than predicting future flows one tries to derive comfort from Balance Sheet.

    What do you think are the catalyts in this idea? By reading the AR it seems EPS growth will be muted, so what can be the trigger here?

    Regards,
    saurabh

    ReplyDelete
    Replies
    1. Hi Saurabh,

      Yes, I too feel that ensuring tangibale asset based margin of safety is a good way to protect downside risks. With respect to triggers, I somehow feel that company shall be able to decent EPS growth due to

      1) Methanol plant getting commissioned at the end of Q1 2013
      2) TIFERT becoming fully operational in H2, which will improve availability of phosphoric acid and hence higher utilization of DAP plant.
      3) Current spread between benzene and caprolactum is not sustainable in the longer term. So, worst case is spread staying same. However, my own hunch is that it will improve in H2.

      Hence in near term, I see positive earning surprise as trigger. Also if GSPC comes out with IPO and after lock in period (1 year), GSFC decides to sell its stake, it will unlock value for its shareholders.

      In medium to longer term, urea price decontrol will put all fertilizers at par, giving level playing field to complex fertilizers as compared to Urea. This will definitely re-rate the company.

      Best Regards
      Dhwanil Desai

      Delete
  2. Great analysis Dhwanil, Its for people like you we get to see some good long term bets.

    Thanks

    ReplyDelete
  3. I think it falls under Debt Capacity Bargain. Avg 5 years Cash Flow From Opearting is Rs. 701 Cr. Assuming a Bond investor would look for 1/3 of cash i.e Rs 233 cr of cash flow from operations. So a Bond investor would come to a valuation of around Rs. 2330 Cr. It looks a great buy at this price...

    ReplyDelete
    Replies
    1. Hi Akash,

      Interesting observation. Even though GSFC qualifies as debt capacity bargain or not depends upon what interest coverage ratio one assumes (as required by the lenders)and the interest rate for the money lent to the company. Typically interest coverage ratio in the range of 3-5 is taken depending upon the volatility in cash flow. In current interest rate cycle, 12-13% is realistic considering base rate of 9-9.5%. I think you have assumed interest coverage ratio of 3 and interest rate of 10%. Personally, I look for interest coverage of 4 and interest rate of 12%. But that is a subjective call. In any circumstances, it is very near debt capacity bargain and is a great buy due to additional cushion available from its various investments. It is a perfect deep value buy.

      Thanks again for sharing your views as I had not looked at debt capacity bargain angle for GSFC.

      Best Regards
      Dhwanil Desai

      Delete
  4. Hi Dhwanil,

    You are maintaining a very good blog. And,, this is a nice write-up on GSFC. You have mentioned about the book, 'There is something to do'.

    Can you suggest some other books that have helped you in shaping your investment philosophy in the last three years??

    ReplyDelete
    Replies
    1. Hi Manish,

      Sorry for a late reply. There are number of books written by or about some of the greatest value investors.

      I would recommend
      - Intelligent investor - Benjamin Graham
      - Security Analysis - Benjamin Graham
      - Margin of Safety- Seth Klaraman
      - Beating the Street - Peter Lynch
      - Common Stocks, uncommon profits - Philip Fisher
      - Warren Buffet's annual letters to berkshire's shareholders
      - Prof. Sanjay Bakshi's lecture notes
      - Charlie Munger's article on mental models

      Best Regards
      Dhwanil Desai

      Delete
    2. Thanks Dhwanil for replying to my mail.

      All the books you have mentioned they belong to the category of classics!

      Are there any other books like 'There is...' that you have read and found quite useful to the value investing approach...

      Delete
  5. Hi Dhawnil,

    What's your email id? Would like to point to something important with regards to GSFC.

    Regards,
    Excel

    ReplyDelete
    Replies
    1. hi, my e-mail id is desaidhwanil@hotmail.com

      Delete
  6. This comment has been removed by the author.

    ReplyDelete
  7. It is one of the dreaded things in business, when assets depreciates.
    llc

    ReplyDelete
  8. As of 27 Feb 2013, I note that GSFC is trading under Rs. 60. Any ideas - Why in the hot Indian market, GSFC is falling?
    - Any fundamentals changed since publishing this article?

    ReplyDelete