Swaraj Engines (SEL)- Vantage Analysis- Part 1

Mohnish Pabrai the famous value investor says that a key component of his investment philosophy is using the mental model of cloning. This means clone the ideas which other proven investors are implementing.  A nice video on his philosophy is here

Rather than limit myself to ideas i thought why not try to clone the stock analysis of other investors. To start with i am trying to copy Prof. Bakshi's analysis of VST Industries and see where it takes us. The link for the original post is here and it is an exceptional article and should be read without fail.

Swaraj Engines

1) Vantage Point of Business Analyst:: A business analyst tries to understand how strong the business is. SEL is in the business of manufacturing engines which are used in Tractors & is a M&M group co.

If we look at the B/S of SEL following points come up 

• Working capital gap is almost zero  ( Trade receivables+Inventory- Trade Payable), which could mean that either company has very efficient WC management or they have liquidity problems. But as they have no debt, it clearly indicates this is due to good WC management. A look at last 5 years confirms this. We have taken last 5 years, since co. is being managed by M&M since 2007. 

				All fig. In Crs
	FY08	FY09	FY10	FY11	FY12
Trade Receivables	16.8	5.2	4.05	8.05	11.91
+Inventory	8.4	12.7	19.9	35.11	33.4
-Trade Payable	16.3	20.2	32.2	35.85	43.49
	8.9	-2.3	-8.25	7.31	1.82

• If we deduct short term provisions SEL has cash of Rs.50 Crs which is in form of investments in liquid & debt mutual funds

From the above we can see that the business of company is well financed and is also pretty stable. The reason for this is the fact that almost 100% sales of the company are to M&M which ensures low debtors and good inventory management.

Let us now try to look at the capital intensity of the company:

	FY08	FY09	FY10	FY11	FY12
Net Fixed Assets	30	26.5	23.8	26.47	49.9
Net Current Assets	36.2	50	41	68	50
Total Capital Used	66.2	76.5	64.8	94.47	99.9

Thus from above we can see that average Capital Employed is around Rs.80 crs.Net sales of SEL in FY12 was Rs.448 Crs, leading to capital intensity of around 5.6, which makes it a moderately capital intensive business.

To be consistently profitable a company can either operate at high margin with high capital intensity or if it can operate with low margins but with very low capital intensity.In this case the PAT margins of the company for last 5 years on average have been around 11.5%, which is good but not phenomenal.This implies that company can generate a return of around 60% on capital invested which again is quite good, and should be reason why company is constantly accumulating cash.

Till now we know, that co. has low WC cycle, is cash rich with decent RoC. Before we go ahead it makes sense to check on the sanity of the reported numbers, which we can see from the cash flow:-

	FY08	FY09	FY10	FY11	FY12
Cash Flow from Ops	39	31.5	40.2	30	49.8
PAT	14	21	37	43	52

As we see either cash flow from ops has been higher than PAT or has been near to it, which assures that cash is not being burned. Also, the Dividend Payout ratio is around 30%, indicating that company does have cash on its books which can be distributed as a healthy dividend.

The average cash flows for past 5 years comes to Rs. 38 Crs, against average capital deployed of 80 Crs giving us cash flow return on capital of 47%.

It has been now established, that we are looking at a debt free, low WC cycle, reasonable ROC business with healthy cash flows. All these are attribute of a great business, but for the fact that capital intensity of SEL is moderate. To over come this SEL should try to maintain its margins or constantly improve them. This can be done simply by constantly increasing the price of goods sold or by taking the more tedious route of reducing manufacturing cost.

	FY08	FY09	FY10	FY11	FY12	Growth Rate
Approx Sales Price of Engines	71500	74000	71000	76000	82000	2.94%
Manufacturing Expenses( In crs)	90	163	216	280	351	58.00%

Now things do get tricky. As seen from above, SEL finds very difficult to increase the sales price, even though manufacturing costs have increased at a sharp rate.The reason why company is able to maintain its margins has been its operational effciency and not pricing power.

And the entity responsible for this is the promoter company.On one hand M&M helps/forces 

SEL to operate super efficiently while on other hand it gives SEL no pricing power.

To summarize as a business analyst key pointers on business would be :-

1) Debt Free, Cash Rich Business

2) Moderate Capital Intensity

3) No pricing power which makes maintaining margins for the company a challenge year on year.

4) Growth dependent on tractor sales by M&M.

End of Part-1.

In the next part i will try to see if i can find the intrinsic value of company and MOS.

cheers,

PS- Prof. Bakshi has used 8 vantage points, but unfortunately i don’t have the acumen and patience like him. So in next part will use only 1-2 vantage points to look at valuation of company.

Kesar Terminals

Business of Company:Kesar Terminals(KTIL) is a unique company with a very simple business model. The company simply erects storage tanks near ports and then rents them out on long term contracts.To my mind once a storage tank is build this looks like a business which anyone can run.

KTIL as of now operates 64 tanks at Kandla Port. The company is also planning to modernize this storage tanks which will help them to attain higher utilization and better margins.

Future Plan: KTIL is constructing storage tanks at Pipavav and Kakinanda at an outlay of around 50 Crs. They have also floated a JV( Kesar Multimodal) with promoter company Kesar Enterprises Ltd (KEL)  in 74:26 ratio for construction of a multi-modal railway park near itarsi. The project will be implemented in 2 phases and total cost will be around 190 Crs. First phase should be operational after 2015 and second phase after 2018.
Both projects in all likely hood will be funded through a mix of debt and equity.

Valuation:
KTIL quotes at a P/E of 4.8x with a dividend yield of 3.5%. Upfront it definitely looks cheap but my idea was to check even at this price does it offer me margin of safety.

I will try to evaluate this business assuming that both projects of the company get delayed and company has to bear interest costs & principal repayments through its existing cash flows. Essentially i want to check if the present business can support the companies future plans or is it a leap of faith by promoters.

Valuing a company like KTIL seems relatively easy considering the simple business model. A basic DCF with conservative growth rates can suffice.

So lets get started with some basic assumptions.

1) D/E of 3:1 leads to total incremental Debt of Rs.44.25 Crs. Even at this ratio their will be significant equity dilution but any equity contribution higher than this will destroy the returns of shareholders.
2) Approx annual interest of 3 Crs, assuming 70% utilization.
3) Cost of Capital 18%
4) Growth rate till 2016 is 6%, and 10% thereon till further 7 years.Terminal growth rate of 3%
5) The project at Pipavav and Kakinada will end by FY 2016 instead of FY 2014..

Scenario 1: KTIL undertakes both projects simaltaneoulsy and both get delayed, which in India is fair possibility. In this case on the assumption that albeit, with delay the projects do start the EV of company comes to around 12 Crs as compared to present EV of 35 Crs. No MOS here.

Scenario 2: KTIL like a good capital allocator does one project at a time. It starts with Pipavav and even if it gets delayed by 3 years the rough EV of the company comes to around 30 Crs as compared to present EV of around 35 Crs. Much better MOS here.

Detailed calculations are given here:: https://docs.google.com/spreadsheet/ccc?key=0ArVxMyZ-jaYtdG1DaGZzd3RKSnJLM0ZQdHJZZWFNQUE

Please do bear in mind that these are rough calculations, and idea is not to predict the cash flows, but to understand what happens if cash flows don't follow the predicted pattern.

Conclusion:
Even though KTIL has a fantastic business, they are again falling into trap of overconfidence and poor capital allocation (Uncanny similarity to Noida Toll Bridge at its inception). As an investor i would have been really happy if company had taken only one project at a time. Imagine the ROE had company taken only Pipavav Project (cost of 27 crs), which it could have easily funded through internal accurals.

So i am giving this company a miss for now, but will track it due to its unique business model and can be re-looked if they are able to execute one of the projects without any delay.

PS- I haven’t considered the impact of debt which will be taken in the JV. Had i taken that probably this post would have ended half way with a firm NO on the company :)