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.