Engineers India: Solid fundamentals; Buy for Long Term

Engineers India Ltd’s follow-on-public offer has finally hit the market yesterday. Govt. is looking forward to raise around INR 500 Crores through divesting its 10% stake in the PSU mini-ratna company, where it currently holds 80.4% of total share. EIL is offering its share in a price band of INR 145 – 150 until Feb 10, 2014 (Monday). EIL is also offering a discount of INR 6 to retail investors (ones who will be bidding for less than INR 2 lakhs) and its employees.

Engineers India is a leading EPC (Engineering, Procurement and Construction) and Consultancy organization of India. It undertakes major complex engineering projects like construction, expansion and maintenance of oil refineries, port terminals, chemical and fertilizer plants etc. It has grown its net profit at a CAGR of 25% in last 9 years (until Mar 2013). With a ten-year average return on capital employed of solid 34.5%, the firm has solid capital allocation and project execution track record.

Now, if investors look at the balance sheet of the firm, they will realize the true genius of its management. The firm has net operating assets of only INR 404 crores on which it has generated operating profits in tune of INR 815 crores in FY13 The firm has net worth of INR 2,295 crores while the total treasury of the business is at INR 2,436 crores. If you include current investments in the calculations made in the table below, the net operating assets stands at negative figure.

Essentially, company has more treasury than shareholders’ funds. This is because in current uncertain economic environment, policy paralysis, no new investments are happening on the ground. That does not mean in any way reflect on the superior capital allocation capabilities of the company's management. So, company is sitting with tons of cash just waiting to deploy it to earn solid ~35% returns.

Conclusion
Not every good business is necessarily a good investment at a given price. Even some of the strong business models have generated negative returns for its investors if they bought it when the stock was overvalued.

The simplest of the way to find out whether the stock is under or overvalued is to ask a simple question: How much future growth in free cash flows current market price is factoring in?
My reverse DCF model suggests the implied FCF growth rate for next 10 years is -11% with a hefty discount rate of 15% and terminal growth rate of 3%. Little hard to believe for the company which has grown its profits at 25% in last 10 years.

You can of course arrive at your own valuation by changing the assumptions of discount rate and terminal growth rates.

Backed with all these calculations, it appears that EIL is a good buy and retail investors should make a bid in its FPO.

Disclaimer: Invest at your own risk, you can lose money on a misprint :)

Weekly Market Commentary - Jan 27, 2014 - Jan 31, 2014

RBI governor threw in a surprise again this week. He maintained the RBI’s stance of treating inflation as its enemy no.1 while increasing the repo rate to 8%. Street was expecting no change in interest rates, some even calling for a cut now with food inflation especially vegetable inflation coming down from recent highs. Last week Urijit Patel committee made a recommendation to RBI to replace WPI by CPI as inflation benchmark for calibrating further policy actions. It is too early to say whether RBI has indeed taken up these recommendations. If that is the case, we’ll see more rate hikes in near future to contain CPI inflation and get it under RBI’s comfort zone.

Sensex and Nifty ended this week with losses of 2.9% and 2.8% respectively while CNX Midcap fell 1.6%.

Monday – Sensex down by 2.0%, Nifty down by 2.1%, Midcap down by 2.9%
Markets tumbled as investors pull out money across emerging markets before Fed tapering announcement. Fed is expected to make another cut in stimulus in Ben Bernanke’s last meeting as Fed chairman. Also, weak PMI data from China last week coupled with Argentina abandoning support of its currency peso on the open market, which led to its 15% slide, affected the investor sentiment.

Tuesday - Sensex down by 0.1%, Nifty down by 0.2%, Midcap down by 0.1%
After an onslaught on previous day, market’s attempts to recover, on the back of short coverings, was cut short by RBI’s decision to hike the repo rate by 25bps to 8%. RBI governor Raghuram Rajan defended his actions by claiming that growth cannot be had unless we have inflation totally under control. He pointed out that although CPI inflation excluding food and fuel has remained flat, WPI inflation excluding food and fuel has risen prompting a rate hike from RBI.

Wednesday – Sensex down by 0.2%, Nifty down by 0.1%, Midcap up by 0.5%
Investors stayed on the sidelines as Fed ends its two-day meeting on Wednesday with most economists expecting a further stimulus cut as US recovery shows signs of traction. The stimulus has led to FIIs pouring $20bn in India in 2013. Though Indian govt and central bank maintains that they are prepared to meet any challenge thrown in by Fed tapering, it would be highly likely that any tapering announcement will negatively affect all emerging markets including India.

Thursday – Sensex down by 0.7%, Nifty down by 0.8%, Midcap down by 1.4%
And Fed did it again. Fed tapers another $10bn, signaling confidence that the US economy can stand on its own. This move had an expected negative impact on all emerging markets. Fed has indicated that it will keep on cutting its stimulus as recovery gains strength. Fed bond purchases now stands at $65bn a month.

Friday – Sensex up by 0.1%, Nifty up by 0.3%, Midcap up by 2.3%
Markets ended flat to slightly positive as investors recover from actions of Indian and US central banks. Indian markets closed January with a monthly loss of 3%, worst since Aug 2013.

Madhav Marbles - Value buy or Value Trap

“Ninety to 95% of all my investing meets the Graham tests. The times I strayed from a rigorous application of this philosophy I got myself into trouble.”

“We do liquidation analysis and liquidation analysis only.”

“One of the dangers about net-net investing is that if you buy a net-net that begins to lose money your net-net goes down and your capacity to be able to make a profit becomes less secure. So the trick is not necessarily to predict what the earnings are going to be but to have a clear conviction that the company isn’t going bust and that your margin of safety will remain intact over time.”

These were some of the extracts from the wonderful book by Christopher Risso-Gill on legendary superinvestor Peter Cundill, “There’s Always Something to Do”. 

Peter was a fan of Graham’s net-net approach and he used it extensively with tweaks of his own to build a portfolio of international deep value stocks which generated 15%+ returns for its investors for well above 30 years!

Today we will try to use Peter's approach of using liquidation analysis to find an investment opportunity in Indian equity space.

I want readers to take a look at the balance sheet snapshot of Madhav Marbles & Granites Ltd. which is in the business of manufacturing and processing Granite tiles and slabs, wind power generation and realty. The company reported a net revenue of Rs.653 million, EBIT of Rs.50 million and net profit of Rs.31 million in FY13. The company had operating cash flow of Rs. 44 million and has been cash flow positive for last five years (maybe longer).

One look at the balance sheet, and you can easily make out that all the liquidity ratios are pretty high: current ratio is 6.6 and quick ratio is 6.2. Actually, you'll see that company’s cash position covers more than 70% of all of its current liabilities. In the event of company needing some urgent funds, it can do so very easily. Even in a distress scenario of 50% marked down on total assets position, the firm can easily meet all its liabilities.

Now the best part of this post. The current market capitalization of Madhav Marbles is Rs. 17 crores. Its liquidation value, after marking down the entire assets by 50% and adjusting for contingent liabilities is around Rs. 32 crores. The liquidation value is double of current market value of this company. See the table below for illustration.

To re-emphasize one can buy the entire company for Rs. 168 millions, sell all the assets at 50% discount, pay off all the liabilities and will still be left with some cash to spare.

I am not sure whether this is a classical deep value investment or a value trap. The company is priced for bankruptcy when its cash position is sufficient to take care of most of its current liabilities.The stock has been largely ignored by the general market with last one year average volume of few hundred stocks on NSE.  I searched for any fraud, scam or cheating case against the company and found nothing.

Let me know what readers think about this investment and if there is some major development or issue with the company I am missing.

Disclaimer: Invest at your own risk, you can lose money on a misprint :)

Weekly Market Commentary - Jan 20, 2014 - Jan 24, 2014

Investors were a cheerful lot for most of this week. So far, result season has been good, has been largely without any negative surprises. Dollar earning sectors seems to have picked up steam on hope of strengthening US recovery. Falling inflation levels have also brought back the rate cut clamour. Everything was good and normal until two important events happened. One, Urijit Patel tabled a report on strengthening monetary framework, which among other things recommended changing the inflation targeting benchmark to CPI from WPI. If this happens, it may lead to higher interest rates in near to medium term and may put a dampener on India’s growth plans (for short term). Two, RBI governor made statements to the effect of inflation fighting would be the main focus of RBI, which dashed hopes of rate cut in RBI review meeting on Jan 28.

Sensex and Nifty ended this week with small gains of 0.3% and 0.1% respectively while CNX Midcap fell 0.9%.

Monday – Sensex up by 0.7%, Nifty up by 0.7%, Midcap up by 1.0%
Market’s mood was cheerful as index heavyweights Reliance Industries and Wipro managed to beat consensus and post healthy results. Reliance fared better than street forecasts as its refinery earned $7.6 per barrel of crude refined, significantly better than Singapore GRMs (Gross Refining Margin) of $4.3. Shares went up initially but lost all its gains in the latter half of the day. Wipro ended the day up as its results showed that business continued to improve as signs of turnaround and margin expansions are growing.

Tuesday - Sensex up by 0.2%, Nifty up by 0.2%, Midcap up by 0.2%
Market continued its uptrend amid some profit booking seen on the bourses. Govt decision to sell stake in Hindustan Zinc to cover some of its fiscal deficit also helped to improve the sentiment.

Wednesday – Sensex up by 0.4%, Nifty up by 0.4%, Midcap up by 0.1%
Indices spurted to all time highs in latter half of the day as investors flocked to buy pharma, metal and banking stocks on expectations of strong corporate earnings and rate cut by the Reserve Bank.

Thursday – Sensex up by 0.2%, Nifty up by 0.1%, Midcap down by 0.4%
Markets continued their rally and closed at another record high as industry bellwether, L&T, which is widely considered the barometer of Indian economy, rose as much as 4% after reporting a 22% jump in standalone net profit for 3Q.

Friday – Sensex down by 1.1%, Nifty down by 1.2%, Midcap down by 1.8%
Indices snapped on last day of the week as RBI governor Raghuram Rajan calling inflation a “destructive disease” dashed hopes of investors expecting a rate cut in the review meeting. These comments bring RBI’s priorities to tackle inflation first before focusing on growth to the fore again. In another event, Ranbaxy’s stocks crashed 20% after US FSA banned the firm from shipping drugs from its Toansa plant. Weak global trend following poor economic data in the US and China dampened the market sentiment.