Stock analysis – Ingersoll rand

About
Ingersoll Rand (india) is a subsidiary of Ingersoll rand (US) with a 75% holding of the parent company. The main business (after all the disposals) of the company is air solutions – mainly compressors and other instruments such as air dryers, filters, after-coolers, receivers, water separators, etc.

Financials
The company has been disposed off three businesses in the last 3 years. This includes the road development, utility equipment, Bobcat business and climate control business. The company has realised a pre-tax profit of almost 217 crs in the last 3 years.
Due to the above developments, the topline of the company is not comparable across the years. The remaining business – airsolutions seems to be growing at double digits for the last few years. The net margins of the company has improved to almost 10% (which could be cylical high) and the ROE has leaped from a good 20%+ to 70%+ number (net of surplus cash on the balance sheet).
The improvement in the ROE has come via improvement in margins and asset turns (both inventory and recievables ratios have shown improvements in the last 4 years).

Positives
The company’s balance sheet looks extremely good. Almost 80% of the balance is cash and equivalents. Part of this cash is from the sale of the various businesses and rest has come from the free cash flow of the business. The core business of the company is throwing off a good amount of cash with low Capex requirements.
The company has become more efficient via a combination of improvement in margins (which may drop) and improvement in various ratios (due to improvement of efficiencies).
The air solutions business has been showing decent growth in the last few years. This growth may slow down in the short to medium term, but should remain good over the long term. In addition the valuations of the company are very attractive. The business is selling for 1-2 times the current years earnings (excluding cash).

Risks
The business risk seem to be low. There are 3-4 competitors in this business like Elgi equipment, Atlas copco etc. However the level of competition has not been intense. However with such high growth rates and returns, foreign competition is being expected. This may result in lower returns and low growth in the future. The valuation however discounts this and more currently.

There are several risks for the minority shareholders. The key risk in my opinion is that the company is a 75% subsidairy of an MNC. The parent company has an unlisted company in india and there is a clear conflict of interest. My personal experience with such type of situations has been bad. The minority shareholders in such cases have suffered from poor governance, poor utilization of excess cash (cash continues to lie in the balance sheet with no clear plans) and no special focus from the parent company. In some cases the parent has bought out the minority holders at an unfair price.

In addition, the Annual report is sketchy in terms of the future plans for the business and how the excess capital will be utilized.

Competitive analysis
The main competitors of Ingersoll Rand are Atlas Copco and Elgi equipment. Atlas Copco is twice the size of Ingersoll rand and Elgi equipment is roughly the same size as Ingersoll rand. The various financial parameters such as Net margins, ROE, Sales etc are similar for Elgi and Ingersoll rand. Ingersoll rand is slightly cheaper than Elgi equipment. However the elgi management seems more focussed on the growth of the business (as atleast they are more articulate about it) and have aggressive growth plans for the domestic and international markets, so that may explain the difference in the valuations.
By various measures even Elgi equipment seems to be cheap and it can be preferred over Ingersoll on qualitative parameters
Atlas copco has similar margins (10%), higher turnover (twice) and lower efficiency ratios (ROE of around 20%) . The valuation for Atlas is however much higher than the other two companies and can be used as a reference point for comparitive valuation

Valuation
The company net of cash is selling at 1-2 times of the free cash flow. At the current rate, the business would be a cash bargain in the next 1-2 years. From a pure, numbers point of view, the stock is undervalued by a decent margin.

Conclusion
The company looks cheap and undervalued by quantitative measures. The core business is growing and should pick up steam once the economy recovers. However there are quite a few small things, which make me uncomfortable from a subjective standpoint. The management has no interest in communicating with minority shareholders (who are less than 25%) on the future plans for the business, the cash holding etc.

In addition the parent has an unlisted subsidiary, which is generally not a good thing for the indian shareholder. If I were to consider this company, it would be part of my graham style portfolio and not the core due to above issues.

Additional point: I did this analysis before the satyam issue. There is no change in my analysis due to the above incident. Having cash on the balance is not a red flag for fraud. One cannot invest based on the assumption that all companies are committing a fraud, unless proven otherwise.

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