AuthorRohit Chauhan

About
Ultramarine is a chemical company with three divisions.

Pigments division – This is the oldest division which makes ultramarine blue pigment which is as a colorant, optical whitener and in paint finishes. The same division also makes LAB which is used in detergents. This division had a revenue of around 45 Crs and a pre – tax margin of around 18 % in 2006

IT enabled services – This is a small division of the company engaged in BPO and engineering services. This division had a revenue of around 15 Crs and margins of 50% in 2006

Packaging products – This division had a revenue of around 9 Crs and a margin of just 7 %. This division had a turnaround in the performance in 2006

The company level margins have marked a sudden rise from 2003 , due to the turnaround in the IT services division and positive contribution of the packaging division

Financials
The company had a turnover of 63 Crs last year and may close the year at 65-70 Crs. The net profit was 15.6 crs last year and may come to 18-19 Crs for the current year.
The company has a 20% holding in thirumalai chemicals on its books which is valued at almost 42 Crs and there are cash equivalents of around 10 Crs
The company has high margins of around 20% + and ROC has been in 25%+ range. In addition the company is debt (the debt on books is interest free sales tax loan)

Positives
The company is shareholder friendly. It has a good dividend payout of almost 50% of net profit (2007 dividend was Rs 3 per share). In addition the company has given bonus issue and has split the stock in the past.
The management seems to be allocating capital rationally and not blowing it away. In addition the IT services division does not require a very high amount of capital.

Risks
This is a very small company. With a 15 Cr revenue from IT services and lack visibility of clients, the revenue stream may not be very stable.
The pigments business is a commodity business and may not offer very high margins and returns. The valuation upside for the company depends on the IT services business continuing its performance as it contributes to almost 50% of the net profits.

Valuation
The company has almost 52 Crs on it balance sheet. However this is unlikely to be realised by shareholders as it is mainly investment in a sister concern – thirumalai chemicals. With a net profit of almost 18-19 Crs, the company can be valued at around 210-220 Crs which is almost 70% higher than the current price.

Conclusion
This is a deep value stock. The company is a small cap company, shareholder friendly with very low competitive advantages. The stock can be purchased as a graham type stock as a part of a portfolio and should be liquidated at 90% of the intrinsic value

Statutory warning – A long post with links to other analysis.

I have analysed the oil & gas industry and specifically refineries earlier (see here). In addition an analyis of the industry is also posted on my spreadsheet.

The oil majors have not been a part of the current bull run and the main reason is the convoluted pricing and subsidy structure. As a result the sector is not doing too well and may have some opportunities.

I have developed an investment thesis for HPCL which is given below

About
HPCL is one of the Oil majors with almost 13MMT refining capacity. It is engaged in the business of refining crude and marketing end products. In addition it is also integrating backwards into E&P, lube marketing via its Lube SBU and into the Gas distribution business.

The problem
The Oil & gas business in india has one of the worst economics possible. The pricing though supposed to be decontrolled, is still controlled by the government. As a result in a rising crude price scenario, where other Oil majors across the world are minting money, companies like HPCL, BPCL, IOC etc have been bleeding.

The typical Gross refining margins for companies like RPL has been around 10 usd per barrel. A company like HPCL should easily be able to make 6-7 usd / barrel. However in the last 1-2 years the Gross margins have been 3-4 and net margins have been around 1 usd/ barrel.

The above is due to subsidized sales of products such as Petrol, diesel and kerosene etc Due to the above situation, O&G companies have been beaten down and now sell below replacement value of their asset.

The opportunity and investment thesis
HPCL now sells at around 9000 crores. The EV is around 10000-11000 crores at best.

The replacement cost for the assets of HPCL can be calculated as follows

1.Refinery – 13MMT ( greefields projects cost around 1200-1800 Crs/ MMT) – 19000 (approximate)
2.Petrol pumps / retail outlets – 7313 (average cost atleast 1 cr/ outlet – 7000 Crs (approximate)
3.LPG distributors – 2202, customers 2.28 crores – ??
4.Other gas assets such as pipeline – 2000 Crs + (1700 crs invested in last 5 years), avantika gas, Bhagyanagar gas etc.
5.Other assets – some value
6. JV’s – MRP (17%) – 1200 Crs and other JV’s

The above assets can conservatively be valued at 25000 – 30000 Crs. So the company sells at 25-30 % of the replacement value of its assets.

The above discount is definitely not an abberation. It is mainly due to policies of the government. However I think the gap is higher than it should be and the main reason is that the market is assuming that the current state of affairs would continue as is.

I don’t believe the government is going to change its ways, however I think the bottom line of company should improve due to the following reasons

1. The company is currently engaged in diversifying its revenue streams via various initiatives and reduce the impact of the pig headed policies of the government. These initiatives are lube marketing, Gas distribution and retail initiatives and oil trading and risk management. The market is currently not valuing any of these real options.
2. The GRM and net refining margins are at their lowest. Going forward the worst case sceanrio is that they would remain at the same level. If that is the case, the bottom line should still improve as the various company intiatives take effect (see page 53 of Annual report)
3. The 9 MMT refinery and expansion of Vizag refinery to 15 MMT and export of the petro-products and E&P activities should help the company improve its margins going forward.

Conclusion
Although there exists a substantial discount to the assets value and possible cash flows, the gap is not likely to close any time soon. However even if the market reduces the gap to 50-60% of asset value, the returns should be reasonable. In addition the company is selling at a 5 year low in terms of its PE and P/B ratio. The key triggers to watch would be crude prices and the level to which the government compensates for the underrecoveries.

I saw the following post on torrent cables on ranjit kumar’s blog. In addition, I found this analysis on amit’s blog.

The fundamentals look enticing

– RONW – 30%+
– No debt
– A 25%+ growth in topline and bottomline
– Operates in the power cable industry which seems to be doing well and is a growth industry.
– Lower valuation than all its competitors

However I am concerned about the following

– Inventory and debtors has increased in the last few years (debtor days is at 60 from almost 20-25 a few years) back. As a result the company has a very low free cash flow. Most of the cash flow has been used up by the incremental working capital
– Cannot get the annual report for the company. As a result I have no idea on how the company is planning to reduce inventory and debtors.
– The company was in BIFR from 1999-2002 (not sure on dates). Why did the company land up in BIFR and why will it not land up in a similar position in the future?

Comments welcome on the above analysis (which is very superficial as of now)

PS: An apology to all who requested me for prof bakshi’s interview. He has however posted the interview on his website. I would strongly recommend reading the interview (I have done it twice and really learnt from it)

About
VST is involved in the manufacturing and marketing of cigarettes. It is the second largest cigarette-maker in India with 12 brands in its portfolio. The company is an affiliate of British American Tobacco (BAT), UK, which holds a 32.16% stake in the company. Some of the major brands of the company are Charminar, Charminar Special Filter, Charms Mini Kings and Charms Virginia Filter. Its products are targeted at the lower-end of the market and have dominance in the small sized (less than 60mm) micro segment. The company is dependent on ITC for the supply of tobacco. Though the major chunk of revenue comes from sale of cigarettes, it is also in the business of selling unmanufactured and cut tobacco.
In order to establish its presence in unrepresented geographies, the company has last year launched a new brand, ‘XL Filter’ in large parts of Tamil Nadu and the hill states of the North East. In 2005, the company also launched another new brand, ‘Shaan’, which has garnered 4% share in the micro segment.

Financials
The company is a debt free company with almost 200 Crs in cash and investments. The company has been consistently been profitable with net margins increasing from 5-6% to almost 15% now. The Return on capital is consistently above 25%+ and excluding the low yielding investment, the company enjoys very high return on tangible capital. The company has been working with Negative working capital for some time and this seems to be increasing too.

Positives
The company has strong competitive advantage due to the nature of the product for which users have a very high brand preference. Competition is limited to ITC and the unorganized sector at the low end. As a result the company has a strong free cash flow and high return on capital

Risks
Topline growth is low due to high excise and price sensitivity at the low end. Also the company is not clear of how it will use the excess cash and there is always a risk that the company may simply blow away the surplus cash.

Valuation
At 58Cr net profit and 200Cr cash on the books, the company can be conservatively valued at 1100-1200 Cr (at 15 times PE of Free cash flow) which is at 50% discount to the current market cap. The company can grow at a 4-5% topline via new product introductions and price increases. The net profit has grown at a much higher rate of almost 20% for the last 10 years and a 6-7% growth in the future should look achievable. This level of growth and the high ROC can easily justify a PE of 15.
In addition, the company has a dividend of almost 20 Rs / share which is almost a 50% payout ratio .

Relative valuation
ITC is the largest player, but it has several businesses and hence it is diffcult to compare the financials. However a segment based analysis shows that ITC has around 17% post tax margins and around 110% return on capital. In comparison VST has a 15% net margin and more than 100% return on capital. ITC is curently commanding a PE of 20.

Godfrey philips is the second largest cigarette manufacturer. It had a net profit of around 87 Crs and has an adjusted cash and equivalents of approximately 200 crs (net of debt). The company sells at a PE of around 15-16 (net of cash). In comparison VST sells at an adjusted PE of around 7 and this could mainly be due to the slightly lower growth rates than ITC and Godfrey philips.

Conclusion
The company is a slow grower and the unit volume are more or less stagnant. The free cash flow for the business is equal to the net profit and the return on capital is also high. The balance has a lot of surplus cash and this should increase in the coming years. The catalyst for unlocking value could be higher dividend, better growth rates in the topline or continued good performance of the topline and bottom line.

I receieved an email on the rumor of the open offer for Lanxess ABS yesterday from mayank. On googling i found the following news item

Lanxess ABS up on open offer hopes

In addition Lanxess ABS has posted the following on their website

Shareholders may take note that Lanxess India Private Limited, Mr Rakesh Agrawal, Mrs Uma Agrawal, Mr Rahul Agrawal, Mr. Vishal Agrawal, Geetganga Investment Private Limited and Tash Investment Private Limited, the promoters of company , have entered into an agreement on June 28, 2007 to sell their share in the Company to INEOS ABS (Jersey) Limited, a company controlled by the British chemical group INEOS. The parties expect the transaction to be completed at the end of September 2007.

So there is a possibility of an open offer. My own intrinsic value calculation is around 300 Rs / share, so even at the current price the stock is available at a 60-70% discount.

However there are some risks
1. The above is still a rumor. Rule no.1 of arbitrage is to avoid getting into such deals based on rumors.
2. Open offer may not be made at a very high premium above the current price ?
3. What happens to the minority shareholder if some decide not to accept the offer ?

I am still trying to analyse the pros and cons on the above. In addition, as i noted in the earlier email, i hold the stock and hence the above post may not be completely unbaised. so please do your own analysis.

Please feel free to leave your thoughts in comments

update : I recieved a comment from ranjit regarding the open offer announcement on BSE. So the open offer is at 201 and for 20% of the capital.

This information changes my view completely. Lanxess ABS holds 51% of the company and other indian promoters hold 19%. As both have agreed to sell out, INEOS would get 70% of the company outright. If the open offer is successful, then they could easily have 90% of the company. I am not sure of the numbers, but i think at 90% they can easily delist the company. So the key point is that investors who refuse to accept the open offer, could in the future be forced to do so. I think company has started doing well and 201 is clearly below the fair price of the company. However the developments are not surprising. This is not the first time an MNC has short changed its domestic shareholders.

update 07/03 – just saw this news on a likely open offer for lanxess ABS. thats a lucky break !!

I had posted the following on my old blog earlier.

Tuesday, May, 25th, 2004

Am i missing something

i have been analysing Bayer ABS.
Found the following positiives
1) selling at 6 time current estimates
2) has zero debt
3) has shown a growth of 10 % plus for the past 5 years
4) has reduced debt and capital employed ( returns in excess of 25 %)
5) Parent – Bayer has strong R&D in plastics
6) user industries such as telecom/ IT / Auto are growing
7) moderate competitive advantages in form of patents / good brand for some products / R&D support from parent

negatives
1) Bayer has not been very share holder friendly ( has vijay mallya as chairman !!!!!!)
2) trying to move several businesses into fully owned subsidaries
cant think of too many negatives. am i missing something ? am i wrong ?
Posted in Weblogs at 03:43:46 AM

I have been re-analysing the company and have come up with the following analysis

The company is now called Lanxess ABS. It is the largest product of ABS (60% market share) and SAN in india. The product is used in by various OEM such auto industry, consumer durables etc.

Performance
The topline for the company has increased by around 11% per annum for the last 6 years, but due to input price pressure, the bottomline has increased by only 3% p.a. The company has performed fairly well inspite of the spike in crude prices (which impacts the raw material costs). As a result of the crude price increase the net margin of the company has come down to 4-5%. The company was not able to pass on the increase in input cost immediately. However with stabilization of the crude prices, the net margins have now increased to around 5-6% and we chould see an increase in the net margins going forward.
The company has improved the various asset turnover ratios during the period. As a result the company has a heatlhy return on capital of 20%+ with zero debt. In addition the company holds almost 80-85 Crs of cash on books which is almost 25% of the market cap

Competition
The main competition for the company is Bhansali polymers which is the second largest company in the product space. Both companies have similar margin structure and seem to be operating as a duopoly. The company has decent pricing power and can maintain a resonable return on capital.

Valuation
With netprofit of around 28 Crs and cash of almost 80 Crs, I would atleast value the company at 450-500 crs. As a result the company is available at a discount of 30-40% of the intrinsic value.

caution : i hold this security. I may continue to hold or sell as i see fit. I may or may not post when i make a sale. Hence the above analysis (as always) is not a recommendation.