CategoryInvestment ideas

Blue star india is primarily in the commercial air conditioning and refrigeration business. The three main business segments are

1.Central air conditioning: This is the main business for blue star. It accounts for 70 %+ of the company’s revenue, has been growing at 25 % and has a pre-tax ROCE of almost 60 %. Blue star is fairly dominant in this sector and has a good market share of almost 30%. This sector is dependent on industrial demand, IT/ITES sector and retail. Lately the industrial sector, IT/ITES and retail sector have been boyant due to which Blue star has a good backlog of orders.

2.Cooling products: This comprises of Window, split A/c and other retail products such as water coolers, cold storage etc. This is a fairly competitive segment with strong brands such as carrier aircon and other vendors. This segment had a good volume growth and revenue growth of 30%. However as this segment is competitive, the pre-tax ROCE is at a respectable 15%.

3.Professional electronics and industrial equipment: This segment had a good growth last year on a small base of 60 Crs. The segment is small accounting for less than 10% of the total revenue. The pre-tax ROCE is high at almost 70%+.

Key competitive strengths
Blue star has key advantages via a strong brand in its key segments. It has a good reputation in terms of project execution and after sales service for the institutional segment. There is certain amount of lockin once a customer (especially if it is an institutional one) has selected and installed a blue star system. Subsequent orders would likely be for the same vendor. Due to high market share, blue star has certain demand and production economies of scale, which allows it to be a low cost provider. The central air conditioning segment is project driven, where project skills, experience and scale matters as the margins are fairly low (pre-tax margins were < 10 %) and hence a company has to be efficient to be a profitable business.

Problems areas
The company has performed well on most parameters such as revenue growth, NPM, ROE etc. However for the last 1-2 years, the free cash flow of the company has been dropping. The current year’s FCF was around 40 % of the operating profits. The main culprits have been account recievables and inventory. The recievables ratio has dropped from 6 to 4.9 and the inventory ratio has dropped from 9 to 7.9. The drops are not alarming and are still good in an absolute sense. However they need to be watched closely to see if the growth is not coming a high price (write-offs of bad debts and inventory later)

Valuation
Assuming (a big assumption though), the company can manage its Working capital, the Net profit can be taken as Free cash flow. The last year EPS (post split) was 5.8. The current year EPS should come be conservatively at 7. Using a DCF (with various assumptions) I would value the company roughly at 140-160 Rs/ Share. My personal opinion is that the stock is fairly priced.

Disclosure : I have owned the stock for the past few years.

Analysis date: Aug 2006

Kirloskar oil engines, a company from the kirloskar group has two main business segments

Engines: This business segment accounts for almost 80 % of the revenue and is the main business segment. This business caters to the farm sector, power sector, industrial machinery, Construction and material handling equipment. In addition the company has contracts/ relationships with OEM manufacturers, the armed forces and has its own service dealers and service personnels. The company has products in a wide HP ranges and has technical collaborations too. The highest volume comes from the small engines segment followed by the medium engines.

Autocomponents: This business segment accounts for the balance 20% and had an above industry growth due to capacity constraints. In addition the company has OEM relationships with some prominent companies such as maruti, sundaram clayton etc. The main products are valves and bearings

Other business: Some other minor businesses such as manufacturing grey iron castings, trading, power generation and sales (which is under review due to dropping sales)

The Company has benefitted from the recent improvement in the capital goods sector and upturn in the power sector. The period from 1996 to 2001 such low growth (20% in almost 6-7 years). Due to the improvement in the business climate the topline and margins have improved dramatically in the recent past. The company is seeing good volume growth in its core business and has also delivered good performance in the export sector which crossed 100 Crs this year.

Due to the nature of the industry (capital goods) with limited and large buyers, and due to cyclical nature the topline and margins are also cyclical. The NPM has fluctuated between as low as 2-3 % to 15 % in the recent past. I would put the average NPM at 6-7 % over a complete business cycle.

The company has become fairly efficient with the Fixed asset turnover ratios expanding from 4-5 to 7-8 in the recent past. Wcap ratios have gone through a dramatic improvement and is now almost 14. This freeing up of the capital has raised the ROE from 8-10 % to almost 30% +. In addition on a total capital base of 795 Cr, almost 500 Crs is investments.

This 500 Crs of investment at market value is almost 1000cr which translates into almost 95 Rs/ share (net of debt)

Valuation: The last year Netprofit is almost Rs 10 / share (net of exceptional items). With almost 95 Rs / share of investment, I would value the stock at approximately 350 Rs / share (max). There are various assumptions behind this valuation, namely

1. Rs 18/ share for current year’s earnings are during a cyclical high. The average earnings are more like 14-16.

2. Rs 95/ share of investments is not really realisable as a major part of this investment is in other group/ JV’s, which are unlikely to be sold off soon.

3. The company has some competitive advantage such as customer relationships, some economies of scale etc. But in the end it is in a cyclical industry with moderate to weak pricing strength and hence I would not accord the core business a PE multiple of more than 16-18.

On running various filters in icicidirect, I was able to list a few companies which were worth further investigation.

My approach was to do a preliminary analysis and reduce the list further to a few more interesting opportunities.

I am listing the companies and my analysis. This analysis is a bit dated as I did this analysis during the aug/sept time frame and have not looked at the recent price for these companies

1. Merck : Indian subsidiary of the american MNC. The american parent has a 100% subsidiary too which could be getting all the new products from the parents portfolio (and I guess special treatment over the listed subsidiary).

The company is selling at approximately 5 times earnings after adjusting non operating income and cash on books. The company has a high ROE of 30 % and low growth of 4-5%. The actual ROE on tangible equity is 60% +.

The company has a Pharmaceuticals and chemicals business. It has recently sold its life sciences business and has approximately 3370 million on its books (Rs 200/ share).

The topline is expected to drop due to the sale of the life sciences business. The pharma business has a growth in single digits and the next years earnings could be 10-15 % over the earnings of 2005 (current year earnings are not comparable due to the sale of life sciences division)

This company is a value play. The management does not seem to be very shareholder friendly. It remains to be seen, what the management will do with the huge cash it has on its books . Will it try to buy out the indian shareholders at an unfair price like a few other MNC’s have done in past? Can happen.

I would estimate the intrinsic value conservatively at 700-800 Rs per share. However it is quite likely that the valuation gap may take a long time to close due to poor growth prospects and a management which may be indifferent to minority shareholders

2. Swaraj engines
The company showed up in my list as the PE seems to be 4-5. However after adjusting for the bonus issue, the actual PE is 14. Also the company has low growth, high debtors position and is mainly supplying to sister companies. It is a small cap company too. I do not see much value in this stock and decided to give it a pass.

The other stocks which I will detail in subsequent posts are

Grindwell norton
Revathi CP
Kirloskar oil engines
Hindustan inks
Tube investments
Neyvelli lignite
Gujarat gas

Please do not take the above list as a recommendation. This above post is just for analysis and I may or may not have invested in any of the above stocks

I came across this post on sundaram clayton which got me interested in the checking on the company. On reading the annual report, this is what is found

• sundaram clayton is in the business of auto-components – namely brakes and into aluminium castings
• The company has a revenue of 5360 million rupees, NP of 534 million rupees
• An average of ROCE of 20%+ with average Debt/equity ratio below 50 % (except current year where ratio is close to 50%)
• Healthy NPM of 8-10% consistently across the years
• Sundaram clayton is also know for its six sigma initiatives and has received several prefered supplier awards over the year

The company has several subsidiaries with a few associate companies too. The rough back of envelope calculation is as follows

The biggest holding is TVS motor company at 57%. A rough valuation is 16000 million (current year NP*12). The value of the holding is conservatively at 9120 million.
All the other subsidiaries are small with combined net profit of roughy 130 million. I would value is not more than 2000 million with Sundaram clayton value not exceeding 1500 million ( a very rough valuation).

So the total value of all the holding seems to be around 10620 million. With around 1090 million as debt and 25 million as cash , I would put the net value of these investment as 9600 million. The stock sells at 885 per share and with 18.9 million outstanding shares, the equity value is 16726 million. Back off the value of this investments and the company is valued at around 7100 million.

So with current EPS of 28, the PE comes to around 12-13.

Now all the above calculations are very rough. But it seems to be that the company is undervalued.
Although my initial analysis has not turned up anything negative, I would still not commit money to the stock as I still have figure out the following

• The catalyst which could unlock the above value.
• A more detailed analysis of the industry dynamics as there seems to be new competition coming up in the same segment as the company (there is mention of this in the management discussion)

I came across a few research reports on exide industries and liked what I saw . In a nutshell

• Exide industries is in the business of  Automotive batteries with brands such as Exide and Standard furukawa.
• Exide supplies to OEM customers in cars ( Maruti, Hyundai, Ford etc), 2 wheelers ( Bajaj, Honda etc ) and has now made an considerable in roads in the tractor segment too. It has a very high market share of around 80%+ in the OEM segment
• Exide has a dominant position in the replacement market ( 60%+) market share and a strong brand and extensive distribution network ( Read  competitive advantage )
• Exide has a strong balance sheet with ROE in high teens and consistent topline and bottomline growth inspite of increases in lead prices ( lead account for around 65 % of Raw material costs )
• Exide seems to have a reasonable pricing power due to its strong brand and is a preferred vendor for a number of OEM customers
• The company is now expanding into the export market ( which accounts for only 5 % of the topline currently )
• The next few years look good for the company as the Automotive sector ( cars, CV and 2 wheelers) has seen good growth and as the replacement cycle is around 18-24 months, strong demand from the both the OEM segment and replacement segment  should kick in.

A few negatives

• Lead pricing would have an important bearing on the margins going forward. However over the next 2-3 years the impact of higher lead prices could be reduced if Exide is able to pass through the cost increases.
• Valuation – The company is priced at around 15 times FY06 earnings. For me it is on the higher end of the price range. If I am able to get more comfortable and confident of the  business (need to read about other companies in this industry), then 15 times FY06 earnings may have a margin of safety. But for the time being, I am still evaluating and trying to get my arms around it.