Let’s start with a premise. Let’s say you believe as I do, that India and its economy is likely to do well for the next 10-15 years. I think it would be safe to assume that the Indian economy would grow between 5-6% for the next 10-12 years.

If you agree with the above point, the nominal growth (real growth – 6% + inflation) is likely to be in the region of 10-12%. If the nominal growth of the economy is 10-12%, then the top companies in India are likely to grow at the same or slightly higher amount over the same period of the time.

The top companies in India are represented by the Nifty 50 or BSE sensex and hence we can expect that the index would grow by 10-12% over the next 10-15 years. It is quite possible that the returns will fluctuate wildly from year to year, but over the long term the returns are likely to average more than 13%. The actual returns for the last 15 years have been around 13-14% when the growth rate of the economy was much lesser.

If you agree with my logic above, then this is my idea –
If one invests in the index via a systematic investment plan (SIP) in a low cost ETF or mutual fund on a monthly or quarterly basis, the overall returns should be fairly good with moderate or low risk over the next 10-15 years.

So where’s the catch
There a two issues. The first issue is discipline. A lot of people equate excitement with high returns and end up with low returns and lots of disappointment. As a result, due to ignorance or mistaken beliefs, they will not follow a simple and sensible plan which could provide good returns at low risk.

The second issue is the validity of the hypothesis that India will do well and not go down the drain. For starters, if it does then all of us will have more to worry than the stock market alone. I sincerely hope that it does not happen, otherwise all bets are off

So are you doing this ?
If I could go back in time and meet the Rohit of 1990’s, I would kick his ass and ask him to start an SIP program in the index or a decent mutual fund instead of chasing some IT stocks. Well, I can’t do that :). So I have done the next best thing – I have an SIP plan for the last couple of years and have kept at it irrespective of the market levels, near term outlook and any other forecasts and prophecies.

I have discussed this approach with several of my friends and have yet to meet anyone who has taken up my suggestion. I think there is a perverse thinking that decent returns require some complex insight and a simple ideas such as this is too good to be true.

About
Facor alloys is in the business of chrome alloys, which is used in the production of steel. The company has a capacity of 70,000 MT (industry capacity – 7 lac MT) and is located in Andhra Pradesh. The company emerged from a demerger of the FACOR group in 2004

Financials
The company was created by the demerger of the FACOR group into three companies, one of which was Facor alloys. The company had accumulated losses and underwent a restructuring exercise during the initial years. The current promoters for the company injected funds into the company and the debt was also restructured in the initial years
The company has since then turned around its performance. The debt has been wiped off and the preference capital has also been paid off. In addition the company, now has cash balance in excess of 30 crs which is around 25% of its market cap. The company has more than doubled its topline in the last 6 years and net profits have gone up considerably too. In addition the asset turns have reduced and Working capital turns have remained steady. All in all the asset efficiency has improved in the last 6 years.

Positives
There are several positives for the company. The company has a strong balance sheet. In addition the steel market which is the consumer industry for the company’s product is growing in excess of 7-8% and hence the company should see adequate demand for its product.
Chrome ore and power are the key raw material for the company. The company has ample cash on the books which it is planning to utilize to invest in a group company to access captive power. In addition the company is also in the process of acquiring chrome mines to gain access to reasonable priced ore. These two developments should provide some hedge to fluctuations in the price of the end product.
The management has also been sensible in allocating capital and has turned around the financials of the company. The company also has accumulated losses which should help in reducing the tax outflow and improve the cash flow for the company.

Risks
The company faces a lot of risk. The industry in which the company operates is a price competitive commodity industry. This industry has low to non-existent pricing power and minor competitive advantage from scale of operations. Due to the nature of the industry, most companies in this industry are unlikely to make high returns over a business cycle.
The company is a much smaller player with exports to various markets across the world. However the Chinese market has considerable impact on the steel demand and hence any slowdown in china could hurt the company, both directly and in-directly.
The company was re-structured in the past and has worked to turn the business around. Although small, there is always a chance that the performance could turn south again

Competitive analysis
The industry is a competitive, commodity type cyclical industry. There are a lot of small companies in this industry in india. Finally the Indian companies are at a cost disadvantage with respect to their south African competitors who have access to low cost power and better ore quality.
The pricing in the industry is determined by the demand supply situation and is also based on the mid to long term contracts with the steel manufacturers.

Management quality checklist

– Management compensation : fairly reasonable at less than 1% of sales
– Capital allocation record : fairly good for the last 6 years
– Shareholder communication – average
– Accounting practice : appears conservative
– Conflict of interest: none that I could see. The company has access to low cost ore from sister company
– Performance track record : appears good for the last 6 years. However industry economics are bad

Valuation
The net margins and the topline growth of the company maybe at a cyclical high. The fair value of the company is between 7-10 if one assumes that the normalized margins are in the region of 6-8% and the growth will average 8-10%. The reason for having a range is that it is difficult to pinpoint a single number as ‘the’ margin or topline growth and peg a fair value to it.
In terms of comparison to other companies in the sector, the company is selling at a 30-40% discount to other companies in the sector.

conclusion
If you search the internet on this company, you are likely to find this stock being touted the next microcap to make you rich. I have seen price targets ranging from 12-15 rs in the next 6 month. The geniuses giving these price target don’t know what they are going to eat tomorrow, but know what the stock price would be. It is still debatable who is the bigger idiot – the one giving the price target or the one acting on it.
I have personally created a small starter position in the company as I am now focused on learning and analyzing small cap and commodity type companies. These companies involve a different approach and mindset. The stock price is very volatile due to the nature of the industry and the size of the company involved. As a result, my estimate of fair value is not more than 9-10 in the best of the circumstances.
The stock can provide decent returns if the demand supply situation remains stable in the next 1-2 years and the company executes well. However, as I said before, if you want to build castles in the air and daydream then there are a lot of geniuses in the market ready to sell you a nice price target.