Stock Update: Disa India Limited

I recently wrote about Disa India here. As discussed during the write up one should not base their investment thesis on something as fragile as a de-listing play. 

There were market rumors that company may use an Offer for sale (OFS) - the new SEBI initiated mechanism allowing promoters to sell stake in a separate window other than regular markets - to pare down the stake to 75% and use the proceeds to fund their upcoming Bangalore center. 

Well it seems the rumor was true. Disa India today formally announced their plans of OFS to pare down their stake to SEBI mandated 75% from the existing 86.487%.

DISA Holding A/S (the "Seller") has submitted to BSE a Notice of Offer for Sale an aggregate of upto 173,483 equity shares of face value of Rs. 10/- each of Disa India Ltd. (the "Company and such equity shares referred to as "Sale Shares") aggregating to 11.487% of the total paid up share capital of the Company as on November 15, 2012 by Promoter through a sale on the separate window provided by the BSE Ltd for this purpose.

The Sale shall take place at the separate window of the BSE Ltd and shall commence on November 20, 2012 at 9.15 a.m. and shall close the same day at 3.30 p.m. Indian Standard Time ("Sale Date").

We had discussed earlier the robust balance sheet and viability of continued growth in the business going ahead. Hence, this sale changes nothing on the business front except that this presents an excellent opportunity to enter the stock at lower price points. 

The stock might see major correction on Monday (19th Nov, 2012) as speculators who had entered for de-listing play earlier would rush to exit. Hence it creates an opportunity for some one with a 3-5 year horizon to enter this stock at much lower prices on Monday or participate in the Offer-for-sale on Tuesday (20th Nov, 2012).

  

Can we hedge against RM volatility from combination plays ?

This includes two of my recent purchases, Balkrishna Industries (BKT) and Gujarat Reclaim & Rubber (GRP).

While looking at natural rubber prices being a key monitorable for BKT , one might wonder whether any combination play might help up remove this volatility.

This is because natural rubber being the key raw material, effects the pricing and margins of tyre manufacturers like BKT. So higher natural rubber prices should hit margins and hit profitability. ( Negative correlation)

Whereas high prices of natural rubber are good for the reclaim rubber industry as it leads to increased substitution of natural rubber with reclaim rubber. Hence, high natural rubber prices are good for GRP. (Positive correlation)

Therefore I was thinking can a combination play on BKT and GRP hedge us naturally against natural rubber price volatility (to some extent, if at all). Point to note here is that each of them merit investment by their own accord given their superior fundamentals and growth ahead. However, we are trying to analyze an additional angle from the portfolio perspective.

Chart 1: Monthly Rubber Prices ( Oct 2007 - Oct 2012)

 

Chart 2: BKT Operating Margin Trend ( Sep 2007 - Sep 2012)

Chart 3: GRP Operating Margin Trend ( Sep 2007 - Sep 2012)

From the charts it is evident that while Balkrishna Industries (BKT) has a proper negative correlation with rubber prices which is seen directly from the margin trend, there is no proper positive correlation of natural rubber prices with GRP. 

So the combination play won't work as natural hedge. However, GRP margins being unaffected during even lower rubber price cycles, both stocks should do well in  period of  softening natural rubber prices. 
 

 

Pearls of Wisdom: Basant Maheshwari on Hawkins

I received a few negative responses regarding the intent of sharing the Hawkins post on TED. This is to re-iterate, that the whole point of blogging is to better interact with other fellow investors and develop counter arguments and dissections on your investment themes.

Hawkins has been one of the prominent ideas of Sri Basant Maheshwari, a much discussed and well documented stock idea since September 2006 when it was first discussed on TED.

The Hawkins post was necessary to highlight that the company is in a somewhat special situation which calls for a compelling buy based on earnings forecast for the next 12 months. Most investors are skeptic of investing in growth stocks at high price and high P/E multiples (TTM).

Going through the Hawkins thread yields great notes of wisdom from Basantji on these points. Here we look at few of his quotes with respect to stock investments in general (and in few cases Hawkins in particular). I encourage you to go through the complete thread on Hawkins at TED.

No position is too big for a stock that is going up and no position is too small for a stock that is headed down. 

Analyzing the variability of a business can be learnt through experience and that experience is a never ending process, the easiest way to go about it is focus on a few variables like RoE, Moat, entry barriers, Capex, demand drivers, Management etc. One of the more easier ways out is to read as much as you can about the great man called Buffett, personally we are all in the learning mode and will continue to remain so because investing is an art and not science but my thought is that the path less traveled has the maximum fruit. Everyone can get the Eps, Pe, yield, Book value through some free website and that is what makes the other path less traveled.

While analysing companies I try and work out numbers such as sales per rupee of Fixed Assets and Sales per rupee of WC. Once you do that you see that smaller amounts of fixed assets and WC have generated large amounts of sales .

The first thing is forget the past and disassociate yourself from where this stock has come from. Just think that you are not aware that a stock has been a 7 bagger in the last 12 months, that will make your analysis easier.

I normally look forward because TTM (Trailing Twelve Months) is already in the price and if you can identify the difference between the consensus and your estimates in the forward earnings you are on track to make decent money.

The big money is made in foresight and not in hindsight. Everyone knows that forecasting comes with errors but that does not mean that you keep looking at the rear-view mirror only.

So if a stock had moved up hugely over the last one year the real beneficiaries have been the ones who had an element of forecasting because they could have bet hard and heavy but had you bought it as another stock in the portfolio it would have created enough excitement and joy but not wealth.

Also cooker has been a low repeat business ever since it was invented. The key areas to look out for is new customers for existing products(cookers) and new products for existing customers (Non stick cookware) and not just repeat sales to existing customers (which will also come).

Not sure why people were surprised by the dividend a general glance at past annual capex, working cap profile and management strategy would have suggested that this company has no genuine use for cash and hence it will be thrown back. Capital allocation is an offshoot of management bandwidth so we can't draw a straight line across all consumer companies.

Sometimes investors lose the big picture by becoming prey to the paralysis of analysis. I have said many times before that Hawkins is better then competitors because of the sheer cash that it throws back. Very few companies have cash eps higher then eps by 30pc and this is one of them. 

At each price we wanted to buy it 10pc lower somehow this psychological price anchoring has no answer. We should be looking at where this stock is going rather then where it has come from. 

Strong distribution and Marketing cannot provide high pricing power. They can provide volumes. For example a cement company with deep distribution set up cannot sell cement at Rs 20 more per bag just because it has a wide distribution network. Just because the unorganized competitors are weak in terms of marketing power, scale and distribution doesn't enable these companies to make high margins on their products.

As Buffett says "It takes 20 years to build a reputation and  5 minutes to lose it if you think about that you will do things differently".

The P/E is decided by the collective wisdom of the market and it is futile to take any confirmed call on that though we do make educated guesswork on the drivers of Pe and how they influence the valuation but as investors we should be more concerned about earnings than valuations, the former influences the latter and not the other way round. 

 

Stock Focus: Disa India Limited

In finding which stocks to invest in, the starting point very often is discussions in forums/other investment blogs/recommendations/hearsay etc.

One rather good way to start the stock selection process is quantitative filtering or screening  based on broad based or custom conditions. Sadly very few efficient and free screens are available for the Indian universe of stocks.

Ayush Mittal ( of Dalal Street fame) and his brother Pratyush have designed this wonderful site called screener.in which fills a much needed void for retail investors. Do try it out for yourselves.

One such custom screens at screener.in based on the following parameters threw up some interesting names

Filtering Conditions:

    Year-on-year improvement in operating margins

    Year-on-year improvement in Net profit margins

    Average dividend payout of at least 10% over last 3 years

    At least 15% growth in Sales

    At least 20% growth in profits

    Debt to equity ratio should be less than 0.3 times

    Market capitalization greater than 30 Crs and less than 5,000 Crs

    Last 10 years operating margins at least greater than 12%

    Debtor days should be less than 90 days

    At least 20% return on equity generated

Stocks screened:

Abbott India Ltd.
Amara Raja Batteries Ltd
Benares Hotels Ltd
Cochin Minerals & Rutile Ltd
Disa India Ltd
Accelya Kale Solutions Ltd.
Mayur Uniquoters Ltd.

Interestingly, it contains both Amara Raja and Mayur Uniquoters which are at present amongst my top holdings. Hence the other names must also be looked into. Talk about confirmation bias :P

One name which is relatively unknown is Disa India Limited. While searching for research on this stock found some references in Prof. Neeraj Marathe's blog.

Prof. Marathe has been following and investing in Disa India Ltd for some time now.  He had presented the idea in his April 2011 post, followed by the AGM note that year, a followup post in Mar 2012 and this year's AGM note.

Of the two aspects marked by Prof. Marathe let us completely ignore the de-listing part. After what happened to Blue Dart basing your investment hopes on a possible de-listing candidate does not hold good. As recent as today, the disinvestment plans of Japan's Ricoh has failed causing a major headache for speculators in that stock.

Disa India : The stock story

So first and foremost we ignore the de-listng part. The obvious second thing that attracts investors in this stock is the dividend yield which is 7.38% even at current price of Rs 2701.

Here again we ignore the safety of this yield. Do not put much stress on the 2000% dividend ( a 200 Rs dividend on an annual EPS of Rs 150) paid last year. As explained by Prof. Marathe, it was more of an attempt to distribute the surplus cash to the promoters rather than rewarding minority shareholders.

So let us focus on the stock itself. A cursory look at the financials reveal that the company has exceptional RoE (45+) coupled with zero debt and high debtor turnover pointing to a business moat. Also the company incurs low capex hence it can steadily distribute high dividends.

Let me follow Abhishek's stock template and try to look in deeper. 

Describe the business in a few sentences. What does the company do? Who are its primary customers?

DISA India is a leading Equipment Manufacturer in India, offering advanced Foundry & Surface Preparation process technology. The Company supplies foundry systems by integrating the range of molding machines and sand mixers. The Company’s products include molding machines, sand mixers and air filters.

It has two manufacturing plants, located in Tumkur and Hosakote, Karnataka. R&D Facility located in Bangalore caters to the development needs of the group companies, worldwide.

In 2009, DISA Group merged with the Wheelabrator Group (the world leader in surface preparation technology) to form the world’s leading metallic parts enhancement company. The combined entity is now called the Norican Group.

The main customers are foundries across the country. The company is seeing a clear trend of foundries being upgraded from the basic manual or semi-manual lines towards high pressure automated lines.

The foundry industry in India has geographical clustering; the five major clusters are in Belgaum, Batala/Jalandhar, Coimbatore, Kolhapur and Rajkot.

Is the sector that the company is in growing? Is there a headwind or a tailwind present?

The Indian foundry industry is the second largest producer of casting with a production of ~9.1million MT of various grades of castings as per International standards. Plan to reach 20 million MT by 2020.

Type of produce include: ferrous, non-ferrous, aluminum alloy, graded cast iron, ductile iron, steel etc. Grey iron castings constitute ~70% of total castings produced.

Application in: Automobiles, railways, pumps compressors and valves, diesel engines, cement/electrical/textile machinery, aero, sanitary pipes & fittings .

Indian Foundries are currently facing a major demand boom, but against a background of severe crunch in availability of labor and power. This is now driving a clear move of upgrading towards High Productivity Automated High pressure moulding Lines.

What is the current market share of the company? Where from will the next growth come?

Disa India is the market leader in manufacturing modern foundry equipment with a 70% market share in India.

There are more than 5,000 foundry units in India. Out of this nearly 80% fall under the category of small-scale industry and are manual. Growth for Disa is seen on both fronts; new foundries as well as automation of existing manual foundries.

Wheelabrator now contributes about 25% of the sales. Higher future growth can be expected with introduction of new machines in this segment. 

Who are the primary competitors? Why is this company a better investment than them?

Competitors like Sinto, Koyo, some Indian manufacturers, etc. do exist. However given the strong R&D, timely capacity expansions and collaborations the management believes company will be able to grow comfortably ahead of competition.

What is the owners’ and managements’ stake in the company?

The Norican Group, a Denmark based entity, owns 86.5% of the stock. As indicated they tried delisting in the past in 2007. The 'discovered price' came to Rs.2960 per share. This was rejected by the management and delisting failed.

Are management's salaries too high?

The MD, Mr. Viraj Naidu takes a total compensation of Rs 81.46 lakhs on a PAT of 22.66 Cr which is at 3.6%. The fees of other independent directors are negligible. 

How ethical is the management?

From Prof. Marathe’s interaction in two consecutive AGMs, he suggests

“…I would rate the company's management very very highly. The overall body language was positive. The management is always open to answering all reasonable questions, without making any tall claims, etc. No-nonsense and to-the-point….”

How much debt is there in the balance sheet? Is it increasing, decreasing or remaining constant?

The company is debt free since 2009. It has 60 Cr cash in hand ( as on Dec 2011)

Update: 19th-Nov-12: As seen from the half yearly results in June 2012, the cash balance has reduced significantly after the payment of Rs 200 dividend per share for CY2011. Latest cash balance is 16.55 Cr ( as on 30 Jun '12)

Is the debt level normal for the sector the company is operating in (i.e. how much is the debt-equity ratio of its nearest competitors)?

Not applicable.

How much cash is there on the BS? What is the cash per share?

Cash & Investments are at 60 Cr are at 16.55 Cr (30 Jun '12). Based on a no of outstanding shares of 15.10 lakhs the cash per share is Rs 396.70 is Rs 109.52 (30 Jun '12)

Is the Net worth rising over the years?

Net worth has increased significantly from 18.65 Cr in 2007 to 55.59 Cr in 2010. After the exceptional 2000% dividend (Rs 200 per share) in 2011 the net worth has reduced to 43.15 Cr in 2011.

Has the company increased its sale, net profit, operating margins and net margins over the years?

	CAGR Sales	CAGR Profit	Avg. RoE	Avg. OPM
10 Years:	28.09%	53.57%	48.32%	19.49%
5 Years:	18.15%	22.10%	46.28%	21.51%
3 Years:	21.40%	24.38%	37.57%	20.55%
1 Year:	25.22%	58.03%	45.92%	20.96%

Has the company increased it RoE, RoCE, (RoA for financial companies) over the years or at least maintained it? How does it compare to its competitors?

	Dec-07	Dec-08	Dec-09	Dec-10	Dec-11
Operating Profit Margin (%)	27.66	21.28	22.97	21.55	24.12
Adjusted Net Profit Margin (%)	17.11	12.32	12.86	12.89	14.72
Return On Capital Employed (%)	75.75	66.68	41.33	48.61	70.79
Return On Net Worth (%)	67.61	48.59	27.74	31.46	45.90

Is the company operating cash flow positive? Is the operating – investment cash flow positive? Is the company net free cash flow positive? Is the Operating cash flow higher than earnings per share?

Operating cash flow is almost similar or slightly lesser than earnings per share. Since business is not capital intensive, generates optimum levels of positive free cash flow.

Particulars	Dec-07	Dec-08	Dec-09	Dec-10	Dec-11
Cash Flow From Operating Activities	13.85	7.33	10.9	14.33	17.55
Cash Flow from Investing Activities	1.87	-1.72	1.48	-0.74	-4.09
Cash Flow From Financing Activities	-13.59	-35.58	-0.1	-0.05	-0.07
Operating cash flow / share	92.33	48.87	72.67	95.53	117.00
Earnings Per Share (Rs.)	86.23	79.27	65.3	100.07	150.07

Does the company pay tax, dividends every year?

The company has been a regular tax player. It paid a large 2000% dividend in 2007. Preserved all cash during the downturn of 2008-09 and again gave large 2000% dividend in 2011.

Is the Free Cash Flow per share higher than dividends paid?

Company pays large one time dividends by dipping into reserves. They prefer to hold cash during uncertain times.Points towards prudent management.

Is the business capital intensive?

RoA is 45.9% (PAT of 22.67 Cr on average assets of of 49.37 Cr) meaning business is not at all capital intensive. [Learner note: For debt free companies. RoA = RoE, so in essence we verified the RoE for CY11.]

The company is expanding existing facilities with the launch of new facility at Bangalore. All Cap-Ex can be comfortably met from internal accruals without need for debt.

What is the expected valuation?

EPS growth expectations are at 20% for 2012 and 15% for 2013. One can expect an EPS of 180 Rs per share for CY12 and 207 Rs per share for CY13.

The Jan-Sep 2012 results are not so promising. Net profits are at 83.04 Cr and 9M EPS of 48.48. Although the Dec quarter is the decisive quarter with bulk of revenue and profits, the 9M figures are not promising.

Is the PE ratio below 15? Is the PEG above 1.0?

Disa is currently trading at a P/E of 20.77 (CMP=2701, LTM EPS=130.4). However excluding cash of 396 Rs per share 109 Rs per share, it is available at P/E of 19.87.

Based on (CMP-Cash) price of 2305 per share 2592 per share, it is available at 12.52x forward CY13E EPS. The PEG is less than 1 (0.83).

Update: 19th-Nov-12:  As seen from HYCY12 results, the company has exhausted major part of the cash in hand (60 Cr in Dec '11) and is left with only 16.54 Cr (Jun '12) which reduces the comfort of cash and makes the stock fairly expensive.

Why do you think the stock is underpriced? Is there an expectation to double the investment in 2-3 year timeframe? If not, why bother?

Based on the strong growth in castings (doubling of capacity from 9.1mn MT in 2011 to 20 mn MT in 2020) and conversion of manual foundries to automatic (currently only 20%) strong growth is expected over next 3-4 years. Also, new launches and cost reductions from Wheelabrator collaboration may add to profits.

The stock is available at attractive levels (net of cash per share). It is low capex, high RoE business with a debtless cash rich balance sheet backed by strong promoters and market leadership. Any possible upsides from delisting play will add to the upside.