Business Quality: Calculating the Value Drivers of the business

Hi Rushme,

Thanks for your views. As I have said before, we can calculate both ratios, and see practically what emerges. And we can rest theories there:)

ROIC = Return on Invested Capital is different from ROCE. Invested Capital represents amount invested in theoperationsof the business. Sum of Operating Working Capital, Net Fixed Assets, and net other assets (net of noncurrent, non-interest bearing liabilities. ROIC does NOT include any non-operating investments such as debt.And that is why many Gurus prefer using RoIC as a measure to compare across businesses with or without debt.

What you are referring to Equity+Debt = Total Capital invested in the business. And referring to RoIC but meaning RoCE, in that case you are right.

Also Leverage/Debt should not be viewed as a dirty word. For funding growth, Debt Capital is always considered cheaper than Equity Capital. It is only when Debt becomes too much that it becomes risky. Otherwise you would have seen companies more often preferring to dilute equity than raise debt.

Companies like Astral and BKT with reasonable debt can also be attractive as they might be creating value by growing much faster than what they would be able to with lesser invested capital. Point that Ayush has been making above.

Please understand our objective is to evolve aconsistent measure)- that can be employed across all types of companies - with debt or no debt. The Tom Copeland Book I refer to is Measuring and Managing the Value of Companies.

For all we know, all this theorising may lead us nowhere. The Measure we are talking of EP/MktCap or EP/EV may not be useful/practical for our purpose of comparing between businesses & their value creation.

-Donald

Mayur Uniquoters 2014E 2013E 2012 2011 2010 2009 2008 2007 Comments
Revenues 498.15 398.52 317.48 248.56 164.73 115.05 90.24 66.26
EBIDT 84.68 67.75 54.20 40.87 27.92 11.78 10.57 6.67
Depreciation 6.48 5.11 3.87 2.67 2.08 1.59 1.39 1.52
EBIT 78.21 62.64 50.33 38.19 25.84 10.19 9.18 5.15
EBIT Margin 15.70% 15.72% 15.85% 15.37% 15.68% 8.86% 10.17% 7.77%
Working Capital 54.80 33.98 29.58 33.01 22.21 12.07 11.88 13.42
Net Fixed Assets 100.00 70.33 49.07 31.3 23.15 22.65 21.32 15.95
Net Other Assets








Invested Capital 154.80 104.31 78.65 64.31 45.36 34.72 33.20 29.37
Capital Turnover 3.22 3.82 4.04 3.87 3.63 3.31 2.72 2.26
EBIT/Invested Capital 50.52% 60.05% 63.99% 59.39% 56.96% 29.36% 27.65% 17.53%
RoIC 33.85% 40.23% 42.87% 39.79% 38.16% 19.67% 18.53% 11.75%
WACC 12.00% 12.00% 12.00% 12.00% 12.00% 12.00% 12.00% 12.00%
Economic Profit Added (EP) 33.82 29.45 24.28 17.87 11.87 2.66 2.17 -0.07
Mkt Cap (Mar End) 615.00 460.00 240.00 140.00 80.00 13.00 22.00

Market Value Added (MVA) 155.00 220.00 100.00 60.00 67.00 -9.00

(over prev yr)
RoRC 33.55% 52.80% 92.97% 68.34% 151.68% 79.56% 101.83%
change in Op profits/change in Invested Capital
5 yr RoRC 51.87% 80.43% 96.00% 97.88%



(indicates pace of value addition)?
5yr EPA/MVA 21.92% 19.27% 27.00% 24.64%



(indicates relative margin of safety?)
5yr EPA/IC 26.22% 26.31% 22.97% 16.67%



(indicates anything??) (quantum of value addition???)

Have a look at this now. Its reaching somewhere...but not sure if we can derive anything more than what RoRC shows up? Is 5yr EPA/IC meaningful??

Anyone wants to play around/help define a more meaningful ratio for EPA? Simple Excel sheet attached

Mayur_Economic_Characteristics.xls (12.5 KB)
Balkrishna Industries 2014E 2013E 2012 2011 2010 2009 2008 2007 2006 Comments
Revenues 4125 3300 2809.98 1997.16 1386.74 1252.43 991.47 877.35 620.21
EBIDT 783.75 660 493.49 371.58 397.16 201.64 233.6 182.62 146.31
Depreciation 165 108.34 83.14 74.44 66.22 56.52 43.83 36 27.34
EBIT 618.75 551.66 410.35 297.14 330.94 145.12 189.77 146.62 118.97
Operating Margin 15.00% 16.72% 14.60% 14.88% 23.86% 11.59% 19.14% 16.71% 19.18%
Working Capital 1856.25 992.28 943.04 572.75 370.61 299.14 359.94 268.75 248.45
Net Fixed Assets 2250 1750.79 1278.03 687.44 614.89 534.55 424.47 399.37 259.74
Net Other Assets









Invested Capital 4106.25 2743.07 2221.07 1260.19 985.50 833.69 784.41 668.12 508.19
Capital Turnover 1.00 1.20 1.27 1.58 1.41 1.50 1.26 1.31 1.22
EBIT/Invested Capital 15.07% 20.11% 18.48% 23.58% 33.58% 17.41% 24.19% 21.95% 23.41%
ROIC 10.10% 13.47% 12.38% 15.80% 22.50% 11.66% 16.21% 14.70% 15.69%
WACC 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00%
Economic Profit Added (EP) 127.13 177.60 119.46 110.87 152.74 38.87 72.24 51.47 44.14
Mkt Cap (Mar End) 2612 2503 2503 1291 1241.37 267 1048


Market Value Added (MVA) 109.00 0.00 1212.00 49.63 974.37 -781.00 1048.00

(over prev yr)
RoRC 9.08% 31.90% 12.69% -9.31% 128.79% -64.85% 43.84% 22.70%
change in Op profits/change in Invested Capital
5yr RoRC 12.39% 24.01% 18.09% 31.92%




(indicates pace of value addition)?
5yr EPA/MVA 50.18% 26.81% 33.96% 33.01% 28.96%



(indicates relative margin of safety?)
5yr EPA/IC 6.08% 7.45% 8.12% 9.40%




(indicates anything??) (quantum of value addition???)

Now comparing this BKT Table with Mayur's table above may tell us a few things:)

Does it??

Donald,

Theory is nothing but distilled knowledge of practitioners. What we are trying to do by identifying success patterns is Theory-making.

Whether we use invested capital (capital used in operations) or capital employed (all capital), the underlying argument of EV or Mcap remains same. It’s very basic idea but I am unable to put it across. One last try:

For two companies with same EP and same market cap, which company will you invest in - the one with lower debt or higher debt? I hope answer to this should put my point across. If not, I give up.

Another point, when we use roic in numerator and mcap in denominator, there is another mismatch problem. roic and EP are related to operating asssets only but mcap also includes value of non-operating assets.

Hi,

Some figures … without averaging for 5 yrs

2012 2011 2010 2009 2008 2007 MAYUR Economic Profit Added (EP) 29.451612 24.283592 17.8701 11.8696 2.6609 2.1666 Mkt Cap (Mar End) 500 242.23 137.47 77.42 12.9 22.4 EP/MCAP 5.9% 10.0% 13.0% 15.3% 20.6% 9.7% BKT Economic Profit Added (EP) 146.28 110.87 152.74 38.87 72.24 Mkt Cap (Mar End) 2503 1291 1241.37 267 1048 EP/MCAP 5.8% 8.6% 12.3% 14.6% 6.9% KAVERI Economic Profit Added (EP) 55.87 27.15 9.53 3.19 5.9 5.66 Mkt Cap (Mar End) 1500 795 458 380 204 383 EP/MCAP 3.7% 3.4% 2.1% 0.8% 2.9% 1.5%

Due to slow net connection I could not get much data… just putting these based on the data which was in this thread.

Taking just same year ratio, we can see that Mayur and BKT were attractive in 2008/2009 and Mayur had better ratios in 2010 and 2011 as well.

For Kaveri perhaps the numbers are not good, because the major performance comes in at June end, which is when the stock get attractive again.

2012 2011 2010 2009 2008 2007
MAYUR
Economic Profit Added (EP) 29.451612 24.283592 17.8701 11.8696 2.6609 2.1666
Mkt Cap (Mar End) 500 242.23 137.47 77.42 12.9 22.4
EP/MCAP 5.9% 10.0% 13.0% 15.3% 20.6% 9.7%
BKT
Economic Profit Added (EP) 146.28 110.87 152.74 38.87 72.24
Mkt Cap (Mar End) 2503 1291 1241.37 267 1048
EP/MCAP 5.8% 8.6% 12.3% 14.6% 6.9%
KAVERI
Economic Profit Added (EP) 55.87 27.15 9.53 3.19 5.9 5.66
Mkt Cap (Mar End) 1500 795 458 380 204 383
EP/MCAP 3.7% 3.4% 2.1% 0.8% 2.9% 1.5%

Now let me put up a poser?

Which among Mayur or Astral will find it easier to double its turnover in next 3-5 years?

To me the answer is clear without needing any arithmetic. Astral can double its turnover from 1000 cr to 2000 Cr easily in next 3-5 years. Can Mayur double its turnover from 500 Cr to 1000 Cr as easily?

Which business is likely to be valued more, as it attains bigger size? (assume can keep growing at similar rates)

Clearly Mayur has a huge advantage in generating Economic Profits. Its spread is 28% vs a mere 10-12% in case of a BKT or Astral.

But as we can empirically understand from above, the Size of the Invested Capital (and thus growing at a faster rate) will also matter a lot even if it invested with a much lower spread.

Unable to capture this from the numbers. Yet something keeps telling me this aspect is not about the subjective parameters, its simple numbers.

Why can’t I catch it?:)) Please help

** Which years? **

** Which size? ** it?:))) Please help

Hi Donald,

My sense on the whole discussion is that we may be chasing something illusive if we are looking at a single number telling us business X is better that business Y. Now this does not mean that there are no quantitative differentiators.

I kind of tried to reflect on what would I consider a better business/more valuable business than the other? I first try to define it in words and then whereve possible look for quantitative proxy. Let me at the outset confess that I am just penning down my thought process and some of the arguments/rationale can be sketchy in articulation and may be ambiguous or even out of context.

Here is how I would define a quality business I want to own

I would look for a business that is able to grow at reasonably high rate for a long period of time bygenerating consistently high rate of return on invested capitalmostly financed thorugh internal accruals.

Now how do we quantify this?

Let me take the first element

Business is able to grow at reasonably high rate for a long periodof time:

When can one see this with reasonbale certainty? When opportunity size is far larger than current revenue base and opportunity size is likely to expand at decent rate.

So first matrix **Opportunity size/Current Revenue. **I think here relative to current base how big is the opportunity size is relevant and not absolute size. So for mayur the ratio is8-10 and for Astral it is much higher may be around 30! Now let me warn that this matrix will be relevant in oligopoly/limited competition/niche businesses. However, most of the stocks that we discuss have such attribute. so it will be relevant.

Second matrix is how fast the opportunity size is expanding? i.e. projected industry growth rate for next few years.

generating consistently high rate of return on invested capital:

We have discussed this ratio, its significance and its components threadbare. so no need to explain. My take is that company that generates ROCE through balanced mix of capital turnover and margins are likely to be far more sustainable and consistentthan companies generating high ROCE primarily due to very high margins. So two ratios to look for

**1) Capital Turnover **

**2) **Operating Profit Margin

high ROCE derived from balance of both is sustinable.

**mostly financed thorugh internal accruals. **

Cash is king!I would prefer companies which generateenough cash to fund reasonable growth and add leverage only as kicker. So how do we measure this?

Here is what i propose. Calculate

Internally Funded Growth = ((operating cash flow-maintenance capex- interest) Capital turn over )/(Revenueform operations) * 100*

This ratio canshow how much growth can be funded through internal accruals? Take example of mayur for FY 12

Operating cash flow - 28.08

Maintenance capex- 3.87 (equvivalent to maintenance depriciation)

Interest and Finance charges - 1.96 crores

Invested capital : 56 crores (my numbers differ here becoz I have excluded cash and investment. Whether this is appropriate or not can bediscussed separately).

So Internally Funded Growth = ((28.08-3.87-1.96) * (317/56) )/ (317) * 100

= 39.7%.

So it means, mayur generates sufficient cash flow to fund 40% growth considering current asset turnover. Now one can alwyas look at averaging out cash flow and smoothen the w/c cycle.

But this can be a good indicator whether company can generate cash to fund its growth.

In my view comparative analysis on above aspects may give some good pointers to attractiveness of one investment versus the other.

Now this analysis is surely not exhaustive and understanding of the business, “moat”, promoter integrity and most importantly price/value matrix are extremely important while one makes an investment. But if a business scores better on most of the parameters than other businesses in portfolio, it will surely deserve a look for higher allocation.

Best Regards

Dhwanil Desai

7 Likes

Again, a great post and excellent contributions from all. Let me put in my two cents worth here (and this may be a bit of a dampener for some). **I think the whole idea of able to make a mathematical model of valuing the future potential of a business is simply not possible. There are too many imponderables over the long term. And the history of business has taught us how things can change dramatically over a 5 year period. **

Everyone is so bullish here about Astral (incidentally, so am I), but can anyone guarantee that 5 years down the line a new composite will not be available with better chemical properties and cheaper price which will make Atral’s (Lubrizol’s) patents not worth the paper it is written on?Just like 10 years back people were talking about PVC replacing GI pipes, who knows if people will say ABC will replace GI/PVC/CPVC!! So, It may be a bankrupt business 10 years from now. So, all the models will go for a toss then!!

I can give you off-hand innumerable examples of industry leaders who either do not exist or exist as dwarfs of themselves today. I can include businesses that even the venerable Buffet thought would be irreplaceable (newspapers) a few decades back who are struggling to survive today (case in point, Newsweek, Statesman, Readers Digest etc). Few more examples where once-market-leaders are biting the dust today are Kodak, Xerox, Hindustan Motors & Premier Auto (in India).

So, in my mind to answer the question of who between Astral & Mayur will find it easier to double its turnover, I would say both will find it equally easy/challenging. If Mayur can crack open the Merc/BMW OEM, it will gallop faster. Astral any way is on a good track for growth. No one can say how things will pan out, so better spread your bets on your highest conviction and low valuation ideas.

Note: Look at Kodak’s AR in the late 70s (or IBM’s for that matter in the late 80’s) and see their ROE/ROCE/ROIC etc and you will not find a thing negative…going great guns…then suddenly out of the blue you get Fuji in the picture and then some years later digital cameras and then mobile cameras and Kodak went bankrupt. And remember Kodak was Fortune 100 company. Same for IBM…all going great selling mainframes in a monopoly market, patent protection, great brand etal… then you get the PC revolution and IBM was an inch-close to closing down.

To plagiarize one of Buffet’s quotes : if mathematical models could tell you the future of stock prices, then mathematicians and statisticians would be millionaires!

9 Likes

Thanks Abhishek,

I too had a similar feeling with mathematical model way to find out which exceptional companies. Past data analysis should be just a part of stock analysis (and hence value driver).

As per Pat Dorsey book, one need to find these data

1). Business moat

1.a. -> Historical solid return : Can be found out by past data analysis

1.b. -> Why competitor can’t steal profit (IP, first mover advantage, tie up with good foreign player)

1.c. -> Competitive advantage period - we are ignoring this as we can’t calculate it, a disturbing trend as per me

1.d. -> industry’s competitive structure

Finding business moat, is also just one part of the whole strategy, namely (Moat, Margin of Safety, Long term view, when to sell)

If one want to go via “mostly mathematical” model, than one should follow alternative approach like Louis Navellier’s Growth Investing strategy, which need good amount of data crunching ability to find out accelerating and slowly decaying business.

** I

_ Note:

_ down.To _

millionaires!

Hi Abhishek, Subhash and All,

I too subscribe to view that basing one’s investment decision on pure mathematical model is never a good idea as one is buying a part of business which has number of attributes which are not quantifiable and fairly dynamic. I think most of us will be on same page on this aspect. Now as Abhishek very rightly metioned, business dynamics change and things can go in a drastically different directions than anybody would have imagined.this is precisely the reason one should always look for “margin of safety” while buying businesses which will ensure that there is at least no loss of permanenet capital in the worst case scenario.

However, after ensuring enough margin of safety, whatever is the opportunity set available, how do we allocate capital? Do we divide capital equally amongst all or take some educated guess and allocate higher capital to some stocks than others? Is there a higher probability of business A being more valuable than businessB?If so why ?

Whatever understanding I have developed till now, tells me that some business have inherently better business economics than others and hence have higher probability of generating high value over longer period of time. Now do these business have some overarching charateristics that logically as well as quantitatively explain higher probability of sustained value creation.? I think the answer may be positive and we may be able to find such few characteristics and quantify them.

So in nutshell, eventhough with this kind of excercise we may not be able bring in “certainty” we can surely bring in higher probability of allocating higher capital to more value generating business than others in the portfolio. So this kind of excercise is not useful asa first step in stock selection but may come handy in a subsequent step while making capital allocation decision.

However in order for this to work, prerequisite is one buys stock which are fundamentally strong, has good past track record, decent management and is bought at substantial discount to intrinsic value.

_

**

It was much easier to get the data using the new feature of customised excel export from screener.in Below is some data to digest..

AJANTA PHARMA LTD. Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
EBIT Margin 14.24% 15.65% 14.27% 14.88% 17.14%
Capital Turnover 1.10 1.00 1.21 1.35 1.46
RoIC 10.51% 10.46% 11.58% 13.41% 16.75%
Economic Profit Added (EP) (3.85) (4.93) (1.32) 4.79 19.67
EP/MCAP -3.60% -6.23% -1.06% 1.92% 5.05%
ASTRAL POLY TECHNIK LTD. Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
EBIT Margin 15.43% 13.41% 12.01% 10.70% 12.36%
Capital Turnover 1.45 1.30 1.91 2.34 2.46
RoIC 15.00% 11.72% 15.37% 16.77% 20.39%
Economic Profit Added (EP) 2.81 (0.41) 5.09 8.37 19.72
EP/MCAP 1.38% -0.34% 3.30% 2.67% 5.00%
ATUL AUTO LTD. Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
EBIT Margin 5.87% 2.96% 8.58% 7.83% 8.02%
Capital Turnover 1.70 2.60 2.24 4.60 5.88
RoIC 6.67% 5.16% 12.89% 24.15% 31.63%
Economic Profit Added (EP) (2.55) (3.09) 0.48 5.33 9.94
EP/MCAP -6.69% -15.19% 1.92% 8.04% 12.73%
BALKRISHNA INDUSTRIES LTD. Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
EBIT Margin 19.06% 14.83% 22.55% 14.82% 15.11%
Capital Turnover 1.26 1.50 1.41 1.58 1.25
RoIC 16.14% 14.92% 21.26% 15.73% 12.62%
Economic Profit Added (EP) 32.45 24.36 91.22 47.02 14.09
EP/MCAP 2.45% 3.95% 11.46% 3.72% 0.81%
KAVERI SEED COMPANY LTD. Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
EBIT Margin 25.85% 23.42% 20.23% 19.19% 18.67%
Capital Turnover 1.21 1.20 1.03 1.37 2.81
RoIC 20.92% 18.80% 13.99% 17.56% 35.19%
Economic Profit Added (EP) 7.13 6.99 3.15 9.52 30.69
EP/MCAP 1.75% 2.62% 1.02% 2.20% 4.85%
MAYUR UNIQUOTERS LTD. Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
EBIT Margin 9.82% 12.47% 15.24% 15.44% 16.11%
Capital Turnover 2.72 3.31 3.63 3.86 4.34
RoIC 17.88% 27.67% 37.07% 39.97% 46.88%
Economic Profit Added (EP) 1.95 5.44 11.37 17.99 25.50
EP/MCAP 7.16% 31.99% 25.50% 14.95% 13.08%
PAGE INDUSTRIES LTD. Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
EBIT Margin 19.57% 19.88% 17.90% 18.51% 21.02%
Capital Turnover 2.35 2.30 2.40 2.24 3.06
RoIC 30.82% 30.64% 28.81% 27.76% 43.12%
Economic Profit Added (EP) 15.48 20.82 24.53 35.98 70.16
EP/MCAP 3.12% 4.65% 3.31% 2.57% 2.72%
PI INDUSTRIES LTD. Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
EBIT Margin 5.65% 10.26% 11.96% 12.75% 13.52%
Capital Turnover 1.77 1.85 2.10 1.91 2.02
RoIC 6.71% 12.71% 16.84% 16.29% 18.34%
Economic Profit Added (EP) (12.44) 1.98 13.69 17.78 29.93
EP/MCAP -19.90% 2.36% 8.26% 3.33% 2.44%
SUPREME INDUSTRIES LTD. Jun-08 Jun-09 Jun-10 Jun-11 Jun-12
EBIT Margin 8.85% 12.55% 12.41% 12.24% 13.78%
Capital Turnover 2.94 4.02 3.61 2.62 3.58
RoIC 17.43% 33.80% 30.05% 21.46% 33.06%
Economic Profit Added (EP) 24.21 89.59 100.39 88.89 174.31
EP/MCAP 3.30% 21.20% 9.75% 4.67% 6.95%
UNICHEM LABORATORIES LTD. Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
EBIT Margin 16.36% 21.46% 24.19% 18.27% 13.51%
Capital Turnover 1.90 1.61 1.56 1.45 1.43
RoIC 20.79% 23.11% 25.35% 17.69% 12.96%
Economic Profit Added (EP) 26.94 45.41 58.95 30.10 5.40
EP/MCAP 4.40% 7.91% 5.99% 1.71% 0.43%

From the data it looks like besides Mayur, it is Atul Auto among these stocks that looked interesting at the end of March with improving performance.

Hi Akbar,

Nice analysis and interesting to see the comparison of our favorite cos.

But I think the inference is not fair for Unichem, Ajanta etc which Hitesh Bhai had explained very well as turnaround candidates. There we are expecting vast improvement in ROIC due to capacity addition already done/new products/stronger distribution etc playing out this year onwards.

Mayur always looks delicious :slight_smile: easily the best even at current price (Naga, can I touch your feet :)). Astral again as Donald pointed out elsewhere needs to begauged with regards to the size of the opportunity. Probably the forex bhai will help in making it more attractive.

Atul - what a company with excellent asset t/o and this when they still have the capacity to reach 48000 units just by having 2 shifts and spending little on capex. But do not know about the Srilankan plant’s capex requirements.

Cheers

Vinod

Hi Vinod,

True, we cannot infer future performance from past data. This data is the snapshot at March end.

What could be done is to project the expected figures for these and others prospective companies based on our expectations and see how they would fare at the current/expected market cap.

That is the nextexercisei would look at.

Best regards,

Akbar

:)) :))). begauged

Great work Akbar :slight_smile:

Thanks for presenting the snapshot. One thing that Pat Dorsey emphasizes time and again is the sustainability going forward, be it margins or asset turnover.

Reminds me of of his example of the projector company selling to growing demand from new multiplexes. As the demand generating segment itself was not sustainable hence the future growth prospect based on that demand was faulty. And the stock collapsed after reporting great earnings during the boom.

How sustainable does a 6x asset turnover look for Atul ? If there’s a disruptive new vehicle which diminishes the demand for 3-wheelers what impact would it have on Atul, now with the expansion plans lined up ?

Astral to this extent looks relatively stabler as the demand generation is more broad based. Also with increased economies of scale, likelihood of EBITDA margin increment from Astral back to 15% levels and beyond seems more rational.

Mayur too have stabler broad based demand typically with the management vision of marking 25% revenue split from each category/industry segment. With growing exports, likelihood of margin expansion for Mayur seems as the product mix changes slowly.

Companies like Hawkins/TTK Prestige have very high asset turnover primarily aided by the manufacturing outsourcing while the products are still sold under the aegis of the respective brand, which cannot be matched say byAstral or Mayur (no significant brand moat)

Companies likely to walk this path will tremendously benefit as it lifts both the margins and asset turnover together (Case in point: Kajaria)

Also companies catering mostly to retail demand (as opposed to B2B) has much greater flexibility to protect margins. Higher RM prices are passed on to customers and lower RM price cycles boost margins significantly (Case in point: Page) which cannot be done by OEM/ B2B suppliers as the RM price cut has too needs to passed on to clients.

Also regarding Pharma companies like Ajanta and Unichem, it is unfair to compare them with other manufacturing companies. Once you have a sales force in place, margins can jump as the brand sells and COGS is very low. It is due to this going with branded generic playersis a better bet thanCRAMs players.

2 Likes

I have computed the EVA and Roiic for pidilite. While the Roiic is not constant,one reason that I can think of is the global acquisitions that the company has made that haven’t paid off. The EVA is pretty impressive and that is because of the increase in roic over the years. I have also carried out the buffett retention test, which shows how much the company has added in market value for every 1 Re held back as retained earnings(discussed by prof Bakshi in his relaxo lecture). The company comes out with flying colors on this one as well. As discussed by Donald in the other thread this gives us a trend on how the company has performed over the past and given pidilite’s clean management this may continue into the future as well. However after looking at this information how does one decide if the stock represents a buying opportunity at the current price. I am convinced with the quality of the business however I want to avoid overpaying for it.

Regards,

Chetan Chhabria

PS: Attaching file showing the workings.

pidilite-eva-figures.xlsx (11.6 KB)

1 Like

Hi Chetan,

My approach to this puzzle is to pit the best against the best. So if Pidilite is in the category of well-discovered quality pedigreed business, I will like to first see how does it fare against an Asian Paints for example (another great example of commodity product successfully creating a well-crafted branding story for itself, just like Pidilite) and then go on to pit it against other brand stories with-pricing-power like a Nestle and a GSK (Horlicks) and even a Page Industries (which may yet not be there butv just as promising or more) - in a bid to separate the wheat from the chaff again.

The purists may scoff at this saying all are very different businesses - but I am after knowing where is the best bang for my buck. Obviously before anybody again raises the bogey :slight_smile: there is a caveat - we must know each of these business intimately enough. Fortunately for well-discovered businesses like these - all you need to do is read 5-6 brokerage reports and set google-alerts to be on top of every newsflow on these and their industries. Good to great familiarity with business and industry can be achieved in very short time - even something like 2 months is enough we saw - last time we attempted the FMCG -separating the wheat exercise.

Yes, Valuation is a different exercise. And these are too well-known businesses. Mr mArket is much more efficient about them. All expectations are usually built-into the price. Yes, we do not like to pay up. The EPA exercise may make it very clear from the Science part which among these is more superior. e.g let me hypothesise that Page Industries will probably prove to be more superior because a) it is growing the fastest and b) Its competitive advantage period (still a midcap market capitalisation) is probably biogger as compared to others - while having a comparable Returns and Dividends Payout profile.

If that is true, then a) I would try to make sure that Page’s (or whichever 2-3 emerge as the most superior EPA generating businesses) sustainability of competitive advantage is un-impaired and have a small nibbling go at it - because Conviction may be HIgh but Undervaluation may be Low - get real familiar with the business - track all Reports, attend AGMs, talk to those invested in it for many years - to develop a proper Capital Allocation strategy for that buisness.

What this will help me achieve - I will be pretty sure about the 2-3 bets I must have in these well-discovered sustainable stories - and will be ready for the BIG CHARGE - when there is a widespread secular fall in the market - that day will also come - sooner than later - but I have to make sure my homework is done by then - with full integrity & honesty.

That again is a systematic running down process - don’t think there are any shortcuts. I am hopeful by way of EPA and other business-quality refinements that we bring in our investment thinking we may - just maybe - be able to spot some of Mr Market’s anamolies again in these categories too - even before everything comes to that horrible widespread secular market lows stage - 'cos before the fall the irrational highs have to come - we are yet to see that kind of froth in the Markets.

Go ahead - You take the Lead. We will all support you in this investigation. Will check your Excel sheet to see if we are both on the same page. Remember the caveat - you gotta make yourself competent for the ART side - know everything there is to know about the business/industry they are in - talk to industry guys - track their near-term journey really well.

I am with you here. I am interested. There may or may not not be dedicated threads for those that we are comparing - go ahead and start those threads - once you have an initial understanding of the industry/business issues - from the brokerage reports - in large caps or well-discovered midcaps the great part is - a collection of brokerage reports are the quickest source to 80% familiarity with the business issues (ignoring the investment recommendations) :slight_smile:

5 Likes

Hello Donald,

Thanks for sharing your approach on how you boil down on what to buy. What triggered my interest in this stock is the strong set of products that the company has. Also recently I had a conversation with a relative who owns a hardware shop on products of pidilite and asian paints. This is what he had to say

Pidilite

Company regularly acquires companies in the domestic market. Which is very evident, however their overseas acquisitions haven’t paid off.

Company has a strong distribution network and products are delivered on time. Maximum credit that the company gives is 1 month depending on the relationship and sales that particular store generates.

Sales have slowed down off late.

Asian Paints

Company has targets for every store/shop. They expect sales to increase a minimum of 10% from every store. If the store is unable to achieve its target then the company is slow/delays in providing goods.

Company does not provide credit. In fact every store/dealer needs to issue PDC’s to the company and the amount is adjusted against their purchases.

Company does not have distributors, company has a sales force which directly takes orders from the dealers and goods are dispatched quickly.

9/10 people coming to the shop ask for asian paints.

Off late due to the slowdown the company has relaxed its norms on achieving the minimum 10% increase in sales target.

Margins that they get is about 10%-12%.

I do agree that pidilite is a well discovered business and a large cap. I also agree that a page or hawkins may grow faster and give better returns. However I do not see any other company breaking their moat very soon, it is going to be very difficult even if someone tries. I personally think it is a business that one should own at reasonable valuations. I had also prepared a small write up on the company(excluding valuations) and am happy to share it with you/community. Please DM me your mail id and I can forward the file to you.

Regards,

Chetan Chhabria

Hi Guys,

I have done calculations oncompanies that trade at a high P/E ratio and have high ROE. These companies employ very little capital in fixed assets and working capital (few of them have negative working capital or employ very little incremental capital in working capital). Most of them (TTK Prestige and Jubilant Foodworks being an exception) have high dividend payout ratios.

Few points stand out out among all the stocks tabled above:

Page Industries: The Company stands out among all the stocks that we discuss with high growth in sales and profitability. It has high dividend payout ratio and stable profitability margins.

Symphony: If we exclude the short-term liquid investments on companyâs balance sheet (which was almost 40% of the employed capital as on June 30, 2013), the return ratios would improve significantly (from 27% to 47% in FY13). The company has started churning out good numbers in 9MFY14 after a relatively slower growth in sales and PAT during FY11 â FY13.

Hawkins Cooker: The stock has very high capital turnover and ROIC ratio. It has employed very little cash in the business and most of the profits earned during the year are paid out as dividend. However, sales and profitability growth has remained anaemic.

TTK Prestige:Unlike Hawkins, TTK has had decent sales growth during FY11 â FY13. However, it has sacrificed margins for the sales growth as reflected in the declining operating profit margins. Its capital turnover ratio and ROIC are declining over the past three years. The dividend payout ratio is also low.

Jubilant Foodworks: The company has had a good sales and profitability growth over the past three years. All of the profit earned by the company is ploughed back into the business as indicated zero dividend payout ratio. RoIC has declined over the past three years.

Asian Paints: Despite the slowdown in the economy, the company has done reasonably well. It has decent RoIC and dividend payout ratio. EPA has also increased over the past three years.

Among the FMCG pack,HUL and Colgatehave the highest dividend payment, capital turnover, ROIC and ROIIC ratios. Their EPA has also increased continuously over the past three years.

The numbers for FY13 are tabulated below while the same for FY11 and FY12 are attached.

Page Symphony Hawkins TTK Jubilant Asian Paints Nestle HUL Colgate ITC P&G
FY13 FY13 FY13 FY13 FY13 FY13 FY13 FY13 FY13 FY13 FY13
Sales 876 378 425 1358 1408 11427 9101 25805 3160 29212 1687
Sales Growth % 27% 21% 16% 23% 38% 14% 9% 17% 18% 16% 30%
PAT 113 60 34 133 135 1114 1117 3797 497 7418 203
PAT Growth % 25% 13% 13% 17% 28% 33% 5% 41% 11% 20% 12%
Dividend Payout % 50% 38% 78% 15% 0% 40% 35% 105% 77% 56% 40%
EBITDA margin % 20% 21% 12% 15% 17% 15% 21% 16% 21% 36% 15%
PAT Margin % 13% 16% 8% 10% 10% 10% 12% 15% 16% 25% 12%
Invested Capital 301 222 66 510 436 3,783 3,558 2,674 490 22,354 805
Capital Turnover 2.91 1.70 6.46 2.66 3.23 3.02 2.56 9.65 6.45 1.31 2.09
EBIT (Rs. Cr) 174 92 53 199 197 1,692 1,701 4,375 663 10,771 286
EBIT/Inv. Capital (X) 58% 41% 81% 39% 45% 45% 48% 164% 135% 48% 36%
Tax Rate % 32% 34% 32% 28% 30% 30% 34% 27% 25% 31% 29%
RoIC % 39% 27% 55% 28% 32% 31% 32% 119% 101% 33% 25%
RoIIC % 32% 27% 203% 9% 22% 22% 7% NM 93% 36% 35%
WACC % 13% 13% 13% 13% 13% 13% 13% 13% 13% 13% 13%
EPA 79 32 28 77 81 690 665 2843 433 4572 99
EPA/Sales % 9% 8% 6% 6% 6% 6% 7% 11% 14% 16% 6%
EPA-Working.xlsx (21.8 KB)