Hey buddy, thanks for actually digging out the specific numbers and presenting it here in such a coherent manner. I am just extremely lazy with these things. I like to write more in a story format. So, at the outset I would like to thank you for doing all the grunt work. Appreciate it. If somebody reads my your post after mine, that is pretty much all he/she needs to know to understand the pros and cons of this story. Brings a much better perspective to the discussion.
Coming to the points raised by you, the company presents its financial numbers in a certain way. What I have observed is that in good quarters, they book all the balance sheet provisions and sort of expense it. This results in improved balance sheet strength and ensures that they don’t have to take this hit during a bad quarter. Now what this does is that optically reduces their profits (with correspondingly lower impact on cash flows because most of these are non cash items). Similarly, in the bad quarters, they book these one off gains, which sort of results in consistency of results across quarters. I personally like these kind of managements as it gives me some predictability into their future numbers. For example, I am quite confident that they won’t report any loss quarter for at least the next 6-8 quarters, because of the capital subsidy and contingent gains due which they will book if at all they have a terrible quarter. If not, this will be sufficient to wipe off their long term debt.
Regarding the point of why they don’t want to do capex and want to pay off their debts first, I am fully convinced and I am in the management’s camp here because of 2 reasons. The first is as somebody who manages a business myself, I can completely identify with them when they say that the scars of 2013 and 2014 are too recent to forget. When I have two bad years like that, I would first like to make my balance sheet debt free. That is what any prudent businessman would do. Like you said, the chemical prices may be at their peak. We don’t know. But in any commodity industry, it is always a bad idea to capex at the peak of the cycle. This is the prefect recipe for disaster.
So, despite concurring with you on most of your observations, why am I still a buyer here? Simple, because cash flow is fact, profit is an opinion. Even if you knock off Rs.500 Crores from the cash flow as unsustainable, you are still left with Rs.1500 Cores of cash flow and cash flow / market cap ratio of 4, which is extremely low in my view for a company which has such a strong market position in most of its verticals.
Finally, regarding the sustainability of chemical prices, that you may very well turn to be right. But who knows. Many of us had the same view 2 quarters back. But, the story just keeps on getting better. Think about it this way- Suppose you are a global chemical/auto/plastics/ pharma giant who sources these speciality chemicals.Before getting into a sourcing agreement with any factory in any country, there is a long process of due diligence and approvals and this takes anywhere between 4-6 months at least. Now if you have complete dependency on China and suddenly their government decides to close these factories abruptly, what would be your reaction. To mitigate your risks, you will first of all look for backup agreements with suppliers in other geographies/ countries to reduce the concentration risk. That is exactly why the Indian manufacturers of key speciality chemicals are looking at potentially very large market opportunity even if China comes back gradually into the market. Its a credibility issue end of the day.
You know investing is all bout milking and learning from past mistakes. I was an early investor in Avanti Feeds as I had quite a few connects in the industry. i bought in at 300, sold it at 1500. A potential 50x (as of LTP Friday EOD) reduced to just 5x because of similar fears about how long will the shrimp prices sustain if the other competing countries come back into the market after recovering from the disease related issues in their backyard. These countries are yet to get back to normal last I checked. Avanti Feeds and Bajaj Finance are the two biggest blunders in my life, wherein, in my own intellectual wisdom I decided to question the power of a large economic and business trends. The amount of capital that I had invested in these 2 companies in 2012, If I would have just sat quiet till today, I would have retired to somewhere in Carribean island and not been writing this post at 1pm in the night. Anyway, the point is I have learnt to not question these long term economic and business trends as they are very powerful. When an entire industry gets disrupted in a particular country, it becomes extremely difficult for the original guys to come back into the game meaningfully. And the beneficiaries of this disruption improve their balance sheet to such an extent that it becomes difficult to dislodge them. Who knows, I may be completely wrong. But this is my view at this point of time. As they say, beauty lies in the eyes of the beholder. If you can name me 3,4 companies of similar size as GNFC trading at Market Cap/ Cash Flow of 3-4x, without any management issues and a reasonable moat, I would love to buy them too.
P.S: On a side note, the sustainability of specialty chemical prices is an issue for all the other speciality chemical players in the industry too. I also think there is at least an arbitrage opportunity here for valuation catch up with all other speciality chemical and fertilizer players. Let’s see the market’s opinion this. I think if the re-rating has to happen it will be done in the next 2 months. So we should get a confirmation soon. Like I said, my humble view is that this company deserves a valuation of Rs.15,000 crores. I loved the way you presented your views though. Would look forward to reading your posts in the future. Thanks.