Phoenix lamps – rising up from the ashes?


(Varadharajan Ragunathan) #1

Phoenix lamps – rising up from the ashes ?

CMP – INR 115

Having learnt from both Warren
Buffet and Phil Fisher, I have developed my own unique style of stock analysis
– that involves about 40-50% of analysis on the ground (which a lot of analysts
miss out on) the rest in desk research- reading AR’s, analysing numbers etc. I
would like to call this the Holmesian way of analysing stocks - unlike
conventional analysis that relies heavily on secondary research, this creates a
double loop mechanism that feeds into the other engine and helps validate or
reject the thesis. This has often proven to be quite an advantage in micro caps
where often “what you see is not what you get in the numbers” and vice versa.

Said all of this, it is seldom
that I come across a stock that is a purists value investor’s delight which
offers a triple play of reversion to mean, de-merger/spin-off optionality and
pure and simple undervaluation. I must thank my friend, Gokul raj who introduce
me to this stock and also shared his note with me from which I have generously
borrowed.

Company background – phoenix
lamps – left for the dead, about to fly higher

The company is Phoenix lamps and
is a small/micro cap with a Market cap of INR 3,250 MM with no analyst
following (don’t I just love these) and of course low liquidity and
institutional interest.

The company, which was majority
owned by Actis was a classic study in “di-worsefication”. A near monopoly
business in automotive head lamps/tail lamps gone terribly awry through a
diversification into CFL’s which is cut throat, high intensity, B2C, branding
heavy business. A decade later and the mistake corrected through a slump sale
of the loss making CFL business, look at the ratios and you will be impressed.
High RoE, high ROCE, FCF positive business with high asset turns (11 x FA
turns) with a 20 % + EBITDA margin with ROCE of 30 % +. It’s got near FMCG
characteristics given the standard nature (My friend at bosch says the key to a
higher margin business in auto is a. high standardisation b. high value to
weight/volume c. OEM + after market possibilities and that’s why bosch is
always in things like ABS, wipers, air bags which are critical parts and fairly
standard. The only exception are high finesse items which involve a lot of high
end labour like machining and critical engine parts.

I looked at the company in the
past and the only reason why I let it slip was the lack of alignment between
shareholders and management – the existing shareholder actis wanted to sell,
the management guys were all professionals who had no clue about shareholder
value.

Recently the company got bought
over by suprajit engineering and this got me delving deeper again.

Triple play – great, proven capital allocator at the helm + improving
business prospects + re-rating possibilities

Let’s get the easy one out of the
way –actis has been stuck in the company for 9 years and started selling down
their shares (from 70 % to 60 % ) and this has resulted in the share price
going down from Rs. 180 to Rs. 100 over six months with no change in
fundamentals. That’s gone and a simple reversion to mean should take this at
least 50 % up.

The business is the largest and
one of the top 3 (Philips, osram) in the
automotive OEM. It’s the largest with 55 % market share in cars/PVs, 60 % + in
CVs and 80 % in two wheeler OEMs. Had lights are a small value but critical
item where there can be no downside – since that entails warranty claims and
OEM’s prefer to play safe with an indian manufacturer. Inspite of all the mega issues involving loss
of focus, it is to phoenix’s credit that it continues to be a leading player –
the threat of Chinese exists in aftermarket but not at OEM level (double
verified) because of quality/warranty issues.

Given the research I have done by
talking to a dealer/distributor, this can be a 15 % growth in the aftermarket
and a 7-8 % in OEMs, going forward.

Suprajit is well known to value
investors in the indian market. I have personally interacted with ajit rai and
I think he is an outsider CEO – buys cheap and is an exceptional operator with
a focus on bottomline and cash flows. He has been looking at acquisitions for
long and finally bought one which in his own words was a company that
manufactures :

Scalable, global standardized product

With a market leadership position in indian
market

With export possibilities

Complementary to his core business of two
wheeler cables

High margins and strong cash flows with minimal
debt

Given what he has done with
suprajit – have a look at ROIC of 30 % consistently and his own
salary/remuneration etc. and I am sure that he will do a good job of at least
maintaining status quo – which by itself should lead to a re-rating

Scuttle butt and research

Spoke to a couple of distributors
and a friend at Philips ;

Philips guys’ inputs – already exited
this market by selling their entire global lighting division. Used to be focussed
on auto market but has slowly exited – still sells high margin products in
after market but for all practical purposes has stopped supplying to OEMs
because of pricing pressures – they exited this business as they were
manufacturing in high cost locations and they want to concentrate on high
margin medical business

Distributors :

Phoenix brand is well known in
north but not so in south/west

Quality is still the best – very few
customers come back for returns

Supplies white labels to even
brands like bosch and has a good reputation for quality

Last 3-4 years have been playing
hot, playing cold – not enough attention in the market

Valuation :

I am attaching an excel sheet
from the screener template and you will find that both EBITDA, asset turns and
RoCE are increasing and last year’s dividend yield was a whopping 11 %- expect
this year’s to be at least 4- 5 %. (that’s a 5 % off on an already discounted
price for suprajit). It’s trading a 8 x
FY 15 and at about 1.8 x PB with an RoE of 30 % translating into a shareholder’s RoE of about
16-17 % - I look for fat pitches with a minority shareholders’ RoE of 10 % (viz., ROE divided by P/B) and that’s a fat
pitch IMHO.

Just mere re-rating to 12-15x
with an EPS growth of 15 % which is doable can lead to a 3-4 x over a few years
and of course if this gets merged into suprajit (which by all means it should),
it should be a fairy tale ending similar
to sun/Ranbaxy.

This has characteristics similar
to companies like Bosch (definitely a notch inferior) on EBITDA margins etc. –
not for nothing does Bosch think highly of this company.

I also expect modest synergies
from cross selling to suprajit’s clients.

The fly in the ointment is the
acquisitions they made in Europe which had a zero profit – they apparently
repackage the bulbs manufactured here and brand them and sell them in Europe –
which IMHO, is a so-so business unless suprajit can turn this around. I expect
zero contribution from this going forward and I would be pleased if there is no
good money to be thrown after bad.

LED’s are a risk but from my
talks with several industry experts given the :

Price differential

Harsh indian conditions of frequent hits which
lead to replacement of expensive bulbs

Wear and tear and rattling that result in LED
life getting shortened

LED’s are not a threat at elast
in the low end cars/CVs/ two wheelers for a long time to come. Even otherwise,
LED’s are only a supplement and cannot replace head lamps – most have only day
time running lights that are LED’s. Only Rs. 20 lakh plus cars have xenons and
LEDs’ and that will take some time to percolate down given the huge costs and
maintenance issues.

I see this as a high RoE business
in a slow growth industry (similar to Duracell purchase of warren buffet) which
can maximize FCFs and grow at a steady pace of 10-15 % easily without any
incremental capital and provide for a dividend yield of 3 – 4 % with a PE
re-rating upside.phoenix mills - numbers at a glance.xlsx (74.2 KB)phoenix lamps - value pickr.docx (18.7 KB)


(sri krishna bhutra) #2

Good analysis. Bajaj auto for its three wheelers uses headlamps manufactured by phoenix lamps.


(sri krishna bhutra) #3

Phoenix also has a high brand recall among indian CV drivers due to the high quality of the head lamps


(huriasahil) #4

hi @varadharajanr
this seems to be good opportunity.I was just checking the volume on yahoo finance at BSE’s desk…it doesn’t seems to be an illiquid stock.


(Chintan Shah) #5

Varadharajan Ragunathan - Thanks for the awesome analysis.

It is possible to have historical numbers for the only lamps business as it will help us understand growth rate for this business alone.

Screener as expected is giving us consolidated numbers which includes CFL business.

Numbers for FY15 (after CFL business was sold off) are very lucrative and is encouraging me to have a deep dive.


(Sreeselva Veene) #6

Varadha,

My rebuttal as promised!!

You missed one more very important positive in this thesis. Sundaram Clayton, a very well established company from the stables of one of the highly respected business groups in India holds nearly 10% stake in Suprajit.

  • Now the negatives:
  1. The problem I have is, Actis didn’t wake up one fine morning and sold the company all of a sudden. They had been trying to sell for the last several years and strangely there were no takers for it. Phillips making an open offer and Actis acting pricey doesn’t sound like a credible story at all. I say this because we have seen many instances of acquirers not minding to pay premium where underlying businesses were perceived to add substantial value. Phillips obviously didn’t see a need for going beyond the valuation they had in mind and hence gave up on the deal. This gets substantiated by the open offer by Suprajit at a price which was not fascinating/eye catching to say the least. Ekansh can tell you more on this I’m sure . Ajith spotted the distress sale and played a vintage Varadha. He was the perfect Hyena in the waiting 

  2. While Suprajit is good at managing it’s core cables business, there’s no precedent to prove how they’ve managed acquired companies. History shows that on a general basis inorganic growth isn’t as rosy as it sounds because:
    a. It takes a while (well, a long while) for even the mightiest of Managements to turn around the week links of any acquired entity. Tatas, Mahindras and even Infosys’s (I personally know) of the world have struggled with turning the sloths around. It takes months and even years many a time to accomplish this feet. Europe subs are three in number now (after divestment in Halonix Tech Pvt Ltd in Aug 2013 as per page 69 of 2013-14 AR) with two of them being the major contributors to the drag namely Luxlite Lamps and International Lamps. While Trifa Lamps has turned profitable last year (don’t know how sustainable that is), the other two are like Raahu and Ketu constantly beating the living lamp (= daylights and nightlights) out of Phoenix, the moon (without these subs).
    b. Getting rid of the loss-making entities is going to be next to impossible especially when getting rid of even a perceived profit making entity was such a Herculean task for Actis.

  3. The P/E isn’t 8 actually. It is nearly 11 x of FY15 earnings if you account for Raahu and Ketu projections. Refer to the attached sheet for detailed analysis on this. With Phoenix declaring Consolidated earnings only once a year and that too with very limited notes to financial statements of the subs, there’s poor visibility on their operation throughout the year (I mean QoQ). Couldn’t spot any con-calls or management interviews providing clarity on the shabby state of affairs of these laggards. Have to admit that this might improve with Suprajit at the helm

Conclusion:
I see a sub-par set of numbers coming out on the 22nd and hence find it prudent to wait for the margin of safety to up through a market reaction to the upcoming results.
Please find attached my reading of the game.

Chintan,

I firmly believe that compliments from even the whole of the ValuePickr community and beyond isn’t quite enough to properly appreciate what Ayush and Prathyush have given to the investment community through Screener.in. The ARs give you all the data you asked for.

Thankfully, I have reduced your work. You’ll get all the data you asked for and some more in the file I have enclosed.Phoenix Lamps - Consolidated Vs Standalone - 16May2015.xlsx (33.7 KB)


(Varadharajan Ragunathan) #7

Thanks Sree - these counter makes us a better investor.

  1. As for the philips story, it is true - they made an offer for Rs. 180/share, close to what actis had paid to acquire in 2006 in 2010 and I am told actis suffered from “loss aversion bias” and did’nt sell. Now philips itslef has exited this business.

  2. AS for the europe situtatiion, do have a look at http://www.phoenixlamps.co.in/pdf/update_on_financials_30_Sept_2014.pdf

Exports have grown at 37 % - remember that these subsidiaries are doing trading and hence a good chunk of it must be for the overseas subsidiaries - the only risks are :smile:

  • if that trend continued in Q3 and Q4
  • if there were pricing presssures on the eventual sae

We would never know that - I am factoring in a zero profit/loss from overseas subsidiaries in line with last year. Anything more will be a bonus

  1. Ultimately, this is a play on suprajit - they had acquired 3-4 half dead cable busineses and turned them around - look at this video. this is a real, live functioning company but I do agree scale of effort required is higher -

I will watch Q2 to see how this pans out and a little more commentary from suprajit on how they will ramp up.

Given the dividend yield - 5 % and rock bottom price, I do not see this going down further. It should hover around Rs. 100 - unless results are really bad.


(Sreeselva Veene) #8

That’s the whole point. Just the topline growth with a bleeding bottom line is a Pyrrhic victory. You win higher sales at a huge cost of setting off of profits of a profitable domestic venture and in the process make it unimpressive at the overall level.
This I don’t think can be rectified in a few days or even months. The best and quick (if possible that is :-)) solution is to get rid of these subs and take a one-time hit like they did with Halonix Tech Pvt Ltd (was also a subsidiary).

One more glaring thing that I missed was: While Trifa and Luxlite haven’t failed to deliver losses ( :smile: ) consistently (-11.88 crores in FY 14 and -8.18 crores the year before that), they’ve (PJ and FK - refer to pages 90 an 91 of 2013-14 AR) been very prompt in taking a combined payout of around Rs.3.43 Cr last year and I’m sure it would only have been a shade lower the year before. Couldn’t find the payout for for the International Lamps guy but I’m sure he would also be drawing somewhere close to 1cr per annum at least.

So, that’s a whopping 4.5 cr (min) thrown at these 3 guys YoY who are running their ventures (even if it’s just trading) at a combined (Trifa turned profitable last year) loss of 12.42 cr !!!. Not sure what the three musketeers are actually doing to make the situation better coz there’s improvement there at all. I always thought the best of Managements generally took a hit on their pockets if their entity didn’t fare well. Meaning they should be more of shareholders/owners and less of employees who keep getting fixed salary regardless of the performance of the organization. As an aside, this is why I think Capital First MIGHT do well (no comparison with Phoenix’s business of course).

Also, we cannot look at dividend payment of last year alone in isolation. The yield looks bigger only because of their slump sale of the General Lighting division. The average yield over the last 10 years is around 2.4% (which isn’t bad as well). Also, they didn’t pay any dividend for 4 continuous before last year (2010 - 2013 with both years inclusive).

So, net net, Suprajit has a very tough job on it’s hands over the next few months and in the process I firmly believe the prices can drift much lower than what you mentioned above. Technically it seems to have a decent support at 85.8 and that seems to be just about the right levels to enter. If you actually look at it, Suprajit also bought at around Rs.89 and I’m sure there’s a fair amount of thinking behind their action.


(Varadharajan Ragunathan) #9

Sree

I see that as an opportunity - I think suprajit would not let them get away with this fattening of purses - even if these are liquidated, these would release a lot of cash to the system.

Ultimately, I am backing suprajit’s capital allocation skills and I have reason enough to believe they are better than average.

If it corrects to Rs 85 or so, I will add a little more.

Also, see slide no. 17 of this presentation on their website dated 23 /6/2014 - they are at 5 % EBITDA in their subsidiaries - I think the loss may have been in FY 14 for the full year because of the legacy costs in the CFL business for the first six months -before they sold it in sept’13.

I think things are not as bad as they seem like once you peel out the legacy issues.


(rohan shah) #11

Hi All,

Prima facie this seems attractive given the valuation differential between PHL and competitors/Suprajit.

However the following questions come to my mind. Would appreciate your views on the same and how we might resolve them.

  1. Are the market shares really as high as PHL claims? If so, why is Lumax Industries at INR 1,000 Cr topline - are they simply stronger in the aftermarket/export segment?

  2. Apart from Lumax/Osram/Erstwhile Philipps Lighting, who are their competitors in India and globally? How does PHL’s product differ in quality/pricing? What % of total costs

  3. What is the magnitude of threat from LED? Trifa and Luxlite appear to have some LED products - are these inferior to those of Philips/others? Are they behind the curve in this segment? What is the price differential between LED/Halogen lamps and how could this segment evolve in the future?

  4. What is Suprajit bringing to the table here? PHL appears to have been decently managed by Actis (ignoring the General lighting foray) - will Suprajit be able to significantly increase asset turns from approx 2x and Ebitda margins going forward? Will Suprajit facilitate cross selling of lamps to its international cables clientele? There may be significant overlap already with PHLs existing export clients.

  5. Why did Actis exit what appears to be an intrinsically solid asset at such a steep haircut and after taking the positive step of spinning off the general lighting division? Was their fund life coming to an end? Why did they sell in the open market prior to the acquisition by Suprajit? Will they hold on to 10% if Suprajit’s open offer is fully accepted?

These are the questions that occur to me at the moment, will work to understand further and would appreciate your inputs as well.


(Varadharajan Ragunathan) #12

@rohansh

I suggest you listen to the conference call by suprajit on research bytes. It will clear all of this.

Phoenix makes lamps - companies like lumax make the lamp dome. So, phoenix sells to lumax/OEM.

From the scuttlebutt, I did actis has been tryign to sell this and did a big mistake by getting into CFL’s which resulted in loss of focus on automotive lamps - for eg., in chennai, no one from HQ has visited the market for the last three years - no dealer promos/marketing/branding have been done

Actis had to exit because of time compulsions - 9 years post investment. They tried to sell down their stake as they struggled to find a buyer. Interestingly enough, the question on everyone’s lips is how suprajit managed to get a debt free, high ROCE asset at such a low price. It only validates the factor that suprajit is a value conscious buyer. I think they will sell 10% and get out as the open offer is unlikely to go through.

Surprisingly, enough there are no other lamp manufacturers above the size of Rs. 50 cr. in India. Lots is imported from china but OEM’s prefer a made in india brand for quality reasons.

cap util is 75% - so any uptick in it with a 40 % gross margin wll lead to huge expansion in EBITDA. Also, europe is badly managed at 5 % EBITDA - it can be juiced out to get to double digits as per my analysis

I see little downside here given the open offer at Rs. 100/share and a 2-3 x upside.


(rohan shah) #13

@varadharajanr Thanks for your inputs. That was a good conf call.

I am trying to reach the others in their ecosystem (Lumax, Fiem Autolite, etc and also distributors/dealers) to further validate Halonix vs Osram/Philips.

Key downside risk could be further bleeding in the short/medium term by the European subs, but otherwise can’t find anything else amiss here.


(Saket) #14

Hi All,
Here are the numbers of the Auto Lamps and General Lighting business.
It is interesting to see that the company’s Auto Lamps division gives a Margin of 20%+ (as from the Segment information). But the numbers have been volatile and in the current year dropped to 16%.

Is there any reason for such good margins?


(Varadharajan Ragunathan) #15

It’s simple - typically players in consolidated markets (where there are few players) enjoy good margins since there is no need for a price war.

If anything, simple reversion to mean would allow for this to earn above 20 % + EBITDA margin - also, given that this is an aftermarket business, it is far less cyclical than an OEM linked business - as the business is dependent on stock of vehicles in the market, not on the flow.


(PP) #16

Simple reversion to mean, whatever that means :smile:

If everything reverted to the mean - then there would be no outperformers and under-performers…

Using such voodoo logic is the best way to lose money


(rohan shah) #17

One practical concern I am not able to reassure myself on: Suprajit has disappointed PHL shareholders with an unexpectedly low INR 100/share offer. There is no clarity as to whether the new parent now plans to merge PHL into itself or allow it to operate as a standalone entity. If the former, then based on the experience with the open offer, what is the likelihood that swap ratio will also not be predicated on a depressed valuation of PHL? While valuations appear attractive when juxtaposed with the superior operating/financial metrics, what will catalyse these towards market levels?

Also, the company appears to be a Tier II supplier to OEMs, through light fixture makers such as Lumax. Are Lumax, Fiem, etc obligated to buy from PHL? What is the % discount of PHL products to Osram/Philips who are said to import lamps?


(Rohit Balakrishnan) #18

@rohansh I believe there is a discount of ~ 30% between Phoenix and others who import it. Phoenix is cheaper


(tyrion lannister) #19

Why suprajit would pay more than 100 rs ( price decided by sebi formula ) when he is getting more than 50% stake ( majority stake) from old promoter itself @89… i dont see any practical concern in that…Merger may be negative for PHL shareholder if it happens immediate. good if suprajit first take company to some good height


(Varadharajan Ragunathan) #20

@rohansh

I find your argument not credible - why should suprajit care about PHL shareholders right now when the majority shareholder was a counterparty in the negotiation. Infact, quite the contrary - it’s a great squeeze of phoenix shareholders - it’s like buying a bond that gives you 8 % FCF. the fact that suprajit bought this cheap is what gives me hope that downside is little.

Said all of this, there is a big risk that the merger, when done after 3-4 years could be at an unfavourable ratio. I am hoping that good sense exists within suprajit management - who otherwise have an impeccable track record.


(rohan shah) #21

@varadharajanr I didn’t say that Suprajit should have offered a large premium to minority shareholders, but as you pointed out, there seems to be no guarantee that they will do anything to reflate the multiple. A high earnings yield is very attractive in theory but what is the point if shareholders aren’t likely to see any of this in their hands? The dividend payout history of PHL has been patchy and Suprajit’s own payout has ranged between 15-20%.Also, Suprajit’s P/E multiple is much higher - if Ajith Rai is truly an “outsider” he is quite likely to use his own paper and merge the two at some point. In short, we are at the mercy of Suprajit’s management.