Vardhman Acrylics - A hopelessly undervalued stock


(Hrishikesh Kale) #1

Hi,

Found this unpolished undiscovered gem. Here are some salient points to start the discussion.

1). Sales growing at around 15 percent per annum on an average in the last 5 years.

2). EBIDTA margins at 15 percent.

3). Debt free.

4). ROCE is 14.5 percent and has increased substantially from the last financial year 9.4 percent

5). Cash and investment comes to 123 crores or Rs. 13.21 per share half of the market price. So entire business available at just Rs. 14 per share.

6). Great half yearly performance and has grown at 14 percentage points.

7). Has need no working capital. Incremental working capital is actually reducing for the last 3 years throwing out more cash.

8). Minimal capex required on an average just 1 crores per year

9). Turnover is nearing 500 crores.

10). All of this at a PE of 5.75 yes 5.75

11). Using simple DCF of the free cash flows the value comes to around 80 assuming it grows at 15 percent and maintains its EBIDTA. So 3x potential for growth.

12). Sitting on a huge cash pile no dividends declared at all.

Is there something more to this share that I am not aware of. In a bull market this seems too good to be true.


(Sreekanth) #2

Hi Hrishikesh

No doubt the numbers look amazing but have you analyzed their business? They are part of the Vardhaman Group with parent Vardhaman Textiles holding more than 70 per cent in this company.

1.Being a manufacturer of Acryclic fibres, the company would be exposed to price fluctuations both on the input as well as output side.

2). Secondly demand for acryclic fibres are sesonal in nature and also faces intense competition from Chinese players so could you explain how this company mitigates them?

3). This industry has also seen players having huge risk appetities for capital investments for frequent capcity expansions… has the numbers captured it?

4.Are the profits sustainable given the fact that there is huge currency and material price risks for the company?

Regards

Sreekanth


(Hrishikesh Kale) #3

Hi Shreekanth,

1). I have analyzed the EBIDTA margins for the last 5 years.

25.35%17.04%12.03%10.87%15.18%

So it averages in the range of 11-15 percentage

2). About your comment on capital investments I do not see that reflecting in the figures

Since 2010 they have doubled their turnover from 270 crores to 470 crores with no additional capex. Here is the additional capex figures on a year by year basis. So the turnover has doubled with just around 4.2 crores additional capex.

3). Sales growth has infact picked up. Here is the growth rate figures for the last 4 years

47.25%-2.07%11.88%7.33%

For H1 sales have grown at a reasonable rate of 14 percent though EBIDTA margins have reduced from 15.18 percent last year to 11.44 percent this year.

4). The figures does not support your comment on seasonality of business. I checked the last 5 quarterly results Here are the sales figures

132.28 132.71 117.96 127.45 117.64

So it looks pretty stable with no wide fluctuations.

About the chinese competition need to do more research on this.


(Hrishikesh Kale) #4
[quote="hrishikesh, post:3, topic:710292844"] for the last 5 [/quote]

A few corrections.

1. In H1 the sales have grown by 10 percent.

2. Capex figures years are in crores. To double sales (200 crores) with an additional capex of less than 5 crores. This looks amazing.
(1.47) (1.33) (0.94) (0.52)


(Hrishikesh Kale) #5
[quote="hrishikesh, post:4, topic:710292844"] for the last 5 [/quote]

And here is the material cost as a percentage of sales years65.67 77.8 79.4 78.09 77.07 So though there is some fluctuation it is within a band of =- 2 percentage






(Shan) #6

I don’t know this specific company, but other things to consider are: when and how much capex will be required next? This is textile business, if the company doesn’t spend on capex, it’s sitting on a time bomb. Will capex lead to impcreasing revenues and profits? Buffett shutdown the textile business of Berkshire Hathaway because he realised that revenue/profit growth is not possible or sustainable because savings get passed on to customers. One way of avoiding this is if the company has strong brands that people will (over)pay for.


(Hrishikesh Kale) #7

PWe can ofcourse discuss the triggers for this stock as well as the risks in investment. But purely from a financial point of view here is my simple calculation.

I am getting Vardman Acry today at a market valuation of 263 crores. (9.30 shares and price is 28.35). Suppose I buy the whole company I will lay my hands of 200 crores of cash and investments which I will promptly put in my pocket. So now In reality i am getting a whole business at a price of 63 crores.

If you see the net profit of the company for 2014 was 43 crores. So assuming that they do not grow at all and maintain the profit in 1.5 years I would have recovered my entire investment.

Ofcourse it is a reasonable assumption that the company will not stop after 1.5 years. So all the earnings from 1.5 years onwards till the company is a working entity is completely free of cost for me.

Using simple logic if the cash earnings per share is Rs. 4.5 in that case dividing it by a long term yield of 10 percent Rs. 45 is the value of the share free of cost even if the company does not grow at all and just maintains its profits.

That is the reason I am saying that there is a 100 percent upside to this stock.


(HG) #8

Hi Hrishikesh,

No doubt, it looks inviting. Your first post said 128cr of cash and investments while your last post said 200cr of cash and investments. Which is the right figure?

-HG


(Subash Nayak) #9

When a company has such poor ROE/Growth record, the question that is needed to be asked is what has changed, which will make it a wealth creator?

Using DCF with assumed 15% perpetual growth rate is useless at best as per my understanding. Last 3 year NP growth was paltry 5%.

Compounded Sales Growth

10 Years:
11.38%
5 Years:
14.25%
3 Years:
5.55%
TTM:
9.82%

Compounded Profit Growth

10 Years:
9.30%
5 Years:
54.19%
3 Years:
5.32%
TTM:
-20.97%

Return on Equity

10 Years:
11.89%
5 Years:
15.30%
3 Years:
12.01%
Last year:
15.58%


(Hrishikesh Kale) #10

Subhash,

There is no such thing as a good horse or a bad horse there is only a mispriced horse.

1). The ROE figure is severely distorted. This is because they are sitting on 200 crores investment in bonds and mutual funds which are earning just about 10 percent return. So 2/3rd of the networth is in financial investments.

To get the actual ROE i suggest remove other income from the net profits and cash and equivalents from the net worth.

We have (43.67-20.63)/(301.08-200) = 23 percent.

2). Sales are growing at a respectable 10 - 13 percent. Not great but ok.

3). Operating margins are around 10 percent. Not great but should improve going forward due to fall in material costs.

4). Most importantly all its growth (200 crores in 5 years) has been with minimal capex (around 5 crores). Same also for working capital. This is a cash generating machine. If you read WB literature WB rates sees candy (Growing at 2 percent pa) as his best investment because all its growth is with minimal capex.

The point is subhash this is not a spectacular business. But does the price justify its value.

I mean we have worse companies with huge leverage trading at 20 PE or more. Here is a company which is a cash cow, has cash in hand of 2/3 rd of its net worth, growing at a reasonable 10 percent, with reasonable operating margins of 10 percent, with almost 75 percent promoter stake trading at a 5 PE.

It deserves atleast twice as much valuation if not more.


(Hrishikesh Kale) #11

128 crores is listed under current investments and the rest under non current investments. So it is 200 crores.

I have also verified this figure from the corporate presentation


(Subash Nayak) #12

Hrishikesh,

You are using convulated math to get an imaginary and useless ROE figure.

A management, who has 200cr in cash (2/3rd of net worth), and has invested the same in FD like investment, thereby paying tax on the interest accrued, is a terrible asset allocator. A smart guy would have done either of these (assuming no scope of reinvestment)

1). returned the same as dividend)

2). buyback share if mcap is way below book value

3). Or invest it in higher ROE business

A management who invests in FD like asset in place of these 3 can never ever be compared with See’s candy business of WB. To add to the wound, its is just at 10% odd growing, that too with not so stable margin. To expect it to quote at double valuation is a “bull market mentality wish”, devoid of much logic. In 2011-12 time frame, you would have got these type of cos at 4-5 pe at max.

Frankly speaking, forum like vp should have moderators, who should have catched such illogical “Fair value of 80” (with assumed 15% growth rate, and current margin in future, god knows from where it come). It is unfortunate that vp stopped having such a mechanism. I hope Donald/Admin take a note of these type of posts (with crazy target price type post), as it will save them from creature like SEBI.

Consider this as my last post in this thread. Brotherly advice to those who follows vp threads, please do due diligence, and dont get carried away by 15% future growth DCF calculation.


(Hrishikesh Kale) #13

Subhash,

At first I think you need to take a crash course objectivity and more importantly in being polite and down to earth.

Comment 1 :

Well many investors seems to be sharing my convulated math. Today 9 lakh shares were traded out of which 60 percentage odd were on delivery basis. Price has jumped 16 percent.

Comment 2 :

allocator

I agree with you on this.

Comment 3:

I think you are severely overestimating your investment and to add intellectual capabilities.

You may contest any of the figures but to use such a language reeks of arrogance without any objective basis. It speaks about what sort of a person you are keep aside your knowledge as an investor.

Comment :

I would request you please consider quitting this forum itself and not this thread. Especially so if you do not have the capacity to listen to contrarian opinions.


(Hrishikesh Kale) #14

Dear boarders,

Please consider this as simple math (Not convulated hahahaha).

In 2014 the owners earnings of Vardhaman Acrylics was 6.52 per share. Owners earnings is operating cash flow + other income - incremental working capital + incremental fixed assets.

Even if the company did not grow at all, Yes did not grow at all, dividing it by the long term bond yield of say 10 percent gives a price of 65 on a no growth basis.

Add to that cash per share of 21.3. This is how I came up with the target of 80.

Here i am assuming 0 growth in operating cash flows yes 0 growth.

All the figures are laid out before you and you can cross check it. Mr. Subhash Nayak and SEBI please note hahahahahah


(Kamal Das) #15

Dear Mr. Kale,

A few points:

1). Owners equity is akin to free cash flow to equity and should be discounted with Cost of Equity.

Assuming no growth, Value of Equity = Expected Free Cash Flow to Equity/Cost of Equity

You can calculate based on your view of beta and market premium. As cost of equity is higher than debt cost of 10%. This will reduce the value of equity.

2). As you are already calculating equity value you should not add back cash. You will add cash (or reduce net debt) if you calculate firm value and use free cash flow to firm.

3). I think the value of owners equity is overstated. One needs to reduce incremental fixed asset not add them.

4). Finally, lets avoid slanging matches and use this forum for a better evaluation of stock. There are reasons for optimistic valuations and there are issues for lower. Lets present both sides and help in better evaluating the stock.

If one is sure the stock will go to 80 from current value of 31, please buy; and if themarketagrees,one’ll have a multibagger and can laugh all the way to the bank. For now lets just discuss both sides of the calculation and get a better view of the stock.

Merry xmas everyone!

Disc: have not looked at stock. A friend recommended it but as it is not listed in NSE, I did not spend time reading about it (I do not invest in only BSE listed stocks).


(Pranav Singh) #16

Hi Kamal,

Could you share the reason of not investing in stocks that trade only on BSE?

Happy Xmas!


(Hrishikesh Kale) #17

Hi Mr. Kamal,

1). As per the definition of owners earning as illustrated by Warren Buffett it is

EBIDTA+Depreciation and non cash charges -incremental working capital - incremental maintainence capital costs.

Owners earnings is different from free cash flows in how they define incremental capital expenditure.

http://www.quora.com/Warren-Buffett/What-is-the-difference-between-Owner-Earnings-and-Free-Cash-Flow.

In our case because incremental capex is so low it hardly makes much of a difference.

2). The Owners earnings needs to be discounted by the long term bond yield.

Refer the book The Warren buffett way Page 127. I will not to discuss the merits of using this parameter. It is discussed in detail in the book. Therein detailed workings are given for Coca cola and Gillette. You may refer that.

3). Incremental maintainence capex for a year is equal to Gross block (x) - Gross block (x-1) - adjustments. I use differnce in gross blocks and make adjustments to align it with maintainence capex.

4). I calculate incremental working capital as

[Current assets (-cash) - current liabilities] (x) -

[Current assets (-cash) - current liabilities] (x-1)

5). About the slanging match, i detest somebody thrashing an analysis without knowing the facts.Intellectual arrogance and ego are the value investors worst traits. You may contest the methodology or the assumptions but never use demeaning language and run down anybody.

I am not a market predictor. I am only trying to value the share. So reference to price in my earlier share is a typo.

All i am saying is this stock is undervalued by a huge margin. Whether it is a fantastic business or not is not the subject matter of the discussion.


(Hrishikesh Kale) #18

Hi Kamal,

Just to add as you have rightly pointed out there is a typo in my earlier post and I quote:

In 2014 the owners earnings of Vardhaman Acrylics was 6.52 per share.

operating cash flow + other income - incremental working capital + incremental fixed assets.

Instead of adding incremental fixed assets it should be read as deducting incremental maintainence fixed assets.Above is a typo but the calculations are right.

The figures for FY 2014 are

Operating cash flow (Operating profits + depreciation) = 23.04 + 11.37 = 34.41 crores

Other income = 20.63 crores

Incremental maintainence capex = 0.52 crores

Incremental working capital = -6.16 * Working capital position has improved releasing more cash. In this calculation i am excluding cash from current assets calculations

So it is 34.41+20.63-0.53+6.16 = 60.68 crores.That translates to Rs. 6.62 per share.Dividing it with yield of 10 percent gives a no growth valuation of Rs. 66.2 per share

I will deduct a margin of safety of Rs. 6 per share as working capital might not throw out cash every year and also to factor in further capex is required.

So 6/.10 gives a Rs. 60 per share valuation of the the future owner earnings on a no growth basis.

I add the cash per share of Rs. 21 per share to come at the Rs. 80 per share valuation.

Now I am being completely objective and transparent in my assumptions and methodology of valuations. Whether you agree to the assumptions or methodology is a different issue and you are free to contradict them.

Now you will realize why i lost my cool on the demeaning language used by the particular boarder.


(Hrishikesh Kale) #19

For your info Vardhman is listed only on NSE and is not listed on BSE.


(ricky76) #20

Few thoughts from me:

1). The company is in a commodity industry but has been mostly making good profits since listing across different types of challenging economic environment. This shows that it has the ability to handle fluctuating RM prices, Chinese competition, temporary dips in demand etc.

2). The secret of this business seems to be very low capex requirments, asset turnover is close to 6X ( part of this may be attributed to trading of Acrylic fibers). Not clear how it is able to manage this, I was under the impression that textiles is a capex intensive industry, could not find out the capacity utilization numbers nor the volume and price mix for the sales numbers.

3). Holding cash and not wanting to increase capex means that it can constantly raise prices to increase sales. A bit hard to believe.

4). Not paying dividends despite high cash balances is a BIG NEGATIVE and a key reason the the business is trading at relatively low multiples in my view. Is the cash real?

5). Valuing the business based on cash holdings and other DCF is a pointless academic exercise for a cyclical commodity business.

6). Prima facie I would not say the business is under valued, one cannot value such businesses on last years earnings. What if earnings get back to 2006, 2008 or 2009 levels? Why should say 2017 PAT be much better than 2014?

7). Practically speaking all this can get ignored in a bull market where the market will pounce on anything that looks superficially good.

Bobby