Cost of debt (interest expense / average debt) for this company is trending up and is currently at 12%. Do you factor this in valuation of the company? If I use bond yield + risk premium approach to determine discount rate in a DCF model, I can’t use a discount rate lower than 14% as cost of debt is 12%. At this discount rate, I am getting a valuation of Rs 800 per share even if I use optimistic growth numbers.
Using CAPM, if I use a equity risk premium of 5%, beta of 1.3 and risk free rate of 7% I am getting a discount rate of 13.5%.Since ERP is only an estimate, I don’t have a lot of confidence in this calculation. Market is discounting other similar companies at 12-13% with lower level of debt so I am inclined to discount APL at no less than 14%. My experience with leveraged companies is bad and often ends being a value trap.
How have you calculated discount rate for this company?
WACC as per my model works out to 13.8 - 14% so I guess we aren’t far off
The bigger determinants would then be -
- Are you considering a sufficiently long time horizon for the DCF? I generally go with a 7-8 year model since my investment horizon is 4-5 years
- Are you expecting the margin profile and return ratios to get better over the period? That can make a big difference for a low margin business like this one
- Limitation of DCF will be that if you plug in capex numbers of 200 Cr for this FY and 150 Cr each for the next 2 years, FCF will be minimal for the first 2 years and the enterprise value will look less impressive than is
- What does the implied growth over the next 4-5 years work out to going by your model?
I generally have a DCF mindset to guess what is being discounted in the CMP, my buy decision however would not be based purely on the DCF model and I would triangulate from OCF yield, P/E etc. This may not be an FCF positive company in the next 2 years but I believe that is the best approach for the business.
If the growth visibility of 20% in the medium term weren’t there this would not be a buy at CMP. My sense is that the implied growth in the CMP is closer to 15% assuming EBITDA hovers around 7.8 - 8% and the PAT % gets incrementally better from here every year. The company should be able to run those numbers over the medium term, even if half of what the latest investor presentation projects come true this should do very well.
All comes down to the margin of safety you are comfortable with, this right now is decently valued but not expensive is what I would say.
I too haven’t been a big fan of leverage but debt is a small price to pay for accelerated increase in market share, I see clear indications that the management will not load up on debt and will continue to manage leverage prudently.
Note - My avg buy price is around 350 so the margin of safety looks very differently from my point of view. If I did not have a position already in I would start buying but not rush in too much in one go
A do use a DCF model but I generally use DDM rather than a FCF model. For leveraged companies a FCFF is more appropriate than a FCFE or DDM but somehow I find it difficult to estimate FCFF when capital structure is likely to change substantially over time and company is reinvesting all its OCF.
I use a 3 stage DDM. I generate dividend estimates by estimating ROE and payout ratio such that over time ROE drops to an average for an industrial company and sustainable growth rate (ROE * (1-payout ratio)) drops to little less than GDP growth rate.
I think margins will expand but for me to justify current valuations, profits have to grow at 18% for next 10 years followed by 8% in perpetuity. This is a realistic assumption but hard to swallow. And even if everything works out as planned my expected return is my discount rate which is 14%. good but not great. The only way this investment can produce 25% + returns if earnings growth exceed my projects and/or market assigns a lower discount rate than me. Again both are real possibilities but sounds like a greater fool theory.
Does buy price really matter (except when you are calculating taxes)? To me margin of safety is difference between current price and current intrinsic value (and not my buy price). MOS may be different for different investors if they calculate intrinsic value differently but not because they purchased the business at different prices.
Spot on, from a pure margin of safety point of view buy price is irrelevant. But my ability to live with uncertainty is much higher due to the lower buy price, I am coming from a behavioral angle here. This approach has worked well for me in the past, if I believe that the business will continue to do well fair valuation wouldn’t deter me from holding or buying especially in the small cap category. From a purely rational point of view your observation is more valid.
Going by your model assuming you are happy with your due diligence - you should wait for a better price. 18% PAT growth over 10 years isn’t something I’d be willing to bet on myself if that’s what my model told me. For a business of this nature the margin of safety needs to be much higher.
Looking at this from other angles, fwd P/E of 13.5 - 14 and OCF yield in excess of 7%. Once again not expensive, more in the fair valuation zone.
At CMP one can go either way based on his investment philosophy and his preference for how he goes about builds his position in a stock.I would start nibbling given that I take 6-15 months to build my position in a stock
Absolutely agree. Currently, creditors are taking a lions share of the value created by the firm (using Porter’s five forces) by demanding 12% return. Equity holders are in a supporting role. I would love to buy their bonds at this valuation. With a 500 cr capex plan over the next 3 years, debt is unlikely to come down although proportionately it may come down as a % of equity. That will tilt the balance of power to equity holders. I wish the management held more of the company, that would have worked in equity holder’s favor.
the one factor I have not considered in my valuation is gradual drop in discount rate once the margins & ROA improve and leverage goes down. That’s a silver lining considering how the ratios are moving out.
http://www.bseindia.com/corporates/anndet_new.aspx?newsid=dc65d705-e89c-459c-8930-a0f30ff6b8ac
Good set of numbers. PAT up 60%. Volume growth is weak but margins have improved significantly.
Stock will likely be under pressure after Q2, volume slowdown needs to be watched carefully. From Q3 onward the lower base effect won’t be present, hence unless volume growth is 20%+ I don’t see how the company can show a bottom line growth of 15%+ YoY.
On all other parameters the numbers look better than expected. Bullish in the medium term but will be slightly cautious over the next 6M
i think we need to check how much of the margin improvement is because of inventory gains and how much is because of improvement in operational performance
Conference call notes:
Sales hit by Kaveri dispute. Faced slowdown in production and transportation for 15 days.
First line of Direct Forming technology to start by end this month. It will allow them to enter a higher thickness and size range. It will lead to import substitution for these products.
New plant in Raipur to be operational by Q4. It will start with one mill and capacity will be expanded to 3.25 lakh TPA by next year. This is first entry by APL into eastern region.
Getting inquiries for exports from Europe.
Focusing on new segments like solar power mounting, fire fighting and air conditioning sector.
Looking to increase share of value added products(GI/GP) from 30% to 35% This will improve margins.
Bringing new technology called inline galvanizing. Using this zinc coating can be done while pipe is being produced. This means you don’t need a separate galvanizing line. They have a contract with the supplier to not give this technology to any other player for 3 years.
Targeting increased sales to OEMs. EBITDA will be 2-3% higher in this segment. Trying to increase share from 1.5% to 10%. OEMs will have longer receivable days.
Current Debt is 540crs.
Expect 18-20% growth in H2.
Still bullish after the Q2 results, though volume growth decreasing & higher base effect kicking in from Q3 are a cause for concern. Management has explained the reasons for the same in the last earnings call. I still do not see what can upset the growth trajectory over the next 3-4 years, short term impact from the demonetization over the next 2 Q’s notwithstanding. Their investment in new technology appears interesting since they can address more segments and sizes through this. Other interesting things are the prospects from OEM’s where margins will be higher since the customers are performance & quality sensitive.
Over the next 18 months I guess we will know if lower relative debt levels & increased margins and business from newer segments are actually materializing. If the company can realize even 50% of the vision they articulated in their corporate presentation by 2020, this should be a very interesting story.
great detailed report.
Also if anybody can share the summary of the recent concall on demonetization effect on the company would be nice.
Thank You
APL Apollo recieves patent for 4 hollow section designs.
there is a huge variation in the cash flows over the past 4 yrs.
APL Apollo tubes’s promoters acquired the AMULYA LEASING…any one having updates about this??
Given how HRC prices have moved, Q3 and Q4 might end up being better than what I expected. We’ll have to see how much effect demonetization has had on the vol growth
We’ll anyway know by this Saturday once Q3 results are out. Very interestingly poised this one
Q3 Conference Call Notes:
Demonitisation and volatility in steel prices have impacted volumes. Volume growth is 8%.
Trade sales grew by 4%. Higher OEM and export sales aided volumes.
Last year OEM + exports contributed 6% of the overall sales, this year it contributes 10%. The target from OEM and exports is 25% of overall business by FY18.
Commissioning of Direct Forming Technology lines to start by Feb-March.By end of FY18 all lines will be commissioned.
Plan to do a major marketing initiative and launch APL Apollo brand in the national market.
Raipur plant to be commissioned by March end. It is strategically located. It is closer to the raw material and will help to reduce logistic costs.
Capacity will go from 13 lac tons to 20 lac tons by FY18.
Expect recovery in volumes in Q4 and 20% growth in FY18.
Q&A:
Reasons for lower Ebitda margins?
Ebitda per ton has improved from 3200 to 3300 but it is lower as a percentage due to increase in steel prices. Ebitda margins will remain in the range of 3200-3500 per ton.
Revenue from DFT lines at full capacity?
Adding 6 lac tons of capacity which will contribute 2000cr of revenue at full capacity. DFT tubes are readily excepted in export market. Export market will open up with this technology.Domestic market will need to be educated about this tech and can take some time.
Capex Plan?
Currently spending 200 cr and next year spending 100 cr. .
Debt level?
Long term- 200cr , short term - 460cr. Dont expect debt levels to increase will fund capex by internal accruals.
Benefit of new technology Inline Galvanising ?
Life of pipe goes up. There is no white rust. Galvanising cost goes down 30-40%. Bringing in only nominal capacity of 30000 tons for specific applications.
Pipes application in CVs.?
Pipes can be used in bus body building. It will replace wood and aluminium. Now supplying to Tata and Ashok Leyland. Opportunity is large in this segment and is largely untapped.
Competition like surya roshni expanding capacity. Comment on competitive advantage?
Competition has intensified but new technology and product range will insulate us. Competition has intensified in traditional ERW pipes but not in value added products.
what could be the reason…can anybody enlighten
Friends
The promoter sold Rs 3 Lakh shares on 27th Feb 17 and another 7.5 lakh shares yesterday the 23rd March for a total value of about Rs 120 Cr. Just a message to all friends to be watchful…
Disc: Not invested…no plans to invest…
source ? its not there in the announcements