Gandhi Special Tubes (GandhiTube)

Stock Opportunities
1

I have posted an analysis on Gandhi Special Tubes on my blog -

http://kiraninvestsandlearns.wordpress.com/2011/01/04/stock-analysis-gandhi-special-tubes-gandhitube/

Your comments are welcome.

Gandhi Special Tubes manufactures and sells automobile components, primarily in India. It offers a range of small and big diameter seamless and welded tubes along with tubular components, such as condensers, compressor parts, fuel injection tube assemblies, and hydraulic tubes. It was incorporated in 1985 and set up its first plant at Halol, Gujarat in technical collaboration with German manufacturer Benteler. Benteler have supplied most of the critical machines and were involved in installation and commissioning of the plant and training personnel in India as well as Germany.

GSTL produces special tubes of small diameter ranging from 3mm to 75mm. These special tubes are used across automobile, refrigeration and engineering industries. GSTL have also started manufacturing cold formed tube nuts for Fuel Injection Tube Assemblies as well as Hydraulic Tube Assemblies. This is a pioneering effort in India as previously tube nuts were being manufactured by machining. GSTL currently derives 80% of its revenues from the automobile sector and the rest from refrigeration and engineering.Apart from its manufacturing business the company also has five windmills with a total installed capacity of 5.35 MW, providing part of the companyas energy supply. The three windmills located in Gujarat are for captive consumption whereas the two in Maharashtra are for commercial purposes. Gandhi Special Tubes Limited also exports its products to customers in Germany, the United Kingdom, and the south east Asian countries.

Company is debt free and has invested surplus cash in capacity expansion & wind mills for captive power consumption. It has a marquee list of clients which include L&T, Maruti Udyog, Ashok Leyland, M&M, BEML, Voltas, Electrolux and Kirloskar among many others.

Financials:

CMP: Rs. 123.55

Market Cap: 181.62 Cr

Face Value: Rs. 5

Promoteras Shareholding: 73%

Book Value: Rs. 69

P/E: 6.95

P/B: 1.77

One of Walter Schloss criteria -> Promoteras Shareholding > 50% is satisfied.

Looking at the basic financial ratios a

Variable Current Industry Median

Net Profit Margin 33.56 1.84

Operating Profit Margin 41.34 5.93

Asset Turnover 0.74 1.52

Return on Assets 24.95 3.15

Return on Equity 24.95 7.94

Debt to Equity 0.00 0.96

Return on CE 35.90 9.73

Interest Coverage 728.80 1.70

Just on basis of ratios, we can derive that -

Superior ROCE, Superior RoE, No debt, Terrific interest coverage coupled with reasonable P/E and P/B make it an attractive stock to be in.

Letas look at the history of managementas performance, rather than a single snapshot (just to ensure we are not under the influence of some accounting shenanigans or one time fad market).

Variable FY06 FY07 FY08 FY09 FY10

Net Profit Margin 29.75 21.41 24.74 28.36 33.56

Operating Profit Margin 35.69 35.53 37.80 38.84 41.34

Return on Assets 32.14 21.64 25.56 18.73 24.95

Return on Equity 32.88 21.96 25.76 18.79 24.95

Capital Employed 50.22 59.46 73.72 85.07 101.51

Return on CE 36.92 32.64 36.54 27.35 35.90

Free Cash Flow to Sales - 3.09 3.15 31.31 27.44

Dividend Payout 18.22 22.84 19.48 23.10 29.02

Based on the above table, we can derive that

)- GSTL has consistently maintained high NPMs and OPMs over the past 5 years (signifying moat)

)- GSTL has had superior return ratios all throughout for the past 5 years (in fact, I checked the results from FY2002 and the results donat differ much)

)- The cream, would be a very good dividend payout, consistently increasing year on year. Current dividend yield is 4%.

)- Margin of safety: It has cash of almost Rs. 24 per share. Thatas almost 20% of the current share price.

Apart from all these ratios and parameters, on an absolute basis a

  1. The Book value for GSTL has increased at a CAGR of 20% over the past 5 years. (adjusting for stock split 1:2 in 2008 )

  2. The Net Sales have had a CAGR of 11% and PAT has had a CAGR of 20% over the past 5 years.

All the above factors indicate that the business has a moat, a capable management which can deliver results on a consistent basis (atleast, for the past 8 years that I have read the results) and has paid dividends consistently which gives us a margin of safety.

Negatives:

  1. The cost of Raw materials is more than 30% of the total cost incurred. Any increase in the prices of raw materials (steel, for example) would put pressure on margins.

  2. The cost of power also eats into profit. However, the captive power consumption should reduce power costs to a large extent in the coming quarters.

  3. Sales have been stagnant for the past 2 years.

  4. Illiquid stock. Garnering even 400 shares would be slightly challenging.

  5. Foray into commercial power generation from Maharashtra windmills is still something I am getting my head around with. Is this diworsefication or a temporary arrangement before they consumer the entire power captively?

Triggers:

  1. The consumer story is in a stage of rapid growth in India. GSTL is well placed to supply tubes to various consumer durable companies.

  2. With the foray into the Engineering segment, sales might increase in the near future.

Recommendation:

GSTL is a virtual monopoly in this industry segment, consistently generating high ROCE and Free cash flow. Its dividend yield of 4% along with the safety of Rs. 24/share cash makes it an attractive stock. I would term GSTL to be a value buy at these levels (and probably accumulate more on declines). The stock is undervalued to say the least and will give good returns if it keeps up with the performance of previous years.

_Disclosure:_I have initiated a small position in the stock.

2 Likes
2

Hi Kiran,

Nice Analysis, i also have been tracking this company since some time but have never really dug deep. Its a classic value stock that generally stays a value pick in most market conditions. Even though the stock is not too far off from its life time highs, its definitely cheap. this looks more like a steady compounder to me unless some kind off rerating happens. Here are a few observations:

First of all i would advise you too look at 10 year numbers rather than 5 years to capture the cycle. if you do that i think you will observe that the topline hasn’t grown at an average rate of 12% while bottomline has done better at 19%. So while the Margins & ROE have been excellent, the company hasn’t really scaled up fast which might be the reason for the low PE multiple.

I am not sure the company has a moat because it fairly attractive sector(don’t know where you got those industry figures from) and it has achieved these returns on a smaller base(which is much easier). Have you looked into the industry to ascertain whether its

or not?? How concentrated is their customer base? These are some question sthat need to be answered.

I wouldn’t read much into the windmill business as its something many companies do these days to save tax. Definitely a good company that is worthy of further scrutiny.

Discl: i have a stock

3

Its remarkable how this stock has managed to withstand the correction in the smallcap & midcap space & stayed in a tight range of 120-125 most of the time. It might be due to the low liquidity , but it also means that the stockowners don’t want to sell it(reminds me of IMPAL) . I have been slowly trying to build a position over the last couple of months. With the board announcing an almost 4% yield dividend with record date on 4th Feb it could push the stock up, could be a good time to enter the stock.

4

Gandhi Special Tubes seems special indeed. I found the time to look into this company in some detail, and came away impressed - though I would like some questions answered.

Gandhi Special Tubes stock story updated.

Especially Kiran & Sid, thanks for bringing this stock into my watchlist. If you guys have been following this stock, please help in taking the discussion forward. Look at the updated stock story, some new points may have emerged.

Some of my top of mind questions:

1). Why is this company faltering on the sales front?

2). One would expect GSTL has enough cost advantages/efficiencies, Export Sales should have figured prominently by now with the company leveraging some global relationships of the OEMS supplied locally

3). OPM over 50%? What are the factors contributing to this situation? Will this be sustainable, why?

4). Working Capital -debtors and inventories have jumped up from levels 2 years back. What are the reasons?

5). What will it take to increase capacity by 50%? what kind of Capex will be required/ does the company have the land, buildings?

We are trying to get some questions answered from Gandhi Special Tubes Management. I have got started in framing the questions. Please add and help in compiling a comprehensive set of questions -and take our digging into this promising company (?) to the next level.

-Donald

2 Likes
5

Gandhi speciality remains a value stock with good dividend yield.

But the question that needs to be answered is from where will the growth come? Unless it shows good topline growth, it will not attract too much interest of market participants.

Dividend yield will offer downside protection as it does in jenburkt etc.

**
**

6

Interesting on first look. But what’s the trigger that would make it expensive in near future:

)- Marked by lowtopline growth (no point comparing with FY09 which was extraordinary rather than the other way round). My guess is it would struggle to post 25% growth both in topline& bottomline this year.

)- Low asset turnover.

)- Gross block has moved from Rs 55 cr in FY06 to Rs 87 cr in FY10 and sales from Rs 64 cr to Rs 84 cr in same period. What do you do with such a company.

)- Rising commodity prices would strain the margin since it can’t pass on the hikes to OEMs.

)- NPM of 30% is a surprise, will need to investigate more. Who are the competitors and what distinguishes this company. Is chinese imports a threat (doesn’t seem so).

)- Slowdown in auto sector growth will impact its fortunes. Howmuch does refrigeration contributeinitssales?

)- Zero debt, FCF are plus.

)- There is no valuation gap from its industry PE.

)- I hopedividend yield was not a filter criteria for its screening because Rs 2.50 out of Rs 5 it did last year was a special dividend.

In this space of automotive small caps, i feel Suprajit was a better pick.

7

**

We should note there was a special silver jubilee dividend declared in FY10 (equal to Rs.2.50 interim dividend) which is the reason dividend yield shows up high over 4%. sustainable nwill be more like 2% - that’s unlikely to offer much protection.

Gandhi

** yield.But **

** participants.Dividend **

etc.

**
**

**

8

Its a good stock and co but concerns remain on the growth side.

Though the margins look good but the problem I see is - its a highly capitalintensivebusiness. So it would be more important to look at ratios like Return on Assets and ROCE.

Regards,

Ayush

9

Questions for Gandhi Special Tubes Management

1). Gandhi Special Tubes has carved out a special niche for itself in the small diameter welded and cold drawn seamless tubes. What is especially noticeable is the steady operating margin expansions to over 40-50% levels that is being maintained. This is an extraordinary achievement coupled with the clean debt free balance sheet.

Congratulations! Kindly share with us the factors that have contributed to this performance. Appreciate if you can share the kind of market share the company enjoys in the 3 market/product segments, and their respective margin contributions. On both fronts â Is it sustainable, and why?

2). Seamless Tubes, Cold Formed Nuts segments â are probably 100% import substitute products.

Looks like there is a deliberate focus of the company towards complex technology, high precision products and making a complete sweep of import substitution â probably with a high degree of automation involved - enabling the kind of margins above. Kindly share the business & product philosophy followed.

3). Given the dominant market share and the relationships it enjoys with major OEMs, one would expect the company to leverage and penetrate these relationships deeper. With most global OEMs now having a base in India, the company should by now have a much wider customer base.

Kindly explain the companyâs thinking and efforts on this front for a bagging share of the global market in its niche segments. When will we see a revival in export focus from the company?

4). New product introductions

The 3 product segments have been contributing to revenues for the last several years together. Seamless Tubes share of revenue contribution has seen the most growth. No new products have been introduced. Are there new product launches in the anvil, or this situation is likely to continue?

5). Top Customers âCurrent business & potential mapping/penetration

Kindly share some details on your top customers. How much business does your top 3 customers contribute. Is there any customer contributing more than 10% of Sales? Kindly give us a sense of the potential from such marquee customers if say you could service them a) across most platforms (e.g. commercial, SUV, passenger) b) bag a sizeable chunk of global business

6). Benteler âRelationship

Kindly share the kind of relationship enjoyed with Benteler who provided the initial technology impetus, process knowhow and raw material sourcing. Where is this relationship today? Is it a source of competitive advantage for the company? Why has the relationship not progressed to say a full-fledged JV that can leverage mutual strengths â global relationships/sourcing and Gandhi Specialâs strengths on productivity, cost efficiency, automation, etc.

7). Sales growth not keeping pace with core business Capex additions.

In 5 yrs from FY06 to FY10, Net Sales has increased by ~21 Cr. However in the same period capex spend on core business (taking out windmill capex of 11.52 Cr in FY06 and 6.29 Cr in FY08) is ~31 Cr.

Also Asset Turnover in the last 2 years has fallen much below 1. Kindly explain the circumstances leading to this and the Managementâs plan to improve on this situation.

8). Long term Sales CAGR is ~13%

Although investors are pretty happy with the earnings quality, the performance on the growth front is worrisome. What are the main reasons for this sluggish performance from a dominant market leader? Please comment on the following scenario plays that are being theorized by analysts in the market.

a) Overall market size is small for the niches you operate in. Having cornered a very dominant market share (some reports mention over 85% share), there is little scope for big ticket growth

b) Unless you find a way to crack open export markets through leveraging relationships with global OEMS, this situation is likely to persist

9). Free Cash Flows. Sustainability. Inorganic growth considerations?

Free Cash flows as a percentage of Sales has climbed to over 25% in FY10. What is the outlook on the next 2-3 years. Is this likely to be maintained? How is the company geared to cope, if there is sudden spurt in demand. Are there enough latent capacities/de-bottlenecking possible to cater to say double the long term growth rate (~13%)in the next 2-3 years. As per the current outlook and plans, when will the company have to incur major capex again.

Is there any thinking in the company on acquiring specialty niche companies in related domains, and growing through the inorganic route.

10). Recent Financial performance â operating margins are contracting. Not much correlation with raw material cost situation.

Going by 9m FY11 performance, GSTL has recorded an 18% increase in Sales coupled with a modest 2% rise in Earnings. This is on the back of higher raw material and other expenditure costs. Operating margins are likely to fall in the 45-46% range from the 50% levels in FY10.

Kindly explain the reasons for margin contractions over the last year, and what is a normalized level that we can come to expect.

11). High Management Compensation - For a company of its size (<100 Crs) GSTL Senior Management is taking in over 15% of the Net Profits of the company. (3.77 Cr, 25Cr in FY10, 2.49 Cr, 15 Cr in FY09).

No doubt, the Management has driven the high performance and great margins for the company, but this level of compensation seems high especially on peer comparison with companies of similar sizes that have registered much better growths. Please comment.

12). Raw material volatility - While raw materials constitute ~30% of Sales, it must be noted that over 50% of the raw material is imported (FY10) and exposes the company to forex volatility risks on top of raw material risks. Exports are minimal.

How is the company managing on this front? Does the company resort to hedging? What are the terms from Benteler for raw material sourcing? What kind of credit terms does Benteler offer Gandhi Special Tubes? Is that also a source of competitive advantage?

13). Broad Plans and vision for the company

Kindly share the major opportunities before the company, and the challenges ahead. How it is gearing up to meet these challenges? When will we see Gandhi Special Tubes crossing Rs. 500 Cr in sales?

1 Like
10

We are trying to get these questions answered from Gandhi Special Tubes Management. Those tracking/having an interest in GSTL, please add to these questions.

Siddharth, Kiran, YSB?

-Donald

11

Hi Donald,

Sorry for the inaction, as i informed you, been busy, even working on weekends. I think this is a fairly exhaustive question set capturing the key issues. Only thing i would like to add(probably exists in the set as a part of some question) is how do they plan to utilize the cash reserves of about 33crs?? THey are debt free & have good FCF generation. DO they have any plans to go in for aggressive expansion or diversification as they can easily do with some debt & use up the cash reserves. This is key in my opinion as it seems that the sector is somehow saturated or they are being too conservative.

12

)- Marked by lowtopline topline&

)-

)-

)-

)-

)-

Howmuch does refrigeration contributeinitssales?-

)-

)- I hopedividend

Very nice counter analysis…I feel these analysis are more important to get the overall view… Your Mental models are working i feel :wink:

13

Donald,

Sorry fro forgetting about this,but If i recollect, you met the Management didn’t you? Didn’t find any updates from your side. Did the meet happen?? Meanwhile the stock has bounced back i guess

.

14

Have there been even partial replies from the management to the questions posted to them?

15

Hey I had missed updating on this due to other pre-occupations! Guilty!

I will have a go at this soon. trouble is I dont take Notes during interviews:)

The bottomline was that growth visibility was poor at 15% or so (compared to many others at over 30%), otherwise expected to maintain its niche leadership and margins.

-Donald

16

Gandhi Special Tubes Management Q&Aupdated.

Thanks for reminding Siddarth and Nirmal. I could recollect most of the details except specifics on market share etc.

Basically growth visibility is poor. I remember now I prodded for more information on this aspect in many ways - new products, exports, greater penetration, etc. but nothing was forthcoming - the only ray of hope forwarded was that OEMs that have set up production in India recently in the south will expand to full capacity in 2 years and that can bring sizeable growth.

Update yourselves and form your own convictions!

FY11 results show a ~12% growth in Sales with a ~4% growth in Earnings.

17

I managed to attend the AGM of Gandhi Special Tubes, while in Mumbai last week:

1). An early investor into the company, Ajay Maniar (www.aavishkaar.in) asked some questions on why the company isn’t returning more money to the shareholders. His observations:

a) Company has Equity Capital base of ~120 Cr, yet generates less than 100 cr Sales, and it has some 50 Cr in liquid investments. Does this business require such a equity capital base, why not return it to shareholders?

b) He also suggested further stock split to encourage more liquidity into the stock counter

Management didn’t have much to counter. They said they are conservative, they have seen bad times in 1987-95 and would like to conserve Cash. 50 Cr liquid investments are in FMP generating a 10% return which is not bad. They will use Cash this year in Capex and moving to a new Corporate Office. No comments on the Equity base!

Other notes:

  1. Windmill business has lost its charm. I/T laws has been changed as the I/T department has taken a different view on the 80% depreciation that was used to show a loss. They want companies to first set off the loss -before claiming benefits. Effectively the tax benefits are no more there.

3). Company carries 5-6 months stock-in-trade, hence larger working cap requirements

4). Growth projections will remain muted. FY11 may be a tough year - despite tractors doing very well, the commercial vehicle segment may slow down.

I spoke to Ajay after the meeting. He said he has made lot of money on the stock in the earlier years, Management is good but way too conservative. They are unlikely to put this money to better use than currently, nor are they likely to return it to shareholders. From these levels, prospects are dull.

We agreed Gandhi Special Tubes is a good safe candidate for parking your money for dividends, at lower levels. Growth prospects are muted and there is unlikely to be much interest in the counter.

3 Likes
18

Just browsed through theAR, finally the management talks about capacity expansion plans… which was mentioned by Donald as discussed in last AGM. Could we see some movement here?

19

Anyone still tracking this stock? I suppose by now we can safely say that this stock is a value trap with 10 year net profit growth rate of 3%

1 Like
20

I recently met the management at the AGM. Here are the key takeaways:

They are into manufacturing of niche products which only a few players manufacture all over the world. All the OEM`s are their clients and they have the monopoly in the products as it is visible on the margin front.(Read this as moat)

No aftersale market for these products.

the competitor is Chinese imports on which heavy import duty is already in place and will stay for the coming years.

Margins sustainable: Management focuses on specialized products to maintain the margins and they intend to maintain it at the cost of growth.

Seeing huge traction from the automobile industry and sees decent demand growth for the next 2-3 years.

The company carries 5-6 months stock, therefore the price benefit will accrue on the cheaper Raw material in coming quarters.

Double shift production has started vs single shift last year.

Last year`s growth rate of 16% to be maintained. Considering the double shift, debottlenecking, change in product mix and few other changes, the impact will be seen from this year and Q1 has already proved that.

Management is confident about the growth for the next 2-3 years.

Sales CAGR for the last 10 years has been around 8%. We can see the trend changing as they grew at 16% last year and Q1 has been fantastic, if this growth is really sustainable for the coming 2-3 years as guided by the management(plus starting of the double shift this year), the stock can give decent returns from the current levels.

P.S. I hold the stock and my views may be biased. Please do your own research before investing in the company.

3 Likes