Grauer and Weil Limited- 101 out of 100?

Stock Opportunities Untested - but worth a good look
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Offer Price = Rs.1600 crores

The question in your mind: What do I get by paying up 1600 crores?

Well, what you get is a business generating 70 crores of free cash flow every year, needing no capital investment to grow, operates at 25% EBIT margins and generating a return on capital greater than 90% even when it is an operating at a capacity utilization of only 50%.

Before you start thinking about the valuation, let me add a mall worth Rs 1100 crores as an additional incentive.

That’s not all. The company will have cash of 130 crores by end of FY 18.

Feel the dopamine rush yet?

Well,let’s get down to business.

The company we are talking about is Grauer and Weil Limited (established 1957), dealing in surface treatment chemicals, industrial paints, engineering services and lubricants. Led by the father son duo of Umesh and Nirajkumar More, this family run company has done wonders over the last couple of decades.

Let us talk about each of the divisions:

Chemicals-

Grauer is the market leader in the segment of surface treatment chemicals, intermediates and specialty electroplating chemicals and has manufacturing facilities in Dadra, Vapi & Jammu. The operations of the company are fully backward integrated making it very difficult for any new players to enter this segment. (Strong entry barriers, this is evidenced by the fact that there are only 3 players in the country in this business making it an effective oligopoly).

The revenues from this business are 300 crores (FY17), EBIT is 77 crores ( margins exceeding 25% ) and capital employed only 85 crores. (ROCE of 90%). The most important point amidst all these figures is that this is at a capacity utilization of only 45-50%,thus company could effectively double its revenues without incremental capital investment.

The market size in India is 750 crores (giving Grauer a 40% market share), which is growing at 8-10% (in line with nominal GDP). As for breakup between price and volume growth, price hikes are roughly 5-6% per annum. The domestic market is largely saturated. With regards to exports, this being a service oriented industry, the company would need to establish service centres in every country it wishes to enter.

Aviation business (read attached Business India article for further details) will be small in terms of revenues, but a high margin business since these are specialised components.
Competitors include Atotech and Artek Ltd (this company is spearheaded by Goenka family who were erstwhile partners of Grauer and Weil Ltd). Grauer is one of only four companies in the world which have the capability to provide such service (as claimed by the management).
This is thus one of the few businesses possessing high asset turnover and high margins.
The total investments in plant and machinery are only Rs 42 crores, on which company generates Rs 300 crores of revenue.

Paints-
In 2008, promoters merged Bombay Paints Limited with Grauer, which is now a 65 crore business. The company has shifted focus from conventional industrial paints to specialised paints which cater to pipeline coating, underground/underwater pipeline coatings, and so on. There is significant revenue growth potential in this segment and long term operating margins should be between 10-15% (as guided by the management).
The company has shifted operations from Chembur to Dadra (Capex of Rs 8-10 crores).
Capacity at Dadra plant is close to 8700 KL per annum and company plans to operate at 50% capacity utilisation in FY18.This business has now broken even, and management is confident of reaching 200 crores of revenue in the next 3 years. It is the first chemical and paints to receive certification from Rolls Royce and is in process of validation for Boeing for supply of specialized coatings. Rolls Royce has also approved Grow Space Aqueous cleaner.

This business has underperformed so far, behaving more as a capital guzzler as capital employed is Rs 90 crores and operating profits in FY 17 was only Rs 3 crores.

Engineering-
The engineering division offers turnkey solutions for effluent treatment. GWIL has a plant of Alandi, near of Pune that manufactures all types of equipment’s used in surface finishing and allied industries.
Revenue in FY 17 was 32 crores and operating profits were 3 crores. This is an offshoot of the chemicals business and is lumpy in nature. Aviation will be a focus area where significant growth is possible.

This business though not very big, has the advantage of being extremely capital efficient as capital employed is only 9 crores.

Lubricants-
Grauer has ventured into manufacturing specialized lubricants and oils at two plants – one in Vapi and Baroti (Himachal Pradesh) producing industrial lubricants such as rust preventives, cutting oils, hydraulic oils, heart treatment oils etc.
The current size of the business is only 10 crores, operating profits of 2 crores and capital employed of 3.5 crores. The management expects to see good growth going forward.

Real Estate-
The company owns and operates a mall going by the name of Growel’s 101 in Kandivali, Mumbai. The mall has 4,30,000 square feet( 10 acres) of retail development with 90% occupancy. Revenues this year should be in the range of 32 – 35 crores (almost entirely cash profits since unrecovered common area maintainence is only 0.5 crores-As per AS 17 disclosure, operating profits are 13-14 crores due to depreciation on mall building).
Personal visits to the mall have revealed a mall that has been built very well( though utilisation of space could have been done much better in terms of the structure of the mall)
Anchor tenats include PVR(a cinema hall is a must for a successful mall), Croma and central. Others include Mcdonalds and starbucks.
Average rental in mall is Rs 87 per sq ft (exclusive of CAM and property taxes). This includes both fixed rentals and revenue sharing contracts with most lessees.
Now coming to an interesting development- Grauer has utilised FSI of 1.16 as against the currently permitted 1.33 (ex TDR) and 1.85 (Including TDR). This is now expected to go up to 3.5-4 with the announcement of new DC rules, thereby creating an opportunity to further develop 10 lakh square feet. Yes, you read that correct.
Management is cognizant of these expected changes, and has prepared complete business plan for multi use development and has been in discussion with various developers and PE players.
They are most likely planning to develop a hotel or commercial complex where the JV partner would bring in substantial portion of cash investment required and Grauer would contribute land as equity component.
In the nearby area, a little bit of scuttle has revealed that Kalpataru has launched a project with a commanding price of 13,000-15,000 per square foot.
This means that post development, the entire developed complex would sit at 14,00,000 square feet. Do calculate market value of this at 13000 per sq ft. I leave you to draw your own conclusions regarding this
Is that all you might ask?
Well, one final thing. The company has a 99 year lease on 2 acres of prime Chembur land which currently houses only the R & D centre. This can be developed at the appropriate time ( Just as an indicator, current market value would be around 200 crores )

Valuation ( purely my estimates, subject to error)

Chemicals-1500 crores (Great business with low growth (reminds me of See’s candies).
Could be valued at a PE of 25x, considering extraordinary ROCE and sustainable earnings power)

Engineering-50 crores (Considering minimal capital requirements of the business, should trade at a high multiple of earnings. The business should enjoy robust growth over the next few years and hence would probably trade at a high multiple)

Paints This is the business where maximum capital has been deployed and is as yet unproven. Should be valued at slight premium to book value 120 crores
Lubricants Small business, has a large headway of growth in the future,low capital requirements 30 crores
Real Estate Currently rental yields are low and mall is slated to generate about 32-35 crores per annum. The annual growth will be in the range of 7-8%,at cost of capital of 13-14% for this business, valuation should be 32/(14-7)% 450 crores
Cash By FY18 end 130 crores
Total 2280 crores

Please note that this does not take into account a single rupee of upside from the new DC rules, which as discussed above will be substantial.
The promoters come across as conservative capital allocators who are looking at steadily growing the company in the right manner. They have consciously repaid most of the outstanding debt in the last few years and have avoided any value destructive acquisitions. They remain focused on value creation instead of empire building (a favourite for most Indian promoters).
Risk Factors:
Key man risk: As with a lot of promoter run companies, even Grauer faces a key man risk in the event of any misfortune befalling the More family.
Product obsolescence: I will be the first person to admit that my understanding of the business technicals is fuzzy at best and hence will leave you to take a call on this
This is my understanding of the business, could definitely be wrong. In that case, I would request all the distinguished investors to correct me. Would definitely love someone to play devil’s advocate and point out all the apparent flaws in this thesis
Disclosure-Invested

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Sorry,the formatting in the valuation section went awry

Chemicals-1500 crores
Engineering-50 crores
Paints-120 crores
Lubricants-30 crores
Real estate-450 crores
Cash-130 crores
Total-2280 crores

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First cut sceptical mindset - PE expansion has already taken place. 5 times in 3 years. Sales Growth is anaemic.

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@Anirudh72, thats a very good write up. As it can be seen, the company was a re-rating candidate (when Mr Tulsian recommended it at around 39 in Aug). The same is already played out as the stock almost doubled since then, to present level of 70. Mr Tulsian’s recommendation here !

Now, what will keep it growing from hereon? Request your thoughts on the growth prospects of the company.

Rgds.

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Good points raised
While chemicals should continue to grow at high single digits, the other segments led by paints will be the drivers for revenue growth.Paints has a huge market opportunity and now with the plant transfer,capex completion,and effects of demonetisation and GST largely over,we should be slated to see huge growth.Management sees the paints business becoming as big as the chemicals business in the long term.
With the SBU structure in place,we can expect to see 12-15% CAGR in revenues over the next 4-5 years.

As for PE expansion,absolutely agree with you. Don’t see multiple rerating for the core business but expect significant upside from the real estate value unlocking
Just to quote the example of Bombay Dyeing and Ruby Mills,real estate in a city like Mumbai is incredibly valuable and the new DC rules can give a huge filip to this vertical. The management has engaged Mckinsey to draft a business plan(most likely a hospitality/commercial development)
The mall has been built very well and enjoys large footfalls,customer recall(spoke to quite a few people living in the suburbs) and great anchor tenants.Even in the midst of substantial number of malls opening up in the suburbs,they have managed to hold their own even as others have faltered

All of these factors make me believe that this company holds substantial value
However,beauty lies in the eyes of the beholder

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Good write up. Since you have already done the work, can I trouble you to provide the following:

  1. Last 10 years revenue, operating profit, capital employed etc. for all the divisions (wherever available)
  2. Why do you think market is undervaluing the company and why do you disagree with the market. What is your unique insight into this business?
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@Advait_6270

Since Mr. Tulsian’s recommendation,the stock has definitely been on fire. However, in my personal (and probably biased) view, the story has just begun.
I think the market still has not recognised how good the chemicals business really is.Other chemical companies have been significantly rerated and trade at PE’s of 25-35x even though their capital efficiency and returns are subpar as compared to Grauer(though part of the reason for the high multiples are also due to the markets belief in the growth opportunity)
Also,real estate value unlocking remains a source of huge upside. Just look at stocks like Bombay Dyeing and Ruby Mills to get an idea. The new DC rules will present them with an opportunity to create a substantial business asset for literally no capital down.

Valuations may be punchy but I guess one needs to pay up for quality

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Hi @Anirudh72 -

Happened to notice that you joined the forum yesterday and this is your very first post. So, firstly warm welcome.

Appreciate your efforts towards sharing your point of view about this stock and its super exciting future prospects.However, i had a look at this counter few days back and my mental maths is pointing differently. Even other wise, I am getting a feeling that this business case has not been presented in a balanced manner. with plenty of avoidable/uncalled for bold formatted text etc.

Lets reconcile:

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Biggest workhorse that I see here is chemical segment with ~70% contribution. Look at the growth rate 5%. Just inquisitive, what was the constrain for them for a more accelerated growth considering this as a oligopoly business with strong entry barriers. Capacity for sure was not a constrain since by your own admission they have 45%ish utilization level. Is it not right to say that they are operating in a specialty per say however the overall market size is just that much hence no biggies bothering much.

Engineering segment is going down consistently for past three years. Top it up with consecutive loasses for past two years. Segment wise positive with 2.93 Cr. as segment result only this year (this is how they term it on AR, my guess it close approximation of segment OP). Looking closely what i see is that there was ‘other income’ of 2.3 Cr. out of this.

Paint segment: Agree few things has started moving well here. 14% top line growth. Hope it sustains the segment result margin of 8% going forward. For past two years this was a loss making unit.

Shop-Entertainment- This segment accounts for 6% of total revenue. After witnessing de-growth last year it has improved now. Decent margins of ~53%.

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Few questions, will appreciate if you can answer:

  1. From where do you arrive at the ROCE of 90%.? On page 18 of the AR company finds their ROCE to be 22.3% My calc on Screener fetched data is giving me ROCE of 23.76. How come such huge gap?
  1. I am seeing an asset turn of maximum 1.05 during last 10 years. should that be considered as one of the highest asset turn over company?
  1. FY’17 Shop-entertainment segment revenue is 25 Cr. Please help understand why there will be a 30-40% jump in top line this year where its already going by 90% occupancy by your assessment.
  1. Without going into plausibility and time line attached for this to have any material impact, I am concerned if we should factor that in though there is no single indication towards the same intent in the AR.
  1. In context of the facts (top line, bottom line numbers) and reason-ability, will appreciate if you can enlighten how you are arriving at the valuations. Specifically, for paint segment valuation of 120 Cr deserves some justification knowing that the current year OM is 5 Crs after two consecutive years of losses.
  1. Hope you had a chance to look at this disclosure. Such frequency and massive right offs for such small cap company are little concerning. On those lines, I am actually puzzled with 3 overseas subsidiaries and 3 associate companies where company has 90% of its revenue coming from domestic India market.

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Just to be more specific about my stand, at this moment, I am not much into if the business is right and deserves our time/investment. Rather my effort is more towards bringing back the much needed balanced view to the discussion (which I think was missing on this post).

Possibilities cant be denied if Paints segment finds its sweet spot down the line, Shoper-entertainment segment get a blaze of fortune with some FSI rule change etc. However, investment thesis cant work on forward looking projections, wishful thinking etc.More so when the script has run reasonably within a short span of time.

Thanks,
Tarun

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Hi Tarun,

Thanks for the warm welcome and really appreciate you taking out the time to state your views.

On reading the post again, totally accept the fact that it comes out as overbullish and have skipped over some of the concerns which have been well pointed out by you.

Chemicals growth has been subdued due to relative saturation of domestic market- Hence expect growth in line with nominal GDP growth.This may well get a filip with the new opportunities prevalent in the aviation segment ,where the company has recently received AS9100 Aerospace certification,enabling it to supply products to the global aerospace industry.They have received approval from Rolls Royce and Go Air.(Do read attached Business Article for more granular information)Article of Grauer & Weil India Ltd…pdf (751.6 KB)
(Encourage everyone to go through regardless of your views on the company)

Domestic market size is small and in my view, it is a good thing that no biggies concentrating on it since we can expect ROCE to remain high in this segment.(In simplified terms,we could consider it to be an annuity sort of business)

Engineering- Thanks for point out the other income of Rs 2.3 crores,that slipped past me.H1 revenue growth has been sharp(100% growth YoY) though reasons for lower profitability need to be investigated. I am less concerned about this segment than the paints segment since there is no need to deploy capital.

Paints- This for me would be the acid test for the company. The annual trends may be less relevant in this case,since they have recently shifted operations to Dahej from Chembur which should aid in operational cost savings. They have managed to continue with sales momentum in H1(with 14% growth) though margins have gone down
Next few quarters should be closely watched

Shoppertainment - Margins of 53% not fully indicative of cash flows since about half of the expenses are actually depreciation(Depreciation should be approx Rs 5 crores and maintainence capex is only around Rs 1 crore)

Your Questions:

  1. My apologies for not making it clearer, I was referring to the chemicals business when I spoke about the 90% ROCE.
    Chemicals PBIT in FY17 was Rs 76 crores whereas capital employed is Rs 85 crores,thus the figure of 90%

2.This comment was specifically pertaining to the chemicals segment. The fixed assets schedule mentions that plant and machinery was Rs 42 crores, whereas chemicals revenues are Rs 300 crores ( do note that part of plant and machinery would be for paints as well) In fact, Rs 145 crores out of the Rs 210 crores of fixed assets are actually invested in land and building. Hence core business with assets of Rs 65 crores and revenues of Rs 400 crores+ has implied asset turnover of more than 6x ( Ive found spreadsheet modelling counterproductive in these kind of situations )

  1. I will point you to H1 results where revenues from shoppertainment segment are more than Rs 15 crores.This has come about since lease agreements have been renegotiated with certain anchor tenants and increase in occupancy from 85% to approx 94%. Hence,taking all of these factors into account, I estimate revenues of around Rs 32-35 crores

4.Though there is no mention in the AR,this was certainly discussed in the AGM and the management has given detailed replies on potential plans in this space including development opportunities and appointment of a JV partner

5.Chemicals has been valued considering cash flows of Rs 75 crores this year,cost of capital of 12% and growth of 7%
(75/(12%-7%)) Cash flows for this segment have been arrived at considering CFO/EBITDA of 100% (for the company as a whole it is 100%,should be more for this segment but let us take this as a base)
Given that:
EBIT=76 crores
Depreciation=6 crores
EBITDA=82 crores
CFO=82*100%=82 crores
Capex=5-7 crores
FCF=75-77 crores
Thus value=75/(12%-7%)=1500 crores
Growth in my view should be 7% however you may work with your own estimates.
Cost of capital for this segment in particular should be 12% considering risk free rate of 7% and 5% risk premium (I have not used CAPM)-5% risk premium seems appropriate given that it is debt free and a stable mature business so risk of detoriaration is low

For engineering value of 50 crores is considering revenues of 32 crores in FY17, and Rs 20 crores in H1.Agree that is not profitable yet, but also doesn’t require much capital to function. Hence in my view if traded as a standalone business,could trade at a valuation of approx 50 crores.Alternatively you may work with a lower number but this forms just 2-3 % of the company valuation

As for paints,this is one business where I admittedly struggled to value.
H1 revenues were Rs 37 crores (Q2 was actually net off GST ,so gross revenues would be higher),we can expect Rs 75-80 crores revenue in FY18. This is one business where I have given higher weightage to the management’s targets and future potential than actual current data. If this business does scale up to 200 crores in the next 2-3 years ,with operating margins of 10% they would generate operating profits of 20 crores and then 120 crores would seem cheap.Admittedly,this is nowhere close to perfect and perhaps too bullish,but if you can give me a better indication of its actual value I would love to hear your thoughts.
Also,in terms of valuation contribution to the entire entity, it forms just 5% of my total valuation estimate and hence may not be as material in terms of the context of the entire company

Real Estate - In my view, I have been very conservative since I have simply calculated the value of the lease rentals from Growel’s 101-considering FY19 rentals of 35 crores,cost of capital of 14%(higher than that for chemicals due to higher risk) and growth of 6-7%(this is in line with average rental increments)
35/(14%-7%)=500 crores

  1. Thanks for pointing this out.Absolutely agree that previous year has significant write offs(Rs 8 crores as per cash flow statement)In FY 17 this was Rs 2 crores.
    Do look at sundry balances written back of Rs 2.6 crores in FY16 and Rs 1 crore in FY17 and bad debts recovered of Rs 1.45 crores and Rs 0.2 crores respectively-these are part of other income)This is approx 10-15% of write offs
    My view on this is that current level of receivables is Rs 65 crores and hence even if we take around 10% as bad debts,there is no material impact in terms of valuation. However, this is definitely a concern and one I did not pay sufficient attention to.

Finally,one more thing I did realise on rereading the post is that I have missed out on talking about one of the most important things-the deployment of the excess cash that is now being generated post repayment of debt.
As of now this has been deployed in mutual funds and FD’s which denotes subpar returns on incremental capital invested.Hence,the real estate opportunity viewed in this light becomes all the more interesting since the company would probably decide to invest part of this into real estate.

Certain back of the envelope calculations:

Construction cost should be Rs 8000 per square foot(this includes Rs 3000 of actual construction costs and Rs 4500 for purchase of TDR to get the benefit of additional FSI) This entails an investment of Rs 800 crores for 10 lakh square foot. In a 50-50 JV, the company would need to invest Rs 400 crores(majority portion will be the land brought in by the company,will leave it up to you to each one’s individual estimates of land value)

Considering development of a hotel/commercial complex, at an average rent per square foot of Rs 100-120(considering this would be 3-5 years down the line),lease rentals would be Rs 100-120 crores per year(company’s share of Rs 50-60 crores). Since the company has put down limited capital, this would be a substantial kicker. (PAT in FY 17 was Rs 51 crores)

Ofcourse these are all probabalistic estimates dependent on rule changes hence have not taken the same into account when valuing the company.
Do note that the mall itself would be valued at Rs 1100 crores by itself if it was sold as is.However,due to prevalence of low yields on property in India,valuing it using the lease rentals currently generated,value would be Rs 450-500 crores depending on WACC and growth estimates

Certainly the part pertaining to new FSI rules can be considered as wishful thinking but that is precisely why I have not taken a rupee of that potential upside into consideration when valuing the company. So hence in that sense if you are comfortable with the remaining part of the valuation exercise now,this is like an option with substantial upside and limited downside

Also,if these new rules do not materialise due to some reason(unlikely,but anything is possible in our country),the management may look to increase shareholder payout or go for a buyback in case they feel that the business is selling below intrinsic value. In either case,that is a good move for shareholders. Promoter holding is at 69% and hence any decision to increase payouts to investors would be in their interest as well

Script has run up in a short period of time and could definitely correct as and when we see a market correction.
But I would be more worried about how the business does rather than worry about short term market price fluctuations.

Hope I have done justice to the interesting questions raised by you.They definitely helped clarify my thinking.Thanks a lot for the detailed reading of the post.Definitely added a lot of value to me,was one of the reasons behind joining valuepickr,in order to engage with investors like yourself and hopefully learn a lot more

Thanks,
Anirudh

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This is why i love this forum, separating wheat from the chaff.

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Hi,

I had actually done this exercise for the last 5 years but have now updated the same to include last 10 years data,Thanks for putting me on it,found it very usefulGrauer & Weil Limited-10 yrs.xlsx (13.3 KB)

The unique insight is that the company is actually composed of 5 businesses each of which are radically different in terms of nature and returns earned.What happens is that the market tends to paint the entire company with a single brush(by looking at consolidated figures)and somewhere the story of individual businesses gets hidden. This stock will not show up on screens due to optically high valuations.Also,there is an absence of institutional ownership and analyst following creating an opportunity to buy before they enter.The real estate value and the fact that the chemicals is undisputedly a good business does not show up(The massive returns on capital earned in chemicals is pretty much hidden)
Personally,this is what I feel,do discount for certain unwarranted bias due to the fact that I am invested in the company(Try hard to get rid of it,but it does subconsciously affect thinking)

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Thanks @Anirudh72 -

I will try to keep it short and straight this time around.

Speaking just about myself, unfortunately the projections of ~2300 Cr. are really stretched.

Paint Business: I for one dont have any iota of hint as to what will take the Paints revenue to ~200 Crs. from current 65 Crs. within 3 years time.
Engineering Segment: Dwindling top line and negligible top line. Still you feel that as a standalone entity someone should pay 50 Crs because its not capital extensive. Sorry I have a BIG difference of opinion about valuing a business.
Chemical Business: Is this not priced to perfection (and beyond actually) at 26 PE where main business will have 6 -7% PA growth and rest all segments are still finding there feet on ground.
Shopper -entertainment - Lets agree on the valuation of 450 Crs. though modern retail format has its own nuances and challenges.

On remaining part of the write-up related to ‘as and when surplus cash and real estate story unfolds and subsequent back of the envelop calculations etc…’, I honestly dont have much to counter. Just that I am not much into hope investing.

Thanks again,
Tarun

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Thanks @T11

Really appreciate your time and valuable feedback.For a 20 year old student like me who has loads to learn,some great takeaways.Would love to keep reading and learning more and more from people such as yourself

Honest disclosure-Had actually invested into the stock a few months back at levels of 43-45 levels.Thinking about adding to my position,hence requested the opinions of other investors at current valuations(my view would obviously be biased)

I think we can safely conclude that current valuations are punchy and require some amount of inherent belief in the business prospects

Loved this conversation.
Thanks once again @T11

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I also initiated position around same price. But meanwhile while talking to one of my friend, came to understand they being very poor in payment to suppliers and in commitment. They were committed payment multiple times in last few months and not paid. Even amount was meager.
I somehow lost comfort and stopped accumulation.

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Could you specify what services/products had been supplied and pertaining to which vertical?
Creditors of 35 crores don’t seem too high and I guess the company would be working with their core suppliers for the past many years now

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That was Machinery item. Concerned people may not want details put in public due to larger businesses interests. But what i am mentioning is absolutely reliable info.

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Fair enough. But do we see this across all their suppliers? Or is this a one off event?
In these circumstances,what kind of an effect does it have on the valuation of their business?

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I came across this one case Incidentally. I do not know or hv tried to know about matter at large. When i had choices, i thought it prudent to be away.
However, that one incident is absolutely reliable input, though statisticaly may be insignificant.

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the valuations look too complicated and speculative . if this co had so much assets , why is the P/B ratio around 6 .free cash flow per equity is 3.1 rs ( for every 80 rs ) and EPS TTM is hardly 2.5

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Price to book around 6 since assets aren’t marked to market so real estate value not reflecting in balance sheet

As discussed above,current valuations are building in some amount of hope on the future of the real estate business in terms of FSI increase,etc