March 21, 2007

A graham idea

I have come across a value stock – India nippon electricals limited. The investment thesis is as follows (my notes)

About (taken from their
INEL was incorporated in 1984 and converted into a joint venture in 1986 between Lucas Indian Service Ltd, a wholly-owned subsidiary of Lucas-TVS Ltd and Kokusan Denki Co. Ltd, Japan - a group company of Hitachi Japan, to manufacture Electronic Ignition Systems for two-wheelers, three wheelers and portable engines. Over the years the company has enlarged its customer base and now supplies to most of the manufacturers of two-wheelers, three wheelers and gensets. The Company's net sales for the year ended March, 2006 was Rs.1678 Million (USD 37 Million). INEL makes the entire range of 2/3 wheelers, digital and analog ignition products.

Commencing its operation in Hosur (Tamil Nadu), over the years INEL has set up two more units one at Pondicherry and the other at Rewari (Haryana) to be nearer to customers and offer service such as just-in-time supplies and to improve response time for introduction of new products.

INEL's product portfolio covers all custom-built ignition system parts for various applications for two wheelers, three wheelers or portable engines, offering Ignition System solutions to meet the needs of the whole range of OEM's in the vehicle industry.

Currently, INEL's range caters to two stroke / 4 stroke engine capacity of 30cc to 175cc. However, depending upon the needs of customers, INEL has acquired knowledge and capability to provide solutions for other applications also.
INEL specialises in offering ignition system solutions by design, development and manufacturing parts such as Flywheel Magneto, Digital / Analog CDI/TCI, Regulator/Rectifiers and Ignition Coils needed for application on various types of engines fitted on motorcycles, scooters, mopeds, 3 wheelers, portable gensets, lawn movers, wood saw cutters and other types of IC engines.

The company has grown from 122 Crs to around 168 Cr with a CAGR of around 7%. Net profits have grown by 17% in the same period (CAGR of around 3.5 %). Cash flow growth is higher due to low CAPEX needs and the evidence of cash and equivalents on the balance sheet of around 80 Crs. ROE has been consistently above 20%. The poor growth in topline and Net profit has been due to the pricing pressure from OEM and raw material increases in the last few years. Current year profits seems to be in the range of 20 Crs which would give a rough EPS of 25
In addition, the company has very low debt on the books and an investment portfolio of almost 77 Crs.

The company is a supplier to all the major 2 and 3 wheeler manufacturers in india (see
here). In addition the management has been consistent and prudent in allocating capital and kept the Return on capital high, even when the margins were getting squeezed.

Further slowdown in 2/3 wheeler growth and additional pricing pressure due to metal price could hurt margins further. The company seems to be working on offsetting by developing new types of fuel injection systems and by exploring the export market

At an EPS of 25 ( free cash flow being higher than that), the intrinsic value can be conservatively put at 350-400 Rs. This is low end of the valuation. If the company can grow the top line and maintain margins, then the valuation can be increased by 20-25%.

Open issues ( for me to explore – any inputs would be appreciated)
- long term growth prospects for the company
- Raw material pricing outlook for the company?
- Competitive scenario – any new competitors?
- How is the export plan working out?
- Plans for the cash on balance sheet?


RaviAranke said...

Hi Rohit,

A possibly silly question. Where do you get access to their annual reports for last few years?

I could take a look once I have some more data than that is available on their web site.


Rohit Chauhan said...

you have to access the edifar database ..they have reports on that till 2004 only

RaviAranke said...

Hi Rohit,

In the absence of latest annual reports, it is difficult to evaluate this.

What is the catalyst that you have in mind which will unlock the value or force the reevaluation?

Earnings are not growing significantly where they would make the market to take notice. In the absence of takeover attempt, it might be a long time (years!) for market to re-evaluate the price.

Some months ago, I had made a purchase of Kothari products (pan parag fame). Its book value is more than the market cap. Tobacco business is a cash minting machine. That's all the analysis I did at the time of purchase hoping that somehow market will recognise the Graham bargain.

However, later I noticed that the promoters own more than 80% of outstanding shares. There is no incentive for the current owners to reward shareholders. There is no way for a hostile takeover. Ergo, the value trap stays as is. I have moved on in due course - hopefully, wiser.

Best Regards,

Anonymous said...

Hi Rohit

Which cash & cash equivalents are you referring to? There is hardly cash of 1 Cr. in the books. And upon that the investments have a component of 20 Crs. of equity funds which have reduced by half till now. I have infact worked at TVS which is the biggest customer of INEL and I know its not easy out there


Rohit Chauhan said...

hi nayeem
INEL has around 2.2 crs in cash and almost 99 crs in investment. of this around 12 crs is subsidiary investment, 60 odd in debt mutual funds and rest in equity funds. with crash in markets since mar 2008 (time of above annual results), the total can be computed as follows
6 (50% for subsidiary)+65 (debt)+12 (50% drop in equity funds) + 10 crs (current year cash)=93 crs. against this the mcap is 71 crs.

i agree with the performance issues. have been tracking the co. and their results are very poor