April 11, 2007

Priced for bankruptcy – Cheviot company

I am currently analysing Cheviot company (for company website see here).

The valuation is as follows

No. of shares outstanding – 0.45 Cr
Price per share – 228
Mcap – 103 Cr
Investment/ cash on book – 63 (last year)+ 10 Crs (this year) = 73 Crs
Net value = 103-73 = 30 Crs
Current year expected NP = 23 Crs

The company seems to be priced for 1-2 years earnings. The market seems to valuing the company with a horizon of 1-2 years and expects the company to be out of business after that !!.

Background

Cheviot company is a West bengal based company into the manufacture and sale of Jute based products. Almost 70% of the sale is export and the rest is domestic (Page 6 of Annual report).

The company has been in business for more than 100 years and is currently the most profitable in its industry (the jute industry as a whole is sick and incurring losses). The company has two manufacturing units, one at Budge budge and the other at Falta. The unit at Budge budge is having some labor trouble which may impact the Topline for the company.

Financials

The company has had a ROC of almost 20%+ for the last few years (if one excludes cash). The company has been consistently profitable and has good free cash flows ( equal to net profits).

In addition, although the volumes have come down, the company has moved up the value chain and has been able to improve realization for the end product (Raw material cost as % of Sales has been coming down over the years). The topline has increase with a CAGR of 6% for the last five years whereas the Net profit has increased by 15% CAGR over the same period.

The company has almost 73 Crs cash on book which has been invested in mutual funds and other liquid investment.



Risk
The indian government has made jute the mandatory packaging material for food grains and sugar to support the industry. In addition the government also provides marketing assistance for the export market which is received as a credit. Thus the industry is surviving based on this support from the government.
The company currently has labor unrest in one of its units which may impact the short term profitability. In addition, this industry is marked by labor issues and strikes.

Conclusion
In my view, the strike could impact the topline for a quarter or two, but it is not a long term risk. In addition, the company has been concentrating on the export market and as a result could continue to do well.

The market is currently discounting all the above issues and more and pricing the company for bankruptcy, which does not seem probable.

12 comments:

Prem Sagar said...

Rohit,
Do you know what the mgmt intends to do with the huge investment portion?

from their last 5 yrs, I see no huge capex and I dont think the mgmt has any plans to invest huge sums into the same business to increase sales or to enter into new avenues to explore new possibilities.

So as of now, the investment portion is just sitting on their books without any plan for it, but merely compounding it. do you think they would do better if they disburse a part of it to shareholders or buy their own shares back?

and the industry itself is struck severly by strikes and I can see several instances of strikes for this co alone. and the whole industry doesnt look enticing.

Assuming that the investments are discounted, would you be willing to buy such a co at 2 times?

Rohit Chauhan said...

Hi prem

very valid concerns.

as far as strikes are concerned, i would not be too worried as the company has been able to manage the financial impact of such strikes in the past. unless the company has some very serious labor issues in the future which shuts down the plants for a very long time, i dont think these labor issues should harm the long term economics of the company

the capex needs of the company are low and hence i expect the cash to increase. i have seen no evidence of the management wasting the cash till date. they have given a bonus, decent dividends and seem to be accumulating cash. need to see how the cash gets used. buyback is unlikely as the no. of shares is low (0.45 crs).

cheviot is a graham play and a portfolio of such companies should do well ..although individually a few of them may do badly

khali_pili_lafda said...

Hi Rohit,
First off great effort on this blog. My observations on Cheviot are below.

1. Jute prices are on the decline on a global scale and may exert pressure on profit margins for Cheviot over the next few years given that export orientation of company has increased.
2. Historically the P/E has always been below 6. Cannot figure out why the markets are unwilling to give Cheviot credit for performance.
3. Company has a lot of cash on hand (Rs543M) with only 4.5M shares outstanding. May be diversifying into Tea - read this online? Saw a spike in Capex in 2003.
4. Labor issues have already been highlighted by you but given that Cheviot operates in West Bengal, labor laws and strikes can be particularly harmful and unpredictable.
5. With only 4.5M shares outstanding - it raises a liquidity red flag since trading may be controlled by a select syndicate. On Apr 12th only 485 shares changed hands although Mkt cap is over 100 crores.

Niraj

Rohit Chauhan said...

Hi niraj

great comments.

my thoughts on the points raised by you
1. i also noticed that jute prices (raw material) is decreasing. i think that is a plus for the company as it improves the net margins for the company (the company sells valued added jute products)
2. i think the historical PE is low because of the various factors in your and prem's comment. small cap, illiquid stock in an unglamorous industry with labor issues
3. i am not sure that the company has diversified into tea. the 2003 increase in gross asset was a revaluation which was reversed in 2004. i checked this in annual report. the capex for last 5 years has been roughly equal to the depreciation
4.agree with you. however i feel that labor does not represent a threat to the long term economics of the company. it can cause short profits to suffer. although a serious labor trouble could impact my assumption. frankly it would be difficult to evaluate this risk objectively
5. this could be the reason for the low valuation

Anonymous said...

Rohit,

The company website states that they have diversified into Tea. (http://www.groupcheviot.net/tea.html) - Close to 1500 Acres of Tea Estate in Assam...

Vijay said...

Hi Rohit,
I have just started learning about investing and find your blog and ideas quite insightful.

I have also been reading some material on value investing [Warren Buffet, Ashwath Damodaran].
Talking about stocks trading lower than their book values, I have come across JK Tyre Industries. It's Price to Book Value ratio is 136/192 = 0.7 (trading at a 30 % discount than it's book value) and PE ratio is 136/ 21.66 = 6.29 (trading at below average of the companies in the tyre segment).

Their annual report shows that their operating profit has gone up by 57% over the last year. Moreover they are also looking at capacity expansion etc.

The thing that I am concerned about is their debt is a big chunk (around 40%) of their liabilities as per the 2006 figures. I was not able to find their balance sheet for 2006-2007 and hence not sure whether they have done anything to reduce the debt.

Looking at the ratios, it looks good, but I still have a feeling that something is wrong with this stock.. any comments ?

Rohit Chauhan said...

Hi vijay
i had a quick 2 min look at the company. i have not dug deep so i may be giving just first impressions

the company has a very high debt load as of Sep07. With the mcap of 400 odd crs, it has a debt of 900+ crs. That is fairly high for a cyclical business where in the pricing power is also low - OEMs tend to squeeze suppliers.
In addition the performanc has improved only last year. last 5 year performance is not very inspiring.
the profit margins are pretty low - 1-2% and Return on capital is pretty low too.
personally i would not be very interested in this company

Vijay said...

Hi Rohit,
I was looking for more companies which were trading at a discount to their Book value [as well as close to their 52 week low]..

I found a few more

Medi Caps (Small cap company with a market cap of 19.64 Cr which manufactures capsule covers for medicines) << Trading at Rs 63 and has a book value of 120
(http://www.moneycontrol.com/india/stockpricequote/medicaps/pharmaceuticals/23/38/pricechartquote/marketprice/MC09)
This company had a 52 week high of 109. It has almost no debt (0.01 crores). But the company has registered a profit growth of 30 % Mar 06 - Mar 07. I was not able to find this year's annual report

Sasken Communication Technologies << ( Telecommunication Software company with a Market Cap of 312.66 Cr). This is trading at it's 52 week low of 109 Rs. It has a book value of Rs 146.81. The third quarter earnings were disappointing though. Moreover this company has zero debt. This company had a 52 week high of 624.

regarding Cheviot company, I observed that the profit that they make is relatively small as compared to the cash they have in hand ( which the company has invested I believe). Unless the company utilises that money for growth ventures, there would not be a positive impact on the stock price..

I feel that I sound like a layman :| .. excuse my 'analysis' as I am yet in the process of reading and learning.

Rohit Chauhan said...

Hi vijay

you have a valid point of view for cheviot.
cheviot is a graham idea - you have to hold a number of these kind of shares in the portfolio. Not all the companies would do well in the portfolio, but enough will do well for a good overall return

regards
rohit

Amit said...

Hi Rohit,

Did you recently get a chance to look at this company?

The company still looks grossly undervalued to me. They just came out with their 2008-09 annual report. Liquid investment (stocks+mutual funds) amounts to about 60 crs using conservative estimates. In addition the net current assets stands at 55+ crs. The company can easily earn post-tax profits of atleast 10-15 crs each year from the jute business. The market cap is only 75 crs.

However, I noticed a red flag. The loans & advances figure has increased by about 20 crs. The cash flow statement mentions an "advance against immovable property" for about 20 crs. However, the interest income is only 23 lacs! There is no mention of this advance anywhere else in the report. An advance of this size (considering the size of the company) deserves special mention. Do you think this could be a corporate governance issue? The funds could have been siphoned off to a related party at no/low interest

Anonymous said...

Hi,
I have brought Cheviot company shares because it's quite cheap but I have overlooked the advance loans which you have mentioned. However when you look at the M&A discussions, I see always the management have been very candid. For example, in 2008-2009 report says the business would be "gloomy". I think this is pretty rare for management to be very frank and blunt.

In my opinion, the company might not give you high returns, but it's a safe bet.

Another interesting thing is, the company is on strike from dec14th :(, I expect the stock price to be at least go down, but I see stock price is nearing 52 week high? Any reasons ?

BTW, I have been mailing to investor email id for some clarification, but I don't get any replies from them? What is the forum to make a complain?

Anonymous said...

Hey,
Gr8 observations guys. The loans and advances has been reversed for this year if you guys look at the latest annual report as of now. So i think, this is also not a concern. The strike is over now and worked for this quarter entirely so i expect decent profits to return from this quarter.