November 30, 2007

Grindwell norton and Free cash flow

I received the following email from sanjay shetty and decided to post it as he has asked a very important question on valuation. I have done some work on it on my own and have put the results in the worksheet – Quantitative calculations.xls

You can download is from
here or use the download link in the side bar. Please see the tabs – Maintenance capex and FCF anal.

My responses are in italics. There is a follow up question from sanjay on maintenance capex. I will post on it in detail shortly with an example. If you have looked at my valuation templates, you may have noticed that I use FCF based on maintenance capex for valuation purposes

Hi Rohit,

I've been viewing your blog, after your comment on my blog (

I had a few questions for you.

What methodology are you using to value companies in India?

DCF, comparitive or relative valuation, sum of parts etc. I try to value a company based on multiple approaches and also depending on the nature of the company

Are you using a Discounted Cash Flow method to calculate Intrinsic value? If so, are you checking the Free Cash Flow, how are you calculating it?

yes, i use free cash flow. I however do not use capital expenditure directly. I use maintenance capex needed to support unit volumes or competitive position (maintenance capex). Difficult for me to explain in brief. i have a few excels uploaded in my google group explaining the calculation.

I've see most of the companies I've analyzed seem to be blowing enormous amounts of cash, with almost negative free cash flow which is worrying. -

I think the key point is whether the capex is maintenance or for growth / accquisition. Let's take a short example. If a company earns 5% on capital , and has 10% margins (asset turn is 0.5). Then to grow by 5%, the company will use all its free cash flow. Also 5% growth is roughly inflation, so in this case the company is using all its free cash for maintenance capex
In case of a company growing by 20% and 10% margins (asset turns is 2), growth of 5% requires only 50% of the netprofit . The rest is cash flow which company can use to aqcuire other companies, give dividend or build assets. This is the case with grindwell norton. Grindwell has low FCF as it is investing the surplus cash in assets to increase volumes.

Hope the above clarifies .i have tried to provide a quick explaination and have left a few things out (like adding back depreciation)

Take for instance Grindwell Norton, which you've recently mentioned on your blog, Every thing seems rosy however Free Cash Flow is the concern.

I have taken out the detailed calculations by sanjay and put the final computations

Free Cash Flow
Mar’ 02 29.178
Mar '03 21.802
Mar '04 17.149
Mar '05 18.481
Mar '06 3.121

The worrying fact about this company is the amount of cash it's blowing, though currently it's Sales, ROIC etc. are all healthy and growing.
Free Cash flow growth is actually going from bad to worse. I'm calculating Free Cash Flow as Net Cash from Operations minus Capital Expenditure which is Purchase of Fixed Assets.

1 comment:

okhade said...

Hi Rohit,

Plz refer to which says (Dec 03-07)

Capital Work in Progress 1.96 2.74 2.69 7.01 16.55


Net Cash From Operating Activities 26.19 29.92 31.38 44.92 27.18

So FCF looks like better than your figures! Is something looks wrong in my calculation?