October 13, 2008

Analysis : Lakshmi machine works

About
Lakshmi machine works is the biggest textile machinery supplier with a market share of around 60% of the indian market. In addition the company also has a machine tool and foundry division which together contribute to less than 10% of the total revenue.
The company’s main market is india and is one of the lowest cost suppliers in the country. In addition the company is also planning to setup a unit in china for textile machinery and is also focussing on the other divisions

Financials
The company’s performance has improved in the last 5 years. This improvement has been on the backdrop of an upcycle in the textile business and the removal of the Textile quotas in the international markets.
The company’s ROE has improved from around 8% to around 30%. The sales increased 4 times during this period. In addition the net profit has gone up by 10 times due to the increase in the net margins from 4.7% to around 10%+ during the same period.
A more commendable improvement has been the improvement in the Wcap turns. The company has become working capital negative and now has almost 600+ crs on the balance. As a result of this improvement the company has a very lean balance sheet where out of the total 800 Crs, only 200 Crs is the invested capital. Due to this the Asset turns is very high at 11.5.


Positives
The company is a one of lowest cost producers in the industry. In addition the company has improved its capital efficiency dramatically during this upcycle. This improvement has come as a result of the improvement in inventory turns and recievable turns.
In addition the company has seen an improvement in net margins due to elimination of interest expenses and other overheads. This has come about inspite of increase in RM prices.
The company is also spending almost 1% of revenue on R&D which is a good, but a higher spend could be better. The company has a decent order book too.
In addition the company expects a replacement demand of around 28 Mn and new demand of around 29 Mn due to growth of the textile industry (page 24 of Annual report)

Risks
The risks are painfully obvious. The textile industry was hit initially due to rupee appreciation and then due to the credit crisis. During such times, CAPEX expenditure is usually put on hold or delayed. As a result the company expects the demand to drop by 10 to 20% in the current year.
Due to demand drop in the international market, other foreign manufacturers could become more aggressive in the India impacting the profitability of the company.


Competitive analysis
The Industry has decent entry barriers. LMW has fairly depreciated investments which would require quite a bit of investment by any new player. In addition LMW also has the benefit of economies of scale due to which it has lower cost in the industry
There is a certain amount of Lock-in too as once a textile producer buys the machinery from one supplier, it would tend to continue with it as there are cost benefits in terms of maintenance, training and CAPEX.
There are also learning curve barriers and contractual commitment barriers in the industry. In all, LMW enjoys a certain amount of competitive advantage in the industry which also shows up as high market share and high ROE.

Valuation
The company has almost 600Crs+ cash on the book. Net of the cash, the valuation is around 200-300 Crs. The net profit for last year was around 240 Crs out of which the other income was around 60 crs. As a result the core income was around 160 crs. Even under a sceanrio where the net profit drops by 50%, the current valuation is around 2-3 times the depressed profit.
A DCF (discounted cash flow) analysis assuming a growth of 7-8% and net margins of 8-10% gives an intrinsic value of around 4500. The current price is around 20% of this value


Scenario analysis
The above DCF analysis can be done with varying assumptions of growth and net margins.
If the company grows at 8% and has 8% margins during the next 7-8 years, the value is around 3900. This looks like a fairly conservative scenario for the next few years. Even with an extremely low margin of 5% for the next 7-8 years the value comes to 2000.
The above scenarios assume that 2009 and part of 2010 would be bad with net profit dropping by 50%.


conclusion
The company has been priced as if it will be out of business soon. The company is being valued at 250-300 Crs net of cash for all the fixed assets, intellectual property, customer relationships etc. In effect the market is saying that company will shut down in the next 1-2 years.
The credit crisis and subsequent recession in the textile industry is bound to impact companies like LMW. However this is part of a normal business cycle. Capital good are the first to bear the brunt of a recession. However that does not mean that the industry is heading for extinction. The pricing however seems to be pointing to that scenario

Some Q&A
I am putting some possible questions and answers which could be on your mind

Q1: The textile industry is in recession and the outlook is cloudy. Should we not wait till it becomes clear ?
The future is never completely clear. If it was clear in 2007 that the textile industry would be in recession in 2009, the stock price would not have gone up to 3000+. In 2007 the market was pricing the stock for a glorious future and now is pricing for complete disaster. The reality is always in between

Q2: The price could drop further. Should I wait for a better price?
The stock is selling at around 30-40% of intrinsic value. No one can predict how much lower it can go. I personally think bottom fishing is a waste of time. Time and energy should be spent on understanding the company, its industry and the future economics of the company than trying to get the last 10% in terms of price

Q3: All the stock analyst and gurus have sell recommendation on the stock. What makes you think you are right and all the others are wrong?
I don’t know if I am right or not. What I like are the odds. There is a high probability that the company and its stock could do well in the future. How well, I don’t know. I could be wrong too. However this is not the only stock in my portfolio. The reason for having a diversified portfolio is that I may be wrong 30-40% of the time and still do well on an overall basis. In addition the downside on the stock is protected as the company is now selling at very low valuations and is priced for disaster.

Q4: The volumes are low and stock is exhibiting weakness
Lets give the stock some horlicks :) ..how does it matter if you plan to hold the stock for the long term. If the volumes are low and there is weakness, it is a good time to buy. When everything clear up, and optimisim and strenght returns it would a good time to sell.

Q5: The technicals for the stock are weak
Huh !! sorry we are from a different planet !!

43 comments:

Anonymous said...

Thanks Rohit for this nice writup.
I was eagerly waiting for LMW's analysis by you, as it is one of the top stock on my list.
According to my simple DCF calculation, with 8% Owners earning growth for first 7 years, and there after 3% till 10th year, Intrinsic value comes around 3700. Keeping 50% margin o safety I should buy at 1850 or lower side. CMP 700 is around 81% discount to Intrinsic value.
As you mentioned, CMP looks as if company is going to be out of market soon, It won't be the case but surely it will be hammered by the bearish market. I take this as an opportunity to buy in small qty.
Do you think this company can be given portfolio weight of 20% or more? Is this company suitable for aggressive investor?

Thanks for the nice post.
Ani

Rohit Chauhan said...

Hi ani
that one quick comment. almost 30 min after my post.
these days every stock is getting hammered irrespective of the fundamentals, so that LMW is unlikely to be spared.
i cannot comment the portfolio wieghtage ..i personally will not exceed 10% in my case

regards
rohit

Anonymous said...

You probably do not have a long history of the company. The last bull run in textiles was in 1995-1996 when company made revenues of 491.91 Cr and profit of 43.31 Cr in 1994-1995. Now if you compare, the profit has grown by 4 times in not last 5 years but by 6 times in last 13 years, CAGR of 14.7%. The net profit margin went to a low of 2% in 1999 when revenues were 410.82 Cr and profit of 8.41 Cr. Thus there was not just a margin decline but a revenue decline. Your analysis holds true only if the revenue do not decrease. Since it decreased by around 20% last time and then margin went to 2%, considering the same scenario, the company may make 1750 Cr revenue and 35 Cr profit in one of the the next 2-3 years. At today's price, the P/E still stands at 20 when it will do this. I am not saying that the last performance will repeat, it can be better this time, but it can be worse too.

Anonymous said...

Yes,
I am Devotee of ValueInvestorindia,
I check it at home before morning tea, Before B'Fast, Lunch & Eve Snacks In office. and before going to bed in night.

Thanks
Ani

sudhanshoo said...

I do not wish to comment on the fair-value analysis for LMW. However, following risks have been untouched in your post:
(a) The cash on books is the advance that the company takes from its customers. It does generate some additional "other income" for LMW but is not really sustainable. Orders can be deferred and order book can become lean on a YoY basis.
(b) Due to the TUFS, most of the textile companies borrowed cheaply from 2002 to 2007 and invested heavily in upgrading and adding spindles. Thus, LMW went through a great time which can be considered unusual too. The numbers provided about addition of spindles in the company's annual report have been borrowed from Ministry of Textile's reports. Studies can be misleading. Given the high debt on most of the big textile companies and huge historical capex, the chances of another round of capacity addition looks distant. An asset turnover analysis (for last 2-3 years) of the textile companies would support my claim.

What I intend to highlight is that there can be a few more pressures on the business and even the cash lying on the books can get eroded. Nevertheless, its a great company with A-class management and if one is patient enough, it might be a great value pick too.

Neeraj said...

hi Rohit,
have been tracking lmw for quite some time now. can u tell me 1 thing? the company's main product is spindles manufacture. now, what is the replacement period for textile companies to change the spindles? when does the recurring demand occur? in my knowledge, spindles last for 4-5 years before they need to be changed.
thats quite a lot of recurring demand for lmw..
have u done some calcuations on these lines? i am yet to get a clear view on this..
regards
Neeraj

Anonymous said...

Hi Rohit

Few observations

1) Out of 100 crores of investments on books, 80 crores is in JSW steel. Cant figure out the logic here. Also that investment's mark to market would be around 40 crore loss.

2) Fixed asset addition this year has 28 crores of vehicles?

3)I agree with one of the previous comments that the cash on balance sheet is not really free cashflow but advance recived against customers.

Otherwise the business generates fairly decent cashflow and bottomline.

Cheers

Ninad

Rohit Chauhan said...

Hi anonymous
i have seen LMW's performance for the last 10 years. It is provided on the last page of their AR.
In my own DCF analysis i am assuming a 10-20% drop in revenue and 60-70% drop in core income. however the difference from the previous downturn is that company is far more efficient and debt free.

i am not sure how you got a PE of 20. I will remove cash from mcap if i have consider only the core earnings.

so it around 300 crs (net mcap) against an earnings of 50-60. the company still would sell at 3-4 or at the most 5 times depressed earnings.

what i not published is the worst case scenario. Even if you assume a 5% growth and 5% net margins over the next 8-10 years, the value comes to more than 1500

regards
rohit

Rohit Chauhan said...

Hi sundanshoo
good point. A lot of cash on the books is due to advance from the customer. If things go really bad, and the advance order crashes, then we could have a reduction in the cash on hand.
i looked at the old AR and could see that advance was around 10% of revenue (when order book = revenue). so in the worst case scenario if the order book goes below revenue, the advances could drop to as low as 150 Crs. In that case the company would be priced at 10-20% discount.
so it seems the market is pricing the company for the worst case scenario.

On the macro sceanrio, i agree it is bad and could get even more ugly. the price is reflecting a bad scenario for the next 1-2 years

regards
rohit

Rohit Chauhan said...

Hi neeraj
i have not analysed in terms of replacement demand for spindles. do not have information for that. i am going based on whatever the management has said in the AR.

also if the environment becomes worse, then this replacement demand would be hit next (after new capex)

Rohit Chauhan said...

Hi ani
that quite interesting. you are really into investing !!

regards
rohit

Rohit Chauhan said...

hi ninad
i recieved your comment and confirmed it, but cannot find it on the blog

The investment in JSW steel comes from the company's investment in southern steel in 2006. It was done at a 52 week high and i think it was not a good investment. we are looking at 20-25 cr loss on it although the company has not recognized it.

28 crs on vehicle is strange, but no worrying.

also the depreciation charge of the company seems excessive at almost 9% of fixed asset and should come down in the future

regards
rohit

Rohit Chauhan said...

i would not count the customer advance in the free cash flow. the advance varies with the order book, but this advance on an average helps in reducing the amount of invested capital

Amar Narayanan said...

Hi Rohit,

Phenomenally concise analysis... I have been tracking LMW for quite some time and have purchased quite a few shares of it in the last few weeks (a big chunk being in the last few days). So my money is where my mouth is :)

I believe there is one thing that you have marginally overlooked... LMW has a phenomenal economic moat... a moat with alligators and crocs actually! All textile manufacturers have faced significant input cost pressures over the past 24 months. While imported machinery has seen its prices being raised several times in this period, LMW has kept it constant largely by internal efficiencies and higher utilization rates. The differential is now so pronounced that LMW's products are about 30% cheaper than imports. Thats a significant competitive advantage by way of an attractive price-value proposition. further, LMW's widespread after-sales network ensures that LMW remains very competitive in the minds of its customers. LMW remains the price setter in this industry, not the price taker.

Also, management has a reputation for being honest and super-efficient. I would like to believe that the management would be as well-equipped to handle a downturn as anybody else.

Amar Narayanan said...

Hi ani,

I dont think you should really worry about putting 10-20% of your net worth in a single position. I know this is contrary to conventional opinion, but I think it deserves some attention.

Buffett and Munger are on record advocating putting a large share of net worth in a single position. Buffett has mentioned that he has frequently had 50% or more (75% in one instance) in a single position in his early days. Munger retorted by saying he had once over 100% in a single position. The point is that when a particular investment idea gives u the conviction that others dont, it is just as sensible to put as much money as practicable in that one position. I personally would advocate a lot more than 20% in a position if you have the conviction to back it up.

As Buffett says, you just need 10 investment ideas in a lifetime to get you very rich. And he himself admits that a large chunk of his success has been the result of about 12 super investment ideas.

Comments welcome

Anonymous said...

Thanks Amar,
I remember the example (By WB?) of Punching card with 20 ticks over a lifetime.
I am fully convinced with the idea of putting large money into focused or concentrated portfolio IF & Only IF one understood the businesses well and have confidence and the conviction about it.

regards
Ani

Shunya said...

Hi Rohit,
I m a big fan of your style of analyzing stocks. I believe its now a time to take contrarian call on real estate . Can you please analyze some real estate stocks which are now showing value particularly mid segment companies. For example ,Prajay Engineers has fallen from 480 to 20 odd levels now.Is it worth buying now??

Anonymous said...

I think i have answers to some of the questions above :
1. About 80% of the RM for lmw is steel. So probably the investment in JSW steel is for securing raw material supplies (maybe even at preferential rates)
2. LMW takes a 10% advance on orders at the time of booking & the rest at the time of delivery. The bill is priced at the price ruling at the time of delivery. If the order is cancelled then the advance is forfeited.
3. These bad times may turn out to be good times for LMW as it will able to grab market share from smaller unorganised players.
4. The management is admitting that they are facing downsizing of orders from their customers.
5. The replacement cost of the current installed capacity of LMW is over 4000 cr. We are getting that at a depreciated value of 500 cr.

SKN said...

Great Post Rohit. I have been doing some valuations of Asian Electronics, SPEL Semi conductors, HDIL, Gujarat NRE Coke and ICSA. What do you think of these? Are you following any of these scrips?

Sachin Purohit said...

Hi,
Based on value-investing, what do you think about MTNL? It is sitting on a lot of cash or cash-equivalent per share as compared to its current share price. Its core business has been ailing since quite some time. But, the price seems to have been beaten down way below its intrinsic value.

Anonymous said...

Hello Rohit,

One general question: what do you make of companies whose majority shareholders are the promoters? Sometimes over 70%? And, what if the owners of the companies are, say, Europeans?

Even if the numbers on the reports are good, will you give it a pass? Or do you think they are good buys?

Regards, Prashanth

Rohit Chauhan said...

Hi amar
i agree LMW has strong position in the industry. As the industry slows and the pain spreads, LMW should gain on the smaller competitor. the company has more staying power.
regarding concentrating your investments, i understand buffett/munger approach but do not follow it as i do not have the level of confidence which they (which is why they are such great investors).
as a result i like to hedge my bets and diversify more

regards
rohit

Rohit Chauhan said...

shunya
i have never looked at real estate companies. they are beyond my understanding and i cannot value them. i may look at them some time, but i am personally not in a hurry to invest in them. there are much more attractive opportunities out there

regards
rohit

Rohit Chauhan said...

anonymous- thanks for your comments on the open questions.

skn - i have analysed any other companies you mention except icsa ..which i have looked at briefly and need to analyse further

regards
rohit

Rohit Chauhan said...

sachin
i looked at MTNL a few years back and gave it a pass. their core business is worsening. i feel the company could be a value trap.

prashant
i do not have a hard and fast rule around that. typically in india such large shareholding has results in poor governance record. for very shareholding there is a risk of delisiting at a poor price. this is a subjective call...you have to look at the management record to make a decision

regards
rohit

Vic said...

Rohit,

Have you started building positions in this? or waiting for it to get cheaper?

It is getting closer to Rs 600 mark..only downward trend.

Thanks,

Vikas

Vic said...

Rohit,

I like Vivek (from TED's) input on stocks as well. He gave the following top picks alongwith his reasons:

ONGC
ITC
Castrol
Voith paper
Foseco india
Shipping Corporation
Goodyear
Great eastern Shipping

In addition to your Glaxo and Balmer Lawrie.

Can you please analyze some of these?

Thanks,

Vikas

Vic said...

Rohit,

I see that you analyzed Glaxo Con sometime back when it was trading @ 20-30% discount.

Would u know current discount at this point? or point me to a link.

Thanks,

Vikas

Anonymous said...

Hi Rohit,
I have done small calculation about GSK Consumer, Please correct me if i am wrong. and please let me know if it falls in line with your Current valuation for GSK.
1) Earnings growth for 7 years - 10%
2) Next 3 year growth - 5%

With this my DCF calculation gives me Per share Intrinsci value Rs. 800
So CMP is at 27% Discount.
If i stick to 50% margine of Safety, i should buy GSK below Rs. 399.

If you provide your numbers then that will help me to cross check my calculations and correct the mistakes if any.

Thanks
Ani

Rohit Chauhan said...

vikas
yes, LMW is below my estimates so i am building a position. if i am bullish about the company and find it cheap ..would be foolish if i didnt do that.
glaxo cons is still 20-30% discount by my estimates. however there are cheaper opportunities out there


ani - my estimate is around 850 ..so we are very close. key is whether are assumptions are good

regards
rohit

Vic said...

Thanks Rohit, I appreciate your feedback very much.

Vikas

Anonymous said...

Hi Rohit,

It's a really nice analysis about LMW. After going through your analysis I am planning to buy few tickets of LMW gradually. But I have one query. As per the current Textile industry forcast, the industry which was growing 12-15% since last few years is going for a 10_20% negative growth for at least next 1- 1.5 years. And that has already been prooved in the recent Qrtly Result of LMW. Since a bear market generally do not value fundamentals, so are we going to get a much cheaper LMW in near future? If there is any such possibility, then it may be a better decision to wait for at least 1 more Qrtly Results when the expected negative results will come up and may bring down the CMP of LMW. What is your opinion regarding this? Will appreciate any feedback from you !

Thanks
gcpradhan1

Rohit Chauhan said...

hi gcpradhan

i really do not know the exact forecast for the textile market ..though i agree the next 1-2 years could be tough

markets generally discount 1-2 years of forward performance , so sometime it is not possible to time a stock precisely.

i personally dont try to catch the absolute bottom. if the current price is compelling, i go ahead with the purchase even if i have a short term losses in the interimn

regards
rohit

Anonymous said...

Thanks Rohit ! Got the point. Yes in market whether bear or bull it is almost impossible to get the timing perfect. As WB rightly said [So if you wait for the robins, spring will be over].

Anonymous said...

Hi Rohit,

What do you think about the fundamentals of this stock after the drop in earnings now. I feel there is lot of value now in this stock except that its future earnings would only depend on the whole textile industry revival. Just wanted to know your thoughts about this scrip and if you find that anything has changed fundamentally.
Cheers
Ravi

KD said...

Hi Rohit,
I was searching for historical data on LMW and landed to your Blog. Read this review and intersting comments on the same. Thanks for this. Do you know from where can I dounload LMW annual reports? I tries company sites and two other data sites, but they have only published two pages under "annual report" rather than the book.
Ketan

Rohit Chauhan said...

hi ketan
welcome to the blog. if i remember correctly, i downloaded all the AR from the company's website

regards
rohit

Rohit Chauhan said...

hi ravi
nothing has changed fundamentally. the company is performing as i expected ..poor short term performance and the price is discounting that and more. long term the company should do well (atleast thats the expectation)

regards
rohit

KD said...

Good Morning, Rohit.
Thanks for the reply. I was searching from the site, but could not find any AR, just press release is available. Let me try again.

Atul said...

Annual Report could also be downloaded from the site: http://www.sebiedifar.nic.in/
Click on the field 'Annual Report' and then choose 'Lakshmi Machine Works Ltd' from the list of companies.

Ashutosh said...

Hi Rohit,

I have a portfolio checkup on TED with name of Ashutosh.Can you also give some of your time in there and commenting on it.

Recently I have bought Marksans Pharma. DO you think will it fair well ??

Neeraj said...

Hi Rohit..
Terrible results from LMW...u must surely have seen them urslf..
what worries me more than the results is the absence of any growth prospects..
whats your plan of action now? would u lower ur estimate of 'intrinsic value' drastically?

regards
neeraj

Rohit Chauhan said...

Hi neeraj
the poor results were expected and priced in.

i dont see any reason as of now to lower my estimate of intrinsic value

lmw is in a cyclical industry and is bound to get hurt in a slowdown

why do you think there are no growth prospects in the long run ? ofcourse in the short run the company could struggle for growth till the textile industry revives itself