January 14, 2009

Stock analysis - Ingersoll rand

About
Ingersoll Rand (india) is a subsidiary of Ingersoll rand (US) with a 75% holding of the parent company. The main business (after all the disposals) of the company is air solutions – mainly compressors and other instruments such as air dryers, filters, after-coolers, receivers, water separators, etc.

Financials
The company has been disposed off three businesses in the last 3 years. This includes the road development, utility equipment, Bobcat business and climate control business. The company has realised a pre-tax profit of almost 217 crs in the last 3 years.
Due to the above developments, the topline of the company is not comparable across the years. The remaining business – airsolutions seems to be growing at double digits for the last few years. The net margins of the company has improved to almost 10% (which could be cylical high) and the ROE has leaped from a good 20%+ to 70%+ number (net of surplus cash on the balance sheet).
The improvement in the ROE has come via improvement in margins and asset turns (both inventory and recievables ratios have shown improvements in the last 4 years).

Positives
The company’s balance sheet looks extremely good. Almost 80% of the balance is cash and equivalents. Part of this cash is from the sale of the various businesses and rest has come from the free cash flow of the business. The core business of the company is throwing off a good amount of cash with low Capex requirements.
The company has become more efficient via a combination of improvement in margins (which may drop) and improvement in various ratios (due to improvement of efficiencies).
The air solutions business has been showing decent growth in the last few years. This growth may slow down in the short to medium term, but should remain good over the long term. In addition the valuations of the company are very attractive. The business is selling for 1-2 times the current years earnings (excluding cash).

Risks
The business risk seem to be low. There are 3-4 competitors in this business like Elgi equipment, Atlas copco etc. However the level of competition has not been intense. However with such high growth rates and returns, foreign competition is being expected. This may result in lower returns and low growth in the future. The valuation however discounts this and more currently.

There are several risks for the minority shareholders. The key risk in my opinion is that the company is a 75% subsidairy of an MNC. The parent company has an unlisted company in india and there is a clear conflict of interest. My personal experience with such type of situations has been bad. The minority shareholders in such cases have suffered from poor governance, poor utilization of excess cash (cash continues to lie in the balance sheet with no clear plans) and no special focus from the parent company. In some cases the parent has bought out the minority holders at an unfair price.

In addition, the Annual report is sketchy in terms of the future plans for the business and how the excess capital will be utilized.

Competitive analysis
The main competitors of Ingersoll Rand are Atlas Copco and Elgi equipment. Atlas Copco is twice the size of Ingersoll rand and Elgi equipment is roughly the same size as Ingersoll rand. The various financial parameters such as Net margins, ROE, Sales etc are similar for Elgi and Ingersoll rand. Ingersoll rand is slightly cheaper than Elgi equipment. However the elgi management seems more focussed on the growth of the business (as atleast they are more articulate about it) and have aggressive growth plans for the domestic and international markets, so that may explain the difference in the valuations.
By various measures even Elgi equipment seems to be cheap and it can be preferred over Ingersoll on qualitative parameters
Atlas copco has similar margins (10%), higher turnover (twice) and lower efficiency ratios (ROE of around 20%) . The valuation for Atlas is however much higher than the other two companies and can be used as a reference point for comparitive valuation

Valuation
The company net of cash is selling at 1-2 times of the free cash flow. At the current rate, the business would be a cash bargain in the next 1-2 years. From a pure, numbers point of view, the stock is undervalued by a decent margin.

Conclusion
The company looks cheap and undervalued by quantitative measures. The core business is growing and should pick up steam once the economy recovers. However there are quite a few small things, which make me uncomfortable from a subjective standpoint. The management has no interest in communicating with minority shareholders (who are less than 25%) on the future plans for the business, the cash holding etc.

In addition the parent has an unlisted subsidiary, which is generally not a good thing for the indian shareholder. If I were to consider this company, it would be part of my graham style portfolio and not the core due to above issues.

Additional point: I did this analysis before the satyam issue. There is no change in my analysis due to the above incident. Having cash on the balance is not a red flag for fraud. One cannot invest based on the assumption that all companies are committing a fraud, unless proven otherwise.

Please read disclaimer

12 comments:

Sachin Purohit said...

The parent company infact seems to have made its intention known way back in 2005 to have complete control over this subsidiary.
http://investor.shareholder.com/ir/releasedetail.cfm?ReleaseID=170680

But strangely, it seems to have offered 325/share whereas the price currently is much less than that. Obviously this earlier offer to buy back the shares seems to have failed for some reason. But the intention of the company is known.

Rohit Chauhan said...

hi sachin
the buyback offer was sometime back. if i remember correctly it has to be higher than the highest price for the last 26 weeks. the company tried a book building option at 325/ share, however the minority shareholders found the price to be too low and hence did not tender the shares. thats the reason for the failure.
since then the stock price has dropped due to bear market.
i wont be surprised if management tries the above stunt again
regards
rohit

hardtoget said...

Hi Rohit,

want to direct your attention to an article written by Prof Sanjay Bakshi in Outlook Profit(23 Jan 2009).
Some details concerning HTMT Global might be of Interest.

Regards
Harold

Rohit Chauhan said...

hi harold
could not find the article. do you the link or the details ?

regards
rohit

Kannan said...

http://ttrammohan.blogspot.com/2009/01/satyams-ex-independent-directors.html
http://ttrammohan.blogspot.com/2009/01/independent-directors-and-consulting.html

Bharat said...

Dear Rohit,

A small request - pls. also include a section on founders/Management. Who they are, what they did and what they will do. What their vision is for Ingersoll etc. I think that's the most important lesson one needs to carry from Satyam.

Also, if there are any arbitrage opportunities for the future.

Regards.

Rohit Chauhan said...

Hi kannan
i agree the independent directors should be held accountable, however the bigger crime was committed by the management. with independent directors it is unfortunately 'whose bread i eat, his song i sing'. there are several other pyschological baises which prevent them from speaking out (that does not absolve them though)

interestingly though a lot of people are rooting for raju ...hmmm - if i rob 100 rs i get beaten up, but if i rob 1000 crs people will root for me

regards
rohit

Rohit Chauhan said...

bharat
excellent point. i have added comments on the management quality for this analysis. i have done this analysis in the past, but not written explicitly about. however i will add these points to the analysis too

i dont see any arbitrage opportunity now. buyback is only a speculation and one cannot arbitrage based on that for ingersoll

regards
rohit

Anonymous said...

Rohit

After the recent issue with Siemens' apparent sale of its IT division to its Parent company at a discounted price, we should be cautious while buying shares of any company with a foreign Parent. These Parent companies are majority Shareholders, but they are ripping off minority Shareholders. They appear not to be concenred about market perception. The stock dropped 30%! But may be as a long term promoter, they were not too concerned and were hoping that "naive" indian investors would bid up prices anyway within a while.We need something in the law to preventthis kind of "dealing".

By the way, Do you have the annual reports for Atlas Copco? I couldnt find them anywhere. Atlas reported other income of 862 million. I would like to know the nature of this other Income.

- Santosh

Rohit Chauhan said...

hi santosh
i heard about siemens ..but did not know the details.
why am i not surprised ?MNC managements are equally bad and some absolute @##$@ or thieves.
they dont give a damn about the minority shareholders and some are as bad as satyam management - robbing the minority shareholder in broad daylight ..but legally .
read the annual reports of some these companies and you will get an idea of what i am saying
regards
rohit

Anonymous said...

Rohit

--Repeat from earlier comment---
By the way, Do you have the annual reports for Atlas Copco? I couldnt find them anywhere. Atlas reported other income of 862 million. I would like to know the nature of this other Income
--End repeat --

It appearsto be recurring on the Income Statement, but the other income may invalidate your assumption of ROE of 20% of Atlas. Thats the reason I am asking ifyou have a copy of the Annual report. I went to Atlas Copco website,but the only Annual Report they publish is for the parent, which is presented in Krona(Swedish currency). Is the Annual Report for the Indian company published somewhere? If so could you point that to me?

-Santosh

Rohit Chauhan said...

hi santosh
i dont have access to the annual report of atlas copco. have you checked the edifar website ?

regards
rohit