April 1, 2010

Analysis - Facor alloys

About
Facor alloys is in the business of chrome alloys, which is used in the production of steel. The company has a capacity of 70,000 MT (industry capacity - 7 lac MT) and is located in Andhra Pradesh. The company emerged from a demerger of the FACOR group in 2004

Financials
The company was created by the demerger of the FACOR group into three companies, one of which was Facor alloys. The company had accumulated losses and underwent a restructuring exercise during the initial years. The current promoters for the company injected funds into the company and the debt was also restructured in the initial years
The company has since then turned around its performance. The debt has been wiped off and the preference capital has also been paid off. In addition the company, now has cash balance in excess of 30 crs which is around 25% of its market cap. The company has more than doubled its topline in the last 6 years and net profits have gone up considerably too. In addition the asset turns have reduced and Working capital turns have remained steady. All in all the asset efficiency has improved in the last 6 years.

Positives
There are several positives for the company. The company has a strong balance sheet. In addition the steel market which is the consumer industry for the company’s product is growing in excess of 7-8% and hence the company should see adequate demand for its product.
Chrome ore and power are the key raw material for the company. The company has ample cash on the books which it is planning to utilize to invest in a group company to access captive power. In addition the company is also in the process of acquiring chrome mines to gain access to reasonable priced ore. These two developments should provide some hedge to fluctuations in the price of the end product.
The management has also been sensible in allocating capital and has turned around the financials of the company. The company also has accumulated losses which should help in reducing the tax outflow and improve the cash flow for the company.

Risks
The company faces a lot of risk. The industry in which the company operates is a price competitive commodity industry. This industry has low to non-existent pricing power and minor competitive advantage from scale of operations. Due to the nature of the industry, most companies in this industry are unlikely to make high returns over a business cycle.
The company is a much smaller player with exports to various markets across the world. However the Chinese market has considerable impact on the steel demand and hence any slowdown in china could hurt the company, both directly and in-directly.
The company was re-structured in the past and has worked to turn the business around. Although small, there is always a chance that the performance could turn south again

Competitive analysis
The industry is a competitive, commodity type cyclical industry. There are a lot of small companies in this industry in india. Finally the Indian companies are at a cost disadvantage with respect to their south African competitors who have access to low cost power and better ore quality.
The pricing in the industry is determined by the demand supply situation and is also based on the mid to long term contracts with the steel manufacturers.

Management quality checklist

- Management compensation : fairly reasonable at less than 1% of sales
- Capital allocation record : fairly good for the last 6 years
- Shareholder communication – average
- Accounting practice : appears conservative
- Conflict of interest: none that I could see. The company has access to low cost ore from sister company
- Performance track record : appears good for the last 6 years. However industry economics are bad

Valuation
The net margins and the topline growth of the company maybe at a cyclical high. The fair value of the company is between 7-10 if one assumes that the normalized margins are in the region of 6-8% and the growth will average 8-10%. The reason for having a range is that it is difficult to pinpoint a single number as ‘the’ margin or topline growth and peg a fair value to it.
In terms of comparison to other companies in the sector, the company is selling at a 30-40% discount to other companies in the sector.

conclusion
If you search the internet on this company, you are likely to find this stock being touted the next microcap to make you rich. I have seen price targets ranging from 12-15 rs in the next 6 month. The geniuses giving these price target don’t know what they are going to eat tomorrow, but know what the stock price would be. It is still debatable who is the bigger idiot – the one giving the price target or the one acting on it.
I have personally created a small starter position in the company as I am now focused on learning and analyzing small cap and commodity type companies. These companies involve a different approach and mindset. The stock price is very volatile due to the nature of the industry and the size of the company involved. As a result, my estimate of fair value is not more than 9-10 in the best of the circumstances.
The stock can provide decent returns if the demand supply situation remains stable in the next 1-2 years and the company executes well. However, as I said before, if you want to build castles in the air and daydream then there are a lot of geniuses in the market ready to sell you a nice price target.

15 comments:

ramurthy said...

believe me if i have this knack of getting this information and compiling i will be the happiest man.I want to do myself like this.I dont know how to do.For ennore coke i want to do like this.i am a regular reader of your blog.please continue ur service.i learned a lot from u

Anonymous said...

Hi Rohit,

I am an extreme novice investor so feel free to correct my analysis. Disclaimer aside, here it goes..

It seems that the right way to calculate the intrinsic value would be take into account proven resources and multiply it with the commodity price subtracting for the cost of production. While I haven't done that it does seem this is a play on commodity price - no?

Comments?
Gaurav

Anonymous said...

Hi

My father used to work for this company. The promoter family does not have a capable manager who overlooks the business and they are not interested in minority shareholders and don't know what corporate governance is (for ex a certain component of salary to the employees is in cash).
This company struggled for a long time and the only thing that has helped it do well despite all the wrong things that they have done is high chrome prices. To sum it up it is a very dangerous play on the chrome prices which buy the way Mr. Mittal had famously said before the crisis where the next big issue that steel industry faces after iron ore prices. I would say you are playing with fire. Stay away.

Sachin Purohit said...

I had glanced through this company's financials, a week ago. The first impression I had was that this business has just come out of a mess that the group from which it demerged. There is not any adequate data to be able to find its management's or its business model's merits or demerits. I did not go any further on analyzing Facor.

There are some other interesting businesses I had an opportunity to glance through in the small-cap segment. Would like to get your views on Mazda Ltd, Anuh Pharma and Kabra Extrusion.

Rohit Chauhan said...

hi rammurthy
i dont think its a knack. i look at annual reports and use google. and there is still a long way to go for me. but i think i am moving in the right direction and should keep improving. holds true for others too

rgds
rohit

Rohit Chauhan said...

hi gaurav
that would work in case the company owned mines. in this case facor does processing and hence one cannot do asset based valuation.
you are right on the price part of it. in case of all commodity companies, price is critical. if chrome alloy price were to crash, the stock price would too

as of now ferro chrome price are up 60% from the bottoms, but still around 10% higher from 3 yrs back. so inflation adjusted they are now at the same levels as 3 yrs back. as a result i feel and ofcourse dont know for sure, that the price may not crash from these levels
rgds
rohit

Rohit Chauhan said...

Hi anon
i believe you. i have no pretensions on the management qlty. i have stated that in my post also. that said, corporate governance is an issue with almost all microcaps. the point is, can one value such stocks and still profit from them over the mid to long term.

my small position and analysis is to explore that. i have no plans of making this bigger postion at all

rgds
rohit

Rohit Chauhan said...

hi sachin
thats true ..it was a basket case - aka BIFR case. however they appear to have turned around in the last 6-7 yrs. is this sustainable or a fluke ? cant say
hence the risk is high. finally this is more of an exploratory position for me, not a serious one

let me look at the other companies u mentioned
rgds
rohit

sms guy said...

hey rohit gr8 work

pls have a look at compact disc
and vst industries
looks good

Sachin Purohit said...

@sms guy..
Compact Disc is scam of a company. None of the movies/telefilms/animations that they have mentioned in their annual reports have ever happened. Its a very shady company and its promoters have got criminal cases against them. They have a dubious track-record of floating companies, siphoning off the funds and then closing down that venture and float another one. Stay away from this company.

Anonymous said...

Hi Rohit,

Thanks for responding. Since the company is into processing, it should be about volume processed no? I would imagine that the margin they enjoy would not differ much.

As for the price according to Indian inflation, I think that's not a completely correct argument, since the prices are mostly set due to international movements and right now heavily dependent on China's demand. It might be profitable (or not) but I am not sure if comparing price to Indian inflation is a valid one.

Regards,
Gaurav

Aniruddha said...

Rohit,
ArcelorMittal eyes stake in Ferro Alloys Corp‎. Yesterday BS published this news.

http://www.business-standard.com/india/news/arcelormittal-eyes-stake-in-ferro-alloys-corp/392465/

What is your analysis about Facor considering this news?

Is it OK to truck load the Facor ?

regards
Ani

Rohit Chauhan said...

Hi ani
i have seen the same news and planning to post. however i would base my decision on such talks alone. one has to be convinced about the stock

rgds
rohit

Nishant Varma said...

Hi Rohit ,

The company is making a return of approx 10-20 crores annually and the asset turnover ratio is a very good one . Currently it has plans to diversify into Facor Power and has had made investments in this direction . I feel the company has potential to go to 8-9 on a conservative side . Besides , Facor Alloys seems to have no expansion plans on core business but the power investment seems to be a different business plan . Overall I feel it is a good stock to hold with decent return . Please comment on your current take on FA

Vishesh said...

Hii Rohit,

I have also bought Facor Alloy @ 7 few months back... it then went to 5 odd levels but managed to get back around 7... what shall be the target?