September 2, 2011

Two differing ideas – Akzo nobel and Techno fab engineering

I have a constant struggle in my mind – Do I pay for quality (overpay?) or do I buy cheap stuff, which may turn out to be a value trap.
The ideal situation would be to get a high quality stock at a cheap price. But then if wishes were horses!, I would be a good looking billionaire with my own private island J.
So let’s look at my current dilemma
Akzo nobel
Akzo nobel is a global company in the business of decorative and auto paints and other industrial chemicals. The company acquired ICI plc a few years back and thus got the Indian business of ICI with the acquisition.
 ICI paints (atleast in the late 90s) was a company with good brands and was fairly aggressive in the paints business. At one point, they even tried to acquire asian paints by buying out the stake of one of the promoters.
ICI paints is one of the oldest paint companies in India and is fairly strong in geographical pockets (West Bengal) and in specific products (premium paints). The company has however not been able to capitalize on its strength in the past and did not seem to have a focused strategy. The new management however seems to be developing a focused strategy of introducing new products, expanding distribution and spending on brand building.
The paints business is a very profitable business with very high entry barrier (I saw this first hand when I was working in the industry). As a result, most of the companies in this business have enjoyed above average growth and high returns on capital
Akzo nobel india has a Return on capital of 100%+ (excluding excess cash on the books) and has been able to grow the topline  and profit by 30% in the last 5 years . In addition the company has been shedding the non-core businesses and freeing up capital. The company is also investing in manpower, its brands and expanding its distribution.
My hesitation in investing is the valuation. If one excludes cash, the company is selling at around 18-19 times earnings. On a comparative basis, the company is cheaper than other paint companies such as asian paints (around 30 times earnings). However I don’t believe much in comparative valuations and find the current valuation a bit high compared to the prospects.
Techno fab engineering
Technofab engineering is in the EPC space and is involved in various turnkey engineering projects in  industries such as power, industrial and oil & gas.
The company came out with an IPO in 2010 at a price of around 235 per share. The stock currently sells at around 142 / share (selling below the IPO price does not mean it is a bargain!)
The company has been in this business from 1970s. The company has grown its topline and profit by more than 30% per annum in the last five years (which means that in the past the business barely grew). The company clocked a turnover of around 290 Cr in 2011 and has around 900 Crs open order book (almost 3 yr visibility)
In addition to the above, the company has around 100 Crs of cash on the books (some of it due to the IPO) which will be invested in expanding capacity to manage the higher order volumes. The company is thus selling at around 2 times earnings, has shown 30% growth in the recent past and delivered a 30%+ return on capital during this period.
The company looks like a complete bargain?
I am not so sure. The EPC industry is characterized by moderate to low entry barriers, high levels of competition (from the likes of L&T and others) and high working capital needs. In addition it is also a very cyclical industry with drop in margins and cash flows during the down cycle.
The dilemma
So the dilemma is whether to invest in an above average business which may be fully priced or in an average business which is very attractively priced.
There is no obvious answer in the above case and it depends on each individual’s mindset. I have invested in technofab types of businesses  in the past with decent, though unspectacular results. In contrast if I am able to invest in a good business at decent prices , then the returns are fantastic
I have not made up my mind yet and have no position in either stock. I plan to dig deeper into Technofab engineering to get a better picture of the industry.
It is quite likely that I will just file away these companies and watch them till either the price is better (in case of akzo noble) or the business quality improves (in case of technofab engineering).

19 comments:

Vikas said...

Hi Rohit,
Again an excellent post.
Just tells how the serious retail investor ( not speculator) is feeling in the current market.
So much dilemma in the mind.
Whether to go for value investing / excellent business at fair prices.
Books say value investing (means investing in low P/BV OR low P/E ratio stocks) give above market returns irrespective of the business.
And on other hand both Warren Buffett & Charlie Munger say - ' Its far better to invest in an excellent business at fair price that in a fair business at excellent price.

In current market, the prices have come down but the excellent businesses still look overvalued.
And dont have the daring to invest in value mid-caps.

Other dilemma which I personally feel is - Whether to follow Rakesh Jhunjhunwala or not.

His investments in say SREI infra / Delta Corp are confusing.
Means he is not fool to invest huge amounts in these companies. The Delta Corp business also looks good but is still over-priced.

So BIG DILEMMAS!!!

But still request you to tell us some excellent business at fair valuation.

Regards,
Vikas

Anonymous said...

Hi,

When in doubt , be in cash.
You can always buy later if its a great company. (check Peter Lynch on Coke)

Regards
Vishnu

Rohan said...

Hey Rohit!! Though Techno fab has been achieving good results since recent past but for future it might require heavy capital expenditures to sustain these results. looks a graham stock, neglected but some puff left to smoke.! Interesting scenario, would love to dig in more. Thanks for sharing!

Anonymous said...

This comparison reminds me of a warren buffet quote
"It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price"

Akzo Nobel is No1 in the world in paints has aggressive five year plans in india.

http://www.paintsquare.com/news/?fuseaction=view&id=5068

Regards,
Ananth

Anonymous said...

What do you think about for profit education companies since they have all taken a beating ...

Vic said...

Hi Rohit,

Another excellent post.

It is so true, makes investing difficult..:-) e.g. if you look at Asian Paints or CRISIL: PE is still high even though there is a decent correction.

On the contrary, several mid caps are beaten down and trading at their 52 week lows.

I wish we get 2008 again..:-)

Thanks,

Vikas

kumar said...

I am always sceptical when it comes to MNCs in India. They are not interested in Indian shareholders, their primary focus lies with the interest of the parent company. And their record has already proved it. So, I stay away from MNCs.

Rohit Chauhan said...

Hi vikas
i think one should follow one's convictions ..i remeber seeing VIP industries 2-3 yrs back which an RJ holding. could not see value there and hence did not buy. I missed a 10 bagger, but dont regret it as i did not have the skill then to see the value in this kind of stock

rgds
rohit

Rohit Chauhan said...

Hi vishnu
thats true ..except you can take that too far too.end of the day there will always be some risk and one can never be a 100% confident

rgds
rohit

Rohit Chauhan said...

Hi rohan
I dont think its a graham stock ..it is priced like one though. it is growing well ..if it can maintain the same growth rate , it can be a multi-bagger

rgds
rohit

Rohit Chauhan said...

Hi anath
ICI india has had aggresive plans for the last 15+ yrs and still have not gone anywhere ..hopefully the new management will be better. at the same time, it is one thing to have aggresive plans and another to be successful. paint marketing is not easy and you cannot unseat asian paints so easily

about this i am very sure as i worked at the ground level for 4+ yrs and saw a lot of competitors try and fail. since then apaints have grown stronger ..so not easy for akzo ..but then can gain mkt share from the other paint companies

rgds
rohit

Rohit Chauhan said...

hi anon
i am looking at for profit companies ...but this sector is similar to real estate sector - full of rotten apples and bad practices

rgds
rohit

Rohit Chauhan said...

Hi vic
be careful what you wish for ..you may get it :)

if 2008 happens, then we may lose our jobs but find good bargains in the market :)

rgds
rohit

Rohit Chauhan said...

Hi kumar
I have had bad experience with several MNC's too, but would not paint everyone with the same brush. i would not label a company and rather look at the actions of the management to tag it so

rgds
rohit

Anonymous said...

Hi Rohit,

Thanks for your response.

I was looking at the latest result for Akzo (Q1FY12). Their topline grew 20% but operating profit (if you ignore other income) looks to be flat.

Do they have good pricing power in the market ?

I compared with Asian paints. They seem to zooming ahead. May be that is why they get high PE.

How would you classify Akzo Nobel as ? is it consumption story related or real estate related which means it is linked to interest rates and hence cylical ?

Regards,
Ananth

prakash said...

Hi,
Please don't treat all MNC's the same.Some MNC's operates business in India through listed and unlisted entities.New products are launching only through unlisted entities .It's not at all ethical.Investor's in these MNC's lose.Big ex is Proctor.Only whisper ,wicks two products in listed and huge brands like Tide,Ariel and all sucessful FMCG products in unlisted entity.Other good examples are Merck,Honeywell,Novartis.

But some are operating business through listed entities only.With technological support from parent,clean & good balance sheet,great dividends these are wealth creators.
Ex.3m,Esab,Glaxo,Nestle Etc.

Vic said...

Hi Rohit,

I agree with you 100% on sticking to one's own convictions. I have noticed that you're getting better at it..:-) which is a great thing.

I think another 2008 might not be so bad for you after all..:-) If one door closes, another opens. At least you will have a good excuse for your wife to pursue investing full time :-).

Vikas

prakash said...

Hi Rohit,
I am not able find Annual report of Technofab.It's true that there is 100 cr cash in balance sheet.In the same way liabilities increased from 36 cr to 124 cr.What does it mean.If you have the annual report please share with me and comment on it.

Vikas said...

Hi Rohit & Fellow-Bloggers,
Posting below the link of Radhakishan Damani's ( Rakesh Jhunjhunwala's Mentor)stock portfolio

http://www.rmdhar.com/index.php/2011/09/11/radhakishan-damanis-multibagger-stock-portfolio-picks/

Regards,
Vikas