January 29, 2012

A bet on china : MOIL

This title must have made you wonder – now what leap of logic is this guy having here ?
Let me walk through the logic to prove to you that I have not lost my marbles (not yet !)
An IPO and frenzy
MOIL came out with an IPO in late 2010 and there was quite a bit of frenzy around it. I think the IPO got oversubscribed by 25 times which shows the level of investor enthusiasm. In my case, I have a personal rule – I never invest in an IPO ( I have written the reason here). As 80% of the IPOs are overpriced and quite a few are junk anyway, I would rather miss a few good chances than be stuck with a lot of duds.
I was asked about MOIL then by a lot of readers on the blog, and due to the above reason I did not look closely at the company.
So why now ? The simple reason is that the stock has dropped quite a bit since then and investor sentiment is a bit negative now. Any time a stock drops or almost everyone gets negative on something, you will find me fishing in that area.
Why the drop ?
MOIL is a mining company and derives almost 80-90% topline and profit from manganese ore. Manganese is a key input in steel making and hence the demand and price for manganese depends on the demand outlook for steel.
MOIL has very high operating leverage. The PBT/ sales ratio has fluctuated between 48% in 2007 to as high as 78% in 2009. The profitability in case of MOIL is highly correlated to manganese prices and due to low levels of operating costs (minimal raw material and manpower cost) in proportion to the sales, any rise in manganese price flows directly to the net profit.
In times of high demand and lower supplies of manganese, the international price for the same has gone up by 30-40% and driven up the profitability for the company. The company was coming off such a peak at the time of the IPO.
In a commodity business, high prices result in capacity addition which in turn drives down the price of the commodity. In case of manganese, South Africa and Australia are big producers  and have increased supply in the recent past. India imports manganese ore as the domestic supply is inadequate for the steel making and for making Ferro alloys (which are exported). As a result, the price of manganese in India is dependent on the international price.
The international prices for Manganese has dropped from their peak levels and so has the profit level for MOIL. Hence the drop in the stock price
So where does china come in ?
I hope you have followed my logic till now – manganese is used in steel making, South Africa and Australia are big producers, India imports manganese and hence manganese prices in india are dependent on international prices, which have dropped in the recent months
So what drives international prices for manganese ? China !
 China account for 50%+ of steel demand globally and is largest consumer of manganese. If china grows, demand and price for manganese goes up. If china slows down or has a hard landing (as some are suspecting), then steel and manganese demand will drop and so will the prices
Sooooo…the profitability in case of MOIL is tied closely to what happens in china
Should you buy MOIL?
If you have a view on what will happen in china in the next 1-2 years, then you may be able to make a decision. In my case, I cannot predict what will happen to the Chinese economy, Indian economy and Indian cricket team (maybe Indian cricket team !) and so I will stay away.
At the same time in the longer run as the company adds more mining capacity and acquires new mines (using the 2000 Crs cash on the book), it will become more valuable. At a certain price, the market may discount a further drop in manganese price and more . I will definitely start looking at the company more closely when everyone thinks it is the worst possible stock.

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer at the bottom of blog.

3 comments:

Vikas said...

Hi Rohit,
Once again great post.
But I would like to ask this.
Dont you think Hindustan Zinc & NMDC are better priced / undervalued compared to say MOIL / Coal India.
Regards,
Vikas

......... said...

China slowdown & Mining Bill & future use of 2000crs of cash----- 3 issues with the stock

sridhar said...

Very good analysis...In my view international prices will affect them because India imports manganese ore and not China directly. But rupee depreciation will help them to some extent and they are a low cost producer. But you are right, it tough to make a decision becoz of too many factors involved. My gut says yes, my mind says no...so I have left it hanging :)