Thursday, November 15, 2012

CMI FPE Ltd. - Interesting, but still work-in-progress..

Wish all of you a very happy and peaceful Diwali..

Well, I often take up the following exercise in my class. You may find it interesting too..

Say there are 2 companies A Ltd and B Ltd. Both are textile companies of the exact same size, having same margin, same products, financials and similar quality of management.

Now say that A Ltd has just bought a new machine, which increases their productivity and thereby, their margins by 5%.

Given a choice, which company's shares will you buy?

Usually, people say A Ltd, which might be your answer too. What if I tell you that there are 3 choices. (No, 50-50 in A and B Ltd is not the third choice).

Well, an interesting answer (I wont call it the right answer) is; You should buy neither A Ltd nor B Ltd shares. Given a choice, you should buy the shares of the company which manufactures those machines!!!

The funda is very simple. What stops B Ltd from purchasing the same machine tomorrow? When their margins increase too, they might start a price war to gain market share. In the process, none of the textile companies will benefit. Only 2 parties will benefit; the end consumer and the machinery manufacturer!
When any sector goes through a boom phase, if one can go up the chain and identify the capital equipment manufacturer, that can become a better investment than the players in that sector! Well, if you would have identified this in the textile sector, in the context of the TUF scheme, you would have invested in Lakshmi Machine Works and your investment would have been up more than 10 times in about 10 years. Not bad!

Without drifting further, I should come straight to the topic of the post - CMI FPE Ltd. As mentioned in the title, it is still WIP for me. I think I need to do a lot more study on the company.

Background

CMI FPE was earlier known as Flat Products Equipment India Ltd and was set up by Late Dr. T.R.Mehta, who was basically a technocrat. He sold the company to the Belgian group CMI in 2008 since he did not have a successor to run the company. CMI also bought a Pvt Ltd company of the promoter, which is now named as CMI Industry Automation Pvt Ltd. CMI currently holds 75% stake in CMI FPE and 100% stake in CMI Industry Automation.
The company is basically a provider of capital equipment required by the steel sector. The company manufactures products like Cold Rolling Mill Complexes, Galvanising Lines, etc. The group is one of the largest and the lowest cost manufacturers of this equipment in the world.
Its but obvious that the fortunes of the company are pegged to the fortunes of the steel sector, which is not exactly going through a rosy period right now. But after all, steel is a cyclical sector and when it turns around, CMI FPE could benefit bigtime, like in the example above.

Basic Financials
Market Cap: Rs.330 cr (CMP Rs.670) (One may note that in FY11, the company recorded sales of Rs.437 cr and PAT of Rs.47 cr. There was Rs.25 cr other income)
By and large debt free. Works on customer advances. PE ratio etc would look ridiculously high, since the last few quarters have been quite bad. Dividend payout at 20ish % has been ok.
Excellent cashflow generation till FY11. FY12 has been bad for the company on all parameters.

Positives

  1. The company works in a very niche sector, with best-in-class technology having huge entry barriers. 
  2. The company is supported by a very strong parent, having global presence. 
  3. From what I could find out, CMI FPE is now the only manufacturing outfit of the entire group globally in this business line. Outsourcing opportunities could be huge.
  4. Slowly, the company is also expanding into new products like PLTCM and providing ancillary services to its clients.
  5. The company has a strong order book position. (estimated to be more than Rs.800 cr)
  6. The cashflows are strong, since the company works on advances from customers. 
  7. I really liked the management's approach. Currently, the company is going through a tough time. During this period, instead of taking a step back, the management has chosen to modernise and expand the company's facilities. Please go through this and this very carefully. Basically, the management has chosen to bear short term pain and keep themselves ready to take advantage of the time when the cycle turns. Also, expanding capacity during a slowdown is usually cheaper. Such contrarian thinking is something which I honestly like.
Negatives
  1. Of course, the biggest negative currently is that their customer sector is going through a tough time. Capex is being differed all over the world by steel companies. Consequently, inspite of having decent order book, execution of the same is being differed by customers of CMI. The pain is very much visible in the recent quarter numbers. (Actually this is why I started looking at it in the first place.)
  2. I am unable to get a proper hang of the steel cycle. So, will the wait for the cycle to turn be a short one or a super long one? Thats something I do not know.
  3. If one looks on the traditional 'value' parameters such as PE, dividend yield etc, this stock will look insanely expensive and wont appeal to many. But I think just looking at the company in number terms is not right. Business and products is what is also important.
  4. CMI FPE has doubled its capacity, even though its existing capacity may not be fully utilised. This will surely lead to increase in the overall fixed cost of the company. As a result, till business conditions improve, the results of the company will look even worse.
  5. Things are a bit opaque on levy of royalty/technical fees etc by the parent on the Indian company. I am not still clear on that front.
  6. There has been recent announcement that the parent would be merging its own 100% subsidiary into the listed company. The details of the merger and the valuation etc has not yet been announced. But it could lead to a corporate governance issue. I am sure everyone remembers the Akzo Nobel incident. Corporate governance issue = derating and further drop in stock price. Howeverrrr, there is one more angle of looking at this event. Hint: Current promoter holding is 75%. The merger would result into the promoter holding going beyond 75%. An MNC subsidiary which could have 75% plus promoter holding, where stock price has been massively hit due to unfavourable business cycle..hmmm.. I will not say more because the D-word is a taboo currently!! :-)
So all-in-all, I find this to be a very interesting case worth studying in-depth. Primary research and things such as talking with industry people, getting multiple views and angles is very important when needs to get out of the excel sheet and understand the business properly. As I said earlier, a lot more work needs to be done on this..

Cheers and happy investing!

Disclaimer(s)!!
1) All the posts on this blog, including this one, are for educational and discussion purposes only.
2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.
3) I may have positions in stocks discussed. As a professional advisor, I advise clients regarding investments. They also may or may not have positions in stocks discussed, depending on their decision. 
4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours! 

20 comments:

Anil Kumar Tulsiram said...

Hi Neeraj

Thanks for another good post. Sometime back I did some research on Graphite India and decided not to invest in it because of black swan event of long-term slowdown in China and its consequences on steel industry. I know many people are talking about China slowdown and China had defied such predictions earlier, but still I think if China does slowdown for long period it will be real pain.

Indirect bet that steel consumption in China will not slow down: China capacity is approximately 600 million metric tons per annum (MTPA). China accounts for 46% of the world's crude steel production. That is more than the European Union, plus the U.S., plus Japan all put together. Even on per capital basis, China consumption is almost 40% higher than US (2009 figures). Further almost 50% of its steel consumption is in real estate and infrastructure . Now if the growth slows down in real estate and infrastructure, which is believed by some market participants, it will hit hard the global steel industry and consequently current company too. Just a 10% decline in consumption of steel in China will produce surplus of 60 MTPA which is equal to India’s steel capacity. Going by doubling of China’s capacity during the past decade this excess capacity may take long time to get corrected and the consequent decline in prices and steel production will hit hard CMI too.

Mahesh said...

Neeraj Sir,

I have one query :

1.
You Said:

"The cashflows are strong, since the company works on advances from customers".

My Confusion :

If company receives money it will hit to "Advances from Customer" in B/S....but to hit cashflow it has to travel from topline to bottom line then cashflow...i am bit confused..how advances from customer directly go to cashflow.?..your education on this Front Highly Appreciated Sir.

2. When the word "contrarian" comes, it always reminds of the Ajay piramal (the contrarian thinker), i get to know about him from Prof. Sanjay Sir blog titled 8 Vintages points.

Your views awaiting :-).

Regards,
Mahesh

Zero Point SomeOne said...

Thanks Commander for sharing your thghts.

Few years back I invested on similar thinking in two stocks namely Praj industry and Everest Kanto (makes CNG cylinders) of expanding sectors. However my move backfired and there was abs no movement in the stock prices they are still on the same level.

I am very much influenced my Prf Sanjay Bakshi's Toll Bridge Biz model of companies. Would discuss at length with you some other time.

Regards
Karun Sandha

Jagadees said...

Nice post. Parag parikh of PPFAS explained beautifully with data in his book, "Value investing and behavioural finance" that one should indeed buy a cyclical company (like cement, sugar, commodities) at its high PE rather than at its low PE as conventional wisdom suggests.

Neeraj Marathe said...

Hello Anil,
I totally agree. However, the same logic was applicable few years ago and still, the steel sector took off! it is indeed very difficult to get a grasp of this sector imho..
In fact, if the slowdown happens, CMI would be hit MUCH MORE than players like Graphite or HEG. While Graphite makes consumables, CMI makes capital equipments.
Thnx for the data.
Cheers!
Neeraj

Neeraj Marathe said...

Hello Mahesh,
Cashflow and P&L are completely different. e.g. if a client gives an advance, the journal entry would be

Bank A/c Dr
To Advance from customer

Both these items appear in the balance sheet and there is no question of taking it thru P&L.
Hope this helped.
Cheers!
Neeraj

Neeraj Marathe said...

Sure Karun,
I always love talking with ppl and boring them :)

Hi Jagadees,
Yes i agree with you..

thnx
cheers!
Neeraj

Achin Jain said...

Hi Neeraj

from the financial view point and your highlighted points, it looks a good company to invest in.
But I have a different view point
a. If that sector requires one to have deep pockets to enter, it means less target customer for this company.
b. If demand of the product that company produces, which buys its machinery from CMI, then why would this company expand
c. If CMI's product is good, it also means less repeat business

Also CMI is illiquid counter very similar to DISA

Neeraj Marathe said...

Hello Achin,
Thnx for your point of view..
yes, CMI is an illiquid stock..but thats something i do not mind! :-)
cheers!
Neeraj

Mahesh said...

Thank you Neeraj Sir. Got It :-)

Solomon said...

thanks for the info, actually i was tracking this company since jan 2012 and purchased few shares whic was Rs 100+ than the present value.

However i went into the details of the company but could not get hold of the nice info you have shared.

Actually i have purchased 20 shares at 670 and 660 today

Thanks for the nice info

Anonymous said...

Dear Sir,
I am ashamed to call myself your student .. In college you have explained how even experts get it wrong, all the events on CNBC etc,and the importance of doing own research... But Still -
I bought CMI FPE since you had written it was interesting and I am a big fan of yours... Honestly what do you think I should do Sir ? Please help me , I have quite a lot of shares and sitting on big losses .....
I dont want to name myself since I was one of the best students of your class ... Please help !!!

Neeraj Marathe said...

Oooo boy! Hi anon,
First and foremost, forget about what we talked in class, forget about experts going wrong (i am not expert) etc etc for a moment..
You said that you bought since i thot the company is interesting, as written in the post. But in the post itself, i am myself saying that more work needs to be done on this. Which means that research is incomplete, questions are unanswered and buying would mean just leaping in the dark!
What i think you should do is irrelevant. What is relevant is what you think you should do!!
You have bought for all the wrong reasons (or maybe without a reason). Now you are holding for all the wrong reasons and i presume you will sell for all the wrong reasons!
Heartiest congratulations, you have discovered the sure-shot recipe to lose money in the stock market. If you repeat this often, i am sure you will achieve bankruptcy soon!
On a serious note, meet me in class, we will discuss it.
cheers!
Neeraj

Sachin said...

Hi Neeraj,

Any further update on CMI ?

Sachin said...

Hi Neeraj,

Any further update on CMI ?

Regards,

Sachin

Neeraj Marathe said...

Hello Sachin,
Naa..no further updates as such..the scenario in the industry is quite bleak..i am unable to make an informed decision about when it is likely to turn around..still, trying to understand and get bit more info..
cheers!
Neeraj

VIKAS KUKS said...

Hi Neeraj,

I have a query regarding their business structure. What constitutes for such high number under cost of traded goods. The company is majorly into manufacturing and not trading, so how come this number is so high(Almost 50% of revenues). I am not from accounting background, so my query might seem foolish. Will be great if you can share some thoughts on it.

Regards,
Vikas Kukreja

pankil said...

Hi Neeraj,

The Company's Annual Report is quite detailed and was reading it last night. They are quite bullish on the Indian Steel Sector in the long term. They are biting the bullet in their tough times and are quite transparent about their reporting as well. The only thing that kind of made me re-think was the company's major floating stock outside of its own holding is in hands of very selected investors whose color we wont get to know. So the stock price will fluctuate a lot depending upon what those selected investors do. They hold abt 13% of the stock. 75% is with the promoters.

Also your point regarding the company wanting to merge the group company within itself and eventually raising their stake in the company. If they do it now, they would have to either then do an OFS to get back in line with SEBI rule or come up with an open offer simultaneously.

They made a good call on not giving any dividend despite a quite negligible loss that they incurred.

if the stock hovers around 200 rupees, it would be a good buy for the long term.

Thanks for introducing the company and giving the detailed background

pankil said...

Hi Neeraj,

The Company's Annual Report is quite detailed and was reading it last night. They are quite bullish on the Indian Steel Sector in the long term. They are biting the bullet in their tough times and are quite transparent about their reporting as well. The only thing that kind of made me re-think was the company's major floating stock outside of its own holding is in hands of very selected investors whose color we wont get to know. So the stock price will fluctuate a lot depending upon what those selected investors do. They hold abt 13% of the stock. 75% is with the promoters.

Also your point regarding the company wanting to merge the group company within itself and eventually raising their stake in the company. If they do it now, they would have to either then do an OFS to get back in line with SEBI rule or come up with an open offer simultaneously.

They made a good call on not giving any dividend despite a quite negligible loss that they incurred.

if the stock hovers around 200 rupees, it would be a good buy for the long term.

Thanks for introducing the company and giving the detailed background

Neeraj Marathe said...

Most welcome pankil..the scenario continues to be bad. Plus the stock has gone in the bloody illiquid category..makes any buying very difficult..
Cheers!
neeraj