Sah Petroleum [Sah] is engaged in lubricants business and derives majority of its revenues from Industrial Lubricants. Currently its trading at TTM EV/EBITA of 1.5x [Peers trade at around 7-8x, excluding Castrol], continuously incurring losses or making nominal profits for the last 3-4 years. Over the last few years company has done two things, which I THINK are mainly responsible for the current state of affairs. Attempting to take directional bets on FX, resulting in huge FX losses [after 2009 none of the peers have incurred any material FX losses] and incurring huge advertisement expenses in failed attempt to build retail brand in auto lubricants. Excluding these two items, EBITA margins of Sah Petroleum is much better than the headline numbers [See Table 3]. Gulf oil and Tide water, whose capacity is quite close to Sah petroleum is trading at EV of more than 650cr compared to Sah EV of 85 crs. EBITA margin of Sah [exl FX and Adv] is around 9% compared to its peers which are in the range of 11-14% [See Table 4] . For around 5% point difference in EBITA, such a huge difference in valuation is not justified. It can safely be stated that Sah is worth atleast twice the current valuation. There are multiple triggers for the value to get unlock 1) Possibility of delisting 2) Exit of financial investor, resulting in open offer 3) Buy as a cigar butt, cheap stock becoming less cheap.
Check out here for the mind map, containing brief summary
Sah Petroleum is engaged mainly in manufacturing of Industrial and Auto oils & lubricants. I do not have exact revenue breakup, but I GUESS high margin auto oils is less than 20% of revenues. You can read more about the company here . During 2008-09, Navis Capital, a private equity firm, acquired 62% stake in the company. Key valuation metrics of the company is as below.
When a company is trading at such a dirt cheap valuation the most obvious question we should ask ourselves is it a value trap. More so, when since late 2005, company is continuously trading below book value and the average price to book value ratio since its listing in late 2004 is around 0.9x. This valuation seems to be justified when one finds that for the last four years company is incurring losses [except for 2011]. Even during the last six quarters, it has reported profits only in two quarters. [Headline numbers are always misleading as explained later]
What’s destroying the value of the firm?
I agree that company operates in an industry which has intense rivalry but unlike industries like airlines there is no ‘price wars’. So what’s destroying the value of the firm? I think there are three main reasons:
- As a % of sales, advertisement expenses stands at 4-5% over the 2010-12 [over three years, almost equal to 40% of current book value], which is mainly to increase its high margin retail sales. Its advertisement expenses are comparable to industry leader Castrol, which spends around 6% of its sales on advertisement. But Castrol is able to charge premium pricing because of its branding strategy, which is NOT yet reflected in Sah petroleum operating profits. [Can be fixed by a new promoter]
- Company takes only 50% cover for its payment liabilities [its acceptances are outstanding for period of atleast 6 months, for peers its less than 2 months], which exposes it to high volatility of USD/INR rates. It appears that company frequently tries to take directional bet on INR/USD rate. eg. In 2008 company did not took any cover at all for forex. In the past, it has incurred 15-25 cr losses on FX, which is around 12-20% of its net worth. [Can be fixed by a new promoter]
- Over the last few years, there was unprecedented volatility in both USD/INR rate and price of crude oil prices. [Uncertain, may continue for some more time. But IMHO, both Oil price and INR should stabilise at same point of time in future. I believe in ‘Something which cannot go on, will not go on for ever’]
While the last problem of volatility in FX rate and Oil prices may continue for some more years, I think Sah petroleum value can increase substantially if the first two problems are fixed. Let’s analyse how Sah Petroleum margins will look adjusting for advertisement expenses and FX losses.
So what’s going to change? I am not predicting that company will curtail its advertisement expenses or any substantial increase in its retail sales. I think over the next 2-3 years following are the triggers which can result in Sah Petroleum re-rating.
- Delisting (over next 4-12 months) : Promoters [along with Navis Capital, a PE firm] holds around 87%. As per the SEBI guidelines all the listed firms needs to bring down their holding to 75% by June 2013. They either need to divest 12% before end of June 2013 or get the shares delisted. At current price it may be beneficial for them to delist the company rather than divest their stake. Company needs around 6.6% to delist. Top 2 shareholders hold 2.95% and next top 39 holds another 2.6%. Even if top 40 shareholders comes together total is only 5.5%. The diversified shareholding structure will ensure discovery of fair price. But risk remains that, It might turn out to be a APW delisting case, where delisting had fallen flat for lack for sufficient shares being tendered. [In a way, its better that delisting fails, better value will be discovered when the firm is sold to a strategic investor]
- Exit of PE firm (next 2-3 years): Navis Asia Fund V [main promoter of the company holding around 60%] was setup in 2007. So going by the normal period of 7 years plus one year extension, PE firm should be exiting this firm in next 2-3 years maximum [i.e by end of 2016].
- Cigar Butt (next 2-3 years): The valuation of company should improve substantially as and when FX rate and oil prices stabilizes Headline numbers are misleading. Excluding FX losses and advertisement expenses, company has never incurred any operating losses except for 2009. Though company may continue to incur advertisement expenses, FX losses should disappear once INR/USD rate and oil prices stabilizes.
Take the above relative valuation with a pinch of salt, as Tide water valuation might be inflated because of on-going rumours of open offer from one of its biggest Shareholder and Gulf Oil is a quite diversified company, announced demerger of lubricant business, recently completed acquisition for USD 1bn of a US based company [debt funded] and have substantial property development going on in Hyderabad and Bangalore. Gulf oil lubricant division contributes almost 80-90% to both revenues and EBITA, as other division profits are nominal or incurring losses.
Some examples of recent capex incurred by peers
What can go wrong?
- All the negatives and what can go wrong are well covered on this blog by Neeraj Marathe. YOU MUST READ THIS BEFORE TAKING ANY POSITION. [edited on 22 Mar 2013]
- 7% spike in raw material prices (assuming no increase in ASP), can wipe out entire profits at operating profit level (after accounting for advertisement expenses)
- Though company is debt free, but presence of substantial trade payables in USD [1.5x its networth] expose company to any steep depreciation in INR/USD rate.
- Since listing in 2004 and upto 2008 [till Navis capital invested into the company], promoters had continuously bought and sold shares in the company, which looks more like taking advantage of market price of the company.
- Disclosures are very poor. No discussion about business or strategy in MD&A section.
- Losses from derivatives transactions were shown under interest.
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