Disclaimer: This is NOT a recommendation to Buy / Sell or Hold
I analysed Lakshmi Machine Works [LMW] around July 2012 and decided not to invest in the stock. Main reason for the rejection was my belief that
“Over the next five years LWM sales CAGR should be around 5% only and in addition with increased competition (now there are six manufacturers having base in India compared to three earlier) there will be pressure on margins and in the best case scenario margins will not improve over 2012 levels. “
Process Vs Outcome
In one of the interviews to SafalNiveshek, Prof Sanjay Bakshi said
“The thing I like to say here is the idea of process versus outcome. The world looks at outcomes but really should look at the underlying processes that produce those outcomes”
I am trying to analyse whether there was any problem with my process of rejection of LMW.
When I rejected it, it was trading it around market cap of around 1,600crs and now it’s trading around INR 3,500 crs market cap. Stock price had doubled in three and half years providing more than 20% CAGR. One can interpret this in two ways 1) Process of rejecting the stock was bad as stock has provided more than 20% CAGR 2) Process was right but bad outcome. So where does this situation falls on Process Vs Outcome matrix.
I believe its the second case, right process but bad outcome. The entire upside was driven majorly by PE re-rating and my thesis that growth will be a challenge proved right. Both sales & operating profits grew at less than 5% CAGR during 2012-2016.
I believe one should focus on INCREASE IN INTRINSIC VALUE rather than increase/decrease in share price to judge whether the process was right or wrong. The above extract from my blog post on Good Business Vs Bad Business shows that even over last 20 years LMW had increased intrinsic value only at the rate of 8% CAGR. As I have explained in my blog post on Good Business Vs Bad Business, PAT growth provides reasonable indication of increase in intrinsic value. [Here I have taken operating profit rather than PAT growth as interest income on surplus cash constitute substantial portion of PAT]
Here is the complete note which I made at the time of rejection of LMW in July 2012.
Industry analysis – I think over next five years sales CAGR should be not more than 5%.
If one go through the spindles data from 1980 to 2010, it becomes clear that 2003-2010 periods is just an outlier in which spindles production increased dramatically compared to past decade. During 1980 to 2000, spindles production on the average was 6-7 million p/a. But during the last decade of 2000-10, it increased dramatically and increased to 10-15m during 2003-10. Even for India spindles consumption remain static during 1990-2004 and on the average was around 1.2m but during 2005-10 it increased to around 2.4m and during 2006-08 spindles consumption was more 3m. I guess this dramatic increase has to do with removal of textile quota from early 2005.
Further Rieter has target of 5% increase in sales over the next cycle. For the last five years LMW sales CAGR is around 3-4% and I believe that over the next five years LWM sales CAGR should be around 5% only and in addition with increased competition (now there are six manufacturers having base in India compared to three earlier) there will be pressure on margins and in the best case scenario margins will not improve over 2012 levels.
I believe that with all the above negatives LMW is priced higher at PB 2x and PE multiple around 14x (trailing multiples).
Rieter, one of the competitors has reported 50% decline in sales from India and guided for decline in sales for CY2012
Rieter, one of the competitor of LMW, which derived almost USD175m (~18% of its 2011 sales) has reported very pathetic 1H 2012 results which were released couple of days back. It has reported 40% decline in order intake (1H 2012 vs 1H 2011) and 50% decline in sales from India. Further Rieter currently reckons that in the second semester with a weaker trend in sales compared to the first semester as part of the order backlog reaches into 2013.
Compared to Rieter which is guiding for decline in sales in CY2012, I understand that LMW is guiding flat sales for FY13. It has currently active order book of 1,200cr so to report flat sales, it need to get additional 500cr. Sales from spot booking which appears quite a challenge.
Disclaimer: This is not a recommendation to Buy/Sell/Hold.
Registration Status with SEBI:
I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”
Details of Financial Interest in the Subject Company:
I may or may not hold any of the companies discussed above in the portfolio which I managed for my family and close friends. Please consult your financial advisors before taking any buy/sell/hold decision. I may change my opinion post publication of this note and may not be able to update because of time constraints.