Disclaimer: This is NOT a recommendation to Buy / Sell or Hold
Note: I had written the below extract in April 2013. Things must have changed now. ” since exceptional judgment is crucial to virtually all investment strategies, a critical element of our due diligence process is to evaluate historical decision points [Website: Massachusetts Institute of Technology Investment Management Company ]. After reading this I have decided to review my investment decision taken 3-4 years back. Purpose is just to highlight the process I followed in rejections of stocks in the past and to evaluate whether rejection was right or wrong based on increase in intrinsic value over last 3-4 years.
I hope it might be of some use to investors who like me, are in an early stage of their value investing journey.
Change in Share Price or Change in Intrinsic Value
Between Change in Intrinsic Value and Change in Share Price, change in intrinsic value is a better indicator. Share price may remain depressed for longer period for various reasons. I have highlighted in my post on Good Business Vs Bad Business that average of PAT growth and Book Value growth over 5 years or more is a good indicator for change in intrinsic value.A good business is one where over 5 years intrinsic value increases by more than 15% CAGR [Of-course while making investment we have to think about possibility of increase in intrinsic value in future]
Book value has grown at 8% CAGR between 2013-16 and profits have declined by about 50%. Taking book value as indicator for change in intrinsic value, we can say that intrinsic value has increased at 8% CAGR during 2013-16. Share price has remained about flat. Ideal period to measure change in intrinsic value is 5 years or more. Unless and until intrinsic value grew rapidly over next two years, it will fail to register 15% CAGR.
What attracted me to Engineers India at first place was
- EIL gets 65-70% of the orders by nomination by the ministry of Petroleum or negotiated settlement basis where the company has signed MoU with the PSUs. Unlike other E&C cos. which can only win through competitive bidding.
- EIL was generating free operating cash, had a negative working capital requirements and limited capex resulted in 21bn of cash (~27% of then market cap)
Reason for rejection: Extract of the mail which I sent to one of my friend in April 2013
My limited analysis suggests that Engineers India historical growth [last 20 years] was much influenced by refining capacity expansion plan of PSUs. This should not be surprising as even in Q3 FY13, more than 65% of its order book from consultancy and turnkey project is from hydro-carbon sector. Its revenue have grown exceptionally during 2008-12 [2.5 times compared to 2003-07 period] and it enjoyed average ROE > 32% [more than double the average of 1998-2008]. Numbers suggest, downturn has just started for Engineers India and we should let the downturn play itself before entering the stock at current price. Of course at current price it’s quite CHEAP, but provided we can identify demand drivers for next five years. Still major chunk of the revenue are from Hydro-carbon sector. I do not know what will drive the refining capacity over next 5 years [even vague clarity is enough, but here I am unable to predict any reason which will result in another period of growth like 2008-12].
- Engineers India revenue performance over next 5 years depends on refining capacity expansion plans of PSUs. As per 12th five year plan document 70 MMTPA is expected to added over next five years out of which 30 MMTPA is from private sector. If we analyse last 15 years performance 2008-12, clearly stands out as an exception. I think Engineers India recent performance [2008-12] was more driven by rapid expansion in refining capacity. Aggregate revenue for period 2008-12 is almost 2.5x of total revenue of 2003-07 and profitability is 3.6x higher. If we look at refining capacity for 2007-12 periods, it expanded by 62% and in absolute numbers refining capacity increased in total by 90 MMTPA. This increase is highest in any of the five-year plan since 1997. Now if we look at period when refining capacity growth was mediocre, for instance during 2000-06, aggregate refining capacity increased only by 18% [from 113 to 132 MMTPA]. Revenue during 2002-07 was volatile, but essentially flat between 550-570crs or even if we look at revenue CAGR of 2000-06 it was mere 10%. Again during 1993-99, refining capacity almost double [from about 55 to 100 MMTPA], revenue more than doubled from 150 crs to 377crs.
- Average ROE for 1998-2008 was 15%, avg ROE for 2002-04 was merely 7%. As I explained above 2008-12 was exceptional period which is also reflected in avg ROE of 32% during this period.
Refining capacity: India’s current refining capacity is around 215 MMTPA out of which close to 30% is exported. China accounts for 20% global oil consumption
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.