Some interesting ideas

November 28, 2007

I have been looking at the following two companies for the past few weeks. I have yet to make up my mind on them. I generally prefer to buy at 50% of conservatively calculated intrinsic value of the company. Both the companies trade at a discount to instrinsic value, but above the 50% mark.

The companies are

Grindwell norton

SRF

My personal notes on each company

Grindwell norton

Grindwell norton is in the business of abrasives and refractories. The industry is dominated by two player – Carborundum and grindwell norton. Grindwell has been doing fairly well for the past few years. It has an average ROC of 15%+ for the past few years. It has been able to maintain a NPM of 10%+. The average sales growth has been over 15% on an average and the NP growth in excess of 20%. The asset ratios have improved, especially the Wcap ratio and the profit margins have improved from 7-8% to 10-11%. The company enjoys reasonable competitive advantage due to R&D support by parent, strong sales force, decent brand and a wide customer base. There are reasonable entry barriers  in the industry too.

Grindwell has recently sold a stake and netted almost 100 Crs from the sale. The Company is debt free and has almost 100-150 Cr in cash and investments. The company is however trading at 20-30% discount to intrinsic value which is above my target price

SRF

SRF has the following business segments – Technical textile divison which  includes tyre re-inforcements, belting fabrics etc. This division makes up almost 50% of the revenue, but contributes to less than 10% of total profits with Pre-tax margins of around 10%. This business segment is facing a lot of competition and has seen margins drop for the last few years. The chemical business makes up 40% of the revenue and almost 90% of the profit. This division is highly profitable with pretax margins in excess of 50%. The profitability of this division has gone up in the last few years. The rest of the revenue is from packaging films business. This business made a loss in 2006 and has just turned around in the current year.

The company has seen margins rise from 4% to around 10% (excluding one time CER gains). The ROC is around 15%+. Sales growth has been 15%+ and NP growth has been 20%+. The company looks undervalued on current measures. However the key point is the sustainability of the margins in the chemicals business. It is diffcult to see how the division would maintain such high margins. If the net margin of the company were to drop to around 6-7% from current levels (which are roughly the average margins), then the EV/Net profit ratio would be around 9-10. At these levels the company is at best undervalued by 20-30%. Need to do more analysis.

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