I noticed this stock because the private equity firm Sequoia had bought a stake in the company which they later increased. So after doing a very superficial analysis, i bought some shares as the stock has been trading at its near lows.
Now since i'm analyzing my portfolio to see if i should keep this one. So here is the story:
Ess Dee Aluminium is a leading manufacturer of pharmaceutical packaging products with core competency in aluminum packaging. With a total 37,000 MTPA capacity, the company is the largest organized packaging player in India in this segment with a market share of approximately 20%. As far as i have been able to find out, Hindalco is its closest competitor with installed capacity almost one third of Ess Dee. The rest of the industry is mostly fragmented with smaller players.
So far they have done a good job up until FY 2011 that is. Their top line grew at a CAGR of 42% during the past 5 years. Lets do a DuPont analysis to understand the company a little better.
2007 2008 2009* 2010# 2011
Net margin 21.9 22.8 -5.29 32.54 16.79
Net Asset Turnover 0.61 0.67 0.74 0.86 0.75
Leverage 1.23 1.27 1.82 1.35 1.31
ROE 16.4% 19.4% -7.1% 37.8% 16.5%
* The figure is negative in 2009 because of the merger of India Foils (That is the reason of the current predicament of the company. More on that later)
# Again the abnormal profit in 2010 because of the tax advantage of the merger.
From the table above, it looks like the company has been able to maintain a ROE of 16%. We can see that the company is capital intensive by looking at the low asset turnover. I generally like a capital intensive company if it can generate more than a rupee for every rupee invested over a long period of time. That in itself is a truism, one may people often forget. Anyway to return to the story, the share price of the company were bid up to Rs 842 at its peak in Jan 2008. After than it declined to sub 150 levels in Dec 08. After that it again soared to above 500 levels in June-July 2010 and is currently trading at around 150. This case is a classic example of the boom bust pattern frequently observed in financial markets.
My first concern in buying the stock was to see if the company has a competitive advantage. This becomes even more important in case of capital intensive companies. After a lot of research into the business model of the company, i'm still not sure about that. The company sells a commodity product and hence it might be difficult to build a sustainable competitive advantage. However, there are a few positives about the company. It has been able to increase its earnings at such a fast pace in the past because of its hub and spoke model, about which you can read more at its website or the annual report. But that alone is not much of a comfort to me.
The recent downslide in the stock prices of the company has been mostly because of the declining earnings over the past 3 quarters starting in the first quarter of 2012. It seems likely that this would continue for the next quarter as well. The management has attributed this to some problems in one of its factories at Hoera, which was acquired as part of the India Foils acquisition. This is a major concern and there is not much clarity about its impact going forward. So i was about to give up on further research and sell my stock.
But then i did a simple cash flow analysis to find out what is the minimum price at which i will still buy the stock. In my modelling i have assumed a zero percent (that's right) growth rate for the next ten years and a zero percent terminal growth rate beyond that. I have taken the cost of funds at the higher end at 16%. And i'm getting numbers in the range of 120!! So, 120 should act as a floor for the stock price. Based on the current market price of 153, the market is currently assuming a growth rate of around 2% for the company over the next 10 years. (I'm assuming a conservative terminal growth rate of 1% in this case.)
Based on the above analysis i'm not selling my shares just yet. If i'm lucky and the stock moves down even further from the current levels, i might start buying more. Meanwhile i will wait for a little more clarity on the situation to decide on the future course of action.
Now since i'm analyzing my portfolio to see if i should keep this one. So here is the story:
Ess Dee Aluminium is a leading manufacturer of pharmaceutical packaging products with core competency in aluminum packaging. With a total 37,000 MTPA capacity, the company is the largest organized packaging player in India in this segment with a market share of approximately 20%. As far as i have been able to find out, Hindalco is its closest competitor with installed capacity almost one third of Ess Dee. The rest of the industry is mostly fragmented with smaller players.
So far they have done a good job up until FY 2011 that is. Their top line grew at a CAGR of 42% during the past 5 years. Lets do a DuPont analysis to understand the company a little better.
2007 2008 2009* 2010# 2011
Net margin 21.9 22.8 -5.29 32.54 16.79
Net Asset Turnover 0.61 0.67 0.74 0.86 0.75
Leverage 1.23 1.27 1.82 1.35 1.31
ROE 16.4% 19.4% -7.1% 37.8% 16.5%
* The figure is negative in 2009 because of the merger of India Foils (That is the reason of the current predicament of the company. More on that later)
# Again the abnormal profit in 2010 because of the tax advantage of the merger.
From the table above, it looks like the company has been able to maintain a ROE of 16%. We can see that the company is capital intensive by looking at the low asset turnover. I generally like a capital intensive company if it can generate more than a rupee for every rupee invested over a long period of time. That in itself is a truism, one may people often forget. Anyway to return to the story, the share price of the company were bid up to Rs 842 at its peak in Jan 2008. After than it declined to sub 150 levels in Dec 08. After that it again soared to above 500 levels in June-July 2010 and is currently trading at around 150. This case is a classic example of the boom bust pattern frequently observed in financial markets.
My first concern in buying the stock was to see if the company has a competitive advantage. This becomes even more important in case of capital intensive companies. After a lot of research into the business model of the company, i'm still not sure about that. The company sells a commodity product and hence it might be difficult to build a sustainable competitive advantage. However, there are a few positives about the company. It has been able to increase its earnings at such a fast pace in the past because of its hub and spoke model, about which you can read more at its website or the annual report. But that alone is not much of a comfort to me.
The recent downslide in the stock prices of the company has been mostly because of the declining earnings over the past 3 quarters starting in the first quarter of 2012. It seems likely that this would continue for the next quarter as well. The management has attributed this to some problems in one of its factories at Hoera, which was acquired as part of the India Foils acquisition. This is a major concern and there is not much clarity about its impact going forward. So i was about to give up on further research and sell my stock.
But then i did a simple cash flow analysis to find out what is the minimum price at which i will still buy the stock. In my modelling i have assumed a zero percent (that's right) growth rate for the next ten years and a zero percent terminal growth rate beyond that. I have taken the cost of funds at the higher end at 16%. And i'm getting numbers in the range of 120!! So, 120 should act as a floor for the stock price. Based on the current market price of 153, the market is currently assuming a growth rate of around 2% for the company over the next 10 years. (I'm assuming a conservative terminal growth rate of 1% in this case.)
Based on the above analysis i'm not selling my shares just yet. If i'm lucky and the stock moves down even further from the current levels, i might start buying more. Meanwhile i will wait for a little more clarity on the situation to decide on the future course of action.
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