In the last post i did not talk about one major risk factor for Polyplex.
If we look at the returns of Polyplex, the return on equity for the last four years have been 16.5%, 17.3%, 14.2%, 26.15% respectively. While this may look good at first sight, it is actually not. That is because the economics of the business are not that good. It is capital intensive industry with the returns on capital invested telling a better story than return on equity. For the last 3 years for which i have calculated the ROIC (using the Stern Stewart method), they are: 11.9%, 9.7% and 25.1%. The returns for the last year are a one off thing as explained in the previous post. So the company is not doing that good as i am certain that the cost of capital is more than the returns. Couple this with the excess capacity in the industry and you should get an idea as to why the stock is so undervalued.
Doing a simple cash flow valuation, i think a fair price right now for the company is around 360. Its market price is half of that amount because of the dismal returns which if they remain at past levels will be shareholder value destroying. Additional capital invested is not really adding commensurate additional shareholder value. And the company is investing a lot of capital - 1000 cr over the next 2-3 years. The company will have to increase the returns for unlocking shareholder value going forward. That can only happen by increasing the margins as asset turnover or leverage will only come down. Now that is a very tricky part - its difficult to increase the margins in an industry with overcapacity. On the positive side the company is investing in high value products such as thick film line in Thailand.
Having said that, there is still a high margin of safety. Patient investors with a horizon of 3-5 years can definitely go in but there is no quick buck to be made here.
If we look at the returns of Polyplex, the return on equity for the last four years have been 16.5%, 17.3%, 14.2%, 26.15% respectively. While this may look good at first sight, it is actually not. That is because the economics of the business are not that good. It is capital intensive industry with the returns on capital invested telling a better story than return on equity. For the last 3 years for which i have calculated the ROIC (using the Stern Stewart method), they are: 11.9%, 9.7% and 25.1%. The returns for the last year are a one off thing as explained in the previous post. So the company is not doing that good as i am certain that the cost of capital is more than the returns. Couple this with the excess capacity in the industry and you should get an idea as to why the stock is so undervalued.
Doing a simple cash flow valuation, i think a fair price right now for the company is around 360. Its market price is half of that amount because of the dismal returns which if they remain at past levels will be shareholder value destroying. Additional capital invested is not really adding commensurate additional shareholder value. And the company is investing a lot of capital - 1000 cr over the next 2-3 years. The company will have to increase the returns for unlocking shareholder value going forward. That can only happen by increasing the margins as asset turnover or leverage will only come down. Now that is a very tricky part - its difficult to increase the margins in an industry with overcapacity. On the positive side the company is investing in high value products such as thick film line in Thailand.
Having said that, there is still a high margin of safety. Patient investors with a horizon of 3-5 years can definitely go in but there is no quick buck to be made here.
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