Earnings : Quality vs Quantum

One of our core holdings, SRF inched towards its lifetime high today crossing the INR 1400 mark & I was reviewing my position. As part of the process I looked back at my investment note made in January 2010 & compared the key metrics to today:-

January'2010    April'2016    % change
Nifty                                  
    5200        7914           52%
Market Price (INR)
      200        1400         600%
Market Cap (INR crores)
    1200          8000         567%
Debt (INR crores)            
      940        2000         113%
Turnover (INR crores)      
    2200        4400         100%
PAT (INR crores)           
      300          400           33%
PE ratio        
      4x          20x         400%


The comparison is amusing & numbers surely don't justify the returns. There is no buyback/ management change that is underway or expected. There has been no sale of property or any non business income/ loss that the numbers hide within. This brings us to the most common question - 
                                                             
                                                     WHY HAS IT RISEN ?  

SRF has had three business divisions:- Technical Textiles, Packaging business, Chemicals & Polymer.  Let us compare the earnings contribution at EBIT level for these businesses :-

(INR crores) FY'10 FY'11 FY'12 FY'13 FY'14 FY'15 FY'16
Technical Textiles 229 180 114 123 163 195 160

Packaging 

40

346

25

6

-5

63

170

Chemicals & Polymer

276

289

594

346

191

298

350
TOTAL 545 815 733 475 349 556 680

Prima facie, none of the businesses indicate any consistency or predictability. But incase of Chemicals & Polymers the numbers tell half the story. From FY'05 - FY'13, 90% of the earnings came from the sale of carbon credits. The management was wise enough to realize that this cash stream will not continue forever & they invested heavily into specialty chemicals taking the capital employed in this business from 500 crores in FY'10 to 2500 crores in FY'16.

This expansion has resulted in a steady & predictable cash flow for the company. Their utilization & clientele is growing every quarter, it is an R&D driven specialist vertical thus steady margins unlike the other two businesses which are exposed to both raw material volatility & demand/ supply imbalance.

So while headline EBIT from FY13 to FY16 remains same for chemicals yet the stock is up 10 times since the QUALITY of EBIT has changed. Quality implies this cash flow is steady, sustainable & growing.  SRF, from FY'05 - FY'13 has roughly traded at a PE ratio of 4. Assuming this multiple continues for Technical textiles & Packaging where no fundamental change has taken place then the market is valuing the chemicals business at 36x its FY 16 earnings. Market values quality earnings very generously, thus if one can spot a transformation early then it can be a multibagger in the making.

Quality driven valuation tends to STAY, Quantum driven valuation tends to SWAY.

P.S: I must add a caveat,  market punishes degradation in quality as well. SRF's biggest investment now is a expansion of 356 crores in a greenfield packaging line as the focus on the chemical side moves to capacity utilization & up-gradation.    


  

Comments

  1. Interesting observation. I think this situation is rare.

    ReplyDelete
    Replies
    1. If you are born poor its not your fault. but if you die poor its your fault. Equity Tips

      Delete
  2. On the contrary, almost every company attempts to add revenue streams. It's not easy to spot the right one.

    ReplyDelete
  3. This comment has been removed by a blog administrator.

    ReplyDelete
  4. A similar product to nickel pig iron (NPI) produced in Indonesia, FeNi Luppen, is set to change the global nickel supply pattern if Chinese stainless steel mills are receptive, SMM learned.CapitalStars

    ReplyDelete

Post a Comment

Popular Posts