Orient Abrasives: Opportunistic Investment Opportunity

Introduction:

Orient Abrasives Ltd is India’s largest manufacturers and exporters of bauxite based High Alumina Synthetic Raw Materials like Brown Fused Alumina, White Fused Alumina, Pink Fused Alumina, White Fused Mullite, Calcined Bauxite, High Alumina Refractory Cement, Zirconia Mullite, Almag (Spinnel) for grinding wheel manufacturers (Vitrified, Resinoid & Coated Products) and refractory manufacturers, also Grinding wheel and Castable Refractory for steel & cement plants. The company has carved itself a storng niche within the overall abrasives and grinding wheel market. As per the company, it has 70% market share in fused aluminium oxide grains, 64% in calcined products and 20% in monolithics.

Business:

The company has three business segments: Abrasive Grains, Bonded Abrasive, and Refractories.

Abrasive Grains: This business manufactures calcined bauxite and aluminium oxide abrasive grains which are important raw materials for refractories used by the steel industry. A portion of this business’s production is captively consumed by the Refractories business.

Bonded Abrasive: Bonded Abrasives are commonly called grinding wheels since they are generally in the shape of wheels that are used for grinding, finishing, honing, polishing etc. Major user industries for this product are automobiles, bearings, cutting tools, steel etc.

Refractories: This business manufactures various types of continuous casting and slide gate retries, low cement castables etc. which are exclusively consumed in the steel plants. The Refractory Division also exports its products to Egypt, Turkey, Indonesia and some European countries.

Industry:

The organized abrasives and grinding wheels market in India is quite an oligopolistic market with four major listed players: Carborundum Universal, Grindwell Norton, Orient Abrasives, and Wendt India. Nevertheless, there are several smaller players who specialize in specific products. The industry is characterized by diverse user industries, an insignificant threat from substitute products, and adequate raw material availability.

The industry has been going through a purple patch mainly on account of good demand from user industries, which has resulted into strong demand for products of companies in this sector. The industry mainly craters to Auto-OEM and Auto ancillaries, General engineering (capital goods), Construction and fabrication, Steel, Bearing etc. Increasing infrastructure activity, booming construction and a flourishing economy in India together have bolstered the revenues of abrasives and grinding wheel sector.

Initiatives:

Orient Abrasives has decided to install a thermal power plant (lignite/pet coke/coal based) at a cost of about INR 340 million at its Porbander works to save on energy costs. The plant is likely to be commissioned by the middle of the year 2007. In the process, the company will considerably save on fuel costs, as lignite / pet coke / coal costs are much cheaper than furnace oil, which is consumed by the existing power plant. The project will be financed partly by internal accruals and partly by term loan from institutions / banks.

Outlook:

With new investments budding roses in Indian industries and with increased outsourcing by Western markets from China and India, the abrasives and grinding wheel sector is expected to witness continued strong demand growth. In the coming years, the user industries for the company’s products, Steel and Engineering Industries, are expected to perform well. The steel industry, which is the largest consumer of the company’s products, is expected to increase its capacity by 50% over the next five years. There is supply shortage in the steel industry. Expansion by the steel industry coupled with the consumption growth places Orient Abrasives on track for a volume growth of 12-13% on the domestic front. As the company is making an increased push to enter the exports market, it should only result in stronger growth for the company.

Concerns:

The company had to suspend production at its Porbander plant w.e.f. February 21, 2006 in view of the directive of the Gujarat Pollution Control Board issued under section 31 - A of the Air (Prevention and Control of Pollution) Act, 1981. The Company has already moved the Hon'ble High Court, Gujarat for resumption of production.

Valuation:

As discussed earlier, the increased demand by the user industry bodes well for the company and places the on track to record high double digit growth in revenues and earnings. Further, the company’s thrust on exports is paying off. For the year ending March 2005, the company can report sales and net profit of INR 1650 million and INR 195 million, giving an EPS of INR 3.2. The current market price of INR 28 discounts this EPS just 8.8 times. Also, the company is quoting at a significant discount to it peer group, approximately 50% discount. Most of this discount appears to be unwarranted. Using a mix of historical multiple, relative valuations and the DCF, we arrive at a price target of INR 45 for the stock with a time frame of one year. One good indication of stocks deep value is the fact that the promoters have been increasing their stake after the recent decline in the stock’s price.

Panasonic Batteries - A stock to power up your portfolio

Panasonic Batteries was established in 1972 in a joint venture between Matsushita Electric Industrial Corporation, Japan and the Lakhanpal group. The Matsushita Group owns a majority stake of 51% in the company. The company's Novino and Sumo range of batteries have strong brand recognition in the large and pencil dry-cell batteries.

The company's growth trajectory has at best been choppy over the last few years. The Indian dry cell industry suffered as a result of the cheap imports from China between 2001 and 2004. But as the customers realized that the Indian batteries offered better value proposition and as the Indian Government imposed anti-dumping duties on dry cell imports from China, the growth rebounded impressively in the last year.

Industry Synopsis: The Indian dry cell batteries market is estimated at about 2.7 billion pieces per annum with broadly three types of batteries namely, Carbon Zinc Batteries, Alkaline Batteries, and Rechargeable Batteries. The growth potential of the Indian dry cell battery industry is huge. The main growth driver for dry cells in India will be the increased demand for the traditional applications like torch lights, transistors, etc as well as rising popularity of battery operated devices like remote controls and digital cameras at the higher end.

Zinc prices are a concern: The dry cell batteries industry is a highly raw material intensive. The major raw materials include zinc, printed metal sheets, carbon rods, and manganese ore. Zinc accounts for approximately 25% of the company’s total input costs and accordingly has a significant impact on the company’s margins. As the zinc prices have been ruling at their highest levels in the last 5 years, it has hurt the margins.

Valuation: Panasonic Batteries is a net cash company with the net cash totaling to approximately INR 295 million or INR 40 per share. The company’s 10-year average Return on Equity stood at 11% (not very attractive). However, the Return on Capital employed averaged at about 15% over the same period and considering that the company carries a lot of cash on its books, the true Return on Equity as per our calculation is a handsome 15%+.

My Discounted Cash Flow values as well EV/Sales and P/E historical multiple based values are close to INR 125. We add up the cash per share to derive our price target of INR 150 (applying some discount to the cash per share as well). The stock appears to be mispriced on a relative basis as well as it is quoting at a discount of approximately 40% as compared to Nippo Batteries and most of it appears to unwarranted. As such, the stock presents a compelling opportunity at the current price of INR 70 (4.2% dividend yield). Would recommend entering the stock at current levels with a target price of INR 150 and a timeframe of one year.

Bimetal Bearings - a deep value pick in the Indian Ball Bearings sector

Bimetal Bearings manufactures thin-walled bearings, bushings, washers, alloy powders and bi-metal strips. Bimetal bearings are used in diesel engines and petrol engines and compressors. Its manufacturing facilities are situated in Chennai, Coimbatore and Hosur. Thin-walled bearings, bushings and washers accounted for 90% of the revenues of the company, with alloy powders accounting for 3.5% and bi-metal strips accounting for 6.5% of the revenues. Principal raw materials include Steel Coils, Steel Strips, and Copper. It exports its products to US, UK, Germany, Italy, Austria, Croatia, Middle East, etc with exports accounting for approximately 25% of the total revenues. It has a good client base which includes some of the most prestigious names in the Indian automobiles industry. It is a dedicated single source for Hyundai India. Other clients include M&M, TAFE, Simpson, Maruti, Ashok Leyland, Cummins, TELCO, Escorts, HM, etc. The company has a consistent dividend history for the past 15 years and at current prices offers a dividend yield of approximately 3%. Industry Headwinds: The bearings sector in India is expected to witness a smooth ride. With user industries like automobiles, auto ancillaries, railways, steel and other industrial sector witnessing strong growth in demand, both from the domestic and export markets. Bearings are broadly classified into ball bearings and roller bearings. The ball bearings are extensively used in the automobile Industry. Hence as a result of the rising demand from Automobile Industry the ball bearings prices were able to remain firm. (The budget has provided the shot in the arm. As the prices for small segment cars have gone down on account of the duty cut, the demand for these cars is set to receive a boost. As small cars account for a large part of the revenues of Bimetal, it will help improve the prospects of the company). With user industries (automobiles, auto ancillaries, etc) witnessing strong growth in demand, the bearing sector appears to be set for a smooth ride. With the automobile sector accounting for approximately 60% of the industry revenues, the fortunes of the industry are very closely tied to the automobile sector.

Valuation: Bimetal is a net cash company with the net cash per share of INR 90. The company has very respectable operating performance numbers. The company has a very health OPM of about 18% and NPM of 13%. It has also generated strong free cash flow with the FCF totaling to INR 57 crores over the last 10 years as compared to the total net income of INR 70 crores while it has managed to grow at 7% during the same time frame. The growth has accelerated towards mid-teens over the last couple of years and considering the improved fortunes of the Indian automobile industry, I would expect to accelerate the growth further.

Using the average P/E, EV/Sales and P/Book Value multiples of the last eight years, we derive a value range of INR 225 - 375. Our DCF returns a value range of INR 250 - 450. Compared to the peers in the Indian bearings industry, the company is currently trading at a huge discount of approximately 60%. We would expect the stock to bridge this gap as most of it is undeserved for. We get a price range using the comparable values as INR 250 - 475.

Overall, I think that the stock represents a good opportunity at around current prices. I suggest an entry in the stock at around INR 240 levels with a target exit price of INR 450. The stock should be a good pick for those who have the patience to stay with it for a time frame of 2-3 years.

Wish you happy value investing.