I had written about Lakshmi machine works earlier here. I would recommend reading the earlier post, especially the comments. The post and comments were right in the middle of the financial crisis. The stock was quoting in the 500-600 range and went down to the low 400 range in the subsequent weeks. At that price, the company was selling for slightly over cash on the books and the market was assuming that the company would go bankrupt soon.

I distinctly remember the comments and a few emails I received on this idea. The general theme was as follows
– The near term outlook for the company is horrible. As a result one should wait till the outlook is clear and then buy the stock.
– The company is barely making any profits and could be in financial trouble if the textile business shrinks further.
– The stock market gurus and pundits are advocating caution and I would prefer to wait (close to the first point).

My logic at that point can be summarized as follows
– The near term outlook was terrible and hence the stock was available at a bargain. Stock don’t sell at throw away prices if the near term outlook is great. The key point to analyse was how the company will do in the long run – that is after the downturn is over
– The company had a 60% market share in the industry and is one of the dominant players in india. They had a very strong balance sheet and good management. The company had a much higher probability of surviving than the other smaller players. On the contrary, I would say that a recession wipes out the weaker players and the stronger ones gain market share and strength due to lesser competition.
– If you listen to gurus and pundits, and don’t do your own thinking then you are likely to be in trouble anyway.

The post of LMW received a big number of hits and I think a lot of people found the company attractive.

I bet you would be thinking that I am busy patting my back !. I am not. In hindsight (which is 20/20), I think I was not aggressive enough and did not commit enough capital to the idea. I was personally quite confident of this company and a few others and still bought very cautiously. The caution had more to do with my extreme risk aversion and less with a specific idea. Anyway, I am working on that.

Let’s look at how the company performed in the last 2 years
– The topline of the company collapsed by 50% in the last 2 years
– The bottomline of the company came down by 60%+
– The return on capital has dropped, but is still at 50%+ levels (excluding surplus cash)
– Fixed asset turns dropped from around 4.1 to 2.5
– The company is still working capital negative (operations generate working capital instead of consuming it)
– Net margins have dropped from 10%+ to around 8% range (excluding other income)
– Net cash on the books (excluding customer advances) increased from 250 crs to 520 crs and total cash from 670 crs to around 830 Crs.
– The management has indicated plans to develop some land in Coimbatore (a real estate venture). This is a bit of a bouncer !

So what grade do we give the company ? I would say A and no I am not out of my mind.

In case of LMW one has to distinguish between the factors which cannot be controlled by the management (external environment and demand) and which can be controlled (their own cost structure and profitability).

The topline and bottom line dropped as expected (which is why the stock was selling for 500 and discounting this performance). However the management did a decent job of controlling the costs and still managed to generate profits during the downturn. There are very few companies which can remain profitable in face of a 50% drop in topline with a profit margin in the 10% range.

Where do we go from here?
The stock is now selling at around 2400. The company has announced a buyback to use up the extra cash, which is a good sign though not a great timing. The current price is partly discounting the expected good performance of the company.

If you assume a net margin of around 8-9% and topline growth of 10%, then the fair value can assumed to be around 2900-3100 range. The stock is slightly cheap, but not a bargain at current levels.

Balmer lawrie is a decent size holding for me and hence I make it a point to review the annual performance in detail. The annual report for the company was published recently and I have been looking at it. Following are my thoughts on the performance of the company –

I have written about the company here earlier. The company has been doing fairly well and the management has been moving the company in the right direction. The changes are not obvious from the overall results, but if one analyses the individual businesses of the company, the picture turns out to be much better.

Let me list some statistics (for last 6 years) of each of the SBU of the company and then give my thoughts on it
Industrial packaging (steel drums/ barrels etc) – Revenue growth per annum: 14%, Profit growth: 29%, Average ROCE: 18%+
Greases and lubes – Revenue growth per annum: 19%, Profit growth: 26%, Average ROCE: 15%+
Logistics (the largest division in terms of bottom line) – Revenue growth per annum: 8%, Profit growth: 19%, Average ROCE: 150%+
Tours and travels – Revenue growth per annum: 11%, Profit growth: 14%, Average ROCE: 30%+
Others (tea, leather chemicals etc) – Revenue growth per annum: -5%, Profit growth: negative, Average ROCE: negative
Overall company – Revenue growth per annum: 11%, Profit growth: 30%+, ROCE: 25%+

A few key points stand out
– The management is moving the company out of the unprofitable lines and investing into profitable businesses. They could move faster, but I still appreciate the performance as they are operating in a PSU environment with unionized labor.
– The management has improved the Return on capital for the good businesses too in the last 5-6 years. For example – logistics, travel etc have seen improvement in capital returns
– The management has paid off all the debt and has surplus cash of almost 300 crs on the balance sheet
– The management has raised dividend rapidly in the last 5 years and the current dividend is almost 4% of the CMP.

I personally think that the management has done a fairly good job of delivering good performance in tough business segments.

A few more points –
– The company has a few JVs (joint ventures) also. One of the JV (TSL) had a fraud and misreported the results for the last few years . As a result Balmer lawrie has prudently written off the investment in the JV. This has depressed the company’s profit for the year.
– The company is investing in the logistics business by opening new CFS. In addition the company has exited most of its unprofitable tea business in UK and hopefully will do so in india too.

The company should be able to make a net profit in the range of 130-140 crores for the year (including JVs). I think a conservative estimate of fair value for the company is around 1300 Rs/ share.

Perception driven investing
There is a lot of perception driven investing in the market. A lot of investors, including me, make decisions based on certain pre-conceived notions. A few of these notions are true, but some are just assumptions which have never been validated.
– PSUs do not make good investments: The assumption is that the PSU label means a poorly run government company which is always losing money. This is however always not true . There are several profitable and well run PSU such as Concor, BHEL etc.
– MNC are attractive investment: The assumption is that the MNC subsidiaries are run by well educated and professional managers. Hence they are good investments. The reality is that these companies are fairly well run, but not for the benefit of the minority shareholders. There have been a lot of instances where the top management has stiffed the minority shareholder to benefit the parent company
– Small and mid caps are risky: All stocks are risky if you don’t know what you are doing. Even walking in the house is risky, if you close your eyes when doing so.
– Rohit is smart, handsome and good looking: This is not a perception, but absolute truth 🙂 even if no one including my wife refuse to agree with it.

Balmer lawrie has suffered from a PSU discount and has always sold below fair value. At the same time it has given 35%+ returns per annum (including dividends) to shareholders who have been diligent enough to evaluate the company beyond the labels and patient to hold on to it for the long term.

I think it is important to check one’s assumptions and perceptions before making a decision. You may be surprised by what you find – that is other than the last point about me, which I can assure you is not a perception but absolute reality 🙂