About
Sulzer india is a 200 Cr company in the business of mass transfer technology (mixers, separation column etc) for industries such as refineries, chemicals, gas processing etc. The company is a subsidiary of Sulzer chemtech AG. The parent also has a fully owned subsidiary – sulzer pumps.
Sulzer india has received technology support from its parent, which holds 80% of the equity in the company

Financials
The company has maintained an ROE in excess of 25%, with the number increasing to around 40%+ in the last 2 years. The company’s total asset base is almost same as the cash balance, so net of cash the invested capital is a very low amount. In addition the company also has a source of additional capital – customer advance which reduce the net capital requirement in the business.
The sales have tripled and net profits gone up by more than four times in the last 4years. The company is debt free and now operates with negative working capital

Positives
The company operates in a knowledge and technology intensive industry. It is supported by the parent in terms of technology and technical transfer. The company also has a strong balance sheet with excess cash and has demonstrated a decent growth record in the last 5 years.
Finally the company has maintained a decent dividend payout ratio in the last few years

Risks
The key risk in my mind is the lack of in depth information available on the company. The annual report is fairly sketchy. The parent holds 80% of the company and has attempted to delist the subsidiary in the past. As a result, I personally don’t expect them to care too much about their Indian shareholders. The tone and disclosure in the annual report seems to reflect the lack of interest on part of the management for the minority shareholder.
The core business of the company is fairly healthy and the company should continue to do well in the future. The risk is how much the minority shareholder will benefit directly from the value creation.

Management quality checklist

– Management compensation : The management compensation is not excessive and appears to be on the lower side
– Capital allocation record (dividend, ROE, excess cash, acquisitions etc) : seems decent with reasonable payouts in the form of dividends
– Shareholder communication: sketchy and poor.
– Accounting practise: appears conservative
– Conflict of interest: Though strictly not conflict of interest, the company pays 2% of sales as royalty to the parent. There is no explicit conflict of interest.
– Performance track record: The business performance has been good even during the downturn.

Conclusion
The company sells at around 11 time current earnings with cash levels in excess of 10% of the market cap. In view the fundamental performance, the company could easily be valued at 20 times current earnings. However fundamental performance is not always the sole determinant of value. In cases such as sulzer, which are MNC subsidiary companies the business performance does not always translate into shareholder returns as long as the management does not take specific measure to improve shareholder returns.
Sulzer has tried to delist the company in the past and current holds 80% of the stock. I will have to stretch my imagination on the point, that the company will suddenly start looking at improving the returns for the minority shareholder. In such a scenario, it is quite difficult to put an appropriate number on the intrinsic or fair value of the company.

Disclosure : I do not currently hold the stock. I may or may not buy the stock in the future and may not declare my holdings. Please read my disclaimer at the end of this blog.

Additional message
Let me take a break from our regular broadcast. I am currently looking for two things and would appreciate if any reader can help me on it

– I am looking at someone with the requisite technical skills, who can help me make changes to my blog layout and design. I can workout an appropriate payment either in cash or kind (you redesign my blog and I provide advisory service for your portfolio). If you know someone or can do it yourself – please write to me on rohitc99@indiatimes.com or leave a comment.
– I am looking at developing an automated spreadsheet for filtering stock based on various preset criterias by pulling data automatically from a public websites. I am not sure if this can be done and would appreciate any feedback on the feasibility of this requirement.

Correction : I posted analysis of JNJ from an old file instead of P&G. correcting it now.

I started the analysis of P&G (US) in my previous post. The balance of the analysis follows

Competitive analysis
The company faces a host of competitors ranging from local to store brands to companies like unilever. Most of the local and store brands compete on price.

P&G has rightfully realized the need for innovating in all the categories to stay ahead of the competition and thus maintain a price premium. In addition the company has a wide portfolio of brands and an extensive marketing and distribution infrastructure. These competitive strengths allows the company to fight price based competition.

The company has been investing almost 10% in marketing and sales and 3% in R&D. These investments are key to maintaining the competitive edge of the company.

Management quality checklist
– Management compensation: The chairman received a total compensation and bonus of around 57 Mn usd, which does not appear excessive. The company has an options program which would result in a rough dilution of around 10% or less.
– Capital allocation record: The management has a very good capital allocation record. They have maintained an ROE in excess of 20% for the 7-8 yrs. In addition the company has maintained a dividend payout in excess of 40%. The excess cash has been utilized to fund acquisitions and buyback stock. I would give the management high grade on capital allocation.
– Shareholder communication: The company has communicated its strategy and focus on innovation. In addition the company has is also transparent in communicating the long term goals such as organic growth, free cash flow target etc and the achievement against the goals. The company has also discussed in detail the performance of each division with clear details of the organic volume growth to enable the investor to understand the source of the topline growth. The company has been consistent in communicating good as well as bad performance.
– Accounting practice: appears conservative and I could not find any red flags. The company seems to have made conservative pension assumptions, has minimal derivative exposures and other off balance sheet liabilities. My only concern is the benefit assumptions. Although the actual returns are negative, the company is using positive expected returns on assets (allowed by GAAP). If the returns do not turn positive, we could see higher pension expense in the future.

Valuation
The company has a free cash flow which is almost equal to net profits. The company has an ROE in excess of 20% and an average growth in excess of 8%. If we assume a CAP period of around 10 years, a net profit growth of 8%, the intrinsic value comes to around 72-75 usd per share. If one reverse engineers the current price, the implied growth seems to be around 2-3% for the next 10 years.
The company thus appears to be undervalued by around 20-25% at current prices.

Conclusion
The company has been able to show a low single digit growth inspite of the global recession. The topline however has shown a low single digit drop. The company is in the process of disposing non core businesses such as coffee and the medical division. This should provide the company extra capital to invest in the core business, retire debt or continue with the buyback program.
The company has maintained its focus on innovation and new products and has been investing heavily in brand building and R&D, even through the recession. This should help the company when growth returns. The company has enormous competitive advantages in the form of strong brands, deep distribution network and a innovation oriented culture. Although the company is not undervalued by a wide margin, it should give moderate returns in excess of the index returns over the next few years. In summary it is moderate return, low risk opportunity.

I have created a pdf version of the analysis. Please feel free to download and share with others.

About
Procter & Gamble is an 79 billion dollar consumer goods company with well known brands such as pampers, gillette, charmin, bounty, tide, pantene etc. The company has operations across 180 countries across the world and operates in the beauty products, health and household care segment.

Financials
PG has consistently maintained an ROE in excess of 25% with a moderate leverage of around 0.5. The drop in the ROE since 2006 is more due to the accounting related to the Gillette accquisition than a drop in the profitability levels.
The company has become a more efficient user of capital by increasing its Fixed asset turns by 25% in the last 6-7 years and by turning Working capital negative during the same period. It has utilised the excess cash to reduce the debt ratios, maintain the dividend levels and buy back stock.
The company has been able to improve its Net margins from around 9% to almost 14% in the last 10 years. It has done this while maintaining an ad expense of around 10% of sales and almost 2.7% expense in R&D
The company has doubled its sales and tripled its profits in the last 10 years too.

Positives
The company under the leadership of A G Lafley has been performing fairly well. The company has increased its focus on innovation in various aspects of the business such as new product, packaging, cost management etc. This focus goes beyond the customary lip service and can be seen via the new product launches and continued volume growth in mature categories. The company continues to invest almost 10% of sales in advertising and upto 3% of sales in R&D which is the highest in the industry.

The company has a successful history of developing and maintaining strong brands. In addition the company also has an enviable marketing and distribution infrastructure which cannot be replicated easily.

The company has been able to grow the topline in high single digits for the last few years with volume growth in most of the categories in the 3-6% range. The value growth in the various categories has been in low double digits range due to the above volume growth in combination with price increases and favourable foreign exchange changes. The company is also growing in low double digits in most categories in the developing markets such as India, China and middle east.

The various financial parameters such as ROE (in excess of 20%) and net profit growth (in double digits for the last few years) have been extremely good. The company has also been able to successfully accquire and integrate gillette and thus gain cost synergy and increased leverage in the market.

Finally the company has been able to generate free cash flows in excess of net profits which it has been using to reduce debt and buyback stock.

Risks
The company is undergoing a transition at the top with Robert Mcdonald as the new CEO. Although the company is unlikely to suddenly change direction and focus, the change is occuring at a time when the volume growth has slowed down due to the recession

The company has recorded negative sales growth in the current year. Although the volume degrowth is not alarming considering the global recession, drops in market shares in categories such as feminine care, male dry shaving, batteries, fabric care and drops in the braun appliance range is a cause of worry and needs to watched closely in the future.

The company operates in a very competitive industry where the low priced local competitiors and store brands are competing in most of the categories of the company. As a result the company faces intense competiton in most of its product categories.

Next post : Competitive analysis, Management quality checklist, Valuation and conclusion.