Cheviot Company – Good Value or Value Trap or Cigar Butt Opportunity?
Cheviot Company Ltd, is a manufacturer of jute yarn and fabrics. It focuses in the niche segment of high value added products such as Fine Jute Yarn, Hessian Sacking, and Industrial Fabrics. Most recently, it has concentrated in selling its products in export market. This business unit is part of Kanoria group (a.ka. Cheviot Group).
One of the readers pointed me to this company. The factors that got my attention in Cheviot were sustained positive cash flow, continued profitability as a jute manufacturer, and dividends. It was pretty surprise for me to find that Cheviot has positive cash flow in an industry that is in perennial loss or runs on continued regulatory stimulus. Is that an indication of quality of management? Let us find out.
Trend Analysis
The whole reason for any business to exist is to generate sales revenue and make more profits. At a minimum, the parameters listed below should have continuously increasing trends. All the data below is from 2000 to 2010.
- Revenue: Overall a slow but increasing trend since 2000 with average y-o-y growth of 5% (SDev. 8%). Neutral observation.
- Earnings per share: Overall an increasing trend, but high volatility. Negative growth seems to be regular occurrence, cyclic industry? Not a good observation.
- Net cash flow from operations: Overall an increasing trend but high volatility. In general, has been above net profit. Good observation.
- Profit/Loss from operations: Overall increasing trends in profits from its operations, but high volatility. Significant drop in 2010. Neutral observation.
- Reported net profit: Overall an increasing trend, high volatility. Dropping in 2009 and 2010. Something is missing because profit from operations was stable, but net profit dropped significantly. Not a good observation.
- Gross margins: Current GM of 13% is lower than historical average of 18%. Not a good observation.
- Operating margins: Current OM of 15% is lower than historical average of 18%. Not a good observation.
- Cheviot: Trend Analysis
Quality of Dividends
In this part of my analysis, I am trying to understand dividend growth rate, consistency, and ability of the corporation to demonstrate sustainability. It is also an indirect way of gauging management’s policy vis-à-vis sharing of profits with common shareholders.
- Dividend per share: Chart 3 shows dividends from 2000 onwards.
- Payout factor: This has been in the range of 12% to 23%. Good observation.
- Dividend growth rate: 7% average growth rate. Practically, non existent dividend growth. Not a good observation.
- Ratio of cash from operations to reported net profit: It has been more than 1.0. Good observation.
- Ratio of profits from operations to reported net profit: This ratio is more than one. Good observation.
- Ratio of Cash from operations to total debt: It has been more than 1.0. Good observation.
Dividend Cash Flow vs. Risk Free Savings Cash Flow
I did not do this analysis because I do not believe Cheviot is a good dividend paying company for two reasons (1) lack of dividend growth; and (2) discrepancy in profits from operations and net profit. More in qualitative analysis section below.
Expected Beta-based Volatility
I measured Beta for this stock’s risk (or price movement) relative to the S&P CNX NIFTY (or index movement). Here, I am trying to understand how a stock price behaves relative to the market.
- The stocks three year Beta value is 0.06, while it is 0.04 for last one year. This means this stock has low volatility w.r.t. S&P CNX NIFTY index.
- If I buy this stock, I should expect relatively lower degree of volatility when compared to NIFTY index.
Fair Value Calculation
The next step is to estimate the fair value so that we can understand return characteristics for this investment.
- NPV price based on 15 year DCF: Rs 118
- Average high yield price calculated based on past 10 years: Rs 167
- Pricing relative to 9 year average PE ratio: Rs 219
- Pricing based on PE ratio of 12: Rs 224
- Graham number: Rs 454
The range of fair value is calculated as Rs 172 to Rs 236.
Qualitative Analysis
- Cheviot is not a typical dividend paying company that I have been discussing on this blog. Although the dividends paid by Cheviot are in-line with my expectation of 22% of its income, the growth of dividends does not exist.
- It has decent cash flow and earnings from operations. But for last few years its net profit seems to be relatively less. At first glance, I was not able to understand this discrepancy.
- Few past annual reports (and management discussions) show the contribution of “other income”. “Other Income” grows by approximately 400% (2007) and 50% (2008). Where does this “other income” come from?
- For example, gross and operating margins of the business has decreasing. Meaning, the business operations seems to have reducing profitability. But ratio of net profit to operating profit is increasing. So if profits are not coming from business operations where is it coming from?
- In 2010, profit from operations have dropped significantly (from 28 crore to 13 crore). But its EPS still continues to increase. The increase in “other income” in 2010 masks the significant drop in profit from operations.
- I was not able to understand what company is doing with the boat load of cash it generates. It has, practically, no debt.
- The cash seems to be getting accumulated, but not in-line with cash from operations. On relative basis, accumulation of cash is less. So where does it go?
Summary
Cheviot was a very intriguing company for me to read on. At first glance, I was surprised that being in a jute industry it is making profit. One aspect that I like about management is its ability to adapt to new business realities. It’s focus on high value added products and export market are yielding good results. I believe this is a good example of how a non-glamour company can be run profitably in a beaten down industry.
Having said that, I just do not understand what does management do with the cash it generates? It neither shares good dividends nor does share price commands any premium. I like the company but do not like the returns investor can get from this company. So what is the verdict?
- This would be a Cigar Butt type of opportunistic play, if there is an opportunity to buy Cheviot shares for Rs 150 or less.
- Otherwise, I believe, if I look at company cash flow without margin of safety, then it is likely to be value trap. The company’s business generates good cash flow, but does not share its earnings with shareholders.
Disclosures: No position in Chevoit Company Ltd.
Disclaimer: This analysis is in the context of my long term buy and hold investment philosophy. It is in accordance with my investment objectives and my personal risk profile. If you intent to use this analysis for your own investment decision, then please make sure it meets your own objectives and your own risk profile.
526817, Cheviot, Cheviot Company, cheviot stock analysis, cigar butt opportunity, Fine Jute Yarn, Hessian Sacking, Industrial Fabrics, jute industry, value trap
Got one post about Cheviot…
http://blog.rcfunds.com/?p=202
@ tip guy, regarding your question on “where does the cash go” and “other income”. it seems company does a lot of equity investing with the cash received from its buisness. that is why there is lot of fluctuation in other income.
i agree at a price 200+ it is value trap. it also agree it seems to waste lot of money it generates from its business. why does it not increase dividends or why does its business/stock price is alwasy in low PE? and this is the reason. i had bought it during last downturn and sold it the moment it crossed 225. i thought i had made a mistake, but now feel good
thanks for the analysis
also good to see you discussing something other than dividends. Not that I am bored, but gives more options. looking forward to read more.. I don’t know your email, so sent you a message from contact, can we touch base on eamil or phone?
hi tip guy, i am still new and learning the nuisances of value investing. I have been doing paper experiments with DCF calculation. when I do the my calculation it comes to 300+ but your is 118 only. I am just wondering why?
but then, in your summary you said “if I look at company cash flow without margin of safety, then it is likely to be value trap”
so I take my DCF of 300 and 50% margin of safety. in this case, the buy price would be 150 much closer to your dcf calculation. in this case it makes sense
can you throw some light how come your dcf is similar to 50% of my dcf calculation?
egarly looking forward to your reply. thanks in advance.
Hey TIP guy, I am trying to get a list of BSE200 companies with div yield greater than 3% ( last year div / current stock price ). Can ou help me?
Hello Student,
I wish I could. I don’t have it either. BTW – why do you think you need it? Do you think current yield has any significant, considering, dividends are only once a year and its not sure like in US?
Best Wishes,
Hello TG,
Regarding your 5 point fair valuation strategy, why is that Book value is not considered?
Hello AVS,
You should check out how I calculate graham number http://www.tipblog.in/education/estimating-benjamin-graham-number/
Best Wishes,
Excellent analysis. I really liked your charts. That is a great way to explore a niche company. Your title caught my attention but the analysis sold me. It would be great to see this as a regular feature.
Thanks for your good words. Yeah, I hope to cover something like that.
Best Wishes,
Hi Tip Guy,
Lame question, what do you mean by the phrase “Cigar Butt Opportunity”
Thanks
Vik
Hello Vik,
Exactly what a cigar butt means. It still have few puffs left. Let me give a simple analogy.
Say one full cigar cost 1 buck.
A full cigar has all the puffs, so you would happily pay 1 buck for it. If you are cheapstake like me, I would look for bargains. I would try to find a cheaper full cigar – this is value investing. Companies in growing industry, profitable industry, etc are like full cigar. Lots of profit to be made.
What about cigar, that is not fully consumed to the end (i.e. a cigar butt). It still has four or five puffs left. It meets your needs to have only four or five puffs. You would probably pay 0.05 bucks only (not 0.2 or 0.4 or 0.6). Other way round, you know you can sell it for 0.1 or 0.15 bucks. Industries or companies running on stimulus, or uncertain prospects, or in bankruptcy, etc are likely to be cigar butt type of opportunities. They still have some value based on assets or liquidation, etc. I believe jute and textile industry are likely to have more cigar butt companies.
Buying a cigar butt at 0.05 bucks makes sense. You still have some profits or puff left. This is cigar butt opportunity.
If you pay like 0.2 or more, then it is not a cigar butt opportunity. You misunderstood a “cigar butt” for “full cigar”. And thought you are getting value at 0.2. This is a value trap.
Does this help?
Hi tipguy
this is an old holding of mine
think of this company of two parts – one is the core jute biz. this is a dog of an industry. constant labor problems, bankrupt competitiors and based out of calcutta.
inspite of this scenario the company has moved into higher value products and maintained high profitability and decent profits
the swings in the profits have due to multiple reasons – the 2008-2009 recession impacted the export market and hence the profits.
in addition this company has labor strikes every 1-2 years and hence losses production and profits.
on a normalised basis the company makes around 15-20 crs profits and has Return on capital
the second piece is the equity operation. the company has invested its entire surplus cash in equities – lost and made money in the bargain
the market – rightly so has ignored this company.
the management has been hoarding cash and returned it to the shareholders – possibly as they hold a big share of the company themselves. so its a governance issue in addition to a bad industry
so on paper the company is a cash bargain which may never pan out
Hello Rohit,
Good to read your comment. I am sure you didn’t buy at today’s price of 225+
Agree with your inputs. Couple of folks did email me mentioning “other income” is the use of cash in equity markets. And that’s where “other income” comes from. I did not find it interesting for long term holdings, so got less interested, also could not find AR. I don’t know how it returning cash to shareholders because dividends are kind of flat and not that significant.
May be during other downturn when it gets below 150, until then pass…..
Best Wishes,
i have belatedly come to a realization that such companies may be a pass for all times.
they dont rise as much when the market goes up. and when the market drops and they drop at that time, it may make sense to buy other companies , possibly cyclicals as the upside is more in such cases.
well, anyway better late than never in my case
I am with you on this one. Your thought process makes sense.
Hi ,
have you gone through camlin company’s profile….they have unique kind of products..also brand name…what is your openion on same?
Hello Chetan,
Somebody else also asked me about this in email. Coincidence?
First, it does not fit into my long term buy and hold objectives. Too much debt, and practically non existent dividends.
Second, it can potentially be considered based on value or future earnings power. But too expensive for that. Buying at 16 or less would make sense.
So for now I pass. But is on my watch list.
Best Wishes,
The Company’s Equity Treasury does not invest prudently the shareholders money. If you carefully see, in past company’s equity investment valuation, Mutual Fund Investment valuation has eroded significantly.
The Treasury is not prudently investing the shareholders money and that is the reason the company is not doing good for investors.
Regards,
Gaurav
Thanks for sharing your observation.