Graphite India Ltd – Good Small Cap Stock for Long Term Holding
Graphite India Limited (GRAPHITE) is the largest manufacturer of graphite electrodes (90% of the revenue). It also provides impervious graphite equipments and GRP/ERP pipes and tanks (10% of revenue). It end customers, and applications are in metallurgical (ferrous & nonferrous), chemical and process, and aerospace industry.
This is small cap which has potential in my long term buy and hold because it operates in niche market with high entry barriers. I want to understand its financial management and whether it meets my buying criteria.
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 2009.
- Revenue: Increasing trend since 2001 with average growth of 31% (SDev. 47%). Neutral observation.
- Earnings per share: Historically increasing trend, but flat for last three years. Average growth of 53% (SDev. 96%). High variability and has possibility of negative growth. Neutral observation.
- Net cash flow from operations: Increasing trend prior to 2004. Reduced until 2006, and now again increasing trend. Neutral observation.
- Profit/Loss from operations: Overall increasing trends in profits from its operations since 2001. Good observation.
- Reported net profit: Overall an increasing trend since 2001 and increase trend. Good observation.
- Gross margins: Current GM of 23.8% is higher than historical average of 17.3% (stdev. 3.01%). Good observation.
- Operating margins: Current OM of 26.8% is higher than historical average of 19.1% (stdev. 3.68%) and increasing trend. Good observation.
Trend Analysis: Graphite India Ltd
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. In is also an indirect way to gauging management’s policy vis-à-vis sharing of profits with common shareholders.
- Dividend per share: Chart 3 shows very slow growth until 2006 and then good growth onwards. Neutral observation.
- Payout factor: This has been less than 30%. Good observation.
- Dividend growth rate: The dividends have not grown at sustained year-on-year basis. i.e. there has been a high level of variability. Overall, on the basis of last nine years, the dividends have grown at an average of 37% (std dev. 61%) which is less than overall EPS growth rate of 53% (std. dev 96%). Good observation.
- Ratio of cash from operations to reported net profit: It had been more than 1.0 prior to 2005. This could be due to the funding for growth plans. Has been improved since then. 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: This ratio was trending upwards prior to 2005. But here also, the debt funding for growth reduced it. It trending upwards. Neutral observation.
Dividend Cash Flow vs. Risk Free Savings Cash Flow
Why should I take risk if I can get a same or more cash flow by putting my capital into any risk free savings, fixed deposits, or any such risk free accounts? Therefore, I try to understand how dividends will affect my cash flow in 10 years of time period. The baseline assumptions are (1) the stock’s dividend yield is 3.6% at current price of Rs 84.00; and (2) savings interest rate is 7%.
- Best case scenario: considering average dividend growth rate of 26% for last nine years, the dividend cash flow will be 2.22 times the cash flow from savings interest at the end of 10 years.
- Worst case scenario: considering low end of the expected dividend growth of 15%, the dividend cash follow will be equal to the cash flow from savings interest at the end of 10 years.
- So at current pricing of Rs 84 and assuming the dividend growth rate of 15%, the cash flow from dividends is equal to savings cash flow.
Projected Beta-based Expected Return
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 and how to factor in the capital appreciation into my expected returns.
- The stocks three year Beta value is 0.18. This means this stock has low volatility w.r.t. S&P CNX NIFTY index.
- The expected return is 8.5% relative to market index.
- Now factoring in 8.5% of expected return into the worst case dividend growth of 15% and current yield of 3.9%, the total cash flow is 3.6 times the savings interest rate.
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 101.23
- Average high yield price calculated based on past 9 years: Rs 50.6
- Pricing relative to 9 year average PE ratio: Rs 78.5
- Pricing based on PE ratio of 12: Rs 138.0
- Graham number: Rs 131.8
The range of fair value is calculated as Rs 81.7 to Rs 100.
Qualitative Analysis
- Graphite is one of the only two companies in this domain in India. Another one is HEG.
- The market in which Graphite operates has high entry barrier for technology and capital intensive. This provides it an edge.
- It seems to have completely executing its growth plans. It has used both organic and inorganic strategies for growth. I has increased internal capacity in India for organic growth. The inorganic growth comes from acquiring German company to remain export competitive in European markets. The debt is being reduced faster than I would expect in any other businesses.
- It has also initiated some product diversification (on industry diversification) within its domain of graphite expertise. However, it revenue from this segment is still only 10%.
- It has steady increasing margins, although I believe it will get capped at certain point. When that will happen? I do not know.
- There are two reasons for which I preferred Graphite over HEG (1) operational cash flow for HEG is less than net profit; and (2) for similar level of revenues HEG has higher debt. Even though its margins and dividends are higher, it seems Graphite has better balance sheet management.
- The downside risk is related to operating in the relative niche markets. Majority of its product is supplied to steel industry, which is expected to remain slow for some more time (probably another 2 years?). It remains to be seen how its product diversification helps its profitability and margins.
Summary…
I would expect Graphite to provide potential capital appreciation over long term and slow dividend cash flow. I believe it will have near term challenge of maintaining its earnings and dividends. However, long term it is very well positioned as being one of the only two suppliers of graphite electrodes and related products. At present, the shares are trading within my fair value range. I will add shares of Graphite as per my allocation levels.
Disclosures: Long on Graphite India Limited.
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.
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Thanks for analysing this stock based on my [& maybe others' request], Tip-guy.
arunsg,
you are most welcome.
As I am following your moves (Those you have published) closely, I wonder when did you add this to your portfolio. Why didn’t you pick this when it was around 40-45 in Sept 09?
Any ways good analysis, I am following you..got small qty today Though I think it is little overvalued.
MIP
MIP,
First, I published the shortlist on Dec 9. Second, I published another one on Dec 30. So, I added between those two dates.
Now why I didn’t pick in Sept09? Simply, because I cannot time the market. Not only Graphite, there were probably many many more such companies out there at that point in time.
Someone else actually asked in an email why I didn’t pick in March-July 09? And I happily ignored the email. It is very easy to look backwards, AND difficult to decide in present, AND next to impossible to predict the future.
The important thing is to make a decision in present. I know my limitations that I find it tad difficult (although not impossible) to determine valuation, whether over or under. That is the primary the reason I say “fair valuation”, I am willing to pay. In my buy-n-hold approach, 10 years down the line, I won’t remember extra 5% to 10% I paid. It will become wash. The key risk is ability of the company to perform consistently and survive. If it does fall below, good, I will keep adding.
hope this helps.
Best Wishes,
I said it sarcastically.
I know one shoul dnot time/forecast the market. You gave me the reason to enter.
After 66 comments from you , I know by now, what you really meant!
It was a good question, plus, I received two similar ones in email. I wanted to put this into perspective, so other reader know my thought process. And hopefully, they do not feel I am try to squat the question.
I am in too.
Hey, I recently came across a scrip Cords Cable (BSE 532941). I went through its book, it looks good and cheap.
I ‘d appreciate, if you can strengthen my view.
Regards
Yogesh Tiwari
Yogesh,
Acknowledged, and thanks for the suggestion. I will check out, when I get to it.
Best Wishes,
Hi,
For your calculations are you using Standalone or consolidated numbers?
Most of the experts recommend to go with consolidated numbers but all the financial sites like moneycontrol, rediff etc show only standalone.
How do you verify whether the nos. that you have arrived at is correct?
Thanks
Sudhakar
Hello Sudhakar,
I believe each of us and everybody else is expert, because each of us are right in some way (its the context that makes it wrong).
Being brutally honest (and not attempting to deride your question), I believe experts are dime a dozen. I only say this because, those expertise is always for someone else, but not for themselves.
On a serious note, Standalone vs. consolidated number; can you help me (and readers of this blog) understand the difference? AND what would be implication in the context of my objectives?
On the verification, is your question related to verification of input numbers or output summary numbers?
Hope you hear from you.
Best Wishes,
Hi,
Consolidated nos. include the nos. of the subsidiaries also. For ex. for tata motors, standalone would be just Tata motors India whereas the consolidated would include JLR and other subsidiaries. In fact the Annual report would contain the financial reports for each of the subsidiaries listed.
So obviously the EPS, BV, ROE, ROCE etc would be different. infact all the numbers will be different.
The reason i asked you is i generally get the nos. from the consolidated pages of the Annual report and when i go to verify the nos. none of the sites have that data. There is always a nagging feeling that i may be wrong as i’m new to investing.
Eg: For grahite india the consolidated net profit for 2005,06,07,08,09 are
60.42, 68.34, 222.36, 142.34, 235.52
whereas the data from money control is
48.00, 62.95, 193.87, 133.65, 193.57
hence my question
Hello Sudhakar,
I requested to help us understand the difference and implication in the context of objectives. It would have really helped everybody here if you had presented your reasoning or viewpoint (instead of just throwing probing questions and quoting numbers). You certainly seem to have quite a bit knowledge becuase you mentioned Tata Motors JLR and all other numbers. Both, the readers and I, would have been happy to learn from you.
I use data from money control (and randomly verify at rediff, ICICI direct, AR). And I can certainly discuss my reasoning to use the same examples, i.e. TATA motors or Graphite.
You quoted numbers and mentioned using consolidated number from AR. Nothing wrong in it. It is perfectly OK to use it. BUT would like to know why? And what is wrong — if we do not use consolidated number.
So again, what is the implication? How does it matter?
Hope to learn from you.
Best Wishes,
dime a dozen, i like that, everybody calls himself an expert now. check out every other blog. its either “indias largest”, “indias best”, “most read”, “high ranked” etc etc….
Tipster you are fired!. That was a good post. I have taken a printout of that post and stick it up on my office cube. whenever somebody talks about stock tips. I point them to that article and they quietly walk away… its fun to see their faces
Hello RP,
happy to know you took prints to hang in you cube. That’s funny. I am sure you are having fun.
Best Wishes,
Good analysis
I am keen to know about your analysis about HEG as well as I hold some.
In addition, your two cents please on paper companies like TNPL, WEST COAST or maybe ansimilar analysis will be great.
Thanks
Rookie
Hello Rookie,
I already mentioned what I could about HEG (or wanted to).
When you want to buy a car, there are 10s of choice. You don’t buy all of them. You pick one which you think is the best your own needs. That does not mean other cars are bad.
Same way, I am not saying HEG is bad company. I prefer Grahite over HEG and I discussed few points why so.
acknowledged your request about paper companies. I will look into them when I get a chance. Sorry couldn’t not help you immediately.
Best Wishes,
@ Tip Guy: It shall be nice to let your readers know at what price you bought it. becuase it will help readers to take advantage of your knowledege.
I am in too with large portion. I have been following your blog for a while, and I have attempted to use your approach, so far I am not been disappointed. Another large portion that I bought was NTPC way back early in this year. the amount of returns i have got on it has beat anyone i had in last 4 years. thank you, i hope you keep doing this.
Hello Tipguy,
Brilliant Analysis !! I will hold this for long term and this will not be a part of my quarterly churn. My faith in Magic formula keeps getting validated each time you or valueinvestorindia.blogspot.com come up with an analysis.
I entered graphite india on october since it was in the top 50 and P/B ratio was less than 1. I am slowly getting inclined to change my approach to buy and hold for 3 yrs based on you guys and will come up with a strategy on this soon.
Adios
Investologic
Hello again,
Would you like to review Gujarat State Fertilizer & Chemicals? It is still trading under the book value and has posted a steady growth over the past 5 yrs. On another note, it would be helpful if you can share your source of 10 yrs data for companies.
Regds
Investologic
Hello Investologic,
Thanks for suggesting GSFC, will take a look when I get a chance.
Best Wishes,
Hi Investologic,
].
If you tweak the Magic formula a bit: take the ratio of Growth of NP / Growth of Sales, you come up with ordered list where you can come up with the list where the NP growth is faster than the sales growth. In this ratio, Graphite India comes out ahead of HEG or ESAB. The closest to Graphite india looks to be Ador [remember Advani Oerlikon - old timers like me
However, in a field where there are multiple players, unless there is a very strong reason for going in to #3 and downwards, its best to stick to 1 or 2. In this case the two are Graphite and HEG and due to reasons mentioned by Tipguy, Graphite seems to score over HEG. I am still to see where Esab comes in comparison of ratios, though sales wise, its a much smaller player. So, in sum, Graphite seems the best bet and I am going in heavily into it!
Cheers,
Arun
Good suggestion Arun. I will try to incorporate that into my next sheet. Lets see what comes out of it.
A bit of a tagent here – for Tip_guy to answer!
What is today’s definition of small cap? Graphite india with 1200Cr cap would qualify as a midcap, I imagined?
*My* current definition:
]
1. Less than 100 cr = Microcap
2. 100-500: Small cap
3. 500-5000: Midcap
4. 5000-50000: Large cap
6. > 50,000 : Monster / giant cap [aside: both denote size,why goes monster have negative connotations - something to think over
Whereas Tip has classified Graphite into Small cap….so what is the consensus/common view of cap classification?
Cheers,
Arun
Hello Arun,
I had an exactly same thought when I looked at market capitalization for Graphite. And the first thought was, is it extremely overvalued for a small cap?
I wanted to keep it simple. I went by its position at BSE. It is included in BSE-Small Cap index. Hence, I stopped at that.
Intentionally, I want to avoid is aspect, otherwise, it adds to complexity. I go by fundamentals, so this classification would have very minimal implications (if there is any).
Does this make sense?
Best Wishes,
Hi TIP Guy,
As usual nice analysis, thanks.
I noticed in your blog that Graphite India is the largest manufacturer of graphite electrodes and one of the only two companies in India. I was wondering if you came across the number, % of market share, it holds in India. So is remaining market covered by imports? What is their position is international market?
Why I am asking? Just to get an idea of potential for growth keeping aside the diversification.
Happy to know your views on this aspect.
Cheers,
~Sachin
Hi TIPGuy,
Nice analysis. Any specific reason you give “neutral” to the revenue growth? Is there any risk in terms of foreign competition?
Rgds,
Siddharth
Hello Siddharth,
Neutral for two reasons (1) it end customers like steel will remain slow for some time (2) its European exports may slow down because of economic slump. Plus the average growth rate is less than std dev, which tells me they do have negative revenue growths.
At least for now, I am not too worried about foreign competition. May be over time, but that is valid for not only this company, its for everything other companies too.
I should have clarified this earlier, but neutral does not necessarily mean bad. From my perspective neutral means I am not jumping with joy but OK with it.
Best Wishes,
Hi,
I am using a paid service for my long term Buy/Sell recommendation. Today they had recommended GI. Its amazing that both the analysis reflect similar thoughts. You are doing excellent work. Please continue your good work.
Hello Alchemist,
That is good to know. I wonder why would one go for paid service, when it is available free on the blogs? (just bragging little bit,
Best Wishes,
I didn’t know that such a good blog existed when i went for the paid service else i wouldn’t have
. To be honest, when you look around in the web, there is a lot of free research information available in the name of Value Investing. Its difficult to take everything as good analysis on the face value. Value Investing itself is a slow and steady process. And to analyze whether a content is actually good and worth following is a tedious process. Thatz y i opted for the paid service. Anyway, i think i have landed on a good blog..So slowly i can phase out my paid service 
Sir,
I was doing graphite analysis on similar lines.The eps did go up to 16 and 22 during 2006 and 2007 (checked from company website).But your graphs don’t reflect that .Could you please clarify the same.
Thanks
Hello Saif,
You are taking about the direct values as shown on the statements. I normalize EPS to the outstanding shares (or share in issue). Normalization brings the “trend” inline with the total number of shares, or help explain the impact of dilution.
Hope this helps.
Best Wishes,
Good analysis though I have covered it at sub 50 levels.
Regards,
ARUN
http://www.arunthestocksguru.com/