Voltamp Transformers Limited (VOLTAMP) is one of the leading player in customized transformers for industrial applications. It has a niche in 132kV market segment and now looking to expand upto 220kV market segment. The key aspect that I like about Voltamp Transformers is its focus on niche market. It has created a space for itself in industrial segments, has zero debt, and focus of controlled growth.
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 based on last 8 years i.e. from 2001 to 2009.
- Revenue: Consistently increasing trend since 2001 with average growth of 43% (SDev. 24%). Good observation.
- Earnings per share: Increasing trend with average growth of 94% (SDev. 95%). This means the growth rates are very volatile. Growths have varied from 26.2% to 102% in last 9 years. Neutral observation.
- Net cash flow from operations: Overall, an increasing trend since the company went for IPO in 2007. There is not much history available before that. Neutral observation.
- Profit/Loss from operations: Consistently increasing trends in profits from its operations since 2001. Very good observation.
- Reported net profit: Overall an increasing trend since 2001. Very good observation.
- Gross margins: Current GM of 22.6% is higher than historical average of 15.4% (stdev. 3.6%). Very good observation.
- Operating margins: Current OM of 23.3% is higher than historical average of 14.4% (stdev. 4.5%). Very good observation.
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 that growing dividend payments since 2001. Individual investors should be looking at dividends from 2006 onwards (i.e. since it got listed on stock exchange). Not much data to make any observation. Neutral observation.
- Payout factor: This is ratio of dividends per share divided by EPS. This has been less than 20% in last five years. Neutral observation.
- Dividend growth rate: Post IPO, there is not much data to make any worthwhile observation. However, based on last four or five years alone, the trend suggests that dividends have not grown with the EPS. Not a good observation.
- Ratio of cash from operations to reported net profit: Not much data here to make any worthwhile observation, but trend suggests lack of consistency. It keeps fluctuating above of below 1.0. Neutral observation.
- Ratio of profits from operations to reported net profit: Consistently more than one. Good observation.
- Ratio of Cash from operations to total debt: This ratio is consistently more than one and increasing. This is an indication that company is relying less and less on debt for growth. Very good 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 1.7% at current price of Rs. 749.20; and (2) savings interest rate is 7%.
- Best case scenario: considering average dividend growth rate of 25% for last few years, the dividend cash flow will be 0.97 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 10%, the dividend cash follow will be only 0.31 times the cash flow from savings interest at the end of 10 years.
- In order to have equal cash flow (i.e. dividends = savings interest) in 10 years time period, the current yield should be 3.6% with average dividend growth of at least 10%. At this yield the buy price is Rs 318.
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 0.88. This means this stock is highly correlated to S&P CNX NIFTY index, and hence it should be expected to remain volatile.
- The expected return is 14.5% relative to market index.
- Now factoring in 14.5% of expected return into the worst case dividend growth of 10% and current yield of 1.7%, the total cash flow is 4.1 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 568.9
- Average high yield price calculated based on past 9 years: Rs 471.2
- Pricing relative to 9 year average PE ratio: Rs 1037.2
- Pricing based on PE ratio of 12: Rs 557.9
- Graham number: Rs 485.2
The range of fair value is calculated as Rs 506.6 to Rs 624.2
- Voltamp is small market cap company that remains focused on its core strength of providing smaller rating transformers to industrial segment. Approximately 92% of its revenue comes from industrial customers, while government SEBs contributes only 8% of the revenue. Typically, majority fo these industrial customers require customized solution. And this is its niche. This allows better cash flow and relatively higher margins.
- Overall, it enjoys approximately 20% market share in its class. In addition, it has 40% market share in dry type of transformers.
- I like Voltamp’s debt free balance sheet and its capital management practices. For a small cap company, it is one of the good ones I have look at in recent times.
- The company came out with IPO in 2005/2006, however, it was not for capital requirements or funding its growth. It was offloading the shares (and cashing out) of two of its long time partners. Lack of debt allows the company to have very good capital usage ratios.
- The company acknowledges the need for future growth and risk, and hence is looking for higher exposure to SEBs, and expanding its product portfolio to transformer with higher kV ratings.
- Risk is slow down of industrial growth, capacity driven margin pressures, and low barriers to entry for Chinese competitors.
Voltamp Transformers is one of the small cap which has very good balance sheet, very good capital management, and a niche market. Being a small cap, it gets my brownie points for ability to focus on its core strength, keeping balance sheet clean, and still manage growth. In the current prevailing growth oriented Indian economy, where every 30+ year company is conglomerizing in the name of diversification, Voltamp Transformers continues to remain focused on its niche market.
A long position bought at fair valuations in Voltamp is expected to provide a long term capital appreciation. Being a small cap and focus on niche markets, it needs to conserve capital and fund its growth. I do not expect this to be good dividend investment. I expect Voltamp to provide a moderate dividend that is in the order of 10%-20% of its EPS.
At this point in time, the stock is trading at 20%-45% premium based on my fair valuation range. At fair valuations, I would be open to invest in Voltamp Transformers depending upon my allocation levels to small cap and power sector. In addition, it should be expected to have high volatility.
Disclosure: No position at the time of this writing.
Disclaimer: This analysis is in the context of my long term investment philosophy. It is in line with my investment objectives and my personal risk profile. Please do your own research before making an investment decisions for Voltamp Transformers.
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