LAKSHMIEFL is engaged in manufacturing and processing food grains and related products. The product includes rice, basmati rice (branded as Lakshmi Foods), parmal rice, rice bran edible oil, wheat flour, de-oiled cake, refined oils, and cattle feed (branded as Heera Moti). It also has 30MW biomass-based power generation business using rice husk as fuel. The company was formerly known as Lakshmi Overseas Industries Limited and changed its name to Lakshmi Energy and Foods Limited in February 2006. Last year, I came to know about this company after reading Supreme Court and agri minister’s tussle over grains rotting in FCI.

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 onwards.

• Revenue: Ignoring year 2008, overall an increasing trend since 2003 with average y-o-y growth of 21% (SDev. 47%). Slowed down in last two years, but not dropped like dead bird. Results of 2008 are for 18 months. Neutral observation.
• Earnings per share: Ignoring year 2008, overall an increasing trend with average y-o-y growth of 18%. Good observation.
• Net cash flow from operations: Erratic and volatile. Overall, it has been below net profit. Reiterates that it is a commodity business. Negative observation.
• Profit/Loss from operations: Throughout positive. Ignoring year 2008, overall an increasing trend in operating profits, with couple of years with slower growth rate. Good observation.
• Reported net profit: Positive from 2003 onwards. Ignoring year 2008, overall an increasing trend in operating profits. Good observation.
• Gross margins: Current GM of 20%+ is higher than historical average of 15%. Good observation.
• Operating margins: Current OM of 28%+ is higher than historical average of 18%. Good observation.
• Net margins: Current NM of 13% is higher than historical average of 8.8%. Good observation.
• Total Debt: Continuously increasing trend, indicating growth is coming at the cost of debt, a representative of commodity business. Negative observation.

Lakshmi Energy and Foods Ltd: Trend Analysis

Quality of Dividends

Usually, in this part of my analysis, I am trying to understand dividend growth rate, consistency, and ability of the corporation to demonstrate sustainability. LAKSHMIEFL is not a company that will find a place in my long term buy and hold portfolio. It is not a company that has visibility for sustainable good quality of dividends. Therefore, I will be skip this part of my analysis.

Dividend Cash Flow vs. Risk Free Savings Cash Flow

I will skip this part of analysis because; I do not consider LAKSHMIEFL as dividend paying company.

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 0.09. This means this stock has low volatility compared to S&P CNX NIFTY index. In other words, comparatively, it has no relation with NIFTY index.
• If I buy this stock, I should expect that shares price movement would be independent of 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 10 year DCF: Rs 120
• Average high yield price calculated based on past 5 years: 35
• Pricing relative to 5 year average PE ratio: Rs 145
• Pricing based on PE ratio of 12: Rs 197
• Graham number: Rs 180

The range of fair value is calculated as Rs 104 to Rs 136.

As mentioned above, this company does not meet my requirements for sustainability. The above approach to calculate my fair value is based on the objective of long term buy and hold. Nevertheless, I performed these calculations for academic purposes to understand relative comparison.

This position is an opportunistic buy, wherein, I will sell once my expected price point is reached. I have decided to follow Prof. Greenwald’s approach to determine enterprise value (EPV). More on this later.

Enterprise value is Rs 108 per share, after excluding debt. For academic purpose, when we compare this EPV with my fair value calculation, it comes within my fair value range.

Qualitative Analysis

• LAKSHMIEFL, a lot has been written about the company in last one year or so. Two years ago, whole financial media and pundits were gaga over this company. The stock’s price went past Rs 200+. Well, did anyone ask, does a company in commodity business deserve such rich valuations?
• As of today, the company just cannot do anything right. Management seems to have lost focus, diversifying into power generation and building paddy inventory in its warehouses. No wonder, the stock is getting clobbered.
• At a fundamental level, raw food processing is a classic commodity business. It has no moat, no pricing power, and above all government regulation. LAKSHMIEFL used to sell 90%+ of its rice to Food Corporation of India (FCI). Hence, it just does not have freedom to grow. The point being, how can such a business command such rich valuations of Rs 200+?
• LAKSHMIEFL is a company in transition. While it continues to grapple with two issues, it also taking multi-faceted approach to future growth.
• First, is the issue of excess inventory driven by low intake by FCI. FCI does not seem to have enough warehouses and hence, it is not purchasing more rice. In addition, Indian government has banned export of standard rice. In these two cases, it does not have any other option but to sell rice at low price in domestic market. The company is holding has large inventories relative to its own recent past.
• Second, is the management trying to diversify revenue base away from over-dependence on FCI and improve its margins. Results show its margins are improving. Company is making effort to enter the crowded basmati rice, branded product segment, and bio-fuel power generation.
• An attempt to climb higher in value chain (branded products) makes sense. But what about bio-fuel generation? The fact that it has abundant raw fuel material, which otherwise goes waste, it has a desire to use this free resource. Does this capital expense make sense? I tend to believe that the margin improvement is coming due to this power plant which can be used for captive power supply. The company does not have to buy power from state grid.

There is one additional factor to understand the general perception about LAKSHMIEFL. The company changed its financial year around year 2008. The results in 2008 consist of 18 months time period (and not 12 month time period). All the relative comparisons of drop in revenue, drop in profits, and drop in EPS appeared to be skewed, because it is not one-to-one comparison. The year 2008 earnings went sky high due to longer duration, which skewed the valuation. Chart 1 and Chart 3 shows the spike in year 2008. If we normalize the revenue and earnings for year 2008, the trend seems to be increasing. The short sightedness is likely pushed the valuation sky high based on these skewed data points.

Summary

I like LAKSHMIEFL for its current valuation with reference to its assets, market domain, and potential recovery. Fundamentally, it is a commodity business with not much of a competitive moat or pricing power. It still continues to rely on FCI as its single largest customer. Relying on FCI can be viewed two ways. Many argue it does not have pricing power (or margins are fixed), but then if FCI decides buy price, then in turn LAKSHMIEFL decides what to pay for its raw material to farmers. In addition, the company has a minimum floor level because it is going to sell to FCI – isn’t that a competitive advantage on downside?

There are risks. The risk comes from being in a commodity business. Management is trying to diversify its revenue base. It is entering different market segment and attempting to climb value chain. While I believe the current prices are well below my fair valuation, the question is how long will it take to reach fair valuation? And that is risk we as investors take!

As an investor, the first aspect we all think about is to have downside protection. LAKSHMIEFL’S current market price minimizes downside risk, and provides growth potential. There are other companies in this space, but I think their current market prices with reference to valuations were not appealing to me.

Disclosures: Long on LAKSHMIEFL. Please read TIPBlog disclaimer.