March 29, 2015

Metalyst Forgings Research Report


www.drvijaymalik.com has a dedicated section for investment & stock specific queries of readers: “Ask Your Queries”. Overtime, readers have asked queries about multiple stocks in this section. Answers to these queries, have been done post preliminary analysis of the stocks under consideration. Such analysis has been found helpful by readers.

Q&A Series is an attempt to summarize & share with all the readers, the key questions and their answers, which have featured on “Ask Your Queries” section. Primary aim of this new feature is to share the knowledge with all the readers of the website.

The current section of this series: “Q&A” covers stocks: Metalyst Forgings Limited (erstwhile Ahmednagar Forgings Limited)


Ahmednagar Forgings Limited

 


Q: Hi Vijay, I have followed your posts throughout and have borrowed many of your investing philosophies. I applied it on one of the stocks that interested me. Wanted to check with you if I am going in the right way or I have missed something.
I am very much interested by Ahmednagar Forgings Limited because of following reasons:
  1. Sales growth : 10yrs > 31%, 5yrs > 35%
  2. Profit growth : 10yrs > 28%, 5yrs > 40%
  3. Has a positive cash flow from operations.
  4. Promoter's stake is ~ 60%.
  5. P/E ratio is also compelling at less than 5.

A: Thanks for writing to me!

Ahmednagar Forgings Limited equity analysis research report


Ahmednagar Forgings Limited has shown consistent sales growth of 25-30% with stable operating profit margins. However, net profit margin (NPM) of Ahmednagar Forgings Limited has declined because of increasing interest costs year on year. 

Ahmednagar Forgings Limited has been able to convert its profits into free cash from operations, which is reflected by cumulative CFO for last 10 years (2005-14) being higher than cumulative PAT over the same period. It is able to collect money from its customers in time, which is reflected by declining receivable days.

However, the concerns arise when we see the data on operating efficiency for Ahmednagar Forgings Limited. Its fixed asset turnover ratio and inventory turnover ratio have been declining over the years. 


Equally important is the fact that the fixed asset turnover ratio is very low, less than 1, which indicates that Ahmednagar Forgings Limited needs to spend more than INR 1 in plant and machinery to produce INR 1 of additional sales. This low asset turnover has serious implications as huge amount of incremental investment is needed to show future growth

For example, Let us assume in first year it Ahmednagar Forgings Limited, targets to achieve INR 100 cr. of additional sales, then it would need to invest INR 111 cr. in fixed assets (100/0.9, because the fixed asset turnover ratio is 0.9 currently). This INR 100 cr. of additional sales would provide additional net profits of INR 10 cr. (assuming 10% of NPM). If Ahmednagar Forgings Limited retains entire profits and invests in its operations, then this incremental investment of INR 10 cr. of entire profits would generate only INR 9 cr. of incremental sales in the second year (as the fixed asset turnover ratio is 0.9). If Ahmednagar Forgings Limited wishes to grow sales by another INR 100 cr. in the second year as well, then it would have to generate INR 91 of sales by investing additional INR 101 cr. (INR 111 cr. total requirement – INR 10 cr. of net profits invested). This INR 101 cr. needs to come from either fresh equity infusion or debt.

Thus, we may see that with very low fixed asset turnover of 0.9, Ahmednagar Forgings Limited would have to keep on relying on additional sources of funds to maintain its growth. This has happened in the past as well. Ahmednagar Forgings Limited has been relying on debt to fund its growth. Its debt has increased from INR 66 cr. in FY2005 to INR 2,773 cr. in FY2014 (42 times increase) whereas its sales have increased from INR 205 cr. in FY2005 to INR 2,397 cr. in FY2014 (11.7 times increase). 

It seems that in the current state, the business model of Ahmednagar Forgings Limited is a perpetual losing proposition. It has already destroyed shareholders’ wealth in the past as it has created market value of only INR 612 cr. (increase in market capitalization) from the retained profits of INR 850 cr. over last 10 years (2005-14)

I believe that unless it improves its fixed asset turnover by investing in any new technology, it is going to land up in a debt trap. Its interest costs have already been spiraling up and might rise further and bringing down profitability.
I believe that an investor can get many other better opportunities than Ahmednagar Forgings Limited in current markets.

These are my views about Ahmednagar Forgings Limited. However, you should do your own analysis before taking any investment related decision about any company.

You may use the following steps to analyse the company: "How to do Detailed Analysis of a Company"

The case of Ahmednagar Forgings Limited is very much similar to the case of Amtek India Limited. An investor should read the analysis of Amtek India Limited as well, to understand how a capital intensive businesses with low fixed asset turnover can prove to be poor investments:


Hope it helps!

Regards,

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  • The financial table in the above analysis has been prepared by using my customized stock analysis excel template which is now compatible with screener.in. This customized Excel template is now available for download as a premium feature. For further details and download: Click Here
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DISCLAIMER

 


The views and opinions expressed or implied herein are my own and do not reflect those of my employer, who shall not be liable for any action that may result as a consequence of my views and opinions.

Registration Status with SEBI:


I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013, since May 25, 2016.

Details of Financial Interest in the Subject Company:


Currently, I do not own stocks of any of the companies discussed above.