September 4, 2016

Analysis: TVS Srichakra Limited (TVS Tyres)

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. The 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: TVS Srichakra Limited, a part of famous TVS group and the leading producer of 2 and 3 wheeler tyres in India under the brand name “TVS Tyres”.


Equity Analysis Research Report of TVS Srichakra Limited, TVS group company 2 and 3 wheeler tyres in India brand TVS Tyres



Reader’s Query

Q:

Dear Vijay,

I have been following your blog for quite some time and I find it extremely educative. Thanks for educating the investor community!

Based on you framework, I have analyzed the stock TVS Srichakra Limited. Please find below my investment rationale.
  • TVS Srichakra Limited has been growing its sales at a good pace of 23% year on year for last 10 years (FY2006-15).
  • The Operating Margin has been steadily improving from 5% in 2006 to 11% in 2016
  • The company has been steadily improving its Net Profit Margins from 1% in 2006 to 5% in 2016
  • Tax pay out rate has been 25 to 30% barring the year 2015 where it has paid tax only to the tune of 15%
  • Cumulative Cash Flow from Operating Activity is ₹606 crores in the past ten years, against a cumulative PAT is ₹324 crores
  • The Self Sustainable Growth Rate has been -5%(2009), 2% (2010), 7% (2011), 11% (2012), 7% (2013), 5% (2014), 9% (2015) but the company has grown its sales at 22% during the same period, this is evident in the  company’s debt levels, it has increased from ₹79 crores in 2006 to ₹205 crores in 2016
  • However, the company has reduced debt levels in the financial year 2016 from ₹304 cr to ₹205 crores, this has also resulted in debt to equity ratio of 0.7% which is very much manageable
  • The company also maintains a healthy interest coverage ratio of 6.8 in the year 2015
  • Net fixed assets turnover has been steady at around 8 over the period of 10 years
  • Receivable days have been decreased from 59 days to 42 days over the period of 10 years
  • Inventory Turnover has also been steadily improving
  • The company has not increased its share capital in the past 10 years
  • The company has been maintaining a healthy dividend payout ratio for the past 10 years
  • The company has total retained earnings for the past 10 years at ₹244 crores against market cap of ₹1,884 crores.  Value created per INR of RE is 7.73 which us very good
  • The company is trading at a PE of 9.8, which does provide reasonable margin of safety

The company is promoted by the TVS group which is known for its high standards in corporate governance.

Please let me know your views.

Thanks & regards,


Author’s Response


Hi,

Thank for sharing your analysis with the author and readers of the website! Let us first analyse the past financial performance of TVS Srichakra Limited.

TVS Srichakra Limited has been preparing only standalone financial statements until FY2010. However, in February 2010, it incorporated its first subsidiary, TVS Srichakra Investment Limited and it started publishing consolidated financials from FY2011 onward.

It is preferable that while analysing any company, the investor should take a view about the entire entity including its subsidiaries, if any, so that she is aware of the complete financial and performance picture of the company. Therefore, while analysing the performance of last 10 years for TVS Srichakra Limited, we have analysed standalone financial performance until FY2010 and consolidated financial performance from FY2011 onward.

Equity Analysis Research Report of TVS Srichakra Limited, TVS group company 2 and 3 wheeler tyres in India brand TVS Tyres


TVS Srichakra Limited, as mentioned by you, has been growing its sales at a good pace of 20% year on year for last 10 years (FY2007-16). It is important to notice that the operating profit margins (OPM) of TVS Srichakra Limited, was following a cyclical pattern until FY2013 as visible from the OPM movement from 6% in FY2007 to 9% in FY2010 and again going down to 6% in FY2013. However, from FY2013 onwards, the OPM has been witnessing steady improvement and has steadily improved up to 14% in FY2016.

Such improvement in operating profit margins is a very good development about any business and requires additional due diligence on part of the investor.

If the investor reads the summary credit rating report for TVS Srichakra Limited released by India Ratings on August 19, 2015, then she comes to know quite a lot of features about the business of TVS Srichakra Limited, which have led to such improvement in the operating profitability margins, namely:
  1. higher contribution of aftermarket segment in the revenue, which apparently has higher profit margins
  2. formula based pricing contracts with OEMs, which allow for passage of changes in the raw material costs to the customers and thereby keeping the profitability margins intact and
  3. improvements in the manufacturing processes leading to cost savings.

All these key informational inputs can be identified in the summary rationale for TVS Srichakra Limited, released by India Ratings, which is in the public domain and available freely to all the investors:
“Over the last three years, the company has increased the contribution of revenue from the aftermarket segment (FY15: 30%; FY13: 25%) and undertaken sustained improvements in manufacturing processes, leading to a decrease in input costs. Consequently, TVSSC has retained some of the benefits of falling commodity prices as reflected in its higher operating EBITDA margins of 10.8% in FY15 (FY13: 5.8%). TVSSC’s agreements with OEMs provide for a formula­based pass­through of raw material price changes”
We are of the opinion that every investor should read credit rating reports for the companies, which she is analysing so that she may come to know about many key informational inputs about the companies.


The investor would notice that the net profit margin (NPM) of TVS Srichakra Limited has also followed the similar pattern like its OPM. NPM witnessed a cyclical pattern from FY2007 to FY2013 and has been witnessing steady improvement since then.


The sudden improvement in NPM from 5% in FY2015 to 8% in FY2016 is also a result of the sale of investments/subsidiary stake by TVS Srichakra Limited in one of its subsidiary companies TVS Europe Distribution Limited. TVS Srichakra Limited has sold its entire stake in TVS Europe Distribution Limited to another TVS group company VS Automobile Solutions Limited.

As per the annual report of TVS Srichakra Limited for FY2016, it has recognized profits of ₹18.17 cr. as part of other income, which is the major component of the total other income of ₹21.44 cr. recognized by TVS Srichakra Limited in FY2016.

Equity Analysis Research Report of TVS Srichakra Limited, TVS group company 2 and 3 wheeler tyres in India brand TVS Tyres



The tax payout ratio of the company has been consistently around 30-33%, except one year (FY2014), which is a good sign.

Operating efficiency parameters of TVS Srichakra Limited reflect that the net fixed assets turnover (NFAT) has been witnessing a mixed picture over last 10 years (FY2007-16). Over this period, TVS Srichakra Limited has been making significant investments in its manufacturing plants to increase its operating capacity to fulfil the growth requirements. Net fixed assets of TVS Srichakra Limited has increased from ₹59 cr. in FY2007 to ₹395 cr. in FY2016.

The capacity expansion seems to be still going on as the company has a capital work in progress (CWIP) of ₹44 cr at the end of FY2016. The continued capex, which might not have been fully utilized right after becoming operational, has ensured that the NFAT has been fluctuating between 5-7 over the years and currently hovering around 6.

Working capital efficiency parameters of TVS Srichakra Limited reflect that the efficiency has improved over the years. The inventory turnover ratio (ITR) has improved from 6 in FY2007 to 10 in FY2016. Similarly, the analysis of receivables days of TVS Srichakra Limited also reflects that it has been able to improve its receivables position by a significant margin. TVS Srichakra Limited has witnessed its receivables days declining from 62 days in FY2007 to 31 days in FY2016.

The management has also acknowledged this improvement in the working capital position of the company and has informed the shareholders about it as part of the section Management Discussion & Analysis in the annual report of FY2016:

Equity Analysis Research Report of TVS Srichakra Limited, TVS group company 2 and 3 wheeler tyres in India brand TVS Tyres



Moreover, when we analyse the key test of a collection of receivables and working capital efficiency, which is the conversion of profits into cash flow from operations by comparing cumulative profit after tax (cPAT) over last 10 years with the cumulative cash flow from operations (cCFO), then TVS Srichakra Limited passes with flying colors.

Over last 10 years (FY2007-16), TVS Srichakra Limited had a profit after tax (PAT) of ₹502 cr. whereas the CFO over the similar period has been ₹998 cr. The above analysis of inventory turnover and receivables days clearly leads an investor to conclude that TVS Srichakra Limited has been able to manage its working capital situation in a significantly better manner, thereby leading to healthy generation of cash flow from operations.

Self-Sustainable Growth Rate (SSGR):

The case of TVS Srichakra Limited is another good example of a case where the limitation of SSGR that it does not factor in working capital changes, gets highlighted. The earlier such case discussed on this website was “Chaman Lal Setia Exports Limited”:


The investor would notice that TVS Srichakra Limited has an SSGR almost in single digits over the years, which is much lower than the sales growth rate of 20% being achieved by the company. As a result, the investor would have expected that the company would have been reeling under debt, which it would have taken to expand capacity to fuel the sales growth.

However, the analysis of debt levels of TVS Srichakra Limited over last 10 years (FY2007-16) indicates that the debt of TVS Srichakra Limited has increased only by ₹15 cr. from ₹121 cr. in FY2007 to ₹136 cr. in FY2016 despite continuous capex being done by the company over these years. TVS Srichakra Limited has done a capex of ₹427 cr. over last 10 years (FY2007-16), which is visible in the steady increase in the net fixed assets and capital work in progress of the company over the years.

The company had taken debt in the interim period, which led to the debt levels spiraling to ₹402 cr. at the end of FY2012. However, since the healthy cash generation has led the company to repay most of its debt and bring the debt levels almost at the same levels of FY2007.

Improvement in the working capital management, as discussed above, is one of the primary factors in the generation of healthy cash flow from operations for the company leading to TVS Srichakra Limited being able to grow at a pace higher than SSGR and still being able to keep its leverage levels under control.


In such cases, where the comparative analysis of SSGR and past sales growth does not explain the debt position of the company, an investor should analyse the free cash flow (FCF) position of the company. As FCF reveals a composite picture after factoring in the working capital and capex parameters.

An investor would notice that over last 10 years (FY2007-16), TVS Srichakra has generated ₹998 cr. from CFO whereas it has used only ₹427 cr. in capital expenditure over the same period (FY2007-16), thereby generating significant amount of free cash flows (FCF).

FCF is one of the key parameters to determine the margin of safety present in the business of any company. You may read the following article to understand more about the margin of safety in the purchase price and business.


This situation of surplus cash has enabled TVS Srichakra Limited to manage its sales growth and simultaneously bringing its leverage levels under control and also declare dividends to shareholders.

Dividend levels of TVS Srichakra Limited have witnessed an increase in line with the profits of the company, which is good sign as the funds for dividend (₹125 cr. over FY2007-16) seems to have been generated from operating cash flows. Increase in dividend in line with profits also highlights the shareholder friendliness of the management, which seems to believe in sharing the fruits of the growth with its shareholders.


However, if the investor reads the annual report for FY2016 of TVS Srichakra Limited, then she would notice that it has invested about ₹40 cr in one of the TVS group companies: TVS Automobiles Solutions Limited.

Equity Analysis Research Report of TVS Srichakra Limited, TVS group company 2 and 3 wheeler tyres in India brand TVS Tyres

An investor should read about the terms of these preferred shares to understand whether the company has taken a decision in favour of shareholders when it invested money in a group company instead of reducing its debt further.

An investor would also notice that TVS Automobiles Solutions Limited is the same company, to whom TVS Srichakra Limited has sold its subsidiary, TVS Europe Distribution Limited in FY2016 and booked a profit of ₹18.17 cr. on the sale. It remains to be seen whether the value of the sale transaction between TVS Srichakra Limited and TVS Automobiles Solutions Limited is the reflection of true market value of TVS Europe Distribution Limited.

You may read more about the assessment of management quality of any company in the following article:


In the annual report for FY2016, the management of TVS Srichakra Limited has informed the shareholders in the section "Management Discussion & Analysis" that it plans to focus more on building the brand of its products:

Equity Analysis Research Report of TVS Srichakra Limited, TVS group company 2 and 3 wheeler tyres in India brand TVS Tyres


If the investor analyses the annual report of FY2016 further, then she would notice that the management has been increasing its spending on the advertisement & sales promotions:

Equity Analysis Research Report of TVS Srichakra Limited, TVS group company 2 and 3 wheeler tyres in India brand TVS Tyres


The investor would notice that the “Advertisement and Sales Promotion” expenses have witnessed a sharp increase from ₹30 cr. in FY2015 to ₹50 cr. in FY2016.

The investor would also notice that the company has been giving more & more discounts to its buyers. As a result, the expense on “Commission and Discount” has also witnessed sharp increase from ₹100 cr. in FY2015 to ₹135 cr. in FY2016. It might be one of the strategy of the company to spend more on the advertisements to increase brand recognition in the minds of end customers and simultaneously giving more commission & discount to the dealers to increase its market share in the aftermarket segment, which is more profitable than OEM segment.

This seems to be in line with the management’s belief that the aftermarket (replacement market) is going to be the biggest market segment of the tyre industry in future, as intimated by the company in the section Management Discussion & Analysis in the FY2016 annual report:

Equity Analysis Research Report of TVS Srichakra Limited, TVS group company 2 and 3 wheeler tyres in India brand TVS Tyres



TVS Srichakra Limited is currently available at a P/E ratio of about 10.4, which does offer small margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

You may read more about estimating the margin of safety in the target investment in the following article:


Overall, TVS Srichakra Limited seems to be a company growing at a descent pace of 20%, which has been witnessing steady improvement in the profitability margins due to improvement in the sales mix by focusing more on the high profitability aftermarkets segment and by entering into formula linked cost escalation contracts with OEMs.

TVS Srichakra Limited has been able to significantly improve its working capital management over the years, which has led it to keep its debt levels under check despite doing significant capex to support the sales growth. The management seems to be sharing fruits of the business growth with shareholders by increasing the dividends in line with profits and making sure that the dividends are funded out of the operating cash surplus of the company.

However, an investor would be better off, if she keeps a track of working capital management by TVS Srichakra Limited to monitor whether it is able to maintain/continue such working capital position by holding on to the its credit policies with buyers and suppliers.

An investor may read more about the guidelines to follow while monitoring stocks in the following article:


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

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

Hope it helps!

Regards,


P.S:




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

Details of Financial Interest in the Subject Company:



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