December 26, 2016

Analysis: Srikalahasthi Pipes Limited (erstwhile Lanco Industries Ltd)

www.drvijaymalik.com has a dedicated section for investment & stock specific queries of readers: “Ask Your Queries”. Over time, 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 Srikalahasthi Pipes Limited (erstwhile Lanco Industries Limited), currently, a part of Electrosteel group, which is involved in the manufacturing of Ductile Iron (DI) pipes, pig iron and portland slag cement.

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis


Srikalahasthi Pipes Limited


Reader’s Query

Dear Vijay,

Hope you are doing well. I have recently started reading your blog. I have done some analysis for the subjected company, would like to read your way of analysis.
  • Industry: Iron & Steel
  • Leading Product: Ductile Iron Pipes (~ 70% of Turnover)
  • Other Products: Liquid Metal MBF & Cement
  • Market Cap on 02-Dec-2016 = ₹1,058 crores

About Srikalahasthi Pipes Limited (SPL): 


SPL is a leading manufacturer of ductile iron pipes, which are used for potable water transportation.

The company has a capacity of 225k TPA as on March-2016 which is increased to 300K TPA now as the CAPEX expansion has been completed as communicated with quarterly results of Sep-2016. The product composition of the company is as below:

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis

Leading Product is DI Pipes and Liquid Metal MBF and Cement are other products which are majorly utilized for the captive purpose.

SPL is continuously trying to reduce the cost as highlighted by the management in the annual report for 2016; it is reflected in the improving OPM%.

Annual %









Particulars
Mar-2016
Mar-2015
Mar-2014
Mar-2013
Mar-2012
Mar-2011
Mar-2010
Mar-2009
Mar-2008
Sales Growth
5.7%
9.5%
14.5%
9.8%
8.4%
5.1%
7.1%
39.1%
25.5%
OPM%
23.3%
17.1%
11.8%
5.9%
8.3%
12.0%
17.9%
13.3%
16.6%
NPM %
13.9%
7.7%
3.9%
-1.5%
-0.5%
5.8%
8.5%
2.8%
5.5%
Tax %
26.0%
30.5%
6.6%
38.6%
5.3%
75.3%
65.9%
65.0%
64.8%

AR2016 reflects management’s intentions to improve operating efficiency and capacity expansion plans. Points to be noted from the Future Prospects section of the annual report are:
  1. Initiation of Rs 100 cr expansion plan during FY 2014-15. – This is completed as per the update from the company with its Q2_2016 results
  2. The DI capacity would increase to 300k TPA
  3. Viability study to install a double corrugated pipe plant to meet drainage and sewerage pipe demand
  4. Set up Ferro alloys plant with an outlay of 55 cr (This has been put on hold as per communication in Sep Quarter results)
  5. Further order details and Water project details

As highlighted in the industry outlook the prospects for the demand of DI pipes looks good in future and considering the capacity utilization achieved at 100% by SPL for the year ended FY-2016. It will be necessary for the company to increase the capacity with growing demand now with 300k TPA capacity it needs to be observed how much is the utilisation for the year needed FY 2017. As the industry is expected to grow at 10-12% which is a +ve sign to my knowledge.

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis

SPL has highlighted its effort to reduce the raw material cost. Which are reflected in the OPM%?

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis

Under opportunities and threats, the company has indicated uninterrupted demand for DI pipes in future and its hold in the southern states of the country, its good track record in execution of huge projects and long timer in the industry. Apart from it, the company has raised concerns over capacity additions in the domestic markets. The company has also stated about establishing a comfortable order book by bagging an order worth 1151 crores from Telangana govt.

Observations from the past performance of the company:


Financial Analysis

1) Sales and profitability:

CAGR %
Mar-15
Mar-13
Mar-11
Mar-09
Mar-06
Particulars
1 Yr
3 Yr
5 Yr
7 Yr
10 Yr
Sales Growth
5.7%
9.9%
9.6%
8.6%
13.4%
OPM% (Wt.Avg of Op Revenue)
23.3%
17.7%
14.1%
14.3%
14.3%
NPM % (Wt Avg of Op Revenue)
13.9%
8.7%
5.4%
5.8%
5.5%
Tax % (Wt Avg of PBT)
26.0%
25.3%
24.7%
37.8%
42.3%
Dividend Per Share
66.7%
n.a
27.2%
25.8%
19.6%

The sales growth 10 YR is around 13.4%, OPM% has been improving from the past three years with 2016 being at 23%, NPM% has also shown improvement with around 14% for the year 2016. The tax outlay has been around 26% for the last year.

Particulars
Mar-2016
Mar-2015
Mar-2014
Mar-2013
Mar-2012
Mar-2011
Mar-2010
Mar-2009
Mar-2008
Sales Growth
5.7%
9.5%
14.5%
9.8%
8.4%
5.1%
7.1%
39.1%
25.5%
OPM%
23.3%
17.1%
11.8%
5.9%
8.3%
12.0%
17.9%
13.3%
16.6%
NPM %
13.9%
7.7%
3.9%
-1.5%
-0.5%
5.8%
8.5%
2.8%
5.5%
Tax %
26.0%
30.5%
6.6%
38.6%
5.3%
75.3%
65.9%
65.0%
64.8%

2) Interest Coverage:

The interest coverage ratio seems very comfortable at 6.3x for 2016 and has been improving from 2014, Debt to equity ratio at around 0.94 times higher compared to your comfortable criteria of about 0.50, the Current ratio at 1.2x again lower than your comfort zone of 1.25x.

Particulars
Mar-2016
Mar-2015
Mar-2014
Mar-2013
Mar-2012
Mar-2011
Mar-2010
Mar-2009
Mar-2008
Interest Cover
6.3x
4.2x
2.1x
0.8x
1.1x
3.8x
5.4x
2.3x
2.9x
Total Debt/Equity (X)
0.9x
1.3x
1.8x
2.2x
2.2x
1.5x
1.8x
3.0x
2.7x
Current Ratio (X)
1.2x
1.1x
1.0x
0.8x
1.0x
0.9x
1.1x
1.1x
1.4x

3) Cash flow:

CFO is positive for almost all the years from 2007 except 2012 where the company has incurred losses.

Particulars
Mar-2016
Mar-2015
Mar-2014
Mar-2013
Mar-2012
Mar-2011
Mar-2010
Mar-2009
Mar-2008
Mar-2007
CFO
183.9
157.6
145.1
185.2
-14.0
35.9
103.4
30.9
46.2
4.5
CFI
-184.8
-72.8
-25.1
-106.0
-65.8
-46.1
-43.2
-30.4
-38.8
-19.3
CFF
-33.1
-82.1
-71.6
-83.5
71.1
12.3
-80.5
30.0
-29.7
37.8
NCF
-34.0
2.7
48.4
-4.3
-8.7
2.1
-20.3
30.4
-22.3
23.0
Cash at Beg
55.4
52.7
4.3
8.6
17.3
15.2
35.5
4.2
26.5
3.5
Cash at End
21.4
55.4
52.7
4.3
8.6
17.3
15.2
34.6
4.2
26.5

4) Cumulative PAT vs. CFO:

CPAT~cCFO looks good according to me, rather avg it has been at 1.7x for 10 years.

Particulars
Mar-2016
10 Yr Total
cPAT
423.6
cCFO
878.7
cPAT ~ cCFO
2.07x
Average 10 Yrs cPAT~cCFO
1.76x


Valuation Analysis


1) PE ratio: is around 6.5x to 7.0x which looks attractive

2) PEG ratio is around 0.07 for March 2016 – however, I request you to cross check with your calculation.

3) Earnings yield is at very comfortable level 18%, request your observations.

Earnings Yield
18.0%
14.0%
39.0%
-15.0%
-4.0%
27.0%
23.0%
30.0%
16.0%

4) P/B ratio doesn’t meet your comfort zone of being less than <1, however, P/S is only at 0.22 which is well below 1.5

Price to Book
2.10x
1.97x
0.44x
0.44x
0.51x
0.73x
1.46x
0.49x
1.44x
Price to Sales
            0.22
            0.13
            0.03
            0.02
            0.02
            0.03
            0.06
            0.02
            0.04

5) Dividend yield:

has been improving from 2014 and is at 1.94% for the year ended 2016, looks good

Dividend Yield %
1.94%
1.89%
5.04%
0.00%
0.00%
3.72%
2.23%
4.74%
2.18%


Business & Industry Analysis


1) Sales growth compared to peers –

not able to calculate as peers are reflected differently in money control and screener.
The increase in production capacity and market share is well reflected with its increasing capacity and utilisation%.

2) Conversion of sales growth into profit –

as per below table, the 10YR profit has grown at a slower rate compared to sales, however, recent performance indicates growth in profits to be accelerating and previous profit growth rate is impacted by a couple of years of losses the company incurred in 2012 & 2013.

Particulars
1 Yr
3 Yr
5 Yr
7 Yr
10 Yr
Sales Growth
5.7%
9.9%
9.6%
8.6%
13.4%
OPM% (Wt.Avg of Op Revenue)
23.3%
17.7%
14.1%
14.3%
14.3%
NPM % (Wt Avg of Op Revenue)
13.9%
8.7%
5.4%
5.8%
5.5%

3) Conversion of profits into cash –

cCFO has been at 1.7 times the CPAT for the last ten years which seems to be a +ve sign.


Management Analysis


1) A background check of promoters:

here there is a concern as the Mayank Kejriwal has been associated with Electrosteel Castings which had gone bankrupt.

Would like your opinion, regarding how much impact could it have on SRIPIPES and could there be chances of SH of SRIPIPES being taken at a disadvantage to benefit ESC

I am not able to decipher this parameter and your views on this would bring a lot more clarity.



2) Management succession plan: not able to evaluate this

3)Salary of promoters:

Net profit of 158.8 crores for the year 2016 vs. remuneration of 11.19 crores works out to 7% for the year ended 2016. However, the company has indicated that remuneration of MD has not exceeded 5% of NP and is within applicable limits as per companies act. But 9.8/158.8 comes to 6.2%?

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis


The salary increase has been enormous for the year ended 2016 as reflected 84% for the MD. The percentage increase of remuneration for all employees was 15.8%. Average increment of 11.88% was given to all employees in 2015-16.

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis

4) Project execution skills:

The capacity increase has not been due to mergers or acquisitions; the company has taken efforts to reduce the raw material cost as mentioned previously in the write-up.

5) Consistent increase in dividend%:

Dividends have been increasing with the profits which are reflected from 2014 onwards.

CAGR %
Mar-15
Mar-13
Mar-11
Mar-09
Mar-06

Particulars
1 Yr
3 Yr
5 Yr
7 Yr
10 Yr

NPM % (Wt Avg of Op Revenue)
13.9%
8.7%
5.4%
5.8%
5.5%

Dividend Per Share
66.7%
n.a
27.2%
25.8%
19.6%

Particulars
Mar-2016
Mar-2015
Mar-2014
Mar-2013
Mar-2012
Mar-2011
Mar-2010
Mar-2009
Mar-2008
Dividend Yield %
1.94%
1.89%
5.04%
0.00%
0.00%
3.72%
2.23%
4.74%
2.18%

6) Promoter Shareholding%: at 50.78% is less than 51%.

7) Promoter buying shares – No

8) FII holding% - 1.49%


Other Business Parameters

1) Product Diversification – DI Pipes sole major contributor to revenues.

2) Govt Influence: Not sure on this one

Margin of Safety


Margin of Safety in Purchase Price

Earnings Yield > 10Yr Govt Yield
18.0%

Margin of Safety in Business
Depreciation
27.09
31.17
27.94
22.18
19.99
18.72
17.95
16.42
15.13
11.57
Net Fixed Asset
488.07
486.36
434.7
440.3
310.09
299.79
275.28
280.09
263.88
241.58
Depreciation%
5.6%
6.4%
6.4%
5.0%
6.4%
6.2%
6.5%
5.9%
5.7%
4.8%
Average Depreciation 3 Yr
6.1%
6.0%
6.0%
5.9%
6.4%
6.2%
6.0%
5.5%
5.3%
4.8%
Average NFA for the Year
       487.22
       460.53
       437.50
       375.20
       304.94
       287.54
       277.69
       271.99
       252.73
         241.58
NFA Turnover %
            2.35
            2.35
            2.26
            2.30
            2.58
            2.52
            2.49
            2.37
            1.83
             1.53

Average 3 Yr NFAT %
            2.32
Average 3 Yr NPM %
8.5%
Average 3 Yr DPR %
14.1%
Self-Sustainable Growth Rate (SSGR) being higher than current sales growth
10.8%

CWIP
19.44
8.89
20.04
17.02
63.14
26.68
34.41
4.25
8.62
7.54
Capex
39.35
71.68
25.36
106.27
66.75
35.5
43.3
28.26
38.51

Positive Free Cash Flow (FCF) post meeting entire capex
144.5
85.9
119.8
78.9
-80.7
0.4
60.1
2.6
7.7


As per above calculations done as suggested by you, the EY is greater than government yield, the SSGR works out at 10.8% compared to last year sales growth of 5.8% it looks that the company still has enough room to grow based on its accruals. FCF also is positive.


Credit Rating


CARE A+ for LT and A1+ for short term which seems comfortable

Major concerns I would like your opinion:


1) Electrosteel Castings Limited being the promoter its influence to the detriment of SPL SH.
2) Risk if any due to related party trade receivables

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis

3) Further as communicated in the September 2016 results: abut steep price rise and government not extending a subsidy of 1.50 rupees.

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis

4) Your views on the working capital cycle as it looks a bit stretched. The company has considered about the risk in receivables and steps taken to mitigate the same.

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis


Particulars
Mar-2016
Mar-2015
Mar-2014
Mar-2013
Mar-2012
Mar-2011
Mar-2010
Mar-2009
Mar-2008
Mar-2007
Inventory Days
52.6
75.5
93.1
118.4
141.0
101.1
83.5
86.6
107.3
Debtor Days
62.7
56.3
49.3
51.1
60.2
64.3
62.9
58.8
64.9
Working Capital Cycle
115.3
131.7
142.4
169.4
201.2
165.4
146.4
145.4
172.2
Creditors Days
32.0
60.6
62.9
51.0
63.5
53.8
49.1
58.6
85.0
Cash Conversion Cycle
83.4
71.2
79.6
118.5
137.7
111.6
97.3
86.8
87.2

Note: Being my first attempt to calculate there are high chances of inaccuracies in all of my data points, thereby I request your kind observations and beg your pardon for inaccuracies as I am constantly improving on it.

Thank You,

Murtaza Nagarwala


Author’s Response


Dear Murtaza,

Many thanks for sharing your analysis of Srikalahasthi Pipes Limited with the readers and the author. We appreciate the time & effort put in by you in the analysis and making it available to the wide audience. It would prove helpful to any investor who might be thinking about analysing Srikalahasthi Pipes Limited.

Let us analyze the financial performance of Srikalahasthi Pipes Limited over last 10 years.

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis


Srikalahasthi Pipes Limited had been growing its sales at a moderate pace of 10-15% over last 10 years (FY2007-16) and as mentioned by the company, it is nearing complete utilization of existing capacity and therefore, to generate future growth, Srikalahasthi Pipes Limited has invested in additional capacity. The additional capacity has been completed by September 2016 and the company expects to use it to generate future growth.

A look at the profitability trend of Srikalahasthi Pipes Limited would indicate that the both the operating profitability margin (OPM) and net profitability margins (NPM) have been highly fluctuating over the years. OPM has been varying from 17% in FY2008 to 6% in FY2013 and then rising to 23% in FY2016. Similarly, NPM has been witnessing wide fluctuations from 3% to 14% and the company has even reported losses for FY2012 and FY2013.

On the face of it, the fluctuating margins indicate that the company is exposed to margins pressure with changes in the raw material prices and the company finds it difficult to pass on the increase in raw material prices to end customers.

The fact of inability to pass on changes in the raw material costs to intact profitability gets exposed, when an investor reads the annual reports of two years when Srikalahasthi Pipes Limited has reported net losses i.e. FY2012 and FY2013.

In the FY2012 annual report, the directors of Srikalahasthi Pipes Limited have communicated to shareholders the key reasons for the losses reported by the company:
  1. increase in the cost of iron ore, one the key raw material for the company, due to the scrapping of the long-term supply contract with NMDC as a result of the order of Hon. Supreme Court of India, which direct sale of iron ore only through e-auction. The cost of iron ore to the company increased by about 25% as a result of this order
  2. increase in power costs due to the load restrictions put in by the Andhra Pradesh and
  3. increase in costs of imported raw material esp. the coking coal from Australia as a result of the depreciation of the rupee against US dollar. An investor would notice that Srikalahasthi Pipes Limited gets about 40-50% of total raw material from imports.

The evidence of losses due to rising input costs as a result of above reasons indicate that Srikalahasthi Pipes Limited is not able to pass on cost increases to buyers. Thereby, Srikalahasthi Pipes Limited remains susceptible to fluctuating profitability margins.

Over recent years, Srikalahasthi Pipes Limited has been able to increase its profitability margins. The company management has stressed repeatedly in the communications to shareholders that it is working aggressively on reducing the operating costs, which has led to successful improvement in profitability margins. As mentioned in the FY2016 annual report of the company:
“Besides the significant increase in the volumes of Ductile Iron Pipes, in its constant endeavour to remain low-cost manufacturer, your Company has undertaken various cost reduction measures during the year under review such as reduction of coke consumption in MBF, HSD oil in Ductile Iron Pipe Plant. The continued favourable trend in the prices of major raw materials viz. iron ore, coal facilitated the Company in maintaining the lower cost of production.”
If an investor correlates the improvement of the margins of Srikalahasthi Pipes Limited with the movement in iron ore prices, then the investor would get further clarity about the reasons for the improvement in the profitability of the company.

Let’s see the movement in the price of iron ore in India for last 5 years:

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis

The above chart indicates that the iron ore prices in India have declined from in excess of ₹85 per ton during Sept 2013 to about ₹25 per ton in Nov 2015. This sharp decline of about 70% in the iron ore prices coincides with the improvement in the operating profitability margin of Srikalahasthi Pipes Limited from 6% in FY2013 to 23% in FY2016.

It remains to be seen whether the company would be able to maintain its profitability margins when the raw material prices increase in future. An investor should keep a close watch on the profitability margins of the company to monitor whether Srikalahasthi Pipes Limited is still exposed to vagaries of commodity cycles.

Srikalahasthi Pipes Limited has been witnessing fluctuating tax payout ratio. However, an analysis of the annual report indicates that the company has been using MAT credits to set off its income tax liabilities.


Looking at the net fixed asset turnover (NFAT) of Srikalahasthi Pipes Limited over the years, an investor would notice that its net fixed assets turnover (NFAT) has remained stable over the years. NFAT has been within a narrow range of 2.25 to 2.50 over the last decade, indicating that there is not a lot of improvement in the asset utilization levels. It might be a result of no significant changes in the technology used to produce DI pipes leading to stable NFAT over the years.

Receivables days of Srikalahasthi Pipes Limited has witnessed improvement and then deterioration resulting in almost stable receivables days of about 65 days over the last decade (FY2007-16). The receivables days once improved to 49 days in FY2014, however, it has since then deteriorated to 63 days in FY2016.

As mentioned by you in your write-up, Srikalahasthi Pipes Limited has stressed that it has managed receivables risk by supply to contractors who in turn bid for government contracts and supply/use the pipes of Srikalahasthi Pipes Limited in government projects.

At the face of it, such an arrangement looks like an ideal solution found by the company to mitigate the delay in realization of payments, which is usually associated with government contracts. However, we believe that on ground, such an arrangement does not insulate any company from the underlying risk as the intermediary party would also be able to honour its payment obligations to Srikalahasthi Pipes Limited only when it gets the money from government departments/agencies for the work done on the project.

If in any situation, the intermediary party (the buyer of Srikalahasthi Pipes Limited) is not able to get the payment released from the government in time, then it is near certain that the payments would be delayed by the intermediary party to its vendors including Srikalahasthi Pipes Limited. It might be one of the reasons for the recent increase in receivables days being faced by Srikalahasthi Pipes Limited.

Moreover, such arrangements of getting intermediary parties in between the key material supplier like Srikalahasthi Pipes Limited and the end beneficiary (government departments/agencies), also leaves a lot of gaps for potential accounting manipulations with many entities (which might get classified as related or unrelated parties), coming into the picture as intermediaries and helping the material supplier to show cleaner books of accounts by way of management of receivables and profitability margins.

Therefore, it is essential that the investor should monitor the movement of receivables days of Srikalahasthi Pipes Limited closely going ahead along with the appearance of any write-off of the receivables/bad debts to understand any development of potential stressful situation for the company.


When an investor assesses the inventory turnover of the company, then the investor notices that the inventory turnover of Srikalahasthi Pipes Limited has improved over the years from 4 in FY2007 to 9 in FY2016. Such an improvement in the inventory turnover is a significant achievement for the company as it leads to relatively lower working capital costs for the company as the relatively lower amount of funds remain blocked in the form of inventory.


Over last 10 years (FY2007-16), Srikalahasthi Pipes Limited has witnessed almost unchanged receivables days and significant improvement in the inventory turnover, which has ensured that the funds are not blocked in the working capital of the company, which is evident from the analysis of cumulative profits and cash flow data of Srikalahasthi Pipes Limited for 10 years (FY2007-16).  The investor would notice that Srikalahasthi Pipes Limited has been able to convert its profits into cash flow from operations. Cumulative PAT during FY2007-16 is ₹423 cr. whereas the cumulative cash flow from operations (CFO) over the similar period has been ₹880 cr. The key reasons for cCFO being higher than cPAT are:
  1. Depreciation (₹208 cr), which is a non-cash expense where the cash outflow has happened previously, when the fixed assets were created and
  2. Interest expense (₹400 cr), which even though deducted as an expense while arriving at PAT, is added back (i.e. adjusted) when calculating CFO. This is done because interest expense is a financing item and therefore, it is deducted from cash flow from financing while preparing the cash flow statement.


Strong cash flow from operations position of the company has been sufficient to take care of the capex done by Srikalahasthi Pipes Limited, which is about ₹456 cr. in FY2007-16, leading to the free cash flow (FCF) of about ₹430 cr to Srikalahasthi Pipes Limited. The company has used this FCF to pay the interest obligations of the company and pay out dividends to shareholders.

As a result of the good cash flow position, credit rating of Srikalahasthi Pipes Limited has been upgraded by the credit rating agency CARE Limited from A to A+ in FY2016:

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis


Srikalahasthi Pipes Limited has been maintaining a low Self-Sustainable Growth Rate (SSGR) over the years of about 4%-5%, which has recently improved to 10.7%. The recent improvement in SSGR is on account of improvement in the net profit margins in recent years. As mentioned above an investor needs to monitor whether Srikalahasthi Pipes Limited would be able to maintain its profitability margins in light of cyclical raw material prices.

Anyway, if an investor reads the article on SSGR:


then she would notice that Srikalahasthi Pipes Limited falls in the third scenario in which companies are able to manage their working capital well. As a result, Srikalahasthi Pipes Limited has been able to contain its debt levels within manageable range despite witnessing significant growth over last 10 years (FY2007-16)

As mentioned above, the investor should monitor the company with respect to its profitability margins and receivables management. If the company is not able to maintain its profitability or its working capital going ahead, then it might be that the company witnesses its debt levels going up.

Promoter managers’ remuneration:


An investor would notice that Srikalahasthi Pipes Limited has paid its managing director, Mr. Mayank Kejriwal, a remuneration of ₹9.8 cr, which is about 6.16% of the net profit after tax of ₹159 cr. for FY2016.

From the statutory requirements, the company needs to keep the remuneration of any of its director within 5% of the profits as calculated according to the section 197 of the companies act 2013. The rough estimate of the profit under section 197 can be assumed to be the profit before tax and by adding back the remuneration being paid to directors.

Therefore, it seems that the company has followed statutory requirements, however, nevertheless, the remuneration of ₹9.8 cr. being 6.16% of profit after tax seems on a higher level from normal market standards, where most of the promoters keep their salaries within the range of 2-4% of net profit after tax.


Issues with the promoter group:


Srikalahasthi Pipes Limited was acquired by Electrosteel group in 2002. Currently, Electrosteel group has been facing a lot of liquidity-related issues as have been pointed out by you in the write-up.
One of the group companies, Electrosteel Steels Limited, has defaulted to its lenders and has turned a non-performing asset for the lenders. As a result, the lenders have taken over the control of the company.

Most of the times, we notice that when any company in the group faces such liquidity challenges, then the promoter management, which most of the times consider all the companies in the group as the family business, uses the funds of one company to relieve the cash flow crunch being faced by the other group company.

However, the same has not happened in the case of Srikalahasthi Pipes Limited, where despite Electrosteel Steels Limited facing bankruptcy, the promoters have not used the cash resources of Srikalahasthi Pipes Limited to help Electrosteel Steels Limited.

This might be a good shareholder friendly approach being adopted by the promoter management. However, upon analysing the annual reports of Srikalahasthi Pipes Limited, an investor would notice that the company has a government agency/department: Andhra Pradesh Development Corporation as one of the shareholders, which holds 0.61% shares in the company.

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis


Moreover, Andhra Pradesh Development Corporation has a nominee director position on the board of Srikalahasthi Pipes Limited, which is being occupied by an IAS officer.

It seems highly plausible that the presence of a govt. nominee director on the board of the company has been one of the reasons that promoter management of Electrosteel group has not been able to use the cash resources of Srikalahasthi Pipes Limited for the benefit of its other group companies, which usually takes place in the form of loans & advances to the group companies.

Analysis of Srikalahasthi Pipes Limited (Lanco Industries Limited), part of Electrosteel group, manufacturing Ductile Iron (DI) pipes, pig iron and portland slag cement. Dr Vijay Malik, Dr Stock analysis


We have seen other similar examples in Indian corporate world. One case that readily comes to mind is of the Vedanta group, where the group used the cash resources of one of the group entities: Cairn India Limited to give loan to its group entity and later on got the merger of Cairn India Limited approved so that the loan need not be repaid by the group company. In the case of Cairn India Limited, the minority shareholders lost out on the economic benefits of the funds provided by the company as a loan to the promoter group entity.


On the contrary, the same group, while dealing with the cash resources of another group company: Hindustan Zinc Limited (HZL), used the dividend route to provide cash of the company to promoter entity. As the dividend route was adopted, all the shareholders including the minority shareholders got the proportionate benefits from the cash resources of HZL.

The key difference between Cairn India Limited and Hindustan Zinc Limited has been that in HZL, Govt. of India has about 30% stake and without the consent of government-nominated directors, the company could not have given loans and advances to promoter group entities as happened in the case of Cairn India Limited.

However, whether similar factors have been at play in case of Srikalahasthi Pipes Limited or the management has been shareholder friendly, remains to be seen. In any scenario, it is advised that the investors should remain cautious and keep a close watch on the utilization of the cash resources by the company. Investors should keep a close focus on the related party transactions being done by the company to assess whether the promoters are showing any signs of benefiting at the cost of the minority shareholders.


New Ferro Alloy project:


As part of the FY2016 annual report, the management of Srikalahasthi Pipes Limited has stressed upon investing in a Ferro Alloy Plant:
“.. attempt to achieve self-reliance in sourcing major and critical raw/essential materials, your Company has planned to set up a Ferro Alloys Plant with an outlay of Rs.55 Crores to meet the requirement of Ferro Silicon, Silico Manganese and Ferro Manganese in domestic and overseas markets, besides catering the captive requirement of the Company. This additional facility would help the Company in achieving higher revenues, in addition to maintaining a lower cost of production. This facility will be commissioned during the second quarter of 2017-18. This project would be funded out of internal accruals.”
However, as rightly mentioned by you in the write-up, Srikalahasthi Pipes Limited has deferred/scrapped the project citing denial of the power subsidy of ₹1.50 per unit to ferro alloy units in the state. The company has cited that the absence of subsidy would render the plant unviable.

It is surprising for the investors that the new capex was being planned in such low margins/returns that it had to mandatorily rely on subsidies to make any money for shareholders. Nonetheless, such is the nature of businesses which are commodity in nature.

Time and again, while analysing Srikalahasthi Pipes Limited, an investor is faced with scenarios which stress that the business of the company does not have any sustainable business advantage over its peers as the business is essentially commodity in nature.

In the past, the increase in raw material and power costs pushed the company into losses, as it could not pass on the rise in costs to its customers. Even in present times, non-availability of power subsidy has turned the management’s plans for ferro alloy plant unviable. Looking at such issues, an investor needs to keep a close watch on its profitability margins.

Trading of goods (Coal):


The company has been trading on coal year on year. While analysing the information related to traded goods in the FY2016 annual report, an investor would notice that:
  1. In FY2016, Srikalahasthi Pipes Limited bought coal worth ₹28.7 cr. and sold it at ₹29.4 cr and in turn making a profit margin of 2.4%.
  2. In FY2015, Srikalahasthi Pipes Limited bought coal for ₹53.3 cr. and sold it for ₹53.8 cr at a profit margin of 0.9%

The question would come to the mind of an investor about the reasons for the company getting involved in the trading activity of coal unless the coal being traded has lost all its economic value and needs to be get rid of at any cost.

Otherwise, if an investor allocates the establishment costs of the company (salaries, administrative expenses etc.) on the traded goods, then the profitability figures on the trading would become further bleak and the company might be wasting its precious resources on this activity, which could have been allocated to other more fruitful purposes.

If possible, an investor should try to assess further the trading operations and rule out whether the buyer for the traded coal is a related party. This is because if Srikalahasthi Pipes Limited is supplying coal to any related party at wafer thin margins, then it might be benefiting the related party at the cost of shareholders of Srikalahasthi Pipes Limited.

Related party transactions:


As highlighted by you in the write-up, Srikalahasthi Pipes Limited has been entering into related party transactions with the group companies of Electrosteel group.

The associate company, Electrosteel Castings Limited accounts for about 5% of the total sales of Srikalahasthi Pipes Limited (₹61 cr. out of total sales of ₹1,146 cr), whereas the outstanding receivables to the Electrosteel Castings Limited are 19% of total outstanding trade receivables (₹39 cr. out of total receivables of ₹207 cr).

It indicates that in comparison to other buyers, the related party Electrosteel Castings Limited is delaying payment to Srikalahasthi Pipes Limited.

An investor should monitor the development of related party transactions and the receivables along with its write-off if any closely to find out if there is any adverse development.

It is to be noted that as part of the AGM in 2016, Srikalahasthi Pipes Limited has got the approval of shareholders for increasing the related party transactions with Electrosteel Castings Limited up to ₹225 cr.


Srikalahasthi Pipes Limited is currently available at a P/E ratio of about 6.4, which provides a margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.



However, as highlighted by the above analysis, there are many issues related to the company being a part of the financially stressed promoter group, like commodity business, fluctuating margins, inability to pass on costs, dependence on govt. releasing timely payments to its buyers, seemingly costly trading activity and related party transactions etc. might be the reasons that the market has been assigning low P/E multiple to the company.

An investor should convince herself with all the aspects of the company before she gets attracted to the low P/E multiple of the company.

Over last 10 years (FY2007-16), the company has retained earnings of about ₹361 cr out of its profits and has generated a market value of ₹933 cr. It indicates that the company has generated about ₹2.58 for every rupee retained by the company from its shareholders.

Overall, Srikalahasthi Pipes Limited seems to be a company, which has been growing its sales at a moderate pace with fluctuating operating margins indicating low supplier’s power over its buyers. The recent increase in profitability seems more due to the fall in commodity raw material prices and it remains to be seen, whether the improving margins remain sustainable in future.

Srikalahasthi Pipes Limited has brought in the intermediary parties as contractors to govt. works, who buy from Srikalahasthi Pipes Limited and execute govt. projects. However, an investor should keep it in mind that ultimately the risk associated with the delayed payment clearance by govt. depts/agencies cannot be eliminated as the buyers might default to Srikalahasthi Pipes Limited in absence of timely payment from govt.

The company has been entering into related party transactions as well as seemingly unproductive trading activities, which are stretching company’s resources.

Srikalahasthi Pipes Limited has been able to manage its inventory well, which over the years has led to the sustained good cash flow position for the company that has led to credit rating improvement for the company.

The company until now has not got itself involved into bailing out stressed promoter group entities by giving loans and advances to them. However, it might be due to the presence of govt. nominee directors on the board of the company. An investor should closely monitor developments at this front to assess the utilization of cash reserves available with the company.

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

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

An investor should keep a close watch on the operating efficiency and the debt levels of Srikalahasthi Pipes Limited along with its profitability margins in future.


Hope it helps!

Regards,


P.S:



DISCLAIMER


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 the companies mentioned above in my portfolio.