This article provides in-depth fundamental analysis of Deep Industries Ltd, a gas/air compression and work over rig services provider for oil & gas exploration industry.
Deep Industries Ltd
Q: Deep Industries Ltd: CMP INR 46/-, Book Value: INR 68/-. Following are some of your checklist through which this company passes:
- PE 6.5
- compounded sales growth last 10 years: 31%
- compounded profit growth: 46%
- paying regular tax
- EPS from 1/- to 7/-
- consistent increase in dividend last 5 years
- increasing CFO
- increasing positive cash flow
- credit rating: A- from Care
- increase in market cap last 10 years
- Operating Expense as a percentage of Operating
- Income has been decreased from 25.26% to 24.72%, which is well below as per Industry norms.
- Promoter holding went up from 59% to 64% in last year
Please share your views.
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Financial Analysis of Deep Industries Ltd:
Deep Industries Ltd has been growing its sales at a fast pace of 25-30% year on year since last 10 years (FY2005-14). Company has been able to protect its operating profitability margins during this growth, which is a very good sign. Operating profit margins (OPM) have been stable at around 55-58%. Stable OPM means that company is able to price its products well with its customers.
However, Deep Industries Ltd has not been able to maintain its net profit margins (NPM). NPM has declined from 35% in FY2008 to 22% in FY2014. The main reason for decline in NPM is due to the continuously increasing interest costs of Deep Industries Ltd.
Interest costs have increased from INR 1 cr. in FY2008 to INR 9 cr. in FY2014. Increasing interest costs have a direct bearing on the profitability margins of any firm and the same is the case with Deep Industries Ltd.
Deep Industries Ltd has been paying taxes at a good rate, which is a good sign.
Operating Efficiency Analysis of Deep Industries Ltd:
Deep Industries Ltd has been able to convert its profits in to cash flow from operations. PAT for last 10 years (FY2005-14) is INR 90 cr. whereas the CFO over the similar period is INR 160 cr. This is also corroborated from the fact that both inventory turnover ratio and receivables days of Deep Industries Ltd have improved in the past.
Inventory turnover ratio of Deep Industries Ltd has improved from 17 in FY2011 to 21 in FY2014. Receivables days have decreased from 115 days in FY2011 to 61 days in FY2014. These fact indicate that the profits of Deep Industries Ltd are not getting stuck in working capital.
Operating efficiency parameters of Deep Industries Ltd reflect that it has not been able to improve its net fixed assets turnover over the years. Net fixed asset turnover is stable at 0.3 to 0.5 levels over last 10 years.
It is very important to note that the fixed asset turnover of 0.5 is very low from healthy business operations perspective. It has serious implications as huge amount of incremental investment is needed to show future growth. Fixed asset turnover ratio of less than 1 indicates that Deep Industries Ltd needs to spend more than INR 1 in plant and machinery to produce INR 1 of additional sales. Let us understand the implications:
For example, Let us assume that in first year Deep Industries Ltd, targets to achieve INR 100 cr. of additional sales, then it would need to invest INR 250 cr. in fixed assets (100/0.4, because the fixed asset turnover ratio is 0.4 currently). This INR 100 cr. of additional sales would provide additional net profits of INR 22 cr. (assuming 22% of NPM). If Deep Industries Ltd retains the entire profits and invests it in its operations, then this incremental investment of INR 22 cr. of entire profits would generate only INR 8.8 cr. of incremental sales in the second year (22*0.4=8.8, as the fixed asset turnover ratio is 0.4). If Deep Industries Ltd wishes to grow its sales by another INR 100 cr. in the second year as well, then it would have to generate balance INR 91.2 of additional sales by investing additional INR 228 cr. (INR 250 cr. total requirement – INR 22 cr. of net profits invested). This INR 228 cr. needs to come from either fresh equity infusion or debt.
Thus, we may see that with very low fixed asset turnover of 0.4, Deep Industries Ltd would have to keep relying on additional sources of funds to maintain its growth. This has happened in the past as well. Deep Industries Ltd has been relying on debt as well as equity to fund its growth.
Total debt level of Deep Industries Ltd has increased from INR 3 cr. in FY2005 to INR 112 cr. in FY2014 (37 times increase) whereas its sales have increased from INR 8 cr. in FY2005 to INR 91 cr. in FY2014 (about 12 times increase).
This 37 times increase in debt has not been sufficient to meet the cash guzzling requirements of business operations and capital expenses of Deep Industries Ltd. It has diluted its equity on a continuous basis over last 10 years (FY2005-14) as reflected by continuously increasing share capital in absence of any bonus issues.
Such kinds of high cash requirements are for growing the business are the features of companies operating in capital-intensive businesses.
As per rating rationale of Deep Industries Ltd by credit rating agency, CRISIL Ltd:
CRISIL understands that, as in the past, all exploration activities of the Deep group over the medium term will be funded through equity infusion by the promoters, shareholders, or strategic investors, and not through cash flows from existing operations.
If Deep Industries Ltd is not able to raise its future cash requirement from further equity dilution, then it would have to rely on debt for funding its business.
Investors should be cautious of investing in companies, which have continuously increasing debt levels, as high debt has the potential of increasing the risk of bankruptcy and reduced profitability under tough business conditions.
You should read the analysis of two other companies: Ahmednagar Forgings Ltd and Amtek India Ltd, to understand the impact low fixed asset turnover can have on the debt levels of companies. You may read their analysis here:
Margin of Safety in the market price of Deep Industries Ltd:
Overall, Deep Industries Ltd seems to be a company growing at a fast pace with sustained profitability margins. However, its net profitability margins have suffered because of continuously increasing interest costs. Deep Industries Ltd has been able to improve its working capital management over the years; however, it has witnessed increasing debt levels and equity dilution due to its capital-intensive business and very low fixed asset turnover. An investor should keep a close watch on its debt levels.
If Deep Industries Ltd is not able to improve its fixed asset turnover by using some different technology or starting some different business segment, which requires low capital to generate additional revenue, then I fear that Deep Industries Ltd has a high probability of entering into a debt trap.
These are my views about Deep Industries Ltd. However, you should do your own analysis before taking any investment related decision about Deep Industries Ltd.
You may use the following steps to analyse the company: “How to do Detailed Analysis of a Company“
Hope it helps!
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- The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
- I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
- Currently, I do not own stocks of the companies mentioned above in my portfolio.