Analysis: Meghmani Organics Limited

Modified on November 14, 2018

This article provides in-depth fundamental analysis of Meghmani Organics Ltd, an Indian manufacturer of green & blue pigments, pesticides & agrochemicals.

 

Meghmani Organics Ltd

Q: Hi Vijay! I would like to share my analysis of Meghmani Organics Ltd. Request you to share your views on Meghmani Organics Ltd.

Market capitalization is INR 466 Cr. It is a small cap stock.

  • Meghmani Organics Ltd trades at price to earnings ratio of 11, which is quite attractive. Current market price is INR 18.5.
  • Sales growth of Meghmani Organics Ltd is shaky at 1%-10% with no proper sales growth pattern. Since last 2 years, sales growth is 11%.
  • Operating profit margin is quite stable at 14%-16%. Net profit margin is 20% on an average.
  • Tax payout is line with corporate tax slab.
  • Debt to equity ratio is 1.2. From FY2012, Meghmani Organics Ltd is constantly reducing its debt.
  • Dividend payout is constantly good at 11% per annum.
  • Receivables days (Debtor days) are 172 days, which is quite high.
  • Inventory turnover ratio is 4.25, which seems average.
  • Cumulative cash flow from operations (cCFO) is higher than cumulative profit after tax (cPAT), CFO is able to take care of CFI & CFF.
  • cCFO ~ 699 Cr, cPAT ~ 219 Cr, cCFI ~ -799 Cr, cCFF ~ 194 Cr
  • Promoters’ shareholding is 50% with no pledging. Promoters have sold 0.5% of shares in recent past. This is not much of a concern.

Recent March 2015 quarter results show:

  • slight 2% decrease in sales growth YoY and QoQ.
  • Operating profits (Gross profits) have improved by 7% YoY and 34% QoQ. This indicates the improvement in Operating efficiency of the company.
  • Finance cost has come down 16 Cr from 21 Cr YoY. This proves the company is taking steps to reduce debt.
  • All these factors have led to improvement in earnings per share (EPS) from INR 0.14 to INR 0.61 YoY.
  • Intrinsic value of MOL can be about INR 30. Market could soon re-rate this stock.

Comparison with peers:

I have compared Meghmani Organics Ltd with Vinati Organics Ltd, NOCIL Ltd and Clariant Chemicals India Ltd:

Comparison of Meghmani Organics Ltd Vinati organics Ltd NOICL Ltd Clariant Chemicals India Ltd

Quick look at this comparison, we can easily spot Vinati Organics Ltd to be the better company in-terms of sales and profits growth.

However, if we look much further in-terms of improving OPM, debt reduction and P/E, Meghmani Organics Ltd seems better bet, as Vinati is already re-rated by the market.

Main Highlights:

  • Co. is working on debt reduction, which could improve earnings effectively.
  • Compared to peers, MOL seems a reasonable bet.

Query:

  1. cCFO ~ 699 Cr its almost triple the cPAT ~ 219 Cr. Please let me know how can a company generate triple the cash than its profits. Is it generating cash by selling its assets?
  2. If CFF is negative, I am assuming the company is paying dividends and reducing debt. Are there any other reasons for negative CFF?

 

Author’s Response

Thanks for writing to me! Let us analyse the consolidated financial performance of Meghmani Organics Ltd over the years.

 

Financial Analysis of Meghmani Organics Ltd:

Meghmani Organics Ltd equity analysis research report Indian manufacturer of green and blue pigments, pesticides and agrochemicals

Meghmani Organics Ltd has been growing its sales at a moderate pace of 7-10% year on year since last 8 years (FY2008-15). As rightly pointed out by you, it is good to notice that Meghmani Organics Ltd has maintained its operating profit margins (OPM) in the range of 14-16% over the years. It indicates that Meghmani Organics Ltd is able to pass on the increase in raw material costs to its customers on a regular basis.

However, if we see the net profit margins (NPM) of the company, then we see that NPM is very low at about 2-3%. Moreover, NPM has been fluctuating wildly from 6% to 0% to 3% over the years. Low fluctuating NPM is a cause of concern, as it reflects that the company and the shareholders are not able to get the fruits of the sales growth and stable operating margins.

Upon analysis of profit & loss statement, it comes out that the increasing interest cost year on year is eating into the profitability of Meghmani Organics Ltd. Interest costs have increased from INR 16 cr in FY2008 to INR 75 cr in FY2015. This is a cause of concern for investors.

 

Operating Efficiency Analysis of Meghmani Organics Ltd:

Operating efficiency parameters of Meghmani Organics Ltd reflect that it has not been able to improve its efficiency levels over the years. Net fixed assets turnover has declined from 7.5 in FY2008 to 1.8 in FY2014. Similarly, inventory turnover ratio of Meghmani Organics Ltd has also declined from 7.2 to 5.5. These are not good signs.

An investor should analyse the operating efficiency in further detail find out the reasons for deteriorating operating efficiency of Meghmani Organics Ltd. She should be confident that the reasons for deteriorating performance are temporary, before she makes any investment decision about Meghmani Organics Ltd.

Low net profitability margins of Meghmani Organics Ltd result that very low amount of funds from its sales are available to the company for investment in its operations. On top of it, low fixed asset turnover demand that large amount of capex needs to be incurred to grow the sales of the company. An investor can verify the continuous capex done by Meghmani Organics Ltd by analyzing the net fixed assets (NFA) and capital work in progress (CWIP) over the years. NFA and CWIP of Meghmani Organics Ltd are increasing consistently over the years.

 

Margin of Safety in the Business of Meghmani Organics Ltd:

If we analyse the profit before tax (PBT) to net fixed assets (NFA) ratio for Meghmani Organics Ltd, then we see that PBT/NFA ratio has been consistently less than 9% over the years. PBT/NFA of Meghmani Organics Ltd is lower than the fixed deposit interest rates provided by many banks in India.

This result can be interpreted in a way that if Meghmani Organics Ltd sells all its fixed assets and deposits the proceeds in a bank fixed deposit, then it would earn more by way of interest income than the profits it is generating on its asset by operating a large company. An investor should think about whether she would want to invest in a business whose earnings do not match bank fixed deposit returns.

Further advised reading: When a company should sell all assets and invest money in FDs?

You may read about some of the other companies, which have such low returns on their assets that the company might be better off selling all its assets and investing the money in bank fixed deposits:

The combined impact of low profitability and low fixed asset turnover ensure that Meghmani Organics Ltd is not able to grow by using only the funds generated from its profits. It has to rely on additional sources of funds like equity and debt to make investments needed for future growth.

Analysis of financial data reflects that Meghmani Organics Ltd has been relying on debt to fund its growth ambitions. Debt levels of Meghmani Organics Ltd have increased from INR 209 cr. in FY2008 to INR 603 cr. in FY2014.

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:

Q&A Analysis: Ahmednagar Forgings Ltd

Q&A Analysis: Amtek India Ltd

Financial numbers reflect that over the years, the tax payout ratio of Meghmani Organics Ltd has been fluctuating from 12% to 58%. An investor should study it in detail to understand the reasons for fluctuating tax payout ratio of Meghmani Organics Ltd.

As rightly pointed out by you, Meghmani Organics Ltd has been able to convert its profits in to cash flow from operations. PAT for last 7 years (FY2008-14) is INR 201 cr. whereas the CFO over the similar period is INR 669 cr. Receivables days, though high, but is nearly stable at 110-115 days over the years.

However, cumulative cash flow from operations (cCFO) is not able to take care of cumulative cash flow from investing (cCFI) and financing (cCFF). As mentioned above, the investing requirements of Meghmani Organics Ltd are significant due to low fixed asset turnover (capital-intensive operations) that cCFO is not able to meet cCFI. Therefore, the company has relied on raising additional debt to meet its funds requirements, as reflected by positive cCFF.

I suggest that investors should not take their investment decisions based on recent performance. Therefore, I would not read much into the latest quarterly results. I advise that investors should base their investment decision on the analysis of performance of the company over long periods spreading over many years.

 

Margin of Safety in the market price of Meghmani Organics Ltd:

Meghmani Organics Ltd is currently available at a P/E ratio of about 9.9, which offers very low margin of safety as described by Benjamin Graham in his book The Intelligent Investor.

Read: 3 Simple Ways to assess the Margin of Safety in a Stock

However, upon analysis of operating performance and the efficiency parameters of Meghmani Organics Ltd, it comes out that there are inherent issues in the business model of Meghmani Organics Ltd. I believe that Meghmani Organics Ltd needs to improve its operating performance significantly, before market rewards it with higher P/E ratio.

 

Conclusion:

Overall, Meghmani Organics Ltd seems to be a company growing at a moderate pace but unable to convert its operating profits into net profits. High interest costs due to increasing debt burden have been eating into its profits. Low profitability margins, capital-intensive business and deteriorating operating performance has ensure that Meghmani Organics Ltd has to rely on debt to fund its growth.

Debt has already increased to high levels despite the sales growth being at moderate levels of 7-10%. It seems doubtful that Meghmani Organics Ltd would be able to show good growth of 20-25% without further going under debt burden, unless it improves its operating efficiency. An investor should keep a close watch on its operating efficiency and  debt levels.

These are my views about Meghmani Organics Ltd. However, you should do your own analysis before taking any investment related decision about Meghmani Organics Ltd.

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

I do not focus on calculating intrinsic value therefore, I would not be able to comment on the intrinsic value arrived by you. I believe that an investor should find a conservatively financed, growing company with stable/improving profitability margins with good operating performance. Once the investor finds such a company, then she should invest in shares of that company at prices which provide her a good margin of safety.

Regarding your queries about calculation of CFO and components CFF, I would suggest you to go through the cash flow statement in the annual report, which would show step-by-step calculation of CFO from PAT/PBT. The calculations would clearly show how the profits get stuck in or released from working capital. Similarly, you would also come to know about all the components of CFF. It would be a good learning exercise for you.

In case after reading the cash flow calculation, you have any query, then I would be happy to provide my inputs for its resolution.

Hope it helps!

Regards,

P.S.

 

DISCLAIMER

  • 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.

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