Analysis: Stovec Industries Ltd

Modified on November 13, 2018

The current section of “Analysis” series covers Stovec Industries Ltd, a leading producer of printing machines & consumables for textile printing, graphics printing. The company is a part of SPGPrints group of Netherlands.

“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

 

Stovec Industries Ltd Research Report by the Reader (Ravikiran Komarraju)

 

About Stovec Industries Ltd:

Stovec Industries Ltd (Stovec) – subsidiary of SPGPrints Group – is an Ahmedabad based company. It is in the business of development and production of automatic and perforated rotary screens printing machines, and consumables for their use in textile and graphics printing industry. The company has been in business since 1972. It operates in three segments:

  1. Textile Consumables and Textile Machinery
  2. Graphics Product
  3. Galvanic

Stovec Industries Ltd Business Segments

Source: Annual Report 2017

Further advised reading: Understanding the Annual Report of a Company

SPGPrints has shifted its global textile printing business to its Ahmedabad plant and over the period, it has increased its stake in Stovec Industries Ltd from 51% to 71% (Source: Business Standard)

Stovec Industries Ltd has recently exited galvanic business by selling the sugar screen business to its subsidiary, Atul Sugar Screens Private Limited (Source: SPGPrints.com)

 

Current Shareholding Pattern of Stovec Industries Ltd:

Stovec Industries Ltd Shareholding Pattern March 31, 2018

 

About SPGPrints Group

SPGPrints is a global leader in textile and graphics printing market. It is headquartered in the Netherlands and has 10 subsidiaries across the world including Stovec Industries Ltd (India). SPGPrints has been in this business for more than 60 years with operations in over nine countries including USA, UK, China, India, and Brazil.

 

Industry Analysis

Textile industry outlook in India:

  • Textile Industry contributes 4% of GDP in India. It employs 45 million people and accounts for 15% of India’s exports
  • India’s market size for textiles has grown at 7.5% over the period 2009-2015 reaching $108.5 Bn. It is expected to reach $ 226 Bn by 2022
  • India’s textile exports accounted for $40 Bn in FY 2015-16 growing at a CAGR of 12%
  • Govt. has unleashed several initiatives over the years to support Textile Industry such as
    • Training & skills: establishing technical institutes (NIFT)
    • Market Expansion: apparel export parks, promoting textiles in new international markets
    • Capital Subsidy: Under ATUFS, a one-time capital subsidy of 15% will be provided with a cap of Rs. 30 Cr. for garments and technical textiles

Despite the big numbers and Govt. initiatives, India’s textile Industry lacks efficiency and is very fragmented. Low-cost substitutes from Pakistan and Bangladesh have created tough competition for Indian garment Industry.

(Source: IBEF)

Label Printing Industry Outlook in India

India is currently the second largest label printing market in the world with a market size of $ 11 Bn growing at 12%-14% over the last 20 years. With the growth in disposable incomes, branding and packaging are assuming significance. Currently, in India, a majority (over 75%) of label printing business are family owned MSMEs and Digital printing is still an aspiration for many.

Gradually, label printing is penetrating to Tier-II and Tier-III cities. The Industry is ripe for investments due to organic demand from retail brands or modernization requirement because of the dawn of the internet. In future FMCG will be a big market driver for Label printing Industry in India.

(Source: https://www.maiervidorno.com/print-paper-sector-india-close-label-industry)

 

Management Analysis of Stovec Industries Ltd

Mr. Ashish Kaul has vacated the post of Managing Director in FY 2014. Mr. Shailesh Wani has taken over as MD in the same period. There have been a few other personnel changes following the sale of Veco Precision Metals (a group company)

Further advised reading: Steps to Assess Management Quality before Buying Stocks

M&A

  • Stovec Industries Ltd invested in Atul Sugar Screens Pvt. Ltd. In FY2013. It has extended a loan of INR 5 Cr and has received an interest of 40 lakh for a period of 19 months (May 2013 to Dec 2014). The interest works out as 8% – very low for a company of the size of Atul sugars. Further, acquiring Atul Sugars never seemed strategic to Textile/ packaging business.
  • For these 3 years, galvanic segment (Sugar business) has been a drag on the company’s performance. Within 3 years of acquiring the business, Stovec Industries Ltd has exited it.

Open Offer

  • In June 2014, Investcorp, Gulf-based PE firm, has acquired 100% stake in SPGPrints and subsequently, made an open offer to acquire 26% in Stovec Industries Ltd (India).

Dividend payments

Stovec Industries Ltd Dividend Payout Ratio

Stovec Industries Ltd seems to be returning 26% – 30% of its profits to the customer.

Managing Director’s Remuneration

Stovec Industries Ltd Managerial Remuneration Salary

MD’s Remuneration seems to be exceeding the 5% of the net profit after tax (PAT) limit. The drop in remuneration in Dec-13 seems to be because of a change in leadership. While it is more than compensated by 140% in Dec-14.

There have been no frauds/ investigations against company’s management including Chairman and the current MD and past MDs.

Related party transactions of Stovec Industries Ltd (with all group entities)

Stovec Industries Ltd Related Party Transactions

*Communication expenses are mentioned as group management expenses and are taken out of related party transactions.

Royalty payments have grown at a CAGR of 133% and Communication Expenses at 66%. On top of this, large dividend payments are also serving the Parent company well. The net outgo has more than doubled in FY 16 (even after normalizing the subsidiary loan). This has been a drain on the company resources.

However, putting things into perspective, royalty payments as a percentage of profit are still a lot lower than the average amounts paid by BSE listed firms.

Stovec Industries Ltd Royalty Payments History

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

 

Business Analysis of Stovec Industries Ltd

Stovec Industries Ltd follows Jan-Dec cycle for reporting results. In the year FY 2013, Stovec has acquired 100% stake in Atul Sugar Screens Private Limited. Therefore, for years post FY2013, consolidated statements have been considered for analysis. In the year FY 2018, the company has divested its complete stake in Atul Sugar Screens Pvt. Ltd.

India is the only place for rotary printing machine manufacturing for SPGPrints. In India, a majority of the market still uses mechanical machines. The market is expected to move from mechanical to semi-automatic and then to automatic machines. Currently, Stovec Industries Ltd is investing in R&D to develop technology for semi-automatic machines. In the future, they will develop fully automatic technology indigenously. (Source: Valuepickr)

Stovec Industries Ltd is a market leader (market-share is >50%) in rotary screen printing machine business (Source: Business Standard) and it is one of the top 3 players in digital textile printing and label printing businesses (Source: Stockaxis)

Stovec Industries Ltd Profit And Loss Statement AnalysisSource: Annual Reports

 

Segment wise reporting:

Revenue split by product segment (In INR Cr.)

Stovec Industries Ltd Segmental Revenue Over The YearsSource: Annual Reports

Based on the revenue earned by each segment, Textile Consumables, and Textile machinery contributes ~84% while the other two segments account for the remaining. The galvanic segment that has galvanic consumable products has been growing at 45% over the last 5 years.

EBIT margins by segment (In %)

Stovec Industries Ltd Segmental Ebit MarginSource: Annual Reports

The EBIT margins (based on internal cost accounting) points to a stable Textile Consumables and Textile Machinery segment, despite the dependence on raw materials such as Nickel and Cotton.

At an overall level, over the last 5 years, Stovec Industries Ltd seems to be operating between 17% and 22% OPM with raw materials contributing to ~50% of sales each year. The key import raw material for the company is Nickel.

Nickel prices (In $ per Ton):

Nickel Price HistorySource: http://markets.businessinsider.com/commodities/nickel-price

Nickel prices have appreciated at a CAGR of 37% over the last 2 years – however, the company seems to have maintained its margins over the same period – Stovec Industries Ltd seems to have reasonable pricing power in the market.

 

Margin of Safety analysis of Stovec Industries Ltd

Self-Sustainable Growth rate

Stovec Industries Ltd SSGR Calculation

Further advised reading: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Sales growth at times has exceeded the SSGR but overall remained under control. The ICR of 413.5 indicates that D/E is comfortable.

Stovec Industries Ltd Cumulative Pat Vs Cumulative Cfo Cash Flow Vs Pat

Cash flow from operations (CFO) of Stovec Industries Ltd has been positive each year over the course of the last 10 yrs.

Stovec Industries Ltd Sales Profit And Cash Flow Growth

 

FCF analysis of Stovec Industries Ltd

Stovec Industries Ltd Yearly FCF Calculations

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

Other Checks & Ratios:

  • ROCE (10 yr) – 31.4%
  • ROE (10 yr) – 23%

Stovec Industries Ltd Market Capitalization Increase For Every Rupee Of Retained Earnings

As per Buffet’s $1 test, Stovec Industries Ltd has returned only 4.77X of the retained earnings over the last 10 yr. This seems to be on the lower side.

 

Working Capital Checks

Stovec Industries Ltd Inventory Turnover Ratio

Inventory days – 74; Receivable days – 105 (Inventory days + Receivable days =180 days).

Inventory turnover ratio of Stovec Industries Ltd seems to be fluctuating between 2.17- 5.53 during the period FY2013 to FY 2017. Further, in FY 2017, cash seems to be stuck in Inventory and Receivables for 6 months in a year – creating the need for working capital loans

Read on: How to Assess Operating Efficiency of Companies

 

Moat Analysis of Stovec Industries Ltd

A) Efficient Scale:

1. Operational Leverage:

Stovec Industries Ltd Operating Leverage Analysis

Operational leverage of Stovec Industries Ltd for the last 5 years has been 1.6 meaning for every 1 unit increase in sales, EBIT increases 1.6 units. Inverting the same, for every 1 unit loss of revenue, EBIT could contract more. If the Stovec manages to add capacity proportionate to the level anticipated level of growth, operational leverage is under control.

2. Financial Leverage:

Stovec Industries Ltd Financial Leverage Analysis

Financial leverage of Stovec Industries Ltd for the last 5 years has been 0.91. This indicates the watertight model of low leverage model followed by Stovec.

3. Geographical distribution of clients:

Stovec Industries Ltd Geographical Distribution Of Sales, Exports

Exports for the last 10 years have only accounted for 11% of sales. The sales are heavily dependent on Indian sub-continent.

4. Client in India:

No information available. However, given that the textile business is fragmented, client concentration is expected to be less

Conclusion: Efficient Scale – Medium; Long-term Sustainability – Medium

 

B) Low-Cost Advantage:

1. Cost Savings:

Over the last 5 years, the cost of goods sold (COGS) of Stovec Industries Ltd has grown at 26% CAGR while sales grew at 29% CAGR. Although the company has been investing in R&D for cost savings or process efficiency, there has not been any visible significant cost reduction.

In 2015, technology for manufacturing of Nova screen has been imported and in 2011 technology for manufacturing new model of printing machines has been imported and fully absorbed.

2. Access to low-cost resources:

Repeatedly, Nickel prices have affected the performance of Stovec Industries Ltd. This means the company is dependent on international market prices for key imports and it has low bargaining power on its prices. Further, the company does not have long-term contracts to hedge its risks.

Year: 2011

Stovec Industries Ltd FY2011 Increase In Nickel Prices Led To Decline In Profitability

Year 2016

Stovec Industries Ltd 2016 Nickel Price Changes May Affect Company's Performance

3. Low-cost funding:

Stovec Industries Ltd does not have long-term debt on its books; hence, access to low-cost funding does not arise.

Conclusion: Low-cost advantage – None

 

C) Switching Cost:

1. Does the company offer a critical product or service where mistakes can be dangerous/fatal?

Consumables for printing machines are critical to a product’s design quality. Textile mills would not like to switch the consumables frequently unless there is a significant reason for the same.

2. Is the product/service offered by the company unique in terms of availability, accuracy, and responsiveness?

There are multiple domestic and international companies competing with Stovec Industries Ltd in the manufacturing business of textile manufacturing machines and consumables – Not unique

3. Does the company offer post sale customer service, which creates high stickiness?

Stovec Industries Ltd’s presence in post-sale services creates stickiness for customers and make them reluctant to switch to its competitors.

Conclusion: Switching Cost – Low; Long-term Sustainability – Low

 

D) Networking Effects:

1. Does the company operate on a platform model or does the business model create networking effects?

Not exactly, but a few customers using the printing machines of Stovec, might also use consumables of Stovec.

2. Are the dealer/distributor relationships based on incentives? Can the company continue to make win-win propositions?

Yes, however, details are not available on incentives paid to sales team and distributors

3. Does the value-chain benefit in terms of knowledge or efficiency by continuing to be on the same network?

Details are not available

4. Is the company so big that the value-chain players don’t have suitable viable alternatives?

No, there are many Chinese players in the market offering similar products

Conclusion: Networking Effects – Low

 

E) Intangible Assets:

1. How much does the company spend on R&D and innovation?

In total, Stovec Industries Ltd has invested only INR 5.5 Cr (<0.5% of aggregate sales) in R&D for new product innovation and cost savings during the period 2010 to 2017

2. Does it have any IP that can create a potential competitive advantage?

No, Stovec Industries Ltd does not have any IP that can be monetized by the company

3. Does the company have any regulatory driven advantage?

No, there are no significant regulatory driven advantages for the company such as a license.

4. Industry-driven advantage?

The Government of India’s scheme to incentivize Garmenting Units by way of additional incentive over and above Capital Investment Subsidy under Amended Textile Upgradation Fund Scheme (ATUFS) is expected to give a boost to employment generation and increased production capacity and exports in the textile sector.

5. Brand Equity – How much does the company spend on Marketing?

Stovec Industries Ltd operates in the B2B segment. However, there are no details available on marketing expenses for the years

6. Is the product/service offered by company rare and valuable?

Stovec Industries Ltd’s printing machines, consumables, and rotary screens are valuable to its clients, but it is not a rare item

7. Does the organizational maturity/ management experience give any additional advantage to the firm over others?

Stovec Industries Ltd’s parent company, SPGPrints B.V. has been in textiles and graphics business for a significant period. Further, it specifies quality standards, which are to be adhered to by the Stovec Industries.

8. What makes it difficult to replicate the product/ service?

Quality standards, brand, and experience makes it slightly difficult to replicate the product in the market

Conclusion: Intangible Assets – Medium; Long-term Sustainability – Medium

 

Valuation Analysis of Stovec Industries Ltd

The stock has returned 760% in the last 5 years. In the last 7 months, the price has come down by 24%.

Stovec Industries Ltd Historical Stock Price Chart

Stovec Industries Ltd Projected Valuations

Further advised reading: How to do valuation analysis of companies?

 

Conclusion:

Positives:

  • Stovec Industries Ltd’s historical performance makes it an attractive bet for the future. Low debt, good financial profile, decent growth, and fair valuation are some of the positives of the stock.

Areas of Concern:

  • Stovec Industries Ltd’s textile business prospects are difficult to assess at this point given the lack of information about the addressable market size and Industry penetration. On the other hand, label printing business industry holds big promise. Again, customer’s propensity to spend on modernization holds the key to assess Stovec’s market potential
  • Based on the analysis and stock valuation, related party transactions seem to be limiting the growth of the company’s reserves. Given, the parent company’s experience, it is hereby assumed that corporate governance issues are handled at arm’s length in true letter and spirit.

 

Author’s Response

Hi Ravikiran,

Thanks for sharing the in-depth analysis of Stovec Industries Ltd Limited with us!

We appreciate the time & effort put in by you in the analysis by going through the past annual reports and company filings. Your hard work provides good insights about Stovec Industries Ltd and serves as a good starting point for an investor interested in study the company.

Let us analyse the performance of Stovec Industries Ltd over the last 10 years.

While analyzing the past financial performance data of the company, an investor would notice that until FY2013, Stovec Industries Ltd used to disclose only standalone financials. This is because; the company did not have any subsidiary until then and in FY2014, it acquired 100% equity stake of Atul Sugar Screens Pvt. Ltd. from Atul Electro Formers Limited. Therefore, since FY2014, the company has been preparing both standalone as well as consolidated financials.

We believe that while analysing any company, the investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire group. Therefore, while analysing Stovec Industries Ltd, we have analysed standalone financials until FY2013 and consolidated financials from FY2014 onwards.

Investors should also note that the company follows the reporting year from January to December of the year unlike most of the other companies, which follow reporting year from April to March. As a result, the latest available financial results of Stovec Industries Limited are available for FY2017 (January to December 2017).

Further advised reading: Standalone vs Consolidated Financials: A Complete Guide

Stovec Industries Ltd Financials FY2008 2017

 

Financial Analysis of Stovec Industries Ltd:

While analyzing the financials of Stovec Industries Ltd, an investor would note that in the past (FY2008-17), the company has been able to grow its sales at a rate of 20-25% year on year. Sales of the company increased from ₹47 cr. in FY2008 to ₹213 cr in FY2017.

While analysing the profitability of the company over last decade, an investor would notice that over FY2008-17, the operating profit margin (OPM) of Stovec Industries Ltd has improved significantly from 7% in FY2008 to 20% in FY2017. However, simultaneously, an investor also notices that the OPM of the company has displayed cyclical patterns where first the OPM improved from 7% in FY2008 to 17% in FY2010. The OPM, then, declined sharply to 10% in FY2011 and later on, it increased to 22% in FY2015. Thereafter, the OPM declined to 20% in FY2017. Therefore, an investor would appreciate that the profitability of Stovec Industries Ltd is displaying long-term improvements with short cyclical patterns.

Investors would appreciate from the past company analysis articles that cyclical profit margins are a characteristic of companies, which operate in businesses that are affected by changing commodity/raw material prices. Such companies find it difficult to pass on the increases in raw material prices to their customers and as a result, they have to take a hit on their profit margins to maintain the sales.

On the contrary, the long-term improving trend in the profit margins indicates the development of positive aspects for the business of the company. It might be an improvement in the brand/business strength of the company giving it pricing power on the customers. Another parameter may be the change in the product mix of the sales of the company over the years, which may have led to higher sales of products with more profitability leading to an increase in OPM. Moreover, long-term improvements in OPM may also be a result of the long-term declining trend of key raw material prices for the companies.

In the case of Stovec Industries Ltd, an analysis of FY2017 annual report indicates that one of the identifiable key raw material for the company is Nickel. As per the information provided by the company in FY2017 annual report, page 67, Nickel constitutes about 30% of the total raw material cost of the company:

Stovec Industries Ltd 2017 Nickel 30% Of Raw Material Costs

Further advised reading: Understanding the Annual Report of a Company

An investor would note that at a share of 30% of the raw material cost, Nickel has the capacity of significantly influencing the cost structure of Stovec Industries Ltd even though there are other raw materials (70%), which would also have an impact. During any particular period, the effect of balance 70% raw materials may be opposite to the effect of Nickel. Therefore, during any specific period, investors may find that the movement of nickel prices may not fully explain the changes in the profit margin of the company.

The following chart provides the movement of Nickel prices over last 10 years:

Historical Nickel Prices 2009 2018(Source: tradingeconomics.com)

An investor would notice that the sharp decline in OPM of Stovec Industries Ltd during FY2011 coincides with the sharp increase in the prices of Nickel in 2011 when the prices increased to almost 2.5-3 times of their previous lows.

While reading the past annual reports for Stovec Industries Ltd, an investor would notice that the company has repeatedly acknowledged its dependence on the price movements of Nickel.

In FY2011, the company disclosed that a sharp increase in Nickel prices affected its business performance (page 8):

Stovec Industries Ltd 2011 High Nickel Prices Reduced The Profit Margins

In FY2017 annual report, page 29-30, Stovec Industries Ltd has disclosed that it imports high-quality Nickel but does not enter into any hedging/price control arrangements for its purchases. It exposes the company to fluctuations of raw material prices.

Stovec Industries Ltd 2017 No Hedging Of Nickel Prices

Further advised reading: Understanding the Annual Report of a Company

A look at the movement of the Nickel prices over the last 10 years indicates that the Nickel prices are in a long-term downtrend where they have declined significantly since their peak levels in FY2011. Such a significant decline in the input cost prices seems to be an important factor in the improvement of the OPM of Stovec Industries Ltd during FY2011-17.

As discussed above, investors need to keep in mind that there are raw materials other than Nickel (70%), which may affect the profit margin of Stovec Industries Ltd differently. Nevertheless, it is advised that investors should keep a close watch on Nickel prices going ahead to monitor whether the OPM of the company witnesses a decline with the increasing Nickel prices.

An investor would note that the net profit margin (NPM) of the company has followed the trend of its OPM. This is primarily because the company does not have debt. The absence of debt avoids interest costs eating into net profitability and the benefits of business operations are available to the equity shareholders.

The tax payout ratio of Stovec Industries Ltd has been about 30-34% over the last decade, which is in line with the corporate tax structure prevalent in India.

Further advised reading: How to do Financial Analysis of Companies

 

Operating Efficiency Analysis of Stovec Industries Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of Stovec Industries Ltd, then she notices that the NFAT of the company has been consistently in the range of 6-7. An investor would also notice that during the entire decade (FY2008-17), the company has been able to grow without doing any significant capital expenditure. The only periods in which it did significant capital expenditure were FY2014 when it acquired the sugar screen business along with the subsidiary Atul Sugar Screens Private Limited and in FY2017 when it has invested about ₹14 cr. primarily in plant & machinery.

As a result, the NFAT of Stovec Industries Ltd witnessed a decline only in the periods like FY2011 when the company, as well as its customers, faced challenging times of rising input cost and the NFAT declined. In FY2014 and FY2017, the NFAT declined due to the capital expenditure, which takes some time to add to sales revenue.

An investor would note that an NFAT of about 6-7 is higher than the normal trend for other manufacturing businesses, which normally have NFAT within the range of 1-3. As a result, an investor would notice that the business of Stovec Industries Ltd is comparatively asset light and the company can grow its business even with limited capital expenditure.

An investor would also appreciate that the low NFAT of Stovec Industries Ltd is also a result of the arrangements of the company with its parent company under which it gets access to the product technology from the parent and therefore, does not have to spend heavily on research & development (R&D). In return, Stovec Industries Ltd pays for the technology by way of royalty payments. Therefore, effectively, an investor may assume that Stovec Industries Ltd has outsourced the capital investment in R&D to its holding company. The net expense of this cost of R&D (capital expenditure) to develop new technology, which is essential for growth, is deducted from P&L as royalty payments instead of capitalizing it as capex in fixed assets.

Therefore, to improve the idea of the investment required to generate sales growth for Stovec Industries Ltd, an investor may factor in the royalty payments as an investment in fixed assets to understand the asset utilization of the company.

Read on: How to Assess Operating Efficiency of Companies

An investor would note that the inventory turnover ratios (ITR) of the company has been stable within the range of 5.7-7 over the years indicating that the company has been able to manage its inventory position well.

Over the years, Stovec Industries Ltd has been able to improve its receivables days. An investor would notice that the company has been able to reduce its receivables days from 98 days in FY2009 to 49 days in FY2017. It indicates that the company is able to fund its business operations efficiently from its operating profits and not rely on working capital finance from banks etc.

While comparing the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of the company for FY2008-17, an investor would notice that the cCFO of Stovec Industries Ltd has been less than cPAT during this period. Over FY2008-17, Stovec Industries Ltd Limited reported a total cumulative net profit after tax (cPAT) of ₹128 cr. whereas during the same period, it reported a cumulative cash flow from operations (cCFO) of ₹117 cr.

This finding of cCFO being less than cPAT goes counter-intuitive to the expectations of investors when they notice that Stovec Industries Ltd has been able to manage its inventory and receivables position well over the years. The investor is able to find the source of cCFO being less than cPAT when she notices that over the years, Stovec Industries Ltd has generated a significant amount of non-operating income (other income) of ₹39 cr. An investor would appreciate that the other income is excluded from PAT while calculating CFO. This is because the other income is a result of the investments (fixed deposits etc.) and are, therefore, considered as a cash inflow from investing.

Therefore, an investor would notice that Stovec Industries Ltd has cCFO lower than cPAT not because of funds being stuck in working capital but because of the significant contribution of non-operating income (other income) to its profits over the years.

Further advised reading: Understanding Cash Flow from Operations (CFO)

 

Margin of Safety in the Business of Stovec Industries Ltd:

Self-Sustainable Growth Rate (SSGR):

Further advised reading: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

While analysing the SSGR of Stovec Industries Ltd, an investor would notice that the SSGR of the company has consistently been above 30-40% over the years whereas the company has been growing at a rate of 20-25% over the years. As a result, Stovec Industries Ltd has been able to increase its sales from ₹47 cr. in FY2008 to ₹213 cr. in FY2017 without the need for external capital. The company has been able to maintain its debt-free status over the years.

Free Cash Flow Analysis of Stovec Industries Ltd:

While looking at the cash flow performance of Stovec Industries Ltd, an investor notices that during FY2009-2018, the company had a cumulative cash flow from operations of ₹117 cr. However, during this period it did a capital expenditure (capex) of ₹56 cr. Stovec Industries Ltd could meet the entire capex from its own sources. As a result, it had a free cash flow (FCF) of ₹61 cr (= 117-56) over FY2008-17. In addition, the company had a non-operating/other income of ₹39 cr. over the same period.

As a result, the company did not need to raise any debt for meeting its capital expenditure plans. It could use the free cash available with it to pay dividends to shareholders and still left with surplus funds. At Dec 31, 2017, the company had ₹43 cr. of cash & investments.

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

Free cash flow (FCF) and SSGR are the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

Stock markets have also recognized the ability of Stovec Industries Ltd to produce high surplus cash from its asset-light business. As a result, the company could generate an increase in market capitalization of ₹524 cr. over FY2008-17 when compared to about ₹90 cr. of earnings/profits retained by it. It amounts to a creation of a wealth of ₹5.83 in terms of increase in market capitalization of the stock of the company for every ₹1 of the earnings retained and not distributed to shareholders.

 

Additional aspects of Stovec Industries Ltd.

On analysing Stovec Industries Ltd, an investor comes across certain other aspects of the company.

1) Management Succession:

An investor would appreciate that Stovec Industries Ltd along with its holding company SPGPrints is owned by various financial investors and not by any promoter family. As a result, whenever any of the key managers leaves the company, then the company hires another professional to lead the company. As a result, the typical issue of management succession, which is highly relevant for family-owned businesses, is not a key issue for Stovec Industries Ltd.

In the past, Stovec Industries Ltd managed a change in leadership during FY2013, when its Managing Director, Mr. Ashish Kaul resigned from the company. The company brought in Mr. Girish M Deshpande as Whole Time Director to manage the operations of the company until the time it could find a suitable person to lead the company. Later during FY2013, the company appointed Mr. Shailesh Wani as the Managing Director of the company.

The following snapshot from the FY2014 annual report, page 61 covering names of key management personnel in the related party transactions section captures the transition of management succession in the company:

Stovec Industries Ltd 2014 Management Succession

Further advised reading: Understanding the Annual Report of a Company

An investor would appreciate that when professional run companies, then it becomes easy for the company/board of directors to consider a large pool of professionals (both outside as well as inside the company) for leadership positions. In the case of family-run companies, it is usually a choice among the few relatives/next generation of promoters. Therefore, a professionally run company provides some advantages in management succession.

Simultaneously, investors should be aware of some of the pitfalls of professionally run companies. Many times, professional in charge of the companies put their personal interest before shareholders’ interest and as a result, they may take decisions, which are not in the favor of long-term interests of the company/shareholders. Such decisions may be focused on influencing the share price if the professional leaders have many employee stock options (ESOPs). Additionally, decisions may be taken to show short-term good performance to earn higher bonuses/commissions based on quarterly/yearly performance.

In addition, the professional may not provide sustained continuity in leadership, as they are open to shifting jobs to competitors who may offer them higher remuneration/perks. As a result, all the experience/skills gained by the professional leaders while working for one company may ultimately benefit the competitor of the company. The probability of such transition of leaders from one company to its leaders is low in case of family-run businesses where members of the family take up leadership positions.

Therefore, we believe that investors should assess the pros and cons of different leadership structures of companies before taking a final investment decision about any company.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

 

2) Acquisition and subsequent sale of Atul Sugar Screens Pvt. Ltd:

(i) Acquisition:

An investor would note that during FY2014, Stovec Industries Ltd acquired 100% stake in Atul Sugar Screens Pvt. Ltd (ASSPL) from Atul Electro Formers Ltd. The company has not disclosed the exact amount paid for this acquisition directly in its annual reports. However, from the detailed notes/schedules to the financial statements, an investor can estimate that the company paid about ₹8 cr. for completing the acquisition, which is reflected in the balance sheet in the following heads:

  • Major heads: (₹7.81 cr)
    • Trademark: ₹3.94 cr
    • Technical know-how and non-compete fee: ₹3.87 cr.
  • Minor heads: (₹0.02 cr)
    • Investment in equity shares of ASSPL = ₹0.01 cr.
    • Value of fixed assets of ASSPL added to the consolidated fixed assets of Stovec Industries Ltd: ₹0.00 cr (actual value is ₹9,695/-)
    • Increase in goodwill, which Stovec Industries Ltd paid to buy fixed assets of ASSPL over and above their value in the balance sheet: ₹0.01 cr.

An investor may know these values from the following sections of the annual reports of Stovec Industries Ltd and ASSPL:

  • Value of trademark, technical know-how, non-compete fees and goodwill from the 2014 annual report of Stovec Industries Ltd, page 52:

Stovec Industries Ltd 2014 Goodwill, Trademark, Non Compete Fees For Atul Sugar Screens

Further advised reading: Understanding the Annual Report of a Company

  • Value of investment in the equity shares from the 2014 annual report of Stovec Industries Ltd, page 53:

Stovec Industries Ltd 2014 Investment In Equity Shares Of Atul Sugar Screens

  • Value of fixed assets of ASSPL from the 2014 annual report of Atul Sugar Screens Pvt. Ltd (ASSPL), page 7: (Annual reports of ASSPL from FY2014 to FY2017 are available at the website of Stovec Industries Ltd):

Stovec Industries Ltd 2014 Atul Sugar Screens Balance Sheet

Further advised reading: Understanding the Annual Report of a Company

An analysis of the summary balance sheet of ASSPL at March 31, 2014, indicates that when Stovec Industries Ltd acquired it in May 2014, the ASSPL did not have any significant assets. Its net worth was only about ₹3.50 lac. It did not have any meaningful fixed assets. All its current assets (trade receivables, inventory, cash & bank balance of ₹42 lac) were to be set off against the trade payables of ₹53 lac.

Therefore, an investor would appreciate that ASSPL did not bring any fixed assets/plants etc. to Stovec Industries Ltd. Almost the entire amount of about ₹8 cr. paid by Stovec Industries Ltd to the seller (Atul Electro Formers Ltd) was a consideration for the trademark, technical know-how, and non-compete fee. As a result, the investor would appreciate that Stovec Industries Ltd paid the entire acquisition cost of ₹8 cr. for the non-quantifiable intangible benefits.

(ii) Sale:

In FY2018, Stovec Industries Ltd sold the entire sugar screens business to one of its group company, Veco B.V.

The sale transaction of sugar screen business constituted two components:

  • Sale of entire equity stake with all the assets of Atul Sugar Screens Pvt. Ltd (ASSPL) for ₹10.4 cr.
  • Sale of assets of Stovec Industries Ltd related to the sugar screen business along with the associated trademarks for ₹9.96 cr.

An investor may find the above considerations in the following disclosures done by Stovec Industries Ltd to Bombay Stock Exchange (BSE):

March 14, 2018:

Stovec Industries Ltd 2017 Atul Sugar Screens Sale Proceeds For Equity Shares

April 5, 2018:

Stovec Industries Ltd 2017 Sale Of Assets To Atul

Therefore, an investor would note that by this two-step transaction, Stovec Industries Ltd sold its entire business of sugar screens with assets & trademark to its group company Veco B.V. for about ₹20 cr.

If an investor assesses both the parts of transactions, then she notices that at December 31, 2017, Atul Sugar Screens Pvt. Ltd (ASSPL) has a net worth of about ₹6.3 cr., which is almost entirely available as cash & bank balance (₹6.8 cr) with the company.

Stovec Industries Ltd 2017 Atul Balance Sheet

Further advised reading: Understanding the Annual Report of a Company

Similarly, the disclosure made by the company to BSE on April 5, 2018, indicates that the sugar screens business owned by Stovec Industries Ltd (outside of ASSPL) had a net worth of ₹19.96 cr.

Therefore, if an investor looks at the sale transaction in its entirety, then she notices that while selling the sugar screens business along with all the trademarks to the group company, Veco B.V., for a consideration of ₹20 cr., Stovec Industries Ltd has given away a total net worth of more than ₹26 cr. (6.3 + 19.96). The net worth of ₹26 cr. given away by the company includes cash & bank balance of at least ₹6.8 cr. held by ASSPL.

Therefore, an investor would appreciate that in this sale transaction, the shareholders of Stovec Industries Ltd did not receive even the full consideration for the net worth given away by them. It is anybody’s guess what valuation has been assigned to the trademarks and intangible benefits, which were purchased by Stovec Industries Ltd in about ₹8 cr. when it bought Atul Sugar Screens Pvt. Ltd (ASSPL).

The company has not disclosed the independent valuation report, which has been used to arrive at these considerations for the sale of sugar screens business to Veco B.V., which is a related party/group company under the holding company. Therefore, we believe that investors may seek clarifications from the company about the finalization of the sale price for sugar screen business and a copy of the independent valuation so that they may assess this transaction properly.

This is because if after detailed analysis of the valuation approach/methodology, an investor finds that the assets including trademark etc. have been undervalued in this sale transaction, then it may indicate shifting of economic benefit from the minority shareholders of Stovec Industries Ltd to the shareholders of Veco B.V. and the holding company.

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

 

3) Contract manufacturing of sugar screens for Veco B.V.

As per the disclosures made by Stovec Industries Ltd with the results of June 30, 2018 quarter, even though the company has sold its assets of sugar screens, it is still manufacturing the sugar screens in those assets/plants.

June 2018 quarterly results, page 4:

Stovec Industries Ltd 2018 Continued The Operations Of Sugar Screen

Further advised reading: How to understand quarterly results filings of the companies?

An investor would appreciate that in this arrangement, the company (Stovec Industries Ltd) has sold the assets of the manufacturing plant but is still using it to manufacture the goods. In such situation, in addition to the manufacturing costs like raw material, labour costs etc., the company (Stovec Industries Ltd) will have to additionally pay for the rent to use the plant for manufacturing goods. Whereas the entity who bought the manufacturing plant (Veco B.V.) is assured of a usually fixed rental income from Stovec Industries Ltd for giving the plant on lease to it.

Please note that the company has not disclosed the terms of the contract manufacturing agreement entered by Stovec Industries Limited with Veco B.V. / Atul Sugar Screens Pvt. Ltd (now a subsidiary of Veco B.V.).

Investors may seek further clarification from the company about its arrangement with Veco. B.V. and a copy of the contract manufacturing agreement. This is because it might turn out to be a case where all the business risk of manufacturing and selling the sugar screens is still retained by Stovec Industries Ltd whereas Veco B.V. has taken away an assured benefit in terms of fixed rental income on the purchased plant.

Moreover, if after seeking clarifications from the company and further analysis, as per the discussion above, investors find that the plant/assets of sugar screens business are transferred to Veco B.V. on such terms, which are more favourable to them, then it will be a double whammy for the shareholders of Stovec Industries Ltd. First, they had to part with the assets on a cheap valuation and second, they are now paying a rent to use these same assets.

Additionally, if the shareholders of Stovec Industries Ltd felt that the sale of sugar-screen business assets was a good development, as it seemed like an unrelated business to its printing and graphics business, then even now, they might bear the entire risk of the business of producing and selling sugar screens. In addition, another party (Veco B.V.) may be taking out a risk-free return (as rental income on the manufacturing plant) out of the profits earned by shareholders of Stovec Industries Ltd by taking the risk of running the sugar screens business. Therefore, the shareholders of Stovec Industries Ltd might be in a worse off situation than earlier.

In light of the same, it is advised that investors should seek further clarification from the company about the terms of the sale of sugar screen assets and the contract manufacturing agreement entered by Stovec Industries Ltd with Veco B.V. and do a further assessment before making a final opinion about the company and its management.

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

 

4) Management remuneration:

While analysing the past annual reports of Stovec Industries Ltd, an investor notices that the company has been continuously paying a remuneration to its managing directors, which is in excess of 5% of net profit after tax (PAT).

We find that despite case-to-case variation in different companies, the remuneration of key management personnel of most of the companies stays within 2-4% of PAT. Please note that this benchmark is not in relation to the statutory limit on managerial remuneration under the Company’s Act, 2013 under various sections like 197 & 198. This is our personal assessment benchmark.

Therefore, we believe that investors should keep a watch on the trend of the managerial remuneration going ahead.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

 

5) Investments in a public listed company, Jaysynth Dyestuff (India) Limited:

While analysing the annual reports of Stovec Industries Ltd, an investor notices that since FY2016, it has started invested in the equity shares of another listed company, Jaysynth Dyestuff (India) Limited, which is into the business of dyes and pigments.

FY2017 annual report, page 95:

Stovec Industries Ltd 2017 Investment In Jaysynth Dyestuff India Limited

Stovec Industries Ltd has invested about ₹1.36 cr. into the shares of Jaysynth Dyestuff (India) Limited and own about 2% stake in the company on June 30, 2018.

Shareholding details of Jaysynth Dyestuff (India) Limited at June 30, 2018, from BSE:

Stovec Industries Ltd 2017 Stake In Jaysynth Dyestuff India Limited

In light of the stake of Stovec Industries Ltd being significant at about 2% in Jaysynth Dyestuff (India) Limited, we believe that investor may seek clarifications from the company about its rationale and future plans related to this investment.

 

6) Property given on lease to a third party:

An analysis of the annual reports of Stovec Industries Ltd reflects that the company owns some property, which it has given on a non-cancellable lease for 7 years to a third party. The company received a lease rent of ₹1.16 cr for the property in FY2017 and FY2016.

FY2017 annual report, page 106:

Stovec Industries Ltd 2017 Land And Building On Lease

Further advised reading: Understanding the Annual Report of a Company

FY2017 annual report, page 97:

Stovec Industries Ltd 2017 Lease Rental Income

It seems that the company has given the land and building on lease to an unrelated third party as the related party transactions in the annual reports do not contain details of lease income. In addition, the lease rental income is present in the consolidated financials as well, indicating that the property is not leased to the subsidiary Atul Sugar Screens Pvt. Ltd (ASSPL).

Annual lease rental payments of ₹1.16 cr. may indicate a value of the property to be about ₹14.5 cr. considering 8% capitalization rate (14.5 = 1.16/0.08).

Moreover, while analysing the past annual reports, an investor notices that the lease rent has been at the same level of ₹1.16 cr. without any increase since FY2012.

FY2013 annual report, page 55:

Stovec Industries Ltd 2013 Land And Building On Lease

It seems that Stovec Industries Ltd has invested about ₹14-15 cr. to prepare a building, which it has lent/leased out to a third party under a contract, which is non-cancellable and does not have any escalation of lease rental for at least 5 years (FY2012-2017). We believe that investors may seek further details from the company about this property, the location, the investment done to purchase the land & construct the building, the name of the counterparty and the reasons for non-escalation of rentals for past 5-6 years.

 

7) Significant increase in the expenses charged by the holding company to Stovec Industries Ltd

While analysing the related party transactions of Stovec Industries Ltd, an investor notices that in FY2017, the company has paid for expenses of about ₹4.16 cr. for its holding company, SPGPrints B.V. In FY2017, these expenses have increased significantly from ₹0.55 cr. in FY2016.

Stovec Industries Ltd 2017 Expenses Charged By SPGPrints B.v.

Further advised reading: Understanding the Annual Report of a Company

An investor would also note that the nature of these expenses is uncertain as they are shown separately from the purchase of raw material, fixed assets, services etc.

Therefore, we believe that investors may seek further clarification from the company about the nature of these expenses, the benefits derived by the shareholders of Stovec Industries Ltd by paying for these expenses incurred by SPGPrints B.V. and the reason for the sudden multifold increase in these expenses in FY2017.

 

Margin of Safety in the market price of Stovec Industries Ltd:

Currently (Sept 20, 2018), Stovec Industries Ltd is available at a price to earnings (PE) ratio of about 19.57 based on consolidated FY2018 earnings. The PE ratio of 19.57 does not offer any margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

Further advised reading: 3 Principles to Decide the Investable P/E Ratio of a Stock for Value Investors

Read: How to Earn High Returns at Low Risk – Invest in Low P/E Stocks

Further advised reading: Hidden Risk of Investing in High P/E Stocks

 

Conclusion:

Overall, Stovec Industries Ltd seems like a company, which has grown its business at a decent pace of 20-25% year on year in the last decade (FY2008-17). The company has been able to show significant improvement in its profit margins. It has kept its working capital utilization at an efficient level. In addition, it has been able to grow by investing limited money in capital expenditure. As a result, Stovec Industries Ltd has shown a profitable and debt-free business growth.

The company has generated a lot of free cash flow, which it has used for paying dividends to the shareholders and for creating investments. However, it is advised that investors should seek further clarifications from the company about some of its investments like a building, which it has leased out to a third party at rentals, which are constant since FY2012. Investors may also seek clarifications about the investment done by the company in shares of Jaysynth Dyestuff (India) Limited in which it now owns a significant stake (1.99%).

Stovec Industries Ltd purchased a company in 2014 to focus on sugar screens business but in 2018, the company has sold the sugar-screen assets to a group company. On the face of it seemed like a decision where the company is exiting a non-core business segment. However, different aspects of this sale transaction, which investors learn though separate disclosures leave many aspects that need further clarification from the company. We believe that investors should seek further details about the valuation of the assets sold by the company as well as the contract manufacturing agreement entered by it with the purchaser of sugar-screen assets. Investors may wish to get this clarification to avoid being in a situation where they are paying risk-free profits to another entity out of the profits earned by them by taking risk of sugar-screen business and that too on assets, which they only sold to the buyer on cheaper valuations.

Stovec Industries Ltd is run by professional managers where the key leadership has changed upon the resignation of the prior managing director. An investor may be aware of the risks faced by companies, which are run completely by professionals. There have been many instances in the corporate world where professional managers gave more priority to their personal interests over the interests of shareholders. Moreover, it seems that the key management of the company is taking a remuneration, which is higher than the usual benchmark of the industry.

Investors may seek clarifications from the company about the significant increase in the payment made by the company to the holding company SPGPrints B.V. in FY2017.

We believe that going ahead investors should monitor the movement in the prices of Nickel and the resultant impact on the profitability of the company. Additionally, investors may monitor the management remuneration, investments that are done by the company from its cash reserves, payments done by the company to Veco B.V. for using the sugar-screen producing asses, changes in the lease rental income and other related party transactions with group companies.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Stovec Industries Ltd. However, investors should do their own analysis before taking any investment related decision about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

Hope it helps!

Regards,

Dr Vijay Malik

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.

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The objective of “Peaceful Investing” approach is the selection of such stocks, where once an investor has put in her money, then she may sleep peacefully. Therefore, if later on, the stock prices rise, then the investor is happy as she is now wealthier. On the contrary, if the stock prices fall, even then the investor is happy as she can now buy more quantity of the selected fundamentally good stocks.

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