This article provides a fundamental analysis of Metalyst Forgings Ltd (erstwhile Ahmednagar Forgings Ltd), a manufacturer of forged automotive components, cold-forged parts and fasteners.
In order to benefit the maximum from this article, an investor should focus more on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc used to get the information. This will help her in improving her stock analysis skills.
Metalyst Forgings Ltd (Ahmednagar Forgings Ltd) Research Report by Reader
Q: Hi Vijay, I have followed your posts throughout and have borrowed many of your investing philosophies. I applied it on one of the stocks that interested me. Wanted to check with you if I am going in the right way or I have missed something.
I am very much interested in Ahmednagar Forgings Ltd because of the following reasons:
- Sales growth : 10yrs > 31%, 5yrs > 35%
- Profit growth : 10yrs > 28%, 5yrs > 40%
- Has a positive cash flow from operations.
- The promoter’s stake is ~ 60%.
- P/E ratio is also compelling at less than 5.
Dr Vijay Malik’s Response
Thanks for writing to me!
Financial Analysis of Metalyst Forgings / Ahmednagar Forgings Ltd:
Ahmednagar Forgings Ltd has shown consistent sales growth of 25-30% with stable operating profit margins. However, the net profit margin (NPM) of Ahmednagar Forgings Ltd has declined because of increasing interest costs year on year.
Ahmednagar Forgings Ltd has been able to convert its profits into free cash from operations, which is reflected by cumulative CFO for the last 10 years (2005-14) being higher than cumulative PAT over the same period. It is able to collect money from its customers in time, which is reflected by declining receivable days.
Advised reading: How to do Business Analysis of Auto Ancillary Companies
Operating Efficiency Analysis of Metalyst Forgings / Ahmednagar Forgings Ltd:
However, the concerns arise when we see the data on operating efficiency for Ahmednagar Forgings Ltd. Its fixed asset turnover ratio and inventory turnover ratio have been declining over the years.
Equally important is the fact that the fixed asset turnover ratio is very low, less than 1, which indicates that Ahmednagar Forgings Ltd needs to spend more than INR 1 in plant and machinery to produce INR 1 of additional sales. This low asset turnover has serious implications as a huge amount of incremental investment is needed to show future growth.
For example, let us assume in the first year it Ahmednagar Forgings Ltd, targets to achieve INR 100 cr. of additional sales, then it would need to invest INR 111 cr. in fixed assets (100/0.9, because the fixed asset turnover ratio is 0.9 currently). This INR 100 cr. of additional sales would provide additional net profits of INR 10 cr. (assuming 10% of NPM). If Ahmednagar Forgings Ltd retains entire profits and invests in its operations, then this incremental investment of INR 10 cr. of entire profits would generate only INR 9 cr. of incremental sales in the second year (as the fixed asset turnover ratio is 0.9). If Ahmednagar Forgings Ltd wishes to grow sales by another INR 100 cr. in the second year as well, then it would have to generate INR 91 of sales by investing an additional INR 101 cr. (INR 111 cr. total requirement – INR 10 cr. of net profits invested). This INR 101 cr. needs to come from either fresh equity infusion or debt.
Thus, we may see that with a very low fixed asset turnover of 0.9, Ahmednagar Forgings Ltd would have to keep on relying on additional sources of funds to maintain its growth. This has happened in the past as well. Ahmednagar Forgings Ltd has been relying on debt to fund its growth. Its debt has increased from INR 66 cr. in FY2005 to INR 2,773 cr. in FY2014 (42 times increase) whereas its sales have increased from INR 205 cr. in FY2005 to INR 2,397 cr. in FY2014 (11.7 times increase).
Advised reading: Asset Turnover Ratio: A Complete Guide for Investors
Margin of Safety in the Business of Metalyst Forgings / Ahmednagar Forgings Ltd:
It seems that in the current state, the business model of Ahmednagar Forgings Ltd is a perpetual losing proposition. It has already destroyed shareholders’ wealth in the past as it has created a market value of only INR 612 cr. (increase in market capitalization) from the retained profits of INR 850 cr. over last 10 years (2005-14)
I believe that unless it improves its fixed asset turnover by investing in any new technology, it is going to land up in a debt trap. Its interest costs have already been spiralling up and might rise further and bringing down profitability.
I believe that an investor can get many other better opportunities than Ahmednagar Forgings Ltd in current markets.
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.
In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
These are my views about Ahmednagar Forgings Ltd. However, you should do your own analysis before making any investment-related decision about any company.
You may use the following steps to analyse the company: “How to do Detailed Analysis of a Company“
The case of Ahmednagar Forgings Ltd is very much similar to the case of Amtek India Ltd. An investor should read the analysis of Amtek India Ltd as well, to understand how capital intensive businesses with low fixed asset turnover can prove to be poor investments:
Hope it helps!
Regards,
P.S.
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Disclaimer
Registration status with SEBI:
I am registered with SEBI as a research analyst.
Details of financial interest in the Subject Company:
I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.
