The current section of the “Analysis” series covers Gandhi Special Tubes Ltd, an Indian manufacturer of welded and seamless steel tubes, cold-formed tube nuts and fuel injection tube assemblies for automobile and other industries.
“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.
In order to benefit the maximum from this article, an investor should focus 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.
Gandhi Special Tubes Ltd Research Report by Reader
Dear Dr Vijay,
Please find the report wherein I have analysed and put in my thoughts on the company M/s Gandhi Special Tubes Ltd.
Request to provide your inputs. I would be happy if the same can be published on your website.
Thanks & Regards
Dileepraj R
About the Company:
The Gandhi Group started as a manufacturer of automobile components way back in 1959. Their products are marketed both in domestic and international markets. They export mostly to Germany, UK and South-East Asian countries.
Their manufacturing plant is based in Gujarat. It commenced production in April 1988. They have technical collaboration with Benteler of Germany, a leading enterprise in steel manufacturing. Gandhi Special Tubes initially started with a project for manufacturing small diameter welded and cold-drawn seamless steel tubes. Most of the machinery was supplied by Benteler who also supported in its installation and training of personnel.
Gandhi Special Tubes Ltd. later forayed into manufacturing of cold-formed tube nuts for fuel injection tube assemblies and hydraulic & other tube assemblies.
The company has clients from sectors/industries like automotive, refrigeration, hydraulics and other engineering services.
Gandhi Special Tubes Ltd.’s current products are:
- Cold-drawn bright annealed seamless tubes, which has applications in
- Hydraulic Tubes.
- High-Pressure Diesel Fuel Injection Tubes.
- Tubes for General Engineering Applications.
- Precision Electric Resistance Welded Tubes, which has applications in:
- Condensers for refrigerators
- Compressor tubes
- Tubes for Automobile applications
- General Engineering Applications
- Cold-formed Coupling nuts
Analysis of Past Performance of Gandhi Special Tubes Ltd:
1) Sales and Operating Profit:
Gandhi Special Tubes (GS Tubes) has been growing sales at a CAGR of 8.2% over the last ten years. Sales had a healthy growth from 2009 to 2012 (it nearly doubled during this period) and then revenues fell and fluctuated over the years 2013 to 2017.
Operating margins of Gandhi Special Tubes were consistently above 30% except for one year (2015 – 25%). This appears to be good and reflects that the company is able to pass on the raw material cost fluctuations to the customers. The operating margins during the last three years 2016, 2017 and 2018 were 30%, 34% and 36% respectively.
The drop in revenues needs to be analysed further.
From the annual report 2017-18, the major contribution to revenue of Gandhi Special Tubes comes from seamless tubes, which contributed a whopping 78.6% of revenues, are eventually used by Tata Motors, Ashok Leyland and M&M among others. This reflects the importance of commercial vehicle and tractor industry sales in the revenues of Gandhi Special Tubes. The cyclicality in revenues could be related to this.
M&HCV sales have a very strong correlation with revenues of Gandhi Special Tubes.
Except for FY2016, Gandhi Special Tubes’ sales rose and fell in tune with M&HCV sales. Looking at the inventory levels, it seems that high inventory was the reason for the trend not being observed in FY2016.
The inventory correction (29%) and perhaps high inventory levels in the system during FY2015 to FY2016 resulted in sales not rising for Gandhi Special Tubes, even though M&HCV sales rose during the period.
In hydraulics, its products are used for construction and mining purposes and clients include the likes of L&T, BEML and BHEL among others.
2) Net Profit:
Net profit of Gandhi Special Tubes grew at a CAGR of 8.6% from FY2009 to FY2018. The cyclicality as seen in sales can be observed here also. The net profit margin is healthy and for the years FY2016, FY2017 and FY2018 were at 20%, 32% and 29% respectively.
Being a debt-free company, interest payment was NIL for Gandhi Special Tubes for the past ten years.
3) Operational Performance:
The inventory turnover of Gandhi Special Tubes varied from 3 to 6 times during the past ten years. FY2017 and FY2018 showed inventory turnover of 4 times and 6 times which seems good. As discussed earlier, this was after a correction in FY2015, during which inventory turnover had reached a low of 3 times. The investor should keep a close watch on the inventory level as can be seen in the analysis.
In addition, the net fixed asset turnover of Gandhi Special Tubes increased from 1.3 times in FY2014 to 2.2 times in FY2018. The capacity utilization also seems to be low, which could be a reason for the low asset turn over. Investors need to look at whether new clients are being added which will give a boost to both revenue and asset turnover.
4) Cash Flows and Capex:
Over the last ten years, Gandhi Special Tubes has generated a cumulative net profit of Rs 235 Cr. The cumulative cash from operations (CFO) is Rs 233 Cr, meaning that it has been able to convert its profit into cash, almost on par. Its current cash return on invested capital (CROIC) is 50.9%, which is also good compared to peers.
To increase the sales from Rs 56 Cr in 2009 to Rs 114 Cr in 2018, Gandhi Special Tubes had put in a cumulative Capex of Rs 46 Cr. Over the same period, the company had generated a cumulative CFO of Rs 233 Cr, leading to a surplus of Rs 182 Cr as free cash flow. (FCF).
The company has used this FCF to pay regular dividends and the total dividends paid in the last ten years amounted to Rs 95 crore.
In addition, as there is no debt, Gandhi Special Tubes is carrying a good surplus of cash and investments.
Gandhi Special Tubes has used only internal accruals for capex as and when required. When capex is low or not required, as in last year, the company has gone for buyback of shares.
5) Taxes:
Gandhi Special Tubes was paying an average tax percentage of 30% during FY 2009, 2010 and 2011.
However, during the years 2016, 2017 and 2018 it has been 26%, 19% and 26% respectively, which needs to be clarified from the company end.
Management Analysis of Gandhi Special Tubes Ltd:
The key management personnel of Gandhi Special Tubes are Mr. Manhar G. Gandhi, Mr. Bhupatrai Gandhi, Mr. Dhirajlal S. Shah and MR. Jayesh M Gandhi.
The salary drawn by Mr Manhar G Gandhi and Mr Bhupatrai G Gandhi is ₹2.11 cr each in FY2018. Each draws a salary of 6.2% of net profit, which is on the higher side.
Salaries drawn were on the higher side in the past years also.
Mr Manhar Gandhi and Mr Bhupatrai Gandhi are brothers. Management succession is visible as the son of Mr Manhar Gandhi; Mr Jayesh M Gandhi has joined Gandhi Special Tubes as a director.
Related Party Transactions:
About ₹ 2 cr of sales are done to Jaishri Engineering Co Pvt Ltd, which happens to be run by Mr Jayesh Gandhi, who is the director of Gandhi Special Tubes. The company (as per information collected from the web) supplies truck pipes and car pipes.
This is not a good scenario and one needs to look into the extent of conflict of interest coming here. In addition, if the same products could be manufactured by Gandhi Special Tubes, then there could be losses in this transaction. Further, if the same know-how of Gandhi Special Tubes is being deployed at Jaishri, this could become a competing entity, which would be detrimental in the long term.
This would require further clarification from the company.
Key Risks:
- As mentioned, Gandhi Special Tubes draws a significant chunk of its revenue from a segment (M&HCV), which is cyclical in nature, which affects the business of Gandhi Special Tubes also.
- The company, though reporting high operating margins, raises concerns over the rising commodity prices.
- Changes in technology and government norms are a consistent threat to the business of Gandhi Special Tubes. An investor should try to keep oneself updated on the same.
Margin of Safety Analysis of Gandhi Special Tubes Ltd:
Gandhi Special Tubes trades at a P/E of 14.1. This reflects an earnings yield of 7%. We can assume a short margin of safety in the price at this level. As discussed above on the business front, the free cash flow (FCF) being generated does give a margin of safety on the business front, and Gandhi Special Tubes commands a good ROCE and CROIC.
In addition, the net cash and investments carried by Gandhi Special Tubes are strong and the company going for buyback of shares will give a boost to ROE as well.
Conclusion:
Gandhi Special Tubes is a manufacturer of small diameter seamless and welded steel tubes, which find applications in various domains, a significant chunk coming from the Automotive Sector.
We found that the Company’s topline depends a lot on the commercial vehicle industry to whom it supplies critical components.
Gandhi Special Tubes has a lean balance sheet. It is a debt-free company, which carries healthy net cash & investments. The company is maintaining a good dividend payout of around 46%. The current dividend yield stands at 2.45%.
Gandhi Special Tubes though operating in a difficult segment has been consistently able to maintain a healthy operating margin and net margin.
However, an investor needs to be keen on the technology developments happening in the sector. The investor also needs to keep a close watch on the inventory levels, which as seen affects the business at various phases.
Dr Vijay Malik’s Response
Hi Dileepraj,
Thanks for sharing the analysis of Gandhi Special Tubes Ltd with us! We appreciate the time & effort put in by you in the analysis.
Let us analyse the performance of Gandhi Special Tubes Ltd over the last 10 years.
Financial and Business Analysis of Gandhi Special Tubes Ltd:
While analyzing the financials of Gandhi Special Tubes Ltd, an investor would note that in the past, the company has been able to grow its sales at a rate of 3-5% year on year. Sales of the company increased from ₹56 cr. in FY2009 to ₹114 cr in FY2018. However, an investor would notice that the sale performance of the company over the last 10 years has been very fluctuating. Gandhi Special Tubes Ltd witnessed its sales increase from ₹56 cr. in FY2009 to ₹107 cr in FY2012. However, from FY2013 onwards, the company faced a difficult time and as a result, its sales started declining year on year. Sales of the company declined to ₹91 cr in FY2016. In FY2017, the company witnessed a revival in its performance and could increase its sales significantly to an all-time high of ₹114 cr in FY2018.
Such a variation in the performance of the company was not limited to only sales/revenue. Gandhi Special Tubes Ltd witnessed significant changes in profitability as well. The operating profit margin (OPM) of the company increased from 39% in FY2009 to 44% in FY2011. However, from FY2012 onwards, the OPM started declining and fell to 25% in FY2015. From FY2016 onwards, the OPM has started recovering and has increased to 36% in FY2018.
The net profit margin (NPM) of the company has also followed a similar cyclical pattern. NPM touched a high of 33% in FY2010 and then a low of 17% in FY2015. Later on, the NPM has recovered to 29% in FY2018.
Further advised reading: How to do Financial Analysis of Companies
An investor would notice that the business performance of Gandhi Special Tubes Ltd has witnessed cyclical nature during the last 10 years (FY2009-18). In the initial years, the company was growing with increasing profit margins (FY2009-11) but then it faced tough times in subsequent years, which resulted in declining sales and profit margins (FY2012-15). Thereafter, the performance of the company improved in recent times in terms of both sales and profitability (FY2016-18).
Such fluctuating performance is a highlight of companies operating in cyclical industries. Cyclical industries depend a lot upon economic environments for their business performance.
To understand more about the impact of industry cycles on the companies, investors may read the analysis of the following companies:
Gandhi Special Tubes is highly dependent on the automotive industry. An upturn in the automotive industry often leads to a rise in sales and profit margins of the company. Similarly, a downturn in the automotive industry leads to declining sales and profit margins of the company.
This aspect of the strong linkage of Gandhi Special Tubes’ performance with the state of the automobile industry comes out clearly from the management’s explanation when the company notices a decline in sales as well as profit margins in FY2013.
FY2013 annual report, page 11:
Due to slowdown in the Automobile and General Engineering industry, your Company’s performance was moderately affected. Sales of Steel Tubes and Nuts during the year had fallen by 9.57% as compared to the sales of the previous year. Consequently the net profit of the Company also registered a decline of 26%.
Companies in cyclical industries have low negotiating power with their customers. As a result, such companies are not able to pass on the rising costs to their customers. Moreover, in the case of Gandhi Special Tubes, key customers are large automobile conglomerates who negotiate hard for prices from their vendors like Gandhi Special Tubes. Therefore, small suppliers like Gandhi Special Tubes are not able to maintain their profit margins when they are faced with rising costs.
Advised reading: How to do Business Analysis of Auto Ancillary Companies
Gandhi Special Tubes has highlighted this aspect of its business in its annual reports since its very early days. An investor may notice that the company has acknowledged that rising raw material costs and exchange rate changes are a big concern for the company in the FY2007 annual report, which is the oldest available annual report on its website. The company had highlighted that it may not be able to pass on the increase in costs to its customers.
FY2007 annual report, page 12:
Risk and Concerns
– The margins could come under pressure due to increase in input costs and other expenses.
– Competition from low cost manufacturing countries such as China.
– Adverse fluctuation in foreign exchange rates.
Further advised reading: Understanding the Annual Report of a Company
When the sales and the profit margins of Gandhi Special Tubes started declining in FY2013, the company emphasized that it does not have strong negotiating power with its customers. Therefore, it may not pass on the rising costs to its customers.
FY2013 annual report, page 16:
Government is considering on levying anti-dumping custom duty on imports from China and Italy. This will increase the cost of Raw Material thereby increasing the cost of production which the Company may not be able to fully pass on to its Customers and this may lead to reduction in the net profit.
Gandhi Special Tubes witnessed the double impact of the slowdown in the automobile sector along with the declining Indian Rupee against the US Dollar in FY2014. As a result, the sales and profit margins of the company declined.
FY2014 annual report, page 16:
The Automobile and General Engineering business was badly affected due to reduction in its demand throughout the year. Depreciation of Indian Rupee against Dollar increased the cost of Imports which marked its adverse impact on the gross margin which declined by 5.29% compared to last year
The same situation is continued in FY2015 when the company witnessed its lowest net profit margin of 17% in the last decade (FY2009-18).
FY2015 annual report, page 14:
It is heartening to note that in spite of general depression, your Company’s Net Sales has increased by 10.02% from ₹ 8353 lacs to ₹ 9190/- lacs. However the operating profit has reduced by 13.43 % from ₹ 2122/- lacs to ₹ 1837/- lacs. This is primarily on account of increase in fuel and labour cost and increase in other manufacturing expenses. The Company was unable to pass on the increase in costs to its customers on account of overall depression in the industry.
Therefore, an investor would appreciate that even though Gandhi Special Tubes has good operating and net profit margins with OPM ranging from 25%-40% and NPM ranging from 17%-30%, it is highly dependent on the cyclical nature of its industry. The company acknowledged its low negotiating power with its customers in the old available annual report of FY2007. The situation is hardly changed over the last decade as the company has acknowledged a similar weak negotiating position in the FY2018 annual report as well.
FY2018 annual report, page 41:
Risk and Concerns: Increase in commodity prices has already resulted in overall increase in cost which is difficult to pass to customers. Further increase in commodity prices may adversely affect profitability.
Further advised reading: Understanding the Annual Report of a Company
Therefore, an investor would notice that Gandhi Special Tubes Ltd is a small player in a large cyclical industry (automobiles) and is impacted by the different business phases of the automobile industry. The company is a small supplier to large automobile conglomerates and therefore, it does not have a lot of negotiating power to increase prices whenever its raw material and other costs increase. As a result, Gandhi Special Tubes Ltd has witnessed its sales and profit margins fluctuate in the past. Looking at the acknowledgement by the company of a similar negotiating state in the latest annual report, an investor may expect that the sales and profit margins of the company may see similar fluctuating trends in the future as well.
When an investor analyses the tax payout ratio of Gandhi Special Tubes Ltd, then she realizes that the tax payout ratio of the company was in the range of standard corporate tax rate prevalent in India until FY2013. However, from FY2014 onwards, the tax payout ratio has been varying wildly from 41% in FY2014 to 19% in FY2017.
While analysing the annual reports of the company from FY2014-FY2018, an investor notices that Gandhi Special Tubes Ltd has been factoring transactions under “Current Tax expense relating to prior years”, which along with MAT credits, is leading to a wide variation in the tax payout ratio year after year.
FY2014 annual report, page 41:
FY2017 annual report, page 59:
Investors may seek more details and clarifications from the company about the nature of these prior period items for which the tax is being adjusted in the later years.
Advised reading: How to do Business Analysis of Auto Ancillary Companies
Operating Efficiency Analysis of Gandhi Special Tubes Ltd:
1) Net fixed asset turnover (NFAT) of Gandhi Special Tubes Ltd:
When an investor analyses the net fixed asset turnover (NFAT) of Gandhi Special Tubes Ltd, then she notices that the NFAT of the company has been on an increasing trend since FY2010 when it was at a level of 1.75. The NFAT increased to 2.90 in FY2012 when the trend was interrupted and in the next two years, NFAT declined to 1.44 in FY2014. Since FY2015, the NFAT has been again on the increasing trend and has reached 2.14 in FY2018.
While analysing the past annual reports for the capital expenditure (Capex) done by Gandhi Special Tubes Ltd, an investor notices that in the last 10 years (FY2009-18), the company has done one major capital expenditure of about ₹30 cr in FY2013-FY2014. The capex included the creation of a third bright annealing furnace at the Halol plant.
FY2012 annual report, page 13:
The Company has planned investment of Rs.30 Crores for expansion project in Halol, Gujarat from internal accruals for:
i. Construction of additional Building, which will be ready tentatively by August, 2012. This is required to install balancing equipments & new machinery as well as for storage of material;
ii. Draw Benches, straightening machines, testing equipment etc. particularly to enhance output of Small Diameter Seamless Steel Tubes & Cold Formers & Threading machines to manufacture Cold Formed Nuts.
iii. Additional handling equipments are being planned in order to cope up with acute shortage of labour and
iv. 3rd Bright Annealing furnace is being planned in subsequent year.
After analysis of the business performance and capital expenditure of Gandhi Special Tubes Ltd over last year, an investor would appreciate that the inherent increasing trend of NFAT for the company is due to the reduction of net fixed assets (denominator) every year due to the annual depreciation of about ₹5 cr, which is about 10% of the fixed assets. The decrease in NFAT during FY2013 and FY2014 is due to the capital expenditure done by the company on the expansion of the Halol plant, which increased the fixed assets but did not increase the sales of the company immediately. This is because:
- New manufacturing plants usually take some time to stabilize and reach optimal production levels.
- The company’s sales were affected by the slowdown in the automobile industry.
Therefore, an investor would appreciate that Gandhi Special Tubes Ltd has witnessed an increasing trend of NFAT, which is interrupted by declining NFAT for FY2013-FY2014 due to capital expenditure.
Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors
2) Inventory turnover ratio of Gandhi Special Tubes Ltd:
An investor would note that over the years, the inventory turnover ratios (ITR) of Gandhi Special Tubes Ltd has been ranging from 3.5 to 5.0. The inventory turnover witnessed a decline in the FY2013-FY2015 when the performance of the company was affected by the slowdown in the automobile industry. However, in recent years, the ITR has improved in line with the overall business performance of the company.
Advised reading: Inventory Turnover Ratio: A Complete Guide
3) Analysis of receivables days of Gandhi Special Tubes Ltd:
An investor would notice that over the years, the receivables days of Gandhi Special Tubes Ltd has been ranging from 55 days to 60 days indicating the company has been able to keep maintain its receivables days over the years. It seems because most of the customers of the company are large automobile conglomerates who pay the company as per the terms of the contract.
Further Advised Reading: Receivable Days: A Complete Guide
When an investor analyses the receivables days along with inventory turnover, then she notices that Gandhi Special Tubes Ltd has been able to keep its working capital requirements stable and under control. The working capital position of the company has not deteriorated over the years. It means that Gandhi Special Tubes Ltd has been able to convert its profits into the cash flow from operations without the money being stuck in working capital. An investor observes the same while comparing the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of the company for FY2009-18.
An investor would notice that over FY2009-18, Gandhi Special Tubes Ltd Limited has reported a total cumulative net profit after tax (cPAT) of ₹235 cr. whereas during the same period, it reported cumulative cash flow from operations (cCFO) of ₹233 cr indicating that it has converted its profits into cash.
It is advised that investors should read the article on CFO calculation mentioned below, which would help them understand the situations in which companies tend to have the CFO lower than their PAT and the situations when the companies tend to have CFO higher than their PAT.
Further advised reading: Understanding Cash Flow from Operations (CFO)
Margin of Safety in the Business of Gandhi Special Tubes Ltd:
1) 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.
An investor would notice that Gandhi Special Tubes Ltd has witnessed an SSGR ranging from -7% to 18% over the years. The sales growth achieved by the company over the years is 8%. Therefore, investors would expect that the company would be able to fund its growth from its internal sources and it would need to depend on additional capital like debt or equity to fund its growth requirements.
An investor is able to observe this aspect of the company’s business when she analyses the cumulative cash flow position including free cash flow for the company over the last 10 years (FY2009-18).
2) Free Cash Flow Analysis of Gandhi Special Tubes Ltd:
While looking at the cash flow performance of Gandhi Special Tubes Ltd, an investor notices that during FY2009-18, the company had a cumulative cash flow from operations of ₹233 cr. However, during this period it did a capital expenditure (capex) of ₹46 cr. As a result, it had a free cash flow of ₹187 cr. (233 – 46).
Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF
An investor would notice that over the last 10 years (FY2009-18), Gandhi Special Tubes Ltd had a non-operating income of ₹57 cr. Therefore, overall, the company had surplus cash of ₹244 cr (187 + 57). While analysing the past annual reports of the company, an investor would observe that the company has used this surplus money in the following manner:
- Dividend payments to the shareholders: The company has used the funds to pay a dividend of about ₹95 cr. (excluding dividend distribution tax) to the shareholders.
- Buyback of shares: Gandhi Special Tubes Ltd did a buyback of equity shares in March 2018 for ₹44 cr. FY2018 annual report, page 19:
During the financial year 2017-18, the Company was successful in buying back 8,80,00 fully paid up equity shares offered to the shareholders through tender offer at a price of ₹ 500/- per Equity share representing up to 5.99% of the total no. of Equity Shares for an aggregate amount of ₹4400.00 Lakhs (Rupees Forty Four Crore only). The buyback process was completed and the shares so bought back were extinguished on April 2, 2018. Post buyback of shares, the paid up Equity Share Capital reduced by ₹44 Lakhs to ₹ 690.93 Lakhs as on March 31, 2018.
- Cash and investments: On March 31, 2018, most of the remaining money is being kept by the company as investments in mutual funds and cash (₹103 cr).
Free cash flow (FCF) is one of 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
Therefore, an investor would appreciate that over the last 10 years, Gandhi Special Tubes Ltd has been able to grow from its own resources without depending on additional/outside funds like debt or equity. During this period, the company generated a significant amount of free cash, which the company utilized to pay dividends to shareholders, buy back shares from shareholders and has kept the remaining money as cash & investments for usage in future.
An investor would appreciate that this is a good conservative manner of business management. It seems that the markets have appreciated the same as well. As a result, in the last 10 years (FY2009-18), Gandhi Special Tubes Ltd has been able to generate a wealth of ₹440 cr in terms of an increase in market capitalization for ₹141 cr of profits retained and not distributed to shareholders. This amounts to a wealth of ₹3.12 in market capitalization for every ₹1 of retained earnings.
Additional aspects of Gandhi Special Tubes Ltd:
On analysing Gandhi Special Tubes Ltd, an investor comes across certain other aspects of the company:
1) Management Succession of Gandhi Special Tubes Ltd:
While analysing the annual reports of Gandhi Special Tubes Ltd, an investor notices that apart from the brothers Mr. Manhar Gandhi (CMD) and Mr. Bhuptrai Gandhi (Jt. MD), Mr. Jayesh Gandhi, who is the son of Mr. Manhar Gandhi, is a member of the board of directors.
FY2018 annual report, page 44:
It indicates that the company has put in place a management succession plan in which the new generation of the promoter family is being groomed in business while the senior members of the promoter family are still playing an active part in the day-to-day activities. However, as per the annual reports, Mr. Jayesh Gandhi is a non-executive director of the company indicating that he is not active in the day-to-day management of the company.
Investors may contact Gandhi Special Tubes Ltd to understand more about the management succession planning of the promoters. Investors may seek clarification about the plans of promoters to hand over the active responsibilities of the company to Jayesh Gandhi in future.
The presence of a well thought out management succession plan is essential in the case of promoter run businesses as it provides for a smooth transition of leadership over the generations and provides continuity in the business operations of any company.
Further advised reading: Steps to Assess Management Quality before Buying Stocks
2) Strategic Decisions of Gandhi Special Tubes Ltd:
While analysing the past annual reports of the company, an investor notices that on multiple occasions, the management has taken decisions to close down products and plants, which it felt is not adding value to the company.
In 2008, Gandhi Special Tubes Ltd closed down its plant in Pune where it felt that the plant is not adding a lot of value to its business and the same activities can be done from its Halol plant, which in turn will save costs.
FY2009 annual report, page 7:
During the year under review, your Company has closed down its Pune Plant with effect from 25th July, 2008. The said plant was engaged mainly in assembly of components transferred from the Company’s Halol Plant and supplying the finished products to customers in nearby area. After completion of the expansion project at Halol, the Company had now sufficient resources at Halol Plant to undertake assembly and supply of products to all its customers from the said plant itself. The contribution of the Pune Plant to the total turnover of the Company was not significant. With a view to reduce costs and convenience of controlling the entire production activity at one location, it was decided to close the Pune Plant with effect from 25th July, 2008 after complying with the statutory equirements under the various laws applicable to the said plant.
In FY2012, Gandhi Special Tubes Ltd stopped the production of refrigeration condenser coils, which had become unviable due to multiple factors.
FY2012 annual report, page 13:
The Company has stopped production of Refrigeration Condenser Coils as this business was highly seasonal, labour intensive & with low value addition. Acute shortage of skilled labour & extreme seasonality of this business made it unviable
Such steps by the management of the company to shut down the products and plants, which are no longer adding value to the company is a good aspect as it saves the capital. An investor would appreciate that these decisions of the company to avoid wastage of capital are in line with the above discussion about the conservative nature of its management.
Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?
3) The threat of changing technology for the business of Gandhi Special Tubes Ltd:
One of the major products made by Gandhi Special Tubes is fuel injection tube assemblies. It is a critical component of the automobile. Currently, due to regulatory demands on automobile manufacturers to upgrade their automobiles to the newer versions of BS-IV and later on to BS-VI, there is pressure on the players to advance their engines technologically to better fuel consumption and lower pollution levels.
In this process of technological advancement of the engine, one of the components, which needs an upgrade, is fuel injection parts, which is the key product of Gandhi Special Tubes Ltd.
An investor would appreciate that if the new engine development by automobile manufacturers requires that a new generation of fuel injection assemblies be used in the vehicles, then Gandhi Special Tubes Ltd would find it difficult to retain its business. Gandhi Special Tubes Ltd has highlighted the risk of its existing products becoming irrelevant due to technological advancements in its annual reports.
FY2016 annual report, page 35:
Tightening of emission norms could see change in technology and could impact demand for Company’s products.
Further advised reading: Understanding the Annual Report of a Company
An investor would notice that if the new business environment requires that new versions of fuel injection products should be made, then Gandhi Special Tubes Ltd should use its research and development abilities to produce new products. However, while reading the annual reports of the company, an investor would notice that Gandhi Special Tubes Ltd does not have any research and development program to develop new products or technologically advanced versions of its existing products.
FY2018 annual report, page 28:
FURTHER PLAN OF ACTION: At present, there are no specific areas in which the Company has undertaken Research & Development.
This is a big concern for the company and its investors because, in the absence of the development of new fuel injection products from Gandhi Special Tubes Ltd, the existing products will lose usage and become irrelevant.
An investor would believe that in the absence of the research abilities of the company, the next best solution is to acquire the technology to make advanced versions of products from other players. Gandhi Special Tubes Ltd has also acknowledged it to the shareholders in its annual reports.
FY2017 annual report, page 35:
Threats: Tightening of emission norms could see change in technology and could impact demand for Company’s products. With the introduction of BS IV standards from 1st April, 2017, there is a major change in specifications for high pressure fuel injection tubes which is one of the applications for which company’s products are used. Technology to manufacture these is currently not with the Company. However efforts are on to get this technology.
However, as per the FY2018 annual report, the company has accepted that it has not been able to acquire this technology (CRDI Tubes) until now.
FY2018 annual report, page 41:
Threats: Tightening of emission norms could see change in technology and could impact demand for Company’s one line of products i.e. fuel injection tubes only .With the introduction of BS IV standards from 1 st April, 2017,there is a major change in specifications for high pressure fuel injection tubes which is one of the applications for which company’s products are used. Technology to manufacture CRDI TUBES is currently not with the Company.
Therefore, an investor would acknowledge that Gandhi Special Tubes Ltd is standing at a critical junction in its business journey where it needs to find new technology to remain relevant in the advancing world of automobile engineering. In case, the company is not able to get the technology to make newer versions of products required by the automobile manufacturers or if any other company is able to acquire this technology and deliver the products to automobile manufacturers, then Gandhi Special Tubes Ltd will find its products becoming irrelevant.
In light of the same, it becomes essential that investors should contact the company to know the status of the acquisition of the new technology and keep on monitoring developments on this front.
Advised reading: How should investors contact Companies/Management for clarifications or additional information?
4) Promoters’ remuneration at Gandhi Special Tubes Ltd:
An investor would notice that in FY2018, Gandhi Special Tubes Ltd has paid a remuneration of ₹2.11 cr each to its CMD Mr. Manhar Gandhi and to its Jt. MD Mr. Bhupatrai Gandhi. An investor would notice that the remuneration of each promoter director is about 6.20% and both the promoter directors is 12.40% of the net profit after tax of ₹34 cr. for FY2018.
The statutory requirements state that the company needs to keep the remuneration of any of its director within 5% and total remuneration to all such directors should be within 10% of the profits as calculated according to 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 ₹4.22 cr. being 12.40% of profit after tax seems on a higher level than normal market standards, where most of the promoters keep their salaries within the range of 2-4% of net profit after tax.
Advised reading: Ideal Level of Remuneration of Promoters
5) Related party transactions with Jaishri Engineering Co. Pvt. Ltd.:
While analysing the annual reports of Gandhi Special Tubes Ltd, an investor notices that the company has involved in sale transactions with Jaishri Engineering Co. Pvt. Ltd (JECPL) for a long time. The oldest publicly available annual report of the company for FY2007 states that Gandhi Special Tubes Ltd had sales transactions of ₹1.29 cr (₹1.52 cr in FY2006) with other enterprises on which directors have significant influence, which included JECPL.
FY2007 annual report, page 42-43:
Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?
In FY2018, Gandhi Special Tubes Ltd had a sales transaction of ₹2.11 cr with JECPL.
FY2018 annual report, page 98:
*In the above table, an investor may note that the company has by mistake mentioned that the figures are in Indian Rupees (₹), whereas the figures are in Lac Indian Rupees (₹ lac). It seems to be a typographical error.
Investors may seek clarifications from the company about these sales transactions and their nature. However, investors may also note that the size of these transactions (₹1-2 cr) is very small when seen in the context of the overall business operations of Gandhi Special Tubes Ltd (₹80-100 cr).
Margin of Safety in the market price of Gandhi Special Tubes Ltd:
Currently (March 12, 2019), Gandhi Special Tubes Ltd is available at a price to earnings (PE) ratio of about 13.08 based on the past four quarters’ standalone earnings. The PE ratio of 13.08 offers a very small margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.
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.
- Further advised reading: 3 Principles to Decide the Ideal 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
Analysis Summary
Overall, Gandhi Special Tubes Ltd seems to be a company operating in a cyclical industry. As a result, Gandhi Special Tubes Ltd has witnessed business phases like increasing sales and profit margins (FY2009-12), declining sales and profit margins (FY2013-15) and then again increasing sales and profit margins (FY2016-18). In line with previous cyclical phases, it is expected that the company may continue to witness such alternating phases of advancing and declining business performance in future as well.
Apart from the cyclical nature of its business, currently, Gandhi Special Tubes Ltd is faced with a critical stage of technological challenge. The company faces a situation of its key products becoming obsolete and irrelevant in case it is not able to develop new fuel injection products (CRDI Tubes) in line with the requirements of automobile manufacturers to make BS-IV and BS-VI vehicles.
Currently, Gandhi Special Tubes Ltd does not have the research & development capability in the company. As an alternative, the company is attempting to get this technology from other players. However, until now, the company has not succeeded to get access to this new technology to make CRDI tubes, which will be very essential to make products needed by its key customers in future.
Until now, Gandhi Special Tubes Ltd has been able to manage its business operations conservatively. The company has kept its working capital requirements under check. The management has frequently taken decisions to shut down unviable products and plants. It has funded its growth requirements from its business profits and has remained debt-free for the entire last decade.
As a result, the company has generated surplus cash from its business. It has used the surplus money to pay dividends to shareholders, buy back shares, and has kept the remaining money as cash & investments for use in future.
Investors may contact the company to understand the status of the acquisition of technology to make CRDI tubes.
Advised reading: How should investors contact Companies/Management for clarifications or additional information?
Going ahead, investors should monitor the profit margins of Gandhi Special Tubes Ltd to understand the phase of the business cycle of the company, status of acquisition of technology to make CRDI tubes, promoter remuneration levels and the amount of transactions with related parties.
Further advised reading: How to Monitor Stocks in your Portfolio
These are our views on Gandhi Special Tubes Ltd. However, investors should do their own analysis before making 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.
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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.
