Stock Analysis- Meghmani Organics

The company is comprised of four subsidiaries: Meghmani Finechem Limited (57%, 25% by IFC Washington, 18% by individual promoters), Meghmani Organics USA INC. (100%), PT Meghmani Organics Indonesia (100%) and Meghmani Overseas FZE (100%). The company is involved in the manufacture of pigments (51%), agrochemicals (46%) and basic chemicals (3%). The company began in 1986 with the production of Phthalocyanine Green 7 (Pigment Green 7) then later on expanded into the manufacture of agrochemicals and basic chemicals.

The pigment industry can be segmented into following:

By Product Type:

  • Organic Pigments
    • Azo Pigments
    • Phthalocyanine Pigment
    • Quinacridone Pigment
    • Other Organic Pigments
  • Inorganic Pigments
    • Titanium Dioxide
    • Iron Oxide
    • Cadmium Pigment
    • Carbon Black
    • Chromium Oxide
    • Complex Inorganic
    • Other Inorganic Pigment
  • Specialty Pigments
    • Classic Organic Pigments
    • Metallic Pigments
    • High-Performance Pigments
    • Light Interference Pigments
    • Fluorescent Pigment
    • Luminescent Pigments
    • Thermo-chromic Pigments

By Application:

  • Paints and Coatings
  • Printing Inks
  • Plastics
  • Construction Materials
  • Others

By Color Index:

  • Red
  • Blue
  • Green
  • Orange
  • Yellow
  • Brown
  • Others

Meghmani is involved in the segments bolded above.

Pigment Segment: The global pigment industry is expected to rise to $32 billion by 2023 growing at a rate of 4% approximately with Asia Pacific region contributing to the majority of the global demand, approx. 50%. The Indian dyestuff and pigments industry is highly fragmented with a large number of small players in the unorganized sector. There are around 50 players in large-scale and organized sector, located mainly in Gujarat and Maharashtra. The highly fragmented Indian colorant industry, valued at $6.8 billion (FY17), exports nearly 75% of its production. Exports have grown in double-digits over the last few years.

In the pigments category, the company manufactures Phthalocyanine pigment with the use of raw material CPC Blue which results in pigment blue and green. The production is done at three locations with a total capacity of 31,140 MTPA. In a simplified way:

Pigment Blue: is a bright, crystalline, synthetic blue pigment from the group of phthalocyanine dyes. Its brilliant blue is frequently used in paints and dyes. It is highly valued for its superior properties such as light fastness, tinting strength, covering power and resistance to the effects of alkalis and acids. It has the appearance of a blue powder, insoluble in water and most solvents. It is used as a colorant Due to its stability, it is also used in inks, coatings, and many plastics.

Pigment Green:  is a synthetic green pigment from the group of phthalocyanine dyes, a complex of copper with chlorinated phthalocyanine. It is a very soft green powder, insoluble in water. Due to its stability, phthalo green is used in inks, coatings, and many plastics. In application it is transparent. The pigment is insoluble and has no tendency to migrate in the material. It is a standard pigment used in printing ink and packaging industry. It is also allowed in all cosmetics except those used around the eyes and is used in some tattoos.

Due to the vertical integration of all the business segments the company uses the CPC Blue for its own use and it to other pigment manufacturers. The end product is sold to the industrial users. As per the latest information the company is having a global market share of 14% (Q2 FY18) up from 8% (FY2016-17) and is among the top 3 global pigment players (capacity wise). The company has got presence in 70 countries and derives 75% (Q2 FY18) up from 68% (FY 2016-17) of its revenues from exports. The clients’ retention ratio of the company is good with 90% repeat clients.

Capturing the market share: Any company in any segment has to have some strategy for capturing additional market share. The winning strategies followed by the global companies in this segment include product launch, joint venture, acquisition, partnership, expansion, and investment.

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PIGMENTS MARKET: TOP WINNING STRATEGIES, 2012-2016 (%)

 

The company has decided to increase its business through a higher focus on domestic markets, focusing on untapped export markets and expanding value-added products which fall in the 46% category. Due to the increased demand, the utilization levels of the company have been increasing for the past few years. The pigments plants were running at capacity of 66% in FY17 and in Q2 FY18 the capacity levels are at 84% from 56% in Q2 FY17. Total sales of pigment for the FY17 was increased by 4543.75 lacs (9.69%) out of which exports grew by 997.94 lacs (2.87%) and domestic sales increased by 3545.79 lacs (29.40%). Last year the company’s Beta Blue plant was involved in fire and has now been revamped with full capacity in the current year.

2nd Quarter Update:

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(Note: Q2FY17 Includes Exceptional item of Rs 24 mn wrt est. loss in Beta blue plant Fire)

Agrochemical Segment:  The agrochemical business is quite an interesting one. The fact that the world population is 7.6 billion as of December 2017 (Wikipedia), will reach 8.5 billion by 2030, 9.7 billion in 2050 and 11.2 billion in 2100, according to a new UN DESA report, “World Population Prospects: The 2015 Revision” makes the case for increased future demand for agrochemicals. The biggest driver for this sector will be the limited land area getting more limited due to increasing population, driving the pressure to produce more in much less land than before. The global agrochemicals industry is expected to reach $266 billion out of which $188 billion will be for the fertilizers market, a CAGR of 4%. Similarly, the market for pesticides is expected to grow to $78 billion with CAGR of 6%.

India is the fourth largest producer of agrochemicals and growing at the rate of 10-12% will make it the 2nd or 3rd largest within few years. The growth of the Indian agrochemical segment is largely dependent on two things the monsoon and as a consequence of which farmers income. Last year was pretty good for the Indian agrochemical sector due to healthy monsoon after 2 years of drought and same is expected in 2018. As far as farmers income is considered, Niti Ayog in its report released in March 2017 ‘Doubling Farmers Income: Rationale, Strategy and Action Plan’ the government is focusing on increasing the sources of income through increase in agricultural productivity, improvement in total factor productivity, diversification towards high value crops, increase in crop intensity, improving terms of trade for farmers and shifting cultivators to non-farm and subsidiary activities. The important thing to understand here is that agrochemical business is highly dependent on monsoon. Around two-thirds of India still depends on monsoon for its irrigation needs. Last year has been good due to good monsoon after two years of drought. This in some way limits the company’s ability to expand the capacity.

Under this segment, the company manufactures insecticides, herbicides, fungicides and mixtures of insecticides, herbicides and fungicides. This is the fastest growing segment of the company with increase in revenue by 4679. 50 lacs (10.98%) in FY17 comprising domestic sales increment by 4541.80 lacs (33.75%) and export sales by 137.70 lacs (0.47%).

Q2 FY 18 Update:     

                                                                                                    Consolidated, figures in Rs mn

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Net Sales increased significantly led by robust growth in Domestic and Exports market, up 42% and 26%, respectively. The domestic market now contributes 44% to Net Sales compared to 41% in Q2FY17. Dispatch/Sales up 10% coupled with robust growth in blended realizations on account of increased sale of higher margin products. EBITDA increased 64% on account of higher realization on products; EBITDA Margin up at 20%. Utilization at 78%, Production up 43% YoY.

 

Basic Chemical Segment:

 

In this segment, the company is involved in the manufacture of Caustic Soda, Caustic Potash, Hydrogen Peroxide and CMS with the total capacity of 187,600 MTPA up to the second quarter. Out of this, the caustic soda and hydrogen peroxide capacity are to be increased by 2,50,000 MTPA and 25,000 MTPA by June’2019. The product structure of the company is as shown in the figure below:

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The company has already spent 6.5 billion rupees over the past 5 years and the company has now decided to invest 5.4 billion rupees over the next 2-3 years to expand the chemicals business which will add a total of 4 billion revenues to the company in their full year of operations. The expenditure will be done in three out of four products. Dichloro Chloromethane (CMS Project), hydrogen peroxide project and Caustic Soda. The expansion will be done through MFL (Meghmani Fertilizers Limited) in which MOL (Meghmani Organics Limited) holds through the following way:

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Out of the four CMS related to product and service both. The company manufactures the chemicals and provides CMS (Chemical Management Services). Here’s a brief about the CMS:

CMS: Every time you reduce chemical use, you reduce cost, emissions, and exposure to liabilities. Beyond the tangible benefits of reduced costs and waste, there are not-so-quantifiable benefits to well-managed chemical programs: reducing accidents; maintaining a good reputation in the community; staying clear of environmental agencies’ spotlights, etc. These are all positive aspects of sound chemical management.

Chemical management services (CMS) involve a strategic, long-term relationship in which a customer contracts with a service provider to supply and manage the customer’s chemicals and related services. Under a chemical services contract, the provider’s compensation is tied primarily to quantity and quality of services delivered, not chemical volume. Chemical services go beyond invoicing and delivering product to optimizing processes, continuously reducing chemical lifecycle costs and risk, and reducing environmental impact. These chemical services are often performed more effectively and at a lower cost than companies can do by themselves.

The chemical services model delivers results by aligning the incentives of chemical suppliers and their customers. The supplier’s profitability is independent of the volume of chemicals sold. In other words, the suppliers no longer get paid based on how well they can sell, but how well they can manage. This model changes the traditional relationship between chemical suppliers and their customers. Here’s how this shift works. In traditional supplier-customer relationships, the chemical supplier’s profitability is a function of the volume sold. The more chemicals sold, the higher the revenue for the supplier. Meanwhile, the buyer has an opposite incentive – to reduce costs or the amount of chemicals purchased. In the chemical service model, suppliers become chemical management providers and are paid for successfully delivering and managing chemicals. Thus, the supplier’s profitability is based on better performance, not on selling more chemicals (see Figure 1).

This shift is accomplished by basing supplier compensation on performance-based metrics and fees, not chemical sales. The customer gains a partner in its efforts to manage chemicals more efficiently; the supplier becomes an integral part of the business by providing a differentiated, value-added service.

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This area of management is new and not many companies are equipped to handle this. Generally, chemical service providers begin by offering a narrow range of chemical management services. That is, they don’t start out in client companies by taking over management of all chemical needs. For example, a chemical service provider might purchase and deliver chemicals, manage MSDSs, pick up waste, and provide data for some environmental reports. Later, they might expand their work scope to include such services as research for chemical substitutes and process efficiency improvements. Following is the type of CMS of services:

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The global Chlori-Alkali (Chlorine based chemicals) market is expected to grow at a CAGR of 5% and 5.5% from 2016-2022. Chlori-Alkali value chain industry includes the following activities:

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Indian Chlor-Alkali Industry (from Annual Report): According to the IMF, India’s FY18 GDP growth is projected to increase to 7.2%. Basic Chemicals – Chlor- Alkalis and PVC are basic building blocks that find application in products of everyday use, including aluminium, paper, textiles and plastic. These industries are expected to witness increase in volume consumption of chlor-alkali chemicals, which will boost the Indian chlor-alkali market in the coming years. Moreover, with growing aspirations of a rising middle class, higher disposable incomes and the current low level of penetration, demand for these products is bound to grow. There is a vast untapped market, especially in the rural areas, which will significantly drive demand. To illustrate, India has a low per capita consumption of 1.85 kg of caustic soda compared to 32 kg in the US and 12 kg in China. Similarly, the ‘Make in India’ programme of the Indian Government is expected to provide a fillip to domestic manufacturing and value addition, provided the right ecosystem is put in place to bring in investments and augment the domestic manufacturing capacity.

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                                                                                            Source: Annual Report 2016-17

On an average power cost consumption accounts for 60% of the cost of manufacturing in Caustic Production, hence almost every company in this production has a captive power plant to reduce the costs and improve the margins. Last year the company has ramped up one of its plants Dahej with the capacity of 60 tons per day. The current expansion capacity which was expected to be commissioned by march 2018 is now postponed to June’19.

The chemical segment is growing steadily with not much higher rates y-o-y.DSFDSFDSF

2nd Quarter Update:

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Long Is The New Short

On Stock Market

(source: Dilbert.com by Scott Adams)

It has always amazed me to see that how people can easily fall for the same error that they seem to correct at other times. The current writing is a consequence of an article I read recently in the last issue of DSIJ (Dalal Street Investment Journal) were in the editor-in-chief V.P. Padode said:

“Markets are poised in a such a way at this juncture that indexes may move sideways but there could be a lot of stock specific actions. We expect indexes to be in sideways trend for the coming couple of months at least while maintaining our targets for Sensex at 36000 levels by March 2018.

Giving targets works like placebo to the people to make them believe that they can measure the temperature with their tongues out even though scientifically that’s not possible. This reminded me of newspaper articles few years back making rounds at that time. I will go in ascending order year wise to make others understand how at different times widely followed and interviewed fund managers and CEO’s said and what happened in reality (or will happen). Taking a look at their predictions and analysing it will give us some answer to the predictive abilities of financial gurus even though there is none.

This news appeared in Business Standard on 5th June, 2014 (results of the general elections were declared on 16th May, 2014 in which BJP government won with wide margin) where Varun Goel, head of PMS, Karvy Stock Broking (there is something peculiar about names like these which makes us believe that the person behind the table must be knowing something, when in reality all he does is making people believe in something of which he isn’t sure of himself) predicted that Sensex could touch 100,000 by 2020. Another article on the same day in the same newspaper appeared wherein five reasons were given (I didn’t read them, not because I was overconfident that they would be worthless but because I was confident that, it just couldn’t happen)  as to why Sensex can touch 100,000 by 2020.

Here’s another one: On October 5th, 2015 an article appeared on Money Control  in which Utpal Seth, CEO of Rare Enterprises mentioned that Sensex can touch 50,000 by 2020. Many more can be mentioned but considering the effort and time, it would be a pointless exercise to mention them all.

Now let’s check what has happened since then and how much of that seemed plausible with the help of elementary mathematics in hindsight.

On the day of news article (first of the above) Sensex was at 25,019. To touch 100,000 within next five years, following needs to happen:

The market capitalization has to increase by 3.0517 times the market capitalization for the year 2015. The expert making this futile prediction also said that 3x is not very unlikely given that from 6,602.69 (2004) it reached 20,286.99 (2007) and went down to 9,647.31 (2009), then again touched 20,509.09 (2010) and reached 25,000 up until 2015.

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Market capitalization to GDP ratio is one the most tracked ratios to find out the valuation of the market. As a general rule a result of greater than 100% is said to show that the market is overvalued, while a value of around 50% is said to show undervaluation, not to mention that determining what percentage level is accurate in showing undervaluation and over valuation has been hotly debated. As per the projected valuations of 2015 the ratio came at 1.028 times of 2015 data. Below is the trend of the past:

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For those who said that its very much possible that mark of 100,000 can be achieved didn’t have a good look at this chart or they were the victim of self-denial. They didn’t understood that the economy of a country doesn’t increase at such a rate that the market would increase 3 times within five years. We can see at the past trend to see what happens when it does. Looking at the chart it becomes clear that from 2004 until late 2007 was the phase of extreme bull period buoyant by the cheer of housing prices in the USA and (in the not-so-extreme sense) 10 years was over since the the economic reforms and it started to bear fruits ten years after (yes, reforms like that takes this much time to show its signs on economy), so the bull of privatisation that was unleashed in 1991 was at its full speed after 2000 (Sensex reached 20,286.99 from 3,972.12 within a period of 7 years, 5x within 7 years). After the fall of 2009, it more than doubled the next year and for the next five year it increased by 1000 points per year.

The bottom line is that: For Sensex to reach 100,000 by 2020 it needs to grow by 25% CAGR per annum. The so called financial gurus prophecies were/are wrong for two reasons:

  1. The data they were referring to were picked at the wrong point in the history’s time line. A period when everything seemed good and nothing could go wrong (remember Reliance Power, the big one).
  2. For the financial market to grow at 25% per annum, all the other metrics of the economy (GDP growth, Credit, Savings, Per Capita Income, Employment, etc…) also has to grow around that rate to support the financial system. Because stock market is like the mirror of the economy, it depends on economy not the otherwise. Think about it, when was the last time our economy grew at that rate (China did it at that rate for at least a quarter of century and see where it is, China’s GDP for 2015 was $10.87 trillion, around 10 times of India). The answer becomes clear when we ask very plausible question, can India become a $10 trillion economy in the next five years? Is it able to grow at the rate which can justify a market capitalization of 100,000 points? The answer is no.
  3. An increase in index 3-4 times within few years (100,000/25,000=4) is exactly the thing that takes the market at the extreme end of the pendulum and it’s reversion causes people to loose their patience.
  4. An analogy: An economy is like the company and indexes (BSE/NSE) are its price. There’s a fundamental rule of investment i.e, a security cannot be worth more than the asset underlying that security, the spread between the price and value will converge over a long period. The increased indexes cannot remain sustainable if the growth rate of the economy isn’t on par with the indexes.

The problem with people is that they make analysis based on the long history of the company, forecasting it long into the future, then taking short term decisions  based on price gyrations…..As Howard Marks said “ The problem is not of informational or analytical but psychological.”

The Present:

As of today Sensex is at the peak of 31,138 and Nifty at 9,574 both of which are at their near highs. If the discussion going round the news is to be believed, both of the indexes are touching the clouds and there is a paranoia in the market that it is nearing its correction while some believe that still some gas is left to push it further near 36,000 or 38 or 40. I never understood hoe people come up with numbers like this. I mean one can only give a range of something like that but not a specific number.

Before making any assumption about the crest and trough of the market we need to understand the reasons behind it. Much of the people rely on their instinct or media clutter on which I have little faith.

In my opinion the markets are rich but not extended to such a point where a correction or crash is eminent. I can’t say where the market is headed (up/down) but, I can come up with a satisfying conclusion for no-fall-yet in market based on some some numbers:

  1. For the past few months, on an average 4000+ crores of money are flowing in SIP’s every month. That’s approximately 48,000 crores.
  2. Since EPFO was given the liberty to invest in the equity markets more than 10,000 crores have been invested by it and there is a plan to invest 18,000 in the current fiscal adding fuel to the stock market that is already on fire.
  3. Increase in NPS schemes is also adding around 2,000 crores a year.
  4. At last, the retail investor who were siding on the sidelines till now will also jump on the bandwagon to get the benefit of rising fortunes. Not to forget that more people will come to senses that stock holding is better way to stay wisely wealthy.
  5. All of the above turns out around 70,000 crores in the current fiscal. Amount of this much when poured in the markets will eventually push the markets in the north.

At the end the only thing that can increase the chances of being correct is that; no matter what or where the stock market is, the only thing that matters is that you have purchased an undervalued company at such low price that it will go up in with time. The fall in market shouldn’t be the concern of investors and when it does, only to the point that it gives us more opportunity to buy of what we already know is good at reduced prices.

Perils to Understanding

” A learned block head is a greater block head than an ignorant one” – Benjamin Franklin

These words of Ben Franklin echoes with greater force when it comes to making people understand the investing ‘process’ (emphasis is needed on the word). People are trained all through their schools that everything can be reduced to the extent that it can be applied by everyone and that’s the wrong way to think. You cannot reduce everything to some formula. I have been trying to make people understand (I gave few classes to students) that there is no standardized ‘process’ to investing. Its an art that needs perfection every time and the way to do it is to realize in the first place that there is no formula for success in investing. Then the most plausible question that they ask is “How can not understand something it you haven’t done it?” The way I explain it to them is that you don’t have to do operation in a lab to know that you cant do it. Here is a comic strip which best tells more incisively the mindset of today’s educational system be it any field:

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Prediction Begets Prediction:

Investors try to emulate the big investors of all time trying to predict or making speculations about what they are buying or selling. They try to know the exact procedure of how they go about making investment. The banality of the situation is that the very same celebrated investors in their investing carriers have denounced predictive value of such future prediction and yet people go on predicting what they are doing. Chris Davis of Davis Funds explains in this video in a very intelligible way about why the prediction business goes on and on: Davis Funds.

What people don’t get to understand is that no one can become the person that they are following. Thinking like Einstein you won’t become Einstein, you become only the best of who you are. We can read anyone’s investment philosophy about how they did this and that, but that wouldn’t be our own. The key to understanding the markets is to have your own philosophy of investment and that will come from what we have learned through our parents and teachers and what our experiences teach us about what we have been taught by our parents and teachers.  The bottom line is that there can be only one Warren Buffet, only one Howard Marks and one Peter Lynch and only one Ray Dalio and they have already walked the earth. There is not going to be another of anyone of them. Also all of them were unique in their own way. The world will continue to produce someone with great record like them but they wouldn’t be the same as these people. What we cannot do what they did nor can anyone else, on the contrary what we can do is to learn from them these great  people is how to be successful at what we do, not them and that’s what they have been teaching all their life.

Only when we understand this, that we will stop asking all the pointless questions and start discussing meaningful questions that not everyone asks every time. This will finding stocks where no valuable investment is made.

The following is a modified version of one of the best books by Peter Thiel “Zero to One” that best describes the point of this blog:

The next Warren Buffet won’t be running another Berkshire Hathaway. The next Peter Lynch won’t be picking stocks in Magellan Fund. If you are copying these guys, you aren’t learning from them.