This part will be divided into two parts:
Let’s assume that the date today is September 24, 2012. We plan to review our earlier research done on Bhushan Steel Limited.
The growth in sales of the company over the past two years is around 77%. While Steel prices have grown by 34%, the rest of the growth has come from Capex of Orissa coming live. Still the company is expanding hot rolled steel production in Orissa, which will be live by the next year.
In terms of ROCE, the performance of the company is decent (Considering its expanding), however the Return on Equity is falling. The main reason for the same is that the cost of raising debt for the company has risen. As can be confirmed in the income statement, that the interest cost has risen by 5 times, while the Borrowings have increased by 2 times. The 10 year government yield has risen from 7.7% in 2010 to 8.5% 2012, thereby making debt expensive. Considering, the company has leverage of 3 times, this can be very risky.
Foreign Currency Exposure: More than 50% of the o/s borrowings are in foreign currency, while just 10-20% of the revenues are in foreign currency. These are alarming signs unless the management does something to pay down debt.
Equity Dilution Unfavourable to Minority: The management has dilute equity by issuing preference shares @ Rs 100 while the Market price is in the range of 400. While this point may be ignored in overall picture, it is not a healthy sign.
While the earnings of the company have increased by 20% over the past two years, the price has increased by 60%, thereby increasing the PE from 8 to 10 levels. In terms of book value , it has increased by 86% while the price by 60% thereby resulting in small contraction, though still at 1.46 levels. It seems Mr. Market is not pricing the marginal assets high.
We believe that the company’s business model is very risky, considering the large amount leverage, commodity industry, foreign currency debt, poor minority shareholding practice and the management is showing no signs of change (Particularly the capital allocation aspects). In fact, from the past two years the business model seems to have deteriorated in terms of leverage.
We will not take any position. You may have a different viewpoint and we would love to know why.
Lets us assume that the date today is 30th August, 2013 and we plan to review our analysis of Bhushan Steel Ltd.
The sales growth of the company has been around 7% while the steel prices have also remained in the range of -2%. Still the company continued with its model of raising more debt and expanding. However, now it seems the cost of debt is increasing faster than the profits thereby resulting in fall of ROE’s from 14% to 10% levels.
Management issues Continue (Confirming Evidence)
1. Orissa plant explosion- This was the third time in 14 years that the new plant of the company resulted in an explosion as a result CEO was arrested. This may be ignored but the recurring nature of the problem does not justify the attitude of the management.
2. Funding Preference Shares: The management continued its practice of diluting equity of current shareholders and issuing preference shares @ Rs 100, while a recent right issue in the market was made for Rs 333. Current price in the market is ranging in the range of Rs 400.
3. Accounting Issues: This point was missed by us earlier. The auditor report is clearly mentioning unaudited accounts of foreign subsidiaries since 2007-2008. Now even another, Indian subsidiary was unaudited. The scale of the foreign subsidiary operations requires an audit considering best corporate governance practices.
The earnings of the company have degrown by -10% while the price has almost remain similar thereby increasing the PE levels from 10 to 12. While the book value has grown mainly due to additional funding, the PB ratio has fallen to 1 levels from 1.7.
Mr. Market is not valuing the marginal expansion of the company.
We will still not invest anything in the company. Main reasons remain very risky business model (too high debt in a commoditised industry) , corporate governance issues.
You may have a different opinion and we would love to know why?
The purpose of these case studies is to practice such cases and help all of us develop patterns to take similar decisions in future and avoid mistakes of both omission/comission. Its like practice before the main match. We may have made some mistakes, please tell us. You may not agree with us. However, we would love to know why you think so or what you may have done differently? So that we may all learn together.
You may visit screener.in and in.tradingview.com for prices. These resources are really helpful.
Before Going further it would be better if you Analyse the case or do the valuation or allocation according to your own Method. That way it may help you to do better with the case further and sharpen your mind for future.
Pick Parts of the case study and use it as it may be helpful to you.
May we all learn and progress together.
We will cover the next phase, 2014 in part 3. (Please click on 3 on the bottom of the page)