For this part let us assume that the date today is 30th July, 2014.
Screening: While going through results of companies the name of Aegis Logistics Ltd pops-up, the sales of the company have grown by 26% to 5000 crore, while the operating profits have turned positive after two years, (-4,-100 to 108 crore), so we think of further investigating the company.
The company is mainly in the business of providing storage facilities for Liquids (Oil Linked) and Gases (LPG, Propane) (Terminalling) at various ports in India. The main customers and suppliers of the company are large oil and gas companies. (India is a large importer of both oil and natural gas). However from the past three years the company has ventured into gas sourcing for customers (Sourcing LPG for a fee) and gas retailing (Cylinders-40 distributors and gas stations-100-Currently focused on three states in the west) business.
Let’s understand the business from the financial viewpoint.
At the first glance the income statement looks like a typical Oil marketing company with raw material cost as high as in 90’s while the operating margins are eager 1-2%. This is true as the company is investing in building gas station, cylinder network and the company is even sourcing LPG for large clients.
There is change in Margin profile of the company since 2011. Particularly more than 6 times jump in revenue. Both Signify that and further the annual report confirms that the company entered into Natural gas sourcing business for clients and self from 2011. The nature of raw material cost is volatile, as the company is dependent on LPG.
Let’s look at the Balance sheet to further know about the business.
Major Investments of the Balance sheet is in fixed Assets (Terminalling business) and while extremely tight cash conversion cycle typically shows the trading nature of the firm in the gas business.
The Return profiles of both the businesses are slightly different. Lets look them up in detail.
Lets look deeply at both businesses. If we look at 2010 and before numbers clearly the storage business seems to be high return generating stable kind of business. Even in 2014 more than 80% of the EBITDA comes from high return generating terminal business, which seems to have small sales of around 400 crores.
While the gas sourcing and distribution business of the company seems to be volatile and dependent on gas/oil prices (Both sales numbers and gas prices confirm the same). It has wafer thin margins but the tight cash conversion cycle supports the same.
It seems some numbers before 2011 will not be that relevant for comparison.
In order to gain more understanding let’s take an industry view. The oil and gas industry comprises mainly of three major components: Upstream, mid-stream and downstream. The upstream segment comprises Exploration and Production (E&P) activities, the midstream segment is involved in storage and transportation of crude oil and gas, and the downstream segment is engaged in refining, production of petroleum products, and processing, storage, marketing, and transportation of the commodities such as crude oil, petroleum products, and gas. The company is involved in both midstream and downstream. (Source 2014 Annual Report)
Terminalling/Storage: High amount of capex over the past 4 years particularly in storage capacity, point toward growing stage of Terminalling industry in India. The customers of the company in this business are Big oil companies like HPCL, BPCL, etc. Not much information could be found regarding the competitors of the company in the storage business.
LPG: In case of Auto LPG retailing business, currently the company is in expansion phase in the same and it is tough to compete from established players like HPCL or BPCL or Indian Oil. However, currently the company is limited geographically to three states and is slowly expanding the network. Currently the industry is in its growth phase.
Lets try to use the Michael porter’s framework for seeing the industry:
1) Threat from New entrants – It does not seem to be as high the technology business while not as low as certain sectors like Paints.
2) Bargaining power from Suppliers – It seems the bargaining power is not that high considering less than one month creditors cycle.
3) Bargaining power of customers – It seems low in terms of tight terms of tight payment cycle. However, it seems the company cannot pass on price and volume both.
4) Threat of Substitute – It is not as low as consumer sector, neither as high as technology sector. Other types of fuel may replace LPG.
5) Existing rivalry among players – Considering the early stages of growth of industry (Public to private) , this does not seem to be intense- seen from LPG business point of view.
6) Threat of Regulation: Regulation largely governs this sector, however slowly the government is moving towards deregulation.
In terms of competitive advantage the terminalling business margins profile and ROCE point towards the presence of same. Its seems having storage terminals at the ports and managing hazardous chemicals, the company seems to have a geographic advantage. Particularly, in terms of hazardous chemicals or oil or LPG, from the point of view of customer the cost of storage is less while the risk of wrong storage is very high, hence it seems reluctance to shift as per price.
In terms of LPG business nothing can be said regarding the competitive advantage, be it trading for a fee or retailing LPG business. The revenues of the business are more than 80% while the EBITDA contribution is less than 7-8%. There seems to be no sign of an advantage. There is very tough competition from PSU players in the same regard. However, nothing concrete has been found regarding or against the same.
Overall currently, the business is in investing stage in terms of LPG supply. Nothing much can be said regarding the competitive ability in terms of LPG business.
This is in no way to undermine the hardwork put in by promoters. It is just a basic part of the process. As of now, There are no signs of fraud or some huge issue with the management of the company.
Overall, high sales growth rates of the company and the focus of the government towards large scale deregulation of the sector point towards growth phase of the LPG sector overall. Currently, the penetration of LPG in poor section of the households in India is lower. Over time it is expected to grow.
Company’s Growth Strategy: Clearly the rising capex towards building new terminals at ports (fixed assets doubling almost every four years) and further confirmation in the annual report signify further chances of growth of the company.
Majority of the growth is internally funded with moderate amounts of Capex, as the nature of the Terminalling business is not that capital intensive.
Not much can be said regarding the LPG business, as it is at a rapid expansion phase and we are not sure regarding the competitive advantage of the same.
The execution skills of the management seem decent. Considering majority of the projects proposed over the long term are executed.
The capital allocation skills of the management seem decent, considering the company despised off a non performing business in 2007 without incurring major losses. Even the equity dilution plan of the company in 2010 is neither too good or too bad.
Overall the management, capital allocation skills are neither too good or bad. No evidence against/for management integrity has been found till now.
We did valuation using very rudimentary methods. Any valuation model just puts out the opinion of the valuer. You may have a different opinion
Mainly a sum of parts kind of valuation method is applied. The valuation of Stable, cash flow generating and growing Terminalling Liquid Business seems comparatively easy vs valuation of LPG business, which is currently in expansion phase and is too uncertain.
Liquid Terminalling Business:
Sales Growth: Assumption taken of growth rates of 8.5% which is less than half of previous 10 year growth rate. This results in total sales of 280 crores which is still not overly high or presumptous if we compare on the basis of Price to Sales multiple.
EBIT Margin : Around 40% considering maintenance Capex to be covered by the company.
P/e Multiple : It is slightly better than a non- growing 10 year government bond @ 8.5%. Giving it a multiple of 14, considering a host of factors.
This exercise results in the value of the company to be around 730 crores. Once we reduce debt from it the value comes to be around 500 crores.
In order to estimate the Gas Business (Both Terminalling and Distribution), we subtract the current market cap of 1100 crores from 500 crores resulting in the value of around 600 crores. If we think in terms of book value it is valued at around 2 times book value, considering the gas terminating assets and geographic distribution (100 stations) we don’t think it is cheap. Mr. Market seems to be pricing in some growth considering the small scale of the company in the industry.
The overall valuation of the company may fluctuate from 700 to 1400 crore depending on the growth in the Liquid Terminal Business.
Currently, we think the market is fairly valuing the company it is neither cheap not overly expensive.
You may have a different opinion and we would love to know why you think so.
We think main risk remains:
1. Competition intensity in the gas business
2. Fragility from customer concentration in the Terminalling business and gas sourcing business
3. Government policy
The current market price of the company is around 35 (Market capitalisation) while the P/E is around 14. The 10 year bond yield is around 8.5%.
At this price we’ll make an allocation of around 2-3% of our portfolio. This may change with time. Currently, as we are not that confidence in the cheapness and stability of our estimates, hence allocation won’t be large. You may have a different opinion and we would love to know why?
The key variables that we’ll track in the firm are:
1) Marginal ROCE
2) Sales growth – Mainly of Oil Terminalling Business (Yearly)
3) Gas business margins and volumes
Review: We will review it almost every year, keeping in mind the 3-4 year view perspective.
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 or 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.
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, from 2014 in part 2. (Please click on 2 on the bottom of the page)