Grauer and Weil: Are the Risks worth the optionality of future growth?

This post is not buy/sell/hold advice. Please see the disclaimer at the end before reading further

  • Grauer and Weil is one of India’s largest companies in the Electroplating and Coatings chemicals business.
  • It is a diversified conglomerate of both commodity and speciality chemicals, with interests in paints and real estate.
  • The diversified businesses may be holding down growth in the core chemicals business
  • Management decisions need to be closely monitored

A 2012 McKinsey survey pegs the potential size of the Paints and Coatings chemicals opportunity in India at 16.5 billion, the largest bucket of opportunity size amongst speciality chemicals.

In 2011 Grauer and Weil had 40% of the market share in the coatings and electroplating chemicals space making it a compelling bet to capture this huge opportunity.

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Source: McKinsey, Winning in India, the Speciality Chemicals Opportunity, 2012

The stock price had reached triple digits until it went for a 10:1 split in 2011.

As of today the stock still trades in double digits. So what is ailing the promise?

In 2012, the company EPS fell by 80%.

2017-06-04_5-44-53.jpg
EPS drops from 6 to 1

This precipitious drop in EPS happened as the company began to address the huge interest on loans taken for all the Capex done in previous years. The chickens had come home to roost.

2017-06-04_5-58-22

The stock price followed this huge fall in EPS by falling into the orbit of low double digits.

2011 was not a good year for the company that had been growing on the cusp of promise. The company announced a merger with Bombay Paints, a subsidiary in what was a very unfavorable swap ratio for minority investors – raising further doubts on management’s decision making ability.

Together with the drop in EPS and high Debt to Equity ratio, this lack of transparency in the merger made Grauer and Weil fall into disfavor with the market inspite of steadily increasing intrinsic value and management ratios in the subsequent years from 2012 to 2016.

Fundamentals of the company have improved. The paying off of the loans borrowed to fund capex has helped de-lever the company’s balance sheet with the Debt to Equity ratio dropping from 1 to a mere 0.1 in March 2016 — making the company virtually debt free.

This lightening of the balance sheet has led to a steady corresponding increase in EPS. In fact, from March 2012 to March 2017, the company EPS has grown at a 22% CAGR.

  • An EPS CAGR growth of 22% puts the PEG ratio at < 1 (Assuming a PE TTM of 19) making the stock undervalued
  • In March 2016, the company posted the highest ever Free Cash Flow of 7 crore last year. More encouragingly, the Operating Cash Flows have constantly been above the Net Profits.

So has Grauer & Weil, or Growel as the conglomerate calls itself, finally become a compelling bet?

Risks and Downsides

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Q4 2017 Segmented Results

As you can see from the latest segmented results above the merged Bombay Paints business remains EPS dis-accretive.

  • Bombay Paints is extremely Capital Intensive compared to G&W’s traditional Chemicals business which produced 20x the impact EPS with roughly the same levels of Capital Employed in Q4 2017.
  • The Engineering business, although slightly more profitable than Paints, remains a drag on the EPS as well.
  • The company’s mall / real estate business is also not doing very well and employs a huge amount of capital.

From the above we may conclude that the company’s profitable Chemicals business is being held down by the capital intensive and inefficient adjacent (Engineering, Paints) and unrelated businesses (Malls, Real Estate).

The company has sold some land that it owned in Mumbai over previous quarters as can be seen in the reducing fixed asset numbers on the balance sheet.

But it may need to do much more. Perhaps a Sintex or Pokarna like demerger of its non-core business could unlock significant value but the Management’s past track record of supporting diversification over minority shareholder interest does not support the possibility of such de-mergers coming to pass.

Additionally we must consider the possibility of further Capex to fund future growth of the company. The company is already operating at historical high asset and fixed asset turnover ratios. So we may be buying the top of its business cycle – which means the EPS growth will only go downhill from here.

The chemicals business is capital intensive and more Capex will take the EPS in single digits down futher into decimal points.

Even assuming no further capex, with 23% CAGR growth, the current EPS of 2 Rupees a share will take 10 years to reach a respectable 16 Rupees a share.

Well that’s smallcaps for you. It all does boil down to quality of the management and its decisions.

DISCLAIMER:

This post is not BUY/SELL/HOLD advice but a statement of my personal analysis and opinion. I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”. No BUY/SELL/HOLD advice is offered on this blog, in any form whatsoever. Views expressed are my own and not of my employer. Stock Markets are very risky and can cause a permanent loss of capital. You should seek professional advice.

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