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Overview:
Ador fontech is a
company of Ador group which was incorporated in 1980. It is a supplier of products, solutions and
services that help in conservation of resources by many manufacturing, mining
and many other industries. They sell
welding alloys , equipment and other heat and wear resistant products. Current market cap is around 142 crores. The do fabrication and repair welding jobs
which is what most manufacturing companies will resort to during bad times to
prolong the life of their assets. Most
of its revenues come from domestic with overseas contribution a very low
percentage (below 10%). Current repair welding market is around 450 crores and Ador Fontech is number two player. EWAC (L&T subsidiary) and Diffusion are the competitors. EWAC is the top player in this segment.
Financials:
Balance Sheet:
Company has very good balance sheet and it is Debt free for the past 5
years. Out of total 51cr of capital, around 14cr is spent on fixed assets
(27%), 7 cr on working capital (14%) and
around 30cr (59%) is held as investments and fixed deposits which shows that
there is very little capital requirement.
Profit and Loss: Current revenue is around
147cr. Out of the total revenue 57%
comes from selling equipment, 34% from
selling other products like electrodes, flux wires and wear parts. Remaining
9% comes from services and others. From the revenues, 40 cr is spent ton
fixed costs (26%) and 79cr (51%) goes towards variable cost. Operating income is the main income for this
company. Other income is about 1.9 cr which is around 7% of the
operating profit. There is no
significant interest payment by the company as it is debt free. The tax rate is at 33% and the depreciation is around 8%.
Cash flow: Average cash from operating
activities is around 11.5 crores. Cash flow has consistently increased over the
years. On an average around 1 cr is spent on capex and that leaves us a free
cash of around 10 .5 cr every year. Company has increased its service center capacity in Nagpur recently.
Ratios (5 Years):
Operating profit
margin and the net profit margin has been expanding over the years. Average operating margins are around 14.5%
and net margins are around 9.3%. The margins have improved due to the sales mix having more services/solutions than trading which was higher in the previous years. Return
on networth is around 33% and Return on capital (before tax) is around is
53%. Average inventory turnover is at 11.5 times and debtor turn over is
around 9 times. Asset turn over is at
7.2 times. Operating Cash flow to Net
profit ratio is at 69%. Around 70% of
the earning are retained by the company and remaining 30% are paid as
dividends. Interest coverage is not
significant for this company as it is debt free.
Growth (5 Years):
Networth growth is
33%. Revenue growth is around 16%.
Operating Profit grew by around 28% and the net profit grew by around
38%. All growth rates seems healthy. Net
profit grew more than the growth of networth which is a good sign. Sustainability of the same may be difficult.
Moat Rating: No
Moat
Brands, Licenses,
Patents - They have some industrial certifications and also partnership with repair solutions/product companies which can be considered a very fragile moat.
Switching cost - None
Network effect -
None
Cost leadership - Not sure.
Management quality/Corporate Governance:
Promoters hold
around 35% stake in the business.
Management has been pretty decent in terms of capital management. They have consistently increased dividends
which shows that they do not want to hoard capital. If we
look at last 5 years, this business had generated around 54 crores. Out of this around 14 crores was distributed
as dividends and remaining 40 crores was retained. Net profit of the company was 5.12 cr in Mar
07. The net profit was 18.36 in Mar 11. So we can assume that this additional 13.24
cr of profit was generated by this retained capital of 40 cr. This gives a RONW of around 33%. Maintaining this margin in a tough industry
shows that management has been running this company efficiently. Annual report did not suggest any evidence of
siphoning cash to the promoter entities.
Managing director's salary was around 3.8% which sounds reasonable for
the performance provided. Shareholders
communication seems to be adequate for company of its size.
Peer Comparison:
EWAC is the market leader with around 250 cr of sales and Ador does around 150 cr. Diffusion is a smaller player with around 60 cr of sales. This is a small market with 3 organized players. Market is not very big for bigger players to enter. If the market size gets larger more players could enter. EWAC and Diffusion are private players so number are not available for comparison
Positives:
Low working capital
and fixed asset needs which would mean that low reinvestment requirement to
fuel growth
Fixed Costs are
lower than flexible costs
Good use of
incremental capital investment to generate superior returns
Repairs and
fabrication demand should be better during slowdown and high interest rate
scenario as companies would try to stretch the life of their asset which augurs
well for Ador fontech.
Promoter has been increasing their stake in the recent years which shows confidence in business.
Niche market with strong client relationships and partnerships with solutions providers for high end welding which has better margins.
Risks:
Business risks: Raw
material price increase and their inability to pass on the cost to customer is
one significant risk. Capex cycles are
cyclical and that could impact the revenue of the company.
Forex Risk : Company
imports leaves are around 25% and exports are below 10% and provides some natural
hedge to their imports. Rupee depreciated could increase the cost of good and impact margins.
Unfair
Competition: Ador fontech is engaged in
repair solutions and this is different than just selling products. This is a small market with few organized players. Low end welding is commoditised but high end welding requires skills and knowledge and quality which has better margins.
Management
Risk: Management has been doing a good
job so far with the capital. They have
been shareholder friendly in paying back the shareholders. Management could invest capital into
unprofitable/mediocre investments which may bring down ROCE and RONW. Management has been slow in sales growth and this could lead to revenue stagnation faster than expected.
Valuation:
Company is available
at EV/EBIT of 5.38 times and
EV/Operating Cash flow of 8.14
times. If we compare this to a bond we
get a earning yield (EBIT/EV) of 18.58%
compared to 8.5% for GOI bond.
Current dividend yield is around 3.1%.
So either the market is considering this profitability to be
unsustainable or the discount could be
because of this being a small cap. Given
that the average PBIT for the past 5 years is around 16.6 cr the earning power value (EPV) for this stock with
zero growth is Rs 138 cr (16.6/12%) if we consider the cost of capital of 12% for this company. This business
is available at 140cr which is fair value for the stock. Ador being a small cap company and infrastructure companies that it services would only grow, it has very high probability for growth.
Decision:
Ador fontech seems to be a well run company
with good balance sheet and satisfactory returns on capital invested. This being a
small cap company, it does not get the attention that is generally given
to the medium and large caps. Business
does not have any moat at all and the margins could be under pressure during
bad times. Given the business
performance in the last 5 years a, Ador Fontech looks fairly priced at current price of 80.55. Long term investors can invest in this stock at this price looking to add more if the price falls as it would only increase its margin of safety and make it more attractive