NSE:
ENGINERSIN; BSE: 532178; ISIN: INE510A01028
November 19, 2011. Current Market Price:
Rs. 229. Sensex 16372. Nifty 4906.
52 Week High/Low: 352 / 215
Buy for duration of at
least 3 to 5 years.
Investment Summary: A business serving one of the
fundamental aspect of human civilization i.e. Energy.
In the
Berkshire Chairman’s letter to Shareholders, 2007, Warren Buffett writes:
“Charlie and I look for companies that have a) a business we understand; b)
favorable long-term economics; c) able and trustworthy management; and d) a
sensible price tag”.
Analysis of EIL
with respect to the above four filters:
a) Simple
Business to understand:
EIL
is a Public Sector Unit. It has two business lines – provide consultancy
services and execute Engineering, Procurement and Construction (EPC) contracts.
Consultancy
business is a high margin business (Net profit margin of 35% to 40%) and
requires negligible capital expenditure. This business contributes approximately
30% to 35% to revenues.
Majority
of EIL’s EPC contracts are on an Open Book Estimate (OBE) basis i.e. contracts
are open ended for design changes and changes in raw material costs are
directly passed-through to the customer. Hence this too is a safe business
model and requires minimal capital expenditure. It also protects EIL from
escalating raw material costs. Profit margin is 10% to 12% and contributes
approximately 65% to 70% to revenues. Since there is minimal capital
expenditure, this business too earns high Return on Capital Employed (ROCE).
Excluding
Investments, Cash and Fixed Deposits, EIL has a negative working capital.
It
is a zero debt company and as on Sep 2011, has net cash of around Rs. 1625 Cr.
Moat (Moat means a
competitive advantage over present and future competition):
EIL
operates in the Energy and Infrastructure sectors i.e. Petroleum Refining,
Petrochemical plants, Offshore as well as Onshore Oil and Gas exploration, Oil
and Gas pipelines, Mining and Metal, Strategic Crude Oil Storage, Ports and Terminals
etc.
EIL
has worked on over 50 refinery projects in India. It has worked on 9 grass root
refinery projects from concept to commissioning. It has been involved in the
establishment of 7 out of the 8 mega petrochemical complexes in India. It has
worked on 205 offshore platforms, 35 oil and gas processing projects, 37
pipeline projects and 26 mining and metal projects. EIL has thus accumulated a
vast database of knowledge through is operations since 1965. It is not easy for
a big business house with deep pockets to get access to this knowledge
database. Thus, there are sufficient barriers
to entry.
Also,
having worked on the majority of the refineries and petrochemical plants may
provide some sort of stickiness from customers for new as well as maintenance
and expansion of existing plants. I believe this provides EIL with sufficient pricing power.
b)
Long Term Economics:
Energy
is one of the fundamental requirements to sustain human civilization. I believe
that five to ten years from now, Indians would be using a lot of petrol, diesel
and gas than at present. This would require setting up of new refineries and
pipelines as well as expanding the existing ones.
Plastic
is one of the major end products of petrochemical plants. Each passing day, we
are using more and more plastic which makes me believe that the per capita
consumption of plastic is going to increase a lot in the years ahead.
All
this shall ensure that there is a steady demand for the services of EIL.
Thus,
this is a business earning high ROCE and RONW (Return on Net Worth) and
requires minimal capital to keep growing.
c)
Able and Trustworthy Management:
EIL
employs some of the brightest minds of India and has one of the lowest
attrition rates for a service industry i.e. less than two percent. Being
majority owned by Government (80.40%) and there being no stock option plans,
there is no incentive for the management to jack up the stock price through
fraudulent means.
Management
is planning to diversify into energy related sectors like Nuclear, Solar, City
Gas Distribution, Water and Waste Management and Fertilizer. While this may
sound risky, EIL has a history of successfully diversifying into Mining and Non-Ferrous
Metallurgy in 1973 and into infrastructure sectors in 2001.
d) A Sensible Price Tag:
Excluding
interest income and income from investments, Adjusted Profit after Tax (APAT) for the year ending Mar '11 is Rs. 442 Cr.
Average APAT from Mar ’09 to Mar ’11 is Rs. 341 Cr.
At the current market price of Rs. 229, market capitalization is Rs. 7726 Cr. Net Cash
is Rs. 1625 Cr. Therefore, Enterprise Value (EV) of the business is Rs. 6100 Cr.
1.
Using the average APAT from Mar ’09 to Mar ’11 of Rs. 341 Cr, market expects EIL’s APAT to grow
perpetually at 4.40%.
2.
Using the Mar ’11 APAT of Rs. 442 Cr, market expects EIL’s APAT to grow
perpetually at 2.80%.
Compare this with the actual top line CAGR from Mar ’07 to Mar ’11 of 49%; Operating profit CAGR from Mar ’07 to Mar ’11 of 47%; PAT CAGR from Mar ’07 to Mar ’11 of 38%.
Note: I own shares of EIL.
My average purchase price is Rs. 248.
Over long periods, stock
price follow the performance of the business.
Divide
the amount you want to invest in EIL into at least five parts. Invest the first part and
if the price goes down, buy more and so on…
Expect average annual return of
15% to 20% over 3 to 5 years.
The
following table indicates the compounded value of 100,000 at 5%, 10%, 15% and
20% for 10, 20 and 30 years. It must be noted that how relatively small
differences in rates add up to very significant sums over a period of years:
|
5%
|
10%
|
15%
|
20%
|
10 years
|
162,889
|
259,374
|
404,556
|
619,174
|
20 years
|
265,330
|
672,750
|
1,636,654
|
3,833,760
|
30 years
|
432,194
|
1,744,940
|
6,621,177
|
23,737,631
|
Priyank J. Sanghavi
+91 96381 04733
