Wednesday, May 26, 2010

Asian Electronics and Ben Graham's principles of investing

Asian Electronics is not my ideal value stock. The company has earned net profits of 71 lacs, 52 lacs and 14 lacs in the last 3 quarters. To its credit, the company has over 220 crores of annual sales but seems to be in dire straits at a CMP of 25.30 rupees. This wasnt the case always; in early 2008, the share price of Asian Electronics was a respectable 515 rupees per share but has faced investor apathy since then.

Is there any value?

While the DCF model will not work any magic here, the NCAV is a different story. One of Ben Graham's potent evaluation tools - the NCAV, throws some interesting numbers when I see the company's Mar-09 numbers.
Net Current Assets = Rs. 355.2 crs
Total debt = Rs. 238.8 crs
Shares outstanding = 2.98 crs
Hence, NCAV (net of all debt) per share = Rs. 39.06

At CMP of 25.30, Asian Electronics is valued at 64% of it's NCA (net of debt) per share.

This corresponds to one of Ben Graham's strict criteria - CMP at 66% of it's NCAV per share. Graham's reasoning was very simple - assuming there is no drastic reduction in the quality of the firm's current assets, there are high chances of getting a sumptuous deal when the firm goes into liquidation. This is a classical situation where the company is better dead than alive.

The NCAV is conservative in approach (which is good). It assumes that the firm will potentially get nothing for it's plant and machinery and investments - not even the salvage value. Asian Electronics seems Grahamian in this respect.

Discount-to-NCAV stocks are normally the ones that have been out of favour with most retailer investors and traders. They are the ones bordering around the no-profit-no-loss mark, have been big previously but have not been able to change to the times. Finding such stocks is not easy but not difficult aswell. Over the last 5 years, I have invested in 9-10 such companies but have had mixed success. I would advice the use the NCAV strategy with caution. Remember, the greater-fool theory is not at work when you are value investing.


Siddharth said...

Hi Shankar,
Good to see you back,hope you blog more often. Nice find,there is a lack of blogs focusing on cigar butts in indian markets unlike the us. Regarding Asian Electronics i would like to point out that it is a little riskier than it appears due to the huge debt load. In an event where the net current assets(NCA) falls by about 50% you are left with a liability rather than an asset. Whereas a same situation with a company having NCAV of x Crs but 0 debt would still leave you with x/2 Crs as assets(Eg. Medi-Caps). Also if you look at it more conservatively by discounting the inventory by 50% & A/c receivables by 25%, it no longer qualifies by Ben graham's criteria.

Shankar Nath said...

Hi Siddharth,

I couldnt agree more. Medi-Caps is one company where I made money and then lost money - hence my distrust on any valuating any company that doesnt provide a positive earning.

You are right on defining %age to asset quality. Cash will be 100%, so can be marketable securities minus transaction costs. I would like to peg receivables at 50% because during liquidation these items are on a fire-sale. One additional item we didn't mention is off-balance sheet liabilities e.g. a pending litigation which can cost the company millions.

Yes, the debt load is high. I prefer to see it more from a debt-servicing perspective rather than a D/E view E.g. if Company X has Debt of Rs. 100 but has an Op profit of Rs. 50, then I'm happy exploring further although the equity might just be Rs. 10.

These stocks can get really speculative at times. Another example is ECE Industries - this stock is up 27% today and it's Mar-10 qtr profit is negative 4.53 crores. However, the balance sheet is a different story and the CMP is below the NCAV.
NCA = 104.4 crs
Debt = 23.1 crs
O/s shares = 0.43 crs
Net-NCAV = 189 per share
CMP (incl the 27% jump) = Rs. 133
CMP to NCAV = 69%

If we use our new formula : Cash at 100%; Inventory, Receivables at 50% ... then Net-NCAV changes to Rs. 147 per share and the CMP-to-NCAV changes from 69% to 89%

Still curious why ECE dipped 23% yesterday and jumped 27% today !


PS: Enjoyed your blog on Tata Motors and Pantaloons with differential voting rights.

Siddharth said...

Hi Shankar,

Thanks a lot for the nice words on my post. Yeah NCAV are very tricky and though i want to explore more,not finding too many in the current market, i was lucky to make money in Medi-Caps & exit. Regarding ECE, Moneycontrol shows Mcap as 115Crs so how is it a Net-Net with NCAV of 104Crs(i guess there has been a rights issue)?? I really feel inventory & receivables need to be discounted to be on the safer side. Looking forward to more stock ideas & posts from your side.


Shankar Nath said...

Hi Siddharth,

Rights Issue at 1:1 record date is tomorrow (May 28).

The issue is being offered at 100 rupees to existing shareholders.

So why would the shares go up and down 25% in 2 days? Is there a pattern?


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