Thursday, May 29, 2008

Tale of a Textile Machinery Company

I will talk about Lakshmi Machine Works. The company had a lifetime high of 12350 (617.5 at today's price) in 1996. The company's price went down all the way to 525 (52.5 at today's price) which is an erosion of 91.5% from top. Then started a big rally and the stock touched a new lifetime high of 4250 in December 2006. The stock is langushing at around 1500 today a correction of 65% from top. Reliance Long Term equity fund bought the stock at 2925 in September 2007 and ICICI Prudential Life Insurance at 2045 in January 2008. Reliance has lost 50% of 66 crore and ICICI has lost 25% of 18.7 crore that it has invested. Now why has this happened? Let's see the profits of this company over the last years:

YearNet Profit

Anybody who has the record only till 1999 will feel that the company has shown degrowth in profits only in 1 year. But if you have a good record till 1990s, you can see that the average profits of the company has grown by just {(242.3013+206.198+148.07)/(42.96+23.78+25.9)}^0.1 = 20.47%. When Reliance bought the stock it was at a P/E of 20 and when ICICI bought it, it was at a P/E of 10. Now the stock is trading at a P/E of just 7. The company earns around INR 200 and pays INR 40 as dividend. The yield turns out to be 2.66%. Why so much under valuation?

Graham has put a lot of emphasis on earnings stability. If you see, the company's earnings went down from 43.31 in 1995 to 8.41 in 1999 which is an erosion of 80% of profits. So if the same situation arises again, the company will earn just 49 Cr and P/E will expand to 35 at current prices. Is this warranted? 1999 was an exceptional year preceded by Asian Financial Crisis in 1997 and the textile exports had gone down and the Indian economy was in doldrums. I don't know if the same will happen again. The rupee appreciation has already cost several lakh jobs in south India and a company with an order book of more than 5000 crore now has got cancellation for many orders. Just like how it has happened for airline companies after crude price rise. Let's see ahead what happens.
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