Patels Airtemp

09May10

Company:

Patels Airtemp was established in the year 1973 and they are into the Refrigeration and Air conditioning business, mostly for industrial clients, and have the following product verticals.

-> Heat Exchangers

-> Air cooled heat exchangers

-> Columns and pressure vessels

-> Refrigeration and Air conditioning equipment

-> High Voltage Air Conditioning projects (Turnkey)

It is not easy to envision these products since they seems to be specialized engineering products. However one can get an idea that these products are used extensively in almost all engineering sectors like Power projects, Refineries, Fertilizers, Cements, Petrochemicals, Pharmaceuticals, Textile, Chemical,  Engineering etc. Unfortunately their annual reports are not available online but could access certain parts from http://www.reportjunction.com.

The good thing is they have been in this business for 30 years and have specialized further in this business rather than trying to diversify beyond their core competence.

One can get a better idea from their website which is very good for a company of its size.

Link1, Link2, Link3

Their products have been approved by NTPC, L&T, BHEL, ONGC etc which is a good sign. Link3 above talks about the various projects they have taken.

Financial performance:

The following is a snapshot of the company’s performance over the last 10 years:

The company’s sales have grown slowly till 2004 and then has taken of on a growth path.It has grown at CAGR 35% over last 5 years compared to the 15% in the long term including the no growth period of 1999-2004. It can be seen that the company has shown super normal profits in recent years which can be seen from the RONW and ROA figures. These are not sustainable.

An analysis of their ROE break-up shows the following trend:

ROE analysis:

Please note that average assets and average equity have been considered above rather than the year end figures. Other Income has not been considered at all in the above analysis.

The ROE has been increasing steadily in last 5 years (10 year average ROE is 18%) because of the following factors as seen above in order of importance:

-> Increasing Asset turnover. It has increased from 0.8 to 2 in recent years.

-> Increasing EBIT margins

->Reduced interest burden due to low debt

-> Reduced leverage

Their tax burden though has shown a weird trend which increases the risk profile of this company.

Recent Performance:

Theyhave been winning many orders of late.

http://www.reuters.com/finance/stocks/keyDevelopments?rpc=66&symbol=PAAI.BO&timestamp=20100414084900

Competition:

The company operates in an area which has significant unorganized competition in India. There is no reason why they have been able to increase ROE and this is not sustainable. They should actually be investing now in building capacity which would increase their asset base and hence bring down ROA. I guess it is difficult to maintain higher asset turnover in manufacturing. The company may have relationships and would be growing in the right way but I do not see the industry to have any high moat.Neither is there a significant entry barrier nor is there any switching cost. This is just a case of a company which has been growing steadily but seems significantly undervalued. Bluestar is a comparable listed entity though it has significant brand power and has a significant B2C business.

Management quality:

The promoters seem to be smart and have been buying shares when undervalued and selling when overvalued. Their stake is around 37% which reduced to 34% during 2008 and has again increased to 37% now. They have been giving earning guidance in their annual report which they have met every year. They have been candid in admitting why certain years their profits were low (Gujarat earthquake was one, High interest rate to temporary high periods of debt was another). All in all I am kind of comfortable with the management.

Valuation:

The company does seem undervalued significantly based on even conservative measures.

Market Cap: 45 crores

Sales: 68 crores

Profits: 7 crores

Last 3 year average profits: 5 crores

P/E: 6.xx

TTM P/E: 5.58

Increase in Net Block for a sales increase from 15 to 68 crores: Almost nothing 0.3 crores

Increase in Netblock for a sales increase from 12 crores in 1996 to 68 crores in 2009: ~1 crore

Increase in Working Capital Investment for sales increase from 15 to 68 crores: 9 crores

It seems that the business can run on very less capital. They have not diluted equity in the last 15 years nor have the run on high debt. Their average 10 year debt equity ratio has been 0.7 with latest being 0.29. They have been repaying back debt with the FCF generated. However as highlighted before they must be investing in enhancing their capacity to maintain their growth. This would reduce the asset turnover and hence ROA.

The company is available at an attractive market cap of 45 crores. My estimate of DCF analysis based on very conservative assumptions of 15% growth for next 8 years against the 35% they have seen and EBIT margins of 11% (10 year average) against the 15-17% they have seen recently and a Terminal Value EBIT(1-Taxrate) multiple of 8 times (not on PAT but on EBIT(1-taxrate)) gives the intrinsic value at 80-90 crores. It appears the firm is available at a discount of 40-50%.

The key reason why the valuation is 80-90 crores and not lesser is because of the FCF generating ability of the business. They have given dividend consistently and returned cash to shareholders.

Concerns: Wavering tax %age is a cause of concern. Annual reports must have been on the site. Anything can go wrong with small firms. They definitely cannot maintain high ROE nor has that been built into the valuations. The valuations focus on the average ROE and average growth rate over a significant time period. However I do believe that at the present valuation, the downsides are kind of limited. This is not a great business to be in and hence is not necessarily a long term holding. I want to read an entire annual report and may take further call based on that. Otherwise would sell it once it reaches its intrinsic value.



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4 Responses to “Patels Airtemp”

  1. Hi,

    Yes, it seems to be a decent small cap company with decent financials. What I would like to understand here is: Is the business scalable??

    For a small cap, I would like to see the company grow at atleast 25% YOY.

    Regards,
    Ayush

  2. Hi Ayush,

    Thanks for commenting!

    This may not become a multibagger since its a B2B business and project oriented and hence not as easily scalable. It is not similar to a retail play or telecom play wherein one just employs the same one city roadmap across the country. Hence I agree to your point. But I do believe it is scalable to the level of 150-200 crores topline if they continue doing the same things at a larger scale.

    The idea behind the investment is as follows:

    1. The company has performed very well in last 4-5 years with 35% CAGR and improving margins. But the market is valuing it at a 50% of “CAGR of 15% sales and depressed margins” in future. At present valuations, I think the downsides are limited for this business. They have also been winning orders consistently and definitely have execution capability.

    2. In B2B, usually the shift in project size happens gradually since past experience in executing larger projects is shown as the basis for winning larger new projects. In that aspect, The company has been winning projects which are larger and larger in size compared to the past which is the right direction in which a B2B business must move. If the company is able to maintain this momentum it must result in a PE re rating hopefully in 2-3 years.

    I may be wrong in my analysis. Lets see what the future has to tell.

  3. Hi Pradeep,
    Wonderful analysis, had heard about this company but didn’t really dig deeper but finally glad that you have analysed it here. My only concern is with applying DCF to microcap companies . I am not a huge fan of DCF as i believe one needs to know a company inside out for it to churn out an approximately right range of Intrinsic values. However if the cashflows are not too lumpy and FCF is decently stable it does make sense.

    Regards,
    Siddharth

  4. 4 Madhu

    Hi,

    I am also tracking this co. Just to add to your perspective, can Patel Airtemp get good business in future from cold storages and warehouses. We all know what food inflation is doing to us, and also a lot of fruits and vegetables are getting rotten due to lack of storage infra…So can this market be big business for Patels going fwd. reply to my email id madhujpn5@yahoo.co.in

    regards
    madhu


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