Disa India – cyclical all the way

In today’s article I will discuss Disa India, a listed foundry equipment manufacturer. You will see an example of a cyclical business.

 

What is a foundry? What is casting?

A foundry is a factory  or a unit where a casting process is used to create metal parts. Metal is heated in induction furnaces or electric arc furnaces. Molten metal is then poured into a mould. After it cools down, the mould can be removed or broken to reveal the casting. This casting is yet not perfect. It has impurities on the surface which have been picked up from the mould. These have to be removed. Surface preparation is the name that is given to this step of the process. This can be achieved by sand blasting (or shot blasting) for example where sand is propelled onto the surface of the yet imperfect casting. Sand strips away the impurity. Pretty much like the feeling you will get if you are in the middle of a sandstorm in a desert. Except that this is many times more abrasive.

 

What is Disa’s business?

They make the casting equipment that is used by an independent foundry or any company that has a foundry division.

Disa India manufactures the following products:

  1. Moulding equipment
  2. Shot blasting equipment
  3. Sand plant equipment
  4. Core systems


To understand cores, read this article on cores from Wikipedia.

 

Is Disa a market leader?

Since 2008, Disa India has maintained majority market share. In 2001, it had a market share of 70%.

That immediately got me interested.

I checked with a friend who works in a furnace manufacturing company. Furnaces are typically ordered when someone orders equipment from Disa because, you need to melt the metal before pouring into the mould.

He mentioned that Disa is a good company that is respected by customers for quality equipment. He knew of customers who ordered Disa products when they bought furnaces from his company.

So, the primary check was good.

 

Who are Disa’s customers?

60% of Disa India’s revenues come from the automobile sector. The balance 40% is generated from companies which supply infrastructure equipment, engineering equipment like pumps and gears and appliance parts suppliers.

 

Disa India financial statement analysis

Figures in INR million.

FY05FY06FY07FY08FY09FY10FY11FY12
Sales470847988896742111815931517
EBITDA1333712932061752513701071
PAT7522818112099151227188
Dividend666302000302NA
Sales growth80%17%-9%-17%51%42%-5%
EBITDA growth179%-21%-30%-15%43%47%190%
PAT growth204%-21%-34%-18%53%50%-17%
EBITDA (%)28%44%30%23%24%22%23%71%
PAT (%) 16% 27% 18% 13% 13% 14% 14% 12%
Cash344485506206329465599436
Net worth284350186306404556432615
Debt29167374050717
Debt to equity0.10.50.20.10.00.00.00.0
Return on Equity26%65%97%39%24%27%53%31%
Operational cash flow13873109143175NA
Capex365762770NA

 

Key observations

  • Quite high return on equity, at the lowest in the crisis of 2008-09, the FY09 return on equity is 24%.
  • PAT margins have not fallen below 12% in the worst year in this period.
  • Dividend payouts do not follow an annual pattern. It seems that the company accumulates cash and then makes a payout once it can.
  • Net profit is back at the same level seen in 5 years back in FY07.

 

Disa India’s cyclical business

Disa gets orders from companies who are setting up foundries or independent foundries who make castings and supply them to other companies.

Take an example of an auto maker like Mahindra who is a customer of Disa India.

What Disa India manufacturers is not bought regularly by their customers. Whenever their customers set up new capacity or replace old equipment, they will buy from Disa India.

This means that their customers should be confident of their business environment and should see strong customer demand for their own products. Only then, will they spend on new capacities or think of replacing old foundry lines (the inevitable scrapping is sometimes delayed in bad times).

Now auto manufacturers operate in cyclical business. Disa in turn supplies to auto manufacturers and only when they want to add new capacity or upgrade equipment.

Can you imagine the cycle for Disa India? It is that much tougher. This is the problem that most capital goods manufacturers face too.

Only the strongest players survive in capital goods. For example in power equipment, you don’t have 15 boiler-turbine-generator (BTG) makers for power plants. BHEL, BGR-Hitachi, JSW-Toshiba, L&T, and Bharat Forge-Alstom are the key domestic BTG makers.

Similarly,  you will not see 20 strong foundry equipment makers. That is the nature of the industry. Entry barriers are high since they operate in a tough cyclical market.

Such companies typically will have reasonable bargaining power over their customers. They will have even stronger bargaining power over their suppliers.

Return on equity which never dips below 23% in the last eight years is no easy feat.

But such companies face a challenge when there is no demand from customers itself.

That is pretty evident in Disa’s financial record.

I like the fact that Disa India is strong in their line of business. They will be around with reasonable certainty, in my opinion. This is not a company that will go bankrupt.

But, it will be at the mercy of the business cycle.

 

Is Disa India a good stock investment?

In such stocks you need to get the timing of the cycle right. It is not easy. You can come in early and face more pain as you see the stock fall further. Plus, there are opportunity costs to having your money locked in a stock that does not rise. You need patience for the cycle to play out.

More specifically, in Disa India, it has risen up over the last year in the hopes that the MNC promoters would delist the company and pay hefty prices to buy stock from the minority shareholders. That did not happen.

The company did an Offer for Sale (OFS) instead where they divested some of their shares and brought their stake down from 86.49% (as of September 2012) to 75% (as of December 2012).

Stock trading volume is very low. Even from the perspective of a retail investor who does not buy or sell huge volumes.

The last year has seen slowing profits. Auto makers are not doing well. Generally industrial capacity addition has slowed down.

At 20 times price to earning as of the day of writing this article, I am not a buyer.

But it definitely is an interesting company that tests your understanding of businesses.

It has a lot of good points, but like they say, there is a difference between a good company and a good stock.

 

What not to do.

I did not tell you the story of what got me started with this obscure, small company. I was looking for companies that have high dividend yield. (Dividend paid divided by market capitalization)

Disa had a juicy 8% dividend yield. It was too good to be true at face value.

When I looked at the company in detail I noticed that these were not regular dividend payouts that sustained.

There are a lot of financial websites that we use. We can get misled by seemingly great information.

Look at the complete picture. Keep digging deeper.

Do let me know your views on Disa. If there are points that you would like to add, please share them in your comments in the area below this article.

 

Recommended reading

Disa India Ltd. – investor relations webpage

Disa India Ltd. corporate presentation

 

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Comments

  1. Vikas Kukreja says

    Hi Kunal,
    Nice writeup on Disa India. Prof Neeraj Marathe is a long term investor in this company and has a lot of conviction for it. Also, management seems to be really grounded and focused on business cutting all noise. With all the green signals, the only question is of what price to pay for the business, which is again subjective. It should certainly be in watchlist and can be picked up for long term whenever a decent correction comes with ofcourse a lot of patience for holding it for long term.

    Regards,
    Vikas Kukreja

    • says

      Vikas, I agree with you word for word. The company is undoubtedly good at what they do. The price is a question. The recent jump because of delisting expectations has driven the price too high. It was at decent valuations before the sharp up move.

      Even I have put it in my watchlist.

      I have some questions in mind after what has happened in Fresenius Kabi Oncology. I will write about that in my next article.

      What other stocks do you find interesting now?

      Regards,
      Kunal

      • Nitin says

        agree with you guys, there is further more pain for Disa during this year, not to mention they already had a discouraging 1st quarter Mar’13.

        • says

          Their daily trading volumes are very low even for a retail investor, forget institutional investors. Shareholding is also concentrated with low float. It can thus remain at lofty prices (and valuations). Not safe really.