Ashish Chugh's multibagger picks: McNally & Good Luck Steel

McNally Bharat and Good Luck Steel Tubes are multibaggers, says Ashish Chugh, Investment Analyst & Author of Hidden Gems. The valuations of McNally Bharat have become quite attractive. They have wide variety of services in the Engineering, Procurement and Construction (EPC) segment.

Also read: Morgan Stanley downgrades ACC, other cement stocks

Good Luck Steel Tubes is Uttar Pradesh based company which manufactures steel tubes and steel pipes. They cater mainly to the structural engineering, automotive and engineering goods sector.

On Good Luck Steel Tubes

Good Luck Steel Tubes is a small cap stock available at throwaway valuations and the major risk associated with investment in this stock is the risks that are associated with investment in small cap stocks, mainly liquidity risk and also the high impact cost. This company is based in Uttar Pradesh and manufactures steel tubes and steel pipes. They cater mainly to the structural engineering sector, the automotive sector and also engineering goods sector.

This company does revenue of close to Rs 700-750 crore and about 25 percent of the revenue is constituted by export sales. They export close to Rs 200 crore. If you look at the financials of the company, FY12 sales were about Rs 680 crore. Profit After Tax (PAT) was about Rs 20 crore. In the first nine months of the current financial year sales are up by about 47 percent to Rs 725 crore and PAT is up by 10 percent to about Rs 19 crore.

Even though the company has a market cap of just Rs 37 crore, we like a few things about the company like, the company has been continuously growing for the last many years. In last five years, the compounded annual growth rate (CAGR) in sales and profits has been between 15-20 percent. This company did about Rs 9 crore in 2008 which has increased to Rs 20 crore in 2012. The other thing is the continuous addition in gross block year after year.

The gross block of the company which was about Rs 58 crore in 2008 has increased to Rs 110 crore in 2012 and also there is a capital work-in-progress as in the balance sheet of March 2012. So, there is a continuous capacity creation. The good part is that all this capacity has been created without any equity dilution and through small addition in debt. The equity of the company is very small at about Rs 3.74 crore and since the time the company came out with its initial public offering (IPO) in 1995, there has been absolutely no equity dilution.

The long-term debt is at manageable level, very small debt of about Rs 25-30 crore and the company has got a 20 year track record of payment of dividend. The only time it skipped dividend was in 1999 and 2002. Besides these two years, the company has been regularly paying dividend to the shareholders. Even though the quantum of dividends is not very high, all the capacity creation has happened without any equity dilution and only through internal accruals.

Promoter holding is high at about 71 percent. A short-term negative in this company is that of late there has been an increase in the short-term borrowings of the company. However, if you see the balance sheet closely this is secured against inventories and receivables. This puts pressure on the margins of the company since the interest outflow is higher.

In spite of the negatives that I spoke about, you have a company doing revenues of about Rs 1,000 crore, doing a PAT of about Rs 22-23 crore and available at a market cap of just about Rs 38 crore, so you are getting this company at a PE of about 1.5. Whether you see this company on a standalone basis or you compare it with the peer group companies like APL Apollo Tubes, you find a huge valuation gap.

From Rs 20 the only risk maybe that you may not be able to see price appreciation in the short-term or you may not be able to get liquidity in the stock, whether it is buying the stock or selling the stock. Any price below Rs 20 or around Rs 20 maybe a good level to slowly accumulate this stock for a long-term.

On McNally Bharat

This is a stock which belongs to a sector which is out of favour right now. It is a contrarian stock I would say in capital goods sector. That is not really the flavour of the season, but then the valuations of the company have become quite attractive. There was a time when these capital goods companies used to trade at a PE multiple of 20-25. Now many of them are available at 4-5 PEs and McNally Bharat being one of them.

This is a company which started off as a material handling company. Of late they have diversified to become a conglomerate. They have wide variety of services in the Engineering, Procurement and Construction (EPC) segment. They cater to power, cement, mining, coal washery and variety of other industries. Talking about the negatives first is that the capital goods cycle currently is slow and in the short-term it is putting a pressure on the companies in the capital goods sector.

In case of McNally Bharat the receivables is high. A lot of their payments have got delayed. This has led to increase in the short-term borrowings of the company. The balance sheet has been an increase in short-term borrowings. Coming to positives in spite of the slow capital goods cycle this company has been witnessing good order flows on a regular basis. The order book of the company currently stands at about Rs 4,000 crore. That is to be executed over the next 24-36 months. In light of that the market cap of the company at the current price is just about Rs 250-260 crore.

The valuations of the company FY12 profits were about Rs 67 crore which is EPS of Rs 21. So, at the current price of about Rs 84-85 one have this stock available at a PE multiple of just about four. The cash profit was about Rs 90 crore, so this company is available at less than three years of cash flow. Its book value is Rs 115, current market price is Rs 85, thus a 50 year old company available at a discount to book value.

Talking about the business, only other company that can handle the sheer diversity of the projects which McNally Bharat is capable of handling is Larsen and Toubro (L&T). So, here is a vacuum in between. When the capital goods cycle turns positive, companies like McNally Bharat will be hugely benefited. There are challenges in the short-term and till the time investment starts to pick up aggressively in the economy there may not bee too much of traction in these companies.