Thursday, March 21, 2013

Sah Petroleums Ltd and the power of "brand"!

This post aims to serve two purposes; to look into Sah Petro as a company and to look at what branding can do to a product!
Lets start with the latter..

All of us would agree that branding works wonders for any product. Many-a-time, we buy a branded product just because its branded, with no idea about what real value addition the branding has done to the base product!
To give a related example, given a choice, what would you fill in your vehicle; Castrol oil or some unbranded oil? Ok, lets further assume that your mechanic is telling you that there is no technical difference in the two oils, but Castrol costs 60% more..then? I am sure that still, you would prefer Castrol. Why take the risk right? Now what do we know about the technical aspects of engine oil? How is Castrol better? Honestly, we dont. Still, we would prefer it since its 'branded'. And the brand is hammered on our heads all the time through clever, targeted advertising. So we do not mind paying up a bit extra for the branded goods.

Well, you will surely say that this was all general gyaan, which everyone knows. How can one prove it?

Please have a look at the following table; (these are FY11 numbers..FY12 onwards, companies do not give the quantitative info in the ARs. I agree the numbers are dated, but they serve the purpose).

Click to enlarge

  1. Castrol's EBIDTA margin is much higher than the rest of the pack. Its % raw material consumption is much lower than others. 
  2. Because Castrol is much larger in size, its advertisement spend is much much higher than others (although in % of sales terms, its the same as others). Higher advertising means you promote your brand more, which gets more customers to go for your brand, which makes you bigger, which enables you to have higher advertising budgets, which means you promote your brand more...and so on..Virtuous circle indeed!!! 
  3. This business is kinda simple.. you buy 'base oil', refine it, pack it nicely and sell it out. A bit of differentiation here and there is possible. If you look at the last row in the table, all the players buy base oil at more or less the same price per litre. 
  4. But, the second-last line where the difference lies. Just look at the average selling price per litre of all the players. (It is not 100% comparable, since Sah sells transformer oils and unbranded oil too, but the sales break-up is not available).
  5. The bigger your brand is, the more you can claim it to be better than others and then you can have the audacity to price it significantly higher than others. In fact, simply because its priced higher, a lot of people will consider it to be better! :-) 
  6. Castrol prices its product significantly higher than others since its products are branded. Sah does not have a great brand and it sells unbranded oil too, so its realisation is far lower, its margins are far lower, its profits are far lower. 
  7. The only way to increase profitability in this business is to increase your selling price. And the only way to do that is to strengthen your brand.
So thats what branding can do to your business! Power of brand is truly immense!!

Now lets get back to Sah Petro as a company. Numbers-wise, it appears very interesting and dirt cheap. I would request you to please take a cursory look at the numbers before reading further. The numbers are available on any financial website, so I wont dwell much upon the same. Lets answer a few questions:

Is the business stable in terms of revenues and margins?
The margins would not be stable. These guys carry quite a lot of inventory. A dip in oil prices would lead to a lot of losses. Since they do not have a powerful brand, a lot of pricing power should not be expected. Also, it appears that they punt around a bit in forex transactions and dont disclose it properly too.

Is the management good?
Well, the company is majority owned by Navis Capital, a PE fund (62%). The erstwhile promoters, Sah family holds about 25%, making the total promoter holding of around 87%. The original promoters were not the best-in-class. They used to punt around a lot in the shares of the company. Navis Capital is a PE and will have their own agenda to pursue. I wouldn't give high marks to the management. Also, I cannot understand exactly who manages the company..Navis, who is the majority shareholder? Or the family, who occupies all the executive positions and has founded the company. From the overall scheme of things, I think that the Sah family still runs the company. Will there be conflicts between these two promoters? Maybe!!

What about the cash?
The company carries cash of around Rs.55 cr, against market cap of Rs.80 cr. That makes it very interesting valuations-wise and Graham-wise! The cash-flow is also ok ok..But the problem is, why have they kept this cash? They do not declare any material dividend. (FY11 dividend was 5 paise..FY12 dividend was 1 paisa!!). Probably, they might have conserved this to go for a big-bang advertising spree. Or to guard against any large loss which may happen due to oil price/forex movements. Whatever the case may be, will we see the cash in our hands as shareholders? Seems Doubtful.

Ultimately, wont the PE exit?
Yes, and that will trigger an open offer. But its too early for them to exit. They got into the company in 2008. Usually a PE cycle lasts for 5-7 years, so a likely exit is still at least 2-3 years away. Also, Navis is currently sitting on more than 50% losses on their investment in Sah Petro.

87% promoter holding = delisting!!
These days, the D word is quite a taboo. More and more people I know are swearing never to get into the delisting theme. Logically, one would say that its better for Navis to get Sah delisted, since selling it off later would be easier. The current valuation is not sky high, making delisting a doable and desirable option for the promoter. However, do take a look at their recent insider trading announcements. The promoters have started 'gifting' shares to 'immediate relatives'. Now will these relatives be also considered in the promoter/PAC category? Or will they be classified as public shareholders? From the announcements, it does look like they are in the promoter category, but we will have to wait for the March 2013 shareholding pattern to confirm this. If they are not classified in the promoter category, then bringing down the promoter holding to 75% wont be a big issue and the D word should not be uttered. Lets wait and watch!

Overall opinion
The stock is available cheap, not doubt. But there is a reason why its cheap. I cannot see any trigger which would lead to a rerating or discovery of 'value' in this one. A sudden good quarter would lead to the stock price zooming up, but I do not have the competency to visualise the same. The business is quite volatile, the management is not very comforting and the cash they are hoarding is not being distributed at all. To use cricketing terminology, the stock would be 'well-left' for me as of now. (Fair warning: it can be proven with empirical evidence that the stock price of whatever is 'well left' by me tends to zoom up!)

Do lemme know your thoughts on my thoughts...

Cheers and happy investing!!

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