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!!




Disclaimer(s)!!
1) All the posts on this blog, including this one, are for educational and discussion purposes only.
2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.
3) As a professional investor, I may have positions in stocks discussed.
4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours! 

19 comments:

Zero Point SomeOne said...

Commander,

Thanks for sharing your valuable thghts.

Regards
Karun Sandha

Neeraj Marathe said...

Wooo! That was a super fast comment Karun..i had just posted the article!!
And thnx for calling me Commander! :)
Cheers!
Neeraj

Anonymous said...

Prof. Neeraj Marathe is a Brand in itself!!!

Neeraj Marathe said...

LOL...good one Anon!
Neeraj

ZeeNut said...

Had spoken to them last about a month ago & CS while not disclosing what they have decided, ruled out any buyback. I also got the impression that bonus to minority shareholders is also not being considered.
If they try re-classification of shareholders, be sure i will be registering a complaint with SEBI (not that it will help).

endlesszest said...

Hi,

I think you are right about why they may be conserving cash, "to guard against any large loss which may happen due to oil price/forex movements".
Last year they lost about 20cr. in foreign currency transaction.

Regards,
Varun

Anonymous said...

Neeraj,

There is not much difference in selling price for Castrol and Tide Water. So looks like brand Veedol is similar to brand Castrol. But the margins for castrol are much higher so looks like it is a better run company(less overheads) or at higher sales the fixed costs do not increase much.

Your thoughts please,

--- Nir

Neeraj Marathe said...

Hi Bosco,
I honestly admire the activism that you undertake whenever anything unfair happens in the markets.
However, your frustration rightly shows in your comment too..
lets see what these ppl do..

Hi Varun,
Yes, that could be a possibility. Unfortunately, the management has never discussed about their plans, so we just cant say for sure :(

Hi Nir,
Well, Castrol is the baaap of the business..no question about it..actually, i had studied Sah when i was looking into Tide..Tide ran up very very fast before i could complete whatever little research i do, hence could not take any action about the same..
cheers!
Neeraj

Anonymous said...

Hi Neeraj sir, any views on the current correction? any juicy picks? :)

cheers

amit

Neeraj Marathe said...

Hi Amit,
Nothing great..just thoda bohot buying here n there..
cheers!
Neeraj

Anil Kumar Tulsiram said...

Hi Neeraj

Been thinking about this stock for a while. Agree with the whole analysis. Sah Petro stands nowhere in front of Castrol. But I think one needs to wear a different hat to analyse this company. If one excludes FX and advertisement expenses then their margins are very close to Tide water and Savita oil, which implies that their assets are as good as these players [Tide and Savita] but management is the one which is destroying value. The assets will be very attractive for any prospective buyer and valuation wise trading at far below the replacement value. For the time being let’s forget about delisting theme, there are many ways to manage this. But this company is majority owned by PE and PE by nature are financial investor and will have to exit some time [may be next 3-4 years]. Now there are two ways to look at it 1) Buy now when they are priced as if nothing can go right and wait for 3-4 years. Increase your exposure if you are convinced about your theme 2) buy when the exit looks imminent in next 6-9 months. Option 2 looks attractive, but the problem is market may not give you opportunity to buy at decent price. Upside is uncertain but very attractive [more than 2x and not related to overall market direction], downside is opportunity cost, and permanent loss seems to be remote possibility.

Neeraj Marathe said...

Thnx a lot Anil for your views. Would request you to recheck the margins...
Also, assets have really nothing to do in this business imho..if you visit any local machine oil/lube manufacturer, you will find that its really a low tech business..
cheers!
Neeraj

QI said...

Industry growth in single digit hence these companies are not able to grow,

Neeraj Marathe said...

Thnx for you view QI..
cheers!
Neeraj

Anonymous said...

Hi Neeraj ,
Sah petroleum Board approves Bonus Shares to the Non Promoter Shareholders in order to comply with minimum public shareholding requirement under clause 40A of the listing agreement. If we consider fair value of company is current mcap around 100 crores then how much price will move ? today it is on upper circuit but upto what price we can buy it for arbitrage opportunity? I would request you to write up a new article on your calculation for sah petroleum.

Neeraj Marathe said...

Hi Anon,
I am in the process of doing the same, on demand!
Could not update the blog for quite some time due to some issues..
cheers!
Neeraj

Anonymous said...

What's your thought on the current open offer ? The price is currently above offer price. Should one hold the shares or sell it at the current market price of approx 22

Anonymous said...

What's your thought on the current open offer ? The price is currently above offer price. Should one hold the shares or sell it at the current market price of approx 22

Neeraj Marathe said...

I am out of the stock with decent long term capital gains.
Cheers!
Neeraj