Friday, January 14, 2011

Cimmco Birla - Back in Action, But Should Investors Enter?

Ever since it became definite that Cimmco Birla (BSE: 505230, NSE: CIMCOBIRLA) will come out of BIFR purview, that is by end October 2010, the interest in the railway wagon maker had been in the upswing, and it rallied throughout November and early December. It was also on October 26th that BSE resumed trading in the scrip.

But since the rally was rather steep, by the time it finally came out of BIFR ambit, with effect from December 15th, the company rechristened  as Cimmco Ltd, had entered a correction phase. And by the time the official Exchange filings came, that is by early January 2011, the correction seems to have been completed, with the scrip trading in a relatively stable range.

However, some investors are watching the scrip rather keenly, to know whether there is an IPO like opportunity in this company, that was resurrected after being officially sick for around 8 years. More interestingly, the resurrection was led by the new co-promoter and former rival wagon-maker, Titagarh Wagons Ltd (BSE: 532966, NSE: TWL), which is the country's second-largest listed wagon-maker in the private sector.

Coming to fundamentals, Cimmco Birla Ltd had been in red with a negative networth for 9 out of 10 years in this past decade. Even worse, this once SK Birla Group company had a history of steadily deepening negative networth, which was around Rs. -12 crore in June 2000, but rapidly deepening to Rs. -570 crore levels by June 2009.

The profit slide was nearly identical, starting with a loss of around Rs. 20 crore in March 2000, to reach over Rs. 106 crore net loss in fiscal 2009.

It was in fiscal 2009-10 that SK Birla Group together with the help of Titagarh Wagons and the oversight of Board for Industrial & Financial Reconstruction (BIFR) succeeded in reversing the slide. Cimmco Birla closed fiscal 2010 in green with a positive networth of Rs. 21.31 crore.

But the real surprise was on the sales and profits front, with annual sales jumping to nearly 320% of the previous year, and net profits jumping to over 660%. Cimmco also generated an EPS of over Rs. 275 in FY'10.

However, looking closely, the positive turnaround in networth and the EPS jump were also due to a restructuring strategy implemented by Cimmco to accomodate the accumulated losses as well as to implement the stake buy by Titagarh Wagons.

This very interesting strategy, undertaken in two steps during the March 2010 quarter, first reduced Cimmco's then existing equity by 80% against accumulated losses. In other words, the remaining 20% became the company's new equity, and for shareholders, this was implemented as 1 new share for each 5 old shares held, but with both the old and new shares having face value of Rs. 10.

Though it looked like a steep loss to existing shareholders, the flipside is that they now own a company with positive networth. This also translated to a significant positive book-value for their share, compared with a worthless negative book-value in the previous year, of over Rs. -400. So far, so good for existing investors.

But the next step of dilution took away some of this sheen, though it was unavoidable, as the stake-buy by Titagarh had to be accommodated smartly. The strategy for this was implemented using the Special Purpose Vehicle (SPV), Cimmco Equity Holdings Pvt Ltd (CEHPL), created earlier, and held equally by former sole promoter SK Birla Group and new co-promoter Titagarh Wagons.

Cimmco Birla then issued over 470% new shares to CEHPL against this new holding company's share application money of around Rs. 48.5 crore. This translated to just around Rs. 30 (Rs. 10 face value + Rs. 19.77 premium) a share for CEHPL.

The lost sheen was primarily about the new book value which stood at just Rs. 10.57 after all these restructuring exercises.

Anyway, thus the stage was set for Cimmco Birla shares which had stopped trading in 2002 at a measly price of Rs. 1.75, to resume trading at around Rs. 30 in 2010. Since 5 old shares accounted for only 1 new share, the actual workout was like a Rs. 8.75 share in 2002 resuming trading at Rs. 30. An appreciation of 243% was not bad even though it took 8 uncertain years for this. Also, comparing with the old face-value of Rs. 10, the appreciation was much lower.

But when trading actually resumed at BSE on October 26th 2010, Cimmco could command an opening price of Rs. 50, and rapidly zoomed up to Rs. 213.45, within a month, before the correction set in.

Now, this correction is very interesting as while it took only 28 trading sessions for the price to shoot up from Rs. 50 to the 52-Week High of Rs. 213.45, it took only even fewer trading sessions - 19 - for Cimmco Birla to enter free fall and register a 2-month low of Rs. 124.5. In other words, a rise of 327%, and then a 42% fall, all within less than 10 weeks.

But the scrip smartly recovered to an extent, and this has initiated much investor interest in this otherwise not very popular counter.

That brings us to the question of valuations, and on first looks, the Cimmco Birla scrip is very attractive, with a trailing twelve months (TTM) EPS of Rs. 305.11 which translates to a price-earnings multiple of just around 0.50 times compared with Kalindee Rail Nirman's (BSE: 522259, NSE: KALINDEE) 26 times, Titagarh Wagon's 11.5, or Texmaco's (BSE: 505400, NSE: TEXMACOLTD) 6 P/E. Many investors also seem to have jumped into the fray thinking that Cimmco Birla is very inexpensive at 0.50 TTM P/E.

But as we have seen, this was due to the abnormal EPS in the March 2010 quarter, and unfortunately for such over-enthusiastic investors, this bumper quarterly EPS is not going to be there in the TTM calculation, when the March 2011 quarter comes into the picture, that is within three months from now.

Another strange aspect is that even if we set aside this abnormal EPS, and try to take a call on this using the first and second quarterly results of fiscal 2011, the divergence between these sequential quarters is quite bad. In the first or June quarter, Cimmco Birla registered an EPS of Rs. 8.35; while in the second or September quarter, EPS nosedived to just Rs. 0.35. And even worse, it seems to be not only a profitability issue, as sales also has gone down by nearly half.

While a percentage of these erratic movements is due to the nature of the wagon / coach business where customers are few and orders are rather big, the Cimmco grade of earnings volatility is not seen in Titagarh or other wagon makers. What this signals is that Cimmco might continue to face some teething troubles.

The other way of looking at the valuations, that is by book-value, also reveals that Cimmco is highly overvalued. Between industry leader Texmaco, second-largest player Titagarh, and the relatively smaller player Kalindee Rail, the average price-to-book-value works out to only 1.7 times, whereas Cimmco, even after the fall, is trading at a hefty P/BV of over 13 times.

Speaking about the upsides, the most significant is of course the expertise of Titagarh Wagons in this industry, as well as the synergies possible between the two companies by way of joint-bidding, production-sharing and cost-cutting. Titagarh has over the years, accumulated significant core competence in this industry, and is regarded as an aggressive player furthering its interests by organic and inorganic methods, including overseas stake buys and technology tie-ups. Titagarh Wagons has also been an effective fund raiser, having roped in PE funds, both national and international.

Another big upside is the demand growth witnessed by the wagon or coach industry by way of quantity and margins. While Indian Railways, the main customer, is known for aggressive growth lately, the margins are also better due to the demand for the newer stainless steel coaches, in which Titagarh is a noted player. Lately, private sector logistics operators like Sical Logistics (BSE: 520086, NSE: SICAL) have also become major procurers of rakes.

But whether such expertise on the part of Titagarh Wagons is enough to turnaround Cimmco's fortunes within a reasonable period, say 1 year from now, remains to be seen.

Another notable upside for the Cimmco stock is its high promoter holding, which now stands at over 80%, in comparison with the 22% it was in December 2009. This is also one reason why the market values it more expensively than its peers, with another reason being the low liquidity of the stock due to NSE still not resuming trading in the scrip. The daily volumes at BSE are quite unattractive now for short-term trades.

Considering all these factors, Cimmco Birla is definitely a stock worth watching for some key developments. 

First to watch for is the December 2010 results, which is due out in January, and then the March 2011 results. A clearer picture on the revenue run rate, profitability, and earnings should emerge by then.

Secondly, the SK Birla Group selling out to Titagarh or any other long-term PE funds can be a definite plus. Entry of PE funds look possible as Titagarh Wagons is used to managing itself with a promoter group stake of around 50% and FII stake of over 12%.

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