I had written about Lakshmi machine works earlier here. I would recommend reading the earlier post, especially the comments. The post and comments were right in the middle of the financial crisis. The stock was quoting in the 500-600 range and went down to the low 400 range in the subsequent weeks. At that price, the company was selling for slightly over cash on the books and the market was assuming that the company would go bankrupt soon.

I distinctly remember the comments and a few emails I received on this idea. The general theme was as follows
–        The near term outlook for the company is horrible. As a result one should wait till the outlook is clear and then buy the stock.
–        The company is barely making any profits and could be in financial trouble if the textile business shrinks further.
–        The stock market gurus and pundits are advocating caution and I would prefer to wait (close to the first point).

My logic at that point can be summarized as follows
–        The near term outlook was terrible and hence the stock was available at a bargain. Stock don’t sell at throw away prices if the near term outlook is great. The key point to analyse was how the company will do in the long run – that is after the downturn is over
–        The company had a 60% market share in the industry and is one of the dominant players in india. They had a very strong balance sheet and good management. The company had a much higher probability of surviving than the other smaller players. On the contrary, I would say that a recession wipes out the weaker players and the stronger ones gain market share and strength due to lesser competition.
–        If you listen to gurus and pundits, and don’t do your own thinking then you are likely to be in trouble anyway.

The post of LMW received a big number of hits and I think a lot of people found the company attractive.

I bet you would be thinking that I am busy patting my back !. I am not.

In hindsight (which is 20/20), I think I was not aggressive enough and did not commit enough capital to the idea. I was personally quite confident of this company and a few others and still bought very cautiously. The caution had more to do with my extreme risk aversion and less with a specific idea. Anyway, I am working on that.

Let’s look at how the company performed in the last 2 years
–        The topline of the company collapsed by 50% in the last 2 years
–        The bottomline of the company came down by 60%+
–        The return on capital has dropped, but is still at 50%+ levels (excluding surplus cash)
–        Fixed asset turns dropped from around 4.1 to 2.5
–        The company is still working capital negative (operations generate working capital instead of consuming it)
–        Net margins have dropped from 10%+ to around 8% range (excluding other income)
–        Net cash on the books (excluding customer advances) increased from 250 crs to 520 crs and total cash from 670 crs to around 830 Crs.
–        The management has indicated plans to develop some land in Coimbatore (a real estate venture). This is a bit of a bouncer !

So what grade do we give the company ? I would say A and no I am not out of my mind.

In case of LMW one has to distinguish between the factors which cannot be controlled by the management (external environment and demand) and which can be controlled (their own cost structure and profitability).

The topline and bottom line dropped as expected (which is why the stock was selling for 500 and discounting this performance). However the management did a decent job of controlling the costs and still managed to generate profits during the downturn. There are very few companies which can remain profitable in face of a 50% drop in topline with a profit margin in the 10% range.

Where do we go from here?
The stock is now selling at around 2400. The company has announced a buyback to use up the extra cash, which is a good sign though not a great timing. The current price is partly discounting the expected good performance of the company.

If you assume a net margin of around 8-9% and topline growth of 10%, then the fair value can assumed to be around 2900-3100 range. The stock is slightly cheap, but not a bargain at current levels.

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