Friday, July 15, 2011

Graham Stock - Polyplex Corporation

Last post was all about Graham and his book "Security Analysis". In this post, I am taking one step further explaining methods which Graham recommended to unearth the so called "Undervalued" stocks with an example. In general Graham talks about the following rules.

1) Book Value of Less than 1

2) PE Ratio of Less than 10

3) Debt Equity Ratio of Less than 1

4) Good Dividend Policy

If the stock fits all the above said criteria, then Graham applies his famous "Margin of Safety" principle (Stock Price trading at a Huge Discount to Book Value) to decide if a particular stock is worth buying. Most of the articles that quote him throw some light on said rules. But what they have not written about is his strong views on "Net Current Assets". More than Book Value, Graham considers "Net Current Asset" value as the very important one to consider when analyzing a stock. This is due to the fact that Book Value lost its significance because of the following two things.

1) The Value of the Fixed Assets as stated bore no relationship to the actual cost.

2) Fixed Asset value bore no relationship to the figure at which they would be sold.

Net Current Asset

Net Current Asset is what we get if we deduct the Current Liabilities from Current Assets. Current Assets section consist of the following in most of the balance sheets.

1) Inventory (Goods not Sold)

2) Receivables or Sundry Debtors ( Goods sold but payments not received)

3) Cash and Bank Balance

4) Loans and Advances

Graham recommends to take Cash and Bank Balances as it is (100%), Receivables at 80% of what is stated in the balance sheet and Inventory at 50% of what is stated (Because it needs to be sold). Calculating the Current Assets by this revised rules will reduce the actual stated value in the balance sheet to a new "Current Asset" value. Then Current Liabilities stated in the balance sheet needs to be deducted from the newly calculated "Current Asset Value" to get the "Net Current Assets".

The next step is to calculate the "Net Current Asset" per share by dividing the "Net Current Asset" by total number of outstanding shares. If the current price is huge discount to "Net Current Asset" per share, then that particular stock is the one which he terms it as "Undervalued" because he sees no reason for a company to trade below the "Liquid" value. Market imperfections lead to undervalued stocks and Graham believes sooner or later, Market will value the stock at the original or fair price. One such stock I identified currently (July 15, 2011) is Polyplex Corporation and will explain why this stocks fits the Graham criteria.

Polyplex Corporation (Current Price : Rs. 194)

Polyplex Corporation is the Indian multinational Polyester film company having operations in India, Thailand, Turkey and USA. The products are used in Packaging, Industrial & Electrical applications, Magneteic Media and imaging applications.

Please download the latest (2010-2011) results and balance sheet from the following link in order to understand the explanations.

Lets calculate the usual Graham figures. (From Consolidated Figures)

1 ) Book Value (Reserves & Surplus + Capital / Total Shares) = Rs. 501 (1605 / 3.2)

2) PE Ratio = 1.5 ( 195 / 130)

Note: Removed Exceptional Item (630 Crores from Net Profit) to calculate the EPS.

3) Debt Equity Ratio = 0.48 (771 / 1605)

4) Continuous dividend from 1997. Rs. 14 in 2010 and Rs. 7 (As of now) in 2011.

So, Polyplex satisfies all the usual Graham stuff and in fact trading more than 60% discount to the Book Value. Lets take this further and calculate the "Net Current Asset" value in Graham Method.

1) Inventory = Rs. 218 Crores ( 436 * 0.50)

2) Receivables = Rs. 265 Crores (332 * 0.80)

3) Cash and Bank Balance = Rs. 860 Crores

4) Loans and Advances = Rs.171 Crores

Adding all this we get Rs. 1514 Crores. From the balance sheet we understand that the current liabilities are about Rs. 364 Crores.

Net Current Assets = 1514 - 364 = Rs. 1150 Crores.

Net Current Asset Value per Share = 1150 / 3.2 = Rs. 359

Current Market Price of Rs. 194 is 46% discount to the "Net Current Asset" value per share.

If you look at closely, you are in for a more shock. Cash and Bank Balance itself is Rs.860 Crores and that translates into Rs. 269 per share. So the current market price is 28% discount to the Cash and Bank balance per share alone. Even if we were to assume that they have decided to pay all the debt (Rs. 771 Crores), still we are left with Rs. 379 Crores of Net Current Assets apart from Rs.1500 Crore Fixed Asset Value.

So, from my point of view, this stock has no business trading at this price and (Market Cap of Rs. 620 Crores when the Cash in Book itself Rs.860 Crores) is "Undervalued". Considering the fact that they generated Rs. 2433 Crore revenue last year makes this stock all the more interesting. Only negative thing I see in this stock is, it is "Cyclical". But that does not warrant this huge discount and my belief is that market will recognize this sooner than later.

Kumaran Seenivasan



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