This piece of research isn't aimed at telling you all that is right about Punjab Tractors Ltd (PTL). The attempt is to try and see what can go wrong, and how sensitive are PTL's key ratios to occurrences.
This approach assumes significance in the case of cyclical. So this piece focuses on the element of risk - how bad can bad times be for PTL, and to ascertain the margin of safety.
During FY93 and FY94, the tractor industry faced bad times. Industry sales fell 6 per cent and 4 per cent (in volumes) respectively. Yet, during these years, PTL recorded growth of 13 per cent and 11 per cent respectively.
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During this period, Eicher, Escorts and M&M recorded CAGR's of -7 per cent, -5 per cent and 2.5 per cent respectively. Yet, PTL showed OPM improvement and profit growth, and its debtors days remained in single digits. Its RoE in those two years was a healthy 23 per cent.
RoE is sensitive to OPM: A look at the RoE vs volume growth sensitivity matrix shows that the RoE is not very sensitive to volume growth which is extremely unusual for an auto company. That is a very good indication of how low RoE can be in a bad year.
Even if volumes fell by 10 per cent in FY98, RoE should not drop to below 30 per cent levels. This can be ascribed to the high level of variable costs in the total cost structure due to the high level of outsourcing. The raw material cost as a percent of sales if 75 per cent.
OPM is a greater driver of RoE. If OPM increases by about 1 per cent point, RoE improves by about 2 per cent points. Only an additional volume growth of 6-7 per cent points would bring about a similar improvement in RoE. So the improvement in RoE in the future would be more dependent on OPM improvement rather than volume growth.
Profitable ancillarisation: PTL's degree of ancillarisation is the highest in the industry. It is the only tractor major to outsource engines.
Engines account for about 24-25 per cent of the cost of a tractor. Despite this, PTL has the highest OPM in the sector. Despite PTL's raw material/sales ratio being a good 10 per cent points higher than competition, its OPM still comes out better.
PTL makes about Rs 24,000 per tractor after paying Swaraj Engines (its engine supplier) Rs 8000 per engine (as operating profits). And despite this, PTL turns in an RoE of 40 per cent. Just imagine what an awesome stock PTL could become if it took over Swaraj Engines, wholly or at least increase its 33 per cent stake to a majority holding.
Other businesses: PTL's other businesses are manufacture of harvester combines, forklifts, spare and castings. The other businesses account for 8 per cent of turnover. Harvester combines are used for agricultural activities. These are high-value items and its sales are primarily to individual customers. This is a low margin product and its sales are primarily in Punjab.
This product is kept alive only for some political reasons. Harvester combines account for about 1.5 per cent of the total turnover. Forklifts account for about 2 per cent of PTL's turnover. Sales of forklifts are primarily institutional. Sales of forklifts are mainly to port trusts, railways and defence. Castings account for 0.2 per cent of turnover. PTL has castings capacity for captive consumption for its tractors.