JB Chemicals: Cash is King

In a rising market such as what we are witnessing today, it becomes increasingly difficult to find good stocks which are cheaply available. 

For me one of the resorts in such a run up is to find statistical graham style cash/debt- capacity bargains (Explained brilliantly by Kiran here: Debt Capacity Bargain) and one of the stocks which has popped up is JB Chemicals (JBC). 

Business of JBC:  JBC was founded by Mr. J.B.Mody and is one of the oldest branded generic drug manufacturers in India. Some of its well known brands are metrogyl, rantac, nicardia etc. JBC also does contract manufacturing with specialty in lozenges and supplies them to various geographies.

Like a typical branded generic play JBC is a good but not great business. The same can be concluded if we look at its RoE & RoC figures, which are in range of 16 to 18% consistently.

The company becomes interesting when we consider that they have recently sold off their OTC business of Russian & Other CIS countries. Sales from this division were around Rs.200 Crs and PAT of around and company received Rs.1200 Crs for the same out of which Rs. 320 Crs was paid as dividend.

At present cash position of the company is as follows:

Cash & Investments= 560 Crs

Less Debt               = 80 Crs 

Balance                 = 480 Crs

Present market cap of the company is around Rs.637 Crs, which means we are getting the whole business for around Rs. 157 Crs or around Rs. 18.

Excluding the CIS business JBC had sales of around Rs.635 Crs in FY 12 and if we assume a nominal growth of 10% & lower end PAT margin of 10%, we get EPS of around 7.5 which means we are effectively buying the company at P/E of 2x, which is much lower than P/E assigned to other comparative companies.

So, it is clearly established that on a valuation front the company looks deep into cheap territory. 

However, there are certain pitfalls one needs to check to ensure that such ideas don't become value trap. Let’s have a look at them

A) Is the management efficient in capital allocation or will they blow away the cash they have got :

Few indicators for this are

• RoE & RoC
• Sales to Free cash flow
• Past usage of cash
• Dividend Payout ratio

1) RoE & RoC- Both look decent but not great which can be expected from a branded generic drugs manufacturer.

	FY12	FY11	FY10	FY09	FY08
RoE	67	16.5	16.5	14.79	11.15
RoC	8.33	17.62	16.59	18.03	10.11

2) Sales to Free Cash Flow- This looks healthy. Any company able to convert around more than 10% of its sales to cash is doing good business. I have not taken this for FY 12 as they comprise of income due to asset sale.

In crs	FY12	FY11	FY10	FY09	FY08
Operating cash	879	133	109	98	38
CAPEX	80	33	12	15	28
FCF	799	100	97	83	10
Sales	797	854	716	670	558
FCF/Sales	-	11.71%	13.55%	12.39%	1.79%

3) Past Usage of Cash: If the company has been generating cash as indicated above it is important to look has the company blown away cash in the past. This can be checked by looking at Dividend Payout ratios, whether they have done unrelated diversification or any special payouts to promoters etc. The same can be checked by again looking at cash flow statements to see if there are lots of investments and if yes where are they going. Similarly is money being constantly used for large CAPEX’s etc can be seen from the cash flow statement.

If we look at AR’s of last 5 years, Dividend Payout Ratio is has been consistently in range of around 13-15% for which is an ok indicator.

The company also doesn’t seem to be very aggressive in CAPEX, or forming subsidiaries or investing in JV’s.

This gives comfort that they will probably not blow away cash in random unrelated things.

B) Integrity of management/Aggressive Accounting- Company is in business for 50 years and there are no as such litigation's/problems evident. Also, spoke too few people in industry who have say management is honest though not the most efficient.

To check for aggressive accounting we looked at cash from operations and PAT for last 5 years. Most of the times there is not much divergence here, which indicates fair accounting by company.

In Crs	FY12	FY11	FY10	FY09	FY08
PAT	677	139	118	25	45
Net Cash flow from operations	879	133	109	98	38

C) Indication of management on future business plans- As per AR of FY12, company has indicated that they want to focus only on pharma segment with more focus on domestic business. They are not is a hurry to use the cash till they get the right opportunities. They are specifically looking to increase product penetration and also get approvals for few other geographies.

Conclusion: JBC looks like a decent bet to me for medium to short term, wherin I expect the valuation gap to close. Although, one needs to keep a track on how does the company plan to utilize the cash? Another point to be noted is that when one looks at cash/debt capacity bargains it is better to have multiple bets.

Regards,

Saurabh

PS- Have initiated a starter position. Also as stated earlier I am invested in other cash/debt bargains like Mazda ltd and Piramal Enterprises ltd