Special Situation: Triveni Engineering Demerger

Triveni Engineering had announced a demerger of its turbine business more than a year ago. The record date was finally fixed as May 3rd 2011. Triveni Engineering will be split into Triveni Engineering and Industries Ltd. (TEIL) and Triveni Turbine Limited (TTL). Both stocks will be listed on the bourses.

Stock price of Triveni Engineering before Record Date: Rs. 100

Current Stock price of Triveni Engineering: Rs. 40

Brief Overview:

Triveni Engineering and Industries Ltd. (TEIL) is one of India’s leaders in the manufacture of sugar (Sugar, Distillery and Sugar co-generation of electricity) and engineered-to-order mechanical equipment, such as steam turbines, high speed gears and water and waste water treatment equipment.

The Board of Directors of TEIL approved the demerger between Triveni Engineering and Industries Limited and Triveni Turbine Limited (TTL) (formerly known as Triveni Retail Ventures Ltd.), and their respective shareholders and creditors for the demerger of the steam turbine business of Triveni to TTL. TTL is a wholly owned subsidiary of the company with Triveni having beneficial interest over all the 100,000,000 equity shares of FV Re.1/-.

All shareholders of TEIL as of Record date would get one share of TTL which will list separately. That is, if you had held one share of TEIL as of May 3rd 2011, your demat account will have one share of TEIL and one share of TTL in a few days.

Other details: Debt on Balance sheet of TEIL is 934 cr. Cash is around Rs. 25 cr. There has been no clarity around sharing this debt (or cash) with TTL. The assumption is TEIL will take on all the debt and cash. However, this is subject to change as more clarity comes by.

Shareholding Pattern:

Currently, TEIL has 25.8 cr shares outstanding. Promoters have a 68% stake in TEIL.

TTL is a subsidiary of TEIL. As stated above, TEIL has a 100,000,000 equity share in TTL. Further, this 100,000,000 equity share is split into 7.2 cr equity and 28,00,000 8% cumulative redeemable preference shares (CRPS) (FV Rs. 10). CRPS will not be listed on any bourses (and hence we do not have any play on this instrument).

As per the scheme of the arrangement, TEIL will issue TTL shares in the ratio 1:1. That is, the total equity of TTL will be 25.8 cr+7.2cr = 33 cr. The financial stake of TEIL in TTL will be (and this is important) 7.2/33 = 22%. (We will ignore the CRPS component for now)

The equity of TEIL will still be 25.8 cr.

After the demerger, Promoters will still have 68% stake in TEIL. They’ll have 74.97% stake in TTL. Promoters have a vested interest in the performance of both the listed companies, which is always a good thing.

An important data point is FIIs had a 16.6% stake in TEIL pre-demerger. This is important as FIIs might not want to hold on to TEIL after the demerger. It probably will lead to indiscriminate selling (and hence lower prices where we can pick them up).

Financials:

Let’s look at the business(revenue) composition of TEIL pre-demerger.

Revenue Composition (in millions)
2005 2006 2007 2008 2009 2010
Sugar (Sugar, Distillery, Power generation) 7864 (80.15%) 9269 (73.35%) 9126 (61.82%) 10774 (62.27%) 14017 (68.38%) 16411 (66.51%)
Engineering (Turbines, Gears, Water Business) 1947 (19.85%) 3368 (26.65%) 5636 (38.18%) 6529 (37.73%) 6482 (31.62%) 8265 (33.49%)

The two main businesses of TEIL seem to be Sugar and Engineering. As the percentage revenue composition would indicate, TEIL derives its revenues primarily from the Sugar and Sugar related industry, although the dependence has decreased substantially over the years, while the Engineering division revenues have increased substantially.

Since TEIL is spinning off its Turbine business, let’s look at the revenue composition of the Engineering business.

Engineering (in millions)
2005 2006 2007 2008 2009 2010
Water 82 (4.21%) 138 (4.1%) 400 (7.09%) 668 (10.23%) 997 (15.38%) 1610 (19.48%)
Gears 239 (12.28%) 450 (13.36%) 605 (10.72%) 769 (11.78%) 733 (11.31%) 1014 (12.27%)
Turbines 1626 (83.51%) 2780 (82.54%) 4639 (82.19%) 5092 (77.99%) 4752 (73.31%) 5640 (68.25%)

The above table indicates that revenue from Turbines unit forms the majority part of the Engineering business. The Water related business though is growing at a scorching pace.

So, what is the contribution, in terms of percentage of the Turbine business to the overall TEIL? The table below indicates that.

2005 2006 2007 2008 2009 2010 Median
Turbine Revenue % as part of entire revenue 16.57% 22.00% 31.43% 29.43% 23.18% 22.86% 23.02%

Therefore, TEIL is spinning of its TTL unit, which contributes 23% to the overall revenues.

(An interesting sidenote: Although Turbines unit contributes only 23% to the overall revenues, the stock price of TEIL (ex-TTL) has been hammered by 60%. Maybe the TTL business has got greater chances of growth than TEIL. Maybe not. Let’s look at the financial valuations now).

Financial Valuation:

Turbines (TTL):

Turbines 2005 2006 2007 2008 2009 2010 CAGR
Sales 1626 2780 4639 5092 4752 5640 28.24%
PBIT Margin 9% 15% 23% 25% 24% 23%
PBIT 153 418 1070 1280 1156 1304 53.50%

The sales of Turbines have grown at a CAGR of 28.24% over the past 6 years. The PBIT has grown faster, proving that the fixed cost per unit is lower, and hence PBIT is higher. The average PBIT is Rs. 896 million (89.6 cr). Assuming tax rate of 30%, the PAT is Rs. 627 million (62.7 cr).

I will make a sweeping assumption here (and to other businesses). The Turbines business is usually classified under the Capital Goods industry. The average P/E of the Capital Goods industry is 29, which is in line with the revenue CAGR of the Turbines business. TTL has tied up with GE back in November 2010 for greater reach and technical expertise and hence sustainability of the revenue will not be an issue (in fact, the order book itself as of Sep 2010 is 560 cr). However, let’s be very conservative and assign a P/E of half of the Capital Goods sector. Let’s say the P/E of this Turbines business is 14. Then, the EV of the Turbines business comes to Rs. 877.8 cr. That is, the price (intrinsic value) of TTL is around 877.8/33 = Rs. 27/- per share (if you include the effect of CRPS, the value is Rs. 25/- per share).

Since the price of Triveni Engineering before de-merger was Rs. 100/- and after de-merger is Rs. 40/-, the market is expecting TTL to list around Rs. 60/-. In the above calculation, if we had taken a multiple of 29 (P/E multiple of capital goods), we would end up at that figure.

The assumption is no debt will be on TTL’s balance sheet. However, any percentage of the Rs. 934 cr debt shifted to TTL will reduce the intrinsic value.

TEIL Valuation (ex-TTL):

Gears business:

Gears (in millions) 2005 2006 2007 2008 2009 2010 CAGR
Sales 239 450 605 769 733 1015 33.54%
PBIT Margin 13% 17% 24% 29% 33% 34%
PBIT 31 76 146 220 244 345 61.92%

Revenue of Gears has been increasing a CAGR of 33.5%. The margins in this business is also pretty high. Again, the PBIT is increasing greater than Sales revenue because of lesser fixed cost per unit.

Let’s value the Gears business. The average PBIT of Gears business is Rs. 177 million (Rs. 17.7 cr). PAT will be Rs. 12.4 cr. Although the Gears business is growing by leaps and bounds, let’s assign the lower end of P/E multiple to this business. Let’s assign P/E as 8 (you can assign 10 too, but I am being conservative inspite of the huge margins and stellar growth). That would bring the EV of Gears business to Rs. 99.2 cr.

Water business:

Water 2005 2006 2007 2008 2009 2010 CAGR
Sales 82 138 400 668 997 1610 81.39%
PBIT Margin 7% 16% 12% 16% 15% 14%
PBIT 5 22 46 105 148 219 112.96%

Water business has been a bumper to TEIL. In fact, of all the business, this business has grown the steepest. The indication from Management (through all those analyst transcripts) is that this business will continue to grow very fast. The CAGR of revenue is 81% in this line of business.

Let’s value the Water business. The average PBIT of Water business is Rs. 90.83 million (Rs. 9.1 cr). PAT will be Rs. 6.37 cr. Let’s assign, again the lower end of P/E multiple for this fast growing business just to be conservative. Let’s say P/E is 8 again (again, conservative – sales growth has been stellar while margins have remained stable). EV of Water business would be Rs. 51 cr.

Sugar co-generation business:

Sugar Co-Generation 2005 2006 2007 2008 2009 2010 CAGR
Sales 188 606 1339 1174 948 1467 50.82%
PBIT Margin 24% 27% 34% 41% 21% 18%
PBIT 45 165 449 476 201 270 43.10%

TEIL has not only been generating captive power, but also has been selling additional power to the UP grid. The CAGR is fantastic (although I doubt how far that is sustainable). The PBIT margins are also coming down.

Let’s value the Sugar co-generation business. The average PBIT is Rs. 267 million (Rs. 26.7 cr). PAT will be Rs. 18.7 cr. Since the PBIT margins are decreasing and sales not being stable, let’s assign a P/E of 6 (assumption of no growth from here) (I have no idea of any company involved in just sugar co-generation business and hence estimate a P/E on best guess estimate). EV of Sugar co-generation business is Rs. 112.4 cr

Distilleries business:

Distillery 2005 2006 2007 2008 2009 2010 CAGR
Sales 207 787 539 889 62.55%
PBIT Margin 11% 23% 18% 10%
PBIT 21 176.9 92 81 56.83%

Let’s quickly value the distilleries business. Growing at a fantastic rate. The average PBIT is Rs. 92 million. However, let’s take the latest figure, as its lesser than the average PBIT. PBIT of Rs. 8.1 cr. PAT will be Rs. 5.67 cr. P/E taken as 8 (P/E of Distilleries industry varies from 5 (GM Breweries) to 78 (United Breweries)). EV of Distilleries business is Rs. 45.46 cr.

Sugar Business:

Sugar business is one of the main businesses of TEIL. In fact, the majority of revenue of TEIL is from Sugar. No wonder that Triveni is counted among Sugar stocks.

Sugar 2005 2006 2007 2008 2009 2010
Sales 7676 8663 7605 8863 12529 14055
PBIT Margin 18% 16% 4% 16%
PBIT 1404 1351 -900 359 2023 -573

However, Sugar business as such cannot be valued with P/E multiples, since it is a commodity business. We can value it through Replacement cost and figure out the enterprise value. Alternatively, we can compare the crushing capacity of TEIL’s sugar business to other Sugar companies.

The crushing capacity of TEIL is 61000 TCD. The closest comparable sugar company is Balrampur Chini with crushing capacity of 73500 TCD (in fact, very close as this company’s sugar plants and supply all are in UP, like TEIL). The EV of Balrampur Chini is around Rs. 2700 cr. (1834 cr market cap, 900 cr debt and 33cr cash). The math is elementary here. The EV of TEIL is therefore Rs. 2240 cr. Let’s assign a margin of safety of 30% here (although sugar stocks have corrected a lot, I cannot estimate whether the current prices are high or low. One indication is that Balrampur Chini has done buyback, which indicates stock prices at current levels are low/below average. However, let’s not take any chances and take 30% haircut from here). Therefore, EV of TEIL after margin of safety is Rs. 1568 cr.

So, what is the EV Market Cap of TEIL, after TTL has been spun off?

Market Cap of TEIL = (Sum of all EVs within TEIL – Debt – Preferred share (CRPS) + Cash)

Market Cap Value (in cr)
EV of Gears (+) 99.2
EV of Water Business (+) 51
EV of Sugar co-generation (+) 112.4
EV of Distilleries (+) 45.46
EV of Sugar business (+) 1568
EV of 22% of TTL business (+) 193.116
Debt (-) 934
Cash (+) 25
CRPS (-) 2.8
Market Cap 1157.376

Intrinsic value of TEIL = 1157.376/25.8 = Rs. 44.85/-

The intrinsic value of TEIL, inspite of conservative estimates all around is Rs. 44.85/-.

Current price is Rs. 40/-.

Debt Analysis:

Assuming the entire 934 cr debt is on TEIL’s books (referring ARs of 2008-09 and 2009-10, Loans and Advances from Triveni Engineering to Triveni Retail Ventures (TTL) doesn’t exceed 20-25 cr), the interest expense is around 85 cr.

This 90 cr interest expense will be deducted from TEIL’s PBIT, which is 23% less (due to spin off of TTL).

To labor on that a little bit,

Revenue Composition (in millions)
2005 2006 2007 2008 2009 2010
Sugar (Sugar, Distillery, Power generation) 7864 (80.15%) 9269 (73.35%) 9126 (61.82%) 10774 (62.27%) 14017 (68.38%) 16411 (66.51%)
Engineering (Turbines, Gears, Water Business) 1947 (19.85%) 3368 (26.65%) 5636 (38.18%) 6529 (37.73%) 6482 (31.62%) 8265 (33.49%)
PBIT 1669 2032 832 2616.9 3864 1646
PBIT Margin 17.01% 16.08% 5.64% 15.12% 18.85% 6.67%

PBIT of TEIL (pre-demerger) is Rs. 164.6 cr. Therefore, PAT would be (1-0.3) * (164.6-90) = Rs. 52.2 cr

In the post de merger scenario (assume similar PBIT), PBIT of TEIL will be 0.77 * 164.6 = 126.74 cr.

Therefore PAT of TEIL will be (1-0.3) * (126.74 – 90) = 25.7 cr.

Revenue is reduced by only 23%. However, PAT has reduced by almost half.

(Essentially, this means EPS is slashed by half. Given the same number of shares, the stock price should have been half of pre-demerger. But it has corrected to 60% of predemerger price).

Risks:

1) Sugar commodity cycle has not been predicted/taken into account. Although 30% haircut from existing prices has been factored into the equation, we might have swings more than that, thereby screwing up valuation. Co-generation and Distillery are also businesses dependent on Sugar, but past performance indicates that the margins are much better than the Sugar business and also profitable even in the downturn of Sugar commodity cycle.

2) The debt amount transfer between TEIL and TTL has not been put forth by the management yet. This might have significant impact on the EPS.

3) Investment components have not been considered in the analysis.

Disclosure: No position yet in the stock.

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  1. #1 by Soham on May 11, 2011 - 5:06 PM

    Arent you double accounting for debt for Balrampur Chini by adding up mkt cap and debt together? Also the cash?

  2. #2 by Kiran on May 11, 2011 - 5:26 PM

    No Soham.

    Enterprise value is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents.

  3. #3 by Dayanand on May 12, 2011 - 4:02 PM

    Very good analysis, Kiran.

    My experience is that this type of special situation takes a long time to fructify…

    For example you can look at Dalmia sugar, Weizmann, Zee News, Kirloskar Industries..all of them are languishing after demerger for a long time…

  4. #4 by Aditya Podar on June 7, 2011 - 12:32 AM

    Hi Kiran,

    Great value investing columns on your blog here !!!

    There is news (media based) that TTL will be listed soon either by end june or may first week. Your valuations are conservative which are always great when one wants to invest for the long term. I hate thinking short term but your excellent analysis on the EV & Intrinsic value of TTL compels me to think short term (even though i hate it).

    You are right that the market values capital good companies between 25-29x. Even if i make a Rs 150 crore addition to your total EV of 1158, the assumed EV will come to apprx 1300 crores / 25.8 = Rs 50.3 for TEIL. A difference of Rs 12.8/- which 34% in a controlled time frame of say 45-50 days. Yes, the debt portion is yet to be clarified but given the history of demerger listing on our indian markets, the crowd generally tends to dismiss such incapability of clarity.

    It would be great if you could share your views.

  5. #5 by Abhijith on August 16, 2011 - 1:26 AM

    Hi Kiran ,
    Nice article.
    I would like to know if TTL is listed as of now? I had invested in TEIL last year. My DMAT account shows a 75% loss after 4th May 2011. I dont know when we will recieve TTL in our DMAT , so that I may update my portfolio.
    Thanks
    Abhijith

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