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A jump in Swaraj Engine on the news of special dividends of Rs 20 per share was like early fireworks of Diwali. A dividend of Rs 33 per share on a market price of Rs 446.60 is a return of almost 7% on the
investments.

But are the investors not getting the bottom line of the entire results? What happens when the dividend’s record date passes and shareholders receive their dividends? Market price plunges down!!

Swaraj engine is one of the investment grade businesses for us.

The headline on the media was all about the dividends of Rs 33 and no one was interested to look into its financial results. If we look at the results then Net profits have jumped by only 5% which is alarming. Swaraj engine managed to give returns of 35% on its retained earnings. It would be totally different returns if they did not announced that special dividends! (Without special dividend it will be 8% return on additional retained earnings)

Swaraj Engine had upgraded its engine capacity but is pretty much dependent on Mahindra’s tractor divisions demand to utilise that in full. The nature of this business is such that its earning growth is totally dependent on the demand from the market. Tractor industry is going through a rough phase and Mahindra is expecting the demand for its tractors to grow this year.

We feel this is the time for management to look for the new markets for their products around the globe then just relying on Mahindra’s tractor divisions’ demand. One thing is very clear that at this point management have no idea to invest this excess cash that this business is producing at effective returns. It will be interesting to see what they think about this idea of looking for new markets.

If these trends of high dividend pay out continue then we can compare Swaraj engine as to any bond with the coupon rate (dividend yield), then market will re rate this business intrinsic value. However, we admire the decision of distributing this excess cash to its real owners by the management. They are considering shareholders as the real owners of the business.

Swaraj Engine intrinsic value for the year end 2013 has fallen down to Rs 277 from Rs 335 in the 2012 year. However, because this business is not reinvesting much of its shareholders profits back into the
business and if it repeats same growth of 5% in its earnings for 2014, then we expect its intrinsic value for 2014 to be Rs 376.

Should management keep sharing its profits with shareholders where they don’t have any avenues to invest money at attractive returns? What other markets can Swaraj Engine can explore to grow its business? Your ideas will not only be valuable to other investors but also to the management of this
business. Share with us what do you think about it.