Several of our Value readers has sent request on Marg in last few days and a hot discussions going on our blog, I thought to share my views and analysis on Marg.

There also seems confusion on how to approach our quality & performance ratings and on our techniques of calculating values.

Let me clear up the dust before getting into Marg. Value Operations platform is not a platform that predicts the price movements or gives any tips on direction of stock price or generates buy sell signals.

The Value Operations platform needs to be seen as a smart tool that can help you in your research so that you can take educated decision. Quality ratings and valuations are both independent and are not attached to our personal view or opinion.

We measure the quality of business not on what management wants us to see but looking at real facts and what really is happening. Let me give you an example, if you look at Marg 2010 -11 Annual report, on page 4 they have printed in large caption and mentioned about ‘Numerical growth’ with asertix on it. They mentioned that book value grew by 46% and profit after tax by 49% compounded rate in last 5 years. (All these figures are on standalone financials!).

If I look at consolidated reports than profit after tax grew by 30% and book value grew by 38% at compounded rate in last five years! This calculation is also made without factoring equity raised by management in last 5 years! Also management might be feeling shy to talk about the compounded
growth in its borrowings and cash flow situation, and thought to ignore it in their Annual Report.

Whether you talk about standalone or consolidated reports, both do not impress me to invest with Marg. There is plenty of business risk associated with this business. Though this business will see its returns to up tick but I am not convinced with the capital allocation made by management. The growth in earnings or after tax profits is not organic. There is nothing new about it; if you chip in more in your bank account too your earnings grow.

Do you think management of any company will come out and say anything negative about the company they manage or talk about it openly in interviews? They will never come out and keep their foot at wrong end. They all love their jobs.

Managing business and investing in business are two separate line of Business. Investors should focus on what money is ‘going out’ and what is ‘coming in’ the business.

Few of the drivers that motivate manager (management) to make acquisition or other decisions are as follows:

– The desire to be bigger

– Pressure from institutional investors to ‘grow’ revenues and profits.

– The desire to increase share price

– Pressure from institutional investors to ‘grow’ faster.

– Pressure from corporate advisers and lenders to take advantage of low interest rate and borrow more.

The approach that I take while investing in any company is that, I am happy to buyout the whole business or keep investing in that company and be one of the biggest investor of that company if its earnings are quality earnings.

Talking about Marg, Value Operations quality and performance rating for this company is C4.

Let’s look at the capital history of this company for last 5 years:

The speed at which debt has been increasing consistently and incremental capital (Networth), the profits looks like flat in the chart. The company had total assets of 3,045 Crore as of March 2011 and generated profits of mere 18.68 Crore that represents 0.61% return on their total assets.

The return of 0.61% on net tangible assets suggest to me that there is virtually no economic goodwill and such business should sell for no more than its net tangible asset, and arguably very less.

Let’s look at the cash flow situation for Marg:

The big purple bar is a money required by company to fulfil its capex requirement and running of the business. Almost entire fund was supplied from borrowings. I am stun to see that this business has not generated a single rupee from its operations in last 5 years and last year they required 800 Crore rupees to fund their hunger to grow and run business. There is a real tough question for the people who talk about business cycle to throw some light on how much more time and extra money required investing to see some handsome profits from this business?

Many of you would argue that they are still in investment mode and need cash to facilitate their projects and once they are fully operational their cash flow will be in positive. Let me segregate what kind of funds was used in maintenance and what was used as capital expenditure. In 2009 they required 600 Crore, out of which only 375 Crore was used as capital expenditure. In 2010 they used 500 Crore and 570 Crore in 2011 on Capex.

The rest of the balance money was used in maintenance. These are the basic characteristics of capital intensified business. To create any real value for shareholders, Marg will have to generate high cash flow from their operations to pay their maintenance bills, dividends, service their debts, pay taxes and left overs to be used to deleverage/ investment.

They have plans to invest another 35 – 40 thousand Crore for investment. Marg is still burning cash to run its operations. Their profits before tax margin in 2011 was 7.32% and to stop burning shareholders cash excluding their capex requirements they need to generate between 200 – 300 Crore to pay their bills. This translates that they need to do business of at least four thousand Crore and report profits in that range.

They have to really do well then breakeven if they want to go with their investment plans. The real value is created when majority of Capex expense are funded internally through their cash flow or they have sufficient money to service their debts. Marg is missing out them.

The biggest threat to any investor is equity dilution. I won’t be surprise in near future this company is very close to raise equity to fund its future projects or to repair their Balance Sheet.

Finally, coming to the valuations, as this business does not report consolidated quarterly reports, it is very hard to value this business ongoing because of lack of information available.

As mentioned earlier, you cannot value this business and take decision on standalone results. Our model calculated its intrinsic value for March 2011 as Rs 21 on its book value of Rs 106 and reported profits of 18.68 Crore.

We are expecting its intrinsic value for March 2012 to be Rs 60 and expect them to report profits two and half times more of reported March 2011. We also expect Intrinsic value for March 2013 to be Rs 221. Many investors might be feeling uplift to see that kind of performance. But hang on, look at the mountain of debt allocated and amount of money they are spending! It is important that they cut down their expenses and start generating cash from operations at least half of their required fund. We consider this business is trading at premium to its expected 2012 value. We need to draw line somewhere, looking at the attractive future valuations you might get tempted to buy this stock. But it is risky to take decision on only valuations and ignore quality of the company. Don’t forget that increment earnings earned by company are on back of debt and is exposed to high risk. Any upset in revenues or earnings will have direct impact to its future value.

Remember, we shared that we believe in Ben Graham theory that in short term market is like voters machine where investors register their popular stocks but in long run it behaves like weighing machine and ‘values’ business not on momentum but looking at business economics.

In March 2011, Marg was trading at Rs108 levels and had fallen down from Rs 190 levels of 2010 and same period Nifty had climbed from 5200 levels to 5800 during the same period. Market is full of irrational investors!

When prices of any stock fall substantially does not mean they are trading at cheap. They might be still costly to acquire!

Again, you have to take my analysis on Marg as a second opinion or as a research paper to compare with your research. Your views on company are most welcomed. Also, if there are any companies you want me to write my views then just go to the comments and leave names of 3 companies. I will endeavour on each and everyone of your request on fortnightly basis, starting with most commonly requested first.