Summary: I believe BEML is NOT a great value pick at current levels because even though it has sound fundamental, it does not have sufficient margin of safety. Personally, I have unrealized losses in the scrip and based on this analysis right now I believe I do not have much more downside at this moment. I have also established that the fortunes of company are more tied to general economic situation of the country. I will wait for another set of quarterly results and economic data and take a call on whether to book my losses and invest in another stock I have confidence in…

 

My Holdings:

My Present Holdings
Avg. Purchase Price	Holding period	Highest Purchase Price	Lowest Purchase Price	Unrealized Profit/Loss
605.47	LT  1 Year	735	499.5	(19.27%)

About BEML:

 The company is an old hand in the construction equipment industry. It was incorporated in 1964 and at present, it is into earth Moving equipments, Railway products and defense products (in the order of their size).  Govt of India owns just over 54% of the company.

BEML’s Ecosystem:

When defined as a pure play construction equipments company one can say that BEML is one of the largest in this business in the country. But a like-for-like comparison of companies in this industry is difficult because there are so few of them that are publicly traded in the country. I prefer to believe that BEML’s ecosystem in terms of its financial dynamics is similar to other industrial machinery manufacturers in the country (more on that later). In terms of its financial dynamics, BEML’s business involves capital intensive work where it receives large orders from other firms who pay for the work over a specific no. of milestones spread over the duration of the project. Hence, the company’s immediate prospects depend not only on the size of the order but also on how soon the order has to be furnished.

BEML’s position in its ecosystem:

Since BEML’s business depends on long term capital intensive orders from other industries and since it dabbles into both construction equipments and industrial work, I prefer to compare BEML with other companies manufacturing industrial equipments, boilers, turbines and engines. Even when we do this comparison, we realize that in terms of the last 3 FY average sales there are 17 companies with more than 500 Cr. Gross sales in India. In that list, BHEL is a clear outlier at more than 35,000 Cr. Rs. average sales. Ignoring that, we see that BEML is indeed a large player in its industry.

Top companies in Industrial Equipment/Boilers/Turbines/Engines/Construction Equipments industry arranged in decreasing order of their average last 3 FY sales (Rs. Cr)

Company Name	Industry group	Main product/service group	Avg Sales
Bharat Heavy Electricals Ltd.	Boilers & turbines	Prime movers	35706.9
Suzlon Energy Ltd.	Boilers & turbines	Wind turbines (Wind electricity generator)	5039.6
Thermax Ltd.	Boilers & turbines	Steam boilers	3749.1
Cummins India Ltd.	Engines	Internal combustion engines	3647.9
B E M L Ltd.	Construction equipment	Earth moving machinery	2926.7
Lakshmi Machine Works Ltd.	Industrial machinery	Textile spinning machines	1661.4
Mcnally Bharat Engg. Co. Ltd.	Construction equipment	Material handling equipment	1406.9
Tecpro Systems Ltd.	Construction equipment	Material handling equipment	1399.7
Greaves Cotton Ltd.	Engines	Diesel engines	1331.2
Elecon Engineering Co. Ltd.	Construction equipment	Material handling equipment	1155.7
Alfa Laval (India) Ltd.	Industrial machinery	Machinery used in food & beverage industries	879.2
V A Tech Wabag Ltd.	Industrial machinery	Water treatment plants	667.2
Praj Industries Ltd.	Industrial machinery	Brewery machinery	663.2
Walchandnagar Industries Ltd.	Industrial machinery	Industrial machinery	649.8
T R F Ltd.	Construction equipment	Material handling equipment	645.8
Action Construction Equipment Ltd.	Construction equipment	Mobile cranes	539.1
Ion Exchange (India) Ltd.	Industrial machinery	Water treatment plants	521.2

With this perspective, I believe that BEML’s fortunes are impacted more by the general economic conditions of its client industries, and less on the basis of its position vis-à-vis its competition.

Reported Financial Performance:

The in the last FY2010-11, the company’s total revenue and PAT decreased on a YoY basis, but the reduction in PAT was more severe than the reduction in Sales.

As per the company itself, the two factors for this were revision of wages and change in product mix . In hindsight, that looks ok because in the recent years the company is steadily increasing its involvement in Railway products business (which is unprofitable for it) and reducing its involvement in earth moving business (which is most profitable). The reasonableness of this move can be argued but at least that explains the variation in its profits.

Below is a high level view of the company’s finances as reported In its annual report.

FY	2008-09	2009-10	2010-11
Net Sales (Rs. Cr)	2822.35	2855.84	2627.48
Reported pat (Rs. Cr)	268.84	222.85	149.76
Average Net Worth (Rs. Cr)	1799.43	1971.74	2087.71

Below is the segment mix of BEML that clearly shows the move towards unprofitable business.

	Mar-09	Mar-10	Mar-11
Segment Gross sales	3,013.47	3,557.67	3,623.52
Defence Products	586.11	679.35	705.67
Earth Moving Equipment & Spares	1,874.85	1,842.53	1,528.03
Others		14.95	57.87
Railway Products	476.9	1,020.84	1,331.95
PBIT	512.03	440.76	284.63
Defence Products	109.19	107.77	89.27
Earth Moving Equipment & Spares	378.54	384.24	250.08
Others		2.32	6.59
Railway Products	15.22	-53.57	-61.31

Free Cash Flows to Equity Owners:

 Along with the above finances, one can look at the below measures from the company’s annual financial statements.

FY	2008-09	2009-10	2010-11
Cap Ex	44.32	26.96	163.03
Dep + Amortization	27.31	32.22	33.64
Absolute change in Non-Cash W/C	-820.04	-158.82	-128.97
Total Increase in Debt	264.37	340.92	-91.44
Total Increase in Deferred Tax Liability	3.07	-34.24	-11.84

 One can see that the company’s Non-Cash working capital is really fluctuating from a year to year basis. Within the details of the balance sheet, one can see that in 2008-09 there was a huge amount of money blocked in inventory and the trade receivables. It augurs well with the general economic situation in that year when the economic activity took a huge hit. It should be noted that since then the receivables have reduced a lot (cash flow was positive this FY) and the amount of money blocked in inventory is reduced as well.

Also, on the debt side, the company paid back a part of its debt in this FY after borrowing big amounts in the last 2 FY.

To take care of such fluctuating performances on Working Capital and Debt sides, I have normalized the Debt and Non-Cash working capital over the past 6 FY. Along with this, the company has reported certain amounts of extra-ordinary items as well (other income, prior period income/expenses etc). I have normalized them as well over the last 6 FY.

When I normalized the above factors and calculated the FCFE, I get the following data (all amounts in Rs. Cr):

Average last 3 FY Sales	2768.6
Net Profit	149.8
Cash Value	48.3
Latest FCFE after Normalization of Debt and Capex	1244.8
Latest FCFE before Normalization of Debt and Capex	-245.3
Average FCFE after normalization for the past 3 years	216.3
Average FCFE before normalization for the past 3 years	-39.4

Clearly for BEML, one can see that the fluctuation of free cash flows is huge when one normalizes h variables involved and that the latest figures of free cash flows are much worse than the average figures over the last 3 FY.

Fit vs Flab:

The business of the company involves capital intensive work. Despite that when one looks at the latest financials, one will find:

1. Current assets are much greater than current liabilities.
2. Current assets are greater than total liabilities.

I believe that is sound financial condition. One more parameter that one needs to look at while judging the financial condition is the interest coverage (i.e. indicator of how much income is left once interest is paid out). In this category, there is an issue. The coverage is just 2.3 for BEML, which means that the company’s income is only 2.3 times its interest expenses. That can be explained because we saw a dip in the company’s profitability, but it also implies that if the income dips further, than the company may have to dig into its cash and reserves to pay back.

In terms of Fir vs. Flab question, I believe that the company is doing well.

Ownership Structure:

54.03% of the company is in the hands of its President Of India. This to me is not the cause of any concern. BHEL (a clear outlier in our set) is owned 67.7% by the President.

Return on Net Worth: 

The PBIT/Avg. Net Worth for BEML has fluctuated between 34.1% and 6.4% in the last 6 FY and for the last FY it was 6.4%. In the last recession 3 years ago, it was 16-21% and so the profitability performance of the company is at its nadir.

Value Judgment:

Based on my analysis till now, I can conclude that BEML is a financially safe company going through a bad turn. However, no company is worth paying 0 price and so one has to understand how the price compares with the inherent value of the company.

The BSE closing price on 13^th October was 487.8 for BEML. When compared with various parameters I believe dictate the worth of a company, we see:

Company	B E M L Ltd.
Latest BSE closing Price	487.8
P/E Reported	13.6
P/FCFE Updated (After Normalization – Latest)	1.6
P/FCFE Updated (Before Normalization – Latest)	-8.1
P/FCFE Updated (After Normalization – Last 3 FY Avg)	9.2
P/FCFE Updated (Before Normalization – Last 3 FY Avg)	-50.4
P/Trailing 4 Qtr Earnings	18.4
P/Bv	0.97
Current Assets > Current Liabilities	TRUE
Interest Coverage	2.28

 With a string of poor results, the company is trading at 9.2 times of its last 3 years average FCFE (net of cash) and just at its book value. In terms of value, I believe the company is worth exactly what it is now.  The company is trading just about at par and any fluctuation in its price depends on only 2 factors:

• Kind of news one gets on profits in the coming quarters (like on orders in profitable businesses like defense)
• Kind of news one gets on state of Indian economy in the coming quarters

In terms of investment opportunity, I don’t believe that there is a sufficient margin of safety here. It is no doubt that the company is inherently sound. But the soundness of the company will protect it only so much from bad times and based on my analysis the quality of that protection is wearing thin.

 In terms of price trends, the prices have bottomed out for now and I believe that they could have gone down more if the company was in any poorer financial health.

Verdict:

It does not make sense to invest in BEML right now. As in investor, there isn’t enough sufficient margin of safety at the moment. However, an optimistic investor can keep an eye on the stock and invest as soon as the future looks brighter. The company has shown that it can bounce very well from bad times (it has shown that).

Note on shifting towards railway coaches business:

At the beginning of the article, I made a point on how the company’s profitability has taken a hit due to its move towards the railway coach production work. There are news articles in market where the company has won good orders on more railway coaches in for Metro projects. So should I conclude that in the coming time the company will become more unprofitable? May be! The fiscal health of GOI is not great and metro station work can take years to complete. However, I believe that improved fiscal situation is a future of India and with the anti-corruption wave, it is possible that the projects end up getting executed faster. Also, if a decision proves to be sufficiently wrong for some time can be reversed as well. The company has shown this in the past as it was once a defense supplies manufactures and then went into became earth moving equipment business. In the larger scheme of things, I think the future could be bright for the firm. However, any investor not willing to by my point of view is advised not to invest in this company for now.

Personal Note on BEML:

I invested for the first time in BEML in Apr 2011 when the price was about 735 Rs. I had started to invest only recently and was very new to the concept of investing in terms of maintaining one’s discipline. I thought it was a great buy (based on that last FY’s reported financials!) and invested a significant amount of money into the scrip. I would not have done that if I knew then what I know now about the fluctuations in fortunes of a capital intensive company in terms of its working capital and cash flows. Once I learnt them, I found out that BEML was in the mid 550’s sometime this year. I increased my holdings in the scrip at those levels because I believe that the company was a par buy at those levels.  But then again, I did not realize the importance of margin of safety. The company had to be sufficiently below its worth for me to bet on its fortunes. I have learnt the lesson now, but unfortunately the hard way.

Lessons learnt:

1)        Never commit a lot of money upfront, esp when you one does not have any margin of safety.

2)       Huge engineering companies depend on their non-cash working capital flows. Giving importance to PAT is the wrong approach.