Picking beaten angels – Part II – LMW (BSE: 500252)

Amongst all the clutter and noise at present in the market, we believe that there are companies which are plugging away slowly, beaten down more than necessary due to market pessimism and worthy of mention as a result of attractive fundamental story. LMW or Lakshmi Machine Works, (BSE: 500252; NSE: LAXMIMACH), is one such name. Below, we present our case:

Investment Rationale:

Lakshmi Machine Works Ltd (LMW) is a Coimbatore, Tamil Nadu based textile machinery manufacturer. LMW is India’s largest and world’s third largest textile machinery manufacturer. LMW is a 40 years old company and sold almost 2.3mn spindles in 2007 with almost 60% of the domestic market. Swiss based Rieter is world’s largest textile machinery manufacturer and has a long association with LMW. LMW acquired the technology to manufacturer textile machines from Rieter’s only. In 1999, both the companies called off their collaboration, but Rieter still continues to hold 13% in LMW and has its own production unit in India as well. Before we start narrating the entire script, here are the following major pillars of our investment thesis:

  1. Orders of Rs.4500 Crores in hand, leading to a sales visibility for next 2 years.
  2. Gets 10% of the order as advance from the customer, leading to negative working capital
  3. Debt free with a cash of ~ INR 600 Crores at FY 07 end
  4. Gets 1.75% of the textile machinery bill amount as subsidy from GOI under the EPCG scheme. Sales of textile machinery to 100% textile EOU are considered to be deemed exports.
  5. Stable OPM of 17-18% and PAT of 11-12%
  6. Implementation of VAT in TamilNadu is saving Rs.2.5-3 Crores every month for the company
  7. Exploring other major Asian textile manufacturing hubs like Pakistan and Bangladesh
  8. Textile Up-gradation Fund Scheme (TUFS) has been extended till 2012 by GOI

  1. No price change since June 2005 with iron & steel, aluminum, brass, copper and pig iron as the biggest raw materials
  2. Invested ~Rs.400 Crores in last few years to double the production capacity to 3.5mn spindles in 2008 from 1.8mn spindles in 2006
  3. No plans to expand the capacity going forward

One Immediate Trigger

Voltas provides presales, order booking and installation services to LMW. In its latest results announced by Voltas, the company has gone on record saying that “Textile Machinery division achieved 20% growth in equipment sales”. Applying the same logic to LMW, the company should post the same growth in its textile machinery business also leading to Rs.2000-2100 Crores of sales in FY08 with Rs.1682 Crores of sales in FY08.

LMW is scheduled to announce its results on May 19, 2008.

Indian Textile industry – Key Facts

  1. Accounts for 14% of industrial production and 4% of GDP
  2. Employs approx 35mn people, second largest after agriculture
  3. India’s textile exports in 2006-07 – $17B. Target to export $50B by 2012
  4. India’s expected domestic textile market in 2012 – $50-60B
  5. Installation of 38.8mn spindles (21mn supplied by LMW) out of which:
    1. 29.8mn are active
    2. 10mn are waiting to be scrapped
    3. 15mn are fit for modernization
  6. 6. India’s textile machinery market (3.9mn pa) is second largest after China (7mn pa). Pakistan is third largest with 1.1mn spindles pa.
  7. 7. India is expected to add 3.5mn – 4.8mn – 5.4mn spindles every year under worst, base and best case scenario till 2012 to reach its $50B export target.

Business Profile

  1. More than 4 decades old
  2. Sold 2.33 mn spindles in 2006-07, with ~60% of the Indian market
  3. Third largest textile machinery manufacturer worldwide with Rieter of Switzerland and Schlafhorst of Germany bigger than LMW
  4. Long-term association with Rieter has helped the company to learn the technology with 90% of raw material and components locally procured. Reiter holds 13% of LMW. Reiter has its own production unit in India.
  5. Large localization helps the company to sell the products at 15-20% less than its global peers.
  6. Invested Rs.410 Crores in last 2 years to increase the capacity from 1.8 mn spindles in 2006 to 3.5 mn in 2008.
  7. Takes 10% of the order as advance, leading to negative working capital. Similar amount on Rieter BS seems to make this a worldwide phenomenon.
  8. Increased capacity and improvements in production has helped the company to decrease the delivery period to 10 months from 18 months.
  9. Worldwide textile machinery demand peaked in 1HFY07. LMW is expected to end FY08 with an order book of Rs.4500 Crores as against Rs.5400 at Q2FY08 end.
  10. Plan the production at the beginning of the quarter by getting an approval from the customers.
  11. Irrespective of the date of arrival of the order, the customer is charged at the time of delivery of the machinery.
  12. The pricing is done as per the prices prevalent at the time of delivery, as per the competitor’s rates and the market conditions. Due to this practice, the margins are expected to remain stable going forward.
  13. The company has been following the current pricing rules since last 40 years and has never faced any issue with any customer.
  14. No price hikes since June 2005.
  15. The company gets 1.75% of the bill value machinery sold as exports or to EOU’s as benefit under EPCG scheme from GOI. The company previously used to share (50:50) the benefits with the customers but now has stopped the practice.
  16. Implementation of VAT in Tamil Nadu is helping the company to save Rs.2.5 Crores – 3 Crores every month.
  17. Holds investments worth Rs.60 Crores. JV with Rieter had sales of Rs.121 Crores and PAT of Rs.9.85 Crores in 2006-07. LMW has invested Rs.12.5 Crores in the JV.

Product Profile

  1. Textile Machinery Division – 90% of the sales
  2. Machinery tools & Foundry Division – 10% of the sales.
  3. As the technology in the machinery tools division is highly guarded by some of the world major’s, the sales mix is not expected to change dramatically going forward.

Shareholding Pattern







Association with Voltas is strategic as the same provides presales, order booking and installation services to LMW. Voltas charges 3%-4% of the bill amount as commission.

We would like to resist from giving any projections considering the uncertain economic environment we are in. Also as per our philosophy, is it what he have that matters and not the uncertain future.

Conclusion

LMW with its leading position and strong order book is a strong defensive investment available at cheap valuations. We expect the company to do well in future and the share price to mirror company’s financial performance.


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4 Responses

  1. I tend to disagree with this stock a bit because:1.Textile players are facing tremendous heat due to dollar volatility2.Many have shut shop3.Most players who added / ordered huge capacity during the 2005 mania are now facing underutilization of capacity – in fact, last week I visited a co. in Coimbatore who told me he has excess capacity.4. As far as the order book goes – there too the position is not as good – textile companies who have placed orders are cancelling them / postponing expansion plans5. To top it all – the wage cost for textile manufacturers is going up like crazy, compounded with lack of availability….leading to put further expansion plans on hold / reconsider themLMW manufacturers machinery / capital, therefore it will precede the overall textile cycle by 2/3 years – as that is the time taken to add capacity. It was a good stock to buy just before the expansion plans started – now we are at the end of the curve – from here orders will only go down and down. Textile manufacturers who have installed capacity and which are underutilized capacity are the ones to buy now – they will be the first to encash when the market turns around.However, LMW has one advantage – it has got tremendous super high value real estate assets in Coimbatore (dont know if it is owned by the company or promoters!!!!!). As yet, it hasnt quite converted into a real estate play – but once it does (and i hope the company does it and not the promoters in personal names), it will be a rocking star.What say…what are your views….

  2. We think that all your views are well founded. Here is what we believe: Textile industry has no entry barriers. A new spindle cost Rs.8000-10000. So even a guy with 1 lac rupees can start a textile unit.. Although worldwide, across the times, it has been witnessed that textile is a capital destructive sector. But I believe that the sector has such a huge fascination that it attracts investors invariably. One major factor that is never talked about is the Indian domestic textile market. According to rough estimates, our domestic textile market is as big as $35-40B against the entire exports of $18B in 2006-07. Government wants to increase the total exports to $50B by 2012. And as textile industry is the second largest employer, come what may, government will never allow the industry to fail. It is just that the dynamics of the industry are such that nobody makes money. Order book is down from Rs.5400 crs in 2QFY08 to estimated Rs.4500 in 4QFY08. But this is the worldwide phenomena. If you check the Reiter’s (World’s largest textile machinery maker) mgmt press notes, they also mentioned that textile machinery market peaked sometime during Q2CY07. There is a very thin line of difference that we need to understand and that is LMW and Reiter has a totally different audience. If you want to build a world class textile plant, then come what may, you will go to Reiter. But if the aim is to have a textile plant, then LMW is the answer. Reiter will never come down to LMW level, and LMW will lever raise its bar to Reiter’s level. Asia due to its cotton and labor advantage has a natural edge over western countries to produce textiles in bulk. That’s why if you check Reiter’s as well, Asia is its biggest market. I am not too much bothered about the labor cost primarily due to 2 reasons:1. We have a large pool of uneducated, unskilled people creating a tremendous supply and this supply is not going anywhere soon2. One of the reasons why labor costs have gone up in last few years is due to the real estate boom. Real estate is the direct competitor with the textile industry to use its labor. With real estate slowing down dramatically, I believe that we will see labor shortage easing out in next few quarters. I believe that LMW’s cycle runs inline with the textile industry as the period to conceive a textile project to the actual development of it is very less. If you believe that orders will only go down from here, then here is an assessment done by CRISIL for the estimated demandWhat I have included in my assessment is only the worst case scenario of 3.5mn spindles every year. So even if the company were to just maintain its 60% market share, they will match the 2008 sales.Real Estate – In 2005, CLSA started valuing Infosys with its land bank. I think that is an absurd position. If I have land and a factory on that, that land has no value for me as I need to run my factory as well. If anything happens on that front, I would be delighted, otherwise, that is just a dead proposition for me. Today is LMW’s first analyst meet. I will provide with more updates post that. Thanks for the questions. We really appreciate your constructive feedback.

  3. I appreciate the quick replies. Basically, whatever I said earlier and whatever I am saying now is because I kind of am privileged with being very close to the sector – we are into it!!! Just a few points:1. I agree textiles is a big market – but what I am saying is, people start adding capacity when the curve is up i.e. the capital equipment makers boom before the market booms (by a few years) and when the market booms – the equipment makers have already made money.2.Also, capacity addition (in most of the industries) always come in lumps – there will be shortage so suddenly the whole world and its wife will add capacity which will lead to a glut and cutthroat competition then no supply for some time and the cycle continues.3. The labour cost going up comment I made was from a textile unit in Coimbatore with 7 plants!!!!4. Agreed – we have a large pool of uneducated and unskilled people. However, textile units need a basic level of skilled people, also this pool is widely dispersed leading to logistical problems to achieve economies of scale. The above co.has shuttles, and its workers come from a distance of 50 kms!!!5. Textiles has become a commodity play for most and hence economies of scale are very important. the other imp. factor is own brand / marketing network6. Coming to the real estate point – i agree that if i have a running factory – land bank valuation is irrelevant. But lets dig a little deep – LMW owns prime properties in cmb which are now defunct units.I have just been there and from my work am involved in real estate. Also, even if these units were operational – the RE value is so high that the co.will earn more on the real estate than it could ever earn through a lifetime of operating the factory. This has especially been the case at cmb, dont know why. (e.g. A PE/VC firm i know invested in a textile co. in cmb a few years ago, now they have decided to just close down the factory, sell off RE and move to a cheaper location further outside the city). So, agreed RE valuation doesnt matter, but when the value goes so high that even moving the whole plant lock stock and barrel is justified – it needs to matter. – Just like the Sasken report you people published!!!!I feel LMW is good co. with strong fundamentals but the time now for high / super high growth is a few years too late. On the RE valuation….i dont have the summation. As far as the booming textile industry is concerned, i’d rate companies like Gokaldas, etc. high.However, one never knows…..if the textile market skyrockets and the exuberance which was seen during 2005 (scrapping of MFA) is seen again and people start adding new capacity….LMW is a sure winner…….but that is “IF”….LMW apart, i like the this interactive conversation moved and am happy this happened with Manav……looking forward to hear more from its analyst meet….maybe I’ll change my opinion…

  4. If you are in the sector, then I can’t beat what you know, but I canalways try. Some of the interesting facts that LMW mgmt shared y’day areas follows:1. Asia accounted for 94% of the new spindles that came online in 2007either for modernization/replacement/expansion. India and Chinaaccounted for 80% of that entire shipment that means if there is anyplace where textiles are getting made it is only India and China.2. Chinese machineries came into India with a big bang, but they werenot able to capture the market as they can’t run on the high speed whichis required by Indian co’s. (Although I don’t understand thetechnicality behind it)3. The company has decided to enter Chinese market and that too only inthe developed markets. The decision is to locate near to the textilehubs and not to go to some far flung space to save some money. Althoughthe decision is not going to have any kind of near term impact, butatleast a beginning has been made. Initially LMW plans to sell CKD(completely knocked down) units there, but the plan is to have amanufacturing unit there. In China, many textile units have more than1mn spindles working in a single location, which is not existing inIndia.4. I liked the mgmt personally. The CFO and his GM finance were notwearing usual black suits, there was no camera person to shoot (GM wastaking pictures on his own), there was no dais, no liquor, no printedmaterial, no gifts and they were very forthcoming to accept that thecompany is going through a bad patch. Buffett says “One can never cut agood deal with a bad guy”.5. Considering the raw material price increases, the company isseriously contemplating a price hike sometime in June or July.6. In the new TUFS scheme announced by the GOI, they have maintained thebenefit only for the machinery and removed it for all other items likebuildings, VRS etc. So it will prompt people to go for a brown-fieldexpansion rather than a green-field expansion.7. RE – You might be right, but I don’t have sufficient info to comment.I would be speculating if I add anything.One bigger step that I forsee and that should help the company is theintegrated textile plants (ITP) plan of GOI. I think this is a majorpositive for the industry in general and will help them to shape up forfuture. One thing which I was not able to get and may be you can explain, LMWmentioned that due to GOI policy for cotton exports, cotton prices havegone up and depressed yarn prices are forcing the companies not to gofor an expansion. What does that mean?Let’s discuss more going forward. I appreciate your thoughts.

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