This Penny Stock Deserves to be on Your Watchlist 

Hello everyone, Rahul Shah here, trying to make investing accessible and profitable for the average investor.

Some of you would know that I analyse penny stocks at Equitymaster amongst other things.

I have also done quite a few videos around penny stocks. However, the last one was done quite some time back.

I thought I will finally fill this big gap by coming up with a new video on penny stocks.

So, here I am. Doing a video on a penny stock and sharing my knowledge with you.

The stock that I am going to talk about today is Visaka Industries.

If you look at the company's market cap, which is in the range of 750 crores and its topline which is around 1,600 crore for the latest financial year, you might think that this is not exactly a penny stock.

Well, I don't define penny stocks based on market capitalisation or topline.

I define them based on the price that they are trading at. If a stock is trading at a single digit or a double-digit price point, it is a penny stock for me.

In other words, any stock that is trading below Rs 99 per share is a penny stock as per my definition.

Given Visaka industries current share price of Rs 85 per share, it certainly qualifies as penny stock based my definition. In fact, the stock is a recent entrant in the penny stock club.

The stock underwent a 5:1 stock split as recently as May 2023. And therefore, there was an adjustment in the share price in order to account for the higher number of shares post the split.

Hence, a stock that was trading at more than Rs 400 per share, had a price adjustment and the price fell below Rs 100.

If you look at the profit and loss statement of the company, especially over the last 10 years i.e. since 2014, you may get a mixed feeling.

The topline between March 2014 and March 2013 has not even doubled in these 10 years. This is much lower than even India's GDP growth rate, which at least doubles every 6 years on an average.

Therefore, the topline growth has been disappointing to say the least.

The bottomline between FY14 and FY23 seems to have done much better. It has gone up more than 4 times during this period. However, this is more due to a low base effect as the company's FY14 profits had crashed due to margin pressure. Therefore, if you consider the profits of FY13 as normal, then the profit growth is almost flat. This means that the company's profits in FY23 were at the same level as 10 years ago.

This is definitely not good news. A company that does not even manage to double its topline and keeps it bottomline flat for 10 years, will have a hard time creating wealth for shareholders on a consistent basis.

However, just as every cloud has a silver lining, the financial performance of Visaka Industries also has some good news.

If you look at the financial performance again, you'll see that the company has done really well in FY21 and FY22.

The profits have hit an all-time high on the back of growth in topline and expansion in margins.

Therefore, the question that we need to ask ourselves is are the profits sustainable or were they one time? If the company is capable of achieving these numbers again, then there is hope for the stock.

However, if they were one time and not achievable on a sustainable basis then there's a big problem.

So, what is it? Are these numbers sustainable?

Well, here's the topline breakup of the company over the years.

As you can see, the company has 3 business segments viz. cement asbestos roofing segment, fibre board segment and Yarn segment. The company has also added a new solar panel roofing segment. But its contribution to the overall revenues is still very negligible and therefore, we are ignoring it at the moment.

As you can see, the cement asbestos segment is the biggest contributor to revenues but has grown at a CAGR of only 4.3% between FY14 and FY23.

Even the yarn segment has grown at a CAGR of only 6%. The best performer has been the fibre board division which has grown at an impressive CAGR of 20%, albeit on a lower base.

As far as the cement asbestos is concerned, the company is second largest player in India in this segment. And there is also a huge demand for it.

However, this segment is a play on rural India where as incomes grow, people will prefer to use asbestos cement roofs over their heads as opposed to the thatched roofs or other material that they are using right now.

The reason the revenues in this segment has grown poorly is because not only is the segment highly competitive with low entry barriers but is also sensitive to raw material prices.

The company has only a limited capacity to pass on raw material price increases on account of competition from substitutes and the limited purchasing power of its target customer.

Hence, while the potential in this segment is still quite large, it will be fair to say that this segment may continue to maintain its historical growth rate.

I have read the past annual reports of the company. I was impressed how the company is fighting hard to control costs and maintain margins in this segment.

It has chosen to have production plants close to the demand centre and also sells directly to retailers so that commissions on distribution can be saved.

There is also a ruthless focus on quality to ensure that the customers get the maximum bang for their buck. Hence, will the industry itself is quite competitive, I will have to appreciate the efforts of the management to control costs and maintain profitability.

So, while the company will still be amongst the top players in the industry, growing at a very fast pace could prove to be a challenge.

Now, in order to de-risk its business from the cyclicality of asbestos cement division, the company forayed into the textile space in 1992.

Yes, from a building product like cement asbestos, it moved into an unrelated industry, textiles.

However, in textiles, it preferred quality over quantity. It became a specialised yarn manufacturer and has acquired some marquee clients over the years.

As you can see in the table, despite being in a highly commoditised industry like textiles, its revenues have remained remarkably stable over the years.

This goes to show that it does have some amount of pricing power in this business. As far as growth is concerned, its textiles yarn division has grown its revenues at a CAGR of around 6% between FY14 and FY23.

The outlook for this business remains optimistic on account of its nicheness, committed clientele, increased exports and new free trade deals being signed by India that could open new market.

So, that was about the yarn business.

This brings me to the third and the most important division, the fiber cement boards business.

As you can see, this is the fastest growing business for Visaka and has grown at a CAGR of 20% between FY14 and FY23.

Here's the revenue split percentage wise. The good thing is that contribution of the highly competitive asbestos business has gone down from 71% in FY14 to 56% in FY23 whereas the high growth business of fibre cement boards has gone up from 9% to 25%.

The good thing about the company's fiber cement board business is that unlike the roofing business, this business is not depended on the rural economy. This is an urban product used in both interior as well as exterior.

The offtake of this product has been consistently growing following enhanced product awareness, shift from timber product, higher affordability, maintenance free, low erection cost, functional use by carpenters, easy transportability and safety in seismic zones.

The company has marquee clients Mahindra Lifespaces, Tatas and L&T in this segment and the products are marketed across 2,500 outlets.

In view of the strong demand, the company is increasing capacity in this segment by almost 30% and the same will be operational soon.

Here are the four businesses of the company in a nutshell.

Fiber cement roofs, the one that's largely dependent on the rural economy. Established in 1985, the annual capacity has gone up from 36,000 tonnes to a huge 8,30,000 tonnes.

Then there's the integrated solar roof division. We have not talked about this division as it is not contributing to revenues yet. However, the future of this division looks quite promising. It is the first of its kind integrated solar roof where the company has secured a patent not just in India but also in US and South Africa. The company has also commenced exports to Africa and the middle east.

The next is the cement fiber boards division, the fastest growing of the lot. This was established in 2008 and the company is the leading player in terms of market share, 32% of sectoral capacity.

Last but not the least is the yarn business. The division was started in 1992 and designed to produce 2,000 tonnes using state of the art air-jet spinning technology. The capacity now stands at 13,200 tonnes per annum.

So, this was a small snapshot of all the four businesses and their revenue history. What do you think? Does the company have a product portfolio that's good enough to allow it grow well in the future?

Well, I do think so. With the way it has diversified away from the competitive cement roofing business and entered new areas like fiber boards and now the solar roof, the company should do well in the future.

The company has done a great job on the capital allocation front as well. In fact, I have been quite impressed with its debt management skills in a capital intensive business like building products and textiles.

As you can see, in all the 10 years between FY14 and FY23, the debt-to-equity ratio has remained below one. This is despite all the capacity expansion it has done over the years and also the ones currently ongoing.

What is more, the company has also rewarded shareholders handsomely by way of good dividend payouts. The payout ratio over the last 10 years has remained between 20%-30%.

So, in conclusion, there's no doubt that the company is present in a difficult industry where growth does not come easy.

But you have to appreciate company's efforts at diversifying its business model, moving it away from the highly competitive and low margin business of cement fiber roofing and towards promising areas like cement fiber boards, textiles and now solar roof panels.

It has managed to achieve this diversification without putting a lot of pressure on the balance sheet, undergoing judicious expansion and keeping a tight lid on costs.

So yes, while growth has been a challenge, you will have to give full marks to the company when it comes to things like stability, quality, and leverage.

Last but not the least, valuations.

The interesting thing about the company's share price performance is that despite below average growth over the last 10 years, the stock has been a 5-bagger.

Yes, that's correct. An investor in the stock roughly 10 years ago would have multiplied his money 5x.

Now, how's that possible? Well, because the stock was trading at distressed valuations 10-years ago where its stock price was at huge 60% discount to its book value.

If the stock's book value was Rs 100 back then, the stock price was just Rs 40. The stock currently trades close to its book value.

So, half of the 5x growth in the company's share price has come from the book value multiple expanding from 0.4x to 1x.

In fact, the company's price to book value had again fallen to just 0.3x during the coronavirus crash.

From there, it moved up almost 8x i.e. 700% over the next 15 months or so.

So, the takeaway is clear.

If you have to make very good returns from the stock, you should buy it at a huge discount to its book value preferably, a discount of 50% or more.

But the stock currently is not trading at a big discount to book value. In fact, it is close to its book value right now. So, does this make it a bad investment?

Even at close to one times book value, the stock has gone on to give 100% returns over the next 12 months. So, if you go by historical trends, buying at a book value of 1x is also not a bad thing to do.

Therefore, the choice is yours. If you are happy with 80%-100% returns in 1-3 years and if you think the company can go back to making record profits like it did in FY21 and FY22, then buying at the current price may make sense.

But if you are not confident and want to play it safe then u can wait for the price to fall another 50% from here so that the price is well below its book value.

But the risk with this approach is that it may never fall to these levels.

So, the choice is yours. There is no right or wrong answer in my view. It is all about the risk-reward equation that you are comfortable with.

So, figure out our risk-reward threshold and decide accordingly.

I will see you again in the next session. Good bye and happy investing.