Group 1

Overall, the year 2015 was decent for this selection of companies because none of them made a
loss. The common factor among these companies is that they are providing input materials to some
of the major consumption categories in the economy. International Steels Limited is an input
provider for the construction, automotive and electronics industry. International Industries Limited
is an input provider to the construction industry. Mughal Steel and Ittefaq Steel are input providers
to the construction industry as well as other players within the steel industry. Dadex is also an
input provider to the construction industry and Bolan Castings is an input provider to the tractor
industry which is intrexicably linked to agriculture. The overall economy grew 4.7% in 2015 which
spurred moderate economic activity in the major consumption categories and allowed these
companies to make the revenues and returns that they did.
The other thing common among these companies is that they are all very closely held, i.e. a huge
percentage of the shareholding is with a small number of sponsors, most of whom are family
members. These companies are effectively family buisnesses with a stock exchange ticker. The
advantage of this setup is that it reduces the agency problem significantly as the owners/sponsors
are closely monitoring day-to-day operations. The disadvantage is that outside investors have an
information assymetry about the company’s operations and thus its share price movements. It also
creates competence problems as executive positions are given on the basis of last names and not
on qualification and acumen.
The most impressive performers in this selection were Mughal Steels and International Industries
Limited, with after tax profits of Rs. 659M (5.4%) and Rs. 731M (4.0%) respectively. In a
commodity business, this magnitude of return (4-5%) is considered quite substantial. The
construction industry was in full flow during this year with huge government outlays on
development of transport and energy infrastructure as well as high private investment levels in real
estate and housing, which allowed them to sell large quantities. Both these companies were able
to generate these returns by keeping their gross margins above 10% (or their COGS below 90%).
Further, they have benefitted greatly from economies of scale as the fixed cost is a very small
percentage of sales.
The reason these two companies were able to make the highest returns is because of the economies
of scale that they have achieved from capital investments in the previous year(s). This is indicated
by the fact that both companies have substantial amounts of negative cash flow in the financing
category which shows that they are paying substantial amounts of loan back. The exact figure is
Rs. 501M paid back by Mughal Steel and Rs. 1941M paid back by International Industries Limited.
Ittefaq Steel had a lower percentage return (2%) than Mughal Steel which has the same product
mix but a much larger asset size. This is attributable to the substantial difference in the COGS-to-
Revenue ratios between these companies, i.e. Mughal has a COGS-to-Revenue ratio of 0.89
whereas Iteffaq is at 0.91. In this high volume low margin business, two percentage points in
COGS make a world of difference. Further, the company looks to be in slightly difficult financial
condition because it has a huge working capital which it is financing through borrowing as the
operations do not have enough meat in them to sustain the business. Some of the borrowing may
be towards CAPEX which might allow the company to catch up on the COGS ratio to its
competitors.
 Group 1

Dadex posted mediocre returns in this time period of 1.2% only despite there being substantial
demand for pipe products. Even though a segment-wise breakdown is not available, comparing the
percentage with INIL shows that the company has not performed as well as it could. Being in a
commodity business, they have done well to keep the COGS at 79% of revenue. However, 9% of
revenue being spent on selling, marketing and administrative costs is very high and is eating up all
the company’s margins. This may be attributable to there being tough competition in the pipe
industry as it does not really have a very high capital cost and thus low entry barrier. Further, the
company is highly leveraged and has a significant interest expense which is taking a cut out of the
earnings.
International Steels Limited is the largest company of the lot by balance sheet size. It has managed
to earn substantial revenues because of the booming construction and automotive industry at the
time. The company has posted mediocre returns of 1.1% after tax despite having a good control
over fixed costs (2%). This is because their COGS and interest expense are biting hard into the
revenues. However, these two factors are inter-related as COGS is a function of equipment
efficiency and acquiring new efficient equipment requires substantial capital which obviously does
not come for free. The company has identified these problems and has invested almost Rs.3B in
2015 out of which Rs. 2.5B they have borrowed. The value of this investment is reflected in
financial statements in further years.
Bolan Castings Limited is the smallest company of the lot by balance sheet size. It has achieved a
profit margin of 3%. The company’s operating cash flows are negative despite posting a net
positive return. This indicates that the company is having payment collection issues. This is
traceable to the credit given by the tractor industry to farmers for purchasing vehicles. These
payment days of tractor companies are likely to be high because of this reason which is impacting
Bolan Casting as well.