The Market Opportunity for Descon Oxychem Limited (DOL)

Despite improving fundamentals and capital structure as noted in my posts here and here respectively, the market appears to be paying no heed to DOL's significant improvement in financial performance for the coming quarters. After rising significantly since the result was announced on 23-09-13, the stock has witnessed serious beating especially during the recent market turn  down.

So why did this happen? Maybe investors were just too cautious around that time and decided to get rid of their more volatile holdings. 

Going through checkered financial performance in the past, DOL has been just that, having been regularly depressed as well as volatile since most of its lifetime as given below. The fact that it has never come above even its par value speaks volumes about the risk investors perceive it with. 

So what awaits us in the future? In line with the previously referenced articles, as well as this one. Significant opportunity has arisen in the last few days:.

Forgive the quirkiness. 

As per the Annual Report of FY13, Descon Oxychem is a much better company now!

As disclosed in its annual financial statements for FY13, management of Descon Oxychem (DOL) has taken steps that will free up some serious cash flow for the next two years. In a nutshell, the company has obtained a grace period of two years for all its debt, including both the bank as well as subordinated debt. Moreover, the subordinated loan will now accrue interest for two years meaning that no finance costs will need to be paid for it.

All this means that the company will save Rs. 300 million each year for the next two years which comes to around Rs. 3 per share per year. Not bad given the stock is currently trading at Rs. 5.5.

While there would be no significant impact on earnings, improved cash flows could reduce short term borrowings and save finance costs. Possibility of dividends can also not be ruled out.  

Now why did the management do this?  The company is in excellent financial shape especially as per the June quarter result. Peroxide prices are at an all time high and will stay high for the September quarter implying that the quarter result will be good.

Maybe they just wanted to be safe given the dip in peroxide prices experienced two years ago.

Fair values are fair values and people rarely take them seriously. However, if they have anything worth, the whole debt restructuring exercise has had a fantastic impact on company valuation. The cumulative shifting of Rs. 600 million in free cash flows two years forward has increased the fair value of the company to Rs. 15, giving us an upside of almost 200% given current levels.

Given the intermediate for the stock appears to be good as per business recorder, peroxide prices are still holding, which implies a good result for September quarter. 

So Descon Oxychem. Lao Maal!

If you'd listended to me, You'd be a millionaire by Now!

Ok, I guess you'd need Rs. 850,000 to begin with.

Sitara Peroxide (SPL) has yielded a 17.5% return since I published my recommendation
six days ago. So if anyone had invested Rs. 851,000 in the stock at the time I published my recommendation, he'd indeed be a millionaire right now :P. The return is even more enticing given that the KSE 100 index has lost more than 5% of its value during the period. This means that the recommendations have acually beaten the market by around 22.5% during the six days ending today.

The story of Descon Oxychem (DOL), SPL's spiritual sister (spiritual since it has the same driving factors as SPL) is no different as it has yielded a similar return of 17.3% during the period.

The basis for the recommendation was simple. Increased peroxide prices would (the companies' product) result in increased gross margins. A constant cost base was also highlighted, as government changes gas prices only on a six monthly basis and the last change would not take place untill for the Septmebr quarter.

Moreover, as borrowed from a daily of SC securities, and credit duly given, decreasing finance costs in view of improved cash flows would further boost earnings.

Both the recommendations were correct and as it turned out, gross margin did increase for both the stocks and the finance costs decreased as well. Moreover, the EPS of especially DOL incerased significantly and the company recorded its highest EPS in 6 quarters.

The EPS chart along with the updated gross margin chart, which is the cornerstone of this analysis is presented below for illustration:

So whats next? My initial thesis was better still results for the September quarter due to even higher peroxide prices. The low finance costs theme should follow through as well driven by further improvement in cash flows. Gas price increase should have posed a risk for the stock since its the major raw material, but that risk has been nullified given the government's decision to deferr the same till November.

Any production and sales hiccups could however disrupt revenues and earnings potential, however if this serves as any consolation, sales and revenues have been relatively stable for the two companies given the historical trend.

Hence in view of further rise in peroxide prices, together with a calculated assumption of constant production and sales, I would still stick to my assertion of further improvement in financial performance for both the stocks for the quarter ended September 30th, 2013.

BUY DOL WHILE IT LASTS!

Buy Descon Oxychem (DOL) while it lasts! Its spiritual sister company, Sitara Peroxide had a good financial performance by predicted by me and has been on upper locks since last 2 days! However movement in DOL, while positive, has been minimal. I would suggest taking a position before the company announced the result soon!

Given the stock level is currently PKR 5.26, it represents a return of 30-50% even if just two upper locks occur! I would recommend to buy it for 6 month investment horizon.  

Sitara Peroxide FY13 Financial Result

Sitara Peroxide Announces Result

Ok Sitara Peroxide announced its result today. The company posted an EPS of Rs. 0.19 for the quarter. However, the EPS is not important as it was not part of the forecast. In my last post I had predicted an increase in gross margin based on increasing peroxide prices. The gross margin in fact did increase, up 4 percentage points month on month, to 26%. So this lends credence to the price-gross margin thesis and the same story should continue with increased effect for the September quarter . I guess Ill update the gross-margin, H2O2 Price graph for corroboration:

Not only does does this reinforce the idea of improved financial performance for next quarter, it also bodes well for Descon whose result will be announced on the 30th. It may be noted that SPL was on upper lock today and with Descon booking sizeable gains as well.

Descon Oxychem and Sitara Peroxide - Improved Financials

Descon Oxychem and Sitara Peroxide - Improved Financials

My post concerns two companies in the hydrogen peroxide industry in Pakistan. Descon Oxychem Limited (DOL) and Sitara Peroxide Limited (SPL). Both of the companies produce hydrogen peroxide that is a chemical used for bleaching, paper making, etc. Not surprisingly, the gross profit margin of these two companies follows the local of hydrogen peroxide prices as illustrated through the below graph:

Source: Business Recorder, Company Reports

Notice the absence of gross margins from the last two quarters. This is because the results pertaining to these have not been announced as of yet. Hydrogen Peroxide prices have however increased substantially during the period. Standing at Rs. 56 per kg today as opposed to Rs.44 in March-13, showing an increase of 16%.

An improvement in gross profit margins appears to be in order for the two quarters, that is, June 13 and September 13. The same analysis could be extended to operating margin due to comparatively lower administration and selling costs.

The final idea lends credit to SC Securities which says that the companies will experience declining finance costs too due to improved cash flows and lower working capital finance requirements.

I would say that a decline of 50 bps points in interest rates during the period should also help in decreasing finance costs. 

Owing to improved gross margins and lower finance costs, improvement in financial performance of the two companies, DOL and SPL appears to be in order for the quarters ending June-13 and Sep-13 .