Image Credit: https://www.thecrucible.org/guides/machining/lathes/
I came across CNC machines through a post in LinkedIn. Up until that time, I had never heard of CNC. CNC stands for Computer Numerical Control. CNC machines are software driven machine tools used in manufacturing plants for metal cutting. My wife, who has an automotive engineering background, explained to me the application of these tools in automobile plants (these tools find application in almost every industry and not just automobiles). She explained to me – I am over simplifying – that at one end these tools are as simple as just having one axis for making one cut or a hole at one time, and at the other end these tools are as complex as having multiple axis for making multiple cuts or holes at one time. Simple tools are also used for making multiple cuts, but they need manual intervention since after each cut, the metal needs to be fed to the CNC machine again (at a different angle perhaps) to make another cut / hole.
Market Size
As per Indian Machine Tool Manufacturers Association (IMTMA) Annual Report 2023, this is a INR 24,000 Cr market in India. More than 50% of the machine tools – by value – are imported. 75% of the market in India is of metal cutting. 25% of the market is in metal pressing, grinding, sheet metal technology like laser cutting and press pack etc. A bulk of this 25% market and some of the metal cutting market is imported.
In India, if manufacturing share in GDP is to increase to 21-22% (as per Morgan Stanley) from current 17% over a decade, then the machine tools market could cross INR 70,000 Cr from 24,000 Cr in 2023. Assuming Make in India impetus drives import substitution down to 40%, the market for Indian players could cross 40,000 Cr (over the next decade) from 12,000 Cr today – this is 3.5x growth in 10 years.
Company Profile
Established in 2003, Macpower CNC Machines Limited is engaged in the manufacture of Computerized Numerically Controlled (CNC) machines. It has a CNC Machine manufacturing unit in an area of around 8 acres at Metoda G.I.D.C., Rajkot, Gujarat (India).
The company listed (IPO) in 2018. Proceeds of the issue were used to help the company backward integrate into the manufacture of Machining components and enhance production capacity. They supply their products to automobile, defense, general engineering and other industries.
Competition
6 prominent players in India – Lakshmi Machine Works (listed), Bharat Fritz Werner, Ace Designers, Lokesh Machines (listed), Jyoti CNC and Macpower CNC. These are present in the 75% metal cutting market.
Market Share
Macpower (~INR 200 Cr sales in FY23) has a market share of 1.6% by value. Lakshmi Machine Works (~INR 1,000 Cr sales in machine tools in FY23) and Ace Designer have the largest share. Until recently, Macpower drew its market share primarily from simple or low-end machines (with an average selling price of INR 20L per machine), they are now striving to establish a stronger foothold in high-end or high value machines (Larger players have an average selling price per machine of ~INR 30L). To achieve this, they have increased their service and sales force across the country.
Things I like about Macpower
- Conservative Management: Promoters follow a model of gradual growth and remaining debt free, with a focus on the margin. Macpower has an operating cost (or in-direct cost) of 20% vs peers 25%. Among the peers, Lakshmi Motor Works is also debt free, but has higher operating costs of 25%.
- Receivable Management: Macpower has a sharp focus on receivables. Their average receivable is 20 days. All peers have higher receivables. The company takes advances against the orders they receive and dispatches the goods only after they receive full payments – specifically for non-government i.e., private orders.
- Focus on selling high value products: Macpower has set up service and sales force across the length and breath of the country – inline with large players – to help increase their sale of high value products.
- Industry Tailwind: There is a lot of focus on manufacturing in India and offering companies an alternative to China. Manufacturing companies need machines and machine tools are central to machines. Right now, the number of CNC machines that India makes in a year is equivalent to the number that China consumes in a month.
What needs improvement?
Backward Integration: COGS (or direct cost) at Macpower is higher at 70% vs peers at ~65%. Macpower is focusing on backward integration to drive their COGS down. As per promoters, in this industry, one can’t make more than 60-65% of raw materials or backward components in-house. Macpower makes 35% in-house and imports the remaining.
Because there is scope for backward integration, an investor would notice that the company typically keeps a lot of raw material and semi-finished goods inventory. They have ~190 days or ~6 months of overall inventory outstanding. Large player Lakshmi Motor Works on the other hand has faster inventory turns.
Macpower is deploying CapEx to make backward components like Turrets and others to reduce imports and consequently reduce COGS. Moreover, foundry is a large part of COGS, which Macpower currently does not do. Many of their peers have their own foundry, as a result of which their COGS is lower. Macpower promoters have indicated that setting up their own foundry and casting will help drive their costs lower (however, they have not indicated when).
Points of Caution
- Related Party Transactions: Although, promoters in the past have waived their right to receive dividends signaling a minority shareholder friendly management, but they do make purchases from related parties. Purchases from related parties were worth 24L in FY23, 49L in FY22, 16L in FY21, 6L in FY20. It would be good to see these purchase going down overtime. Moreover, there was a delay in filing related party transactions in FY23 resulting in a fine.
- Miscellaneous Expenses: They reported high miscellaneous expenses of 3.2 Cr in FY23 and 2.4 Cr in FY22. Shareholders will benefit if the company itemizes or explains these expenses. These expenses are under 1.5% of sales, but substantial relative to PAT
Investing (rather I should say long-term investing; and certainly not trading) in small cap companies is all about betting on their promoters. Once you have established that the promoters are not treating the company as their ATM, then placing your bet mostly hinges on the promoter’s vision and their ability to execute that vision. Of course, you want to buy stake at the right price and you want the company to be in a growing market!.
Valuation
Since the time I started looking into this company, the market cap increased from under INR 500 Cr to ~INR 600 Cr. , which is 40x earnings. As per my DCF valuation – after projecting the 3 financial statements – I find the fair market value of this company to be around INR 450 Cr, which is 30x earnings. Lakhsmi Machine Works is trading at ~34x earnings.
Valuations are subjective. I have taken the following assumptions to project out cash flows and value Macpower:
- Growth: Driven by gradual capacity expansions and 75-90% capacity utilization (inline with history), Macpower doubles it market share to 3.3% over the next 10 years resulting in sales increasing 7x to INR 1,400 Cr.
- Capacity Expansion: From 1,500 machines to 2,000 machines by FY25 (per management commentary) and 6,000 machines (assumption) by FY33. I have factored in the cost of land requirement (45,000 sq foot of land requirement per 500 machines – as per management) to expand beyond 2,000 machines.
- Margin: Gross margin increases to 31% from 29.8% today due to backward integration. I will give them a higher gross margin if and when they get their own foundry. Economies of scale benefit resulting in indirect expenses reducing from 19.6% to 16% over 10 years.
- Cost of Equity: Discount rate of 14% as my bare min return expectation.
Summary
The above assumptions needs to be true to justify a price of INR 450 Cr (i.e., 30x earnings) today. As per my FY28 projection, the company will do Sales and PAT of INR 550 Cr and ~70 Cr respectively. Assuming the company trades at 30x 5 years out, then the then market cap could increase to ~INR 2100 Cr (from 600 Cr as of 24/11), which is 3.5x growth in 5 years i.e., 28% CAGR.
I am keen to participate in the machine tool growth story, however I am being resistant to FOMO and will not take a position in Macpower until the company is available at a significant discount.
PS: This is not a recommendation.