My notes on Sealmatic, a company that makes mechanical seals

Usually after analyzing a company fundamentals and the industry, I try to ascertain the growth potential and plug every number from the company’s financial statements in a spreadsheet, and project the financials to arrive at the DCF fair value.

However, in this instance, due to paucity of time I am just putting forth my notes (qualitative) on why I find Sealmatic interesting. Sealmatic is a small cap company that makes mechanical seals, which find application in industries with equipment requiring leak proof flow of liquids or gases – oil and gas, petrochemicals, power plants (thermal, solar and nuclear) and chemicals.

Sealmatic was started in 2012 by Umar Balwa and Hanif Chaudhary. The promoters got into this business back in 1989. They partnered with a German company EagleBurgmann later on and then eventually were forced to sell their stake in 2007. The promoters entered this business again 5 years later under the name Sealmatic. 

My notes (qualitative) on why I find Sealmatic interesting:

1.     Technical Certifications: They have received various technical certifications from international bodies and are currently undergoing certification for ISO 19443, which will qualify them for critical business in the nuclear power plants. This would make them the only company as a mechanical seal company globally who would qualify such a coveted certification, and the second company in India after L&T.

2.     Customer Approvals: They are a technically qualified vendor to Fortune 500 companies such as Reliance, IOCL, BPCL, GAIL, NTPC, NPC etc. Since this is a critical product, getting approved by these vendors take many years. They are technically qualified with various pump OEMs e.g., KLB, Sundyne, Sulzer, KE, KSB, Andre, Rio etc. They supply products to OEMs, which work with EPCs (e.g., Engineers India Limited, Toyo, HNG, Aker etc.) to deploy their seals at end customers (e.g., Reliance, IOCL etc.).

There are barriers to entry in this business!

3.     Customer Stickiness: Once approved with a particular OEM (and with end customers), the OEM sticks with the company that has done standardization for them. In refineries, power and chemical plants, the plant equipment life cycle is typically 30 years. When a pump gets commissioned to the end user, they get annuity i.e., supply and maintenance of seals for the next 30 years. Management believes that they would generate a lot of operational maintenance (O&M) of business at a higher profitability from 2026

4.     Domestic Penetration: Indian companies have historically been working with large foreign suppliers – EagleBurgmann (erstwhile company of promoters; and largest globally and largest in India), Flowserve and John Crane. The promoters leveraged their past track record and that combined with the “Make in India” impetus to become a supplier in the Indian market. Their export: domestic revenue split is 60:40. Many of their end customers in India are undergoing a lot of capacity expansion. They believe with the huge domestic demand they can change it to 40:60 in the near future.

5.     Specialized Products: Seals are not nearly sold on a cost basis. They are sold on engineering knowhow.

6.     Expansion:

• With O&M a key growth driver, they have opened a service center in Pune and are in process of opening service centers in Kolkata and Chennai.
• They are undergoing capacity expansion in their Daman factory. In the international market, they sell products in the US and Europe. They are now foraying into Middle East. However, their products are sold through distributors resulting in lower margin in the international market.

What could be better?

Working Capital:  CFO in FY23 is negative since the company IPOed in Mar 23 and kept most of the cash as a fixed deposit in current assets resulting in optically high levels of working capital. Higher inventory also dragged the CFO. Adjusting for the inflated IPO led current assets uptick (i.e., reducing the fixed deposits) CFO comes out to be +ve. Despite the adjustment, cumulative adj. CFO over the past 4 years (need to get CF stmts from prior years!) is lower than the cumulative PAT over the same period. This suggests that money is getting stuck in WC. I don’t want to give this business a pass just yet because of this although it is extremely important. I will closely monitor the adj. CFO. A few years of low CFO is okay, I care about the long term CFO > PAT equation.

Now the Most Important Part!

Corporate Governance:  Investing in companies (and more so small caps) is equivalent to partnering with business promoters. Hence, evaluating promoters is most important. This is subjective. Once you have found responsible, honest and dedicated promoters and all you got to do is to tag with them in their journey for the long haul (until ofcourse they become unfriendly to shareholders).  

I typically look at the following to gauge promoters:

• Promoters – background, experience, remuneration vs profits, incentives including ESOPS, and any cases of fraud
• Auditors – remuneration trend, frequency of change in auditors
• Related Party Transactions – loans given to related parties, sales to / goods procurement from related parties, receivables from such related parties, rent paid to related parties vs market rates, multiple car loans etc.
• Unexplained other expenses

Social media has been abuzz with fin influencers advocating investment (or rather trading) in Indian small cap stocks using growth triggers such as capacity expansion, large orders, capital raises etc. with a complete disregard to corporate governance and cash flows. Analyzing corporate governance is subjective and investors need to make their own view of the company.

One should invest their hard-earned money only in companies with owners who at the minimum have a clean background, are not treating their company as their personal ATM, paying hefty fees to auditors to cover up accounting shenanigans, giving interest free loans to related parties, taking multiple vehicle loans for personal reasons (this is almost impossible to judge and hence investors need to form their own view) etc.

Coming to Sealmatic promoters. The promoters have an experience of 3 decades in the mechanical seal business. I went through whatever I could find on them online. I like what they built when they were part of EagleBurgmann. A gripe that I have is that promoter Mr. Umar Balwa does not draw a salary (the other promoter draws 40L p.a.). One may view this as being selfless or one may find this rather odd given dividends are barely enough to compensate adequately.

Mr. Umar Balwa’s family is into real-estate and hospitality business, which usually is a red flag to me, but I could see a clear attempt to keep things at an arm’s length. There are a few transactions in which Sealmatic paid promotion expenses to their related hospitality firm, but they are immaterial and seem genuine. There was a material transaction, however, in which Sealmatic gave a loan of 1.25 cr in FY23 to that related party, but that was recovered in 8 months. The promoter described that purpose of that temporary loan was to scout for land for capacity expansion, a plan that was later put off since Sealmatic decided to lease the land instead. (It is important to mention that I didn’t find any connection of the promoters with the infamous 2011 telecom fraud that involved DB realty MD Shahid Balwa and CFO Asif Balwa) 

However, transactions with the realty and hospitality company needs to be tracked closely in the future. 

Market Pricing – Looks Expensive..

Market Cap: Sealmatic is trading at a market cap of Rs. 450 Cr (as of 6/10/23) at 41x trailing earnings. I have not done a DCF (yet), but this multiple looks steep. Indian pump companies KSB, Shakti Pumps with a much larger market cap. are trading at similar rich multiples as well. Flowserve Corp (makes both pumps and seals) in the US trades at 21x trailing earnings. This is just for context.

Pumps and Valves is a Rs. 10,000 Cr market (as of 2022) in India alone. For equipment requiring pumps and valves, you need a mechanical seal. If I were to over-simplify without really getting into any details (and I may be way off!), then seals are 20-25% of the cost of pumps. Hence, with this high-in-the-sky assumption mechanical seals are a 2,000-2,500 Cr market in India. There are of course many market researches which estimate this market to be much much higher. I’d rather stay low and conservative.

The question is that can this small cap become 5x (or 10x) over let say 5 years?

Assuming 25x is the right multiple (I have no basis yet! I usually do a growth rate estimation and a DCF to estimate the fair multiple). For 5x appreciation, the company needs to trade at 2,250 Cr i.e., a net profit of 2,250/25 = 90 Cr. At the current 18% net margin, the company needs to do a revenue of Rs 90/18% = 500 Cr (i.e., grow ~8x in sales and appreciate 5x in market cap).

Again, allow me to take a leap and assume that they will have 40 : 60 export : domestic split.

So now the question is that can Sealmatic make 300 Cr (60% x 500 Cr) in India over 5 years i.e., a market share of ~10-12% 5 years out in order to 5x in market cap?

These are just notes to myself. You as a reader.. please feel free to ignore my numbers.. don’t read too much into them since they are assumptions piled over assumptions!

My Conclusion

I like the business, but the market cap is high.! I am leaning towards talking a position when there is a dip.

My to dos:

1. Research more on the mechanical seal industry and estimate the growth potential for Sealmatic over 5 years.
2. Value the business using that growth rate (determine the fair multiple)
3. Monitor working capital. Keep tabs on corp. governance. Any red flags and I am out!

For any questions or comments, feel free to email me at gautamrastogi.investandrise@gmail.com or PM me on linkedin