The Irony of Cash

I have been pondering over the annual reports of mining giants in India. Interestingly, Indian mining companies have a lot in common:-

1) They are leaders in their field, commanding more than 50% market share.

2) They belong to the lowest quartile cost-wise, setting benchmarks in efficiency. 

3) They are government owned thus get renewals & new leases at nominal cost. 

4) They have professional managements thus ensuring strong systems & transparent practices.

5) They have negative working capital & nominal capex requirement. 

6) They are all showing signs of volume growth anywhere between 5-15%.    

7) They are debt free companies, infact sitting on cash anywhere between 40-75% of their market cap

Basically they tick every box of a stockpicker's checklist. The problem with these "tickers" is they are hardly ever reasonable. Luckily, the commodities boom is crumbling (well .. Made in China is not meant to last) so have prices for these businesses.

Let's take the case of one such business MOIL - Manganese Ore India Limited. It scores highly on the checklist.

Current Price : INR 235
Market Cap : ~ 3900 crores
Avg 5 year PAT : ~ 480 crores
Avg 5 yr cash earnings : ~ 510 crores
Cash & equivalents : ~ 3000 crores
Avg 5 year Operating Income : ~ 950 crores
Avg 5 year Operating PAT : ~ 350 crores

MOIL is doubling its capacity to 2 mn tonnes by 2020 which is just 4 % of global trade & we as a country are importers for this commodity so this will not change the demand supply balance. Currently manganese prices are close to their 2 year high, despite the rout & thus near term earnings will be just as strong.

Given the above, It would be fair to value MOIL's business at 3500 crores, which the market is valuing at 900 crores (market cap - cash). An upside of ~300% which I would love to bet on. But, here ends my dream, let's look at the real picture.

When I buy MOIL, I get cash of 3000 crores as well thus I pay 3900 crores today for an entity that is worth ~ 6500 crores. An upside of 60% which still seems lucrative but who knows how long the market will take to correct itself thus a chance of lowering the returns substantially.

This is the IRONY of CASH. Cash offers a safety net, MOIL is unlike to fall more than 20% but the net is so big & heavy now that the ship moves very slowly.

Here is another perspective, MOIL's productive assets of ~450 crores generate earnings of 350 crores at an ROE of 77% & cash of 3000 crores will generate ~180 crores at an ROE of 6%. In 54 years, the company has accumulated tangible assets of 450 crores & strangely sits on a cash pile of 3000 crores. They wish to only triple capacity by 2030 thus no substantive capex. The strange attraction of not distributing generous dividends rather to hold onto cash for the "fear of unknown" has turned these money making machines to wealth destroyers over the longer term.  

Compare all these companies (Nalco, NMDC, CIL, MOIL) with VST Industries. All their operating metrics are similar except that VST has paid 75% of earnings as dividend, keeping its balance sheet light thus VST has returned capital gains in excess of 20% CAGR + a 5% dividend yield.

In the long run companies with high leverage go BUST, companies with high cash go NOWHERE.