The stock still seems undervalued despite almost doubling over the last two years.
The 14 per cent decline in L G Balakrishnan’s stock over the past six months has nothing to do with its fundamentals. The decline seems to be the effect of the severe market correction of the past six months, which saw small-cap stocks decline by an average of 18 per cent. The stock’s fundamentals have only improved during the period.
The earnings growth recovery that began three quarters back, from the June 2024 quarter onwards, has strengthened during the December 2024 quarter. Revenue, gross profit, and operating profit increased by 12.7 per cent, 24.2 per cent, and 61.7 per cent, respectively, during the quarter. The trends of gross and operating profit margins have turned positive. LGBB’s return on capital, which had been declining for almost three years, turned positive during the quarter.
LGBB’s valuation has become more attractive due to the simultaneous benefit of a lower stock price and an improvement in earnings. Over the past six months, when its stock price declined by 14 per cent, its earnings-per-share increased by 16 per cent. The stock today trades at 15 times earnings-per-share and 2 times book value compared to 17.70 times earnings-per-share and 2.47 times book value six months ago.
LGBB’s last three-year stock performance has one unique lesson to impart. Due to an earnings slowdown, the stock experienced almost 10 consecutive quarters of profitability decline. Stocks are normally found to underperform during periods of declining profitability. However, LGBB’s stock nearly doubled during its declining profitability phase.
Apparently, the stock’s undervaluation seems to be the reason behind this divergent performance: a rising stock price during declining profitability. LGBB’s stock was undervalued when the decline in profitability began; the rise in stock price was the market price converging towards its intrinsic value. The lesson inferred from this case is that an undervalued stock will rise towards its intrinsic value even during periods of declining profitability.
The stock still seems undervalued despite almost doubling over the last two years. An operating profitability, RNOA (return on net operating assets), of 19.25 per cent is discounted into the current market price of ₹1,155 per share. The FY24 RNOA stood higher at 24.3 per cent; the expected RNOA for FY25 is further higher at 28 per cent. Accordingly, the current market price is at a 22 – 32 per cent discount to its fair value.
The US president imposed a 25 per cent tariff on imported ‘automobiles and certain auto parts’ into the US in April 2025. LGBB principally manufactures transmission systems for two-wheelers; it derives around 20 per cent of its revenue from exports. The stock’s reaction to the tariff measures suggests the tariffs likely have a minimal to negligible negative impact on LGBB’s business.
Over the past five years, the company has generated large operating cash flow. Operating investment needs demanded only 38 per cent of the operating cash flow; the rest is free cash flow. 9 per cent of the operating cash flow went towards repaying debt, 12 per cent went towards paying dividends, and 41 per cent accumulated on its balance sheet as cash and financial investments. The low and declining capital expenditures and accumulation of financial assets seem concerning.
Overall, we are positive on the stock. We have been positive about the LGBB’s investment prospects since we first discussed the stock in April 2023; it was trading at ₹745 per share then. We were positive in every subsequent review of the stock.
Our previous review of the stock was in November 2024; we were positive about the stock then, too, but the stock has lost 14 per cent since then. However, the decline seems to be caused by the severe market correction and US tariff shocks of the past six months and is less related to its business performance. The stock is expected to continue to converge towards its intrinsic value going forward.
Disclosure
This post is not a piece of investment advice to buy or sell stocks. We are neither registered investment advisors nor research analysts. This analysis is prepared for our internal investment decision-making. The purpose of sharing it is purely informational.
Investment in the stock market is subjected to various risks and can result in capital losses. It is advisable to do your own research and/or consult your investment advisor before making your investment decisions.
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