Wednesday, June 29, 2011

The 'Value' Mindblock

Each of us have got different views, different opinions and different mindsets when it comes to investing. Some of us like to 'play' in stocks, some like to get into under-researched stocks with good businesses and some are content investing in 'bluechips'.
However, as investors, each and every one of us should properly understand one thing; what do we properly understand?! We should know our circle of competence/our comfort zone and invest accordingly. This will ensure not only decent returns, but also a good night's sleep.
This brings us to the topic of the post - a mindblock that 'value' investors face. The value gang typically goes for stocks that are cheap vis-a-vis their future potential and which also offer a decent margin of safety in case things go a bit wrong. Personally, I also look for a 'trigger' which will help the discovery of value in such stocks. Otherwise, such stocks will remain perennially cheap. (Look at Ultramarine Pigments for example).
In this entire exercise of investing, I often face a certain mindblock. Let me tell you about it with an example. Look at the following companies.

The companies I have illustrated are all established, proven and robust businesses. They are not concept stocks like, lets say, Zee Learning or Delta Corp, which have interesting business, but have yet to 'prove' themselves.
Now the question is, will I buy any of the above companies at present market caps? The point is, I just cant!!! Why not? The valuations!! Look at just the PE Ratio to begin with. Such high PE Ratios tell us that Mr.Market expects a lot of growth from these companies in future (As the companies have delivered in the recent past). Mr.Market also likes the business models which could actually deliver the growth expected of them. And yes, these companies really could deliver.
My problem with such stocks is that there is no margin of safety for black-swan/unforseen events. The valuations already discount a high future growth. And as long as the growth comes in, the valuations continue to be high. But what if for some damn reason, the growth does not come in. What would happen to the valuations (and effectively the stock price) then?
Lets take Jubilant Food for example. Personally, I thought that it was expensive at 400 bucks. I thought the same when it became 500, then 600, 700 and now 800!!! Jubilant Food has been nicely growing for the past coupla years. They have recently expanded their products portfolio, which could help sustain and increase future growth. The valuations therefore continue to be high and the stock will give returns as long as the growth sustains.
The question is, what will happen to the valuations of such stocks, if the expected growth does not sustain or some unforeseen event screws up the basic business model? Crash in the stock price is an understatement.

There comes the mindblock:

  • Should one buy into such 'high growth' stories, paying through the nose for the growth? Or
  • Let them be and suffer opportunity losses (like I suffer all the time). Invest in the 'cheap' cheap stories and stick to what you understand and are comfortable with.
Views invited...

Cheers and happy investing!

Wednesday, June 15, 2011

Goodyear India Ltd - Seeking Answers

I have been tracking Goodyear since quite some time. The reasons I really like this company are:

  1. Excellent brand and brand recall: Goodyear is associated with quality and blah blah (You get the point)
  2. Good positioning in the industry: Goodyear manufactures farm and medium commercial truck tyres and trades in radial passenger tyres and off-road tyres (manufactured by an associate company). Their positioning in replacement market is also very good and the company is making active efforts to improve it further.
  3. Extremely strong balance sheet: Cash of Rs.217 cr against a market cap of Rs.700 cr. The company is selling some land in Ballabgarh, which is expected to bring in another Rs.150 cr as per broker reports.
  4. Decent valuations: At about 10x trailing and 2.2% dividend yield, it isn't over the top expensive.
  5. I will not talk about the delisting angle, because thats been done-to-death in today's market.
However, there are some points in my mind where I am horribly stuck! They are as follows:
  • The company's main raw material is rubber. Does Goodyear use higher proportion of synthetic rubber? What is this proportion? What are the cost advantages here? (For CY2010, their per kg rubber cost was Rs.153)
  • What is the break-up of manufactured goods sales and trading sales? (essentially, I am trying to understand the margins they make in the tyres they procure from an associate company)
  • The AR states that this arrangement with the associate company (Goodyear South Asia Tyres Pvt Ltd) is on a non-exclusive basis and can be terminated by either party after giving four months' notice. If this happens, what is the back-up plan that Goodyear India has? (These sales constitute approximately 20% of the company's total sales)
  • Almost all tyre companies are aggressively putting up capacities. Goodyear India seems to be chilling out. Their installed capacity has increased just from 12.7 lakh tyres in 2005 to 14.2 lakh tyres in 2010. The AR also does not talk of any aggressive growth plans. Why this contrarian approach? What is the management's thought process?
  • What is the break-up of OEM sales and replacement market sales?
  • Goodyear India pays money to the parent under heads such as 'expenditure of trademark fee' and 'expenditure of regional service charges'. The amount paid is about Rs.35 cr. Is this a formula based payment (such as percentage of sales, etc) or is it arbitrary? 
If anyone has answers to these questions, I would be highly indebted if you mention them in the comments to this post or email me on

Cheers and happy investing!!

Sunday, June 5, 2011

Jagatjit Industries - As weird as it gets!!

A few clarifications from my side, which will help you choose whether to read further or not!!

  • The basic idea for this weird case was pointed out to me by a friend of mine. I worked on it fully, but its really not my original discovery.
  • There is no money making opportunity here.
  • IT GETS REALLY REALLY CONFUSING! (and funny too!) Its a fine example of how funny situations can emerge by following the law to the letter!!
Ok, so now you know that there is no money to be made here. Still, if you wana read, here goes!

Jagatjit Industries' history is the stuff that Star TV serials are made of! We have the grand old founder, his three sons from two marriages who, of course, don't get along, we have a fight for control of the company, cases filed by two brothers against one with the CLB seeking justice, creative issues of financial instruments (equity) and of course, to top it all, we have a very very very veryyyyyyy weird open offer!! 
Spoiler: the open offer would result in a 380% acceptance ratio!!!

Sounds interesting? Lets check it out! 

The background

The shareholding of Jagatjit Industries goes like this:
Please click to enlarge

Ok, some points for you:
  1. Jagatjit Industries had allotted 25 lakhs Differential Voting Rights shares to one of its promoters, in which, one share carried 20 voting rights. So, these 25 lakhs shares are equal to 5 crore shares (25 lakhs shares multiplied by 20), as far as voting rights are concerned.
  2. Now, due to this, the promoters had to make an open offer to shareholders, aggregating to 20% of the VOTING CAPITAL of the company.
  3. Now, because of the DVRs, the voting capital will be different than the actual capital, right? 
Here is how the open offer calculation goes..
The original open offer was made in April 2006, when the GDRs were not issued yet. Hence, the total capital for our calculation purpose is only 2.09 crores equity shares. (without considering GDR wala shares)
Let us calculate the open offer, based on 'voting rights' criteria:

Please click to enlarge

So basically, the open offer has to be 20% of the voting capital of the company (which in this case, is different than the equity capital, since some shares carry more votes!!)

Therefore, the open offer will be for 20% of 6.85 crores equity shares, which is 1.37 crores equity shares. BUTTTTTTTT the public holding is only 35.8 lakhs equity shares!! So whom will the promoters make an open offer to??? Hilarious!!
Here is what the Jagatjit Industries' Company Secretary (CS) and SEBI ka conversation might have been like... :-)

CS: Sir, we have to make an open offer for 20% of the voting rights. So in our case, we have to make an open offer for 1.37 crores equity shares, right?
SEBI: Yessir, thats what the law says and thats what you will have to do!!!
CS: But Sirrrr, our public holding is only 35.8 lakhs shares. So, to whom will we make an open offer for 1.37 crores shares???
SEBI: Hey thats none of my concern. You have to do what the law says...
CS: But Sirrrrrrrrrr, if the open offer succeeds fully, ALL the public shareholders will tender and we will have to accept it fully.
SEBI: Yaaa, so??
CS: Sirrr, promoters will then hold 100% shares!!! Isn't that kinda like automatic delisting??
SEBI: Yaaa, so??
CS: But Sirrrr, delisting without reverse book-building??
SEBI: O teri!!! Is this whats happening???
CS: Yessss Sirrrr...thats what i have been trying to explain!!!
SEBI: Ok, give us some time to think about it and we will get back to you soon!!
CS: Ummm...well ok..

Well, SEBI did think about it for five years, which has resulted into this new open offer!! Now, the promoters will have to pay the shareholders interest for five years too!! Hence the open offer has been fixed at Rs.38 PLUS Rs.31 interest, thats Rs.69!!! Shares are quoting now at Rs.68.80. Remember, you can buy any quantity you want from the open market and tender it at Rs.69. IT WILL BE FULLY ACCEPTED!! The offer is open upto June 13, 2011.  In fact, an offer for 1.37 crores shares, when public holding is just 35.8 lakhs shares, means 380% acceptance ratio!! 

All in all, this is one hell of a weird, yet interesting situation which has arisen by following the law to the letter, which will also result in promoters holding 100% of the shares, enabling them to delist the company without going in for reverse book-building!! Can other companies get any ideas from this? ;-) Hope not!!

Hope you enjoyed this as much as I did!!

Cheers and happy investing!!!

P.S. There are some points relating to Jagatjit Industries that i have deliberately not mentioned since they were not relevant to the crux of the article..