Wednesday, April 28, 2010

Funda-mental Shorter Term Positions!

In case you are expecting any intra-day, intra-week or even intra-month calls, please read the following first:

For me, a 6 months time frame would be short term, a time frame upto 2 years would be medium term and beyond 2 years would be longer term time frame for investing.

So for those of you, whose average holding period typically lasts a few hours, this post would be of no interest!

Also, let me clarify that this activity has never been my focus area, nor is it my main objective for being in the market. Hence, under this 'theme', I would advocate taking a small, 2-3% of the portfolio position and take advantage of a 30-35% spike in price, typically over one or two quarters. One should also consciously ensure that one's position size in this activity does not increase with consistent success, if any! ;-)

Let me explain myself with the help of a couple of examples:

LG Balakrishnan & Bros Ltd.

CMP: Rs.265/-
Mkt cap Rs.204 cr (EV Rs.313 cr)
Trailing PE: 11x
Dividend yield (normalised) 1%

Consider these points:

  • LGB is basically a 2 wheeler auto ancillary company. The company manufactures motorcycle transmission chains, sprockets and small parts, using fine blanking process.
  • The company's brand Rolon commands over 50% OEM and replacement market share. Clients include all 2 wheeler manufacturers in India.
  • The balance sheet is in decent shape, specially after the sale of its industrial chains business last year. Valuations are not really cheap, but cannot be called over-the-top expensive either.
  • Bajaj Auto is LGB's biggest customer. Now, upto November 2009, Bajaj Auto's monthly sales were quite sluggish. November onwards, the monthly sales have really taken off, as often discussed in numerous newspaper articles. (Monthly bikes sold 56% up in Oct 09, 137% up in Nov 09, 85% up in Dec 09, 112% up in Jan 10, 80% up in Feb 10 and 85% up in March 10)
  • So will this have a positive spill-over effect on LGB's sales? Will LGB's March 2010 results look really good, specially because of the low base effect? Time will tell..
  • Mr.Market usually rewards good results with a spike in the market price, as there occurs a 'reversion to mean'; since in light of good results, the stock suddenly starts appearing cheap. When this happens, the spike in price can earn an investor a tidy profit.
  • A visible negative: LGB has some optionally convertible bonds, to be converted in 2012. This could lead to dilution in equity. Anyways, under this theme, one would not stick around until that time!
Interesting? Well, here is another example..

Gujarat Alkalies & Chemicals Ltd.

CMP Rs.119/-
Mkt cap Rs.870 cr (EV Rs.1183 cr)
Trailing PE: 8x
Dividend yield 2.5%

Consider these points:
  • GACL is a diversified chemical company, but is primarily a caustic soda manufacturer. It is also the country's largest caustic soda manufacturer.
  • In mid 2009, caustic soda consumption in the US turned sluggish due to overall depressed conditions. (US is the largest producer of caustic soda). A lot of mass scale dumping of the commodity in India took place.
  • Prices of caustic soda crashed in the country. Here is a dated ET article about the same. Prices crashed from Rs.22000-25000 per ton to below Rs.10000 per ton!
  • The industry appealed to the government to levy safeguard duty, which was levied in December 2009. Notification.
  • Post safeguard duty, the prices of caustic soda have started rising again and are now above Rs.20000 per ton. A recent news article..
  • So, with increase in realisations, will GACL report better numbers in March 2010 and June 2010 quarters? Raw material prices (salt) have not increased a lot.
  • Andhra Sugars has a caustic soda division. The March 2010 results of Andhra Sugars show a 90% increase in the caustic soda segmental profits. This could be a pointer to the likely results of companies in this sector.
  • A visible negative: GACL has announced a mega expansion plan, for which it will have to take up significant debt and maybe dilute equity too.
I would re-iterate that putting money under this theme is an extremely risky proposition. Second-guessing near term results should not be an investor's main activity. (Watching good movies can be! :-) ) 
I would never advocate taking a major portfolio position under this theme, but it is an interesting way of looking at things nevertheless! 

Also, if one has taken a position under this theme, a spike in market price is all one looks for. (Something like a 30-35% spike can be aimed for in most cases). Once the spike happens and the 'reversion to mean' takes place, the objective of buying the stock gets fulfilled. One should immediately sell off the stock, once it becomes fairly valued. One should not allow greed to take control and hope for higher market price. (Even if it happens later, fine, let others earn too! :-) )

So, one need not speculate/punt while taking shorter term positions. Such positions can make your portfolio go that extra mile.
Reading newspapers, industry journals and talking with industry people is the best way to get information which will help you take such calls.
If you get any, do let me know! :-)

Tuesday, April 27, 2010

Aditya Birla Chemicals - Perplexingly Cheap!

The purpose of this post is to discuss only the valuation of the said company. I have not discussed the company's business strategy/its expansion plans/sector prospects or any such criteria. In the process, I would also like to discuss 'valuation' as a general concept, not specifically related to this company.

Some stocks in the market are cheap..others are CHEAP.
Aditya Birla Chemicals (ABCL) probably belongs to the latter category.
Aditya Birla Chemicals Ltd is a chemical company belonging to the Aditya Birla Group. (I think that was the least-value-adding sentence ever! :-) )
ABCL's main product is Chlor Alkalies (chlorine and caustic soda). One can have a look at their products here.

ABCL is valued by the market as follows:

"Results of the quarter ended December 31, 2009 has been effected due to annual planned shutdown of power plant taken in the month of Nov´09."
One should take this factor into account while looking at the trailing valuations.
Seems cheap huh?

Well, if you had invested in this company on 26/04/2006, you would have made a total (not compounded) return of 32% in the last 4 years. Now, i am a very conservative fellow, but this kind of return would not excite even me! Dont get me wrong, I really do not care about a stock's historical price movement.. this was just to give you a perspective. :-)

Now let us look at the company's historical performance. I have tried to list down basic financials, which can give us an idea of its past performance.

Growth: ABCL has shown consistent growth over the past 5 years.
Cash-flow: ABCL generates a decent amount of cash. This has led to the entire growth being financed through internal accruals over the past years. The company has not diluted capital and has, in-fact, repaid debt consistently.
Margins: Being a commodity business, margins can fluctuate. 35% operating margins can be considered as normal. (Margins are higher than its peers like Gujarat Alkalies and Chemicals)
Valuations: Extremely low, consistently! The market has neither fancied this stock, nor given it decent valuation ever.
In fact, it can be observed that, over the years, as the company has improved its financials and performance, it has become cheaper!!!

So whats wrong? Why is Mr.Market giving this company such pathetic valuation?
Now I agree that a commodity-type business will never get high valuation, but should the valuation be this low?

Let us look at some typical factors which lead to a company being accorded very low valuation: (My comments are in red)

  1. Dishonest/inefficient management: ABCL is a Aditya Birla Group company. One can say with near certainty that the management is neither dishonest nor inefficient.
  2. Dubious financials: The numbers do seem to be in place. I do not believe that there is any problem with the numbers.
  3. Products with bleak future: This also does not seem to be the case. ABCL's products are well in demand. The company is also getting into more value-added products.
  4. Absence of growth: Mr.Market typically accords low valuations to businesses where growth is severely depressed. This also does not seem to be the case here.
  5. Extremely low margins: Businesses with very low single digit margins are accorded low valuations. This also does not seem to be the case here.
  6. Low dividend distribution: Yesss!! This could be one of the reasons for the low valuation. ABCL has never distributed more than 11% of its profits. In the small cap space, investors generally prefer companies paying out more dividend. However, as long as the company's return ratios remain high, i am comfortable with low dividend payout.
  7. Who will look at a boring commodity-chemical company?? Could this be the reason? Well, if yes, I would be very interested in investing in the company.
  8. ABCL's website does not have an 'investors' section: ok ok, now i am being ridiculous! :-)
Well, then, what could be the reasons for such low valuation being accorded to the company? It is pertinent to note that these valuations have been depressed for years together, not just in the recent past. More importantly, how long do you think will the company keep on getting such low valuation?

Questions questions!! Is there a clear answer? Well, i invite readers to contribute their thoughts, to my thoughts! I am a firm believer that valuation is more art than science and such discussions add great value.
Looking forward to your comments..
Cheers and happy investing!

Thursday, April 22, 2010

Analyst Bias

"Research Analyst"... Probably the best profession in the world! Here's why:
  1. Unlike other professionals like Doctor, Lawyer, etc., one does not need any specific qualification to become a research analyst.
  2. There is virtually no penalty/answerability for going wrong (or even horrendously wrong). Think about it. (Of course, an analyst will be answerable to his boss, who can go wrong himself! :-) )
  3. The analyst gets to blame others all the time. E.g. If a company does not declare results as per the analyst's 'projections', the analyst gets to say that the company has 'underperformed'. Arey!! How can the company ' underperform'? Isn't it the analyst who has 'underperformed', who has not made correct and logical assumptions to arrive at forward numbers? But no! Its always the company and its management who underperform! Sweet! :-)
Research analysts are known to have gone phenomenally wrong (and occasionally, phenomenally right) on the investment advice they dole out. Of course, there exists a big conflict of interest, since most of the analysts are employed by brokers. So the basic objective of their research is to generate brokerage for their employer, and not necessarily the welfare of investors! ;-)

Anyways, enough with the pointless analyst-bashing, partly because i am an analyst myself!
The purpose of the post is to discuss the phenomenon called 'analyst bias'. Now, this affects all investors and not just analysts. So it makes sense to know about it..

Let us see how an analyst should make a recommendation, logically. After that. we shall see how an analyst who is affected by 'analyst bias' makes the recommendation. Damodaran has written on this concept in his books.

The logical thought process of a research analyst:

Now, lets look at the thought process of an analyst affected by 'analyst bias':

As one can see, the entire thought process of an 'affected' analyst gets inverted. Instead of starting with research and ending with an opinion, the analyst has started with an opinion and follows it up with research!

I do not mean to demean analysts per say. Unfortunately, even though this affects all investors, the phenomenon is called as 'analyst bias'. Think about many times have we bought stocks, just because someone gave us a 'tip'? And afterwards, we end up rationalising our decision one way or another.

So how to escape and guard against analyst bias? One very logical approach is to do original research, filter away the noise and ignore 'tips'. Another way is...

Remember this handsome gentleman? For those of you who are not into movies as much as i am, this is the character 'two-face' from Batman: The Dark Knight. He can provide us with an answer to our problem!

Don't get me wrong. I am not asking you to become disfigured, yet cool! :-) What we need to learn from this is about having a bit of 'split personality'.

What if we do this.. For any company that we think is a 'buy', we prepare a 'sell' report on it! I agree that this is extremely difficult, given our natural thinking patterns and biases. It takes time. So the next best thing is to ask someone (some friend, maybe) to give as many 'sell' points for the company as possible. This would help us come across points and arguments, that we might have unknowingly ignored, since we considered the stock a 'buy'. This would help broaden our view and take better and informed decisions.

So there is a lot more to movies than just entertainment after all!! Psychology and behavioural finance are absolutely fascinating and i intend to post more on these topics. Hope you will enjoy them as much as i do.

cheers and happy investing!!

Wednesday, April 21, 2010

Kesar Enterprises - Seems Sweet!!

Statutory Warning: Kesar Enterprises is a sugar company!

In spite of this, if you still have any interest left in this post, please read on! :-)

Kesar Enterprises (KEL) is a sugar company based in UP. It also has small divisions like power generation from molasses, seeds, smart crops, etc. The reason i am writing about this company is because it is demerging one division, which has the potential to create substantial value to the shareholders.

The situation:
Along with the sugar business, KEL also has a liquid storage division. The company had announced the demerger of this division into a separate company, Kesar Terminals and Infrastructure Ltd. (KTIL), which would of course be listed. The demerger has already been sanctioned by the Mumbai High Court and all that remains is for the company to hold a Board Meeting and announce the record date and other details. The ratio for this demerger has been fixed at 7 shares of KTIL for every 10 shares held in KEL.

I have tried to value KEL and KTIL directly on market cap basis, without getting into per-share calculations.  

Valuation of sugar business:
Analysing sugar business and investing in sugar companies is not my cup of tea. I do not like the business at all and have never analysed/studied any sugar company. So i faced a big problem here and i feel this is the weak link in my hypothesis.
So, of course, i had to talk with someone who analysed sugar businesses. After talking with quite a few people, there was consensus that the replacement cost of a plant of KEL's size would be at least Rs.250 crores. KEL has debt of Rs.165 crores for FY09. So that gives us an approximate market cap of (250-165)=Rs.85 crores. This is close to the present market cap of KEL. We can conclude that the sugar business is fairly valued. (Again, i am stressing that this is just a rough calculation. Since i do not like the dynamics of the sugar industry in India, i have not even studied the sector/any sugar company and hence, cannot value sugar businesses properly.)

Valuation of the storage business:
KEL's liquid storage division has become an annuity kind of business for the company. For FY09, the business had a topline of about Rs.14 crores and PBIT of just over Rs.7 crores. After considering interest on debt to be transferred to KTIL Rs.13 crores and taxes, KTIL can have PAT of Rs.5.5 crores. KTIL has plans to grow into an integrated logistics player, from having only storage business. Companies in this sector get valuations in excess of 20x trailing. To be conservative, we will give KTIL a valuation of 10x.. that seems quite reasonable right? Soooo PAT of Rs.5.5 crores and a PE of 10x should give KTIL a market cap of Rs.55 crores at least.

Great!! Now lets summarise...

This demerger could create substantial value for the shareholders. Post demerger, KTIL has substantial growth plans of its own, but lets not get into that, since i am approaching this as a 'special situation' case and not as an investment case.

Now lets take a look at the risks/limitations in this entire exercise:

  1. Inability to value sugar business with conviction: As i have already mentioned, its just not something i am particularly good at (like a lot of things!). So if there is anyone out there who can value KEL's sugar business properly, I am more than willing to buy you a nice single malt ka bottle! :-)
  2. Time risk: All the legal and procedural formalities for the demerger have been completed. All that is left is for the company to announce the record date and go ahead with the demerger. It is very much probable that the company might declare the record date, along with the results announcement. (before April 2010-end). So in my view, the time risk is not significantly high.
To conclude, it does seem that if one buys shares of KEL at current market cap, it would prove to be a good special situation position. The MOS comes from the current market cap of just Rs.80 odd crores, which is quite near to the value that KTIL could command and the fact that all legal formalities are over. 

Cheers and happy investing!!

MTNL - Value Trap?

A typical value investing principle states that any company, whose market cap is less than its cash on books, is a buy. (It should be preferably debt free.)

Now lets look at MTNL in this light.
CMP Rs.74/-
Market cap Rs.4600 crores
The company is debt-free.
Cash on books as per March 09 balance sheet Rs.4803 crores
Investments on books as per March 09 balance sheet Rs.465 crores.

Even if one does not consider the investments, the cash on books alone is more than market cap. Sounds yummy? Well then how bout this BSE announcement on 22nd March 2010:

Mahanagar Telephone Nigam Ltd. has informed the Exchange that 'In the matter of deduction under section 80IA of the Income Tax Act, 1961, the Income Tax Appellate Tribunal has allowed to MTNL a further proportionate relief for the Assessment Years 1998-99, 1999-2000, 2001-02, 2002-03 and 2005-06. As a result of this order, MTNL would be entitled to an estimated amount of Rs.1380 crores which would include an Interest amount of Rs.624 crore approximately'.

If we add this to the March 09 cash on books, MTNL would be having cash of Rs.6183 crores. Against a market cap of Rs.4600 crores! It doesnt get better than this huh? Blind buy? Sitter? Well not quite.. Lets see some reasons why...

  • Lets look at the quarterly results broadly. The company has been making losses at the PAT level. But if we add back depreciation, the company is making cash profits. Thats good right? Welllll...if we look into it more, 'other income' is a major chunk, which is essentially the income earned on its huge cash reserves. If we reduce other income from the results, it is evident that the core business of the company is burning cash.
  • As a business, MTNL's performance has been really poor, to say the least. During the era when other telecom companies grew by leaps and bounds, MTNL has barely managed to grow. Also, there are issues like a large employee base, inefficiency, limited growth opportunities, etc.
  • The upcoming 3G auctions will take huge chunk out of MTNL's cash reserves. MTNL operates in prime circles, where the bidding for 3G can prove to be expensive. (i have no expertise in this, but estimates suggest that it could take more than Rs.1500 crores out of MTNL's cash reserves.)
So, all in all, there is high probability that MTNL's shareholders will never get any of the cash on books (through dividend or buyback) and in-fact the cash will eventually erode..

MTNL seems to be more of a value-trap, rather than a value-buy..

The Introductory Post..

A big hello to all. And welcome to my blog.

A bit about me
I am a consulting equity analyst based in Pune, Maharashtra. Investing is my passion and investing in equity is what excites me most. I have built my core competency around investing in Indian listed companies, specifically mid-caps and small-caps, using fundamental analysis and value investing principles. I also dabble in special situation cases every now and then.
By nature, I am quite conservative and risk-averse, and it spills over in my approach towards investing too. I am an avid reader and i read books based on value investing, behavioural finance and psychology.
As a hobby, I teach in the capacity of a visiting faculty in 3 business schools based in Pune, where i take up specialisation subjects like Security Analysis, Portfolio Management, Derivatives and Financial Markets. Please click here for my Linkedin Profile.

This blog is a place where I will discuss my thoughts on investing in general, specific investment opportunities and investment psychology. I believe that investing is a profession where learning never stops. I would like to discuss my thoughts and ideas with readers and learn more and more. 
This is not at all meant to be any kind of business venture.

The standard disclaimer
Everything that I publish on this blog are my personal thoughts and opinions. They are in no way a representation of opinions of any of the organisations I work with. Most importantly, this is a place for discussions only. None of what I publish should ever be construed as an investment recommendation (or otherwise). Also, I will not disclose buying/selling details of any particular stock. Being a professional analyst, i believe it would be unethical and unfair to do so. 

Cheers and happy investing!!!