Friday, November 18, 2011

Triton Valves - Numbers tell the story

Spoiler alert & warning! If numbers and number crunching puts you to sleep, please do not read this post!

Triton Valves is a BSE listed small cap company. The company's products are pretty interesting..

Triton is India's largest manufacturer of tyre valves and cores (yes, those little things that poke out of your wheel rim). It is an OEM supplier to almost all tyre manufacturers in India.

Intuitively, one might think that this would be a very good business due to following reasons:
1) The business requires massive scale. For competition to come in, such scale would prove to be a BIG entry barrier. (Imports, aka Chinese goods would surely be a threat)
2) For a tyre manufacturer (Triton's customer), the valve cost is not a large component of total cost (In FY11, Triton's per unit selling price of a valve was just Rs.14.35). So a small increase in price would not be a huge deal for the tyre manufacturer.
3) Due to all these, Triton should be having pricing power, assured and sticky business and growing customers.
Sounds like a very interesting business and opportunity right? I thought so too and glanced through the company.

Well, the numbers show a totally opposite picture. So this post is not only about Triton but also about the importance of numbers in analysis and investment decision making. I personally feel that a good look at the numbers is very essential to get comfort level while investing in a company.

FY04 onward, Triton's sales have grown at a 17.5% CAGR (all numbers in Rs.Cr)

The profitability, however, shows a totally different picture. Operating profits grew at a CAGR of 9.3% and PAT grew at a CAGR of 5.4% only

Cash flows have also shown a deteriorating picture

As a result, the balance sheet has gone for a toss, with debt piling up..

Inventory CAGR (25%) and debtors CAGR (20%) has been much higher than sales CAGR (12%). So every time the company's sales increased, the working capital requirement increased more than the increase in sales, resulting in perennial need of cash for funding working capital.

So what was the cause of all this deterioration? Lets see..

The selling price per unit of Triton's products has grown at a CAGR of 5.2% and 1.7% respectively.

But the raw materials price per unit has grown at a much higher CAGR of 15.6% and 11.5% respectively.

So as raw materials prices rose, Triton was not able to raise its products ka selling prices proportionately, leading to falling margins. In FY04, raw materials consumption was 38% of sales. By FY11, it had become 64% of sales!

Now what will happen if you put more money into the business and expand capacity, but the margins keep going lower? On the expanded capacity, you will earn lesser percentage returns. The return ratios suffer. ROCE, RONW have dropped over the past 6 years.

So what conclusions can we draw from the data?

  • Triton does not have pricing power. The growth in selling price per unit has not even been in line with the growth in the raw materials price per unit. This has caused a hit on margins.
  • Hit on margins, coupled with need for expansion every 2-3 years means that even the new assets deployed will generate lower returns. Further, these assets need to be financed by debt, since working capital also blocks cash. This has led to balance sheet deterioration too.
  • Customers have basically squeezed Triton on two major fronts; product pricing, working capital. And as I have often observed, margins once sacrificed become virtually impossible to regain.

So, the numbers say that (till now, at least..lets not talk about future right now) Triton is not an exceptional business, has no moat or pricing power of its own and will earn super profits only due to luck (e.g. sudden fall in commodity prices). Well, thats just what the numbers say.. What do you say? :-)

Cheers and happy investing!!

P.S. My apologies if I let loose the 'analyst' in me on all you unsuspecting folks! :-D 
P.S. Part 2: This is just a number crunching analysis. This does not reflect upon the quality of management (the Gokarns are decent folks, I think) or what they have managed to achieve in really trying times, over the last 7-8 years.

Tuesday, November 15, 2011

The biases of value investors..

Value investors are considered to be a class apart. They do things differently, they have their emotions under control and they make fantastic returns over longer periods of time. We have n number of examples to substantiate the same. Listen to Buffett's interview vis-a-vis a broker or an analyst or a hedge fund manager's interview and you will agree!
On the blog, I have discussed quite a few examples of biases and mental screw-ups that investors face. (The articles can be found under the 'behavioural finance' label on the right hand side of the blog). Well, value investors are supposed to be well aware of these biases and generally avoid them. But they are humans after all and it got me thinking as to what other biases specifically affect the value guys?
My thoughts on this topic are based on observations of my own behaviour/thought process and that of others whom I consider to be value-oriented investors and with whom I interact. I agree that a specific value investor may not be prone to all the biases listed and also that there may be other biases out there affecting value investors. I would like to add that I am (and probably will be) very much a victim of some of the biases listed below. So lets try and take the mask off the value investors eh? :-D

The 'absolute cheapness' bias
Followers of Graham will especially understand what I am saying. Typically, value investors run screeners to find stocks that are quoting at absolute cheap valuations; e.g. PE ratio of less than 8 times etc. Of course, it is just a starting point, but I have rarely seen investors of this breed being comfortable with valuations of 30-40 times. Even value investors who take investing decisions exclusively based on a company's business model and not just numbers like PE ratio will flinch at the thought of a stock quoting 40 times trailing earnings. The flip side of this bias? Focus on absolute cheapness might lead to missing the bigger picture or ignoring hidden assets of a company which are currently not earning anything.

The 'under-researched stock' bias
A large number of hard core value investors I know enjoy the process (of finding an opportunity) more than the result (profit/loss). Everybody loves profit, of course! :-) But because of this inclination towards the process, lot of value oriented people are obsessed with trying to discover something new, trying to catch something that the market has not understood. There lies their 'kick'. How many value investors will try to discover value in an Infosys or a Tata Steel? As a result, value investors enjoy digging into unknown companies' ARs and trying to find value. The flip side of this bias? Such value investors will miss a 'well covered' stock, like a large-cap, which sometimes becomes a 'sitter' due to Mr.Market going bonkers!

The 'conservatism' bias
Value investors have a licence to be conservative! :-) Lots of them can be also classified as pessimists too! Of course, when a pessimistic guy finds an attractive idea and loads up on it, results can be fabulous. Of course, this wont happen very often, but thats ok! I feel 1 or 2 ideas in an year, in which you can load up is quite ok! The flip side of this bias? Lotsa opportunity losses because the 'conservative' value investor let it go; and selling the stock too early, because the 'conservative' value investor thought the stock has become 'overvalued' too early.

The 'sometimes the best thing to do is to do nothing at all' bias
I feel this is one bias behind which value investors hide when they are actually scared and afraid! It becomes nothing but a mental justification. E.g. a value investor might be actually scared that the market will fall because of debt in Europe, unemployment in US, interest rates in India, real estate in Middle East, fudged data in China and coz there are too many craters on the moon. So, he might not buy a stock he thinks is really cheap, so that he can buy it lower when the market falls! What he is actually doing is trying to time the market but the mental justification to this is 'sometimes inaction is the best action'! This is a very very dangerous bias and will surely lead to confusion, incorrect decisions and overall misery!

The 'bad management' bias
Without taking any names (for my protection), there are certain families or groups which are considered to be 'bad managements' due to their past activities and history. Now I have to mention something, which happens lotsa times: someone says that ignore this company, its a bad management. I ask why is it bad? And the answer usually is 'someone told them' or 'its generally said that they are bad'. Very few times, people give sensible reasons as to why is a particular management bad. Usually, they just 'think' that its bad, thats all! Value investors are usually ethical people and they wont want to earn money in a 'wrong' way. Well I also agree with this and while there are certain groups whose companies I wont touch, having this in-toto mindblock may sometimes lead to some really good opportunities being lost. Managements might change, new generation might take over which is radically different. Keeping an open mind (but an alert brain) helps!

The 'ignore macro stuff' bias

A lot of value investors I know take investing decisions based purely on valuations and not based on macro scenario. This has its pitfalls too. e.g. interest rates affect own discounting rates, industry scenario will change our growth assumptions. I personally am not very great at analysing macro stuff, but totally ignoring macro happenings will lead to incorrect decisions. I think that a fine line is to be maintained here as per one's inclination as well as ability to understand and analyse macro economic data.

The 'circle of competence' bias
We all have heard Buffett and Munger talk about the circle of competence n number of times. It essentially means; identify what you are good at and what you know, identify what you are not good at and what you dont know and then just stick to the former! But some lazy value investors escape taking efforts by saying that something is 'out of my circle of competence'. e.g. I give the very same answer when someone asks me about any pharma company, saying that I do not understand pharma. Now what stops me to get off my behind, read read read and understand pharma? Nothing! But I still havnt done it! So this is a good justification for my laziness right?! Btw, this also raises the debatable topic of should one be comfortable with a COC or should one go about expanding it?! This topic probably deserves an independent post! :-)

The 'we have to do things differently' bias
I have experienced some value investors having this kida and compulsion of doing things differently. They have this OCD to be different all the time. I agree that being different is a good trait of a value investor, but bring different, thinking differently and acting differently just for the heck of it doesn't make sense! The flip side of this bias? You will frustrate people you talk with and they might probably hit you on the head with something. On a serious note, such investors will make a simple straight forward decision complicated and make a mess of things!

Well there you have it! Some biases that I think value investors face. I do not claim that all of these biases are undesirable and should be avoided. Some of them are very much desirable, depending on the kind of investor you are. But what is important is to recognise these biases, identify whether a bias exists in yourself and to watch and monitor it carefully. See to it that it doesn't cloud your decision making process.

Cheers and happy (value) investing!!

Thursday, November 10, 2011

Bharat Bijlee - Going cheap..but yet to electrify!

Bharat Bijlee (BBL) is one of the oldest transformers companies in India with a very conservative and respectable, but very secretive (!) and closed management. (I know..I have been attending the AGM for the past 3 years) The present financial position of the company is as follows:

The profits one sees in the results include exceptional items, which need to be disregarded to know the real position of the business.

About the company

BBL manufactures sub-station transformers upto 220 KVA, with an installed capacity of 13380 MVA. BBL is also into manufacturing of electric motors, gearless machines used in various industries. The company also has a business segment for executing substation projects on turnkey basis. Please check out the AR here and the September quarter numbers here to get a feel of the two businesses of the company.
The past two years have been really bad for the transformers sector. Overcapacity, rise in costs and reduction in Government orders have hit the sector extremely hard. The performance of all transformer players like BBL, Voltamp and TRIL has deteriorated and so have their stock prices!
BBL's transformers business is no exception and in fact, in the June 2011 quarter, the transformers division reported losses, with the September 2011 quarter being just a shade better. In a normalised environment, BBL's transformers business does Rs.500 cr of business on existing capacity, with 10-12% operating margins (upto 20% in really favourable scenario) and 7-8% PAT margins. But, I do not expect a favourable environment for the transformers sector for the next 3-4 quarters at least.
 The electric motors division, however, is reporting healthy numbers both in terms of topline and bottomline. Margins are in healthy two-digits, with the management taking active steps to improve the business, as evident in their actions mentioned in the AR as well as the last 3-4 quarters' numbers. Here , sales growth of 15%, 12% operating and a 8% PAT margin is very much achievable.
The very positive factor about BBL over the last 3 years has been its cashflow. In a challenging environment, where competitors' cashflow has been hit worse than their margins, BBL has shown consistently high cash generation. (Numbers in Rs. Cr)

Anyway, coming back to the earnings perspective, I expect transformers business cycle to turn-around in FY13, with players making normalised margins again. BBL's electric motors business is showing decent traction and continues to grow (segmental margins (17%!!!) have shot through the roof in the September 2011 results)
So lets paint a scenario here, for FY13 numbers. (Please note that I am totally allergic to formal analyst-type 'projections'. Whenever I try to get a feel (i will desist from calling it projections) of future earnings, simplicity and conservatism are the things I give utmost importance. So what you see here is merely a reference point and is in no way, fairly accurate, imho!)

So, can the business do Rs.56 cr of PAT in FY13? (which is Rs.42 cr of earnings in today's terms) I think the probability of that happening is quite high. Also, please note that I have not at all considered the 'other income' on investments, which is fairly high for the company. (Rs.14 cr for FY11)
Valuing this at a low multiple of 8x yields a valuation of Rs.336 cr.

Now come the investments! BBL has the following investments at present (FY11 end)..Number of shares are also in crores..dont mind the decimals :-)

I have taken a 20% haircut to the market value of equity shares (One may take a higher cut for more depressing valuation!!) So, that works out to another Rs.308 cr.
BBL holds these shares since ages and usually, I wont value them at market value, since the company did not intend to sell them. However, in FY11 as well as Q1FY12, the company has sold some shares of Siemens, which is why it makes good sense to me to now consider the market value of the investments.

So, simply adding the business value (Rs.336 cr) to the investments value (Rs.308 cr) and reducing existing debt (Rs.95 cr) gives a total valuation of Rs.549 cr, which is Rs.970 per share. The stock currently quotes at Rs.700, a discount of about 25%.

What I intend to do

1) The company is going cheap for sure. If one compares this with Voltamp, which has about the same transformers capacity (but not same types of transformers), one will realise the 'relative cheapness' of BBL. However, since there are very few relatives whom I like, I never walk down this road! :-) (I have not included this 'peer comparison' to keep the length of the post respectably short!)
2) However, for a cyclical, which is not exactly going through a rosy period right now, the valuations are not dirt cheap and the discount is not high enough.(although you may argue that in the first place, the calculations supporting this 'discount' do not appear accurate, like 'projections' do..well, i do not mind the inaccuracy, as long as i am inaccurate by being on the lower side) Anyway, so I do not intend to make any haste in buying this one. If it drops nicely, nice! If it doesn't, better to move on to some other company.
3) I do intend to keep close watch on the company. Last year, the management passed an enabling resolution to raise upto Rs.400 cr debt. Do they intend to expand lots? Do they intend to start a new business line? I would like to see what they do and how they progress.

All in all, nothing electrifying about it, which would make one ogle and drool.. Hope that time comes too! Till then,

Cheers and happy investing!