The last mail

Its been a while since I posted something on my blog. Apologies for this since i moved jobs ( from banking to eCommerce) and have been quite caught up in getting a hang of my new work.

On my last day in my previous organization I had written the following good bye mail:
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Hi,

 

This is probably my last email from this mail I’d, so let me begin by wishing all of you very best for future (I know bonuses are round the corner :))

 

As I write this I am filled with mixed emotions. On one hand is the heady exhilaration of starting something new (have found a benefactor who is funding me to start a bee farm in Cyprus) whereas on other is the sad realization of parting with an experience which I have really cherished.

 

And the reason I feel sad is not because I am leaving an organization, but probably because I will be leaving some fantastic people with whom to quote from Mad Men “Had Swell of a Time”. In ways known and unknown to them, they helped me grow not only as a professional but also made me grow as an individual. Office where we spend substantial amount of our lives should be a place to forge friendships and discuss things beyond work and I have been lucky to form some great friendships. It was during one of these discussions that these folks inspired me to look at greener pastures (and not only in terms of currency!!!).

 

Lastly, would like to thank my seniors, my team (who unfortunately have declined to join me :( ) and my colleagues for making this journey at YBL a fun-filled and enriching one.

 

I can be reached on xxxx@gmail.com or on my twitter handle @saurshan or you can comment on my ramblings at my blog www.constantseeker00.blogspot.com

 

Saurabh

PS- Cyprus is bankrupt; I have no benefactor and I don’t think I can ever be a farmer. Ouch Damn these Bees!!

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The reason why i mention it here is to capture the reactions which i got after the email and the learning fn our behavior, apart from making all of you aware of my fantastic sense of humor :)

Reaction 1: What the hell, who quits a job to start a bee farm ?- Obviously these folks didn't read the mail and fell for the first line. This is reminiscent of how often we behave in investing. Few good lines, few good comments often push us to take an investing decision.

Reaction 2: How did you get a benefactor? How did you sell your idea- Again a trap in which we often fall, trying to answer the wrong questions. When we look at a stock the first question we try to answer often is what is the return i will make, rather than questioning the underlying business.

Reaction 3: That is a great and funny email :). That is what investing should be for all of us, if its not fun, looks like a burden, and you can't laugh on your mistakes go buy an Index Fund.

Hope all of you enjoyed reading this and hopefully i will be more regular in my posts now.

Cheers,
saurabh

Guest Post: Its only Words

This is a Guest Post from a renowned investor known in our world as VIJI. I have been lucky to learn quite a bit from him, and going forward would try to post nuggets from him.
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Experience teaches many lessons provided one has open mind to learn.  As an investor, I have learned many lessons over the years. One of the more important lessons is to be leery of repetition.

If I hear a word, phrase, or a concept repeated often to explain a myriad of phenomena, I immediately question the worth of the commentary, as well as the validity of the commentator's underlying thesis.Repetition of the familiar is often a mental short cut. It allows the commentator to explain a cause and effect relationship, even though he/she might be unsure of the relationship (or he/she might simply be attempting to fill space).

Below are a few commonly invoked buzz words or phrases investors would be better off ignoring.They simply fail to impart any insight yet their use is ubiquitous.

Fear: This word is most often used upon the bursting of an asset-price bubble. Investors are fearful, so that's why we are in a recession. Unfortunately, fear is wrongly used as a synonym for uncertainty.An investor is more often uncertain, not fearful. And he is usually uncertain, and rightfully so, after the bursting of an asset-price bubble because he is unsure of governments response to the bursting. And he is uncertain how other market participants will react to the government's response. Therefore, it is uncertainty keeping him out of the market, not fear.

Greed. The word “greed” is often associated with fear. It was greed that led to an asset-price bubble.But asset-price bubbles form not because of greed, but because of investors acting on outside incentives.Investors acting on incentives, even if the incentives are misguided, doesn't mean the investors are greedy.Greed is also incorrectly used to denote ambition. The two are not the same. Ambition means working to get what you want.Greed is an attempt to get something for nothing. Most investors and analysts are ambitious, not greedy.

Probabilities and Statistics. An analyst who says “there is a 40% chance of the economy falling into recession” is proffering nonsense. Economies and investments are not a gamble like the roll of a fair die, where you know there is a 20% chance of hitting any number.Economies and investments deal mostly in uncertainty, not risk. Uncertainty cannot be quantified, because it  deals with un-quantifiable human action.Risk - like the chance of a house burning down within a five-kilometer square radius - is quantifiable because it is not influenced by deliberate human action.Ignore prognostications like “ABC company has a 70% chance of hitting Rs XYZ  within the next three months.” There is simply no way of knowing, unless the source of the prediction is revealed, such as “according to current options prices.”

Market Efficiency. This should only refer to ease and cost of exchange between individuals. Instead, market efficiency is used to reflect fully and realistically all that is known about a company.If markets are truly efficient, as some academics believe, then there would be no RJ or for that matter even Warren Buffet.It is impossible to know the amount of information embedded in a stock price.

Markets Acting. Any reference to a market doing anything is wrong from the start. Markets cannot act; they can't do anything. A market isn't a place; it's a process of exchange.When a reporter says something like “the market sold off today,” he is talking about the activity of many individual investors and then ascribing that to “a market.” To refer to the market doing anything on its own is to talk of the market as if it were an acting entity, which it isn't. Markets reflect the actions of individuals; the markets themselves do nothing. The distinction is worth remembering, because there is rarely only one reason for why the market ended the day up or down. All individual investors don't act on the same information.

I am not mentioning  these mental short cuts to point fingers.

I have been guilty of invoking them myself on occasion.The key is to become aware of the habit, and not be fooled.

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cheers,
saurabh
PS- I took the shortcut to writing a post, please don't do that while taking investing decisions.

Build(er) to Wealth

If I had tons of money (I know I can dream big), the one business I would have definitely done was of Real estate. For me it is one of the few business where a large amount of capital can be deployed at very attractive return rates

Also, it is a fairly simple business to understand. It is similar to a manufacturing without the complexities associated in manufacturing.  So one needs to acquire a land as his raw material at a reasonable price, then build/ manufacture the flat and sell it at a marked up price (on which he has substantial control).

And then I woke from my dream and realised to my utter dismay I can't become a builder. But, on other hand I realised I can do own such businesses by buying their stocks.

This led my search into the real estate sector, and again to my dismay  return ratios of  most companies in this sector were horrible.

Quoting from the movie Snatch > Never underestimate the predictability of Stupidity", i realised that despite the pricing power real estate companies enjoy they committed the same mistakes which their manufacturing counterparts with no pricing power had did.

In manufacturing what happens if a company buys lot of raw materials  and demand slows down.  Well you get one real messy situation as your fixed costs and interest costs kill you. This is what also happened with most real estate players. They bought land banks using debt on the assumption that demand would keep growing forever at a furious pace, and when the tide turned, the debt burdened almost wiped them out.

In all this mess i though did find a company which seemingly behaved like the company in my dream. Its name is Ashiana Housing


Background: 
Ashiana Housing (http://www.ashianahousing.com/index.php) is a real estate developer with focus on group housing cost/old age housing. Their main focus till now has been developing projects in Tier-2 towns like Bhiwadi, Jaipur, Jamshedpur etc.


The big differential between Ashiana Housing and other builders is that Ashiana treats land as a raw material rather than an investment and thus focuses on execution rather than chasing land banks.

By following this business model Ashiana has entered into a positive feedback loop explained below. Such loops are rare to find and  are very difficult for competition to replicate. ( Read more about this in this Book )

1)  Due to its  focus on execution, Ashiana has an impeccable track record of completing its project before scheduled delivery dates.
2) This has led to banks offering full disbursements of home loans ( around 60-70% of flats are purchased using home loans) rather than funding construction linked loans. This leads to lower interest costs for the customer, since in a construction linked funding loan only interest is repaid till the complete disbursement
3) This then leads to more customers preferring Ashiana over other builders, even though Ashiana usually has a premium attached to it
4) This leads to float for Ashiana in form of advances from customers, who in turn have been funded by banks. This interest free float can then be utilised by Ashiana for land acquisition or quicker project execution or for forming JV's with other land owners


The above is verified by the fact that Ashiana is almost a zero debt company and has cash of around Rs. 85 Crs as on 31st December 2012. Since has not blown away its cash in land bank game and acquiring assets its average 5 year RoE is around 35%.

Present scenario:

Ashiana had been suffering from 2 problems, one related to its valuation and another completely unrelated to its valuation.

The unrelated Problem:: Company changed its method of accounting from percentage completion method  (POC)to contract completion method. In the first method as the construction happens and sales get booked, revenues are recognised and so there is a smoothness in reported revenues. Under the POC method, revenue gets accounted after a certain minimum cost threshold is reached which varies from 5% to 25% of budgeted costs. However this method does not reflect the liabilities and assets of the company accurately. Ideally,  till the flat is delivered to customer the entire amount received from customer is liability but in POC method this is never accounted for.
In contrast in contract completion method revenue is recognised only when the ownership of flat has been transferred to customer a la manufacturing setup. This often leads to lumpiness in revenues and low visibility of revenues in immediate future.

Ashiana changed its method of accounting from POC to contract completion, leading to loss in visibility of revenues for few quarters. Now Mr. Market hates uncertainties, and since there is uncertainty in revenues he has not been kind to the company.


The Related Problem:: In a ruling in 2011, government of Rajasthan had stopped giving any fresh permissions of conversion of Agricultural land into non-agricultural land. This led to what we can say as raw material shortage for Ashiana. However in last 4-5 months, most of these issues have been resolved at government levels and Ashiana is now getting regular approvals (raw material) for its construction activities.

Now, since the problem related to valuation has been resolved lets actually look at

Valuations:

The first step I took was to look at the cash flows which company will accrue over say a period of next 3-5 years. The calculations for this is given in the table below. The data for future saleable area is taken from company presentations and can vary a bit

Present Saleable area	Location	Saleable Area(in lac sq. ft)	Area booked	Gap
Ashiana Aangan	Bhiwadi	20.56	20.52	0.04
Utsav	Jaipur	3.7	2.47	1.23
Ashiana Brahmananda	Jamshedpur	4.8	4.67	0.13
Ashiana Amarbagh	Jodhpur	5.95	5.82	0.13
Utsav	Lavassa	6.87	2.61	4.26
Rangoli	Jaipur	26.06	16.88	9.18
Marize Plaza	Jamshedpur	0.83	0.3	0.53
Treehouse	Bhiwadi	1.2	0.46	0.74
Ashiana Aangan	Neemrana	4.2	2.93	1.27
Future Saleable Area
Ashiana Town Thada	Bhiwadi	39	0	39
Utsav	Kolkatta	7.5	0	7.5
Milakpur Land	Bhiwadi	31.49	0	31.49
Ashiana Navrang	Halol	6.43	0	6.43
Gulmohar Garden	Jaipur	11.5	0	11.5
Anantara	Jamshedpur	4.69	0	4.69
	Jodhpur	5	0	5
	Neemrana	3.6	0	3.6
Total Saleable Area				126.72

I then tried to estimate a normal case and worst case scenario for the company

	Normal Case	worst case
Average Realisation per sq.ft	2500	1750
Expected Sales over 5 years ( Total Saleable Area* Avg. Realisation)	3168	2217.6
PAT over 5years# ( In Crs)	792	443.52

# Best Case Margins are 25% which is historical and worst case assumption is that it reduces to 20%

Considering the unique nature of business if we suppose that company doesn’t acquire any fresh land bank, it will have minimal running expenses and almost all of PAT will be available as free cash to the company. Let me further worsen the case and assume that all this cash flow is accrued to company only in 5th year ( Ashiana completes projects usually in 3 years). The scenarios then look like this

 

All fig. In Crores	Normal Case	Worst Case
PAT over 3 years= Free Cash Flow	792	443.52
Discount rate of 10% for period of 4 years	491.77	275.39
Add Cash as on 31/12/2012	85	85
Market Cap	576.77	360.39
Present Market Cap	460

Conclusion:

1. At a Mcap of Rs. 360 Crs company ( Make my dream true and let it reach this level) will be nearly valued at distress valuations with no visibility in sales growth and with almost no possibility of increasing its sales price, both of which seem unlikely.
2. Even in case of normal scenario, we have assumed that company is not going to use cash to buy more land. In all probability it will buy more land and thus employ capital at rates in excess of 30% ( historical RoE)
3. I have been a buyer in this stock on every dips, and in case it falls to levels of Mcap of Rs. 360 Crs I will do significant addition into it.
 

Thanks and Happy Investing

Saurabh

PS- Invested in Ashiana Housing, and hence views may be biased

To FY13, 14......& beyond

FY 2013 has been a remarkable year in stock markets, like every other year!!


There were the usual ups and downs, the usual spectacular rise and equally dramatic fall.

For me though the standout part was that i felt Mr. Market was exceptionally right this time.

We know by definition stocks mean "A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings"  and if one observes that stocks that have lost most of their value actually had issues on their earnings or assets.

This makes me realise that Mr.Market is getting increasingly good in his work and  we will need to think of newer ways to beat him ( Can i see the exotic options, intra-intra day traders clapping their hands? ).

Sorry to spoil the party guys, but we don’t need newer ways. What we do need to do is re-learn the old ways (I know its boring, but Buffet,Munger, Graham still work) and more importantly practice what we learn.

So here is what I am trying re-learn and practice for next few years

1) Quoting Munger, " All i want to know is where I'm going to die so I'll never go there" and here are the places i don't want to go

• Companies with high Debt/Equity
• Consistent -ve cash flow from operations
• Continuous equity dilution, except in case of Banks and NBFC's
• Companies having high number of pledged shares

2) All business are either cyclical or non- cyclical- Take your pick!!

I learnt the lesson hard way, when I convinced myself few cyclical businesses as growth or value buys.

Therefore, going forward the first question to hence ask would be what determines the demand of the product which company makes. Hopefully that will give the clue to whether the business is cyclical or not.


3) All business either posses a competitive advantage or they don't

Its the hard truth of our capitalist world. Most companies function because their functioning ensures that value chain keeps moving.  I have often confused this with competitive advantage to my regret and loss.

There is no perfect tool to evaluate this but endeavour would be to use Porter's 5 forces model, Moats suggested by Pat Dorsey etc to try and atleast give a shot at this.

4) All stocks which crash/our cheap don't automatically  become great investments

There is a famous saying in poker, that if in fist 30 minutes you don't know who the sucker is then you are the sucker.

Similarly, when a stock falls dramatically and you buy it just because it has fallen so sharply,  pat yourself because you have become the sucker.

I patted myself quite a few times last year and don't intend to ever get myself patted in that manner.

That's it for now. Here's wishing all of you a superlative FY14.

Regards,
Saurabh

Bharat Bijlee- Lights On or Bijlee Gul

Bharat Bijlee Ltd (BBL) is a company engaged in manufacturing of transformers,lifts and electric motors. It is one of the oldest engineering companies in India and is run by an honest management and conservative management.

BBL is directly dependent on power sector and industrial activity for its business and expectantly the company is going through tough times, with them declaring losses in last 2 quarters. In these tough times company has invested in upgrading its plants, has done optimization of its factory lines etc to enhance the productivity and reduce costs.

A look at financials of the company indicates that management has been effective in employing capital, average RoE is around 20% for last 5 years. Company has no debt and in fact has substantial cash and investments on its books.

What makes the stock interesting is the cash and investments it has on its books. As on FY 12 the company has following investments:-

1. 0.21 Crs shares of Siemens India Ltd, Present Value Rs. 114 Crs
2. 0.051 Crs shares of HDFC Ltd, Present Value Rs. 41 Crs
3. 0.033 Crs shares of HOEL Rs.2. 5 Crs
4. Other investments in HDFC Bank, ICICI Bank etc of around Rs. 3.5 Crs
5. Around 25 Crs in Liquid funds and Cash

Total value of these investments and cash is around Rs. 186 Crs. The present EV of the company ( Debt as on H1 FY12 of around 95 Crs) is Rs. 385 Crs. Excluding cash company is definitely quoting at really cheap valuations.

The investments + cash and history of management not blowing away these away limit the chances of permanent capital erosion.

Any uptick in the power sector will automatically lead to jump in sales of the company and with an RoE of 20% BBL can benefit significantly.  

So is this stock an investment recommendation?

Seems YES from above, but i wont be investing here. My reasons for not investing are given below.

Sweets kept in open attracts a lot of flies, which in turn can spoil the sweet : 
No matter the past track record it is imperative to understand how the business environment itself has changed. Imagine yourself to be a CEO of a large engineering MNC with focus on power sector. It is clear to you that demand in developed economy has slowed down and India though its present problems still is one of the largest market to enter. You will look at RoE/RoC numbers of companies like BBL, BHEL etc and conclude that money can be made in this segment . So you would be keenly observing India, you will have some small operations in India and then when you see signs of improvement will enter the market big time.

If viewed in this landscape it can be seen that mid-sized companies like BBL will be the first ones to get hit. With limited balance sheet strength it will difficult to compete with MNC's in improved environment wherein a lot of players can come and hurt BBL both on quality and pricing.

Although it can be argued that company has done well even after liberalization, but the mega investments in power and the recognition that investments are required in power have come to notice only since 2007-2008. Since, that point a look at sales growth shows how company is struggling.

For a mid-sized company having a moat is critical for it to survive. This can be done by  operating in a niche or by innovating new products or by growing at a rapid clip by eating competition  BBL seems to be failing on all these fronts. There innovation has been limited to productivity measures which wont take them beyond a point

To conclude, when BBL is looked through the lens of a Business analyst who uses Porters 5 force model and not just financials things don't look so rosy here. As Prof. Bakshi says, the right sequence to look while analyzing a stock is Business, People and then Price. 

Most of us including me as in this case did the opposite: Price, People and then Business and often fall into value traps.

Regards,
Saurabh 

PS- What am i doing here? I was influenced by the first part of this blog and had taken a position here. As of now I have reduced my holdings significantly. I plan to attend the EGM on 11th March to try and get answers to my above apprehensions.

Updates from Rubber Expo 2013

Indian Rubber & Tyre show is being conducted in Bombay Exhibition Center (BEC) from 22-24th Jan, 2013.

Since, it is being conducted in BEC ( Owned by NESCO) and GRP has a stall in it, i thought it would be a good idea to do a visit here.

Updates from the visit are given below:

GRP & Industry::

1. Overall demand situation is not great,  but company is somewhat insulated as 70% of their sales are with Tyre Companies
2. Focus is now on Asia & Indian markets, and company is trying to make players aware of the products launched by them
3. Company was surprised to see 7-8 new competitors, although all seem to be of small scale. Also, according to marketing manager, it is difficult to break existing clients as testing process of reclaimed rubber is around 1-1.5 years
4. Brand name of the company is very well established, so participation is more of a showcase event
5. There was very low participation from European companies which are usually present in large numbers, but a lot of Chinese players were present. Also, a very active stall was from Srilanka.
6. Not much info on thermoplastics, apart from the fact that they are starting to get good response. Saw leaflets of these products.
7. Most of the products were either rubber compounds or products related to synthetic rubber. 
8. On tyre section, very small showcase, mostly from known players like CEAT, BKT etc
9. Overall felt that the reaction to show was quite Tepid, with low footfalls and not much hustle. Maybe it could be because i went at around 11 am :)

NESCO:

1. Company seems to be chugging along. IT Building- 4 is ready and is around 15-20 storeys I think. External work and lobby work is still in progress
2. Also, saw starting of levelling and digging in few land patches, so maybe company has already set plans for another building
3. Companies like SERCO, Citibank etc currently occupy halls, which are double storey. In case NESCO is able to get more FSI on these halls, they can also be converted into mutli-storey towers.
4. It is fair to assume, that NESCO is not a valuation mismatch story, as from ground it seems company has no plans to sell its land. It thus, can be a growth story with lumpy revenue jumps basis sale/rental of additional office space and hence critical to have a view of 3-5 years here

cheers,

Saurabh

PS- Invested in both GRP and NESCO

PPS- If any one else has visited the exhibition do share your comments.

Sporty Investment Insights

I am a huge sports fan, courtesy my school days and watch almost every sport ( much to the annoyance of most people around me).

To me sports brings out the raw human traits and those excel in sports are ones who are able to master these traits. Also, it is the best way to learn taking losses on the chin and looking ahead.

Buffet in his famous baseball example and Howard Marks in his Tennis example have spoke about the correlation between sports and investing.

In the paras below, I try to capture the essence of my favorite teams/players and try to see how they can be metaphors to investing.

Football: FC Barcelona: There philosophy is simple, if opponent doesn't have the ball they can't score. So they keep the possession ( usually in high 60's) and wait and wait for the right opportunity to attack. Similarly, when they lose the ball they work double hard to get the ball back in their possession

Similar to Barca style, one needs to wait patiently for the right moment to attack the market quickly and decisively. In case we make an error in investing, we need to rectify it at double speed to regain control of our investing field.

Tennis: Roger Federer: Arguably the greatest player in Tennis ( arguably, since i dont want to start a debate on tennis here :P ).  He has a complete game with great serve, good ground strokes and one of the best net players. In my limited knowledge he is the complete player.

Drawing an analogy here would mean that if one really wants to succeed in investing then we need to improve our all round investing game. If we are good in stock picking, but poor in capital allocation then success in long term will elude us.

Cricket: Rahul Dravid & Steve  Waugh: Both players though have had a fantastic career and are legends of the game. There determination, hunger for runs, and ability to stand tall when things were not working out both for team or for them individuality is exemplary.Both these batsmen built there games on strong defense and had ability to leave a lot of balls.

We can inculcate the same concept that in investing it is not necessary to chase every stock idea. Another thing to learn from them was their focus on process of batting and their ability to cut noise surrounding them. Similarly our focus should be on the process of investing (using checklists, limiting number of stocks etc)

MotoGP: Valentino Rossi: In his case, unarguably Rossi is the best Moto GP racer of all time. His ability to win races in worst of circumstances is unparalleled. While he was a very agreesive rider, his ability to win came from his ability to master braking or deacceleration. In high speed races where almost all bikes are equally fast the ability to slow at a lower rate than other riders ensures your victory.

In investing Rossi teaches us to invert. He won most races not only because he was faster, but also because he deaccelerated at a rate slower than other riders. Similarly, when we invest it is imperative to look at why and in what circumstances will your stock hypothesis not stand true and take a call based on that.

Apart from the above a common trait in these teams/sportsperson is that all of them are extremely humble and realize that there is life beyond sports.
I think Seth Klarman had commented that any buy/sell decision in stock market is by de-facto an arrogant decision since you are telling the person on other side of trade that he is wrong.

Thus, being humble and realizing that investing is just a part of life and not the whole life is critical to we being happy and doing well.

In the end wishing all of you a to have a Sporty and fantastic New Year. 

cheers,

PS- My new year resolution for last quite a few years is too start playing a sport, but no success there :(. Pointers to improve this will be much appreciated.