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.

ILFS Investment Manager- Free Lottery?

Background: 

ILFS Investment Managers Ltd (IIML), is one of India's premier & probably one of the oldest PE funds. It manages various schemes/funds which invest in Real Estate, Infrastructure & other similar sectors.

Business Model: As IIML is a PE Fund, its basic function is to raise funds under various schemes and then invest the same in opportunities available in Indian space. 
The invested amount also known as the Earning AUM is what it earns fee income on . 

The income on this AUM has 2 components

1. Annual Management Fees: This is around 1.75-2 % charged annually, and is taken every year till the tenor of each scheme. This is the predictable revenue stream for IIML.
2. Carry Income: Each scheme has a defined hurdle rate ( around 11-13%). This is the bare minimum rate the fund will try to return, although this is not an obligation. If the fund is able to generate returns above the hurdle rate, IIML gets a certain percentage of the additional return generated ( 20-30%). These are accrued to IIML usually after the scheme ends and money is returned to investors in scheme.

From the above income, majority expenses are in form of salaries and overheads. The profit margins are around 33% and IIML distributes around 70% of these earnings in form of dividends. 

Present Situation:

The AUM of IIML is primarily invested in real estate and infra. Both these sectors have been in doldrums for last 3-4 years. This has led to the following for company

1. Negligible or no growth in AUM of IIML- Company has been trying to raise funds for last 2 years now, but might be able to raise just USD 100 mio by FY13. Management con-call says that outlook for raising funds remains bleak. Also, IIML will start having large exits of funds starting FY14-15 and thus AUM will further dip. No new funds and foreseeable exits, will lead to IIML having falling Earnings going forward
2. Negligible carry income- Since, real estate and infra have not performed there has been no carry income for the company. This has led to no kicks in earning of the company.

What is the bet now?

As discussed the revenue stream of IIML has 2 components, fixed income through annual fees and variable income through carry.  Let us assume the worst case scenario in which  IIML is niether able to raise fresh funds nor gets any carry income. 

Even in such a scenario IIML will earn the fixed annual fees. By understanding when do these schemes end we can predict the fixed revenue which will accrue to IIML over next 5 years or so and thus do an estimation of the earnings of the company. 

If the above exercise gives me a value which is higher than the market cap of company less cash, then we are entering a well run business with fixed revenues at a price lower than its liquidation value. This also exposes us to some other events like improvement in economic scenario leading to growth in AUM and subsequent increase in carry income. Also, by entering at this value my downside is protected since IIML pays out almost majority profits in form of dividend.

Estimation of Value:

I took the following assumptions ( based on historical data of company)  while try to find the value of company

1. Cost of capital= 10%
2. Fee income= 1.75%
3. PAT margin= 33% ( Historically it hovers in this range only)
4. USD/INR rate= 50

Schemes of IIML:
  

Fund	USD Mn	INR Crs	Start Date	Maturity
Growth Funds
Leverage India	153	765	2004	2013
Tara India fund	225	1125	2007	2017
Auto Ancillary	15	75	1998	-
South Asian Regional	25	125	1995	-
Total	418	2090
Infra Funds
AIG Indian Sectoral	91	455	1996	-
SCI Asia Growth	658	3290	2008	2016
India Project Dev	16	80	2000	-
Pan Asia Dev. Fund	45	225	2006	2013
Total	810	4050
Real Estate Funds
ILFS Realty-1	525	2625	2006	2014
ILFS Realty-2*	895	2237.5	2007	2015
Yatra & SIREF	430	2150	2007/09	2016
ILFS Milestone	229	1145	2007	2015
	2079	8157.5
Total	3307	14297.5

 * This is a 50:50 JV, hence I have considered only 50% of total AUM

Basis the above table, the earnings can be projected as given in table below:

Fig. in Crs	FY12	FY 13	FY14	FY15	FY16	FY17
Opening AUM		14297.5	13807.50	11182.50	7800.00	2360.00
Loss in AUM		490*	2625	3382.5	5440	1125.00
Closing AUM	14297.5	13807.50	11182.50	7800.00	2360.00	1235.00
Income
Fee @ 1.75%		241.63	195.69	136.50	41.30	21.61
Other income		13.53	10.96	7.64	2.31	1.21
Total		255.16	206.65	144.14	43.61	22.82
PAT@ 33%		84.20	68.20	47.57	14.39	7.53

* As per latest managment con-call IIML has already raised USD 66Mio and will be able to raise around USD 100 Mio by end FY13. This increase has been accounted for here


Since, we have estimated the earnings in case the fund is liquidated, we can do PV of these earnings to determine the worst case value of the company.

 

Cost of Capital	10%
		PV
1	84.20	84.20
2	68.20	56.36
3	47.57	35.74
4	14.39	9.83
5	7.53	4.68
Total		190.81

  This gives me a worst case value of Rs. 191 Crs. If I add cash of 100 Crs the value of the company is around Rs. 290 Crs. Thus any case IIML is not able to raise any further funds or does not get any carry income it can be approximately valued at around Rs. 290-300 Crs

Conclusion:

The present market cap is around Rs. 490-500 Crs as compared to liquidation value of around Rs. 290 Crs. 

For me it is not a free lottery yet, but i would be watching this idea very closely. Any, indication/ confirmation of IIML being able to raise funds, would lead me to revisit the above numbers.

Resources:
Link for XL sheet used is here
Company presentation is here 

Regards,
Saurabh
PS- Not invested
 

Weekend Learning

Last weekend I had a chance to meet some fantastic investors (Gaurav , Ayush , Neeraj, Ashish, Puneet, Suhail) and also got a mail from a friend of friend who attended Valuex (An investor conference in Mumbai held last Saturday). Basis these interactions i have tried to capture the learning i had and highlighted one's which I personally find of key importance

Investment Philosophy:

1. In India Statistical Bargains remain cheap for a very long time, due to limited catalysts. These catalysts such as form of investor activism, minority stockholders doing some corporate action etc are usually inactive. Statistical Bargains originated in US, where there are means to induce these catalysts. Also, lack of growth in US companies has led to investments moving to these ideas.
2. India, we all agree is a growing economy, and hence the best bets are the ones which have a growth component attached. Buy stocks at reasonable valuation( Margin of Safety) which show signs of growth and then ride the growth. Also, in such stocks be mentally prepared for horizon of 3-5 years and also ups and downs in between. If one is able to ride the growth they can be the big winners.
3. Their are 3 segments to broadly classify businesses B2C , B2B & B2G (Business to Government)  and clearly B2G is most frowned upon
4. People are scared of investing in illiquid stocks because they are scared of working hard --> Stocks are usually illiquid because they have not yet been discovered. Infosys used to trade less than 1,000 shares / day in 1994.
5. In an Indian context Price is what you pay, Value is what the promoter allows you to make. Cash, real estate, assets should be taken with a grain of salt as most likely a promoter will not allow you to realize its value.

Investment Methodology:

1. Promoter integrity is the top thing too look. Indian promoters find ways to take out money and hence it is key to be associated with right kind of people. Meeting distributors, creditors, end-users is one way to see how involved the management is in the business. Attending AGM's is another way to get a feeler on the company and also to understand the outlook and future plans of promoters.
2. RoE is the holy grail. If RoE is less than cost of capital creating sustainable wealth is almost impossible. 
3. Also evaluate company on asset turnover and margins. These are the 2 levers which company has to increase RoE
4. Double Counting creates bubbles: During periods of boom margins are the highest to which we apply high valuation multiples. Margins are mean reverting, thereby in your analysis it is important to adjust for this factor
5. Don't mix your investment themes. Example, Special Situations with bargains or with long term ideas.
6. Even if stock is up 100% from your purchase,but if you find growth story intact and valuations cheap keep adding.  Its all about buying well, rather than selling well.
7. Have an exclusion list. If any company falls in that sector/ concept don't waste time. For example, most of us agreed that B2G is an example of ideas to avoid.
8. Dumbest thing to do is forecast. Be comfortable with the idea that you don't know the future. It is very difficult to comes to term with this.
9. In bear markets don't use relative valuations but use your judgement on absolute valuations. In bull-markets use relative valuations to make selling decisions.

Psychological Biases and other thoughts

1. Use Anchoring bias as a tool to take decisions. If you find a stock good, buy it then you will be anchored to that price rather than waiting for price to come down.
2. Assuming that all stocks which you have will be a 10 bagger is living in fool's paradise, but if your process is right you will get once in a while a large bagger. 
3. Make sure your investment process does not change in good or bad periods. Good performance makes one complacent while bad performance makes one defensive
4. Differentiate between Hold-to-Maturity and Revert to Mean Ideas in your portfolio:

   Hold-To-Maturity: Great businesses which are compounding machines that have been bought at reasonable valuations. These are long-term investment ideas. 

   
   

   Revert to Mean: OK businesses at beaten down valuations because of poor performance where performance can bounce back in the foreseeable future. 

5. Markets are not efficient but they reflect current investor psychology. 
6. How do you determine in an investment decision whether you suffer from overconfidence or are just an independent thinker. Every business has certain milestones, when those milestones are not being hit by the business you must reconsider your investment 
7. Use simple scenario analysis to avoid investment pitfalls. For e.g. to Justify 2000 valuations for IT they would have to go at 75%-100% in the foreseeable future. If they did this for over 10 years, they would have become 40% of India's GDP. Even if they did manage to do this the Rs would have to go down to Rs 25 whereby margins for these companies were not sustainable. 
8. Read, read and read more. Few books recommended
1. Finding the next Starbucks
2. The Warren Buffet Way
3. Commentary of international value funds

And finally, we did discuss some stock ideas like Suprajit, GRP,Atul Auto, Magma Fincorp, Ashiana Housing, Ashok leyland, Clariant, BASF etc.

Hopefully we all will benefit from these thoughts, and incorporate the same while evaluating an idea.

cheers,

saurabh

PS- Don't consider all of us bores. We did discuss things beyond stocks and investing :)

A Tale of 2 Situations

Once there was an investor,  who one fine day entered the holy gates of big bad city called Stock Markets.  To help me in this city he found there were various types of people. The most talked ones were the high priests who sat in high temples of finance, and eulogised about everything and anything. Then there were a lot of traders, merchants who helped him in navigating the city on weekly, daily and hourly basis and finally there were the outcasts, who said generally spoke less and did all contrary things.
After meeting all of them and getting fairly acquainted with the city our hero decided to venture where few went, to the den of alchemists who made money without taking risk. They did this by finding special situations which nobody would see.

There he met a gatekeeper who gave him 2 tests and said that he had to go through to them to meet the alchemists.

Gatekeeper: Company Name: IGL Ltd
The price of the company was going all over the place (some times variation is as high as 30-40% in a day) as the company was engaged in a legal battle with a government body on pricing of gas prices. The ruling for the case is coming on 10th August and CMP is 250 . What will you do?
Hero: Interesting since company can either win or lose the case I will do the following:

• Buy a put option of August Expiry with strike price of Rs.220. The present price of such an option is Rs. 0.78 and lot size is 1000 my cost will be Rs.780
• Buy a call option of August Expiry with strike price of Rs. 270. The present price of such an option is Rs. 2.79 and lot size is 1000 my cost will be Rs. 2790

So by paying total of Rs.3570 i have given a wager on both positive and negative decision for company. If ruling goes against, stock price falls by around 20%  and i make a killing on my put option. Similarly, if it is in favour i make a killing on call option.

Gatekeeper:  Good. Now let me take you to the courtroom and you can see how things pan out. 

In the courtroom, as our hero waits anxiously proceedings begin and end in 5 minutes. The ruling is neither positive or negative but has been deferred till November 31st. 

Hero: Horror! Horror! this cant happen to me. I never thought of this scenario and now i will lose a fair bit of my wager as a lot of people would have bet on either side and now they will sell.
Gatekeeper: Aye Aye Sir! You will lose money but more importantly learn these 2 lessons

• A special situation is really "special" only if the outcome is known. Else, it has speculation involved in it.
• Always do a probabilistic analysis of all scenarios. For example, in this test all 3 scenarios of favorable, unfavorable and status quo were equally probable. 

Now let bygone be bygone, let me give you another test:

Gatekeeper : Company Name: Muthoot Finance Ltd- The company has a zero coupon bond maturing on 11th Oct 2012. The maturity value of this bond is Rs.1132. Suppose today is 7th Sept 2012 and value is Rs.1115. What will you do?

Hero: Aha! this is a simple one. As in previous test i know the outcome and also there is only 1 scenario of company paying me back. Although another scenario could be of company defaulting on its bond, but past track records and recent performance of company tell me that this is has a negligible chance. So, I will buy this bond at Rs.1115 and then on maturity i will get Rs. 1132. If i use the XIRR function my return is around 16.5% p.a, which is far higher than bond investments.

Gatekeeper: My friend you take things too simplistically. Did you consider the brokerage and tax? Suppose your brokerage is 0.3%, then your purchase price becomes Rs. 1118.3 and returns lessens to around 13%. Add short term taxation to it and returns further fall to around 9.1%.  Does it look that exciting now?

Hero: Hmm...no it surely dose not, but i never thought that these things impact returns.

Gatekeeper: As i said there are no mistakes only lessons. The lessons here is that Returns in special situations are moderate, so always consider transaction costs and tax and then take a decision.

That is it from me for now.

Hero: So now can i go in? 

Gatekeeper: Of course you can. The fact that you have taken tests is good enough. Now proceed to the real alchemists who reside here and here.

Regards,
Saurabh
PS- The protagonist was yours truly, and gatekeeper in one case was Kiran.