Finolex Industries- Growth cum Deleveraging play

You may have a look at the profile and financials of the co’ here 

Going forward, this is what the management says about FY14.

In FY13, other expenses shot up by approx. 100crs and finance cost came down by 24crs. Major portion of the other expenses was towards settlement of derivative losses.

Q4 of FY13 indicates how FY14 might shape up. Company ended Q4 with an EPS of Rs 6.39. So if we assume raw-material prices to remain stable and interest cost to fall by 15-18crs, Finolex may end up FY14 with an EPS of around Rs 18 and with the co’ paying out 50% of its earnings as dividend, ROE shoots up to 24%. So despite the sharp run up in the stock price, there is scope for another 30%+ price appreciation. Not considering sale of land parcel.     

Arshiya International: Connecting Business Model & Leverage

This post is basically a writeup to make sense of the significant debt of Arshiya. The common view among Investors is “I like the business model of the company but not the stock due to high leverage”.

Let’s start with the business model of Arshiya. One can refer to this excellent presentation by the company on the same. The company plans to open FTWZ across different parts of the country i.e In Panvel (West), Khurja (North), Nagpur (Central) and Chennai (South). Panvel FTWZ is partly operational (5 warehouses) and expected to be fully operational by June’13. Khurja FTWZ is partly operational (3 warehouses) and expected to be fully operational by the end of FY14. Company is in the process of acquiring land in Nagpur.

Arshiya’s stock price has not gone anywhere this year as earnings have been stable for four consecutive quarters (around Rs 35crs) as Depreciation and Interest expenses increased more than the EBIDTA. But one should look at the QoQ growth in EBIDTA and it has grown by around 16% for past two quarters and margins have grown from 26% to 29%. FTWZs have strong EBIDTA margins of 70%+. Once Panvel and Khurja FTWZs are fully operational, the overall margins can shoot to 35%+ which will ensure earnings increasing more than depreciation and interest expenses. Management is trying to contain expenses wherever possible. For example, they entered into lease agreement with GATX for rakes and conversion of rupee loan of Rs 300crs into dollar loan which acts as a natural hedge since income from FTWZ are in foreign currencies. Link for Q2FY13 Investor updates.

One of the concerns of the investors have been the high equity dilution (23%) recently through issuance of warrants to promoters. The fact that the issuance is not to an ‘outsider’ and the return on equity isn’t diluted mean the concern is unwarranted. Promoters have already converted 22.5% of the total issue. Its a case of promoters being more optimistic on its business than shareholders. Enterprise value stands at Rs 3335 crs with Equity (at current price of Rs 122) being Rs 885 crs (assuming full conversion of warrants) and Debt of Rs 2450 crs. My sense is incremental debt should be minimal going forward as funds raised through warrants and cash generated from ongoing projects once fully operationalized should be sufficient enough for capex of Nagpur FTWZ.

I think at 4x FY14 earnings, debt is discounted more than required. Considering the business model, competitive advantage and growth, Arshiya’s stock should possibly trade atleast 6x earnings or 1x P/BV for a 16% ROE going forward assuming no additional dilution. Such stocks generally does well in a bull market and declining interest rates scenario which hopefully will pan out over the next one year.

Kenneth Andrade – Peter Lynch of India?

Updated as of 29th June,2014

One can argue whether he deserves the tag or not or its too early to attach the tag. Hence the Question mark in the title.

Kenneth manages popular fund IDFC Premier Fund. Premier Fund’s AUM has grown from around 200crs in 2006 to around 4400crs currently. Fund has delivered 20%+ CAGR since launch and 15%+ over last 3 years. Had he not went overboard on PSU stocks in 2012, his fund would have been in top quartile now.

Let’s look at some of the portfolio’s holdings. I tried to find out the avg. purchase price through bulk deals and avg. qtrly price found earliest in the shareholding pattern.

Strides Arcolab -» Had first acquired 4.38 lac shares @ 63 in Feb’09. Almost 15 bagger now. Exited.

Bata India -» Avg. price of 100 during the Dec’08 Qtr. That’s around 12 bagger in 5 and half years!

Page Industries -» Avg. Price of 400 during the June’07 Qtr. 18.5x now. 10%+ dividend yield on top of that.

Kaveri Seeds -» Avg. price of Rs 50 (adjusted for split). Around 14.5x since first entered.

VST Industries -» Acquired 2.22 lac shares @ 575 during Oct’10. More than 3x now. Exited.

Blue Dart Express -» Acquired 1.82% stake at an avg. price of 650 during the June’08 quarter. 6x now.

MRF ->> Avg. Price of Rs 10,000 during the Sept’12 Qtr. 2.3x now.

Coromandel International ->> Avg. Price of Rs 75 (adjusted for split) during Sept-Dec’08 Qtr. Around 3.5x now.

Doubled his returns in Hexaware and e-clerx. Both exited.

Other holdings like Asian Paints,GSK Consumer and STFC have delivered steady returns.Exited.

Pantaloon and IRB Infra are among the few stocks which didn’t played out for the fund.

P.S. Fine. We will attach the tag after the next bear market!

Disclosure: Have vested interest in the fund.

MT Educare : Quality Education Franchisee

You can read about the business model from here

What I like about the company :

1) Scalability. The company has grown at a revenue CAGR of 21% and Profit After Tax of 68% over the last 4 years. I believe they should continue to grow at the same pace in terms of revenues while earnings should be lower at around 40% over the next 2 years. They just have to increase capacity utilisation and some growth should come from new centers, pre-university tie-ups and IIT-JEE preparation courses.

2) Return ratios (ROE/ROCE) are impressive at around 30% though it should be lower this financial year due to the dilution of IPO.

3) The management has announced 50% dividend payout with dividend to be declared half-yearly.

4) Negative Working Capital as you can see in the investor presentation

5) Management wants to be asset-light as far as capex is concerned as one can read in this interview of the promoter Mahesh Shetty.

6) Coaching is a competitive business in Mumbai (Company derives major revenues from here) but still I observe most of the “branded” coaching institutes in Mumbai are able to increase fees by Rs 500-2000 per student every year depending on the stream/course.

At CMP of Rs 103 (Market Cap of 400crs), it trades at 16x FY14 earnings so not cheap from any perspective for its size but for a company with above features, it won’t come cheap. If it does, load on!

Geometric MD’s Letter to the Shareholders

Dear Shareholders,

Last year, we began a journey to Transform Geometric. I would like to spend most of this note talking about what this means for the Company and its shareholders,especially how this will play out in the current fiscal.

When I was asked to take up the responsibility of leading Geometric again on the 8th of April,2011, I spent a considerable amount of time meeting customers to understand their needs and expectations, while assessing how Geometric met these needs.

What became apparent is that our Company is blessed with a growing market. The engineering space has traditionally been a laggard when it came to outsourcing. Much of engineering was considered ‘core’ to any manufacturing company, and hence, not open to ‘outsiders’. This is changing slowly but surely. Companies are being driven to consider newer approaches by macro factors such as demographics, demands of markets in emerging economies, competition and technology. Indeed, the major PLM technology providers themselves, barring calendar 2009, have had stellar years with growth in double digits. So the addressable market is doing well and growing.

The question therefore is why has Geometric been unable to grasp this opportunity in its entirety. My analysis is that as a Company, we were unprepared to meet these growing needs. Our approach was based on “tell us what to do and we will do it.” Our cost structure was not competitive enough and we were too internally focused in terms of our organisation structure. Finally, our approach did not take into account the growing demand by customers for vendors to support them globally and not just in one country. 

We therefore sought the services of a leading management consultant to help us benchmark ourselves with respect to competition and global needs, at the same time helping us prepare a focused action plan. The exercise began in earnest in Oct’ 2011 and will continue throughout this year. The initial part of the exercise focused on costs, a necessary element to build momentum for change, while creating a pool of savings, which we could invest to fund our future growth.

In FY12, we sought to better integrate our software services and engineering services businesses with a view to enabling greater collaboration within the organisation and offer end-to-end services to our customers. I’m glad to say, this has led to an increase in cross-selling. While we saw continued growth in our key verticals, viz: automotive and industrial; last year also witnessed increased traction in other industries like aerospace,ship-building and oil and gas.

So what should shareholders expect at the end of FY13? I thought it important to laydown certain specific expectations for Geometric excluding our joint venture so that you can better judge how we, the management have performed in the next twelve months.

  1. Cost of Revenue (%) : In constant currency terms, we need to see that cost of revenue continues to see an improvement,despite increases in salary. This will signify continued improvement in pyramid management and more importantly, improvement in quality/productivity.
  2. G & A Costs: As a % of revenue these should decline by atleast 2% points, despite increase in space occupied due to an expansion in manpower.
  3. Scalable growth: We must see atleast 15% growth YoY on an average from our existing top-10 clients (excluding 3DPLM). By our fourth quarter, the run rate on the growth YoY for the comparable quarter should have exceeded the average signifying we have improved our traction.
  4. Target accounts: While we may not be able to share the names of new or very recent accounts, we have targeted for growth, ten key accounts from which we will generate dollar revenues of several million in the current fiscal. 
  5. Attrition: We have been losing talent at a rate slightly above that of the industry. By the last quarter, the attrition should be atleast 1-2% lower than the industry average as widely circulated.

There is however one caveat. Today, the uncertainty caused by the economic environment continues. For example, the Euro Zone remains a cause for concern and it is very clear that any upheavel in Europe will have global consequences. While, in my view, such a calamity will not affect the long term trend, it certainly will affect our performance in the current year. Nevertheless, the approach we follow will help us build a scalable enterprise, and will, therefore, be important over the longer term.

Sincerely,

Manu M. Parpia

Managing Director & CEO

My view: If the management delivers on the above, then I think earnings should grow by atleast 25% in the current year which means at around 6.2x with 40% ROCE (in FY12) and improving payout ratio, the stock looks cheap. 

IDFC MF’s Expectation for 2012

Domestically we believe 2012 will be a year of consolidation and slow growth with low visibility on pickup of the investment climate and demand pull waning due to a non supportive fiscal. A lot needs to be seen how political order is restored and the budget session would be a pointer to the government’s stance on fiscal deficit and growth.

Our themes for 2012 would be currency depreciation (continuation of risk off trade), growth slowdown (political and policy), NPA scare in the banking system, likely falling commodity prices, and a declining inflation and interest rate scenario. In this capital starved economy where availability and cost of capital are issue for sustaining normal operations, investment pickup is unlikely and asset / capital light businesses should do well. That would entail IT, pharmaceutical, consumer business and the services part of the economy to do well. We believe it is too early to play financial leverage or operating leverage as a large part of India Inc will struggle with a weak demand.

My view: I have observed that its not easy to forecast for the whole year. Be it any smart investor! I think its better to divide 2012 into first half and second half. I believe 2Ps (political and policy) would both be favourable for India Inc in the second half while first quarter of first half should be a consolidation period. Remain long on consumption.

We hope the year 2012 is a great one for India and all of us. Wish you all a very happy and prosperous New Year!!

Akash Prakash’s Amansa Capital Portfolio

Amansa Capital, run by Akash Prakash, having assets under management of around $300mn with a focus on midcap companies in India. In an interview with FinanceAsia, Akash Prakash mentioned that they have invested in around 25 companies with investment size of $8mn-12mn each though I can only find out 13 of them with market value of $110mn.

Cholamandalam Investment and Finance Ltd (market value of around Rs 53crs)

Max India (Management mentioned they will recover all losses of previous 3 quarters and end FY11 in the black. Major beneficiary of reforms in Insurance if and when it happens )

Whirlpool of India (MV of Rs 50crs) . I had posted about Whirlpool last year in my blog.

Greaves Cotton (Manufacturers of engines for Piaggio, Tata Motors and Mahindra & Mahindra’s three-wheeler vehicles. Also manufactures Construction equipment. I have a vested interest in this stock)

Rallis India (Stock had a dream run over the past 2 years. Still it should do well in the long term)

Entertainment Network of India Ltd (ENIL) (Owners of Radio Station “Radio Mirchi” )

Gujarat Pipavav Port (Anchor investor in IPO last year)

Blue Star (See recovery in earnings only in H2 of FY12)

Kirloskar Oil Engines Ltd (market value of around Rs 32crs)

Edelweiss Capital (I have not seen any industry as competitive as broking)

Carborundum Universal (The company targets a Return on Capital Employed of 25% from 21.5% currently over the next few years)

OnMobile Global (Beneficiary of 3G)

Tube Investments of India ( It seems like some sort of obsession with Muruguppa Group companies! )

I think (from the few companies I track) the portfolio is very well diversified across sectors with companies known for maintaining high standard of corporate governance. Since Akash Prakash appears on business channels frequently and writes a column for Business Standard with no mention of his fund’s holdings anywhere, I thought why not find out from the BSE!

Key-takeaways from Whirlpool Annual Report FY10

Theme of the Annual Report,

Taking a leap into the next growth curve

India is at an inflection point of sustained growth and so is Whirlpool. With a strong brand, well differentiated products and a healthy balance sheet, Whirlpool of India has embarked on a journey of accelerated growth. With the intention of doubling its business over the next 3-4 years, it has charted a 3-pronged business strategy.

  • Grow the core business
  • Extend the core business
  • Expand beyond the core

This business strategy will be supported both by heavy investments and channel strategy.

Channel Development:

  • Reaching out to tier 2, 3 & 4 towns

The immediate focus of Whirlpool is on 700+ towns in tier 2, 3 and 4 where it plans to expand its presence.

  • Expanding Modern Trade Footprint

Volume grew by almost 60% last year, vital for growing the premium range.

  • Enhancing Brand Experience

Increasing visibility and reach through exclusive outlets by trebling the number of brand shops from the current count of 35.

Home Appliance Industry comprising Refrigerators, Washing Machines, Microwaves and Air-conditioners grew by 15-20%. Our estimate of category growth is 15-20% for Refrigerators and Microwaves and 20-25% for Washing Machines and Air-conditioners.

Outlook and Opportunities:

Penetration of home appliance is still very low and the long term growth opportunity for this industry is very attractive. Out of every 100 consumers living in urban India, only 33 own a refrigerator and 13 a washing machine and these numbers are miniscule in rural areas. Penetration of air conditioners, microwaves and electrical water purifiers is even lower.

Within the home appliance industry, categories/segments that are expected to grow ahead of the industry average are washing machines, microwaves and air-conditioners.

My take : Whirlpool has a diversified portfolio of products leading with refrigerators. Market size should be huge but the competition is also intense. It is a debt-free company with a very good return ratios (ROE of 44% and ROCE of 49%) and at CMP of 300, it trades at 30x FY10 and 23x FY11 expected earnings which is neither cheap nor expensive. Company plans to invest Rs 4bn over next 3 years which indicates the growth prospects it foresees.

Theme: Domestic Consumption -The way forward!

All the data below has been sourced from the Investor Diaries of Arisaig Partners, $471mn India Fund focussing on Consumer stocks in Asia. The Fund holds Colgate, Nestle, GSK Consumer, Marico, Godrej Consumer, Britannia and Jubilant Foodworks.

Approach: Our approach involves two stages:

Firstly, we try to predict the long term potential size of each of the key consumer segments in which we invest (e.g. confectionery, soft drinks, detergents, noodles, fast food, beer, etc.). We do so by comparing consumption trends globally in relation to GDP per capita at various stages of economic development. We have been pleasantly surprised by how much data is available in this area. This allows us to create a scatter diagram, and then a “best fit” curve – a guide as to how demand for a product or service can be expected to develop as GDP expands, structural barriers decline and, most importantly, consumers’ propensity to spend higher proportions of their income on discretionary items rises. This “triple whammy” can lead to sector growth rates well above general levels of economic growth. We refer to this as our “scale factor”. It invariably takes the shape of an “S” when graphed.

Having established a number for the sector growth potential by country, the second stage of our model looks at company specifics. We estimate the potential for a company to increase its market share and then try to assess its likely economic value added. We do this by making assessments of long term trends in margins, tax rates and fixed and operating asset intensity. This allows us to establish a long term cash flow profile for each company based on its value adding capabilities. Then we discount the cash flows back to provide a current valuation.

Long term Strategy:  We say this strategy will outperform because over long periods dominant consumer companies always do. This is for obvious reasons: low capital intensity, high cash generation, defensible moats (brands, distribution etc), and resilience against external shocks (we all need to eat, drink, wash and brush our teeth). The equivalent companies in the US have compounded at 15% per annum over the last thirty years. Add in emerging market tail winds in the form of: (a) disposable incomes rising faster than absolute incomes; (b) the evolution of a credit culture (mortgages and credit cards); (c) favorable demographics (except in China); (d) urbanisation; (e) formalisation of consumption (i.e. more supermarkets / fewer Mom & Pops); and (f) improving distribution reach as a result of infrastructure development, then these Asian businesses should do even better over the long haul.

HUL: We met the CEO to review our seventy page research report which concludes that the company will struggle both to retain market share in soaps and detergents and to drive growth from food and cosmetics (it is really only strong in deodorants, where, admittedly, wider usage would bring immediate benefit). Whilst he impressed us with his plans to improve distribution and product time-to-market, we feel our money is better placed with the more focused Nestle and Colgate.

Colgate: We were told that they have no plans to introduce non-oral hygiene products, such as the Palmolive range, until their market share in toothpaste reaches 70% from the 50% currently. The risk is the possible entry of P&G into this sector with Crest, the largest selling toothpaste brand globally, although, for now, P&G seems more concerned with battling Unilever in detergents.

Nestle: Despite dominant market shares in baby food, instant noodles, soups, sauces, coffee, etc., annual sales have only just surpassed USD 1 billion. Of course, this is miles above the USD 8 million revenues recorded when the company first listed in India in 1978 – at Rps 12.5 per share versus today’s Rps 2400 per share. We expect revenues to be in the order of USD 12 billion twenty years hence. This does not take into account the likely launch of the Perrier, Haagen-Dazs and Gerber brands.

Britannia: Indians eat more biscuits than anybody else in the world – about 150 per annum each; yet their market remains tiny, barely USD 1.9 billion in size. The bulk of, course, are the plain glucose variety costing only USD 1.4 per kilo (versus USD 16 in Japan!). Britannia Industries, has been the only disappointment, as last year’s decline in raw material prices allowed a flood of opportunistic, cheap glucose biscuit manufacturers to take market share. The introduction, however, of a unified sales tax across the country from 2010 will see off many of the fly-by-night producers who in this sector, as in many others, depend on tax dodging to stay competitive. The tax will free up fixed and working capital as producers will no longer be obliged to operate multiple factories and warehouses to qualify for tax advantages on a state-by-state basis.

GSK Consumer: Although the Horlicks malt drink accounts for 75% of the India business, plans are well advanced to extend this brand into nutrition bars and the like, as well as to launch the Lucozade energy drink brand.

Potential: Right now market share is, in the case of India, 12% of its packaged food (Nestle), 33% of its biscuit (Britannia), 40% of its toothpaste (Colgate) and 20% of its hair care sectors (Marico). What’s more, it is worth remembering that the market share data only refers to the “organised” sector. As consumers shift from the informal market, often equal in size to the visible sector, the overall scale of the addressable opportunity will increase dramatically. Just by holding their current market shares, these companies could eventually become global leaders.

Risks: The risks to this rosy scenario are mainly geo-political – China and India could go to war over water. Six out of seven of the region’s largest rivers originate from the Tibetan plateau, which could explain why the area is so hotly contested.

Valuation: In the old days we thought it was better to own the third player on 10x versus the market leader on 20x. Well, that was misguided. The third player invariably gets marginalised, resorting to dodgy practices to stay alive, whilst the market leader consistently surprises positively, using the cash flow from its dominant position to reinforce its brands, etc. Our men may be de-rated, but they won’t be de-railed. As brand owners, they have pricing power. Indeed they tend to push up prices faster than their costs. They don’t have debt and, if rates rise, will simply earn more on their cash holdings. Meanwhile, their customers still need to eat, drink and wash. A portfolio of dominant consumer companies is the best inflation hedge of all.

Rakesh Jhunjhunwala’s holdings as on 31st December’09

This is just a small brief of Big Bull’s holdings (bought/sold) during the last quarter.

Bought:

Lupin – 79,500 shares

Titan – 1,57,000 shares

Nagarjuna Constructions – 12,50,000 shares

Rallis India – 35,000 shares

McNally Bharat Engineering – 4,80,078 shares

Sold:

Punj Lloyd – 12,50,000 shares

Praj Industries – 12,50,000 shares

Karur Vysya Bank – 5,27,503 shares

HOEC – 5,50,500 shares

No change in holdings in Crisil, Pantaloon-DVR, Bilcare, Geojit BNP Paribas, Geometric and Zen Technologies.

Big Bull is selling stocks whose earnings disappoint or are likely to disappoint in the future. Punj Lloyd since its IPO has gone nowhere.

VC/PE: Small Cap Stock Ideas!

Venture Capital/Private Equity investors are usually the one who spots the emerging companies and exit with a phenomenal returns.  VC/PE, typically invest in the unlisted companies but there are investments in the listed space as well. I found 4 interesting small cap (<2000crs market cap) companies with Interesting business model and Scalability. What’s more is that these are the only listed companies in their respective segments. They have no listed peers.

Manappuram General Finance & Leasing Ltd (CMP- 651) : Provides loans on gold which is at large an unorganised segment currently. Market cap of Rs 1125crs (it will increase after the merger with its subsidiary), ROE of 30-35%, NIM of 13% and the Highest Credit rated  NBFC. Venture Capital investors hold an aggregate 32% stake in the company.

Shriram City Union Finance (CMP – 394) : It is sort of a micro-finance organization. Small ticket retail loans with shorter tenors operating in the semi-urban and rural areas. Market cap of Rs 1816crs, ROE of 20%, NIM of around 11-12% and a Strong management. Shriram Group is very popular among the VC/PE  investors.

e-Clerx (CMP – 426) : Only listed play on the KPO space. The company derives major portion of its revenues from the financial vertical. It has a market cap of 789crs, ROE and ROCE in excess of 35% and growth will be directly related to the US economy.

Himadri Chemicals (CMP -432) : Manufactures Coal Tar and plans to triple capacity and be counted amongst the top three players globally in 3 years. It has a market cap of Rs 1426crs, ROE of around 20% with a high entry barriers which leads to a certain competitive advantage.

Leader v/s Second largest player: Stock returns Comparison

Most of us might have faced a dilemma whether to buy the Industry leader or its nearest competitor. So lets take a look at historical returns over three years as these include 14 months of Bear market. Stock returns reflect how management of both the leader and its nearest competitor faced the global recessionary environment. I have excluded Tata Steel v/s SAIL comparison as the former has a global presence while the later is restricted to India, RIL v/s ONGC due to govt. intervention in the operation of ONGC, Sun Pharma v/s Cipla due to FDA issues at the former’s subsidiary.

SBI v/s ICICI Bank

SBI delivered 82% returns compared to just 5% returns from ICICI Bank.

HDFC Bank v/s Axis Bank

The former delivered 72% returns while Axis outperformed with a huge margin with 127% returns.

It is interesting to note that relatively SBI has outperformed even HDFC Bank which is considered to be the darling of Indian markets when it comes to financials.

Infosys v/s TCS

Surprise. Surprise. Returns from TCS (20%) are better than Infosys (12%) .

Bharti Airtel v/s Rel Comm

The gap between both the stocks returns are huge with Bharti Airtel delivering 10% returns while RCOM with a negative returns of 57%. The problem with all the ADAG companies are their focus on market share rather than profitability.

DLF v/s Unitech

Unitech’s returns were 2 times the DLF on the downside with -67% compared to -33% of DLF.

Hero Honda v/s Bajaj Auto

Inspite of losing market share to Hero Honda, Bajaj Auto’s stock has done relatively better with 185% returns compared to 112% from the leader’s stock,  since it was listed after its demerger of various businesses on 26/05/08.

Voltas v/s Blue Star

Blue Star did much better than Voltas with 101% returns compared to 59% from the later. Blue Star’s focus on return ratios did the trick for them.

Exide v/s Amara Raja Batteries

Amara Raja Batteries did relatively better than Exide with 216% returns while the later delivered 197% returns. I guess Exide’s underperformence was due to its loss making life insurance business.

Welspun Gujarat v/s Jindal Saw

The leader delivered a return of 215% compared to its nearest competitor (Jindal Saw) returns of 149% over the last three years.

Conclusion: Its divided here with the leader doing relatively better to its competitor in 4 out of the 9 cases. So buying the second largest player may sometimes be the better option than the industry/segment leader.

2009 Predictions: How they fared!

Its time to look back and see how have my prediction for 2009 fared even though there is still a month left to end the year and anything can happen in the remaining days to come. As things stand today, here is how it turned out:

ICICI Bank is the 3rd best performer in the constituents of Sensex stocks against my expectations of being the top performer.

RIL did announce its plan for acquiring Lyondell-Basell but the acquisition has not yet been completed and RIL may or may not acquire the company.

ICICI did sell a small portion of 3i Infotech in the secondary market but yes neither 3i Infotech nor First Source has been put on the block.

Right now, Sensex is trading at much higher level than my predicted range of 10k-14k.

Rupee is around 46 to the dollar v/s my prediction of 45.

Like equities, commodities has surprised on the upside as well. Crude is trading around $78 as against my expectation of $40-60.

India’s  Q2 GDP came at 7.9% v/s China’s GDP of 8.9%. So my macro prediction turned out to be correct !

PE players have not been active in any of the markets forget about India.

I got my underweight calls on Metals and Real-estate WRONG.

So, overall, I did reasonably well. Not bad but not good either. There is always scope for improvement!

Lupin: Multi-year growth story!

Lupin is India’s fifth largest drug-maker and has one of the best return ratios in the industry with ROE of 35% and ROCE around 28%. It provides growth visibility for the next 3 years . The company is also making all the right moves whether its acquisition, hedging, product launches and use of capital. Its acquisition strategy is based on geographical presence and margin improvement through back-ending of production. After Ranbaxy, Lupin is the only other Indian company present in Japan (world’s 2nd largest market). Its hedges around 35% of its total exposure through forward contracts rather than through exotic instruments. Product strategy is to launch niche and differentiated products with a focus on Para IVs and FTFs. There is also efficient usage of capital through working capital optimisation.

Growth in the future will come from the following areas:

FY11:  Company acquisitions in Latin America and GCC. Branded generic products acquisitions (Antara and Allernaze)

FY12:  Generic version of GSK’s Combivir and Forest’s Namenda (FTF), Biosimilars, Oral Contraceptives (Only 2 players present currently) and Milestone payment ($40-45mn) from Salix if the extended release product of Rifaximin progresses well during trials. Margins improves due to back-ending of production, capex might decrease by 150crs over FY11 and tax rate goes up by 2-3% due to possibility of sunset clause not being extended.

FY13:  Launch of generic version of Schering Plough’s Clarinex, Fortamet (exclusive FTF),  Novartis’s Lotrel, Royalty and API sales from Salix’s Xifaxan.

Developed countries focus on containing healthcare costs should benefit generic players like Lupin. All these should result in earnings growing by atleast 25% over the next 3 years. Risk remains of very high competition once product is out of the exclusive sales period.

Rakesh Jhunjhunwala’s holdings as on 30th September’09

This is just a small brief on what the Big Bull bought/sold the last quarter.

He bought 1,54,500 shares of Lupin, 1,37,105 shares of Titan Industries, 6,00,000 shares of Karur Vysya Bank, 203000 shares of Rallis India and 8,00,000 shares of Geometric in the quarter ending September’09.

He sold 19575 shares of Bilcare. This is his second consecutive quarter of selling in Bilcare.

No change in holdings in Crisil, Punj Lloyd, Pantaloon Retail, Geojit BNP, Praj Industries, Zen Technologies and Nagarjuna Constructions. Not all the companies have disclosed the shareholding pattern.

Wish you a very Happy Diwali. Don’t expect markets to go up by 90% again by the next Diwali though the bull market remains intact ! Avoid Index stocks and buy quality midcap stocks.

Sanjoy Bhattacharya’s Views and Stock Picks

Sanjoy Bhattacharya, Partner, Fortuna Capital who advises an hedge fund “Aristos”, write a column for Forbes India. Here are the links of the article he has written till now. It makes for an interesting reading. He is very much focussed on “high ROCE” companies. I have seen him at the Myiris Investor show twice and I quite agreed to the point he made there.

The Myth of Fair Value

The Letdown and After

Stray Where You Are

When Pigs Take Wing

Aristos Fund posted a gain of 7.26% in July compared to 8% gain by Index and the Fund is up by 39.4% year to July.

Random Thoughts on Markets

Positive signals coming in from the Govt. Divestment, National Unique Identity programme, Direct Tax Code 2009, etc. But reforms on Insurance and Pension still pending. 3G auction pending. These remain the key triggers.

Two Index heavy-weights stocks (RIL and Bharti Airtel) are  facing unknown events. Any positive news on these will take markets higher.

FII inflows till date have been around $6-7bn. India can see inflows back to the FY08 levels or even more i.e $15bn-18bn. Big Boy of Dalal Street LIC can’t increase stake in most of the Index companies while most of the FII inflows have been coming through Exchange Traded Funds. Rupee could trade at 42-43 levels by the end of FY10.

Monsoon impact on earnings should be marginally negative.  FMCG companies should pass on the increase in prices to the consumer while Autos should continue to benefit from low interest rate regime.

Low base effect will make sure that every headlines sound like “Ahead of expectations”.

Fiscal deficit not a major concern as long as there is an improvement in the global economy. Finance Ministry has considered crude @ $80 while calculating subsidies. However, its diificult to take a call on the outlook for crude oil.

Demand for Real-estate is highly dependent on the IT sector. There is no major recruitment in the IT sector yet so it is difficult to see the demand coming back to 2007 levels in the near future while low interest rates might offset the same to a greater extent. What happens when the interest rates go up remains to be seen.

Impact of global inflation and rollback of stimulus package remains to be seen. This could turn out to be risks on the downside.

Rakesh Jhunjhunwala’s Multibaggers !!

I have tried to find out when did the Ace Investor Rakesh Jhunjhunwala first bought a stock and at what (Average) price, adjusted for bonus issue and stock split through the BSE Shareholding pattern and BSE Historical prices data. BSE doesn’t disclose holdings less than 1% so its very likely that he must have bought some stocks earlier and subsequently raised it to more than 1%. In bracket is the multibaggers he is making at CMP (as of today). Considering his acquisition price, the dividend yields on most of his stocks is as high as 20% !!!

Crisil was bought in the March’02 quarter when the stock was trading at an average price of 250 (16 bagger) .

He bought Titan in the June’02 quarter when the stock was trading at 65. At the Myiris.com Investor meet two years ago, Jhunjhunwala mentioned he bought Titan at 40 which means he bought Titan before the June’02 quarter (30 bagger)

RJ first bought Lupin in the Dec’02 quarter when the stock was trading at 60 (15 bagger)

Pantaloon was bought in the Sept’03 quarter when the stock was trading at 22. Rights issue excluded (15 bagger)

Nagarjuna Construction was bought in the March’04 quarter when the stock was trading at 16 (9 bagger)

Praj Industries was bought in the March’04 quarter when the stock was trading at just Rs 4.5 (21 bagger)

Bilcare was bought in the March’04 quarter at 125 (3 bagger)

Geojit BNP Paribas was bought in the March’05 quarter at 7.5 (almost 6 bagger)

Punj Lloyd was bought in the March’06 quarter at 210 (No bagger here)

Karur Vysya Bank was bought in the June’06 quarter at 275 . Rights issue of 1:2 in 2006 excluded. (No bagger here)

Rakesh Jhunjhunwala’s holdings as on 30th June’09

This is just a small brief on the shares Ace Investor Rakesh Jhunjhunwala bought/sold in the June quarter. I may request readers to do their own homework before blindly copying his portfolio.

He bought 1,07,200 shares of Lupin, 7,00,000 shares of Nagarjuna Construction, 2,44,838 shares of Rallis India, 2,00,000 shares of Praj Industries and 2,85,000 shares of Hindustan Oil Exploration.

He sold 50,000 shares of Karur Vysya Bank, 27,000 shares of Titan Industries and 2500 shares of Bilcare.

No change in holdings in Crisil, Punj Lloyd, Pantaloon -DVR, Geojit BNP Paribas, Geometric,  Prime Focus, Zen Technologies and Mid-day Multimedia. Due to equity dilution in Pantaloon Retail, RJ’s holdings in Non-DVR Pantaloon might have come down to below 1% and hence it is not disclosed in the Shareholding pattern.

My observations: He increased his holdings in Lupin for the second consecutive quarter while he sold some Titan Industries in the last two quarters. My estimate is that he bought stocks worth Rs 35crs during the June quarter.

Disclosure: I hold Lupin and Punj Lloyd.

Rakesh Jhunjhunwala: A long-term Bull Run!

A column written by the Ace Investor in Business Today dated 28th June’09.

Click here to read the article.

Quality Stocks: Companies with ROE & ROCE of over 30%

I have compiled a list of quality stocks which one can look at based on earnings growth and return ratios (FY09) . I have excluded FMCG and Banking from the list.

Amara Raja Batteries (CMP: 92)

Ahluwalia Contracts (CMP: 87)

Bajaj Electricals (CMP: 400)

Blue Star (CMP: 342)

Crisil (CMP: 3412)

Divis Labs (CMP: 1117)

eClerx Services (CMP: 300)

Exide Industries (CMP:66)

Mphasis (CMP: 370)

Opto Circuits (CMP: 160)

Page Industries (CMP: 545)

Sesa Goa (CMP: 185)

Thermax (CMP: 408)

Titan Industries (CMP: 1180)

TRF (CMP: 825)

Voltas (CMP: 123)

Voltamp Transformers (CMP: 842)

Stocks with a little lower ROCE but over 30% ROE are Crompton Greaves and Tulip Telecom (both have ROCE of around 25%).

If you can pick 5 stocks from the above list whose earnings are expected to grow over 20% over the next few years and available at FY11 PE of less than 12, then I believe you can easily outperform the Index over the longer term.

Sensex @ 21000 in 2010?

Madhu Kela of Reliance MF, Nilesh Shah of ICICI Pru AMC and Ajit Dayal of Quantum AMC believes Sensex will hit new high in 2010. I tend to agree with them. I had mentioned in my earlier post of Indian economy growing by atleast 8% in FY11 which I see as one of the reason for the index hitting new high as GST, Oil & Gas Discoveries and Global recovery boost the earnings of the Sensex companies. The added trigger could be the de-control of oil prices since the election is now over. Even if oil prices are not decontrolled completely but raised around the market prices, subsidy burden of ONGC will ease considerably and boost its earnings. ICICI Bank business should have undergone a significant change with focus on CASA,NIMs and ROE while bank’s lending should pick up after the consolidation. HDFC and HDFC Bank will continue with their 20%+ and 30%+ earnings growth. With the capital inflows coming back into the country, Real-estate players will start raising money through equities and pay back the debt to the Indian banks. This will ensure that the restructured assets have not turned bad. SBI & ICICI Bank will be the biggest beneficiaries. L&T might demerge some of its subsidiaries while its infrastructure business continues to deliver 25% earnings growth. BHEL too should continue to deliver 20-25% growth. US economy is expected to recover by the end of 2009 which should lead to increased spending by the US companies. Infy,TCS and Wipro will benefit from the same but the rupee appreciation will take off some sheen. Defensives like Telecom and FMCG should as usual deliver 15%+ growth . Metals will rebound as global economy recovers. Autos could be under stress as interest rates rise and commodities shoot up so growth could be around 10% in this sector.

If the global recovery happens by the end of 2009, Sensex FY11 EPS and FY12 EPS should be around Rs 1090 and Rs 1250 respectively which markets will start discounting by the end of 2010. At the one-year forward PE of around 17, Sensex does have a high probability of hitting new high. Inflation and Commodities prices remain a risk on the downside.

India’s Best Managed Companies

FinanceAsia’s annual poll of Asia’s top companies have been voted by 238 investors and analysts across the region (including yours truly).

Infosys topped across the board by bagging the best managed company, best corporate governance, best investor relations, best corporate social responsibility and most committed to a strong dividend policy. Not surprised!

Bharti Airtel was voted the second best managed company and investor relations.

HDFC Bank stands third on the best managed company and investor relations.

Tech Mahindra and Opto Circuits were voted the best midcaps while Sanghvi Movers and Bharat Bijlee voted as the best small-caps.

Check out the complete list here

George Soros exiting Indian markets ?

Billionaire investor George Soros’ Fund Quantum M has been selling its holdings in different companies. As per the filing of shareholding patterns on BSE, Quantum M has sold its holdings in Reliance Capital, Future Capital, GVK Power & Infrastructure, Orissa Sponge Iron & Steel, Indiabulls Real-Estate and Indiabulls Financial Services. In April, his fund has been selling shares of Rel Infrastructure (595895 shares sold in March quarter and 1304191 shares on 6th April) and JSW Holdings (311232 shares of 965991 shares held by his fund as on 31st March’09) according to the bulk deals on BSE. Quantum’s holdings in Dish TV is awaited.

His fund still holds 1.5% stake in Anant Raj Industries, 5.63% in Gujarat Ambuja Exports Ltd, 3.17% in Karuturi Global as on 31st March’09. So he has not completely exited the Indian markets.

One can make out clearly that there are higher number of stocks his fund sold in the March quarter than the stocks his fund holds. Soros is known for his currency bets. He has fared poorly in equities.

George Soros mentioned in his 28th Jan article in FT,

Although I positioned myself reasonably well for what was coming last year, one thing I got wrong cost me dearly: there was no decoupling between markets of the developed and the developing worlds. Indian and Chinese were hit even harder than those in the US and Europe. Since we did not reduce our exposure, we lost more money in India than we had made the year before.

Infact, his fund was on a buying spree in February and July last year!

Rakesh Jhunjhunwala’s holdings as on 31st March’09

This is just a small brief on the shares Ace investor Rakesh Jhunjhunwala bought/sold in the March quarter.

He bought 6,50,000 shares of Geometric Ltd, 1,75,000 shares of Karur Vysya Bank, 1,34,000 shares of Lupin

He sold 1,21,000 shares of Titan Industries, 7,00,000 shares of Pantaloon Retail and 11,00,000 shares of Nagarjuna Constructions.

No change in holdings in Rallis India, Praj Industries, Punj Llyod, Crisil and Mid-Day Multimedia.

I will keep on updating the changes in shareholdings in other stocks. For a detail check on his holdings, visit The Equity Desk. If I have missed any stock, do let me know!

Barclays’ Economist got it all Wrong

Barclays Capital’s Economist Sailesh Jha has been consistently getting all his forecast wrong since August last year. His forecast started with Inflation touching 17% in 2008 and we know that inflation never went above 13%. In the current year, he predicted rupee will tumble to 56 to the dollar by June. Rupee has appreciated in the past few weeks and is now trading around 50 to the dollar. Dollar-Rupee movement is highly correlated to Sensex movement. So Rupee will hit 56 only if Sensex tumbles to 7000.  Since anything can happen in the next two months, we will see how the prediction pans out. Jha predicts that bonds yields will fall to 5.1 by the end of Q2CY09. Yields are currently trading at 7.01%. With the huge government borrowing in the coming quarter, I am sure his prediction will fail. According to the Barclays economist, Indian economy is likely to grow by 4% in FY10. If our economy can grow by 5.3% in a tight liquidity scenario, we will probably grow above 5% in an easy liquidity condition. Infact, we have seen signs of recovering in Q4FY09 in major industries except textiles and gems and jewellery. I believe the effect of low interest rates have been underestimated by economists and analysts.

I hope Barclays is not acting on his forecast. But then for what is he paid for ? Unfortunately, Economists don’t get fired too easily. As someone rightly said,” When your neighbour loses a job, its a recession and When an economist loses a job, its a depression“.

Banking Simplified!

Banking is considered to be the pillars of any economy. It is essential to understand this sector to get a sense of the various industries, consumer sentiment,etc. I am in the process of understanding the minute things operating in this sector. Let me share whatever I have learned till now. What are the factors which affect CASA, NIMs, NPAs,etc..

CASA impact on NIMs

Banks pay 3.5% interest on savings account. In reality, the actual cost of savings account is less than this as banks pay interest on the minimum balance kept between 10th and the last day of the month. The average cost of savings account is less than 3% and overall the cost of demand deposits could be even less than 2%, depending on the combination of savings and current accounts (CASA) of a particular bank.

Treasury/Government Bonds

Prices and yields of bonds have an inverse relationship and firm yields could saddle banks with mark-to market losses on their government bonds portfolio. Most banks do mark-to market accounting, making provisions for losses or profits at the end of each quarter, based on the difference between bonds prices and purchase prices. In case of 10 year bonds, prices fall by 7 paise for every basis point rise in yields. For example, if yields rise 100bps above last quarter then banks will have to provide for a loss of Rs 7 for every Rs 100 invested. Currently, banks investments of upto 25% of deposits in govt. bonds are protected from booking depreciation in bond yields if the bonds are kept in the HTM portfolio. The other two portfolios of banks bond investment are “Available for sale” and “Held for trading”. Banks are allowed to shift their bonds to HTM category once a year.

Impact of Ratings on Capital Requirements

Under the current standardised methodology of risk weighting, Triple “AAA” to “AA-” rated assets need to be risk weighted at 20%. However, if the credit rating sink to “A”, the risk weighting increases to 50%.

Bulk/Wholesale deposits

Bulk deposits are deposits by the corporates of the amount of Rs 1cr or more. Banks usually issue Certificate of Deposits (CDs) to corporates for a period between 3-12 months. In a tight liquidity scenario or higher interest rates regime, bulk rates might be higher than retail deposit rates. Rates fall equally fast in a surplus liquidity scenario. It might be slightly above Govt. bonds yields.

Interest Cost to the bank

The cost of funds of most banks is between 6-6.5% (mix of term and demand deposits rates). The cost of funds goes up by 2.5% due to the establishment costs and maintenance of CRR and SLR costs. Thus, the total cost to the bank is between 8.5-9%. To maintain Net interest margin of 2.5-4%, banks have to lend at 11-13% to the borrowers.

NPA’s Management

Banks protect their assets from becoming a non-performing loan (NPL) by going through the Corporate Debt Restructuring (CDR) exercise. Restructuring typically involves rescheduling the principal repayment date or even reducing the interest rates to help revive the borrowers cash flows. Banks recover non-performing loans through one-time settlement and compromise schemes, Lok Adalats, Debt Recovery Tribunals (DRT) and SARFAESI Act in addition to their own internal recovery process. A bank is allowed to write-off gross NPAs to the tune of mark-to market gains in govt. securities.

Loan Asset Classification

Banks classify loans as standard assets, sub-standard assets, doubtful assets and loss assets. Except for the standard assets, banks have to make provisions for the rest as they are treated as NPAs. According to RBI, an NPA is defined as a loan or advance where interest or installments of principal amount remain overdue for a period of 90 days in respect of a term loan.

Buy Cairn India at 17% discount to CMP!

Cairn Energy holds 65% stake in Cairn India. Cairn India has a market capitalisation of Rs 30,836 crs as on 9th March closing whereas its parent Cairn Energy is trading at a market cap of 2.35bn pounds at the London Stock Exchange which equals to Rs 16,607.45 crs if one goes by the exchange rate of GBP = Rs 70.67. Cairn Energy’s 65% stake valuation comes to Rs  20043.4 crs which is 17% discount to the market cap on the NSE. I wonder is the 17% discount given to the holding company. The risk here is that one cannot bet with certainty that the discount price between the FTSE and NSE will narrow going forward. I am not sure about the holding company discount in the European markets but in India it can vary widely between 5-75%.

I am not advising to buy or recommend anything. Its just that if you wanna buy Cairn India then buying through Cairn Energy makes sense. I think this is the reason for the biggest hedge fund HSBC India Fund to buy Cairn Energy rather than Cairn India. Another benefit could be no risk of currency fluctuation as the fund is based in UK.

Top Ten US Financials v/s SBI’s Market Cap

Lets take a look at the market cap of the top ten US Banks v/s  State Bank of India at yesterday’s closing prices.

JP Morgan Chase -$79bn

Wells Fargo- $45.94bn

Goldman Sachs – $39.84bn

Bank of New York Mellon – $24.57bn

Bank of America – $23.20bn

U.S. Bancorp – $22.99bn

Travelers Cos – $20.89bn

Morgan Stanley – $19.29bn

Metlife – $13.10bn

American Express – $12.83bn

If we compare the top bank in India in terms of market cap, State Bank of India (SBI) which closed at a market cap of $12.5bn, it seems like after topping Citigroup,Royal Bank of Scotland, Lloyds and Barclays (except first, rest are not based in US) , SBI is all set to overtake Metlife and American Express this year. Isn’t it amazing that two financials having operations all over the world being overtaken  by a bank with major presence in just one country. SBI is now close to Deutsche Bank. In two-three years, SBI could vault into the list of top 25 banks globally. I am not sure what is the ranking of SBI currently. If you have any idea then let me know!

GMR Infra/Jindal Steel might replace RPL in Nifty

Last time after the Satyam saga, I had mentioned that Axis Bank or Rel Cap might replace Satyam in Sensex and Nifty stock constituents. Rel Cap replaced Satyam. Though Axis has joined the Nifty club by replacing Zee Enterprise from Feb’27. Now I expect GMR Infra or Jindal Steel & Power to replace RPL if the merger between RIL-RPL go through simply because both are heavily traded counter and their market caps are around Rs 15,000crs.

LIC cannot increase stake in 18 Nifty companies

According to Insurance regulator IRDA, any life insurance company cannot hold more than 10% stake in a particular company. Its implications is that the big boy of Indian stock market LIC (equity investments of over Rs 2 lakh crs) will not be able to increase its stake in 18 out of the 50 Nifty companies. LIC’s stake in these 18 companies are as follows:

ABB – 12.86%

ACC – 17.48%

Ambuja Cement – 11.25%

Axis Bank – 10.36%

BPCL – 9.88% (which is pretty much close to 10%)

Cipla – 13.49%

GAIL – 9.98%

Grasim – 12.75%

Hindalco – 10%

ITC – 13.98%

L&T – 17.38%

Mah & Mah – 17.61%

Maruti Suzuki – 14.64%

Reliance Infra – 13%

Siemens – 13.26%

Tata Motors – 10.27%

Tata Power – 11.44%

Tata Steel – 11.56%

LIC have little room to increase its stake in ICICI (9.38%) and Tata Communications (9.21%). The life insurance major has NIL exposure to DLF, NTPC, Reliance Power, Sun Pharma and Suzlon Energy. In the first three stocks, promoter’s holding is 85% or more as on 31st Dec’08. Fresh money could be deployed in Bharti Airtel, BHEL, Cairn, HDFC twins, Idea Cellular, PNB, RIL, SBI and Sun Pharma.

How will Media fare in an Economic slowdown

Media & Entertainment is generally considered as a recession-proof industry. So what will be the impact on advertisement in a slowing economy. Industry experts outlook remains cautious for India. KPMG-Group M forecasts a 8% advertising growth in FY10 while Media Partners Asia (MPA) forecasts a growth of 7.2% in 2009 and 9.3% in 2010 compared to 14.4% in 2008. Pitch- Madison forecasts a marked slowdown to 2% YoY growth in advertising. Advertisement revenues account for 70-80% of the total revenues of the Media and Entertainment industry. High single-digit growth is better than a negative growth seen in other developing countries. Saving grace for the media industry could be higher penetration of DTH but still it would not be significant to offset the softening ad spends.

Interestingly, Star Group, the biggest TV network in India, gets less than 8% of the total broadcasting revenue pie. The Times of India Group, gets less than 10% of the total revenues in print.

Dish TV compared to EchoStar Corp. of USA

This is what Bruce Berkowitz, founder, Fairholme Capital Management writes in his introduction to Part IV (basically on the importance of free cash flow) in “Security Analysis“. He gives an example of EchoStar Corp., parent of the DISH satellite TV business. I thought it could be compared to Dish TV in India.

That company went public in June 1995, on the premise that there was room for another pay-TV provider. By 2000, at the peak of Wall Street’s infatuation with all things tech, EchoStar had 3.4mn subscribers, an enterprise value (market value of equity, plus net debt) of approx. $30bn, and a reported annual loss of nearly $800mn. Worse yet, the company was consuming cash like crazy as it sought to build its infrastructure and customer base – and that alone would take it off many value investors radar.

Fast forward five years, and the subscriber topped 12mn. With many of the start-up costs behind it, free cash was flowing and growing -monthly subscriber fees are a pretty reliable income stream. Yet at that time, in 2005, EchoStar’s enterprise value was just $17bn. Clearly, the market was not giving the company much credit for its cash generating abilities. That allowed Fairholme to purchase shares in an excellent franchise business with a double-digit free cash flow yield while risk-free investments were paying 5%.

At the peak of 2008, Dish TV’s market cap was Rs 4282crs and its debt was around Rs 450 crs resulting in an enterprise value of Rs 4732 crs and a reported annual loss of Rs 414crs. Currently, its market cap is around Rs 2000 crs thanks to rights issue and the company continue to report losses.

Seth Klarman in “Security Analysis”

I am currently reading what is considered as the “bible of value investing”, Security Analysis by Ben Graham and David Dodd. Seth Klarman has written the preface to the Sixth Edition of the book. Though the whole piece is worth reading, I have taken out some key things which I believe should be kept in mind by every investor.

Investing in bargain-priced securities provides a “margin of safety” – room for error, imprecision, bad luck, or the vicissitudes of the economy and stock market.

As Graham has instructed, those who view the market as a weighing machine – a precise and efficient assessor of value – are part of the emotionally driven herd. Those who regard the market as a voting machine – a sentiment-driven popularity contest – will be well positioned to take proper advantage of the extremes of market sentiment.

Essential characteristics of a value investor are patience, discipline and risk aversion.

As Warren Buffett said in his famous article, “The Superinvestors of Graham and Doddsville”, “It is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately with people or it doesn’t take at all. Its like an inoculation. If it doesn’t grab a person right away, I find you can talk to him for years and show him records, and it doesn’t make any difference.”

While formulas such as the classic “net working capital” test are necessary to support an investment analysis, value investing is not a paint-by numbers exercise. Skepticism and judgement are always required. For one thing, not all elements affecting value are captured in a company’s financial statements – inventories can grow obsolete and receivables uncollectible; liabilities are sometimes unrecorded and property values over or understated. Second, valuation is an art, not a science. Because the value of a business depends on numerous variables, it can typically be assessed only within a range. Third, the outcomes of all investments depend to some extent on the future, which cannot be predicted with certainty; for this reason, even some carefully analysed investments fail to achieve profitable outcomes. Sometimes a stock becomes cheap for a good reason: a broken business model, hidden liabilities, protracted litigation or incompetent or corrupt management. Investors must always act with caution and humility, relentlessly searching for additional information while realizing that they will never know everything about a company. In the end, the most successful value investors combine detailed business research and valuation work with endless discipline and patience, a well-considered sensitivity analysis, intellectual honesty, and years of analytical and investment experience.

Another important change in focus over time is that while Graham looked at corporate earnings and dividend payments as barometers of a company’s health, most value investors today analyze free cash flow.

Good businesses are generally considered those with strong barriers to entry, limited capital requirements, reliable customers, low risk of technological obsolescence, abundant growth possibilities, and thus significant and growing free cash flow.

There is a significant downside to paying up for growth or worse, to obsessing over it. Graham and Dodd astutuely observed that “analysis is concerned primarily with values which are supported by the facts and not with those which depend largely upon expectations.” Strongly preferring the actual to the possible, they regarded the “future as a hazard which his (analyst’s) conclusions must encounter rather than as the source of his vindication”. Investors should be especially vigilant against focusing on growth to the exclusion of all else, including the risk of overpaying. Again, Graham and Dodd were spot on, warning that “carried to its logical extreme, ….(there is no price) too high for a good stock, and that such an issue was equally ‘safe’ after it had advanced to 200 as it had been at 25.

Top holdings of Top Indian Hedge Funds

Four largest Indian hedge funds manage cumulatively $6.55bn. So where is the ‘smart money’ betting on in the Indian stock market.

HSBC GIF Indian Equity Fund (AUM of $2.3bn) top 10 holdings include Cairn Energy, Jindal Steel & Power, Wipro, HCL Tech, TCS, Maruti Udyog, Idea Cellular, Aditya Birla Nuvo, DLF, Glenmark. Cash: 2.39%  (Seems to be betting on out-of favour stocks)

Aberdeen Global Indian Equity Fund (AUM of $1.5bn) top 10 holdings are HDFC, Infosys, Satyam, Hero Honda, ICICI, GSK Pharma, Grasim, HUL, ITC, Bharti Airtel. Cash: 2.4% (Ofcourse the fund exited Satyam after 31st Dec’08 )

JP Morgan India Fund (AUM of $1.42bn) top 10 holdings include Infosys, HDFC Bank, HDFC, RIL, ICICI, Bharti Airtel, BHEL, ITC, NTPC and L&T. Cash: 10.5% as on 31st Jan’09. (Quality names should do better this year)

Fidelity India Focus Fund (AUM of $1.33bn) top holdings include ICICI, United Spirits, MCX, Suzlon, Tata Motors, Financial Technologies, Pantaloon, SBI, Piramal Healthcare, HDFC Bank. Fully invested. (Investing in stocks where funding is the key issue)

8% Economy growth in FY11?

I know I am thinking too far since we have not even completed FY09 which is expected to grow between 6.5-7% and FY10 between 5-6%. Now what is the trigger that will push the economy to grow from 5-6% to 8% ? (Many of you might be thinking I am too optimistic). According to me, there are three factors which will lead to 8% GDP growth.

1) Production of Oil & Gas by RIL and Cairn, RPL refinery will boost India’s GDP by atleast 1% in FY11.

2) Implementation of GST from April 2010 will contribute an additional 1.4% (atleast) to GDP according to Vijay Kelkar, Chairman, 13th Finance Commission.

This is what Nandan Nilekani mentions in his book “Imagining India”
about Mr.Vijay Kelkar,

I have been a long time admirer of his, especially after I saw a remarkable presentation he gave in 2002, titled ‘India: On the Growth Turnpike’, which predicted -with what would turn out to be unusual accuracy -India’s growth trends over the next few years.

3) Recovery in the world economy will also help in accelerating the Indian economy  (Assuming 5.5% growth in FY10)

All in all, bulls will be back by the end of 2009 or early 2010!!

Educomp Solutions: A steal at CMP!

I have mentioned about Educomp in my previous posts here and here

A look at some of the brokerages target on Educomp will give a sense that the stock is a bargain at CMP of Rs 1410 (Feb futures closed at Rs 1341 on Friday). Lets start from aggressive ones to conservative.

CLSA – 4400  (Analyst Bhavtosh Vajpayee & his team was voted No.2 Technology/IT Services & Software Analysts by Institutional Investor in 2008. Bhavtosh Vajpayee was also voted as one of India’s best analyst by Business Today. They also helped Nandan Nilekani in his book “Imagining India” to get an investment analyst perspective)

Merrill Lynch – 3400

SSKI-IDFC – 2800

Credit Suisse – 2700

Kotak – 2550

First Global report criticize that the company does not generate free cash flows at the operating level. Someone should tell them that Bharti turned FCF positive this year and has been a multibagger if one had invested in 2003.

I would highly recommend to read a report on Indian Education sector by CLSA analysts to understand the business,  Clarifications and Letter to shareholders and then take a call on investing in the stock.It always pays to do one’s own homework!

If I had to summarise, Recession-proof business, Scalable business model, well funded for growth, available at decent valuations, company taking measures to be among top 10 in India in Corporate Governance and No payment issues as they bag most orders from Govt. (though debtor days are high)

My advice to Educomp management is to get their Corporate Governance standards rated by Crisil and Appoint one of the Big 4 audit firms as their Statutory Auditors. Appointing GT as their internal auditors wouldn’t give much confidence as they ultimately report to the company management even though its a good move.

AUM’s of Life insurers as on Dec’08

Currently in India, 21 life insurers are operating of which 20 are private. Every month, it is mandatory for Mutual Funds to disclose their AUM but not for players operating in the life insurance industry. One can only know about this when quarterly results are declared. So here it is (Only top 10 players). I wish life insurers had given the break-up of assets managed between debt and equity. Thanks to corporate governance issues with ADAG companies, Reliance has for the first time disclosed the information I never expected!

LIC, the BIG boy of Indian equities, manages assets worth Rs 8,06,000 crs

ICICI Pru Life AUM of Rs 28,445.2 crs, of which Rs 14863.3crs in Equity and Rs 13581.8crs in Debt)

SBI Life AUM grew by 80% to Rs 13,272 crs.

Max New York AUM of Rs 4827 crs, up 45% YoY

Reliance Life AUM of Rs 4495 crs, up 57% YoY (of which Rs 2524.4crs in Equity and Rs 1970.6crs in Debt)

Bajaj Allianz AUM stands at around Rs 13,152.6 crs

Birla Sun Life AUM is Rs 7958.5 crs, up 21% YoY

HDFC Standard Life AUM stands at around Rs 9,500 crs

(The company has not declared any official figures for Dec quarter. But they did announce an AUM of 10k crs in Sept’08 with 55% of assets under equity. Since then, Index have fallen 33% by the end of Dec’08. So my sense is that AUM would be around that figure considering new premium inflows and gains in debt investments)

Kotak Life manages assets worth Rs 3374 crs.

Tata AIG AUM stands at over Rs 4000 crs

Just to compare with Life insurance industry, Indian Mutual Funds managed assets worth Rs 4,18,336crs as on 31st Dec’08 whereas life insurers manages almost 9,00,000 crs worth of assets!!

On the liquidity side, my calculations show that private life insurers are sitting on Rs 5000-5500crs (over $1bn) cash as on 31st Dec’08 waiting to be invested in the equity markets.

Stay Hungry, Stay Foolish

I found out some interesting things from “Stay Hungry, Stay Foolish” by Rashmi Bansal which is about 25 young entrepreneurs who graduated from IIM-A.

Shantanu Prakash, Educomp Solutions:

Market penetration levels are less than 2%. And Educomp can keep growing 100% over the next ten years without reaching a saturation point.

We are now five times larger than our nearest competitor in India.

Educomp today has atleast 25 employees who are dollar millionaires.

Educomp is valued at about $1.5bn (as of May’08). I think we can be a $10bn company in the next three years.

Vinayak Chatterjee, Feedback Ventures

Money is a by-product. Business growth, turnover, bottomline is a by-product of what your heart and head wants you to do. So if you follow that money will follow. Woh Gandhi waali baat hai ,”Find purpose and the means will follow”.

Feedback is one of the top 10 engineering companies in India with 5000 kms of roads, bridges and industrial parks to its credit.

Somewhere in ’98-99, we built up overheads far higher than our order book. We had negative cash flows. It was the second last day of the month and there was no money to pay salaries. Vinayak met Deepak Parekh and he immediately handed over the cheque.

Deepak Parekh, a “bailout man” ? First UTI, then Feedback and now Satyam.

R Subramanian, Subhiksha

RS started Viswapriya Financial Services & Securities Ltd, an IPO financing company in 1991. In 1996, he exited the business as the markets were very weak but he had money unsure of how to utilise it.

Current situation is completely the opposite. He needs money immediately. I remember, at one point, he mentioned that he will takeover the big players in Retail (read Reliance, Bharti).

Rashesh Shah, Edelweiss Capital

In ’94, the index was at 4500. In 2003, it was at 3000. Adjusted against the inflation, the market had lost 80% of its value.

Reality check on Corporate Governance in India

ET’s supplementary Corporate Dossier carries a reality check on Corporate Governance in India. Its an excellent piece. Click here to read.

Also read how Kris Gopalakrishnan was selected as Infy’s CEO.

Sunil Singhania’s expectation in 2009

Sunil Singhania is an Ex.VP -Equities of Reliance MF. He has been managing some of the top funds like Rel Growth Fund, Rel Diversified Power Fund among others.

What are the key concerns of the Indian market in the medium term ?

In the medium term, it will mostly be fundamental concerns. We have seen a big slowdown in a number of sectors. There is the old inventory of raw material lying around and there is a lot of marked-to market loss in that. Because of the demand slowdown a number of companies are operating at sub-optimal capacities. These two factors are going to put a lot of pressure on profitability. And there is also higher interest cost because of higher interest rates putting further pressure on profits. The results will be disappointing in the next two quarter. But the market already expects it and has already discounted it. It is not going to be an unexpected shock.

When the markets pick up, which sector will be the one to move first ?

Right now the call is that interest rates are falling and the economy is reviving. So the sectors to get impacted first will be the interest rate sensitives like construction, capital goods and to some extent auto companies. These stocks have fallen a lot and they would be the direct beneficiaries of a falling interest rates. But I would be more cautious and not get euphoric too early.

From a valuation perspective, pharma looks good with its significant entry barriers. They are big beneficiaries of rupee depreciation since they are export oriented and raw material costs have dropped significantly. This sector will grow by 15-20% over the next few years. (My note: I guess he is talking about Divis Labs ).

IT will not command the valuations it used to earlier. We dont see the problems in the US disappearing over the next one year. The IT exposure to financial services is quite high. The near term earnings may not be at risk due to rupee depreciation but the kind of growth which IT companies enjoyed a few years ago will no longer happen.

Source: Value Research Online

Oil below $50/bbl: Companies at risks

There are many companies whose earnings are at risks with crude oil trading below $50/bbl (right now below $40/bbl). Indian upstream companies like ONGC, RIL, Cairn India and GAIL , Indian Capital Goods companies like L&T and Punj Llyod. Offshore companies like Aban Offshore. Refining companies like RPL.

Cairn India is highly leveraged to Oil price. Every $1/bbl decrease in WTI reduces Cairn’s EPS by 5.2% in FY09E, 2.3% in FY10E. ONGC‘s EPS will be impacted by 3-5%  for every dollar decrease in oil price. If ONGC share 33% of under-recoveries on cooking fuels, assuming no under-recoveries in retail fuel, then at $52/bbl, its under-recoveries would be Rs 53bn which would reduce its net realisations by 16% to $44/bbl.

RIL is also impacted by the direction of gross refining margins. Every dollar movement impacts its EPS by Rs 10. RIL is least impacted as its share from production of gas will increase going forward.

GAIL‘s petrochemicals business could be impacted negatively with EPS declining 0.6% for every $1/bbl decrease in crude price.

Approx. one-third of L&T’s business comes from hydrocarbon business. With oil prices below $50/bbl, clients might start re-evaluating the feasibility of the projects which will lead to either cancellation of orders or re-negotiation of price. Some respite for L&T could be ONGC’s plan to invest $5.3bn in gas finds by 2013. But L&T can only bid for shallow water projects as it lacks deep sea projects capabilities.

66% of order book of Punj Llyod comes from Oil & Gas and petrochemicals sector and more than 70% of order book comes from overseas. Punj Llyod has a history of contractual disputes (IOC-PIL, GAIL, Petronet, SABIC).

Aban Offshore is impacted due to higher supply of rigs coming into the market with a declining demand for rigs as E&P projects is not viable with crude below $50/bbl.

I would avoid all the above stocks (except RIL) till crude price recovers to $50/bbl on a sustainable basis. I think crude price are not going to rebound to $50/bbl in the next six months (maybe a year). As for Oil Marketing companies (OMCs), it is more of a trading play than a long term bet as it is dependent on govt. policies.

CRAMS players like Divis and Dishman Pharma might be one of the beneficiaries as their raw materials constitute of oil derivatives.

Six Midcaps worth Investing

Midcaps have been battered down in the last one year which gives investors an oppurtunities to buy stocks at attractive valuations. Below are the stocks with good management, strong earnings growth, superior return on equity and adequately funded for the growth available at reasonable valuations.

Everest Kanto Cylinder (CMP: 171)

EKC is the largest domestic manufacturer of high pressure gas cylinders used for the storage of industrial gases and CNG. The company currently has four manufacturing plants (Aurangabad, Gandhidham, Tarapur and Dubai) that have a total production capacity of 806000 cylinders per year. An aggressive expansion plan, including a greenfield plant in China and new plant in SEZ would increase EKC’s capacity to 2.3mn cylinders over the next four-five years. EKC should grow at a EPS CAGR of 45%+ over the next two years with EBITDA margin of 28-30% and ROE of around 35%.

Risks: Crude price @ $40/bbl which could impact CNG’s strong economics and consequently slow CNG penetration.

Future Capital (CMP: 156)

FCH is a focused alternate investment advisor with $1.5bn AUM in consumption related sectors and plans to grow its AUM to $5bn by FY11. It has exclusive rights to offer financial products (loans, third party distribution of insurance, credit cards and mutual funds) at Future Group outlets. FCH benefits from a declining interest rates scenario. FCH has one of the best management. Its a niche business model.

Risks: Might face some problem in raising capital this year but things should be better next year. Also, no exit option till capital markets improve.

Jain Irrigation (CMP: 346)

Jain Irrigation makes irrigation and piping products, plastic sheets, tissue culture planting material and processed food and vegetables. The firm has a 40% market share in total exports of dehydrated onions from India. The company had an order book of more than Rs 600crs as on Sept’08. Only 3mn hectares of irrigated area is under micro irrigation compared to a total irrigated area of 69mn hectares. The govt. emphasis on increasing micro irrigation bodes well for the company. The company has expansion plans of Rs 600crs spread over next three years. MIS business order flow to strenghten further with central govt. approving disbursals even in absence of disbursals by the state govt. Growth in international business will slow down.

Debt of Rs.16bn on the books. Margins would expand by 5-7% with favorable business mix and raisin prices. EPS is expected to grow over 35% in the next two years with ROE of around 25%. Its shareholders includes the likes of George Soros, Matthews India Fund, Rel MF and Arisaig Partners.

Risks: 7.5mn warrants issued to promoters are due for conversion in May’09 at Rs 478/share. Possibility of conversion is 50:50.

Shriram Transport Finance (CMP: 195)

STFC is the largest asset financing NBFC with AUM of over Rs 225.5bn. The company is a leader in organized financing of pre-owned trucks with strategic presence in 5-12 years old truck and a market share of 20-25%. It has a pan-India presence with 462 branches and employs 12619 employees. The company has built a strong customer base of over 0.6mn. Over the past 29 years, it has developed strong competencies in the areas of loan origination, valuation of preowned trucks and collection. It has a vertically integrated business model and offers a number of products which include: Pre-owned CV financing, New CV financing and other loans like accidental repair loans, tyre loans and working capital finance, etc. The company is supported by strong institutional investors like TPG New Bridge, Chrys Capital, Tiger Global, Blue Ridge, Citicorp and Axis Bank providing it growth capital support.

STFC helps private and foreign banks meet their priority sector lending by selling down the loans originated by it. Every year the company sells around Rs 2500crs of its loans to these banks. Basically, securitization of loans.

AUM is expected to grow to Rs 30,000crs by 2010.
Net NPAs – 0.91% in Q2FY09 from 0.88% in Q1. Could increase to 1.2% by the end of FY09 and 1.4% by FY10 as economy growth picks up in H2FY10.
Book Value – Rs 104.67 (Rs 150 expected by FY10)
Net Interest Margin – 7.71% in Q2 v/s 7.38% in Q1
ROE – 32.38% (Q2) v/s 30.41% (Q1)
ROA – 3.36% (Q2) v/s 3.16 (Q1)
 
Risks: Promoters not exercising conversion of warrants into equity shares by May’09 since conversion price is 300 which is 50% above CMP. This will result in company non infusion of Rs 216crs. I personally feel it would be exercised. GDP contraction more than anticipated.
Opto Circuits (CMP: 90)
OCIL is a leading manufacturer & supplier of electronic medical equipments. OCIL is a manufacturer and exporter of invasive and non-invasive medical equipment & supplies wide range of electronic devices and patient monitoring products in the healthcare segment. OCIL’s topline is contributed by 75% non-invasive products and 25% by invasive products. OCIL’s product portfolio includes digital thermometers, sensors, probes, pulse oxymeters, patient monitoring systems. OCIL derives 95% of its revenues from overseas markets, of which 70% comes from OEM’s. Invasive segment is expected to grow at 100% over the next few years. The global stent market is estimated at $12bn and growing at around 12% annually. Non-invasive segment will grow by new product launches. With the acquisition of EuroCor in Germany and Criticare in US, OCIL has got tremendous advantage to cater to new geographies with its diversified product basket and penetrate the existing markets, which leave enough scope for growth amid global slowdown.
EPS is expected to grow at over 45% for the next two years with EBIDTA margin over 30% and ROE of around 43%. Debt is Rs 2bn. OCIL has a track record 7 consecutive yearly bonuses.
Sintex Industries (CMP: Rs 145)
Sintex is India’s largest manufacturer of a range of plastic applications. With a well diversified portfolio and very limited competition in place, it stands a market leader in the Indian plastics processing industry as well as its expertise in the niche segment of corduroy fabrics and men’s structured shirting for premium brands add to its sheen. It manufactures a range of plastics at its 9 manufacturing plants across the country which includes prefabricated structures, industrial custom moulding products, monolitic construction, FRP products and water storage tanks. It has a market share of about 70% in overhead water tanks, 80% in specialized industrial tanks, and more than 60% of pre-fabricated structures.
Over 75% of revenues comes from plastics while the remaining comes from construction and textiles. Exports share will rise to 40% in FY10 compared to 27% in FY08. Sintex has an order book of Rs 15bn to be executed by end of FY10 in its monolithic business. The company is sitting on Rs 1700crs cash to be used for capex and acquisitions. EPS is expected to grow at a CAGR of 40% over the next two years (assuming no FCCB conversion) with ROE of 20% and EBITDA margin of around 18%.

Why India will continue to trade at a premium to EMs

Five reasons why India will continue to trade at a premium to Emerging Markets.

Better Corporate Governance though there are some companies where corporate governance standards are doubted, like JP Associates, Sterlite Industries, ADAG companies, DLF (Sensex) and Unitech (Nifty). But the weightage of these companies in Sensex is around 10% in aggregate which is not so high compared to other Emerging markets. Satyam was an isolated case. In Korea, there is an issue of corruption.

High ROE’s: In FY10, Sensex ROE is expected to be around 17% which is higher compared to 14-15% for Emerging markets. 

Diversified across sectors: Sensex constituents are diversified across various sectors with cyclicals and non-cyclicals. Going ahead RIL’s share from cyclicals business will be less than half the total revenues. Brazil and Russia are basically commodity exporters which means they will continue to trade at low PEs. 50% of Taiwanese Index is Tech.

Domestically demand driven economy: India’s demographics and low exports share to GDP make it less vulnerable to external threats. On the other side, India is dependent on capital inflows.

Healthy Corporate balance sheets with relatively low debt to equity, reasonable cash balances and freshly added stock.

Satyam and Corporate Governance in India

First some facts on Corporate Governance:

2007 ranking on Corporate Governance by Asian Corporate Governance Association (ACGA) placed India 3rd out of 11 Asian countries, behind Hong Kong and Singapore, but far ahead of China, in 9th place.

Govt. of India has introduced a New Companies Bill which would allow shareholders to pursue class-action lawsuits against the company.

Directors can sit on as many as 15 boards. Independent directors should make up atleast half of the board strength in a publicly held company.

Now some views by Management professors from Wharton (courtesy: Knowledge @ Wharton)

Mauro Guillen,

Indian business has an advantage in arguing that the problem is limited to Satyam and is not systemic. India is not perceived like Russia – it is neither everyone’s darling nor the plague. This works to the country’s advantage because it deflects the blame of such occurrences to the way governance works in emerging economies rather than to India.

Michael Useem

Draws a parallel between what occurred at Satyam with the scandals at WorldCom and Tyco rather than at Enron,” At WorldCom, the CFO and the CEO were knowingly mistating the accounting and financials of the firm; at Tyco, the CEO and CFO were knowingly taking money from the company for personal purposes. Satyam’s disaster has a parallel to these acts of malfeasance. If it survives, Satyam maybe able to redeem itself with new management and governance codes. He recalls working as a consultant a couple of years ago with Tyco where the company’s new CEO Ed Breen systematically went about cleaning up after the departure of disgraced CEO Dennis Kozlowski, instituting strong corporate governance practices. Tyco is one of the best examples of corporate governance turnaround.

Jitendra Singh on governance practice at Infosys,

He drew a “level of confidence” from the accounting rigor and governance mechanisms at Infosys, where he was an independent director from 2000 to 2003. He recalls how T.V. Mohandas Pai, the company’s then CFO, “would take so much time going into accounting details. ”

How effective independent directors can be is mainly a factor of the “dynamics inside the board room once the doors are closed”. There is an attitude in some Indian companies that the board members actually work for people who have brought them onto the board. This is a completely misguided attitude. It looks like this may have been the problem at Satyam. The real strength of a healthy board is when a consensus gets overturned by a dissenting view.

Saikat Chaudhari on Enron v/s Satyam

At Enron, the CEO stonewalled, while whistle-blowers came out with the truth. At Satyam, there were no whistle-blowers. The CEO blew the whistle on himself.

Rakesh Jhunjhunwala’s holdings as on 31st Dec’08

This is just a small brief on the shares Ace investor Rakesh Jhunjhunwala bought/sold in the December quarter.

He bought 1,64,000 shares of Titan Industries (0.38%) , 6,80,000 shares of Geometric Ltd, 61,944 shares of Rallis India, 982 shares in Praj Industries

He sold 24,00,023 shares of Hindustan Oil Exploration Company Ltd, 820000 shares of Bhushan Steel (complete exit), 7,00,000 shares of Nagarjuna Constructions and 14500 shares of Lupin.

No change in Pantaloon Retail, Punj Llyod, Bilcare, Crisil, Geojit Financial, Prime Focus and Mid-day Multimedia shareholdings.

I will keep on updating the changes in shareholdings in other stocks. For a detail check on his holdings, visit The Equity Desk.

Sun Pharma replaces Satyam: What does it mean?

BSE has announced that Satyam will be replaced by Sun Pharma in the BSE Index Sensex. What does it mean for the market as a whole ? EPS estimates changes significantly. Consensus EPS estimates for Sensex for FY10 is forecasted at Rs 970. Satyam EPS for FY10 was estimated at Rs 35. Consensus EPS for Sun Pharma is estimated at Rs 85 for FY10. Which means that EPS for the Sensex will get boosted by Rs 50 to Rs 1020 in FY10. This in turn reduces the forward price/earnings ratio. Market cap of Sensex will be up by Rs 10,000crs or $2bn. But the negative part is that EPS will de-grow by 6-7% YoY for Sun Pharma. Plus point is that it will serve as a defensive in case of market crash, excellent promoter (Dilip Sanghavi was awarded as the “Entrepreneur of the Year” by Economic Times in 2008 ) , ROE of around 25% and forward P/E ratio of 12-13x compared to 6x for Satyam (before Maytas deal) . All in all a positive for the investors !!

Axis Bank might replace Satyam in Sensex/Nifty

Its a Black Day for Corporate India with serious damage to the Corporate Governance standards in India. I would not get into the implications of the Satyam fraud since everyone right now is focussed on the same. But one thing which I want to guess is who is going to be the contender for being included in the elite club, I mean, BSE Sensex and Nifty since Satyam’s market cap has been hammered down to Rs 2700crs which is more like a midcap company than a large cap company and the prospects of being merged with another higher. My guess is that Axis Bank and Reliance Capital are the likely replacement for Satyam which has a weightage of 0.62% in Nifty and 1.57% in Sensex. The chances of Axis being included in the Index stocks is more since it has a higher market cap than Rel Cap. But Rel Cap is one of the top traded counter in both the exchanges so on that parameter it scores over Axis. I dont think market cap is one of the parameter in selecting Index stocks as Jaiprakash Associates (Sensex stock) has a market cap of Rs 8400crs which is lower than both Axis and RelCap. Neither earnings (Rel Power).

My only wish is that if there is indeed a replacement for Satyam, I would prefer a stable Axis over wild swinging Rel Cap.

Plz note that these are just plain guesses and what actually turn out might be different from what I say.

Life Insurers premium declines for Second straight month

Life Insurance industry continues to see de-growth in their premium income for second straight month with November figures seeing a decline of 7.05% in First Year Premium after a 6.73% fall in October’08. The total premium collected has dived from Rs 6081.16 crs in Nov’07 to Rs 5652.39 crs in Nov’08.

Individual Single premium down from 1980crs in Nov’07 to 1310crs in Nov’08.
Individual Non-Single premium down from 3503crs to 3074crs
Group Single premium is up from 535crs in Nov’07 to 927crs in Nov’08
Group Non-Single premium is up from 63crs to 342crs
For the period upto Nov’08, Life Insurance industries premium has grown by a marginal 1.43%.  Shikha Sharma, CEO, ICICI Pru Life expects a flat growth in fiscal 2009. One can only conclude that flows into equity markets will be equal to or less than last year’s figures.

Satyam Saga: A 26/11 with a Corporate angle

I see lots of similarities between the Satyam Saga and the 26/11 Mumbai terror attacks.
 
– Those responsible for the Governance quit: Home Minister of the country, CM and Dy CM resigned. Independent directors of the Satyam did the same.
 
– Activism: Shareholders made sure the deal is cancelled whereas the Indian citizens is making sure that Govt. took some concrete steps/actions.
 
– Damage done: Shareholders lost money, Company’s reputation at risk. People lost lives. Tourism Industry suffered in the peak season.
 
– Measures : Restoring the faith of the people/shareholders in both the cases.

Uday Kotak’s Letter to Shareholders

Key takeaways:

1) At the peak of global financial crisis, Fareed Zakaria asked me a question at the WEF in Davos – What is a good bank for the future? My answer was, a good bank needs 3 human qualities : prudence, simplicity and humility.

2) Unlike 2009 which was a V-shaped capital markets led recovery, I believe that this time around capital markets may not fund the real sector companies easily but instead fund the banks who may have to hold the can for the real sector. It is here that banks have to ask themselves whether their core business is lending or taking equity risks for debt rates of return.

3) On interest rates, I believe there will be a gradual reduction in cost of funds and lending rates. Reduction of deposit rates of say one year below 8% is a challenge. Particularly so because rates in small savings schemes continue to be above 8%.

4) On the other hand, bond markets are more benign and they will to some extent, enable recapitalization of banking system as a counter force to credit stress.

5) Three significant areas of opportunity:
   i) Digital
   ii) Affluent customers
   iii) Non urban areas (i.e any place outside top 50 cities)

6) New Banks : How will they affect us? They will increase the pace of competition for talent and customers. However, going by our experience of last 10 years, banking, particularly on the retail side, is much long haul than we expected when we began our journey. With increasing complexity, I wonder whether we would have plunged into banking today as decisively as we did 10 years ago.

Importance of ROE

Kiran (@_kirand) wanted me to do a post on my fascination with the ROE ! I hope this post benefits other retail investors too.

Return on Equity (ROE) basically is Profit after tax/Shareholders Funds * 100 OR EPS/Book Value * 100. Numerator is a part of P&L statement and denominator part of Balance Sheet.

In DuPont analysis which breaks the component of ROE,

ROE = Net Profit Margin*Asset Turnover*Equity Multiplier

i.e ROE = (Net Profit/Sales) * (Sales/Assets) * (Assets/Equity)

In other words, it is a function of profitability,operating efficiency and financial leverage.

A Company cannot grow its earnings over the long term greater than its ROE. Either it has to raise debt or dilute equity. One reason why banks keep raising money through equity every 3-4 years. Even the retailers and most of the infrastructure players.

ROE can be boosted by debt taken at lower interest rates. Textile Companies get loan at subsidised rate of interest of around 7% or companies with forex loans. So the narrower the gap between ROE and ROCE, the better it is for shareholders. Even better would be ROCE > ROE which will be possible if a company doesn’t have any debt and/or negative working capital.

Small Equity base also helps to enhance ROE (Hawkins Cookers is a case in point, 0.5cr shares and payout of 60% so addition to denominator is minimal). All other things remaining constant, a Company doing buyback will result in ROE expansion.

ROE should always be looked in conjunction with dividend payout ratio. Higher the payout ratio, higher the ROE, higher the probability of PE re-rating and hence higher the stock price! Money would be made from earnings growth but wealth created from PE re-rating. Many stocks continue to be cheap inspite of high ROE simply because of low payout. Markets tend to doubt the genuineness of numbers if the payout is low.

PE re-rating (P/BV in case of banks) doesn’t necessarily come from ROE expansion. Scarcity value can also help in PE Re-rating. Look at HDFC Bank or for that matter consumer facing companies stock performance over the last few years. As they say Good things are rare and they don’t come cheap in life.

PE ratio can expand to a certain level after which stock price track earnings growth. So to assume HDFC Bank can deliver more than 18-20% returns from here would be unrealistic.

Companies having strong ROEs tend to fall less compared to others in a bear market. One would have seen ITC,Nestle and Infosys falling 18-20% while the index fell 50% in 2008.

I always admire management focused on ROE/ROCE. Blue Star, Crompton Greaves, Kotak, Titan to name a few (Read the Chairman’s letter of these co’s in their Annual Report to know why).

P.S. Special thanks to Mr. Basant Maheshwari from whom I learned the importance of ROE.