Value investor india

Value in midcaps ?

May 28, 2007

3 Min read

I have written earlier that there seems to be more value in the midcap space than Large caps represented by the Sensex and Nifty. The above hypothesis came about as I am finding far more ideas in the midcap than the large cap sector of the market.

I decided to check the above hypothesis and generated the above two charts for the Nifty index and CNX midcap. The nifty index has appreciated by around 23% in the last year, whereas the midcap index has increased by around 13 %. Does this prove my hypothesis. Yes and no !. Yes because some of the stocks have come down quite a bit and may be worth investing. No, because the midcap index as a whole is not too cheap, currently trading at around 17 times PE.

So blindly buying into the index may not make sense, but picking specific stocks would.

Based on the above view I tried to look for some mutual funds in the midcap space and found the following interesting. I am listing the negatives of each of the funds. The returns of the funds have been fine and they may be worth a look

Birla midcap – This is a 5 star fund. It does not have a very long operating history. The fund has been around 3 years and the last 2 years performance has not been great

Sundaram mid cap – This fund has delivered good performance in the long run. However the last 1 year performance has not been great. Also the fund has a new fund manager. The fund is extremely spread out and has more than 70-80 stocks in the portfolio

Franklin prima fund – This fund has the longest operating history. It has done well in the past and the fund manager has been around from the beginning. The manager follows a buy and hold philosophy and has higher portfolio concentration. The last 3 year performance has been average though.

As usual, the fund expenses are high and the volatility of these funds is also high. An SIP mode of investment may be a good approach.

In addition, funds like HDFC equity and Franklin prima plus have a diversified approach and can move between various caps. These funds may also be good way of investing in the mid-cap space too as HDFC equity has around 50% exposure midcaps and Franklin prima plus has around 35-40% exposure to midcaps.

You can look for the details for each fund at valueresearchonline.com. I am not recommending any of the above funds, just laying out the facts for some funds which I find worth investigating further in the midcap space. A superior approach would be to pick specific stocks, but that requires a higher amount of effort and time.

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Red flags – Aftek infosys

By Rohit Chauhan

In Rejected investment ideas, Uncategorized

May 24, 2007

3 Min read

15 comments

Aftek infosys appeared on my stock screens a few days back. I also had a comment from prem sagar on the company. The company seems to be extremely undervalued. It seems to have almost 400 Crs of cash on the books with a market cap of just around 650-700 Crs. With the last year profits of 98 crs, the company seems to be selling at a PE of 2-3. On the face of it the company seems to be an investors wish come true. My initial scan showed nothing wrong, so I decided to dig deeper and came up with a can of worms.

– the company’s management was penalized by SEBI for participating with Ketan parekh in various behind the scene deals during the 2000 bull market (see here)

– The company had an investment of almost 46 Crs in a company called Arexera. They have accquired this company this year (the balance portion) for a sum of 56 crs. One would consider this accquisition to be significant. The positives of the acquisition are mentioned all over the report. However the valuation of the deal is not mentioned. The company had a net profit of 1 Crs last year (see page 100 of the annual report). The company was acquired at a valuation of 100 Crs ( PE = 100 !!!). The management has not discussed the valuation anywhere in the report and why they paid so much for it. Finally surprise , surprise – this company was accquired from the promoters !!! . See the cash flow statement on page 83. There is an entry for 54.8 Crs which was paid to promoters to acquire this company. So the management accquires this company and has a related party transaction and does not mention this in the complete report??

– The company has issued 3.96 lac warrants to the promoters. They have received 10% of the price now and the rest can paid by the promoters within 18 months. Why have these warrants been issued if the company is swimming in cash, had some FCCB still open and is making almost 100 Crs per year ?

– Promoter holding is only 12%.

– FCCB issue in the last few years to raise capital. This capital is being used to accquire companies like Arexera from promoters.

The stock may do well (had a jump of 10 % recently). However I have bad feel of the whole thing. All the red flags I have pointed above don’t give me any confidence in the management. I still think the business will do well and the company should make money. But I am not sure if the shareholders will benefit or the promoters would. Their past and current actions don’t give me any confidence. I am definitely giving the stock a pass although there could be some trading gains to be made.

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Analysis of Novartis india

By Rohit Chauhan

In Investment ideas, Uncategorized

May 21, 2007

3 Min read

4 comments

Novartis india is the Indian subsidiary of Novartis AG. The company has the following business segments – Pharmaceuticals, Generics, OTC and Animal care.

The company is in various therapeutic areas such as Immunology and Transplantation, Oncology, Gynaecology, Central Nervous System, Respiratory, Pain and Inflammation, Ophthalmics and Orthopaedics. In the OTC space the company has some strong brands such as Sandoz.

Financials

The company has just tread water in the last few years. The topline growth has been more or less flat and is currently at around 520 Crs. The bottom line is now at around 88 Crs. Both the topline and bottomline have growth a low single digit growth rates and I expect the same to continue.

The Global parent has a local unlisted subsidiary and has made comments of introducing products through the unlisted subsidiary. As a result the topline and bottomline growth for novartis could be at best 5-7% per annum for the next few years. The poor growth in the last few years has mainly been due to poor performance of generics, sale of the Rifampicin (anti-TB) business and due to price control on some of its brands.

Valuation

At the current profit of 88 Crs and EPS of around 27.5, the company sells for around 12-13 times PE. In addition the ROE and ROCE is actually very high. The 2006 AR shows that the company as just 10 Crs in fixed assets and negative working capital. As a result the Return on capital is very high (>100%). All the assets are in cash or inter corporate deposits and other liquid investment.
It seems the company has become complete asset free and is outsourcing almost its entire production.
In addition in one of the earlier AGM, the company has mentioned that the excess profits would be returned via generous dividends. The dividends for the last few years have been 200%+ giving a dividend yield of almost 3-4%.

On a comparable valuation basis, the other pharma MNC with similar business model sell at around 20-30 times PE.

Thus the stock appears undervalued with intrinsic value between 600-650 Rs

Risk

Poor topline and bottom line growth or even de-growth. In absence of few product launches in the Pharma segment and continued competition and price pressure the company could have a drop in net profits. The OTC and animal care business seem to be growing, but do not have very high margins
In addition the parent could increase the focus on the unlisted subsidiary and milk the listed one for profits.

Conclusion

The company is selling at a 4 year low. I feel that all the negatives seems to be priced in. Net of cash, the company sells at almost 8-9 times earnings or cash flow. This seems to be fairly low for a stable and profitable pharma business.

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Business models of Pharma industry

By Rohit Chauhan

In Competitive advantage, Industry analysis, Uncategorized

May 17, 2007

4 Min read

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I have written (see here) earlier on the pharma industry in 2005. A few high profile patent challenge losses in 2005 and 2006, brought down the valuations for several companies. My basic thoughts about the industry have not changed

I have been analysing the industry further recently and can see two different business models.

The Domestic market focussed model

Most MNC’s like novartis, merck, pfizer come under this model. The key characterisitics of the model are

1. Subsidiary of a global MNC operating in india for the last few decades
2. The subsidiary operates as an extension of the global company and due to the patent law in the past, has introduced mostly the off-patent drugs.
3. Strong brands, marketing network and good return on capital and strong competitive advantage.
4. Possibility of introducing the drugs from global portfolio. However in some cases the parent company has an unlisted subsidiary and hence treats the listed one as a cash cow. In such cases the market is rightly giving a lower PE multiple due to the poor corporate governance attitude of the parent.
5. Strong cash flows due to minimal R&D and very low assets in the business as most of the manufacturing is sub-contracted.
6. Low growth in domestic market, marked by constant price controls (DPCO and new pharma policy) by the government on various essential drugs. This has resulted in poor topline and bottomline growth for several companies solely dependent on the domestic market.

The International market focussed model

1. This model is followed by the indian pharma companies such as ranbaxy, dr reddy’s, nicholas pharma etc
2. These companies are in the process of globalizing. Their approach to it has been through the drugs which are coming off patent (generics strategy). These companies have built a strong R&D infrastructure in india to develop these drugs coming off patents. They also have a marketing and legal infrastructure in foreign markets to file ANDA and other applications for these drugs as soon as they come off patents. If these companies win these cases, then they get a 180 day exclusive marketing period for these drugs. Post the exclusive period too, these companies are able to maintain good market shares. Thus these companies have created a value chain of R&D labs in india, and a distribution, marketing and legal infrastructure abroad to funnel these new drugs coming off patents.
3. These companies are following riskier strategy as these legal challenges are costly and if the company loses one, the entire money is down the drain.
4. The market was pricing earlier as if each of these ‘bets’ would pay off. However due to some high profile failures in the past, the market has started pricing the risk of the strategy now.
5. Some companies are also acting as outsourcers for the global pharma companies. This is the contract or custom manufacturing business. There a large no. of FDA approved facilities in india ( second largest in the world). Several indian companies now provide advanced manufacturing facitility to global pharma companies and are now doing accquisitions in this space to accquire complementary assets abroad.
6. The third segment of this model is the R&D segment where some of the top companies are now investing heavily in R&D to develop NCE and NDDS. Some of the molecules are now in the stage I and Stage II trials. Some companies such as DRL have licensed these molecules to other companies and they get royalties based on milestones. This is a high risk, high return startegy. However it is likely the larger pharma companies in india could go down this path and emulate their global counterparts.

It is easier to predict the cash flow and valuation of the domestic model as the overall business risk is lower in that model. The international business model has a higher upside, however the valuation seems to reflect that upside in several instances. All these international market focussed model has ‘real options’ embedded in it. However I do not have the skill to do the valuation of these options. It is often difficult to predict which Patent challenges would be successful and which ones will fail

For additional detail on the pharma industry see here. The article is dated, but useful to understand the various terms such as ANDA, Para I,II etc.

There are several good stocks in the pharma industry available at reasonable valuations. I have discussed about merck earlier. In addition I am looking at novartis and alembic too.

Caution : Stocks which i look at generally perform poorly in the short term as they are undervalued. Please do your own research before investing in them.

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Value in midcaps ?

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