Value investor india

September 1, 2011

4 Min read

I have a constant struggle in my mind – Do I pay for quality (overpay?) or do I buy cheap stuff, which may turn out to be a value trap.

The ideal situation would be to get a high quality stock at a cheap price. But then if wishes were horses!, I would be a good looking billionaire with my own private island J.

So let’s look at my current dilemma

Akzo nobel

Akzo nobel is a global company in the business of decorative and auto paints and other industrial chemicals. The company acquired ICI plc a few years back and thus got the Indian business of ICI with the acquisition.

ICI paints (atleast in the late 90s) was a company with good brands and was fairly aggressive in the paints business. At one point, they even tried to acquire asian paints by buying out the stake of one of the promoters.

ICI paints is one of the oldest paint companies in India and is fairly strong in geographical pockets (West Bengal) and in specific products (premium paints). The company has however not been able to capitalize on its strength in the past and did not seem to have a focused strategy. The new management however seems to be developing a focused strategy of introducing new products, expanding distribution and spending on brand building.

The paints business is a very profitable business with very high entry barrier (I saw this first hand when I was working in the industry). As a result, most of the companies in this business have enjoyed above average growth and high returns on capital

Akzo nobel india has a Return on capital of 100%+ (excluding excess cash on the books) and has been able to grow the topline and profit by 30% in the last 5 years . In addition the company has been shedding the non-core businesses and freeing up capital. The company is also investing in manpower, its brands and expanding its distribution.

My hesitation in investing is the valuation. If one excludes cash, the company is selling at around 18-19 times earnings. On a comparative basis, the company is cheaper than other paint companies such as asian paints (around 30 times earnings). However I don’t believe much in comparative valuations and find the current valuation a bit high compared to the prospects.

Techno fab engineering

Technofab engineering is in the EPC space and is involved in various turnkey engineering projects in industries such as power, industrial and oil & gas.

The company came out with an IPO in 2010 at a price of around 235 per share. The stock currently sells at around 142 / share (selling below the IPO price does not mean it is a bargain!)

The company has been in this business from 1970s. The company has grown its topline and profit by more than 30% per annum in the last five years (which means that in the past the business barely grew). The company clocked a turnover of around 290 Cr in 2011 and has around 900 Crs open order book (almost 3 yr visibility)

In addition to the above, the company has around 100 Crs of cash on the books (some of it due to the IPO) which will be invested in expanding capacity to manage the higher order volumes. The company is thus selling at around 2 times earnings, has shown 30% growth in the recent past and delivered a 30%+ return on capital during this period.

The company looks like a complete bargain?

I am not so sure. The EPC industry is characterized by moderate to low entry barriers, high levels of competition (from the likes of L&T and others) and high working capital needs. In addition it is also a very cyclical industry with drop in margins and cash flows during the down cycle.

The dilemma

So the dilemma is whether to invest in an above average business which may be fully priced or in an average business which is very attractively priced.

There is no obvious answer in the above case and it depends on each individual’s mindset. I have invested in technofab types of businesses in the past with decent, though unspectacular results. In contrast if I am able to invest in a good business at decent prices , then the returns are fantastic

I have not made up my mind yet and have no position in either stock. I plan to dig deeper into Technofab engineering to get a better picture of the industry.

It is quite likely that I will just file away these companies and watch them till either the price is better (in case of akzo noble) or the business quality improves (in case of technofab engineering).

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Time to open up the wallet?

By Rohit Chauhan

In Uncategorized

August 20, 2011

6 Min read

27 comments

26-Aug : A clarification
In the post below, i spoke about investing in the index either via a systematic investment plan or through some simple rule set ( such as buy below a PE of 12 and sell above 20).
I did not imply that one should be investing in the index now !. I am surely not investing in the index now as it is not as cheap as i would like it to be.

However if you want to avoid all this mumbo jumbo, the best option is to use a systematic investment plan and invest in a mutual fund or index fund on a regular basis.

Finally, remember to switch off the finance channels on TV to avoid derailing a sensible long term plan.
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I have a little extra spring in my steps these days!

Let me share a small personal story. As a kid growing up, diwali was a great time for me. Being a north Indian, sweets are a big part of diwali. We would visit our grandparents during diwali, and I had complete freedom to eat as much sweets or mithai as I wanted to. I have always had a sweet tooth and I still recall a month of pure bliss during diwali. Barfi, gulab jamun, pedas …mmmmm!

I feel like it is diwali or almost diwali these days. I don’t mean in the literal sense, but everyday I look at the market and find my favorite barfis and pedas available for less and less J

But it is such a bad time!

I think all of us know the million reasons why one should not invest money and stay away from market. US is in a mess, Europe is a disaster waiting to happen, India is overheating …blah blah blah.

One cannot open the papers or watch a channel without someone trying to predict a disaster sometime soon. Where were these idiots in the beginning of the year when the index was at 20000 levels? If they could not see six months out then, how are they able to see six months out now?

The truth is that, it is never a good time to invest. There always is some problem somewhere. It could be macro problems such as now or industry/ company specific issues such as in the infrastructure or IT industry. By the way, the right time to sell would be before the market realizes that there is a problem in the industry and not after it has been priced in.

If risk avoidance is the goal, then the only way to invest is in bank deposits. Even in the case of bank deposits, one faces the inflation risk. So in effect, one cannot escape risk. The only thing an investor can do is take intelligent risks for which one is compensated (much like an insurance company)

What is an intelligent risk?

An intelligent risk is one for which one gets the appropriate return adjusted for the risk. The main component for intelligent risk taking is diversification and pricing. You do not overpay for it and you diversify. This is much like an insurance company.

The unsaid part in the above is that one knows what one is doing. No amount of diversification or price can save you from ignorance.

Why not wait till it all clears up

Unless you have some crystal ball to look into the future, it is futile to try to predict the turning point (if you do have a crystal ball, why waste it on the stock market anyway).

Majority of the investors are typically late in knowing when the tide has turned and then there is a mad rush into stocks (remember April 2009 when the index jumped by 10%+ in a day !)

If like me you cannot predict the turning or don’t care to, then a good time to buy is when the prices are low. It is quite possible that things could turn worse before they get better and you may get a better opportunity. However trying to pick the bottom or the top is a fool’s game and I would prefer to pick up stocks which are cheap enough and then just stick with them.

So what to buy?

The first question to ask yourself is this – Do I have the stomach to withstand large swings in the stock prices and considerable paper losses for sometime? It is quite possible that all this may take some time to clear up and could test your patience.

The second critical point is whether you need the money in the medium term. If you need the money in the next five years, then don’t put that money into the stock market. A large drop will scare you and you may exit the market at the wrong time.

The perceived risk in the stock market is high during bear markets, but the actual risk is lower. Everyone was scared in March 2009 – so the perceived risk was high. But if you invested during that period, you made good returns.

If you are short on time and cannot do the research, then you can do what I have done in the past – Invest in an index fund. As I have said in the past, investing in an index is a good option for a lot of investors, especially if you not have the time and interest in analyzing stocks. You can use a simple rule set like mine or do some fancy math to figure the right time to buy.

I was short on time during the first quarter of 2009 and felt the market was fairly cheap. To take advantage of the undervaluation, I invested quite a bit in index funds to take advantage of the low valuations.

If however you have the time and inclination to analyze stocks, then beaten up sectors which do not have a structural issue is a good place to start. I think infrastructure and capital good is a place to search for bargains. The IT industry on the other hand has structural issue and I will not invest in any company unless it is really really cheap.

My mouth has started watering these days and if the market continues to drop, it would be an early diwali feast for me J

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We will all run our TVs without power

By Rohit Chauhan

In Uncategorized

August 8, 2011

4 Min read

17 comments

The Indian middle class is on the cusp of a fantastic change. The economy is growing by leaps and bound and so is the per-capita income. With all this money in our hands, we are and will continue to buy fridges, TVs, pressure cookers and all other comforts of life.

The white good companies have not even scratched the surface ! We have one of the lowest penetration for all these white goods and consumer goods in the world. It is silly not to believe in a glorious future. Companies like Hawkins, nestle, marico and all other FMCG and consumer companies deserve even higher valuation, because they will all grow at phenomenal rates.

In contrast, the infrastructure companies deserve the kind of lousy valuations we are seeing in the market now. Power companies, power equipment producers and all kind of companies engaged in building the infrastructure deserve the sub par valuation because the environment is hostile. The government will never fix the policy issues and we will continue to have poor quality roads, blackouts and lack of other amenties.

If the market and a lot of investors are correct, I can visualize a scene where I will be sitting in my house without power, gas and connecting roads but with the best plasma TV and all kinds of soaps, detergents and packaged goods.

I think I need to figure out a way to run my 100 inch TV without power and use my fancy shampoo without water 🙂

Is it not obvious that this scenario is not consistent? If consumer goods are to grow, then the rest of the economy has to grow and hence the valuations of all kinds of infrastructure related companies have to be higher. If the power, water and infra companies are doomed, do you think any of the other consumer companies will do well ?

A personal story

I hear this logic often – India has 50 Cr middle class. The global average is around X per million of population. In india, even if we double the consumption levels from here, we are looking at a huge opportunity. In view of this logic , the consumer companies deserve a higher valuation

Where have we heard this logic before? Remember the dotcoms and IT stocks in 2000, infrastructure and real estate in 2007-2008?

Let me give a personal story. I used to work in the consumer goods industry in the 90s in sales. Among the many products, we used to sell soaps . The logic would go like this – A family of 4 can use around 2-3 soaps per month. In a town of 100000, there should be a consumption of around 2-3 lacs per month. We currently sell around 10000 bars per month. So even if I can increase the penetration levels by 1%, we can easily double the volumes.

The above argument is very plausible and so easy to follow. Except reality does not work that way.

An armchair investor like me sitting comfortably in a chair at home and sipping masala chai can come up nice projections on a spreadsheet and justify any price for the stock. But if you have worked in sales, let me tell you that it takes a lot of effort and time to grow sales. The reasons can be varied – such as poor ROI at the micro level due to which production penetration cannot be increased, or high competition – but the end result is that growth is not an easy linear process.

Company specific growth depends on a lot of factors beyond the basic macro opportunity and it is rarely a simple, linear process. If you make simplistic assumptions and pay top valuations for it, then the experience can be bad if those expectations do not materialize.

I have been investing in consumer good companies for some time now and my preference is to look for companies which can tap into a large macro opportunity and have the management capability to do so. At the same time, I don’t want to pay too much for it. Although’ too much’ is a subjective term and any number would be arbitrary, I would rarely pay more than 15-18 times earnings

Survivorship bias

The worst counter argument against the above logic is to give an example of a titan or a nestle. For every titan or such high valuation company which subsequently did well, I can give 2 examples of companies with high valuations which disappointed investors as the business reality did not match the expectations.

One should pay for quality, but not take the logic too far. Even if it is arbitrary and one risks missing some good companies, I would still prefer to have some cutoff to avoid buying an over priced stock which disappoints me in the future.

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Analysis : Maharashtra seamless

By Rohit Chauhan

In Company analysis, Uncategorized

July 31, 2011

4 Min read

5 comments

About
Maharashtra seamless is in the business of seamless and ERW steel pipes. These steel pipes are made from steel billets and HR coils respectively.

Seamless pipes are used mainly in the oil and gas and other such industries where there is a need to carry fluid under high pressure application. ERW pipes which have a higher diameter are also used in the same industry, in water distribution and other applications in airports, malls and other civic locations.

The company now has a capacity of around 550000 MT in seamless pipes and produced around 220000 MT. In addition the company has a capacity of around 200000 MT of ERW pipes and produced around 115000 MT.

The company is a certified supplier to several prominent O&G companies such as ONGC, Oil india and GAIL and other companies such as SAIL, NTPC etc. In addition the company is also an approved supplier to several global O&G companies such as Chevron, Saudi aramco and occidental oman etc. The company has benefited from the imposition of anti-dumping duties on seamless pipes from china, due to which its products have become competitive in various foreign markets.

Financials
The company has increased its revenue from around 383 Crs in 2003 to 1760 Crs in 2011 with an annual growth of around 18% per annum. The topline growth has however slowed from 2007 onwards. The net profit has grown at a CAGR of around 20% from around 62 Crs in 2003 to around 346 Crs in 2011 (excluding other income).

The net profits have grown at a higher rate than the topline due to improvement in margins. The net margins have mainly improved due to reduction in overhead expenses as % of sales.

The company has paid off its debt completely and now has a surplus of around 700 Crs on the balance sheet. The company raised around 300 Crs of capital via FCCB in 2005 for expansion which was converted to equity in 2006. This capital has however not been utilized as the company has been able to generate sufficient capital from operations to fund its capex, pay off debt and maintain its dividend.

Positives
The company has been able to maintain an ROE in excess of 25% for the last 8-9%. To get the true picture of the core business ROE, one needs to adjust for the excess cash and revaluation of fixed assets. The ROE numbers have dropped in 2011 mainly due to revaluation of fixed assets which caused the networth numbers to go up by almost 67% in one year.

The company has been able to maintain a reasonable growth in topline which has however slowed down in the recent past. In addition the company has been able to improve its margins from 12-13% levels to around 16% levels. It remains to be seen if this level of margin will be maintained.

The company has been able to pay off its entire debt and has close to 700 Crs excess capital on the balance sheet. The company has imported a plant from Romania for seamless pipes which it is installing near its current facility. This new plant will take the capacity up from 350000 to 550000 MT. In addition the company is also going in for backward expansion in steel billets which is a key RM for the seamless pipe (remains to be seen if the expansion is a good move). The company can easily meet all its expansion plans with the excess capital on the books.

Risks
The company sells a product which is a commodity product. The company has been able to maintain its gross margins inspite of fluctuation in steel prices which account for more than 60% of the total cost. It remains to be seen if the company will be able to maintain these margins in a slower growth/ higher competition environment (where other companies are expanding capacity too).

The company has managed the liability side of the balance sheet quite poorly. The company raised around 300+ crs in FCCB in 2005-06 which been idle since then. This is expensive capital which has been lying on the books and earning low rates of return. This excess capital has depressed the return numbers for the company.

Next post: Competitive analysis of the company, management review, valuation and final conclusion.

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Two differing ideas – Akzo nobel and Techno fab engineering

Time to open up the wallet?

We will all run our TVs without power

Analysis : Maharashtra seamless

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