Wednesday, July 30, 2008

Turbulent Times

It seems that we are going through turbulent times in stock market. There is no clear indication of where the Sensex and the overall market is going. Value companies are still not doing well (container corporation, britannia, cipla, ITC, etc...). Their profits are also not growing very fast (10%,10%,10%,-4% respectively for this quarter). The situation in market seems pretty similar to what was present at the end of 1969 in US when all the value investors went to Ben Graham to ask him that we are not finding any good stocks in market. Buffet even liquidated his partnership which invested in stocks because he was not finding good investment options.

Let one year pass and we will come to know what happens to Sensex and Nifty. Sensex/Nifty are still at a P/E of 18 while the earnings growth is just 12%. Will these two converge?
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Tuesday, July 22, 2008

Stay away from buying Realty

I would like to tell everybody reading this blog to stay away from buying any real estate at least for the next three years. After reading Sabeer Bhatia building nanocity, I am convinced there is no juice left in IT and everybody is running behind real estate. Read this India's real estate boom coming to an end. These are the last buyers of real estate boom in India. Property prices corrected by 70% between 1996 and 2001. Will it correct by that much amount between 2007 and 2012?
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Sunday, July 13, 2008

What two i's have done to Britannia

I will talk about the impact of two i's, ITC and Inflation, on the profitability and price of share of Britannia. Following table shows the Operating Profit Margin and Net Profit Margine of Britannia over the last 8 years ( Operating Profit Margin = (Net Sales - Expenditure)/Net Sales, Net Profit Margin = Net Profit After Tax / Total Income) :

YearOperating Profit MarginNet Profit Margin

Figures for 2007 and 2008 are consolidated. If you see the more details at BSE you will find that the profits for 2003, 2004 and 2005 were helped by large other income mainly arising out of sale of securities. ITC started its operations from FY 2004. Inflation in wheat and edible oil prices started from FY07 onwards where government had to import wheat, edible oil prices shot up by 80% (my own experience when groundnut oil prices of Gemini shot up from INR 65 to INR 118). Sugar also had a short run but its prices came under control due to windfall harvest of cane. It seems than that profit margins of Britannia were unaffected by the entry of ITC (This is in contrast with HUL whose profits fell from 1800 Cr to 1200 Cr in 2004 due to entry of P&G in Indian Detergent market. P&G slashed prices of Tide by 40% and HUL had to follow suit. That kind of harakiri hasn't happened yet in Biscuits).

Till 2005, the Tax to PBT was around 30% which fell to 9% in 2007 and rose to 20% in 2008. I assume it will rise to 25% in future. The depreciation had remained constant at around 20-25 Cr which increased to 39 Cr in 2008. Interest burden is almost nil.

If we consider 2003-2006 to be exceptional years of high profits for Britannia, and 2007-2008 to be exceptional years of low profit margins, than still 9% OPM can be assumed for calculating long term profits, 1% for depreciation+interest and 25% of 8% = 2% for tax giving 9%-1%-2%=6% for Net Profit Margin only from operations, other income extra.

The sales growth of Britannia historically has been 14% (Sales increased from 100 Cr in 1983 to 2800 Cr in 2008).

Thus for the next 10 years, if we assume that the long term condition prevails, in 2018, the company should make INR 10000 Cr worth of sales and 600 Cr worth of net profits. Considering a conservative P/E of 15, the company should trade at a market cap of around 9000 Cr.

During these 10 years, company will generate profits of around INR 3300 Cr. Thus if we buy britannia today, we will get 3300 Cr in 10 years + 9000 Cr at the end. So in 2018 we would have got 12300 Cr. (I have not counted the profits of each year invested because 3300 Cr we will get in tranches from 2009-2018 170 Cr every year increasing by 14% a year).

Considering a risk free return of 8% on PPF, we are willing to pay INR 100 to government to get INR 216 in 2018. Thus we should give a market cap of at least INR 5695 Cr to Britannia at this point of time. But it is languishing at around 3200-3500 Cr in the current market, a margin of safety of 40%. For a big FMCG company like Britannia, this should be enough.

I would recommend STRONG BUY on Britannia today at INR 1350.
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Thursday, July 10, 2008

Future Sensex Candidates

BSE determines the candidates for Sensex based on free float average market capitalization of stock for 6-months. But it also looks at sectors. Based on BSE , it seems that top 17 are already in Sensex. Reliance Petroleum and Essar Oil have been skipped to take Tata Power and Sterlite into Sensex from 28 July. Stocks till Maruti Suzuki are in Sensex which has free float market cap of around 8000-8500 Cr. Axis Bank, Reliance Capital and IDFC from finance,
Sun Pharma from Pharmaceutical
Cairn and GAIL from Oil and Gas
Jindal Steel and Power from Metals/Power
might be the next candidates to enter Sensex. Stocks to go out will be Maruti Suzuki or Mahindra and Mahindra.

This shows that Auto is no longer a core sector in India's economy or is slowly going out just like GM and Ford went out in US. In pharma also the growth has slowed a lot. Just like Ambuja, ACC will also go out of Sensex within 2-3 years.

The companies which look promising to me over 10-15 year period to enter Sensex are Nestle and Asian Paints. Nestle was part of Sensex till 2003 and Asian Paints was in Nifty in mid nineties. The problem with Nestle is volumes. Otherwise I am sure it will replace HUL in the next 10-15 years.
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Sensex will not cross previous highs till 2015

Everybody is talking about when the Sensex will bottom and when it will start its previous march towards new high. I want to differ and stick my neck out to say that Sensex will not cross its previous highs till 2015. I will put my own analysis. All the march quarter results for Sensex companies are out. The Sensex closed at 13,926.24 with P/E shown here 17.24. That makes an EPS of 807.78.

Sensex was trading at 3386.89 in 2003 June with an average P/E of 14.61. Thus EPS in June 2003 was 231.82. In the last 5 years Sensex earnings have gone up by almost 3.48 times i.e. 28.36% compounded annually. Some of these contributions were from cyclical commodity businesses like Cement (Ambuja Cement, ACC, Grasim), Metals (Tata Steel, Hindalco), Power/Infrastructure (BHEL, L&T, Rel Infra, NTPC, Jaiprakash Associates, DLF) and Oil and Gas (ONGC, RIL). Some of the earnings were from slowing sectors like Auto (Tata Motors, Maruti Suzuki, Mahindra & Mahindra), Pharma (Ranbaxy, Cipla), FMCG (HUL, ITC) and Tech (Infosys, Satyam, Wipro and TCS). The biggest contributions were from fast growing businesses of Finance (HDFC, ICICI, HDFC, SBI) and Telecom (Reliance Communications, BHARTI). Cipla and Ambuja Cements are going to be replaced by Sterlite and Tata Power.

What my gut feeling is that Cement, Metals, Auto and Infrastructure will see only 7% compounded annually increase in their profits in next 7 years till 2015 (equivalent to inflation).

Oil and Gas will increase their profits at 15%.

Pharma, Telecom, Financials and FMCG will be able to increase their profits by 12% for the next 7 years (counting equity dilution for financials).

IT will increase its profits by 15% till 2010 but then higher taxation and wage will erode their profit margins so they will also increase profits 7% compounded annually (equivalent to inflation).

Now if we consider the weight of these sectors in Sensex,
Auto (2.91), Cement (2.58), Metals (5.09) and Power/Infrastructure (15.7) makes 26.28%
Oil and Gas makes 19.37%
Pharma (2.57), Telecom (8.47), Financials (20.09) and FMCG (7.39) makes 38.52%
IT makes 15.83%

Now if Sensex's 26.28+15.83=42.11% grows at 7%, 19.37% grows at 15% and 38.52% grows at 12%, the whole Sensex will grow at 10.75% and achieve an EPS of 1650 in 2015. At 14 times 1650 comes 23104.

There are many ifs and buts here. Growth rate may be very very wrong. New comers to Sensex (Sterlite and Tata Power) may make huge jumps in profits due to increase in commodity prices or power reforms carried out by government, and so on.

Last time when Sensex touched 21207 on 8 January 2008, the market capitalization of the BSE was 75 lac crore. Indian economy is today at 44 lac crore and if it grows by 8% for the next 7 years, the economy will become 75 lac crore. Generally, stocks are fairly priced when GDP equals total market capitalization of stock exchanges.

Let's see.
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Monday, July 7, 2008

Some Value Picks?

I would like to provide some interesting small/mid cap stock ideas in this post.

Savita Chemicals4211.5220Transformer Oil
Automotive Axles3612.5215Truck Axles
Banco Products61.429Gaskets
Indraprastha Gas124110CNG Distribution

I will review performance of these stocks every year.
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Tuesday, July 1, 2008

Is TVS Motor Headed towards LML?

Some years back, LML shut its plants and became bankrupt. Looking at the financial results of TVS motor, it looks like it is also headed towards a similar fate. The company's fundamentals are quickly deteriorating. Company had a pretty good result in 2003 and the stock price touched a lifetime high of 113.69 (actually 1136.9 but it had announced a split 10:1). Then again in March 2006, a lot of hope took the stock to a lifetime high of 186.7. Today it is at INR 25. The book value of the stock is 34 but it has a debt of around INR 635 Cr which balances all the net worth. The lifetime low is INR 6.5. Let's see if it breaks it.
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