Wednesday, December 30, 2009

Myopic Markets

Benjamin Graham has always emphasized on normalized earnings since there are many one time expenses/income reported by companies which needs to be adjusted to know the true earning power of the company. But markets may remain myopic and look at only the reported numbers. I will provide two examples of this situation:

The first example is that of a pharmaceutical company, Unichem Laboratories. The company has always been a very well managed company. Due to improvement in employee productivity, many companies allowed employees to opt for VRS during 1995-1997. This added some one time expense for companies. Unichem also allowed some employees to opt for VRS and incurred an expense of INR 9.08 Crore in 1997 and INR 11.13 Crore in 1998. The EPS of the company was thus INR 8.16 instead of INR 20.93 for 1997 and INR 9.41 instead of INR 22.21 for 1998. The facts were clearly mentioned in the annual report and annual results of the company. EPS for 1996 was INR 15.31 thus EPS declined by almost 40%. The company's share price declined from INR 270 to INR 84.75 between March 1996 and February 1998. This made a P/E of 9 on reported earnings but a P/E of only 4 on actual normalized earnings. What happened next when the market realized this mistake? When the company reported EPS of INR 23.65 and INR 36 for years 1999 and 2000 respectively, the investors became overly optimistic and share price went up to INR 780 in February 2000, a P/E of 21.67, nine times the original price in two years.

The second example is that of an FMCG company, Britannia Industries. The company reported a one time income of INR 120.2 Crore in FY2000 so the total profits came in at INR 203.2 Crore, with EPS of INR 72.5. The share price went up to INR 1809 in September 1999 while the actual profits were only INR 83 Crore with an EPS of INR 29.65. Thus, even though P/E looked like 25, the P/E on normalized earnings was more like 61. Even today after ten years, the share price is below 1999 high.

Conclusion? Wear specs!!!!
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How Government Policies affect companies?

There is already a well known example of Oil Marketing Companies in the Indian Stock Market. But these companies are majority government owned and so the impact of government policies on these companies can be understood. But even companies not owned by Government can have a major impact of policy changes. Let's take an example of cooker makers. There are two main organized cooker makers in India, Hawkins and TTK Prestige. The following shows their profits and share prices during the last thirteen years.

YearProfitsShare PriceProfitsShare Price

The two durations of government policy changes are marked with bold. What was that change? The change was very simple. The Central Excise Duty on cookers was increased from 8% to 16% from 1st April 2000. The results of these companies started deteriorating from that year itself as the profits went down by 50% or more. The companies started making losses in 2002-2003 and the government woke up. The duties were again revised from 16% to 8% from 1st April 2003. The companies started making profits from the first year itself and see the results of the last year.

The share prices too declined along with profits during 2000-2003 by around 40% to 70%. Hawkins skipped dividend only in 2003 while TTK skipped for three years of 2002-2004. The investors who bore the pain of heavy losses and no income of dividend have been rewarded handsomely as the prices are up by more than 35-50 times (not percent) today.
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Thursday, December 17, 2009

F***ing Ba***rds

I am talking about BSE. I have maintained my own excel sheet of BSE500 and BSE SMALL CAP indices where I keep every company's book value, its debt, its profits and sales of last 20 years, etc... I have a practice of visiting their SMALL CAP and BSE 500 scrip watch page, copying the daily quotes, pasting them in an excel and copying the price column and pasting it to my own maintained excel sheet every day. But these guys keep changing the order of the scrip every day. Sometimes RIL is represented as Reliance Industries, sometimes Reliance Inds and sometimes RIL. When I paste the newly ordered prices into my excel sheet, price of Reliance Power appears against RIL and price of RIL against Reliance Infrastructure. Can somebody please lay off these guys at BSE and hire some professionals?
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India Inc is not deleveraging at all

World over the private sector is reducing its debt but in India, the party is still not over. Companies, especially small by size, are continuing their debt binge. Even the banks are lending without strict lending norms as can be seen in case of many companies.

The total outstanding debt of 473 BSE SMALL CAP Index companies stood at approximately INR 1,68,000 Crore at the end of FY09. This only includes debt of standalone non-financial entity. BSE SMALL CAP index's total market cap is just INR 3,22,680 Crore, with P/E of 17.68 and P/B of 2.13. This indicates that net profits of BSE SMALL CAP index would be around INR 18,250 Crore (and lower if we exclude financials) and Book value around INR 1,51,500 Crore (and lower if we exclude financials). Thus the total outstanding debt is even more than the book value (or net worth or shareholders' equity) giving debt/equity of 1.1 (higher if financials are excluded). Since the interest rates are low right now and the profitability of many companies is above average, the companies have been able to bear their interest burden. Reverse the two and the situation will become completely different. If interest rates increase and operating margins contract, the outcome will be nothing but horrible. Even with the current scenario, it will take more than nine years for companies to pay their debt completely. The only thing difficult to predict is the timing. The real punishment will be to the banks since their assets will deteriorate.

Compare this to companies belonging to BSE 500 index. The total outstanding debt of 500 BSE 500 Index companies stood at approximately INR 7,68,000 Crore at the end of FY09, excluding that of financials, 4.5 times that of BSE SMALL CAP index companies. The total market cap of BSE 500 is at INR 55,00,000 Crore, i.e. 17 times that of BSE SMALL CAP index. The P/E of 21.16 and P/B of 3.79 gives net profits at INR 2,60,225 Crore and book value of INR 14,57,102 Crore. Thus total outstanding debt is much less than the book value, with debt/equity at 0.53. It will take just three years of profits to pay the debt completely.

This puts BSE500 companies in much stronger position than that of BSE SMALL CAP. This is just a conclusion based on average. The individual companies may vary. Also notice the fact that some companies like, 3i Infotech, Alok Industries are present in both the indices. This is just to highlight the fact that investing in small companies is riskier than that of larger ones. Even when it comes to restructure debt, the banks would provide favourable terms to big companies compared to smaller.
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Tuesday, December 8, 2009

Mismanagement of money?

I was looking at the list of companies trading at a market cap below the money they raised during their IPOs in the last five years provided in previous two articles, and found one of them, named Precision Pipes and Profiles, interesting. The company till March 2007 had investments of only INR 0.72 Crore, on their balance sheet which subsequently increased to INR 56.86 Crore at the end of March 2008 and declined to 21.24 Crore in March 2009. This made me curious and led me to read their annual reports of FY2008 and FY2009. I found that the company heavily invested in equity mutual fund schemes during April 2007 - March 2008. Some of the schemes were liquid, FMP schemes and were sold off during April 2008 - March 2009 but equity schemes still remained in the investments and that too at a very steep decline in NAVs.

SchemeUnits 2008Value 2008Units 2009Value 2009Value Today
Birla Special Situation Fund93887538041373193887534831452386977407
Birla Sunlife Industries Fund9011331739759011316472712706093
Fidelity Equity Fund2671542982226715289834784111
HDFC Infrastructure Fund20000001870800020000001036400021782000
JM Basic Fund53860107160319832012385063572139
Kotak 30612851918655
LICMF Equity Fund44540393953445402539271092031
LICMF Infrastructure Fund54000005007960054000003049380049680000
Reliance Growth Fund7373037359106945720417553661495
Reliance Natural Resources Fund296296228511111
Tata Infrastructure Fund203307458631415116319350364875006
AIG World Gold Fund19559901754523224404887

The value today for the investments mentioned in the annual report of 2009 stands at
INR 199535169 which is still below the actual invested amount of INR 205188460. The company clearly mismanaged money. At the end of March 2009 itself, the market value of schemes was 45% lower than the invested amount. Thanks to rise in stock market over the last 10 months, the market value of this schemes today is just 2.8% lower than the invested amount. But we don't know if the company has already sold them or not. Let's wait for the next annual report.
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Thursday, December 3, 2009

Some Thoughts on IPOs - Part 2

This is an extension to the first part of this post. Here are the ones excluded from yesterday's post:

CompanyIPO timeOffered EquityTimes SubscribedRaised MoneyMarket Cap Today
First Winner IndustriesJune 200831.02%1.1468.75 Crore33 Crore
Niraj Cement StructuralsMay 200831.42%1.0761.75 Crore54 Crore
Sita Shree FoodMarch 200847.65%2.4131.5 Crore20 Crore
Tulsi ExtrusionsFebruary 200845.62%1.8348.45 Crore35 Crore
Bang overseasJanuary 200827%1.1372.45 Crore68 Crore
Cords CableJanuary 200827%4.6341.65 Crore46 Crore
Porwal AutoDecember 200733.11%137.5 Crore15.5 Crore
Precision PipesDecember 200735.71%10.5975 Crore91 Crore
Kaushalya InfrastructureNovember 200740.93%5.88451 Crore39 Crore
Renaissance JewelleryNovember 200737.99%2.7579.86 Crore92 Crore
Dhanus TechnologiesSeptember 200721.37%28.29113.13 Crore58 Crore
Magnum VenturesAugust 200746.92%2.7552.92 Crore33 Crore
Alpa LaboratoriesJuly 200744.06%0.94564.6 Crore25 Crore
Roman TarmatJune 200725%29.2650.75 Crore59 Crore
Vishal RetailJune 200716.85%76.12110 Crore150 Crore
NelcastJune 200725%795.26 Crore102.5 Crore
Decolight CeramicsMay 200742.98%1.743.45 Crore18.5 Crore
Asahi SongwonMay 200730.33%2.1233.5 Crore36 Crore
Abhishek MillsFebruary 200729.27%1.2441 Crore43 Crore

The total money raised by all these companies comes to about INR 3500 Crore. The market value of the same shares today is less than INR 900 Crore, 25% of original investment even after 4 years in some cases. Not just the fractional ownership, the whole companies can be bought today for less than INR 2900 Crore. This surely is just one side of the coin. There were some good issues too, like Educomp, ICRA, etc... which have given decent returns to investors but the risk was not worth taking.
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Wednesday, December 2, 2009

Some thoughts on IPOs

This post is to highlight the fact how investors are fooled into investing in IPOs. The basic idea of the post is to show that some of the companies coming up with IPOs in the last 5 years raised more money in their IPOs than their total market cap today. Please have a look at the table:

CompanyIPO timeOffered EquityTimes SubscribedRaised MoneyMarket Cap Today
Raj TelevisionFebruary 200727.5%2.3691.7 Crore78 Crore
AMD MetplastFebruary 200742.16%4.8876.25 Crore56 Crore
Oriental TrimexFebruary 200764.50.9548 Crore22 Crore
Evinix AccessoriesFebruary 200732.71%3.442 Crore35 Crore
Broadcast InitiativesFebruary 200744.27%2.36102.6 Crore36.5 Crore
Indus FilaFebruary 200725%1.3482.35 Crore50 Crore
Euro CeramicsFebruary 200732.87%2.8692.75 Crore71 Crore
Transwarranty FinanceFebruary 200742.86%1.5231.2 Crore19 Crore
Cinemax IndiaFebruary 200731.86%41.86138.26 Crore160 Crore
House of PearlFebruary 200733.52%3.67362.83 Crore172 Crore
XL TelecomDecember 200626.07%8.159.35 Crore80 Crore
Ruchira PapersNovember 200645.57%2.5328.5 Crore19.5 Crore
Blue BirdNovember 200625.07%4.8292.14 Crore100 Crore
Global Vectra HelicorpOctober 200625%3.5364.75 Crore60 Crore
Hov ServicesSeptember 200632.3%2.5181 Crore89 Crore
Lokesh MachinesMay 200625.47%19.3742 Crore52 Crore
R SystemsMarch 200632.57%3.36110.21 Crore105 Crore
Uttam SugarMarch 200615.53%4.63136 Crore156 Crore
Nitco TilesMarch 200644.9%4.51184.8 Crore162 Crore
Nitin SpinnersJanuary 200657.14%16.5149 Crore29.5 Crore
Celebrity FashionsDecember 200525.5%23.681 Crore35 Crore
Kernex MicrosystemsDecember 200534.85%22.9599 Crore105 Crore
Prithvi InformationDecember 200525.17%15.27135 Crore116 Crore
SPL IndustriesJuly 200531.03%28.2663 Crore30 Crore

The list is so long my finger pains and I am not including more.

Investors bought fraction of a company at a price and today the whole company is available at a fraction of that price, after two-three years. I don't believe in Efficient Market Hypothesis, so I do believe some of the companies listed above and also some which have not been included are real bargain today. I would see if I find some bargains and list in the next post.
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Is dubai the next bear stearns?

I am just trying to compare current crisis with one in the past. Bear Stearns had to borrow from Fed on March 15, 2008. JP Morgan then bid for Bear Stearns at USD 2 and finally agreed to pay USD 10 on March 28. There was a kind of panic in investors across the world for few days. The Sensex too declined from 16371.29 on March 29, 2008 to 15343.12 on April 4, 2008. There was a big rally after that to 17490.9 till May 5, 2008. And everybody knows what happened after that.
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Tuesday, December 1, 2009

Some Statistics

Looking at the way market is heating up, I would like to provide how odds stack up against investors at current valuations. In the data available for Nifty from January 1, 1999 till 1st Dec 2008 (yes, this is 2008, since I don't know what returns Nifty gives from 2nd December 2009 onwards), the following observations can be made:
  • There are 721 days out of 2485 total days when Nifty settled above a P/E of 20. The next one year returns from Nifty averaged -8.5%, lowest -56.8%, highest 65.7% and median -14.5%.
  • There are 222 days when Nifty settled below a dividend yield of 1%. The next one year returns averaged -25.6%, lowest -56.8%, highest 26.4% and median -21.0%.
  • There are 1438 days when Nifty settled above P/B of 3.5. The next one year returns averaged 8.18%, lowest -56.8%, highest 89.95% and median 6.76%.
These statistics show that except P/B, other statistics do not favour investments in Nifty at these levels.
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Monday, November 30, 2009

Is large cap pharma entering bubble?

The most useful way to analyze a company is by its net profits. But another way of looking at the company is through its cash flow statement. Even though, the valuations of some of the large cap pharma stocks appear little bit stretched, looking at the cash flow statements make them look like they are in bubble territory. Here is the table:

CompanyMarket Cap (INR Crore)OCF(FY09)OCF(5 year average)Market Cap/OCFMarket Cap/5 year average OCF
Dr Reddy's19K4804504042.5

Even the ones that look cheap like Sun Pharma and Lupin are trading at more than 25 times their operating cash flow of FY2009. And since these companies have grown at a rapid pace in the last five years, the P/OCF of average will be much higher. The last five years were quite tough for many of the above companies and may not be the same in the future. But aren't investors paying too much for future?
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Tuesday, November 24, 2009

Ch** bhi main, Kotwal bhi main

I was reading the list of companies trading at a big discount to their book value, and found one of them interesting. The company's name is "Priya Dyes and Chemicals". I looked at the annual results of the company and found that this might be a turnaround case in chemicals sector. I went to company's website and started reading at its annual reports. What I found in their "Auditor's report" section was that the name of the auditor is "M/s. M. L. Bhuwania & Co." and the name of the promoter is "SHRI A. K. BHUWANIA". The other surprise was that the company's name has changed to "Priya Ltd" and the biggest segment of sales for the company is "electronics items", "PCs", "thin clients", etc... The company was making losses in the year 2001-2002 and had accumulated losses till some time back. Don't know if the title fits with this company.
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Friday, November 20, 2009

Why so much inventories?

I was recently looking at the list of highest dividend paying companies and found an interesting company named Zodiac-JRD-MKJ which, according to the finished products list on moneycontrol, is a jeweler. The company's balance sheet for FY09 shows that the company had an inventory of INR 38.18 Crore and Net Current Assets of INR 43.09 Crore. This is surprising since the company's net sales in FY09 was INR 17.73 Crore. That means company is having inventory of 2 years and working capital is two times that of sales. The total market capitalization of the company is just INR 12.37 Crore.
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Tuesday, November 10, 2009

Why rising debt pose a threat?

Many companies face a dilemma when ROCE decline due to increasing competition in a business. On one hand they can continue with their current business and wait for better times and on the other hand they can increase the debt to expand a business so that when better times arrive the company can take better advantage of it. But the second option has a lot of risk and there are many examples observed in the Indian Capital Market.

One example is the pharmaceutical company, Wockhardt. Following table shows how the company kept increasing its debt during the past few years:

YearROCEDebtDebt (consolidated)

The company's consolidated revenues in 2006, 2007 and 2008 were below its consolidated debt. The consolidated ROCE would look much worse than the figures above and will surely be in single digits. The company's interest cost on consolidated basis increased from INR 97 million in CY05 to INR 2712.5 million in CY08. The company incurred hedging losses to the tune of INR 5800 million in CY08 and had already incurred hedging losses of INR 4320 million in the first three quarters of CY09.

The company's share price hit a lifetime high of INR 562 in March 2006 and a low of INR 67.5 in March 2009, a decline of 88% in three years. Today its trading around INR 190, 66% below its all time high even after three years.

When investing in a company, make sure the management is not so ambitious that they try to achieve their ambition at a cost of their shareholders' wealth.
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Monday, November 9, 2009

Indian Real Estate - a bubble?

This is my first post on investment other than equities. I am living in Pune and for the last two years, I feel the real estate prices in and around Pune are inching stratosphere. The prices in the area I live in were quoting around INR 3000 per square feet in 2006. A 2-BHK (two Bed-room, one Hall and one Kitchen) flat cost INR 3 million + parking space of INR 0.15 million + MSEB charges of INR 0.075 million. The total cost of buying the flat would be INR 3.225 million. On top of that there are 1% registration charges and 5% stamp duty making the total outgo at INR 3.4185 million. Consider the cost of basic amenities mentioned below in the table:

AmenityCost (INR)
6 Fans6500
14 Lights2000
2 Geyser8000

This and other costs would add another 0.1 million to the cost and the flat would cost INR 3.5 million without any furniture.

Now come to present and the price have moved up to INR 4000 per square feet. The total cost of making a 1000 square feet flat livable comes to around INR 4.6 million.

The average income of a salaried employee across various industries with age of around 35 years (the average age at which an Indian male buys a residence) can be about 0.8 million (just estimate, no official source of this figure available). This makes property prices out of reach of a common man with ratio of property to income at 5.75. Looking at some charts at CR, we can see that in US, it went above 5 and created a bubble during 2006-2008.

Even the rent is not able to justify the price. The rent in the area is around INR 15K per month yielding 180K per year. The rent to price or rental yield is 3.91% and after taxing at the highest slab, it comes to just 3% 2.61%. This is justified provided the interest rate remains at the levels they are right now. A one year fixed deposit provides around 6.5% but after the taxes of highest slab, it comes down to around 5% 4.35%.

All this calculation does not mention about the expenses incurred on maintaining a property. Monthly society maintenance is around INR 1.5K. The property taxes are around INR 6K. And I assume there will be other expenses, like painting every few years, internal maintenance of the flat etc... adding to a total of INR 30K per year. Thus the actual income from rent is not INR 180K but just 150K, which makes the rental yield goes down to around 3.26% and just 2.5% 2.18% after taxes if you count it in the highest tax slab.

Consider the counterexample of a flat in 2002-2003, which was selling for INR 1200 per square feet in the same area. The total cost with all the charges was just around INR 1.5 million. The rent at that time was around INR 75K yielding 5% before tax and 3.85% 3.35% after tax, this compares with the 3.91% and 3% 2.61% respectively that we calculated above. The only difference at that time was that the fixed deposits were earning anywhere around 9-11% per year.

The consequences of the burst of this bubble will be really bad.
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Wednesday, November 4, 2009

Midcap IT ready for shakeout?

Due to intense competition lately, it has become difficult for some of the IT companies to maintain their ROCEs. The companies are increasing their debt at an unprecedented rate for growth but are not able to earn proper returns on their invested capital. Have a look at some of them:

Company3i InfotechGeodesicCore ProjectsFirstSourceCranes

According to what I understand, anything below 15% for two or more years leads to debt spiral where company keeps increasing its debt to fund growth and the interest outgo will keep eating into profits. Some of the above companies have expanded their debt by more than 10 times in last 5 years. This really is unprecedented and may signal what is coming in the future for IT sector.
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Tuesday, November 3, 2009

Some more EPS

Let's have a look at some more EPS numbers as shown in the table:

IndexJan 7, 2008Nov 4, 2008March 9, 2009Today
BSE5008882.28/30.04 = 295.673879.58/12.8 = 303.092983.02/11.72 = 254.525945.36/19.67 = 302.25
SMLCAP13975.19/23.17 = 603.154035.11/6.37 = 633.452866.68/5.94 = 482.616741.24/15.33 = 439.74
CNX5005500.15/27.06 = 203.262421.25/12.42 = 194.951966.85/11.24 = 174.993727.45/17.6 = 211.79

From the above EPS numbers it is clear that the biggest variation in EPS was in BSE SMALL CAP index. The EPS went down from 633.45 in November 2008 to 439.74 today, a decrease of 30%. The SMALL CAP index was trading at a P/E of 23.17 in January 2008 and came down to a P/E of 5.94 in March 2009, a correction of 75% in P/E itself. The earnings went down by only 24% from 633.45 to 482.61. But the slide didn't end in March. The earnings declined to 439.74 today. Some of it has come due to changes in index constituents but a lot of it has come from profit declines. The SMALL CAP index went down from around 14K in Jan 2008 to 2.8K in March 2009, a correction of around 80% in around 15 months. If you consider the peak earnings of 633.45, at a level of 2866.68, the P/E came to around 4.53.

Surprisingly, Both BSE500 and CNX 500 EPS have gone beyond what it was in January 2008 but P/E has contracted and so the index values are still 33% below their lifetime high made in January 2008.
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Sensex-Nifty EPS after Q2 FY2010

Sensex EPS increased from 771.5 after Q1 FY2010 to 15404.94/19.7=781.98 after Q2 FY2010. Nifty EPS increased from 223.4 after Q1 FY2010 to 4711.7/19.81=230.38 after Q2 FY2010. This compares with Sensex EPS of 10631.12/13.1=811.54 and Nifty EPS of 3142.1/13.76=228.35 on November 4, 2008.

This is a degrowth of EPS for Sensex and growth in EPS for Nifty YoY while QoQ both have seen increase. The reason for growth in Nifty can be attributed to new scrips like JSPL, Axis Bank, IDFC introduced in place of Tata Communications, NALCO and Zee.
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Friday, October 30, 2009

Why this company is hesitant in paying dividend?

The company I am talking about is "Compact Disc India".

The company first calls for a meeting on February 20, 2006 to consider dividend. The decision to recommend 10% interim dividend was differed in the meeting till the next meeting on 23 March 2006. The meeting on 23 March 2006 was postponed. That meeting never happens.

The company again called for a meeting on 30 May 2008 to consider dividend. The company forgot to inform about any decision taken on dividend in the outcome of the meeting. The updates were communicated to the exchange that the dividend will be discussed in AGM. The company again called for a meeting on 22 August to consider dividend. The board did declare a dividend along with a Shareholders welfare fund worth 50 lacs which will provide interest free loans for personal use to those shareholders who are holding the shares of the company for last 10 years. There was no mention of the word dividend till the next year.

The company called for a meeting on 20 January 2009 to declare interim dividend. The meeting was adjourned on 16 February 2009 and never happened.

The company called for declaration of dividend again on 28 August 2009. The company declared a dividend in the meeting on 4 September 2009. When the AGM was held, the company deferred the declaration of dividend as "in Agreement executed by the company with its bank (lender), the company has to take prior approval of the bank before declaring the dividend." The company again issued a clarification that the dividend declaration was deferred.

Now the company has called again for an EGM to be held on 30 November to declare a dividend in a notice given on 24 October 2009.
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Wednesday, October 21, 2009

Total Market Cap above GDP

One of the valuation that measures whether the stock market in general is undervalued or overvalued is the ratio of total market cap of all the listed companies to GDP. According to economic survey 2008-09, GDP at current market prices was INR 53,21,753 Crore in FY2008-09. According to the BSE, the total market capitalization of all the listed entities was at INR 58,46,175 Crore on Oct 20, 2009. I am not able to get the data for the FY2009-10, but as far as I can remember, the GDP this year will be somewhere around INR 60,00,000 Crore. This makes the current market cap to GDP ratio at 100%. This is much lower than the ratio of 170% reached at the time Sensex was at 21200 in January 2008 when total market cap was INR 80,00,000 Crore and the GDP in 2007-08 was INR 47,23,400 Crore. At the bottom when Sensex reached 8K in March 2009, the total market cap was around INR 30,00,000 Crore, while market cap to GDP ratio at around 56%.

This is despite the fact that many sectors are still not having a single big company listed. This includes Insurance, Restaurants, Advertising, Railways, and many more. Conclusion? The undervaluation of equities is gone.
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Wednesday, October 7, 2009

How government owned companies work?

I would like to give an example of how government owned companies work. The company involved is MMTC. Looking at the balance sheet of MMTC, it can be seen that the company has fixed deposits worth INR 5762.5 Crore while debt of INR 4305.2 Crore at the end of FY09. Now Annual Report of the company shows that it paid INR 665.869 Crore as interest in FY09 while the interest earned was 782.402 Crore. Thus the interest rate earned on fixed deposit was 782.402/5762.5=13.57% while interest paid on loans was 665.869/4305.2=15.47%. If instead, the company had not borrowed money and utilized its own deposits, the company would have saved INR 81.65 Crore, that's 37.6% of its PBT of 217.11 Crore in FY09. What a waste of money!!!.
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Tuesday, October 6, 2009

Are investors over optimistic?

Let's look at valuation of some of the companies:

ABB, a power equipment manufacturer, has a market capitalization of around INR 17K crore at a market price of INR 800. The company earned a net profit of INR 547 Crore in CY08 and has seen a decline of INR 87 Crore in profits in the first two quarters this year, TTM profit being INR 460 Crore. This makes the company valued at a P/E of 37 with degrowth in earnings. The dividend last year was INR 2.2 and the yield turns out to be 0.275%. It will take 363 years for an investor to get dividend equivalent to price of the share if the dividends do not grow.

BOSCH, an auto component maker, has a market capitalization of around INR 13K crore at a market price of INR 4000. The company earned a net profit of INR 633 Crore in CY08 and has seen a decline of INR 143 Crore in profits in the first two quarters of this year, TTM profit being INR 490 Crore. This makes the company valued at a P/E of 26.5 with degrowth in earnings. The dividend last year was INR 25 and the yield turns out to be 0.625%. It will take 160 years for an investor to get dividend equivalent to price of the share if the dividends do not grow.

Gujarat Gas Company, a city gas distribution company, has a market capitalization of around INR 2500 Crore at a market price of INR 200. The company earned a net profit of INR 160 Crore in CY08 and has seen a decline of INR 4 Crore in profits in the first two quarters of this year, TTM profit being INR 156 Crore. This makes the utility company valued at a P/E of 16.5 with degrowth in earnings. The dividend last year was INR 1.5 and the yield turns out to be 0.75%. It will take 134 years for an investor to get dividend equivalent to price of the share if the dividends do not grow.

Hindustan Zinc, a zinc producer, has a market capitalization of around INR 34K Crore at a market price of INR 800. The company earned a net profit of INR 2727 Crore in FY09 and has seen a decline of INR 129 Crore in the first quarter of this year, TTM profit being INR 2598 Crore. This makes the metal company valued at a P/E of 13 with degrowth in earnings. The dividend last year was INR 5 and the yield turns out to be 0.625%. It will take 160 years for an investor to get dividend equivalent to price of the share if the dividends do not grow.

The conclusion? Wait for better opportunities. Wealth does not build over long term with this kind of valuations.
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Wednesday, September 30, 2009

How has Nifty composition changed?

I would like to compare the constituents of Nifty between 2003 and now. Here are some statistics:
  • In 2003, there were eight companies belonging to FMCG sector in Nifty, namely, Britannia, Colgate, Dabur, Glaxo Consumer, HUL, ITC, Nestle and Tata Tea. Today there are only two companies from this sector in Nifty, namely, HUL and ITC. Just to add, ITC was only in cigarettes at that time. Today it is in cigarettes, biscuits and soap/shampoos too.
  • In 2003, there were six companies belonging to Pharma sector in Nifty, namely, Cipla, Dr Reddy, Glaxo, Novartis, Ranbaxy and Sun Pharma. Today there are only three, namely Cipla, Ranbaxy and Sun Pharma.
  • These two examples show that when a particular sector has a very high representation in an index, it collectively underperforms the index. Individual companies like Colgate, Dabur, Glaxo Consumer and Nestle might have outperformed the index but the bigger players like HUL and ITC clearly underperformed the index. Today sectors that dominate Nifty are
  1. Finance with seven companies representing the sector in Nifty
  2. Power with five companies in generation/transmission/distribution and five in equipment.
  3. Metals with six companies in aluminium/copper, steel, and iron ore.
  • In 2003, there were total 21 different sectors that were represented in the Nifty constituents (if banks and housing finance, petrochemicals and refineries, auto 2 wheelers and 4 wheelers, steel and aluminium, are considered separate. If they are combined, the sectors would reduce to 17). Some of them included Hotels (Indian Hotels), Shipping (Shipping Corporation of India), Chemicals (Tata Chemicals) and Media (Zee). Today there is no representation of these sectors in Nifty (ITC is more of FMCG now then hotels). Today the number of sectors represented in Nify have reduced to 19 only (if you consider oil exploration, gas transmission and refineries, steel, aluminium and metals, banks and housing finance, separate. If these are combined, the sectors would reduce to 14 only). This clearly shows that many big companies from a particular sector has been put in the index. The examples are
  1. Finance where HDFC, HDFC Bank, Axis Bank, SBI, ICICI Bank, Reliance Capital and PNB all are part of Nifty.
  2. Power Equipment where ABB, BHEL, Siemens, L&T and Suzlon are all part of Nifty.
  3. Telecommunication services where BHARTI, RCOM, Idea and TataCommunications are all part of Nifty and if BSNL lists then it too will be included.
  4. Power where RINFRA, RPOWER, NTPC, Tata Power and JSPL are all included.
  5. Metals where Hindalco, Nalco, SAIL, Tata Steel, JSPL and Sterlite are all included.
  • From the above examples, it seems NSE should put a cap on number of companies representing a particular sector in Nifty.
  • Surprisingly, developed nation like the US does not have a single power company in the Dow Jones Industrial Average.
  • There is no representation of Media/Advertising, Chemicals/Paints, Retail, Insurance (there is no seperately listed entity to represent this sector), Transport (Railway/Airlines), Textiles, Paper, Auto Ancillaries (including tyres), Logistics, Hospitals, Restaurants and Consumer Durables in Nifty.
We can conclude from this that investing in Nifty is not a diversified way of investing in the whole Indian economy. It is better to chose a broader index like S&P CNX 500 or BSE500.
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Tuesday, September 22, 2009

BSE500 Replacement Candidates

According to me, any financial index should represent a diversified view of an economy. BSE500 is one such index which represents 93.2% of the total market capitalization of all the stocks listed on BSE. Due to my personal reasons, I feel the following stocks should not be part of BSE500 and should be removed from it as early as possible:

GTL Infrastructure
Ispat Industries
Karuturi Network
Noida Toll Bridge

You can also think that these are possible candidates which can be removed from BSE500 in near future.
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Wednesday, September 16, 2009

Is D-Street misinterpreting advance tax numbers?

Advance tax numbers for many companies are out and the D-street is seeing a sign of revival in the numbers. Let's see if the enthusiasm is overdone or not.

First of all, the D-street is forgetting about the big increase in taxes levied by the FM in budget of 2009, i.e. MAT has been increased from 15% to 20%. This change in policy itself increases the taxes by around 33%, 20/15=1.33, it is that simple. Secondly, many companies did not pay higher advance tax in first quarter since MAT recommendation came in budget only on 2nd July 2009, well after the first advance tax was already paid. So YoY comparison of taxes is not going to help.

Some articles are comparing QoQ advance numbers which is worse than comparing YoY numbers since first quarter advance tax paid by companies is 15% of the estimated taxes for the full year while the second quarter advance tax paid by companies is 30% of the estimated taxes for the full year. Read the article on the website of Income Tax Department. The companies have to pay not less than 15% taxes by June 15 and not less than 45% taxes by September 15.

With these two points in mind, it is clear that by adding the advance tax of June 15 with September 15, we can calculate the estimated taxes that the company expects to pay for FY2010. Here is the table:

AT=Advance Tax
CompanyQ1 ATQ2 ATTotal ATTotal AT/0.45 = Estimated FY10 TaxActual Tax for FY2009Estimated FY10/Actual FY09 change
Tata Steel23040063014002113-33.75%

RIL and TCS already has to pay 33% higher tax due to higher MAT so RIL taxes will actually go down after MAT increase is considered. Tata Steel stock went up by 8% today with this news of higher QoQ advance tax. Nobody can stop bulls!!!!!
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Wednesday, September 9, 2009

How wrong financial analysts can be?

I would bring to your notice one of the worst financial analysis, in my humble opinion, done by an analyst while comparing two companies. Read the report here. The report compares performance of Bharat Forge with that of Infosys at the peak of auto demand in June 2005. The share price of Bharat Forge at that time (adjusted for 5:1 split) was INR 286.78 and that of Infosys (adjusted for 1:1 bonus) was INR 1106.39. Today the share price of Bharat Forge is at INR 217.2 while that of Infosys is INR 2192.2. Thus during the last four years and three months since this article was written, Bharat Forge has given -24.27% returns while Infosys has generated 98.14% returns. Simply put, the analysts at that time was comparing apples with oranges. Although this seems easy in hindsight, the comparison itself was wrong in the first place. One is a manufacturing business while the other was a services business. As many great investors know, services can command higher EBITDA margin and have big entry barriers. Manufacturing has lower margins, higher competition and low entry barriers. The only conclusion is : take everything that is being said on Dalal Street with a pinch of salt.
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Fru****ted Promoters?

I want to introduce to you one fru****ted promoters, that of a company named FDC. Have you seen good companies buying back their shares at lifetime high price? (please exclude AA group companies from good companies). FDC is going to do that as mentioned here. The company is buying back its share upto a maximum price of INR 60 while the lifetime high for the company's stock price is INR 66 made on date 15 Dec 2004, yes almost 5 years back. That is the only reason why promoters are fru****ted. It has been five years and the company's stock price has gone down instead of going up. What about fundamentals? The companies profits have increased from INR 66.27 Crore in FY2004 to INR 83.21 Crore in FY2009, an increase of 25.6% while the stock price has gone down from INR 66 to INR 51.4, a reduction of 22.2%. This is not it. The company already bought back 51.82 lakh share at an average price of INR 34.31 aggregating INR 17.78 Crore during the first buyback plan announced on November 18, 2008. So the equity capital has decreased by around 3%, i.e. the market cap of the company from peak of INR 1263.64 Crore has gone down to INR 962.28 Crore i.e. by 23.85%. How is P/E of the company affected? The P/E in December 2004 was around 19.15 while today it is 11.56, a reduction of 40%. I agree with promoters that the company is undervalued at INR 51.4 and have a stake in the company but of course at a much lower price than the maximum buyback price. Happy Value Investing!!!!
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Tuesday, September 8, 2009

Something out of the box

The quote that feels more relevant in today's environment:

"nothing sedates rationality like a large dose of easy money"

-Warren Buffett
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Saturday, September 5, 2009

Are some services overpriced?

I would like to bring to notice the warranty/disclaimer provided by two of the most profitable services businesses:

1. Computer Software Product : Here are some quotes from sample text of disclaimer/warranty provided by one of the biggest software product companies:
  • Without prejudice to any other rights, XYZ may terminate this EULA if you fail to comply with the terms and conditions of this EULA.
  • XYZ warrants that the Software will perform substantially in accordance with the accompanying materials for a period of ninety (90) days from the date of receipt.
  • Supplements or updates to the Software, including without limitation, any (if any) service packs or hot fixes provided to you after the expiration of the ninety day Limited Warranty period are not covered by any warranty or condition, express, implied or statutory.
  • Except for any refund elected by XYZ, YOU ARE NOT ENTITLED TO ANY DAMAGES, INCLUDING BUT NOT LIMITED TO CONSEQUENTIAL DAMAGES, if the Software does not meet XYZ's Limited Warranty, and, to the maximum extent allowed by applicable law, even if any remedy fails of its essential purpose.
  • Any replacement Software will be warranted for the remainder of the original warranty period or thirty (30) days, whichever is longer, and XYZ will use commercially reasonable efforts to provide your remedy within a commercially reasonable time of your compliance with XYZ's warranty remedy procedures.
  • Except for the Limited Warranty and to the maximum extent permitted by applicable law, XYZ and its suppliers provide the Software and support services (if any) AS IS AND WITH ALL FAULTS.
  • Notwithstanding any damages that you might incur for any reason whatsoever, the entire liability of XYZ and any of its suppliers under any provision of this EULA and your exclusive remedy hereunder shall be limited to the greater of the actual damages you incur in reasonable reliance on the Software up to the amount actually paid by you for the Software or US$5.00.
2. Credit Rating Agencies : Here is a sample text from disclaimer of renowned rating agency in India.
  • XYZ does not guarantee the completeness or accuracy of the information on which the rating is based.
  • XYZ is not responsible for any errors and especially states that it has no financial liability whatsoever to the subscribers / users / transmitters / distributors of this product.
Both the disclaimers almost the same thing:
  • There is no warranty that the product XYZ is selling to you will perform as you or XYZ wants.
  • XYZ already knows that there are faults in the product but XYZ is not liable for the losses arising out of those faults.
What else I see common in both the industries:
  • Both of them depend too much on manpower and human skills. Ratings agencies have shifted to computer generated models lately but those models in turn are again developed by humans.
  • Both the agencies command EBITDA of over 30 to 40%.
Compare these with some of the other services industry like Airlines and Laundry. You get compensated for lost baggage in an airline or damaged clothes in a laundry and both the industries have very less profitability compared to the ones mentioned above. Can we expect a change in future?
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Monday, August 31, 2009

More Insider Selling

The insiders seem to differ from mutual fund managers. MF Managers are buying like mad and insiders are selling as if there is no tomorrow. Here are some more disclosures: JM Financial, Piramal Healthcare, DLF 1 and 2, Aptech, Lupin, Oracle Financial, IL&FS Investment Managers 1, 2 and 3, Ambuja Cements 1 and 2 and Voltamp 1 and 2.
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Sunday, August 30, 2009

Has buffett made two mistakes and not one?

Buffett admitted in his 2008 Berkshire Annual Letter to shareholders that he made a mistake buying Conoco Phillips shares at the peak oil price. Looking at Berkshire's complete portfolio it seems Buffett has made one more mistake, that of buying Kraft shares. (This is my own opinion so take it with a pinch of salt.) The reason is pretty clear. The company's last ten year history shows that the company's moat is becoming weaker and weaker year after year. The net profit margins have shrunk from double digits to less than 5%. ROE has declined from low teens to around 8.5% which is way lower than the average of its competitors. Kellogg's has ROE of 79%, with a net profit margin of 9%, General Mills has ROE of 25% with an NPM of 9% and H J HEINZ also has better ROE and profit margins than Kraft. If inflation is a big concern due to pumping of liquidity by federal reserve, than interest payment on 18B USD worth of debt that Kraft has accumulated for acquiring businesses is going to eat up a lot of profits in the near future. The competitors are smaller compared to Kraft in terms of size but that do not make them vulnerable. Let us see how this investment turns out for Berkshire.
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Saturday, August 22, 2009

How irrational markets can remain?

I will provide two examples of irrational markets.

The first one is of Timken India. This is a bearing manufacturer. It was started as a joint venture between Timken USA and Tata Steel both holding 40%. In 1999, Tiken USA acquired the remaining 40% stake from Tata Steel. During the boom times of 2005-2008, the share price hovered between INR 120 and INR 180, almost 5 to 7 times its price of INR 25 in 2003. Till CY2007, the company's EPS never went above INR 6. Thus the company was always trading above P/E of 20 and never fell into the value criteria. Fast forward to future and the company made EPS of INR 8.32 in CY2008 and the price fell to INR 50 during the carnage of October 2008, very near to its book value of INR 47. The market cap of the company at that price was just INR 320 Crore. Even today, the share price is hovering around INR 90 with a market cap of INR 575 Crore. The TTM profit is INR 48.96 Crore making a P/E of 11.75.

The other company I want to talk about is Fedders Lloyd. The company's share price in 2006-2008 bull market traded anywhere between INR 100 and 200. The company made an EPS of INR 6.26 in FY2007 ending in June 2007. Thus the P/E ratio was never below 20 making the share out of investment horizon for value investors. Fast forward to future and the company made an EPS of INR 7.28 and INR 4.12 for FY2008 and FY2009. The share price in October 2008 fell as low as INR 16, a P/E of just 2.2. The market cap of the company at that price was just INR 50 Crore while net current assets stood at INR 160 Crore and debt at just INR 75 Crore. If you had liquidated the company, you would still have got 95 Crore and more for its real estate and plant machinery. The share price has run up to INR 37 and even today the P/E ratio is just 8.98 with market cap just INR 110 Crore.

Can you guess from this how many good years' of earnings the stocks were discounting in the bull market of 2005-2008? There are many such examples and I have already talked about some of them like Gulf Oil, etc. earlier. Whenever somebody quotes a price to you, take it with a pinch of salt. Even if everybody agrees with him.
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Saturday, August 8, 2009

Insiders selling more?

Recently I saw a lot of insider selling. Ambuja Cements, Wipro, M&M, IL&FS Investment Managers, Paper Products, and Kotak Mahindra Bank are some in the list. There are many more that you can find out here.
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Thursday, August 6, 2009

Which sector will create new lows in next correction?

People might get surprised by the title of this post since nobody is talking of any correction in the stock markets right now. When the Sensex went to 8K in October 2008 and touched it again in March 2009, most of the sectors corrected heavily from their lifetime peak. L&T was down from INR 2300 to INR 560 (75%), BHEL was down from INR 2925 to INR 1000 (65%), NTPC went down from INR 290 to INR 115 (60%), etc. etc. Which sectors still looks very expensive and can go down more in the next correction? The more may not be in prices but may be in P/Es, i.e. since earnings will grow from say 10 to 15, price may go to 105 instead of 100 but P/E will be at 7 instead of 10 in the last correction.

The first and foremost that I see is Power. Utilities generally do not trade in high P/E multiples. They are doing it in India right now due to high growth lying ahead. But that growth may not come in the companies who are already generating power. New players will enter the space and take the share out of the existing players' pie. Thus the enthusiasm of investors will not come true about power companies. NTPC, Tata Power, BHEL and Reliance Infra fall under this sector.

Oil & Gas is a commodity and can trade at a P/E of single digits. So RIL and ONGC can clearly make new lows, may be not in terms of prices but can be in terms of P/E.

FMCG remained in low twenties even when the Sensex was trading at almost single digit P/E. They can correct more and they have a reason too, monsoon. HUL and ITC fall under this sector.

Cement will have some pressure since prices have started correcting. This is not a dent in profits, this is a dent in revenues. Grasim, Jaiprakash Associates and ACC will get impacted.

We are talking about almost 40% of the index constituents. Be cautious. I am posting this on 9th August but since I started preparing it on 6th August, the date of posting is coming up as 6th August.
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