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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