Sector in Decline - Newspaper Publishing and Media

Lately, you all might have seen that I am buying some publishing businesses such as Jagran Prakashan, Just Dial while I was already holding Hindustan Media Ventures. The valuation of these companies are given below in the table

Company	Market Cap	Operating Cash Flow(3 year average)	P/E	Net Current Assets
Jagran Prakashan	3800	445	12.25	575
DB Corp	4329	370	13.9	675
Hindustan Media Ventures	1246	150	9.15	1330
Just Dial	3765	155	26.23	1000

If you check the history of many of the companies, Jagran Prakashan (who owns Dainik Jagran) did a buyback at INR 195 for 292.5 Crore and share price is now at INR 125. On the day of buyback validity, the share price was at INR 160. Jagran also owns another listed company Music Broadcast which owns 91.1 FM - Radio City. Surprisingly, Music Broadcast is also doing buyback. DB Corp (who owns Dainik Bhaskar) announced a buyback at INR 340 for 312.5 Crore while the current price is INR 237. Just Dial is an internet based business for finding local businesses (Yelp of India). It also has approved buy-back at INR 800 for 220 Crore. I am not sure why at one side market is evaluating cash-rich companies like these generating decent cash flow at ridiculously low valuations while some others are trading at 75-100 times cash flow such as Dabur, Honeywell, Berger Paints, Page Industries, Jubilant Food and many others. Time will tell whether I am right or the market.

How markets can be very wrong

I had in previous post already mentioned names of several commodity companies Peabody Energy and Arch Coal. The graph on LA Times about Electricity produced from coal in the state of California is reproduced below:

It is clearly visible that something drastically changed in 2011 and the coal based electricity production fell off a cliff. The charts of both the companies' stock price is shown below:

Both the shares were trading at much higher prices in 2011 ($3250 for Arch Coal trading at $0.36 now, $72 for Peabody trading at $0.95 now) that means the market was not discounting the event of replacing coal with other cheaper options for producing electricity. Both the company's filed for bankruptcy recently.

How can market be right in 2011?

Carnage in Commodities

Many readers of this blog will see the investments I have made to the right of this post and find the names like Cairn India, GMDC, Maharashtra Seamless, MOIL, NMDC, OIL India and Tata Sponge Iron. Most of these I bought in the last one-two years thinking the shares are offering value but I have been beaten down by Mr Market and every month I am seeing newer lows for the share prices of these companies. The average buying price for these stocks is 220, 80, 204, 208, 90, 460, and 650 respectively while the current trading prices for the same are 130 (-40%), 56 (-30%), 136 (-33%), 185 (-10%), 91 (0%), 320 (-30%) and 375 (-43%). Even though the losses looks big, the number of stocks 7 make a very small percentage of my overall holding of 28 stocks, i.e. 25%. So the average loss of 26% on 25% of your holding comes to around 6.5% of your total investment which looks big if your portfolio is INR 1 Crore since 6.5% is 6.5 lakhs but minuscule amount of INR 65K if your portfolio is just INR 10 lakh. For me, the good news was that I invested higher percentage in non commodity companies with better conviction so the portfolio share of the commodity stocks is even lower at just 16% and the losses are just 4.5%. Even though value investors like me try to avoid capital loss, due to events not controlled by the investor, some losses are expected and I just need to minimize them.

If you look at the investments made by other gurus in commodity companies recently Gurus pile into commodities and What gurus are saying about commodities, most of them have lost money except in Gold. Peabody energy stock price has gone down from 25 to 2 in six months, Arch Coal went down from 2 to 0.5, Freeport Mcmoran going down from 10 to 7 with as low as 4 in January. Carl Icahn even had to sell his Apple Inc holdings recently at 30% correction from top price and his company Carl Icahn Enterprises was downgraded recently Carl Icahn Enterprises in danger of downgrading to junk due to heavy loan to value ratio.

I am not trying to defend myself here but what I am saying is that the errors are part of human decision making and the three words "Margin of Safety" ensures survival. I do try to put enough margin of safety in everything I buy. One of the recent examples of this was my purchase of Shilp Gravures at INR 46. The company's share price went on to reach INR 116 a month back but since it got notice from GPCB (Gujarat Pollution Control Board) to shut down the plant GPCB Notice, the price came down to INR 63 which is still higher than my purchase price.

If I still have conviction about my investments in these companies, I can average down but for many the equation has changed. For Cairn, a merger is announced with Vedanta and not sure what promoter would do with the cash present on Cairn's balance sheet. The oil price have come down from $60 to $30 since I bought these shares impacting the profitability. Oil India made huge investment to buy Videocon's Oil assets in Africa OIL and OVL invests in Africa. The transaction was done at a time when Gas prices were hovering near $4 while they are trading at $1.8 now. So times change and so do equations.

Be safe, be prepared.

I was wrong about CFS business

I had written about CFS business profitability to head south? on March 16, 2009 but the latest results from Gateway Distriparks show that the reverse is happening. The ROCE earned by GDL at that time was 20.15% but for FY12 results, it is 174.17/639.50 = 27.24% compared to 113.03/586.10 = 19.28% for FY11. Although some numbers do not make sense to me. The result published on NSE website for FY10 shows capital employed in CFS business as INR 273.30 Crore while the latest results on BSE show the same at INR 586.10 Crore, even though the total in all segments in both the results add up to INR 687.94 Crore. The difference started in results between FY08 and FY09 when capital employed dropped in CFS business from INR 441.83 Crore to INR 325 Crore but the depreciation in FY09 was just INR 44.47 Crore. In the same year, the capital employed in Rail Transportation business grew from INR 153.83 Crore to INR 426.89 Crore. Even the last year result on BSE shows capital employed in CFS business at INR 273.31 Crore so this year's results can be considered incorrect it seems but still we can say that even with the results with lesser capital employed, ROCE would come much higher.

I had also mentioned about investment by LIC in the company at an average price of INR 153 in year 2007. The current price of INR 143 is still below the investment price of LIC. The company came out with IPO at INR 92 in 2005 and also bought back shares in January 2009 at an average price of INR 81.

Image(s): FreeDigitalPhotos.net

Hydro Power Sector

Following listed companies are in the hydro power sector in India:

• Jaiprakash Power Ventures
• NHPC (National Hydroelectric Power Corporation)
• SJVN (Satlaj Jal Vidhyut Nigam) 

This sector is utility so returns on capital are controlled by government and the companies cannot charge the amount they wish from their end-users/customers. The following table summarizes their financial conditions:

Financial Ratio	Jaiprakash Power Ventures	SJVN	NHPC
Market Cap (Crore)	9777	7880	22141
Net Worth (Crore)	5170	7205	24584
Debt (Crore)	12381	1753	14569
Debt/Equity	2.4	0.24	0.59
Average ROCE (five years)	10.15	15.20	6.41
Average Interest Cover (five years)	2.5	5.48	4.76
Interest Cover (last year)	1.62	8.12	5.68
Price/Book	1.89	1.09	0.9
Mutual Fund Holding	HDFC, etc...	ICICI, Tata, etc...	UTI, ICICI, Tata, etc...
Dividend Yield		4.2	3.33

On most of the parameters, except price/book ratio, SJVN is better than the other two. JP power ventures is highly indebted and most probably will not be able to meet its financial obligations sometime or the other in the next few years. How can a value investor like me suggest you to buy the shares of a company whose bonds are not investment grade? So the best investment looks like SJVN at this point of time.
Image: markuso / FreeDigitalPhotos.net

Large Disparity across sectors/sizes

Have a look at the following table:

Company	Market Cap (INR crore)	P/E	P/B	Price/Sales
Nestle	46,500	52	36	6.2
Asian Paints	32,000	33	16	5
Titan Industries	21,000	39	20	3
Dabur India	19,500	35	17	5
Glaxo Consumer	11,500	35	10	4
CRISIL	7,500	40	20	11
TTK Prestige	3,900	35	30	5

The companies mentioned above are today considered high quality. But look at the figures and see that they are trading at mind-boggling valuations. Price/Book of 30 times for a consumer goods company which was making losses in FY2003 and is trading at more than 35 times TTM earnings with less than 0.4% dividend yield!! All the FMCG companies have discounted more than 5 years of earnings growth in their valuations. Generally, an FMCG company is a reasonable buy if you get it at 2.5-3 times sales. Most of the ones above are trading at 50-100% higher valuations then their reasonable price.

Now look at the table below:

Company	Market Cap (INR crore)	P/E	P/B	Price/Sales
Oil India	27,500	7.7	1.7	2.3
Maharashtra Seamless	2,700	8.3	1.5	1.3
Balmer Lawrie	900	6.5	1.7	0.45
ZF Steering	330	7	2	1.1

There is clearly a big disparity between the valuations of companies in the tables above. On one hand the investors are so enthusiastic about the prospects of the company that they are willing to pay more then 30 times earnings and on the other hand they are not willing to give even a P/E of 10. There is a difference in terms of size in many of the companies in terms of market cap but the gap would narrow down if both the companies are having similar kind of P/E, P/Sales multiples. This is what is called Stock Market!!!!

Image: Dino De Luca / FreeDigitalPhotos.net

Is this the end of MSFT?

This is the first time I am posting on a company not listed in India. I am talking about Microsoft. This post is inspired by Microsoft's buyout of Skype for $8.5 billions. Many of the big companies that are favourite of speculators get to a point where their dominance is threatened by creative destruction that is the core of capitalism. Microsoft has dominated tech industry for more than thirty years now. But over the last ten years, the growth of internet has just shaken the ground below this bellwether company. The company has meager presence in this area and is struggling to build products that make its presence felt on internet. The last time the company was this desperate was in 1997-98 which resulted into buyout of Hotmail at exorbitant price of $400 million in January 1998. I don't have the data for the revenue and profitability of this acquisition over the last fourteen years, but Microsoft share price did get a boost from $15 to $25 in a span of just eight months. The price today is still hovering at $25 and change after almost thirteen years.

Even the current internet division in Microsoft is bleeding with heavy losses with annualized loss number to the tune of $3B(billions with a B). The PC sales declined annualized 4% in the last quarter although the notebook sales increased and with the prevalence of virtual machines, operating system sales may not match one-to-one with hardware sales since many virtual machines can run on a single hardware server.

I am working in technology sector and not in Microsoft so my opinion may be biased. So take this with a pinch of salt. There is a famous call from Bill Gates on Kodak in 1991 when its share price was hovering around $30. When asked about Kodak, Bill Gates said, "Kodak is toast". The share price did go up to $90 and today going for $2 and change. Will he say the same thing for Microsoft today?

How great companies outperform index over time?

Many a times so called analysts mark companies in FMCG and Pharma sectors as defensive. But if we look at the returns generated by these companies over long term, they are many a times much better than the returns generated from index. Today, I will describe two good companies from FMCG sector which have shown the same kind of characteristics over the last 10 years. The first is Nestle and the other one is Glaxosmithkline Consumer Healthcare. If you look at the returns generated by these companies over the last ten years, they can be summarized as shown in the following table:

* Average price

Company	Price 2002-03	Price 2007	Price 2011
Sensex	3000	18000	19000
Nestle	500	1100	3500
Glaxo Consumer	250	550	2200

You can see that during the bull market till 2007, both the companies underperfomed the Sensex by a hugh margin but after 3 more years, they are now outperforming the index. The Sensex generated returns of more than 40% compounded annually between 2002-03 and 2007 and many of the stocks like L&T, Reliance and BHEL went up by more than 25 to 50 times. The returns generated from both these stocks were of the order of 15-20% at best during those times. But the situation has changed over the last three years, all the stocks that generated great returns earlier are still trading 30-40% below their 2007 peak while these companies multiplied their returns and generated more than 40% returns compounded annually during the last three and a half years while the Sensex hasn't moved much. It is just in hindsight that somebody would have bought L&T and Reliance in 2003, sold them in 2007 and bought Nestle and Glaxo from that money. But buying good companies at great prices never turns out to be a bad deal.
Image: renjith krishnan / FreeDigitalPhotos.net

Is TCS really doing better than Infosys?

The financial media is ripe with the articles of praise for TCS and Infosys seems to have lost its glory over the last one year. See the headlines below:

• TCS takes over Infosys (livemint)
• TCS Infosys treading different paths (livemint)
• TCS topples Infosys as the most valued IT company (trak)
• TCS tops Infosys (DNA)

Most of the analysts are not looking at the results of companies with sharp eyes. See the following table:
* 9 months FY11

Year	Infosys			TCS
	PBT	Tax	Tax/PBT	PBT	Tax	Tax/PBT
2007	4249	386	9.08	4876.59	663.96	13.61
2008	5344	685	12.82	5812.33	786.31	13.53
2009	6907	919	13.31	6095.37	838.95	13.76
2010	7899	1681	21.28	8197.61	1196.97	14.60
2011	9313	2490	26.74	7812.19*	1367.08*	17.5

If we forget about the quarterly movements of revenues then over the last 6 years, Infosys consolidated revenue increased from 7129.65 Crore in FY05 to 27501 Crore in FY11. During the same time TCS revenue increased from 9748.47 Crore in FY05 to estimated around 37000 Crore in FY11, not much difference between the two in terms of growth.

The annual report of Infosys clearly provides details about the expiry of tax exemption due to Software Technology Park(STP) scheme of government of India. There were five big centers (Bangalore, Pune, Mysore, Hyderabad, and Chandigarh) whose tax exemption expired in 2009 and there are three more (Chennai, Bhubaneshwar and Mangalore) whose exemption expired in 2010 and so the effective tax rate for Infosys has increased from 13.31% to 26.74% over the last two years. If the tax rate had remained the same, Infosys EPS this year would have been higher by INR 20. Due to new SEZ policy of government, the tax rate may again go down a bit due to lower MAT rates on SEZ and Infosys annual report does mention five centers whose tax exemption expires after 2020. On the other hand, TCS annual report does not give any information about this but STP is going to expire in March 2011 so TCS' tax ratio is likely to move higher in the next year which not a single analyst seems to be talking about right now.

Yes; the operating profit margin of TCS has caught up with that of Infosys over the last two years but I doubt they can do better than Infosys going forward. Let's see.

Being too far ahead of your time is indistinguishable from being wrong
 - Howard Marks

Image: xedos / FreeDigitalPhotos.net

How banks made money while investors lost - in India

There has been a lot of bashing of banks in the United States over the last three years when the US taxpayer saved banks while the employees of the banks made billions in bonuses. There wasn't a lot of bashing on banks in India though and in November 2010 the bank index climbed to all time high. Sadly though, there were companies and their investors who got punished (I wanted to use a different word but was afraid of getting sued) by a lot of private banks between 2007-2009. Here are two examples that I would like to provide:

Sundaram Brake Linings

The company had a turnover of INR 189 Crore in FY07 and was earning a decent ROCE above 20% till 2007. When the financial markets froze in 2008, the derivative contracts the company had entered into with the help of Axis Bank and Yes Bank backfired. The banks started asking for losses on derivatives but the company refused to pay up and went for suits in Madras high court against both the banks. The banks won the case and now the company has to pay a total sum of 109.48 Crores. Did you read that figure? The company's total profits between 2001-2007 was INR 61.79 Crore. Even if we assume that the company will keep its earning power and will make double the profits between 2008-2015 (prices in India double every 10 years), the company will have to pay almost 90% of its profits in these years as compensation of losses on derivative contracts. The company has already paid these banks over the last three years and the total liability has come down to INR 84.12 Crores in the latest quarter.

HimatSingka Seide

The company had a turnover of INR 174.164 Crore on standalone basis in FY07 and was making above 20% ROCE if the fixed deposits were removed from capital employed. The company had a total derivative MTM loss of USD 41.5 million, i.e. INR 166.5 Crore. The company totally had to write off INR 68.213 Crore in FY09 and FY10. This is more than the net profit of FY07.

Branded Apparel Sector - Part 3

This is part 3 in the series of article discussing Branded Apparel Sector. The previous parts are here:

• Part 1
• Part 2

Zodiac Clothing Company

Zodiac is a 26 year old clothing company. The company mainly manufactured shirts but is now selling trousers and accessories like belt, ties and handkerchiefs too.

Branded Apparel Sector - Part 2

This is part 2 in the series of article discussing Branded Apparel Sector. The previous parts are here:

• Part 1

Trent

This is a Tata Group Company running branded apparel stores under the brand of "Westside".

Branded Apparel Sector - Part 1

The textile sector in India is one of the biggest employment generators. There are several different industries that are part of a chain of processes involved in creating the final product, an apparel. These include

• Spinning
• Weaving/Knitting
• Finishing - Dyeing and Printing
• Accessories - buttons, zippers, elastic etc...
• Chemicals - dye etc...
• Retail distribution

Sometimes number two (or even five) is better than number one

This is a long post with some examples. This post is to highlight the fact that it is not always number one in any particular industry, either in terms of sales or profits, who is the best. There might be special situations when some company down the rank in terms of sales and profits doing better than the leaders in its industry.

Is banking crisis very near in India?

Markets are more insane at two times, near the top and near the bottom. Right now the markets does not look like near the bottom. So we can conclude that the former is a more likely scenario. The recent run-up in Sensex and Nifty has mostly been fueled by two sectors having a big weight in both the indices, Banks and IT. Since IT is something difficult to analyze, I am trying to find the insanity of Mr Market in valuing banks. Consider following companies from BSE500

Company	Debt March 2010	Networth March 2010	EBITDA (TTM)	Interest Payment (TTM)
3i Infotech	1608.1	895.1	274.06	98.97
Aban Offshore	3153.15	2172.93	868.96	336.85
ABG Shipyard	2897.44	1122	503.55	158.96
Adhunik Metallic	1218.49	615.5	273.09	121.61
Adani Enterprises	3471.31	1970.1	489.3	177.57
Alok Industries	8509.68	2716.02	1372.9	606.39
Amtek Auto	3352.51	2592.7	491.24	113.6
Arvind	1870.58	1421.06	341.18	164.71
Bajaj Hindusthan	3075.15	2293.67	630.16	207.38
Bharti Shipyard	2292.8	850.83	329.15	125.38
Dalmia Cement	2850.41	1377.65	417.64	196.13
DLF	12637.86	12830.01	2153.66	949.22
Era Infra	2482.03	1456.59	708.13	271.01
Essar Oil	10353.73	4673.65	1506	1193
Ispat Industries	7351.05	2031.88	1616.95	1017.87
Jaiprakash Associates	17908.71	8500.72	2985.64	1161.84
Jet Airways	13896.98	2641.98	1638.52	1023.88
Kingfisher Airlines	5665.56	-2125.34	-462.73	1247.33
Mercator Lines	1473.47	1053.94	183.03	91.97
Moser Baer	2183.43	1692.02	508.3	183.92

and there are many more like Videocon, SKumars, Rei Agro, Shiv Vani, which makes my fingers tired. We are talking about debts to the tune of more than 2 lakh Crore, which are at stake here. Most of the above companies' net worth are below their debt. All are running highly leveraged business. Interest cover (EBITDA/Interest) has fallen below 4 for most of the companies and are near 2-3 in the latest quarter. This at a time when interest rates in India are at historically low. Just 50% hike in interest rates (i.e. from 7% to say 10.5%) would make it difficult many of the companies to pay their interest. This combined with a hit to profit margins may result a big blow to Indian companies and finally to Indian banks. Be ready for a jolt.

Security analysis does not seek to determine exactly what is the intrinsic value of a given security. It needs only to establish that the value is considerably higher or considerably lower than the market price. - Benjamin Graham

Is FMCG a bubble?

I have written about bubble forming in Large Cap Pharma in the past. Is the same happening with FMCG? Let's look at the following table and see:

Share	Market Cap (INR Cr)	TTM P/E	P/E of 5 Year Average EPS	P/E of 10 Year Average EPS
Nestle	28432	42.5	54.8	87.6
Dabur	18140	36	52.6	80.6
Colgate	11550	25.5	36.8	68.1
Marico	7595	32.8	48.1	71
Asian Paints	24135	32.4	59	88.9

I have to remind investors here about the valuation of companies with a lot of enthusiasm at the peak of the Sensex level in January 2008. Almost all companies are appearing near the bubble territory. At the bottom in April 2003/2004, following were the valuations:

* bottomed in April 2004
Share	Market Cap (INR Cr)	TTM P/E	P/E of 5 Year Average EPS
Nestle*	4821	18.32	28.2
Dabur	1055	11.6	14.6
Colgate*	1630	18.4	25.6
Asian Paints	2085	15	19.85

Be cautious!!!

Buying a neglected and therefore undervalued issue for profit generally proves a protracted and patience-trying experience. And selling short a too popular and therefore overvalued issue is apt to be a test not only of one’s courage and stamina but also of the depth of one’s pocketbook. - Benjamin Graham

Is change coming?

I had written about two industries, computer software and credit rating agencies in the previous article in September 2009. I had argued that both the industries are providing a service/product which is very important for other industries but both of them do not want to take any liability of the service they are providing.

The game, at least for the rating agencies, seems to be changing. The Dodd-Frank Financial Regulation Bill makes the credit-rating agencies liable for the advice they give and it will be easier to sue them if the bond does not perform up to the stated rating. It took almost 100 years to make the rating agencies accountable for their service.

The shares of Moody's have fallen by more than 70% from top in 2007. Even Buffett admitted he should have sold more shares of Moody's earlier. The Indian stock market seem to be unaware of the consequences since CRISIL and ICRA stocks are making new highs. Is market wrong here?

Since the computer software industry is new, I guess it will take 50 more years for them to become accountable.

The analyst must pay respectful attention to the judgement of the market place and to the enterprises which it strongly favours, but he must retain an independent and critical viewpoint. Nor should he hesitate to condemn the popular and espouse the unpopular when reasons sufficiently weighty and convincing are at hand. - Benjamin Graham

Some auto-ancillary stocks have still way to go

Recently, I was delighted to see a big run up in share price of an auto ancillary company, ZF Steering Gear. The company came out with its quarterly earnings on July 14, 2010 and the share price went up from INR 300 to INR 390 in less than ten trading sessions. But I still feel the company has a long way to go before it runs out of steam. Why? The reason is the past performance. The company's share price is still more than 10% below the August 2005 high of INR 450. The profits have climbed from INR 20.5 Crore in FY2005-06 to INR 36.19 on TTM basis and is expected to do at least INR 45 crore this year. The book value of the company has increased from INR 77 in FY2005-06 to INR 150 FY2010. Thus P/E has contracted from around 20 to less than 10 and P/B has contracted from 5.8 to around 2.6. Disclosure: I have a long position in the stock.

Investors are well advised to buy a business that's so good that a dummy can run it, because sooner or later a dummy will run it. - Peter Lynch

Macro Call

There are very few times when a value investor is able to make a macro call. But I am daring to do it at this stage. The call is on financial sector in India. If you look at Index composition of Nifty and Sensex, there is hardly any diversification left. Financial sector represents 23.74% of Sensex (ICICI Bank, HDFC, HDFC Bank and SBI) and 25.37% of Nifty (AXIS BANK, HDFC BANK, HDFC, ICICI BANK, IDFC, KOTAK BANK, PNB, RELIANCE CAPITAL, SBI). As all of you must be knowing, a value investor generally does not invest in financial firms since they are difficult to evaluate. This leaves just 76.24% of Sensex for investment for a value investor like me.

It has already been observed many a times in the past that when a particular sector garners most of the weightage of a financial index, it underperfoms the index. The evidence can be seen in IT sector after 2000 and FMCG and Pharma in India after 2003. So I am taking a call on Indian Financial sector today, that the sector would be an underperformer in the next five years.

Abnormally good or abnormally bad conditions do not last forever. - Benjamin Graham

Cement Sector : Contradictory Articles

As an investor, I keep reading financial news on several websites. One of them is LiveMint. Recently I saw two articles completely contradictory to each other about cement sector:

• Increase in demand, capacity addition to boost cement sector - 12 April 2010
• Low demand, pricing pressure bad news for cement stocks - 14 April 2010

It is just two days and the same website shows different views about a particular sector. Please see that the first article is from Sharekhan and the second one is from Religare Hichens Harrison. Different views is what makes Market.

If there is a difficulty or a doubt, the security should be declined. -  Walter Bagehot