Why book value matters?

Most of the value investor understands the importance of book value in determining the intrinsic value of a company. Book value represents the hard assets including its inventory, fixed assets minus depreciation and its cash/receivables minus all the liabilities like provisions, accounts payable etc...Ben Graham suggests not to pay much higher than book value while buying shares of a company.

If this criterion is strictly followed, there might be some set of companies that an investor may not be able to invest in ever. These companies include FMCG firms like Nestle, HUL and GSK Consumer since they distribute most of their earnings as dividends and so the book value of the company does not increase much. These companies also work sometimes on negative working capital so their book value will be very less compared to their earning power and so their intrinsic value can only be calculated based on their earning power.

But in bull markets, like the one we are in, investor enthusiasm stops differentiation between these companies and average small/mid cap companies. See the following table for the examples:

* 2006 numbers
Company	Book Value March 2005	EPS March 2005	Share Price September 2005	P/B September 2005	P/E September 2005	Book Value March 2010	TTM EPS	Share Price Today	P/B Today	P/E today
Ador Welding	63.36	19.95	260	4.1	13	108.45	21.22	170	1.57	8
GMM Pfaudler	36.39	5.21	116.94	3.21	22.45	62.9	8.07	94	1.5	11.65
GM Breweries	25.63*	14.3*	117*	4.57*	8.18*	60.12	17.73	101.8	1.69	5.74
India Nippon	122.4	22.86	286.5	2.34	12.53	187.17	30.95	242	1.29	7.82
Gateway Distriparks	62.39*	7.88*	131.4*	2.1*	16.67*	61.91	7.4	120	1.94	16.22
TV Today	35.58	2.83	96.15	2.7	33.97	52.56	-7.17	62	1.18	NA
Voith Paper	141.15	17.22	200	1.42	11.61	217.81	21.44	200	0.92	9.33

Most of the companies were purely trading at that time based on their earning power and the importance of book value was completely ignored by Mr Market. After more than five years, they are trading at prices lower than what they were trading at in 2005. The loss is not even compensated from dividends since capital erosion is far more than the cash received by an investor from dividends. The story may not end here. In the bear market of 2001-2002, these vary companies were trading at a steep discount to their book value and the same may happen when the next bear market comes. This doesn't mean the investor should shy from buying these names since the loss would be a notional loss unlike the loss that has happened over the last five years which is real.

The typical experience of the speculator is one of temporary profit and ultimate loss. - Benjamin Graham

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Sensex Nifty preliminary EPS after Q3FY11

While there are some companies, like Tata Steel, Tata Motors, M&M and Unitech still left to announce their Q3FY11 numbers, the preliminary EPS for Sensex and Nifty can still be calculated. Sensex ended at 18008.15 with a P/E of 19.78 which gives Sensex EPS of 910.42. The Nifty ended at 5395.75 with a P/E of 20.67 which gives Nifty EPS of 261.05. This compares with Sensex EPS of 876.36 and Nifty EPS of 250.62 at the end of Q2FY11 and Sensex EPS of 806.81 and Nifty EPS of 232.5 at the end of Q3FY10.Thus Sensex EPS has grown by 12.84% compared to last year while Nifty EPS has grown by 12.28%. This too in a year when the whole economy grew by more than 20% in nominal (inflation 12% + real 8%) terms. Now try to think how the EPS would grow to 1250 in five quarters, i.e. 28.86% compounded annually? If it cannot, then ask samir arora why he thinks Sensex is trading at 14.5-15 times FY12 earnings?

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Have some investment opportunities started emerging?

With a correction of more than 10% in NSE Nifty over the last two months from a high of 6338 on 5 November 2010 to 5624 on 17 January 2011 and more than 20% in BSE SMALL CAP index from a high of 11168 on 10 November 2010 to 8860 on 17 January 2011, there are fair amount of chances that some investment opportunities will really be available. There is a big contradiction between the two set of companies since some large caps are still trading at a P/E multiple of 30-50 while some small caps are available just near their book value with a P/E of 4-10. Following is the list of some of those small caps:

Company	Current Market Price	Market Cap	TTM Profits	TTM P/E	Average Profits of last five years	P/E of five year average EPS
Ador Welding	184	250	28.85	8.67	30.6	9.4
Asahi Songwon	74	91	15.99	5.69	7.5	12.14
Eldeco Housing	153	30	9.22	3.25	5.9	5.07
GM Breweries	106	99.2	16.59	5.98	9.14	10.85
Gandhi Special Tubes	120	177	25.92	6.84	17.82	9.93
Premco Global	25	7.7	1.53	5.03	0.88	8.75
WimPlast	170	102	17.1	5.96	6.306	16.17
Dynemic Products	25	28.32	7.02	4.04	2.75	10.31
Plastiblends	170	110	13.66	8.05	12.77	8.61

And there are many more like Natural Capsules @51, Medicaps @65, Eimco Elecon @270, Garware Wall Ropes @72, VTM @160, Mac Charles @ 230, Mazda @ 110, SI Paper @ 47. Most of the companies I have mentioned have been profit-making companies and some are consistently giving dividends over the last 15 years and still Mr market is quite depressed about their future. None of these are burdened with high debt that may affect their future profitability and existence. Are they really value traps?

Special Situation in APW President Systems

APW President Systems informed the exchanges on 7 January that Schneider Electric has acquired 55% shareholding in APW President Systems from promoters at a share price of INR 195. SEBI rules require an open offer of 20% to the minority shareholders. The announcement of the offer has been done and the specified date is February 4, 2011. Dates of opening and closing the offer are 2 March 2011 and 21 March 2011 respectively. The share price is currently hovering around INR 182. Let's analyze the payout of this special situation.

The promoters hold 71.3% (4312501) shares in the company while the general public holds 28.7% (1735499) shares. The open offer is for 1209600 shares, i.e. the acceptance ratio will be 69.7%. If an investor buys 100 shares of APW President Systems at INR 182 today, the total investment would be INR 18,200. If 70 shares get accepted in open offer at INR 195, he gets 13,650 back.

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.

Indo Borax - A Ben Graham value play

I was looking at the list of companies trading below their book value and came across Indo Borax Chemicals. The company's share is trading at INR 81. The company has equity worth INR 3.481 Crore of 34,81,000 shares of face value INR 10. This translates into a market capitalization of INR 28.2 Crore.

Negatives:

1. The company started paying dividend only in 2007.
2. Dividend yield at current price is just 1.875%. 
3. The company diversified in infrastructure and construction business by creating a subsidiary as mentioned in announcement dated 7 December 2009. The promoters hold 40% in the subsidiary and the company owns 60%. Good luck for corporate governance.
4. The tax/PBT was very high last year when company paid INR 3.31 Crore worth of tax on INR 7.938 Crore worth of PBT, i.e. a tax rate of 41.7%. Tax/PBT was less around 33% between 2006 and 2008.
5. I sent an email to the company to provide annual report to see the details about "Loans and Advances" which have risen from INR 7.94 Crore in FY09 to INR 22.82 Crore in FY10. Most probably they have been given to the new infrastructure subsidiary and I consider this as big negative.

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".