ICICI Bank NPAs rising alarmingly

The gross/net NPA for ICICI bank are rising alarmingly.

	ICICI Bank	Axis Bank	HDFC Bank
Sep 2007	2970.94	280.68	243.74
Dec 2007	3227.82	234.26	279.78
Mar 2008	3490.55	248.29	298.52
Jun 2008	4033.57	325.66	496.07

Till March, increase was 250 Crore every quarter, in the last quarter it was 550 Crore. The interest rates have actually started pinching only after June, when CRR and Repo rate were increased resulting in interest rates rising by 0.75% on Housing and Car Loans. May be we will see an increase of over 1000 Crore in Sep 2008 quarter. The figures for Axis Bank and HDFC Bank looks much better. The total non performing assets of HDFC Bank is being added every quarter in the balance sheet of ICICI Bank, this too after a big selling of NPAs to ARCIL (around 9000 Crore till 2006).

Many midcaps at prices of December 2003

I was recently looking at charts of some of the midcap companies and found that many of them were trading at a price level available in 2003 December when Sensex was at 6000. Here is the list:

Automotive Axles was at 300 today at 280
FDC was at 50 (100 before 1:1 bonus) today at 35
ZF Steering Gear was at 140 (280 before 1:1 bonus) today at 155

During these five years, the earnings of these companies have increased significantly (3x for Automotive Axles, 2x for FDC and 4x for ZF Steering Gear). Sensex EPS has also grown by around 3x and Sensex is at 14500 i.e. 2.42x. This shows what happens to small companies when investors lose interest from them. All these are debt free companies with significant dividend yield of more than 3%.

The secret of Sun Pharma

If you analyze the profit loss account of Sun Pharma, you will find that the company hardly pays 3-4% of its PBT(profit before tax) as Tax, while CIPLA, Cadila pays almost 20% of their PBTs as tax. The reason behind this low payout of income tax lies in one of its subsidiary partnership firm established in tax heaven of "British Virgin Island(BVI)". The rule of this island is that if a company makes 90% of its profit outside BVI, it only has to pay 1% income tax. Sun pharma does all its profitable business through this subsidiary, earns 1500 Cr worth of profits and pays meagre 2% as tax. I don't know if this should be considered good for shareholders or bad.

Sensex EPS Growth 0%?

When I posted on July 10, Sensex earnings was 807.78. Yesterday on 5th August at 14961.07, Sensex P/E is at 18.54 . Thus EPS turns out to be 806.96 less than what it was on July 10, i.e. June quarter results have lowered Sensex EPS instead of increasing it. The reason may be due to lower reported earnings by ICICI Bank, State Bank of India, ITC, ACC, Jaiprakash Associates, Mahindra & Mahindra, Maruti Suzuki, NTPC, Ranbaxy and Tata Motors. The pain has increased due to significant equity dilution by HDFC, HDFC Bank, Hindalco, ICICI Bank, Jaiprakash Associates, Reliance Infrastructure, State Bank of India and Tata Steel. As of 5 August 2008, these companies account for around 40% weightage in Sensex. The methodology of BSE site may be wrong.

Turbulent Times

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

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

Stay away from buying Realty

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

What two i's have done to Britannia

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

Year	Operating Profit Margin	Net Profit Margin
2001	8.6	5.2
2002	9.39	5.25
2003	11.36	7.46
2004	11.81	7.95
2005	11.58	8.92
2006	11.55	8.44
2007	5.77	4.58
2008	8.40	6.27

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

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

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

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

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

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

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

I would recommend STRONG BUY on Britannia today at INR 1350.

Future Sensex Candidates

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

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

The companies which look promising to me over 10-15 year period to enter Sensex are Nestle and Asian Paints. Nestle was part of Sensex till 2003 and Asian Paints was in Nifty in mid nineties. The problem with Nestle is volumes. Otherwise I am sure it will replace HUL in the next 10-15 years.