The major events over the last few weeks created a small scare for some of the Indian banks. The fear was the level of exposure to the Lehman Brothers bankruptcy and the ongoing credit crisis.
Considering that a lot of us including my family and me have our savings with ICICI bank, I decided to have a look at the Annual report of the bank in detail. Following is the analysis of the bank from a depositor’s perspective (and not an investor’s perspective).
Some positives
The bank raised 20000 Crs in 2007. As a result of the issue, the CAR (capital adequacy ratio) now stands at around 14%. The bank has an annual profit of around 4150 Crs and a consolidated profit (including subsidiaries) of around 3100 Crs.
ICICI has several subsidiaries. In aggregate the subsidiaries are making losses, mainly due to the insurance sub. Due to the insurance accounting (expensing the policy expenses in the current year), the insurance subsidiary has been showing increasing losses as it grows. However the subsidiary has value, which is growing. In all, my personal estimate for the valuation of subsidiaries is around 23000 Crs, which is around 30% of market cap and almost 50% of book value
Negatives
The bank has been in the limelight due to the losses incurred by the collapse of Lehman brothers. This has been a case of availability bias. The market has been focused on the dramatic instead of the important (as usual).
The derivative related losses (dramatic) incurred by the bank have been to the tune of around 887 Crs which have been charged to the P&L statement (marked to market) and around 203 Crs, which have been charged to reserves.
AS 30 accounting requires mark to market accounting (and P&L pass-through) for certain derivatives and reserves adjustment for others (read AS30 to understand the details).
At the same time there has been a rise in the Gross NPA from 4850 Crs to 8350 crs. This increase is more important for the bank and its valuation as retail assets account for around 60% of the bank’s assets. However the market did not react strongly to this important change as it is hidden in the Balance sheet. The NPA have increased further in the current quarter. In addition the provision are around 55% of Gross NPA. So there is still an exposure of around 3500 Crs, which could hit the P&L in the future.
accounting is pretty complex
Bank accounting and especially derivative accounting is complex. It is very difficult to make out whether the bank is making or losing money on its entire derivatives exposure at any point of time. The bank discloses the total notional exposure which is atleast 1000 times or more of the net exposure. The profit or loss is a multiple of the net exposure. So it is difficult to figure out the profit or loss on the derivative book based on the bank disclosures alone.
In addition mark to market accounting is also misleading. It is equivalent to drawing your personal profit or loss based on change in share prices. If you think a stock is worth 100 rs, and you bought it for 50 rs and the price dropped to 30, how will you account for it ?
Mark to market accounting says, report a loss of 20 now. If the price jump to 70 in the next quarter then reverse this loss and report an ‘income’ of 40. However you may choose to ignore these swings and say I intend to hold the share for next 3 years and believe the market is mispricing the stock in the interim.
So what is the truth ? frankly there is no objective truth. It depends on the specific instrument and circumstances. Accounting requires being conservative and hence the loss of 20 in the current quarter.
This is the kind of complexity we are dealing with derivatives. The bank may very well have losses on the portfolio or they may right in saying that these are only notional losses as the underlying credits are still intact.
are there solvency issues ?
I think there are no solvency issues for the bank based on the current losses and statements from the bank. The bank has reduced the credit derivatives by almost 800 Mn usd. This does not mean that the bank will not have losses in the future due to derivatives. There is a huge derivatives exposure (notional) on the banks balance sheet.
As of March 2008, the fair value for the derivatives was positive and for interest swap is midly negative (page 116) , so the bank is not losing money on those derivatives (as of march 2008) . However this value may turn negative in the future.
However the point to remember that the bank is making around almost 1000 crs per quarter on a standalone basis. In addition it has a high capital cushion and assets in the form of subsidiaries. So there is a decent amount of capital cushion to absorb any of these losses. There is always a risk of unknown losses hiding in the balance sheet in the derivative books due to black swan events. I frankly cannot evaluate and estimate those losses from publicly available documents.
Finally the trump card for the bank is the concept of ‘Too big to fail’. Do you think the Indian government would risk allowing the bank to fail (second largest bank in the country) and jeopardize the financial system?
valuation based on book value ?
I am amazed at the simplistic valuations done by a lot of people and analysts. For ex: ICICI is selling at X times book value and hence it is a buy !! If you read the Annual report, you will realise the complexity of this company. It would be silly to value the bank based on book value alone
The bank has assets (subsidiaries) and risk (derivative exposure) which are quite difficult to estimate (atleast for me). A simple book value based valuation is a foolish way to value this bank.
The minimum analysis to arrive at the final valuation is to value the bank and its subsidiaries. The derivative exposure and other liabilities need to valued separately and the net value should be derived from the difference. Luckily, investing in stocks is not like exams where I will get flunked for not answering a question. I can always pass on the stock.
Sunday, September 28, 2008
Analysing ICICI bank – from a depositor’s perspective
The major events over the last few weeks created a small scare for some of the Indian banks. The fear was the level of exposure to the Lehman Brothers bankruptcy and the ongoing credit crisis.
Considering that a lot of us including my family and me have our savings with ICICI bank, I decided to have a look at the Annual report of the bank in detail. Following is the analysis of the bank from a depositor’s perspective (and not an investor’s perspective).
Some positives
The bank raised 20000 Crs in 2007. As a result of the issue, the CAR (capital adequacy ratio) now stands at around 14%. The bank has an annual profit of around 4150 Crs and a consolidated profit (including subsidiaries) of around 3100 Crs.
ICICI has several subsidiaries. In aggregate the subsidiaries are making losses, mainly due to the insurance sub. Due to the insurance accounting (expensing the policy expenses in the current year), the insurance subsidiary has been showing increasing losses as it grows. However the subsidiary has value, which is growing. In all, my personal estimate for the valuation of subsidiaries is around 23000 Crs, which is around 30% of market cap and almost 50% of book value
Negatives
The bank has been in the limelight due to the losses incurred by the collapse of Lehman brothers. This has been a case of availability bias. The market has been focused on the dramatic instead of the important (as usual).
The derivative related losses (dramatic) incurred by the bank have been to the tune of around 887 Crs which have been charged to the P&L statement (marked to market) and around 203 Crs, which have been charged to reserves.
AS 30 accounting requires mark to market accounting (and P&L pass-through) for certain derivatives and reserves adjustment for others (read AS30 to understand the details).
At the same time there has been a rise in the Gross NPA from 4850 Crs to 8350 crs. This increase is more important for the bank and its valuation as retail assets account for around 60% of the bank’s assets. However the market did not react strongly to this important change as it is hidden in the Balance sheet. The NPA have increased further in the current quarter. In addition the provision are around 55% of Gross NPA. So there is still an exposure of around 3500 Crs, which could hit the P&L in the future.
accounting is pretty complex
Bank accounting and especially derivative accounting is complex. It is very difficult to make out whether the bank is making or losing money on its entire derivatives exposure at any point of time. The bank discloses the total notional exposure which is atleast 1000 times or more of the net exposure. The profit or loss is a multiple of the net exposure. So it is difficult to figure out the profit or loss on the derivative book based on the bank disclosures alone.
In addition mark to market accounting is also misleading. It is equivalent to drawing your personal profit or loss based on change in share prices. If you think a stock is worth 100 rs, and you bought it for 50 rs and the price dropped to 30, how will you account for it ?
Mark to market accounting says, report a loss of 20 now. If the price jump to 70 in the next quarter then reverse this loss and report an ‘income’ of 40. However you may choose to ignore these swings and say I intend to hold the share for next 3 years and believe the market is mispricing the stock in the interim.
So what is the truth ? frankly there is no objective truth. It depends on the specific instrument and circumstances. Accounting requires being conservative and hence the loss of 20 in the current quarter.
This is the kind of complexity we are dealing with derivatives. The bank may very well have losses on the portfolio or they may right in saying that these are only notional losses as the underlying credits are still intact.
are there solvency issues ?
I think there are no solvency issues for the bank based on the current losses and statements from the bank. The bank has reduced the credit derivatives by almost 800 Mn usd. This does not mean that the bank will not have losses in the future due to derivatives. There is a huge derivatives exposure (notional) on the banks balance sheet.
As of March 2008, the fair value for the derivatives was positive and for interest swap is midly negative (page 116) , so the bank is not losing money on those derivatives (as of march 2008) . However this value may turn negative in the future.
However the point to remember that the bank is making around almost 1000 crs per quarter on a standalone basis. In addition it has a high capital cushion and assets in the form of subsidiaries. So there is a decent amount of capital cushion to absorb any of these losses. There is always a risk of unknown losses hiding in the balance sheet in the derivative books due to black swan events. I frankly cannot evaluate and estimate those losses from publicly available documents.
Finally the trump card for the bank is the concept of ‘Too big to fail’. Do you think the Indian government would risk allowing the bank to fail (second largest bank in the country) and jeopardize the financial system?
valuation based on book value ?
I am amazed at the simplistic valuations done by a lot of people and analysts. For ex: ICICI is selling at X times book value and hence it is a buy !! If you read the Annual report, you will realise the complexity of this company. It would be silly to value the bank based on book value alone
The bank has assets (subsidiaries) and risk (derivative exposure) which are quite difficult to estimate (atleast for me). A simple book value based valuation is a foolish way to value this bank.
The minimum analysis to arrive at the final valuation is to value the bank and its subsidiaries. The derivative exposure and other liabilities need to valued separately and the net value should be derived from the difference. Luckily, investing in stocks is not like exams where I will get flunked for not answering a question. I can always pass on the stock.
Considering that a lot of us including my family and me have our savings with ICICI bank, I decided to have a look at the Annual report of the bank in detail. Following is the analysis of the bank from a depositor’s perspective (and not an investor’s perspective).
Some positives
The bank raised 20000 Crs in 2007. As a result of the issue, the CAR (capital adequacy ratio) now stands at around 14%. The bank has an annual profit of around 4150 Crs and a consolidated profit (including subsidiaries) of around 3100 Crs.
ICICI has several subsidiaries. In aggregate the subsidiaries are making losses, mainly due to the insurance sub. Due to the insurance accounting (expensing the policy expenses in the current year), the insurance subsidiary has been showing increasing losses as it grows. However the subsidiary has value, which is growing. In all, my personal estimate for the valuation of subsidiaries is around 23000 Crs, which is around 30% of market cap and almost 50% of book value
Negatives
The bank has been in the limelight due to the losses incurred by the collapse of Lehman brothers. This has been a case of availability bias. The market has been focused on the dramatic instead of the important (as usual).
The derivative related losses (dramatic) incurred by the bank have been to the tune of around 887 Crs which have been charged to the P&L statement (marked to market) and around 203 Crs, which have been charged to reserves.
AS 30 accounting requires mark to market accounting (and P&L pass-through) for certain derivatives and reserves adjustment for others (read AS30 to understand the details).
At the same time there has been a rise in the Gross NPA from 4850 Crs to 8350 crs. This increase is more important for the bank and its valuation as retail assets account for around 60% of the bank’s assets. However the market did not react strongly to this important change as it is hidden in the Balance sheet. The NPA have increased further in the current quarter. In addition the provision are around 55% of Gross NPA. So there is still an exposure of around 3500 Crs, which could hit the P&L in the future.
accounting is pretty complex
Bank accounting and especially derivative accounting is complex. It is very difficult to make out whether the bank is making or losing money on its entire derivatives exposure at any point of time. The bank discloses the total notional exposure which is atleast 1000 times or more of the net exposure. The profit or loss is a multiple of the net exposure. So it is difficult to figure out the profit or loss on the derivative book based on the bank disclosures alone.
In addition mark to market accounting is also misleading. It is equivalent to drawing your personal profit or loss based on change in share prices. If you think a stock is worth 100 rs, and you bought it for 50 rs and the price dropped to 30, how will you account for it ?
Mark to market accounting says, report a loss of 20 now. If the price jump to 70 in the next quarter then reverse this loss and report an ‘income’ of 40. However you may choose to ignore these swings and say I intend to hold the share for next 3 years and believe the market is mispricing the stock in the interim.
So what is the truth ? frankly there is no objective truth. It depends on the specific instrument and circumstances. Accounting requires being conservative and hence the loss of 20 in the current quarter.
This is the kind of complexity we are dealing with derivatives. The bank may very well have losses on the portfolio or they may right in saying that these are only notional losses as the underlying credits are still intact.
are there solvency issues ?
I think there are no solvency issues for the bank based on the current losses and statements from the bank. The bank has reduced the credit derivatives by almost 800 Mn usd. This does not mean that the bank will not have losses in the future due to derivatives. There is a huge derivatives exposure (notional) on the banks balance sheet.
As of March 2008, the fair value for the derivatives was positive and for interest swap is midly negative (page 116) , so the bank is not losing money on those derivatives (as of march 2008) . However this value may turn negative in the future.
However the point to remember that the bank is making around almost 1000 crs per quarter on a standalone basis. In addition it has a high capital cushion and assets in the form of subsidiaries. So there is a decent amount of capital cushion to absorb any of these losses. There is always a risk of unknown losses hiding in the balance sheet in the derivative books due to black swan events. I frankly cannot evaluate and estimate those losses from publicly available documents.
Finally the trump card for the bank is the concept of ‘Too big to fail’. Do you think the Indian government would risk allowing the bank to fail (second largest bank in the country) and jeopardize the financial system?
valuation based on book value ?
I am amazed at the simplistic valuations done by a lot of people and analysts. For ex: ICICI is selling at X times book value and hence it is a buy !! If you read the Annual report, you will realise the complexity of this company. It would be silly to value the bank based on book value alone
The bank has assets (subsidiaries) and risk (derivative exposure) which are quite difficult to estimate (atleast for me). A simple book value based valuation is a foolish way to value this bank.
The minimum analysis to arrive at the final valuation is to value the bank and its subsidiaries. The derivative exposure and other liabilities need to valued separately and the net value should be derived from the difference. Luckily, investing in stocks is not like exams where I will get flunked for not answering a question. I can always pass on the stock.
Tuesday, September 23, 2008
Value investing is simple but not easy
The above is a statement by warren buffett. It is a very apt comment. Value investing does not require a major leap of faith. Most of us can find companies selling below intrinsic value. That is the simple part. The difficult part is ignoring your emotions and buying such a stock.
Value investing is even more difficult when the market is in a momentum phase, as it was during 2003-2007, when most of us could have made money by buying the hottest stock. Investors piled into real estate, infrastructure and other hot stocks and made good money as a result. Unfortunately very few have been able to hold on to the gains. Some may have suffered losses if they entered these stocks late in the game.
In addition a lot of these investors are now blaming the markets, the weather, the government and everyone else except themselves for the losses. I have personally learnt a key lesson over time – blame yourself for the losses and you will learn from the mistakes and not repeat them in the future.
Value investing is dumb
I frequently got mail or comments then, which went this way – My friend and my milkman have made a lot of money in the last 2 years. You keep talking of value investing, intrinsic value etc etc. All that is fine …but where are the results ? I think value investing is dumb !
My response typically was – Value investing is not a fad or a technique. It is buying something for less than it is worth. However this approach has to be combined with the temprament of not getting swept up in the euphoria of the markets. As much as one has to buy undervalued stocks, one has to avoid overvalued or fully valued stocks too.
So the reason value investing is diffcult is because one looks like a complete dumb a** buying stocks which have been dropping for some time, which do not have sexy prospects and which no one wants.
Price tracks value ..eventually
In the end price tracks value. Let me repeat – Price always tracks intrinsic value. This is the fundamental law of markets. The stock price may get disconnected from intrinsic value for some time, however it eventually converges to the intrinsic value of the company. So the key to making money is to buy below intrinsic value (preferably where the intrinsic value is also increasing) and sell when the stock sells above the intrinsic value. That’s all there is to value investing ..simple to understand but not easy to execute.
As an aside, I saw the following discussion on TED ( a discussion board on stocks) and liked what vivek had to say. I would recommend reading his response towards the end of the thread. I could not have said it better. Vivek’s response kind of demonstrates why value investing is not easy
‘A Balmer Lawrie is still available at these valuations, but can you go beyond " Balmer Lawrie makes a 52-week low or What return the stock has given in the last 3 years".....the answer will be a flat "No".....
The thing is one needs to train his eyes....thats all’
Value investing is even more difficult when the market is in a momentum phase, as it was during 2003-2007, when most of us could have made money by buying the hottest stock. Investors piled into real estate, infrastructure and other hot stocks and made good money as a result. Unfortunately very few have been able to hold on to the gains. Some may have suffered losses if they entered these stocks late in the game.
In addition a lot of these investors are now blaming the markets, the weather, the government and everyone else except themselves for the losses. I have personally learnt a key lesson over time – blame yourself for the losses and you will learn from the mistakes and not repeat them in the future.
Value investing is dumb
I frequently got mail or comments then, which went this way – My friend and my milkman have made a lot of money in the last 2 years. You keep talking of value investing, intrinsic value etc etc. All that is fine …but where are the results ? I think value investing is dumb !
My response typically was – Value investing is not a fad or a technique. It is buying something for less than it is worth. However this approach has to be combined with the temprament of not getting swept up in the euphoria of the markets. As much as one has to buy undervalued stocks, one has to avoid overvalued or fully valued stocks too.
So the reason value investing is diffcult is because one looks like a complete dumb a** buying stocks which have been dropping for some time, which do not have sexy prospects and which no one wants.
Price tracks value ..eventually
In the end price tracks value. Let me repeat – Price always tracks intrinsic value. This is the fundamental law of markets. The stock price may get disconnected from intrinsic value for some time, however it eventually converges to the intrinsic value of the company. So the key to making money is to buy below intrinsic value (preferably where the intrinsic value is also increasing) and sell when the stock sells above the intrinsic value. That’s all there is to value investing ..simple to understand but not easy to execute.
As an aside, I saw the following discussion on TED ( a discussion board on stocks) and liked what vivek had to say. I would recommend reading his response towards the end of the thread. I could not have said it better. Vivek’s response kind of demonstrates why value investing is not easy
‘A Balmer Lawrie is still available at these valuations, but can you go beyond " Balmer Lawrie makes a 52-week low or What return the stock has given in the last 3 years".....the answer will be a flat "No".....
The thing is one needs to train his eyes....thats all’
Value investing is simple but not easy
The above is a statement by warren buffett. It is a very apt comment. Value investing does not require a major leap of faith. Most of us can find companies selling below intrinsic value. That is the simple part. The difficult part is ignoring your emotions and buying such a stock.
Value investing is even more difficult when the market is in a momentum phase, as it was during 2003-2007, when most of us could have made money by buying the hottest stock. Investors piled into real estate, infrastructure and other hot stocks and made good money as a result. Unfortunately very few have been able to hold on to the gains. Some may have suffered losses if they entered these stocks late in the game.
In addition a lot of these investors are now blaming the markets, the weather, the government and everyone else except themselves for the losses. I have personally learnt a key lesson over time – blame yourself for the losses and you will learn from the mistakes and not repeat them in the future.
Value investing is dumb
I frequently got mail or comments then, which went this way – My friend and my milkman have made a lot of money in the last 2 years. You keep talking of value investing, intrinsic value etc etc. All that is fine …but where are the results ? I think value investing is dumb !
My response typically was – Value investing is not a fad or a technique. It is buying something for less than it is worth. However this approach has to be combined with the temprament of not getting swept up in the euphoria of the markets. As much as one has to buy undervalued stocks, one has to avoid overvalued or fully valued stocks too.
So the reason value investing is diffcult is because one looks like a complete dumb a** buying stocks which have been dropping for some time, which do not have sexy prospects and which no one wants.
Price tracks value ..eventually
In the end price tracks value. Let me repeat – Price always tracks intrinsic value. This is the fundamental law of markets. The stock price may get disconnected from intrinsic value for some time, however it eventually converges to the intrinsic value of the company. So the key to making money is to buy below intrinsic value (preferably where the intrinsic value is also increasing) and sell when the stock sells above the intrinsic value. That’s all there is to value investing ..simple to understand but not easy to execute.
As an aside, I saw the following discussion on TED ( a discussion board on stocks) and liked what vivek had to say. I would recommend reading his response towards the end of the thread. I could not have said it better. Vivek’s response kind of demonstrates why value investing is not easy
‘A Balmer Lawrie is still available at these valuations, but can you go beyond " Balmer Lawrie makes a 52-week low or What return the stock has given in the last 3 years".....the answer will be a flat "No".....
The thing is one needs to train his eyes....thats all’
Value investing is even more difficult when the market is in a momentum phase, as it was during 2003-2007, when most of us could have made money by buying the hottest stock. Investors piled into real estate, infrastructure and other hot stocks and made good money as a result. Unfortunately very few have been able to hold on to the gains. Some may have suffered losses if they entered these stocks late in the game.
In addition a lot of these investors are now blaming the markets, the weather, the government and everyone else except themselves for the losses. I have personally learnt a key lesson over time – blame yourself for the losses and you will learn from the mistakes and not repeat them in the future.
Value investing is dumb
I frequently got mail or comments then, which went this way – My friend and my milkman have made a lot of money in the last 2 years. You keep talking of value investing, intrinsic value etc etc. All that is fine …but where are the results ? I think value investing is dumb !
My response typically was – Value investing is not a fad or a technique. It is buying something for less than it is worth. However this approach has to be combined with the temprament of not getting swept up in the euphoria of the markets. As much as one has to buy undervalued stocks, one has to avoid overvalued or fully valued stocks too.
So the reason value investing is diffcult is because one looks like a complete dumb a** buying stocks which have been dropping for some time, which do not have sexy prospects and which no one wants.
Price tracks value ..eventually
In the end price tracks value. Let me repeat – Price always tracks intrinsic value. This is the fundamental law of markets. The stock price may get disconnected from intrinsic value for some time, however it eventually converges to the intrinsic value of the company. So the key to making money is to buy below intrinsic value (preferably where the intrinsic value is also increasing) and sell when the stock sells above the intrinsic value. That’s all there is to value investing ..simple to understand but not easy to execute.
As an aside, I saw the following discussion on TED ( a discussion board on stocks) and liked what vivek had to say. I would recommend reading his response towards the end of the thread. I could not have said it better. Vivek’s response kind of demonstrates why value investing is not easy
‘A Balmer Lawrie is still available at these valuations, but can you go beyond " Balmer Lawrie makes a 52-week low or What return the stock has given in the last 3 years".....the answer will be a flat "No".....
The thing is one needs to train his eyes....thats all’
Thursday, September 18, 2008
Credit crisis – Impact on us
The crisis is now full blown. I have not seen panic at this scale personally. I have read about it, but not seen it personally. It almost feels as if companies are being targeted one at a time. Lehman went into bankruptcy and AIG just survived through government help, though equity holders have been wiped out (almost). Now it seems the market has moved on to Morgan Stanley, Goldman Sachs and Washington mutual. It almost feels as if the market is killing one company at a time. Scary!
How does it impact us in India?
I think, the impact would initially be limited to companies with Global businesses. So IT companies with revenues in this space could get hit in the short term. However I think it should work out for these companies in the medium to long term as they find new clients, geographies and start growing again. The business model for IT companies is not under threat. However in the short run, IT companies are and could keep getting hit. However I would be worried about small IT companies with high exposure to the Financial and associated sector.
The next in line to get hit could be banks like ICICI bank and others, which have foreign operations and derivatives on their balance sheets. I am currently analyzing ICICI bank and I can tell you that complexity for most banks have gone up. As I wrote earlier, I exited banks quite some time back when I realized that I could not evaluate the risks correctly. That said, I think none of the Indian banks are under serious solvency threat. The profits could get hit, but most of the Indian banks do not have massive exposure of derivatives. I am analyzing ICICI and other banks from a depositor’s point of view and not from an equity investment point of view. So I am looking at these banks from a safety point of view.
Other than the above two sectors, I cannot think of any broad sectors, which could get hit hard by this crisis.
Second order and higher order effects
What is missed out in most analysis, is the second and higher order effects of an event. Indian companies may not get hit directly, but a recession in developed countries and lack of liquidity and risk aversion is bound to affect us in the medium term.
For the last, 3-4 years almost every asset class in India has gone up. There were all kinds of reasons given for this rise, but rarely was liquidity mentioned as one of the key reasons. Now with the liquidity drying up, I don’t think we will be seeing such double-digit growths in Real estate and other markets.
What am I doing?
I don’t get worried about drops in stock prices. Such drops are a part of the game. When I invest in equity, my main worry is permanent loss of capital and not temporary losses due to volatility.
Personally, I had put my buying on hold for the last couple of months. For some reason, I felt that the markets could go south in the medium term. As a result I stopped buying some time back. However I did not back this hunch by going short, as I may very well may have been wrong. I did buy some puts, but did not build a decent position as I was not sure. I think I should start trusting my gut more.
I am still standing pat and not planning major activity for some time. I personally don’t expect these issues to get worked out in a few weeks and feel that I could be getting better bargains in the near future.
I have a question and would appreciate if some could answer, as I have not been able to figure it out – If the bank/ DP fails, what happens to my shares. Is it similar to a savings account where you can lose your savings or are the shares held by NSDL or someone else and hence I am safe?
How does it impact us in India?
I think, the impact would initially be limited to companies with Global businesses. So IT companies with revenues in this space could get hit in the short term. However I think it should work out for these companies in the medium to long term as they find new clients, geographies and start growing again. The business model for IT companies is not under threat. However in the short run, IT companies are and could keep getting hit. However I would be worried about small IT companies with high exposure to the Financial and associated sector.
The next in line to get hit could be banks like ICICI bank and others, which have foreign operations and derivatives on their balance sheets. I am currently analyzing ICICI bank and I can tell you that complexity for most banks have gone up. As I wrote earlier, I exited banks quite some time back when I realized that I could not evaluate the risks correctly. That said, I think none of the Indian banks are under serious solvency threat. The profits could get hit, but most of the Indian banks do not have massive exposure of derivatives. I am analyzing ICICI and other banks from a depositor’s point of view and not from an equity investment point of view. So I am looking at these banks from a safety point of view.
Other than the above two sectors, I cannot think of any broad sectors, which could get hit hard by this crisis.
Second order and higher order effects
What is missed out in most analysis, is the second and higher order effects of an event. Indian companies may not get hit directly, but a recession in developed countries and lack of liquidity and risk aversion is bound to affect us in the medium term.
For the last, 3-4 years almost every asset class in India has gone up. There were all kinds of reasons given for this rise, but rarely was liquidity mentioned as one of the key reasons. Now with the liquidity drying up, I don’t think we will be seeing such double-digit growths in Real estate and other markets.
What am I doing?
I don’t get worried about drops in stock prices. Such drops are a part of the game. When I invest in equity, my main worry is permanent loss of capital and not temporary losses due to volatility.
Personally, I had put my buying on hold for the last couple of months. For some reason, I felt that the markets could go south in the medium term. As a result I stopped buying some time back. However I did not back this hunch by going short, as I may very well may have been wrong. I did buy some puts, but did not build a decent position as I was not sure. I think I should start trusting my gut more.
I am still standing pat and not planning major activity for some time. I personally don’t expect these issues to get worked out in a few weeks and feel that I could be getting better bargains in the near future.
I have a question and would appreciate if some could answer, as I have not been able to figure it out – If the bank/ DP fails, what happens to my shares. Is it similar to a savings account where you can lose your savings or are the shares held by NSDL or someone else and hence I am safe?
Credit crisis – Impact on us
The crisis is now full blown. I have not seen panic at this scale personally. I have read about it, but not seen it personally. It almost feels as if companies are being targeted one at a time. Lehman went into bankruptcy and AIG just survived through government help, though equity holders have been wiped out (almost). Now it seems the market has moved on to Morgan Stanley, Goldman Sachs and Washington mutual. It almost feels as if the market is killing one company at a time. Scary!
How does it impact us in India?
I think, the impact would initially be limited to companies with Global businesses. So IT companies with revenues in this space could get hit in the short term. However I think it should work out for these companies in the medium to long term as they find new clients, geographies and start growing again. The business model for IT companies is not under threat. However in the short run, IT companies are and could keep getting hit. However I would be worried about small IT companies with high exposure to the Financial and associated sector.
The next in line to get hit could be banks like ICICI bank and others, which have foreign operations and derivatives on their balance sheets. I am currently analyzing ICICI bank and I can tell you that complexity for most banks have gone up. As I wrote earlier, I exited banks quite some time back when I realized that I could not evaluate the risks correctly. That said, I think none of the Indian banks are under serious solvency threat. The profits could get hit, but most of the Indian banks do not have massive exposure of derivatives. I am analyzing ICICI and other banks from a depositor’s point of view and not from an equity investment point of view. So I am looking at these banks from a safety point of view.
Other than the above two sectors, I cannot think of any broad sectors, which could get hit hard by this crisis.
Second order and higher order effects
What is missed out in most analysis, is the second and higher order effects of an event. Indian companies may not get hit directly, but a recession in developed countries and lack of liquidity and risk aversion is bound to affect us in the medium term.
For the last, 3-4 years almost every asset class in India has gone up. There were all kinds of reasons given for this rise, but rarely was liquidity mentioned as one of the key reasons. Now with the liquidity drying up, I don’t think we will be seeing such double-digit growths in Real estate and other markets.
What am I doing?
I don’t get worried about drops in stock prices. Such drops are a part of the game. When I invest in equity, my main worry is permanent loss of capital and not temporary losses due to volatility.
Personally, I had put my buying on hold for the last couple of months. For some reason, I felt that the markets could go south in the medium term. As a result I stopped buying some time back. However I did not back this hunch by going short, as I may very well may have been wrong. I did buy some puts, but did not build a decent position as I was not sure. I think I should start trusting my gut more.
I am still standing pat and not planning major activity for some time. I personally don’t expect these issues to get worked out in a few weeks and feel that I could be getting better bargains in the near future.
I have a question and would appreciate if some could answer, as I have not been able to figure it out – If the bank/ DP fails, what happens to my shares. Is it similar to a savings account where you can lose your savings or are the shares held by NSDL or someone else and hence I am safe?
How does it impact us in India?
I think, the impact would initially be limited to companies with Global businesses. So IT companies with revenues in this space could get hit in the short term. However I think it should work out for these companies in the medium to long term as they find new clients, geographies and start growing again. The business model for IT companies is not under threat. However in the short run, IT companies are and could keep getting hit. However I would be worried about small IT companies with high exposure to the Financial and associated sector.
The next in line to get hit could be banks like ICICI bank and others, which have foreign operations and derivatives on their balance sheets. I am currently analyzing ICICI bank and I can tell you that complexity for most banks have gone up. As I wrote earlier, I exited banks quite some time back when I realized that I could not evaluate the risks correctly. That said, I think none of the Indian banks are under serious solvency threat. The profits could get hit, but most of the Indian banks do not have massive exposure of derivatives. I am analyzing ICICI and other banks from a depositor’s point of view and not from an equity investment point of view. So I am looking at these banks from a safety point of view.
Other than the above two sectors, I cannot think of any broad sectors, which could get hit hard by this crisis.
Second order and higher order effects
What is missed out in most analysis, is the second and higher order effects of an event. Indian companies may not get hit directly, but a recession in developed countries and lack of liquidity and risk aversion is bound to affect us in the medium term.
For the last, 3-4 years almost every asset class in India has gone up. There were all kinds of reasons given for this rise, but rarely was liquidity mentioned as one of the key reasons. Now with the liquidity drying up, I don’t think we will be seeing such double-digit growths in Real estate and other markets.
What am I doing?
I don’t get worried about drops in stock prices. Such drops are a part of the game. When I invest in equity, my main worry is permanent loss of capital and not temporary losses due to volatility.
Personally, I had put my buying on hold for the last couple of months. For some reason, I felt that the markets could go south in the medium term. As a result I stopped buying some time back. However I did not back this hunch by going short, as I may very well may have been wrong. I did buy some puts, but did not build a decent position as I was not sure. I think I should start trusting my gut more.
I am still standing pat and not planning major activity for some time. I personally don’t expect these issues to get worked out in a few weeks and feel that I could be getting better bargains in the near future.
I have a question and would appreciate if some could answer, as I have not been able to figure it out – If the bank/ DP fails, what happens to my shares. Is it similar to a savings account where you can lose your savings or are the shares held by NSDL or someone else and hence I am safe?
Sunday, September 14, 2008
A failure a week
First it was Bear stearns, but the US treasury (similar to our Finance ministry) and the Fed (similar to our RBI) engineered a bailout. Bear stearns, an investment bank was bought out by J P morgan, a commerical bank, in March. This bailout was done to calm the markets and reduce systemic risk.
Well, next in line were Freddie Mac and Fannie Mae which were nationalized (federal takeover) for the same reason last week. Now this week it is the turn of Lehman brothers which seems to be on the verge or ready to file for bankruptcy protection. Merrill lynch, another Investment bank and brokerage, is in merger talks with Bank of america. After Lehman brothers, Merrill lynch seems to be the weakest firm and so it could come under attack.
More companies at risk
AIG, one of the largest insurers has fallen by 30% and is at risk now. So is washington mutual, another large bank. So we have a situation where the credit crisis (acutally bad investments on part of the banks and institutions) is now engulfing the financial system. Finally the S*** is hitting the fan !
We could very well see a domino effect and the US government may decide not to bail out any more companies. We could be in for some nasty times.
What does it mean for us ?
So how does it effect us ? Well if you are into medium to long term investing, not much. Actually the panic could create opportunities for us in india. I really don’t see Indian companies getting impacted (other than IT or export oriented companies due to a possible recession in the US and other economies). The impact for IT companies in the long run should not be too much. However there could a short term impact in companies with a high percentage of revenue in the BFSI segment.
All this mess, makes you wonder what kind of risk our banks and financial services firms are taking. I am repeatedly reminded of this statement by warren buffett
‘When you combine ignorance with leverage you get some pretty interesting results’
Well, next in line were Freddie Mac and Fannie Mae which were nationalized (federal takeover) for the same reason last week. Now this week it is the turn of Lehman brothers which seems to be on the verge or ready to file for bankruptcy protection. Merrill lynch, another Investment bank and brokerage, is in merger talks with Bank of america. After Lehman brothers, Merrill lynch seems to be the weakest firm and so it could come under attack.
More companies at risk
AIG, one of the largest insurers has fallen by 30% and is at risk now. So is washington mutual, another large bank. So we have a situation where the credit crisis (acutally bad investments on part of the banks and institutions) is now engulfing the financial system. Finally the S*** is hitting the fan !
We could very well see a domino effect and the US government may decide not to bail out any more companies. We could be in for some nasty times.
What does it mean for us ?
So how does it effect us ? Well if you are into medium to long term investing, not much. Actually the panic could create opportunities for us in india. I really don’t see Indian companies getting impacted (other than IT or export oriented companies due to a possible recession in the US and other economies). The impact for IT companies in the long run should not be too much. However there could a short term impact in companies with a high percentage of revenue in the BFSI segment.
All this mess, makes you wonder what kind of risk our banks and financial services firms are taking. I am repeatedly reminded of this statement by warren buffett
‘When you combine ignorance with leverage you get some pretty interesting results’
A failure a week
First it was Bear stearns, but the US treasury (similar to our Finance ministry) and the Fed (similar to our RBI) engineered a bailout. Bear stearns, an investment bank was bought out by J P morgan, a commerical bank, in March. This bailout was done to calm the markets and reduce systemic risk.
Well, next in line were Freddie Mac and Fannie Mae which were nationalized (federal takeover) for the same reason last week. Now this week it is the turn of Lehman brothers which seems to be on the verge or ready to file for bankruptcy protection. Merrill lynch, another Investment bank and brokerage, is in merger talks with Bank of america. After Lehman brothers, Merrill lynch seems to be the weakest firm and so it could come under attack.
More companies at risk
AIG, one of the largest insurers has fallen by 30% and is at risk now. So is washington mutual, another large bank. So we have a situation where the credit crisis (acutally bad investments on part of the banks and institutions) is now engulfing the financial system. Finally the S*** is hitting the fan !
We could very well see a domino effect and the US government may decide not to bail out any more companies. We could be in for some nasty times.
What does it mean for us ?
So how does it effect us ? Well if you are into medium to long term investing, not much. Actually the panic could create opportunities for us in india. I really don’t see Indian companies getting impacted (other than IT or export oriented companies due to a possible recession in the US and other economies). The impact for IT companies in the long run should not be too much. However there could a short term impact in companies with a high percentage of revenue in the BFSI segment.
All this mess, makes you wonder what kind of risk our banks and financial services firms are taking. I am repeatedly reminded of this statement by warren buffett
‘When you combine ignorance with leverage you get some pretty interesting results’
Well, next in line were Freddie Mac and Fannie Mae which were nationalized (federal takeover) for the same reason last week. Now this week it is the turn of Lehman brothers which seems to be on the verge or ready to file for bankruptcy protection. Merrill lynch, another Investment bank and brokerage, is in merger talks with Bank of america. After Lehman brothers, Merrill lynch seems to be the weakest firm and so it could come under attack.
More companies at risk
AIG, one of the largest insurers has fallen by 30% and is at risk now. So is washington mutual, another large bank. So we have a situation where the credit crisis (acutally bad investments on part of the banks and institutions) is now engulfing the financial system. Finally the S*** is hitting the fan !
We could very well see a domino effect and the US government may decide not to bail out any more companies. We could be in for some nasty times.
What does it mean for us ?
So how does it effect us ? Well if you are into medium to long term investing, not much. Actually the panic could create opportunities for us in india. I really don’t see Indian companies getting impacted (other than IT or export oriented companies due to a possible recession in the US and other economies). The impact for IT companies in the long run should not be too much. However there could a short term impact in companies with a high percentage of revenue in the BFSI segment.
All this mess, makes you wonder what kind of risk our banks and financial services firms are taking. I am repeatedly reminded of this statement by warren buffett
‘When you combine ignorance with leverage you get some pretty interesting results’
Thursday, September 11, 2008
Analysis : BEL annual results
Read my earlier analysis of BEL here
Results summary
The company had an average year in 2007-2008. The sales growth was around 7% and the profit growth was around the same. The net profit margin improved to around 20%. The company maintained the ROE numbers at the 25%+ levels and continues to be a zero debt- cash rich company
The open order book has now increased to 9586 Crs with around 3100 Crs executable in the current year. This provide visibility to around 80% of the annual revenue.
The business is skewed to the fourth quarter due to the projects nature of the business and hence the company accrues almost 60% of its profit in the last quarter.
The positives
The company maintained its ROE, margins and other key performance indicators such as order book, Fixed asset Turnover ratio, Raw material costs etc.
In addition the company is now spending almost 5.1% of revenue on R&D and plans to increase it to 8-9% of sales. This is a very positive development as R&D is crucial in this business . BEL is among the very few indian companies which spend on R&D and may have the highest spend in terms of sales. The company has been developing a lot of new products and now gets almost 83% of the turnover from indigenously developed products
The company has conservative accounting for foreign exchange (Company has no derivatives) and charges all changes to the Profit and loss statement.
Finally the company continues to be a debt free company with almost 2400 Crs in cash on the books. Net of cash, the ROE numbers of the company are fairly high, which reflects the strong competitive advantage of the company.
The negatives
The number that concerns for me is the high level of recievables. The recievables have shot up from around 1000 odd crores in 2005-06 to around 2080 Crs in 2007-08. As a result recievables have consumed almost 60% of the free cash for the last 2 years. This is very discomforting and will have to watched closely. The management has indicated that they are planning to bring it down, however I am still concerned about this number which is now a red flag.
The other concern is the very high skew for the fourth quarter. It is not very healthy to book so much business in a single quarter, especially the year end to make the numbers. Projects type business (for ex: blue star) have higher skews in Q4, however such skew results in poor recievables turns, bad debts and other issues (more on that later).
The valuation
The company now sells at around 6 times earnings (net of cash). So the market is clearly expecting the company to perform pretty badly. Now this is a company earning very high return on capital, growing in mid to low teens and in a business which is pretty immune to the economy (defence spending). In addition, though private companies are now being allowed in defence since 2001, BEL has been able to do well.
Other than the fact that the company is PSU, I cannot find a reason for almost a 50-60% drop in the stock price (other than that the market as a whole has declined).
Added note : I would not read too much into the Q1 results. As I said earlier in the post, if the company books too much revenue in Q4, the next years Q1 results get impacted.
I have loaded the a detailed analysis of the company in google groups.
Results summary
The company had an average year in 2007-2008. The sales growth was around 7% and the profit growth was around the same. The net profit margin improved to around 20%. The company maintained the ROE numbers at the 25%+ levels and continues to be a zero debt- cash rich company
The open order book has now increased to 9586 Crs with around 3100 Crs executable in the current year. This provide visibility to around 80% of the annual revenue.
The business is skewed to the fourth quarter due to the projects nature of the business and hence the company accrues almost 60% of its profit in the last quarter.
The positives
The company maintained its ROE, margins and other key performance indicators such as order book, Fixed asset Turnover ratio, Raw material costs etc.
In addition the company is now spending almost 5.1% of revenue on R&D and plans to increase it to 8-9% of sales. This is a very positive development as R&D is crucial in this business . BEL is among the very few indian companies which spend on R&D and may have the highest spend in terms of sales. The company has been developing a lot of new products and now gets almost 83% of the turnover from indigenously developed products
The company has conservative accounting for foreign exchange (Company has no derivatives) and charges all changes to the Profit and loss statement.
Finally the company continues to be a debt free company with almost 2400 Crs in cash on the books. Net of cash, the ROE numbers of the company are fairly high, which reflects the strong competitive advantage of the company.
The negatives
The number that concerns for me is the high level of recievables. The recievables have shot up from around 1000 odd crores in 2005-06 to around 2080 Crs in 2007-08. As a result recievables have consumed almost 60% of the free cash for the last 2 years. This is very discomforting and will have to watched closely. The management has indicated that they are planning to bring it down, however I am still concerned about this number which is now a red flag.
The other concern is the very high skew for the fourth quarter. It is not very healthy to book so much business in a single quarter, especially the year end to make the numbers. Projects type business (for ex: blue star) have higher skews in Q4, however such skew results in poor recievables turns, bad debts and other issues (more on that later).
The valuation
The company now sells at around 6 times earnings (net of cash). So the market is clearly expecting the company to perform pretty badly. Now this is a company earning very high return on capital, growing in mid to low teens and in a business which is pretty immune to the economy (defence spending). In addition, though private companies are now being allowed in defence since 2001, BEL has been able to do well.
Other than the fact that the company is PSU, I cannot find a reason for almost a 50-60% drop in the stock price (other than that the market as a whole has declined).
Added note : I would not read too much into the Q1 results. As I said earlier in the post, if the company books too much revenue in Q4, the next years Q1 results get impacted.
I have loaded the a detailed analysis of the company in google groups.
Analysis : BEL annual results
Read my earlier analysis of BEL here
Results summary
The company had an average year in 2007-2008. The sales growth was around 7% and the profit growth was around the same. The net profit margin improved to around 20%. The company maintained the ROE numbers at the 25%+ levels and continues to be a zero debt- cash rich company
The open order book has now increased to 9586 Crs with around 3100 Crs executable in the current year. This provide visibility to around 80% of the annual revenue.
The business is skewed to the fourth quarter due to the projects nature of the business and hence the company accrues almost 60% of its profit in the last quarter.
The positives
The company maintained its ROE, margins and other key performance indicators such as order book, Fixed asset Turnover ratio, Raw material costs etc.
In addition the company is now spending almost 5.1% of revenue on R&D and plans to increase it to 8-9% of sales. This is a very positive development as R&D is crucial in this business . BEL is among the very few indian companies which spend on R&D and may have the highest spend in terms of sales. The company has been developing a lot of new products and now gets almost 83% of the turnover from indigenously developed products
The company has conservative accounting for foreign exchange (Company has no derivatives) and charges all changes to the Profit and loss statement.
Finally the company continues to be a debt free company with almost 2400 Crs in cash on the books. Net of cash, the ROE numbers of the company are fairly high, which reflects the strong competitive advantage of the company.
The negatives
The number that concerns for me is the high level of recievables. The recievables have shot up from around 1000 odd crores in 2005-06 to around 2080 Crs in 2007-08. As a result recievables have consumed almost 60% of the free cash for the last 2 years. This is very discomforting and will have to watched closely. The management has indicated that they are planning to bring it down, however I am still concerned about this number which is now a red flag.
The other concern is the very high skew for the fourth quarter. It is not very healthy to book so much business in a single quarter, especially the year end to make the numbers. Projects type business (for ex: blue star) have higher skews in Q4, however such skew results in poor recievables turns, bad debts and other issues (more on that later).
The valuation
The company now sells at around 6 times earnings (net of cash). So the market is clearly expecting the company to perform pretty badly. Now this is a company earning very high return on capital, growing in mid to low teens and in a business which is pretty immune to the economy (defence spending). In addition, though private companies are now being allowed in defence since 2001, BEL has been able to do well.
Other than the fact that the company is PSU, I cannot find a reason for almost a 50-60% drop in the stock price (other than that the market as a whole has declined).
Added note : I would not read too much into the Q1 results. As I said earlier in the post, if the company books too much revenue in Q4, the next years Q1 results get impacted.
I have loaded the a detailed analysis of the company in google groups.
Results summary
The company had an average year in 2007-2008. The sales growth was around 7% and the profit growth was around the same. The net profit margin improved to around 20%. The company maintained the ROE numbers at the 25%+ levels and continues to be a zero debt- cash rich company
The open order book has now increased to 9586 Crs with around 3100 Crs executable in the current year. This provide visibility to around 80% of the annual revenue.
The business is skewed to the fourth quarter due to the projects nature of the business and hence the company accrues almost 60% of its profit in the last quarter.
The positives
The company maintained its ROE, margins and other key performance indicators such as order book, Fixed asset Turnover ratio, Raw material costs etc.
In addition the company is now spending almost 5.1% of revenue on R&D and plans to increase it to 8-9% of sales. This is a very positive development as R&D is crucial in this business . BEL is among the very few indian companies which spend on R&D and may have the highest spend in terms of sales. The company has been developing a lot of new products and now gets almost 83% of the turnover from indigenously developed products
The company has conservative accounting for foreign exchange (Company has no derivatives) and charges all changes to the Profit and loss statement.
Finally the company continues to be a debt free company with almost 2400 Crs in cash on the books. Net of cash, the ROE numbers of the company are fairly high, which reflects the strong competitive advantage of the company.
The negatives
The number that concerns for me is the high level of recievables. The recievables have shot up from around 1000 odd crores in 2005-06 to around 2080 Crs in 2007-08. As a result recievables have consumed almost 60% of the free cash for the last 2 years. This is very discomforting and will have to watched closely. The management has indicated that they are planning to bring it down, however I am still concerned about this number which is now a red flag.
The other concern is the very high skew for the fourth quarter. It is not very healthy to book so much business in a single quarter, especially the year end to make the numbers. Projects type business (for ex: blue star) have higher skews in Q4, however such skew results in poor recievables turns, bad debts and other issues (more on that later).
The valuation
The company now sells at around 6 times earnings (net of cash). So the market is clearly expecting the company to perform pretty badly. Now this is a company earning very high return on capital, growing in mid to low teens and in a business which is pretty immune to the economy (defence spending). In addition, though private companies are now being allowed in defence since 2001, BEL has been able to do well.
Other than the fact that the company is PSU, I cannot find a reason for almost a 50-60% drop in the stock price (other than that the market as a whole has declined).
Added note : I would not read too much into the Q1 results. As I said earlier in the post, if the company books too much revenue in Q4, the next years Q1 results get impacted.
I have loaded the a detailed analysis of the company in google groups.
Sunday, September 07, 2008
Replying to a comment, a correction and misc thoughts
I got the following comment recently
If I take u back to 1994, how would u have spotted Infosys. The only way one could spot it could be through the market opportunity, good results and good management.or u may enlighten if there was any other way. So it could have been a kind of recurring deposit wherein one wud have seen good results and put money in that company every quarter.
I agree there could have been companies where the growth wud have stopped, but then its like finding out 20 horses in a race of 5000 and then slowly and steadily identifying the best horse through results only. When I say results I mean higher EPS also and not just a company like Teledata or any other which diluted its equity too.
Thats what big companies like GE, Tatas do. Hire gud people and then thru performance weed out the non performers.
Agreed that Educomp is richly valued or investing in Infosys in 2000 wud have been burning fingers. What I am saying is that implmenting the value investing approach with growth companies.Take micro technologies for instance. It has been growing at CAGR of >50% for last 4 years. It has a book value of 206 approx. It trades at 220. EPS of around 50. Almost no debt. Mcap of <250>60% CAGR for last few years.
These companies are not richly valued at all.Thru Value Investing combined with Growth, I could see huge returns. Unfortunately I did not put a lot for money. e.g Rajesh Exports in a single year increased its sales from 200 to 2200 crore somewhere around 2003. That time the stock did not appreciate and had excellent value(128 book value, eps around 40, Price around 150. It gave 25 times returns since then), That was the time to enter and make huge money. and I did but with a small amount as I was learning then.
Following is my response :
Hi anonymous
There is a book, The gorrila game, which talks about an approach on how to invest in tech companies.
Approach is similar to the one you mention ..buy the whole basket ..and then follow the results of each. sell the poor performers and invest the cash into the good performers. That could have been a way to make money in infosys.
However it would have been diffcult to have the foresight in 1994 that infosys would do so well.even employees working in infosys did not recognise that (employees who were given options then thought the options were worthless).
I think growth is compatible with valueinvesting. Growth in the end, is a variable in the valuation process. As long as your are paying less than the growth implied intrinsic value, you will do well. So microtechnologies and Geodesic may fall in that bucket. They maybe insanely undervalued due to the excellent prospects. I have however not looked at these companies and hence cannot comment. However I would definitely look at them now.
Regarding your experience with rajesh exports, I can understand what happened as I have gone through similar experiences several times – namely how do you know beforehand that you are right on a company. I think as one gains experience, one learns to identify and benefit from such opporunities.
A correction
In the valuation of several companies I have used the following formulae to check the valuation
Mcap – cash on hand = Net Mcap
Net Mcap / Net profit = effective PE.
There is an error in the above approach. Typically the above cash earns 8-10% as part of the other income. The net profit should be adjusted with this non core income to arrive at the effective PE, otherwise you end up double counting the cash.
The error, lucklily has not changed most of the valuations I have done, but it is an error all the same and has a bigger impact if the cash as a % of market cap (mcap) is high. It is such an obvious error, but I have missed it till now. Well, better late than never.
A quote
I saw this quote from Keynes (A famous economist)
When the facts change, I change my mind. What do you do, sir?
Reply to a criticism during the Great Depression of having changed his position on monetary policy, as quoted in Lost Prophets: An Insider's History of the Modern Eonomists (1994) by Alfred L. Malabre, p. 220
This quote is very apt in investing. One analyses companies based on present facts and a set of assumptions. Valuation is finally an exercise of projecting the future. By being conservative, you can reduce the possiblity of an error. However when facts change dramatically, I am reminded of the above quote and find it prudent to change my mind – nothing wrong with that. Even a 60-70% success rate in picking stocks (being right 6-7 times out of 10) can give very good results in the long run.
Misc thoughts
I am reading through the Annual reports of several companies which I follow. I will be posting my analysis on the same. The market seems to be going one step forward and one step back. There are problems developing in the US and the markets may start weakening in the US. In india, inflation seems to be high and somehow the policy response has still not been strong enough. I think the RBI thinks that this inflation is temporary and it will cool on its own.
I hope they are right for everyone’s sake. If however they are wrong and they forced to hike the rates further to kill inflation, then we could have nasty times ahead of us in the market.
If I take u back to 1994, how would u have spotted Infosys. The only way one could spot it could be through the market opportunity, good results and good management.or u may enlighten if there was any other way. So it could have been a kind of recurring deposit wherein one wud have seen good results and put money in that company every quarter.
I agree there could have been companies where the growth wud have stopped, but then its like finding out 20 horses in a race of 5000 and then slowly and steadily identifying the best horse through results only. When I say results I mean higher EPS also and not just a company like Teledata or any other which diluted its equity too.
Thats what big companies like GE, Tatas do. Hire gud people and then thru performance weed out the non performers.
Agreed that Educomp is richly valued or investing in Infosys in 2000 wud have been burning fingers. What I am saying is that implmenting the value investing approach with growth companies.Take micro technologies for instance. It has been growing at CAGR of >50% for last 4 years. It has a book value of 206 approx. It trades at 220. EPS of around 50. Almost no debt. Mcap of <250>60% CAGR for last few years.
These companies are not richly valued at all.Thru Value Investing combined with Growth, I could see huge returns. Unfortunately I did not put a lot for money. e.g Rajesh Exports in a single year increased its sales from 200 to 2200 crore somewhere around 2003. That time the stock did not appreciate and had excellent value(128 book value, eps around 40, Price around 150. It gave 25 times returns since then), That was the time to enter and make huge money. and I did but with a small amount as I was learning then.
Following is my response :
Hi anonymous
There is a book, The gorrila game, which talks about an approach on how to invest in tech companies.
Approach is similar to the one you mention ..buy the whole basket ..and then follow the results of each. sell the poor performers and invest the cash into the good performers. That could have been a way to make money in infosys.
However it would have been diffcult to have the foresight in 1994 that infosys would do so well.even employees working in infosys did not recognise that (employees who were given options then thought the options were worthless).
I think growth is compatible with valueinvesting. Growth in the end, is a variable in the valuation process. As long as your are paying less than the growth implied intrinsic value, you will do well. So microtechnologies and Geodesic may fall in that bucket. They maybe insanely undervalued due to the excellent prospects. I have however not looked at these companies and hence cannot comment. However I would definitely look at them now.
Regarding your experience with rajesh exports, I can understand what happened as I have gone through similar experiences several times – namely how do you know beforehand that you are right on a company. I think as one gains experience, one learns to identify and benefit from such opporunities.
A correction
In the valuation of several companies I have used the following formulae to check the valuation
Mcap – cash on hand = Net Mcap
Net Mcap / Net profit = effective PE.
There is an error in the above approach. Typically the above cash earns 8-10% as part of the other income. The net profit should be adjusted with this non core income to arrive at the effective PE, otherwise you end up double counting the cash.
The error, lucklily has not changed most of the valuations I have done, but it is an error all the same and has a bigger impact if the cash as a % of market cap (mcap) is high. It is such an obvious error, but I have missed it till now. Well, better late than never.
A quote
I saw this quote from Keynes (A famous economist)
When the facts change, I change my mind. What do you do, sir?
Reply to a criticism during the Great Depression of having changed his position on monetary policy, as quoted in Lost Prophets: An Insider's History of the Modern Eonomists (1994) by Alfred L. Malabre, p. 220
This quote is very apt in investing. One analyses companies based on present facts and a set of assumptions. Valuation is finally an exercise of projecting the future. By being conservative, you can reduce the possiblity of an error. However when facts change dramatically, I am reminded of the above quote and find it prudent to change my mind – nothing wrong with that. Even a 60-70% success rate in picking stocks (being right 6-7 times out of 10) can give very good results in the long run.
Misc thoughts
I am reading through the Annual reports of several companies which I follow. I will be posting my analysis on the same. The market seems to be going one step forward and one step back. There are problems developing in the US and the markets may start weakening in the US. In india, inflation seems to be high and somehow the policy response has still not been strong enough. I think the RBI thinks that this inflation is temporary and it will cool on its own.
I hope they are right for everyone’s sake. If however they are wrong and they forced to hike the rates further to kill inflation, then we could have nasty times ahead of us in the market.
Replying to a comment, a correction and misc thoughts
I got the following comment recently
If I take u back to 1994, how would u have spotted Infosys. The only way one could spot it could be through the market opportunity, good results and good management.or u may enlighten if there was any other way. So it could have been a kind of recurring deposit wherein one wud have seen good results and put money in that company every quarter.
I agree there could have been companies where the growth wud have stopped, but then its like finding out 20 horses in a race of 5000 and then slowly and steadily identifying the best horse through results only. When I say results I mean higher EPS also and not just a company like Teledata or any other which diluted its equity too.
Thats what big companies like GE, Tatas do. Hire gud people and then thru performance weed out the non performers.
Agreed that Educomp is richly valued or investing in Infosys in 2000 wud have been burning fingers. What I am saying is that implmenting the value investing approach with growth companies.Take micro technologies for instance. It has been growing at CAGR of >50% for last 4 years. It has a book value of 206 approx. It trades at 220. EPS of around 50. Almost no debt. Mcap of <250>60% CAGR for last few years.
These companies are not richly valued at all.Thru Value Investing combined with Growth, I could see huge returns. Unfortunately I did not put a lot for money. e.g Rajesh Exports in a single year increased its sales from 200 to 2200 crore somewhere around 2003. That time the stock did not appreciate and had excellent value(128 book value, eps around 40, Price around 150. It gave 25 times returns since then), That was the time to enter and make huge money. and I did but with a small amount as I was learning then.
Following is my response :
Hi anonymous
There is a book, The gorrila game, which talks about an approach on how to invest in tech companies.
Approach is similar to the one you mention ..buy the whole basket ..and then follow the results of each. sell the poor performers and invest the cash into the good performers. That could have been a way to make money in infosys.
However it would have been diffcult to have the foresight in 1994 that infosys would do so well.even employees working in infosys did not recognise that (employees who were given options then thought the options were worthless).
I think growth is compatible with valueinvesting. Growth in the end, is a variable in the valuation process. As long as your are paying less than the growth implied intrinsic value, you will do well. So microtechnologies and Geodesic may fall in that bucket. They maybe insanely undervalued due to the excellent prospects. I have however not looked at these companies and hence cannot comment. However I would definitely look at them now.
Regarding your experience with rajesh exports, I can understand what happened as I have gone through similar experiences several times – namely how do you know beforehand that you are right on a company. I think as one gains experience, one learns to identify and benefit from such opporunities.
A correction
In the valuation of several companies I have used the following formulae to check the valuation
Mcap – cash on hand = Net Mcap
Net Mcap / Net profit = effective PE.
There is an error in the above approach. Typically the above cash earns 8-10% as part of the other income. The net profit should be adjusted with this non core income to arrive at the effective PE, otherwise you end up double counting the cash.
The error, lucklily has not changed most of the valuations I have done, but it is an error all the same and has a bigger impact if the cash as a % of market cap (mcap) is high. It is such an obvious error, but I have missed it till now. Well, better late than never.
A quote
I saw this quote from Keynes (A famous economist)
When the facts change, I change my mind. What do you do, sir?
Reply to a criticism during the Great Depression of having changed his position on monetary policy, as quoted in Lost Prophets: An Insider's History of the Modern Eonomists (1994) by Alfred L. Malabre, p. 220
This quote is very apt in investing. One analyses companies based on present facts and a set of assumptions. Valuation is finally an exercise of projecting the future. By being conservative, you can reduce the possiblity of an error. However when facts change dramatically, I am reminded of the above quote and find it prudent to change my mind – nothing wrong with that. Even a 60-70% success rate in picking stocks (being right 6-7 times out of 10) can give very good results in the long run.
Misc thoughts
I am reading through the Annual reports of several companies which I follow. I will be posting my analysis on the same. The market seems to be going one step forward and one step back. There are problems developing in the US and the markets may start weakening in the US. In india, inflation seems to be high and somehow the policy response has still not been strong enough. I think the RBI thinks that this inflation is temporary and it will cool on its own.
I hope they are right for everyone’s sake. If however they are wrong and they forced to hike the rates further to kill inflation, then we could have nasty times ahead of us in the market.
If I take u back to 1994, how would u have spotted Infosys. The only way one could spot it could be through the market opportunity, good results and good management.or u may enlighten if there was any other way. So it could have been a kind of recurring deposit wherein one wud have seen good results and put money in that company every quarter.
I agree there could have been companies where the growth wud have stopped, but then its like finding out 20 horses in a race of 5000 and then slowly and steadily identifying the best horse through results only. When I say results I mean higher EPS also and not just a company like Teledata or any other which diluted its equity too.
Thats what big companies like GE, Tatas do. Hire gud people and then thru performance weed out the non performers.
Agreed that Educomp is richly valued or investing in Infosys in 2000 wud have been burning fingers. What I am saying is that implmenting the value investing approach with growth companies.Take micro technologies for instance. It has been growing at CAGR of >50% for last 4 years. It has a book value of 206 approx. It trades at 220. EPS of around 50. Almost no debt. Mcap of <250>60% CAGR for last few years.
These companies are not richly valued at all.Thru Value Investing combined with Growth, I could see huge returns. Unfortunately I did not put a lot for money. e.g Rajesh Exports in a single year increased its sales from 200 to 2200 crore somewhere around 2003. That time the stock did not appreciate and had excellent value(128 book value, eps around 40, Price around 150. It gave 25 times returns since then), That was the time to enter and make huge money. and I did but with a small amount as I was learning then.
Following is my response :
Hi anonymous
There is a book, The gorrila game, which talks about an approach on how to invest in tech companies.
Approach is similar to the one you mention ..buy the whole basket ..and then follow the results of each. sell the poor performers and invest the cash into the good performers. That could have been a way to make money in infosys.
However it would have been diffcult to have the foresight in 1994 that infosys would do so well.even employees working in infosys did not recognise that (employees who were given options then thought the options were worthless).
I think growth is compatible with valueinvesting. Growth in the end, is a variable in the valuation process. As long as your are paying less than the growth implied intrinsic value, you will do well. So microtechnologies and Geodesic may fall in that bucket. They maybe insanely undervalued due to the excellent prospects. I have however not looked at these companies and hence cannot comment. However I would definitely look at them now.
Regarding your experience with rajesh exports, I can understand what happened as I have gone through similar experiences several times – namely how do you know beforehand that you are right on a company. I think as one gains experience, one learns to identify and benefit from such opporunities.
A correction
In the valuation of several companies I have used the following formulae to check the valuation
Mcap – cash on hand = Net Mcap
Net Mcap / Net profit = effective PE.
There is an error in the above approach. Typically the above cash earns 8-10% as part of the other income. The net profit should be adjusted with this non core income to arrive at the effective PE, otherwise you end up double counting the cash.
The error, lucklily has not changed most of the valuations I have done, but it is an error all the same and has a bigger impact if the cash as a % of market cap (mcap) is high. It is such an obvious error, but I have missed it till now. Well, better late than never.
A quote
I saw this quote from Keynes (A famous economist)
When the facts change, I change my mind. What do you do, sir?
Reply to a criticism during the Great Depression of having changed his position on monetary policy, as quoted in Lost Prophets: An Insider's History of the Modern Eonomists (1994) by Alfred L. Malabre, p. 220
This quote is very apt in investing. One analyses companies based on present facts and a set of assumptions. Valuation is finally an exercise of projecting the future. By being conservative, you can reduce the possiblity of an error. However when facts change dramatically, I am reminded of the above quote and find it prudent to change my mind – nothing wrong with that. Even a 60-70% success rate in picking stocks (being right 6-7 times out of 10) can give very good results in the long run.
Misc thoughts
I am reading through the Annual reports of several companies which I follow. I will be posting my analysis on the same. The market seems to be going one step forward and one step back. There are problems developing in the US and the markets may start weakening in the US. In india, inflation seems to be high and somehow the policy response has still not been strong enough. I think the RBI thinks that this inflation is temporary and it will cool on its own.
I hope they are right for everyone’s sake. If however they are wrong and they forced to hike the rates further to kill inflation, then we could have nasty times ahead of us in the market.
Tuesday, September 02, 2008
Analysis: NIIT tech Annual results
Warning: Parts of this post are boring as I would be discussing about Hedge accounting, reserve adjustments etc. However if you are invested in IT stocks, I would recommend you to get a good understanding of these concepts as they are now critical to understand how the company is doing.
Results summary
The company had an average performance for the year 2007-08. The ROE was maintained at 30% level. The sales growth was lower at around 6% (reduced partly by the rupee appreciation) and the net profit growth was around 3%. The net profit margins were maintained at 14.3%. The operating margins also held steady at 19%.
The key segments of BFSI, Insurance and travel now contribute to more than 80% of the revenue. Europe continues to the major geographic segment with the contribution to revenue at 50%. The other performance parameters such as % revenue from top customers, no. of new customers etc showed decent improvement.
The company completed the accquisition of ROOM solutions during the year. This business was not profitable during the year as it is in the investment mode as per the management. In addition the company made another small accquisition of Softec in the airline IT solution space. Thus the company is pursuing a strategy of both organic and inorganic growth in the focus verticals, especially in Insurance and transportation.
The positives
The company did not perform as well as the tier I vendors. However the company is now pursuing a strategy of focusing on key verticals. It is growing through accquisitions in these verticals and accquiring the required IP and customers via these accquisitions. This strategy makes sense for mid size companies such as NIIT tech, which cannot compete with the Tier I companies on scale alone.
The company maintained its margins and ROE inspite of the slowing markets and currency fluctuations. The company performed as expected and as the valuations are currently discounting a terrible performance, the stock price did not suffer.
The cash and equivalents for the company now stand at 220 Crs which is almost 30% of the mcap. The company continues to sell at around 2.5 times earnings (or slightly higher than book value), which means the market expects the company to be out of business pretty soon.
The negatives
The volume growth for the company was poor for the year 2007. The company is definitely not performing as well as some of the Top tier companies.
The accquisition for ROOM solutions was done at 100 Crs. The company is currently making losses. NIIT tech Management has paid quite a bit for the company and must have seen a lot of value. I hope they are right. Although subsequent poor performance of ROOM may not hurt the company a lot, it would definitely put the capital allocation skills of the management into question. I would personally rethink my entire thesis about the company if the accquisition turns out to be a dud
The performance of the accquisition is more critical than it seems on the face of it as the company has a large cash holding. This cash holding would grow further in the future and the management would be looking at new accquisitions with this cash. A poor track record would hurt the performance in the long run.
The accounting
The company accounted a forex loss of around 6.7 Crs in the P&L account with net impact of +.8 crs ( still trying to figure how they arrived at this number).
Now for the dry part,
The company maintains effective and non-effective hedges. The effective hedges are used to hedge the revenue and recievables. The company booked a loss of around 15.5 crs against reserves in the year 2008. These reserves have increased to around 65 Crs in Q12009. So if the rupee remains at the current levels, the company will close the hedges (which cover 27 months of revenue) over the next 27 months and take a loss of 65 Crs on the P&L account.
So the question is – Has the company already incurrend a loss of 65 Crs ? Yes and No. If the company were to close the contracts then it will have to account for the losses. However NIIT tech is not in the business of derivatives. These derivatives and contracts are used to hedge forex revenues. It is possible that the exchange rate could go in the opposite direction and the losses could worsen or they could go in the intended direction and the company could make profit and come out smelling roses.
The valuation impact
How should one account for forex gains/ losses? I think it would stupid to consider these losses as an ongoing one and capitalize it.
For ex: 2008 net proft was 137 Crs. So would you net the above loss of 15 Crs and say the Net profit is 122 crs and use this number for the final valuation ?
I would rather do the following
Say we take the appropriate PE as 15. The value of the company is 137*15= 2055. I would net off 15 crs from this value to arrive at the final value of 2040 Crs. I would apply the same logic if the company made a profit.
Over the long term, I think the forex gains or losses should be a wash (net impact should be minimal). Unless the treasury department is foolish (which doesn’t look likely) or very smart, the hedges should end up serving their purpose of reducing the impact of exhange losses or gains.
Ofcourse I am assuming the company will not start looking at Forex hedges and derivatives as a source of profit. That is a different ballgame completely. If the company gets in exchange speculation (and some companies have tried that stunt), I will take a very dim view of it.
The employee benefit (AS15) impact is not too high for the year and hence I would not concern myself too much about it.
Reading up
I am currently reading AS30 standard to get a better understanding of the new accouting standard for mark to market accounting. It is quite a dry read. However if you are interested in understanding the accounting and results of IT companies, then it is important to understand these standards. I would say, that if you are into fundamental analysis, the understanding all the AS standards is crucial.
Ofcourse reading AS standard is as entertaining as getting your dental work done. But investing is not always fun ..is it ? :)
I have still not changed my mind about the company. The market expects a far worse performance and as long as the company can do better than what is expected, the returns for an investor should be good.
The analysis for NIIT tech is uploaded here. Earlier posts on NIIT tech here, here and here
Results summary
The company had an average performance for the year 2007-08. The ROE was maintained at 30% level. The sales growth was lower at around 6% (reduced partly by the rupee appreciation) and the net profit growth was around 3%. The net profit margins were maintained at 14.3%. The operating margins also held steady at 19%.
The key segments of BFSI, Insurance and travel now contribute to more than 80% of the revenue. Europe continues to the major geographic segment with the contribution to revenue at 50%. The other performance parameters such as % revenue from top customers, no. of new customers etc showed decent improvement.
The company completed the accquisition of ROOM solutions during the year. This business was not profitable during the year as it is in the investment mode as per the management. In addition the company made another small accquisition of Softec in the airline IT solution space. Thus the company is pursuing a strategy of both organic and inorganic growth in the focus verticals, especially in Insurance and transportation.
The positives
The company did not perform as well as the tier I vendors. However the company is now pursuing a strategy of focusing on key verticals. It is growing through accquisitions in these verticals and accquiring the required IP and customers via these accquisitions. This strategy makes sense for mid size companies such as NIIT tech, which cannot compete with the Tier I companies on scale alone.
The company maintained its margins and ROE inspite of the slowing markets and currency fluctuations. The company performed as expected and as the valuations are currently discounting a terrible performance, the stock price did not suffer.
The cash and equivalents for the company now stand at 220 Crs which is almost 30% of the mcap. The company continues to sell at around 2.5 times earnings (or slightly higher than book value), which means the market expects the company to be out of business pretty soon.
The negatives
The volume growth for the company was poor for the year 2007. The company is definitely not performing as well as some of the Top tier companies.
The accquisition for ROOM solutions was done at 100 Crs. The company is currently making losses. NIIT tech Management has paid quite a bit for the company and must have seen a lot of value. I hope they are right. Although subsequent poor performance of ROOM may not hurt the company a lot, it would definitely put the capital allocation skills of the management into question. I would personally rethink my entire thesis about the company if the accquisition turns out to be a dud
The performance of the accquisition is more critical than it seems on the face of it as the company has a large cash holding. This cash holding would grow further in the future and the management would be looking at new accquisitions with this cash. A poor track record would hurt the performance in the long run.
The accounting
The company accounted a forex loss of around 6.7 Crs in the P&L account with net impact of +.8 crs ( still trying to figure how they arrived at this number).
Now for the dry part,
The company maintains effective and non-effective hedges. The effective hedges are used to hedge the revenue and recievables. The company booked a loss of around 15.5 crs against reserves in the year 2008. These reserves have increased to around 65 Crs in Q12009. So if the rupee remains at the current levels, the company will close the hedges (which cover 27 months of revenue) over the next 27 months and take a loss of 65 Crs on the P&L account.
So the question is – Has the company already incurrend a loss of 65 Crs ? Yes and No. If the company were to close the contracts then it will have to account for the losses. However NIIT tech is not in the business of derivatives. These derivatives and contracts are used to hedge forex revenues. It is possible that the exchange rate could go in the opposite direction and the losses could worsen or they could go in the intended direction and the company could make profit and come out smelling roses.
The valuation impact
How should one account for forex gains/ losses? I think it would stupid to consider these losses as an ongoing one and capitalize it.
For ex: 2008 net proft was 137 Crs. So would you net the above loss of 15 Crs and say the Net profit is 122 crs and use this number for the final valuation ?
I would rather do the following
Say we take the appropriate PE as 15. The value of the company is 137*15= 2055. I would net off 15 crs from this value to arrive at the final value of 2040 Crs. I would apply the same logic if the company made a profit.
Over the long term, I think the forex gains or losses should be a wash (net impact should be minimal). Unless the treasury department is foolish (which doesn’t look likely) or very smart, the hedges should end up serving their purpose of reducing the impact of exhange losses or gains.
Ofcourse I am assuming the company will not start looking at Forex hedges and derivatives as a source of profit. That is a different ballgame completely. If the company gets in exchange speculation (and some companies have tried that stunt), I will take a very dim view of it.
The employee benefit (AS15) impact is not too high for the year and hence I would not concern myself too much about it.
Reading up
I am currently reading AS30 standard to get a better understanding of the new accouting standard for mark to market accounting. It is quite a dry read. However if you are interested in understanding the accounting and results of IT companies, then it is important to understand these standards. I would say, that if you are into fundamental analysis, the understanding all the AS standards is crucial.
Ofcourse reading AS standard is as entertaining as getting your dental work done. But investing is not always fun ..is it ? :)
I have still not changed my mind about the company. The market expects a far worse performance and as long as the company can do better than what is expected, the returns for an investor should be good.
The analysis for NIIT tech is uploaded here. Earlier posts on NIIT tech here, here and here
Analysis: NIIT tech Annual results
Warning: Parts of this post are boring as I would be discussing about Hedge accounting, reserve adjustments etc. However if you are invested in IT stocks, I would recommend you to get a good understanding of these concepts as they are now critical to understand how the company is doing.
Results summary
The company had an average performance for the year 2007-08. The ROE was maintained at 30% level. The sales growth was lower at around 6% (reduced partly by the rupee appreciation) and the net profit growth was around 3%. The net profit margins were maintained at 14.3%. The operating margins also held steady at 19%.
The key segments of BFSI, Insurance and travel now contribute to more than 80% of the revenue. Europe continues to the major geographic segment with the contribution to revenue at 50%. The other performance parameters such as % revenue from top customers, no. of new customers etc showed decent improvement.
The company completed the accquisition of ROOM solutions during the year. This business was not profitable during the year as it is in the investment mode as per the management. In addition the company made another small accquisition of Softec in the airline IT solution space. Thus the company is pursuing a strategy of both organic and inorganic growth in the focus verticals, especially in Insurance and transportation.
The positives
The company did not perform as well as the tier I vendors. However the company is now pursuing a strategy of focusing on key verticals. It is growing through accquisitions in these verticals and accquiring the required IP and customers via these accquisitions. This strategy makes sense for mid size companies such as NIIT tech, which cannot compete with the Tier I companies on scale alone.
The company maintained its margins and ROE inspite of the slowing markets and currency fluctuations. The company performed as expected and as the valuations are currently discounting a terrible performance, the stock price did not suffer.
The cash and equivalents for the company now stand at 220 Crs which is almost 30% of the mcap. The company continues to sell at around 2.5 times earnings (or slightly higher than book value), which means the market expects the company to be out of business pretty soon.
The negatives
The volume growth for the company was poor for the year 2007. The company is definitely not performing as well as some of the Top tier companies.
The accquisition for ROOM solutions was done at 100 Crs. The company is currently making losses. NIIT tech Management has paid quite a bit for the company and must have seen a lot of value. I hope they are right. Although subsequent poor performance of ROOM may not hurt the company a lot, it would definitely put the capital allocation skills of the management into question. I would personally rethink my entire thesis about the company if the accquisition turns out to be a dud
The performance of the accquisition is more critical than it seems on the face of it as the company has a large cash holding. This cash holding would grow further in the future and the management would be looking at new accquisitions with this cash. A poor track record would hurt the performance in the long run.
The accounting
The company accounted a forex loss of around 6.7 Crs in the P&L account with net impact of +.8 crs ( still trying to figure how they arrived at this number).
Now for the dry part,
The company maintains effective and non-effective hedges. The effective hedges are used to hedge the revenue and recievables. The company booked a loss of around 15.5 crs against reserves in the year 2008. These reserves have increased to around 65 Crs in Q12009. So if the rupee remains at the current levels, the company will close the hedges (which cover 27 months of revenue) over the next 27 months and take a loss of 65 Crs on the P&L account.
So the question is – Has the company already incurrend a loss of 65 Crs ? Yes and No. If the company were to close the contracts then it will have to account for the losses. However NIIT tech is not in the business of derivatives. These derivatives and contracts are used to hedge forex revenues. It is possible that the exchange rate could go in the opposite direction and the losses could worsen or they could go in the intended direction and the company could make profit and come out smelling roses.
The valuation impact
How should one account for forex gains/ losses? I think it would stupid to consider these losses as an ongoing one and capitalize it.
For ex: 2008 net proft was 137 Crs. So would you net the above loss of 15 Crs and say the Net profit is 122 crs and use this number for the final valuation ?
I would rather do the following
Say we take the appropriate PE as 15. The value of the company is 137*15= 2055. I would net off 15 crs from this value to arrive at the final value of 2040 Crs. I would apply the same logic if the company made a profit.
Over the long term, I think the forex gains or losses should be a wash (net impact should be minimal). Unless the treasury department is foolish (which doesn’t look likely) or very smart, the hedges should end up serving their purpose of reducing the impact of exhange losses or gains.
Ofcourse I am assuming the company will not start looking at Forex hedges and derivatives as a source of profit. That is a different ballgame completely. If the company gets in exchange speculation (and some companies have tried that stunt), I will take a very dim view of it.
The employee benefit (AS15) impact is not too high for the year and hence I would not concern myself too much about it.
Reading up
I am currently reading AS30 standard to get a better understanding of the new accouting standard for mark to market accounting. It is quite a dry read. However if you are interested in understanding the accounting and results of IT companies, then it is important to understand these standards. I would say, that if you are into fundamental analysis, the understanding all the AS standards is crucial.
Ofcourse reading AS standard is as entertaining as getting your dental work done. But investing is not always fun ..is it ? :)
I have still not changed my mind about the company. The market expects a far worse performance and as long as the company can do better than what is expected, the returns for an investor should be good.
The analysis for NIIT tech is uploaded here. Earlier posts on NIIT tech here, here and here
Results summary
The company had an average performance for the year 2007-08. The ROE was maintained at 30% level. The sales growth was lower at around 6% (reduced partly by the rupee appreciation) and the net profit growth was around 3%. The net profit margins were maintained at 14.3%. The operating margins also held steady at 19%.
The key segments of BFSI, Insurance and travel now contribute to more than 80% of the revenue. Europe continues to the major geographic segment with the contribution to revenue at 50%. The other performance parameters such as % revenue from top customers, no. of new customers etc showed decent improvement.
The company completed the accquisition of ROOM solutions during the year. This business was not profitable during the year as it is in the investment mode as per the management. In addition the company made another small accquisition of Softec in the airline IT solution space. Thus the company is pursuing a strategy of both organic and inorganic growth in the focus verticals, especially in Insurance and transportation.
The positives
The company did not perform as well as the tier I vendors. However the company is now pursuing a strategy of focusing on key verticals. It is growing through accquisitions in these verticals and accquiring the required IP and customers via these accquisitions. This strategy makes sense for mid size companies such as NIIT tech, which cannot compete with the Tier I companies on scale alone.
The company maintained its margins and ROE inspite of the slowing markets and currency fluctuations. The company performed as expected and as the valuations are currently discounting a terrible performance, the stock price did not suffer.
The cash and equivalents for the company now stand at 220 Crs which is almost 30% of the mcap. The company continues to sell at around 2.5 times earnings (or slightly higher than book value), which means the market expects the company to be out of business pretty soon.
The negatives
The volume growth for the company was poor for the year 2007. The company is definitely not performing as well as some of the Top tier companies.
The accquisition for ROOM solutions was done at 100 Crs. The company is currently making losses. NIIT tech Management has paid quite a bit for the company and must have seen a lot of value. I hope they are right. Although subsequent poor performance of ROOM may not hurt the company a lot, it would definitely put the capital allocation skills of the management into question. I would personally rethink my entire thesis about the company if the accquisition turns out to be a dud
The performance of the accquisition is more critical than it seems on the face of it as the company has a large cash holding. This cash holding would grow further in the future and the management would be looking at new accquisitions with this cash. A poor track record would hurt the performance in the long run.
The accounting
The company accounted a forex loss of around 6.7 Crs in the P&L account with net impact of +.8 crs ( still trying to figure how they arrived at this number).
Now for the dry part,
The company maintains effective and non-effective hedges. The effective hedges are used to hedge the revenue and recievables. The company booked a loss of around 15.5 crs against reserves in the year 2008. These reserves have increased to around 65 Crs in Q12009. So if the rupee remains at the current levels, the company will close the hedges (which cover 27 months of revenue) over the next 27 months and take a loss of 65 Crs on the P&L account.
So the question is – Has the company already incurrend a loss of 65 Crs ? Yes and No. If the company were to close the contracts then it will have to account for the losses. However NIIT tech is not in the business of derivatives. These derivatives and contracts are used to hedge forex revenues. It is possible that the exchange rate could go in the opposite direction and the losses could worsen or they could go in the intended direction and the company could make profit and come out smelling roses.
The valuation impact
How should one account for forex gains/ losses? I think it would stupid to consider these losses as an ongoing one and capitalize it.
For ex: 2008 net proft was 137 Crs. So would you net the above loss of 15 Crs and say the Net profit is 122 crs and use this number for the final valuation ?
I would rather do the following
Say we take the appropriate PE as 15. The value of the company is 137*15= 2055. I would net off 15 crs from this value to arrive at the final value of 2040 Crs. I would apply the same logic if the company made a profit.
Over the long term, I think the forex gains or losses should be a wash (net impact should be minimal). Unless the treasury department is foolish (which doesn’t look likely) or very smart, the hedges should end up serving their purpose of reducing the impact of exhange losses or gains.
Ofcourse I am assuming the company will not start looking at Forex hedges and derivatives as a source of profit. That is a different ballgame completely. If the company gets in exchange speculation (and some companies have tried that stunt), I will take a very dim view of it.
The employee benefit (AS15) impact is not too high for the year and hence I would not concern myself too much about it.
Reading up
I am currently reading AS30 standard to get a better understanding of the new accouting standard for mark to market accounting. It is quite a dry read. However if you are interested in understanding the accounting and results of IT companies, then it is important to understand these standards. I would say, that if you are into fundamental analysis, the understanding all the AS standards is crucial.
Ofcourse reading AS standard is as entertaining as getting your dental work done. But investing is not always fun ..is it ? :)
I have still not changed my mind about the company. The market expects a far worse performance and as long as the company can do better than what is expected, the returns for an investor should be good.
The analysis for NIIT tech is uploaded here. Earlier posts on NIIT tech here, here and here
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