My Brief Notes on the Auto industry

The Auto industry consists of the following products segment and key companies

4 Wheelers (cars, UV etc) – Maruti, Hyundai, Tata motors, Ford etc. This is a fast growing sector of the market with the most action. Rising incomes and easier credit has resulted in growth in the industry. India is also developing into a Hub for exports especially for small and compact cars. This sub-sector is characterised by high competition and aggressive marketing. The key player is maruti with around 51% market share. The last 3-4 years have seen growths in excess of 15-20%. In addition competition is increasing in this segment with aggressive growth plans from Maruti, Tata motors and other foreign majors such as Toyota, GM, Hyundai etc. I have been looking at some of the companies in this sector and there are some good ideas. I will be posting on a few later.

2 wheelers (scooters, Bikes etc) – This has been a growth sector for the last decade. The annual volume is almost 8 Mn units making india one of the largest markets in the world. Bikes account for the majority (around 70 %??) of the demand with the rest taken by scooters and mopeds. The bike segment consists of the entry level bikes which are price sensitive, the mid-segment called the deluxe segment which is dominated by hero honda’s splendour and the top segment. The top segment has high growth currently, lower pricing pressure and shared between bajaj auto and hero honda. This sector has seen slowing down of growth recently and pressure on margins due to increase in raw material costs and increased competition.

Commercial vehicles ( LCV, MCV and HCV) – This sector is dominated by tata motors followed by Ashok leyland. The LCV and HCV sectors are seeing good growth due to development of infrastructure and the transportation model moving towards hub and spoke. The less than 16 ton segment is however seeing its share of the pie shrink. Competition is expected to increase due to foreign players such as Iveco and others. The latest quarter has been weak for the commerical vehicles sector. . The commerical vehicle industry is quite cyclical in nature and the companies in that sector are making an effort to reduce the impact by increasing the service, spares and export component of the business. The two companies in this sector Tata motors and ALL seem to be fairly priced. I will be posting on Ashok leyland soon.

Basic financials of the industry
The industry is characterised by economies of scale. The net margins are low (4-5%) and not likely to increase much due to competition and raw material pressures. The industry has a ROC of 20%+ and moderate compeititive advantages due to Entry barriers from scale, brands and first mover advantage. Rivalrly is not intense as yet, however competition is likely to increase when demand slows and foreign competition intensifies.

A more detailed Analysis of auto industry is updated in the worksheet (Business analysis_working_aug 2007) under ‘AUTO AND ANCILLARIES’

My Brief Notes on the Auto industry

The Auto industry consists of the following products segment and key companies

4 Wheelers (cars, UV etc) – Maruti, Hyundai, Tata motors, Ford etc. This is a fast growing sector of the market with the most action. Rising incomes and easier credit has resulted in growth in the industry. India is also developing into a Hub for exports especially for small and compact cars. This sub-sector is characterised by high competition and aggressive marketing. The key player is maruti with around 51% market share. The last 3-4 years have seen growths in excess of 15-20%. In addition competition is increasing in this segment with aggressive growth plans from Maruti, Tata motors and other foreign majors such as Toyota, GM, Hyundai etc. I have been looking at some of the companies in this sector and there are some good ideas. I will be posting on a few later.

2 wheelers (scooters, Bikes etc) – This has been a growth sector for the last decade. The annual volume is almost 8 Mn units making india one of the largest markets in the world. Bikes account for the majority (around 70 %??) of the demand with the rest taken by scooters and mopeds. The bike segment consists of the entry level bikes which are price sensitive, the mid-segment called the deluxe segment which is dominated by hero honda’s splendour and the top segment. The top segment has high growth currently, lower pricing pressure and shared between bajaj auto and hero honda. This sector has seen slowing down of growth recently and pressure on margins due to increase in raw material costs and increased competition.

Commercial vehicles ( LCV, MCV and HCV) – This sector is dominated by tata motors followed by Ashok leyland. The LCV and HCV sectors are seeing good growth due to development of infrastructure and the transportation model moving towards hub and spoke. The less than 16 ton segment is however seeing its share of the pie shrink. Competition is expected to increase due to foreign players such as Iveco and others. The latest quarter has been weak for the commerical vehicles sector. . The commerical vehicle industry is quite cyclical in nature and the companies in that sector are making an effort to reduce the impact by increasing the service, spares and export component of the business. The two companies in this sector Tata motors and ALL seem to be fairly priced. I will be posting on Ashok leyland soon.

Basic financials of the industry
The industry is characterised by economies of scale. The net margins are low (4-5%) and not likely to increase much due to competition and raw material pressures. The industry has a ROC of 20%+ and moderate compeititive advantages due to Entry barriers from scale, brands and first mover advantage. Rivalrly is not intense as yet, however competition is likely to increase when demand slows and foreign competition intensifies.

A more detailed Analysis of auto industry is updated in the worksheet (Business analysis_working_aug 2007) under ‘AUTO AND ANCILLARIES’

The Subprime mess and opportunity

Only when the tide goes out do you discover who's been swimming naked - warren buffett

It is diffcult to avoid reading on the subprime mess in the US. I have an oversimplified explaination –
'Losses being incurred by individual and institutions for overpaying for financial assets like CDO, MBS (mortage backed security) and other debt due to greed (for higher yields), ignorance (not knowing what was behind these assets) and overconfidence (too much faith on models)'. So what we are seeing is repricing (or correct pricing ?) of these assets.

Well for a much better understanding on what is happening and what may happen in the months to follow , read this article on fortune.

In a nutshell the opinion is that this bubble will take some time to unwind, there could be volatility in the markets due to that and there could be steep losses for some.

I think india is not going to be affected much directly. However we could see second order effects. With a liquidity crunch, it is quite possible that the excess liquidity which is driving our stock and real estate markets may dry up. This could cause some volatility and short term drops. How much and when ? ...who knows. I think the equity markets are already reacting and there maybe be some anecdotal evidence of the same happening in the real estate market too.

If, like me, you have also been tracking some stocks or have surplus cash to invest , the next few months may provide a few good opportunities. For ex: the auto sector, oil and gas and several mid-cap, microcaps are now selling at much lower prices and could soon be great bragains.

The most common cause of low prices is pessimism. We want to do business in such an environment, not because we like pessimism, but because we like the prices it produces. It's optimism that is the enemy of the rational buyer - warren buffett

The Subprime mess and opportunity

Only when the tide goes out do you discover who's been swimming naked - warren buffett

It is diffcult to avoid reading on the subprime mess in the US. I have an oversimplified explaination –
'Losses being incurred by individual and institutions for overpaying for financial assets like CDO, MBS (mortage backed security) and other debt due to greed (for higher yields), ignorance (not knowing what was behind these assets) and overconfidence (too much faith on models)'. So what we are seeing is repricing (or correct pricing ?) of these assets.

Well for a much better understanding on what is happening and what may happen in the months to follow , read this article on fortune.

In a nutshell the opinion is that this bubble will take some time to unwind, there could be volatility in the markets due to that and there could be steep losses for some.

I think india is not going to be affected much directly. However we could see second order effects. With a liquidity crunch, it is quite possible that the excess liquidity which is driving our stock and real estate markets may dry up. This could cause some volatility and short term drops. How much and when ? ...who knows. I think the equity markets are already reacting and there maybe be some anecdotal evidence of the same happening in the real estate market too.

If, like me, you have also been tracking some stocks or have surplus cash to invest , the next few months may provide a few good opportunities. For ex: the auto sector, oil and gas and several mid-cap, microcaps are now selling at much lower prices and could soon be great bragains.

The most common cause of low prices is pessimism. We want to do business in such an environment, not because we like pessimism, but because we like the prices it produces. It's optimism that is the enemy of the rational buyer - warren buffett

Passive v/s Active investing

There is an interesting post by prem sagar on passive v/s active interesting. In response to the post deepak has posted a response on his blog

If I have understand it correctly, prem’s position is that one should calculate the delta returns one would get by investing actively and compare it with other sources of income such as a job and decide if it is worth the effort. For ex: an extra 3-4 % return on a portfolio of 10 lacs could mean 30-40 K extra money. Not enough to make active investing worth your while.

In contrast deepak’s position is that if the returns are around 50% then the delta would be 3-4 lacs (for a 10 lac portfolio). With these kind of returns, active investing can be looked at seriously.

I have thought long and hard on this above issue. My take is as follows

I think prem’s position is perfectly valid for a new investor. I really doubt if it is possible to earn 50% annual returns for a long period of time (atleast 5 years or more) by spending 1-2 hours per day on the side. However if you are one of those guys (I am definitely not) who has earned 50% per annum (from 2001-2006, which covers a bear and bull market) then you are an exceptional investor. If I were you, I would seriously look at investing as a career. I would get my returns audited (no one is going to believe unaudited claims) and then look at the publicizing the returns. For a person capable of earnings such returns, attracting capital would not be diffcult. One can start an investment partnership and become really rich.

However I am definitely not such a guy. My final objective is to reach that level referred to by deepak. So what I do in the interimn?

This is my thought process (which mirrors prem’s approach partly)

a. save money and increase the amount of investible capital
b. learn and improve my skills to improve my returns
c. When the investible capital becomes high and my returns (for atleast 5 years rolling) cross a threshold, it maybe time to look at investing as profession (assuming you love to do this, I do)
For ex: passive investing returns are 15% (long term index returns). Active investing returns are say 30%.Investible capital is say 100 lacs. Then a net extra return of 15 lacs may be worth the effort.

BTW, to give you an idea of what 30% long term returns mean, consider the following – superinvestor ‘warren buffett’ has made 26% per annum for last 50 years, george soros has made 30-35% per annum (may be a bit more) for around 30 years and rakesh jhunjunwala around 70% (assuming he started with 5000 rs and has 4000 crs or 1 bn dollars now). So if you can make 30%+ for more than 10 years, you are an exceptional investor and can really do well.

For lesser mortals (it is easy to think that you are exceptional based on 1-2 years returns, I did that myself in 1999-2000), I think prem sagar’s approach is a valid one to start with, learn as you go along and deepak’s is the one to aspire for.

As an aside, I completely agree with deepak’s concept of leverage which is also referred to by several other authors.

Passive v/s Active investing

There is an interesting post by prem sagar on passive v/s active interesting. In response to the post deepak has posted a response on his blog

If I have understand it correctly, prem’s position is that one should calculate the delta returns one would get by investing actively and compare it with other sources of income such as a job and decide if it is worth the effort. For ex: an extra 3-4 % return on a portfolio of 10 lacs could mean 30-40 K extra money. Not enough to make active investing worth your while.

In contrast deepak’s position is that if the returns are around 50% then the delta would be 3-4 lacs (for a 10 lac portfolio). With these kind of returns, active investing can be looked at seriously.

I have thought long and hard on this above issue. My take is as follows

I think prem’s position is perfectly valid for a new investor. I really doubt if it is possible to earn 50% annual returns for a long period of time (atleast 5 years or more) by spending 1-2 hours per day on the side. However if you are one of those guys (I am definitely not) who has earned 50% per annum (from 2001-2006, which covers a bear and bull market) then you are an exceptional investor. If I were you, I would seriously look at investing as a career. I would get my returns audited (no one is going to believe unaudited claims) and then look at the publicizing the returns. For a person capable of earnings such returns, attracting capital would not be diffcult. One can start an investment partnership and become really rich.

However I am definitely not such a guy. My final objective is to reach that level referred to by deepak. So what I do in the interimn?

This is my thought process (which mirrors prem’s approach partly)

a. save money and increase the amount of investible capital
b. learn and improve my skills to improve my returns
c. When the investible capital becomes high and my returns (for atleast 5 years rolling) cross a threshold, it maybe time to look at investing as profession (assuming you love to do this, I do)
For ex: passive investing returns are 15% (long term index returns). Active investing returns are say 30%.Investible capital is say 100 lacs. Then a net extra return of 15 lacs may be worth the effort.

BTW, to give you an idea of what 30% long term returns mean, consider the following – superinvestor ‘warren buffett’ has made 26% per annum for last 50 years, george soros has made 30-35% per annum (may be a bit more) for around 30 years and rakesh jhunjunwala around 70% (assuming he started with 5000 rs and has 4000 crs or 1 bn dollars now). So if you can make 30%+ for more than 10 years, you are an exceptional investor and can really do well.

For lesser mortals (it is easy to think that you are exceptional based on 1-2 years returns, I did that myself in 1999-2000), I think prem sagar’s approach is a valid one to start with, learn as you go along and deepak’s is the one to aspire for.

As an aside, I completely agree with deepak’s concept of leverage which is also referred to by several other authors.

My notes on power sector - II

My notes on the power/capital goods and other suppliers

Capital goods suppliers

This sector is dominated by BHEL and ABB followed by several smaller players and Chinese manufacturers. BHEL accounts for almost 65% of capacity and market share. This sector has seen good growth in the last 3-4 years and should see continuing growth for the next couple of years. ABB has a smaller product range mainly for the power sector and industry automation. However it is more profitable company than BHEL and doing extremely well for the past few years.
The companies in this sector are characterized by high return on capital and good competitive advantages. The key competitive advantage is due to Scale, technology and an existing customer base. The companies in this sector are now investing in R&D and also targeting export markets as they increase in size.
This sector should see more competition due to the high demand from Chinese manufacturers, domestic OEM players and foreign players.The market recognizes the bright prospects of this sector and most of the companies in this sector seem to be fairly priced.


Other suppliers (power cable industry)

This industry is characterised by several players. The key ones are
KEI industries
Diamond cables
Nicco
Universal and torrent

The industry was loosing money during the period 2001-2004. Several players had negative networth and the stronger ones such as KEI had very small profits. Since 2004 due to the boom in the power sector, industry, Oil and gas and real estate, demand has soared and this has resulted in a turnaround for all the companies in the sector. Several of them such diamond have wiped out accumulated losses and are now profitable. The stronger and aggressive players such as KEI have invested in additional capacities and are now growing rapidly. There is now a huge demand in the domestic market and some of the export markets. Several companies in this sector are tapping this demand and doing well.

The industry is however cyclical with almost 70% cost due to raw material. The key RM is copper, aluminum and steel the prices for which have increased in the last few years and fluctuate rapidly. The industry has weak competitive advantages and the key strengths come from scale of operation, customer relationship and operational efficiencies. As a result during the cyclical downturn several companies lose money heavily.

KEI industries and Torrent cables are currently the most profitable players with ROC in excess of 30%. At the same time the other companies in the industry have also turned around in performance due to the strong demand. KEI industry is growing rapidly through organic growth via capacity additions, product range extensions and export markets. It is also looking out for acquisitions abroad. Torrent cables is also doing well and has fairly good financials. These two companies seem to be good investment candidates in the sector

The other companies have had a turnaround in the last few years and hence it may not be easy to predict how they will fare during the next downturn.

To get a better understanding of the dynamics of the power cable industry, the AR for KEI industries is a good starting point.

My notes on power sector - II

My notes on the power/capital goods and other suppliers

Capital goods suppliers

This sector is dominated by BHEL and ABB followed by several smaller players and Chinese manufacturers. BHEL accounts for almost 65% of capacity and market share. This sector has seen good growth in the last 3-4 years and should see continuing growth for the next couple of years. ABB has a smaller product range mainly for the power sector and industry automation. However it is more profitable company than BHEL and doing extremely well for the past few years.
The companies in this sector are characterized by high return on capital and good competitive advantages. The key competitive advantage is due to Scale, technology and an existing customer base. The companies in this sector are now investing in R&D and also targeting export markets as they increase in size.
This sector should see more competition due to the high demand from Chinese manufacturers, domestic OEM players and foreign players.The market recognizes the bright prospects of this sector and most of the companies in this sector seem to be fairly priced.


Other suppliers (power cable industry)

This industry is characterised by several players. The key ones are
KEI industries
Diamond cables
Nicco
Universal and torrent

The industry was loosing money during the period 2001-2004. Several players had negative networth and the stronger ones such as KEI had very small profits. Since 2004 due to the boom in the power sector, industry, Oil and gas and real estate, demand has soared and this has resulted in a turnaround for all the companies in the sector. Several of them such diamond have wiped out accumulated losses and are now profitable. The stronger and aggressive players such as KEI have invested in additional capacities and are now growing rapidly. There is now a huge demand in the domestic market and some of the export markets. Several companies in this sector are tapping this demand and doing well.

The industry is however cyclical with almost 70% cost due to raw material. The key RM is copper, aluminum and steel the prices for which have increased in the last few years and fluctuate rapidly. The industry has weak competitive advantages and the key strengths come from scale of operation, customer relationship and operational efficiencies. As a result during the cyclical downturn several companies lose money heavily.

KEI industries and Torrent cables are currently the most profitable players with ROC in excess of 30%. At the same time the other companies in the industry have also turned around in performance due to the strong demand. KEI industry is growing rapidly through organic growth via capacity additions, product range extensions and export markets. It is also looking out for acquisitions abroad. Torrent cables is also doing well and has fairly good financials. These two companies seem to be good investment candidates in the sector

The other companies have had a turnaround in the last few years and hence it may not be easy to predict how they will fare during the next downturn.

To get a better understanding of the dynamics of the power cable industry, the AR for KEI industries is a good starting point.

My notes on power sector - I

My notes on the power sector below

The power sector can be divided into the following sub-sectors

a. Generation – This sector has companies such as NTPC, REL, tata power and state generation units
b. Transmission and distribution – Mostly owned by SEB except in a few places such as delhi where it has been privatised
c. Capital good suppliers such as BHEL, ABB, L&T etc
d. Other suppliers like power cable companies, fuel suppliers etc.

Detailed analysis of the sector is provided in the business analysis spreadsheet. I have a new version (Business analysis_working_aug 2007) recently.

A brief analysis of each sub-sector follows

Generation

Generation is dominated by companies such as NTPC and State generation utilities. A few private sector players such as REL and Tata power also are important players in the sector.

This sector is characterised by fixed return on capital of around 12-14%. The tariff’s are adjusted in such a way that the company has a fixed return on capital. In addition government companies such as NTPC have had a recievables issue in past due to non-payment of dues by SEB. This was resolved by state government bonds and in the last 2 years this problem seems to be contained. Private sector companies such as reliance do not have a similar issue and have a zero net debt situation

Due to the huge power deficiet in the country, there is current a lot of expansion and new generation capacity being put in place. The XI plan envisages almost 85000 MW of capacity addition. All the generation companies such as NTPC, REL etc have big expansion plans which should result in increase in earnings and good growth. However the sector is characterised by political interference and hence there could be several risks to the expansion plans.

Companies such as REL, NTPC, and Tata power have substantial competitive advantages due to their long term experience in the power sector, financial strength and current backward expansion in fuel sources such as coal, gas exploration and forward integration into transmission, power distribution and power trading.

Most of the companies in this sector sell at around 19-20 times their earnings and seem to be fairly priced. However if government regulation and other obstacles in the power sector are resolved, these companies could see a lot of growth with good return on capital.

Next post : Capital goods suppliers and other suppliers such as power cables

My notes on power sector - I

My notes on the power sector below

The power sector can be divided into the following sub-sectors

a. Generation – This sector has companies such as NTPC, REL, tata power and state generation units
b. Transmission and distribution – Mostly owned by SEB except in a few places such as delhi where it has been privatised
c. Capital good suppliers such as BHEL, ABB, L&T etc
d. Other suppliers like power cable companies, fuel suppliers etc.

Detailed analysis of the sector is provided in the business analysis spreadsheet. I have a new version (Business analysis_working_aug 2007) recently.

A brief analysis of each sub-sector follows

Generation

Generation is dominated by companies such as NTPC and State generation utilities. A few private sector players such as REL and Tata power also are important players in the sector.

This sector is characterised by fixed return on capital of around 12-14%. The tariff’s are adjusted in such a way that the company has a fixed return on capital. In addition government companies such as NTPC have had a recievables issue in past due to non-payment of dues by SEB. This was resolved by state government bonds and in the last 2 years this problem seems to be contained. Private sector companies such as reliance do not have a similar issue and have a zero net debt situation

Due to the huge power deficiet in the country, there is current a lot of expansion and new generation capacity being put in place. The XI plan envisages almost 85000 MW of capacity addition. All the generation companies such as NTPC, REL etc have big expansion plans which should result in increase in earnings and good growth. However the sector is characterised by political interference and hence there could be several risks to the expansion plans.

Companies such as REL, NTPC, and Tata power have substantial competitive advantages due to their long term experience in the power sector, financial strength and current backward expansion in fuel sources such as coal, gas exploration and forward integration into transmission, power distribution and power trading.

Most of the companies in this sector sell at around 19-20 times their earnings and seem to be fairly priced. However if government regulation and other obstacles in the power sector are resolved, these companies could see a lot of growth with good return on capital.

Next post : Capital goods suppliers and other suppliers such as power cables

Reading up on capital goods industry

I am currently reading and analysing the capital goods, power and projects industry as a whole. The reason for studying them together is that several companies in the above sectors overlap or are suppliers to the companies in the other sector. For ex: BHEL (capital goods) is a supplier to the Power industry (ex: NTPC).

I will post a detailed analysis later. However a few points stand out

- The capital goods and projects (such as L&T, ABB etc) industry is firing on all cylinders. They are growing a high rates, have high big order books and a high return on capital.
- The market is valuing these companies at 40-50 times earnings. Somehow everyone has forgotten that the above industries are cylical (remember 1999-2002?) and the cycle can turn downwards too. In that event, the stocks can get whacked badly.
- Competition is increasing as india is becoming a major source of demand globally. Increased competition is never good for profits and valuation

Reading up on capital goods industry

I am currently reading and analysing the capital goods, power and projects industry as a whole. The reason for studying them together is that several companies in the above sectors overlap or are suppliers to the companies in the other sector. For ex: BHEL (capital goods) is a supplier to the Power industry (ex: NTPC).

I will post a detailed analysis later. However a few points stand out

- The capital goods and projects (such as L&T, ABB etc) industry is firing on all cylinders. They are growing a high rates, have high big order books and a high return on capital.
- The market is valuing these companies at 40-50 times earnings. Somehow everyone has forgotten that the above industries are cylical (remember 1999-2002?) and the cycle can turn downwards too. In that event, the stocks can get whacked badly.
- Competition is increasing as india is becoming a major source of demand globally. Increased competition is never good for profits and valuation

A Few good books

I am planning to read the following books in the coming months

- Way of the turtle (great book on trading)
- EINSTEIN : His life and universe (biography)
- The dhando investor – reread (book by mohnish pabrai)
- Security analysis – reread ( value investor’s bible)
- Micheal porter’s – competitive advantage

update 9-Aug
- more than you know (on investing and mental models)
- Black swan - great book by nicholas taleb - a must read

For the past few years, time is more of a constraint than money (in terms of books :) ) for me. So I typically work out the topics where I think I need to learn more. I then find well rated books on that topic and go through it. I do this typically once a year and am able to read 10-12 books every year. I purposely limit my self to not more than 15 books as that would take away time from reading annual reports.

I am looking for good books on the following topics

- Options and derivates
- Accounting
- Accounting standard – US GAAP and Indian GAAP
- Probability

Any suggestion are high welcome

A Few good books

I am planning to read the following books in the coming months

- Way of the turtle (great book on trading)
- EINSTEIN : His life and universe (biography)
- The dhando investor – reread (book by mohnish pabrai)
- Security analysis – reread ( value investor’s bible)
- Micheal porter’s – competitive advantage

update 9-Aug
- more than you know (on investing and mental models)
- Black swan - great book by nicholas taleb - a must read

For the past few years, time is more of a constraint than money (in terms of books :) ) for me. So I typically work out the topics where I think I need to learn more. I then find well rated books on that topic and go through it. I do this typically once a year and am able to read 10-12 books every year. I purposely limit my self to not more than 15 books as that would take away time from reading annual reports.

I am looking for good books on the following topics

- Options and derivates
- Accounting
- Accounting standard – US GAAP and Indian GAAP
- Probability

Any suggestion are high welcome

Maturity to handle losses

I typically write posts beforehand and publish them later. The following was written around the 15th of July.

Over the last 7-8 years of investing I have outperformed the index by around 8-9% per annum. This has been mainly with a buy and hold type of investing and without any leverage, options or any other type of investments. However I have underperformed the index several times. I have underperformed around 2 out of 8 years of investing. If I reduce the time horizon, the number of times I would have underperformed the index will be even higher, maybe 30-40 % of time if I consider monthly buckets.

There is no fun in lagging behind the index. As I put it in another post, the benchmark I follow is the BSE index. My entry into active investing was also perfect. I started actively and seriously investing around dec 1999, right around the peak and promptly saw my portfolio cut by 25% in a years time.

I remember reading charlie munger and warren buffett say that temprament and ability to take losses without going nuts is crucial to investing. Most of us will have losses over our investing lifetime (diffcult for most to believe now as the indian market has been in a bull run from 2003).

I am still pained when I lag the index or when my stock goes down by 5-10%. However the advantage I have now is that I have experienced it several times and am able to be rational about it. When I was new to investing it was diffcult for me figure whether the market was being irrational or if I was missing something and my analysis was at fault.

For example I invested in concor in 2002 at around 250 –300 Rs/ share. The stock promptly dropped to around 180-190 Rs/ share. This company has a big competitive advantage to the point of a monoploy in container transport, high return on capital and was selling at around 5 times earnings then. When the stock dropped, I was not able to understand the reason behind it. I could see nothing wrong with the stock even after analysing it again. So I kept faith on my analysis and held on to the stock. The stock sells at around 2400 now. It is easy to look smart or stupid in retrospect, but I was not a 100% sure then.

The difference now is that I have more faith on my analysis and have more experience (and scars !!). I still get pained by losses, but am able to keep my emotions better under control.

01-August

I did not realise that I would be seeing the market crash so soon. Earlier I would read and try to check for the reasons behind the crash. Now, I usually don’t bother. The main reason is that my guess is as good as anyone else’s which in the end is a guess. However not bothering to find the reason does not mean ignoring the market crash. On the contrary, stocks which were cheap earlier are now cheaper and some stocks are getting more interesting. So if the price drops further, I see a good opportunity to pick up a few stocks or increase my investments in a few exisiting ones. Ofcourse the assumption here is that the underlying analysis is correct and nothing has changed from a fundamental standpoint.

The above viewpoint is ofcourse not conventional wisdom and is painful to execute especially when your holdings have already dipped below cost.

Maturity to handle losses

I typically write posts beforehand and publish them later. The following was written around the 15th of July.

Over the last 7-8 years of investing I have outperformed the index by around 8-9% per annum. This has been mainly with a buy and hold type of investing and without any leverage, options or any other type of investments. However I have underperformed the index several times. I have underperformed around 2 out of 8 years of investing. If I reduce the time horizon, the number of times I would have underperformed the index will be even higher, maybe 30-40 % of time if I consider monthly buckets.

There is no fun in lagging behind the index. As I put it in another post, the benchmark I follow is the BSE index. My entry into active investing was also perfect. I started actively and seriously investing around dec 1999, right around the peak and promptly saw my portfolio cut by 25% in a years time.

I remember reading charlie munger and warren buffett say that temprament and ability to take losses without going nuts is crucial to investing. Most of us will have losses over our investing lifetime (diffcult for most to believe now as the indian market has been in a bull run from 2003).

I am still pained when I lag the index or when my stock goes down by 5-10%. However the advantage I have now is that I have experienced it several times and am able to be rational about it. When I was new to investing it was diffcult for me figure whether the market was being irrational or if I was missing something and my analysis was at fault.

For example I invested in concor in 2002 at around 250 –300 Rs/ share. The stock promptly dropped to around 180-190 Rs/ share. This company has a big competitive advantage to the point of a monoploy in container transport, high return on capital and was selling at around 5 times earnings then. When the stock dropped, I was not able to understand the reason behind it. I could see nothing wrong with the stock even after analysing it again. So I kept faith on my analysis and held on to the stock. The stock sells at around 2400 now. It is easy to look smart or stupid in retrospect, but I was not a 100% sure then.

The difference now is that I have more faith on my analysis and have more experience (and scars !!). I still get pained by losses, but am able to keep my emotions better under control.

01-August

I did not realise that I would be seeing the market crash so soon. Earlier I would read and try to check for the reasons behind the crash. Now, I usually don’t bother. The main reason is that my guess is as good as anyone else’s which in the end is a guess. However not bothering to find the reason does not mean ignoring the market crash. On the contrary, stocks which were cheap earlier are now cheaper and some stocks are getting more interesting. So if the price drops further, I see a good opportunity to pick up a few stocks or increase my investments in a few exisiting ones. Ofcourse the assumption here is that the underlying analysis is correct and nothing has changed from a fundamental standpoint.

The above viewpoint is ofcourse not conventional wisdom and is painful to execute especially when your holdings have already dipped below cost.

Ultramarine and pigments

About
Ultramarine is a chemical company with three divisions.

Pigments division – This is the oldest division which makes ultramarine blue pigment which is as a colorant, optical whitener and in paint finishes. The same division also makes LAB which is used in detergents. This division had a revenue of around 45 Crs and a pre – tax margin of around 18 % in 2006

IT enabled services – This is a small division of the company engaged in BPO and engineering services. This division had a revenue of around 15 Crs and margins of 50% in 2006

Packaging products – This division had a revenue of around 9 Crs and a margin of just 7 %. This division had a turnaround in the performance in 2006

The company level margins have marked a sudden rise from 2003 , due to the turnaround in the IT services division and positive contribution of the packaging division

Financials
The company had a turnover of 63 Crs last year and may close the year at 65-70 Crs. The net profit was 15.6 crs last year and may come to 18-19 Crs for the current year.
The company has a 20% holding in thirumalai chemicals on its books which is valued at almost 42 Crs and there are cash equivalents of around 10 Crs
The company has high margins of around 20% + and ROC has been in 25%+ range. In addition the company is debt (the debt on books is interest free sales tax loan)

Positives
The company is shareholder friendly. It has a good dividend payout of almost 50% of net profit (2007 dividend was Rs 3 per share). In addition the company has given bonus issue and has split the stock in the past.
The management seems to be allocating capital rationally and not blowing it away. In addition the IT services division does not require a very high amount of capital.

Risks
This is a very small company. With a 15 Cr revenue from IT services and lack visibility of clients, the revenue stream may not be very stable.
The pigments business is a commodity business and may not offer very high margins and returns. The valuation upside for the company depends on the IT services business continuing its performance as it contributes to almost 50% of the net profits.

Valuation
The company has almost 52 Crs on it balance sheet. However this is unlikely to be realised by shareholders as it is mainly investment in a sister concern – thirumalai chemicals. With a net profit of almost 18-19 Crs, the company can be valued at around 210-220 Crs which is almost 70% higher than the current price.

Conclusion
This is a deep value stock. The company is a small cap company, shareholder friendly with very low competitive advantages. The stock can be purchased as a graham type stock as a part of a portfolio and should be liquidated at 90% of the intrinsic value

Ultramarine and pigments

About
Ultramarine is a chemical company with three divisions.

Pigments division – This is the oldest division which makes ultramarine blue pigment which is as a colorant, optical whitener and in paint finishes. The same division also makes LAB which is used in detergents. This division had a revenue of around 45 Crs and a pre – tax margin of around 18 % in 2006

IT enabled services – This is a small division of the company engaged in BPO and engineering services. This division had a revenue of around 15 Crs and margins of 50% in 2006

Packaging products – This division had a revenue of around 9 Crs and a margin of just 7 %. This division had a turnaround in the performance in 2006

The company level margins have marked a sudden rise from 2003 , due to the turnaround in the IT services division and positive contribution of the packaging division

Financials
The company had a turnover of 63 Crs last year and may close the year at 65-70 Crs. The net profit was 15.6 crs last year and may come to 18-19 Crs for the current year.
The company has a 20% holding in thirumalai chemicals on its books which is valued at almost 42 Crs and there are cash equivalents of around 10 Crs
The company has high margins of around 20% + and ROC has been in 25%+ range. In addition the company is debt (the debt on books is interest free sales tax loan)

Positives
The company is shareholder friendly. It has a good dividend payout of almost 50% of net profit (2007 dividend was Rs 3 per share). In addition the company has given bonus issue and has split the stock in the past.
The management seems to be allocating capital rationally and not blowing it away. In addition the IT services division does not require a very high amount of capital.

Risks
This is a very small company. With a 15 Cr revenue from IT services and lack visibility of clients, the revenue stream may not be very stable.
The pigments business is a commodity business and may not offer very high margins and returns. The valuation upside for the company depends on the IT services business continuing its performance as it contributes to almost 50% of the net profits.

Valuation
The company has almost 52 Crs on it balance sheet. However this is unlikely to be realised by shareholders as it is mainly investment in a sister concern – thirumalai chemicals. With a net profit of almost 18-19 Crs, the company can be valued at around 210-220 Crs which is almost 70% higher than the current price.

Conclusion
This is a deep value stock. The company is a small cap company, shareholder friendly with very low competitive advantages. The stock can be purchased as a graham type stock as a part of a portfolio and should be liquidated at 90% of the intrinsic value

More patience required ?

I have posted on kothari products earlier (see here). I exited the stock quite some time back.
see below the latest price action (ouch !!!). well this is not the first time :)

update 25/07 - i checked up on the news and any other new developments. Could not find any fundamental reason on this spike. I am still sticking to my earlier thesis that i should not get into such stocks in the first place.

Key reasons being

- poor management and poor capital allocation

- management is not shareholder friendly and is not transparent at all

- no visible trigger for the value to get unlocked.

I would however keep tracking new developments and see if i missed something obvious.On the other hand, L&T was a clear miss from my end. I failed to do a sum of parts (the cement business which was destroying capital and the EPC business which was doing well) and also did not realise that once the cement business got divested, the value would get unlocked. As buffett says, i was looking in the rear view mirror and not through the windshield.

More patience required ?

I have posted on kothari products earlier (see here). I exited the stock quite some time back.
see below the latest price action (ouch !!!). well this is not the first time :)

update 25/07 - i checked up on the news and any other new developments. Could not find any fundamental reason on this spike. I am still sticking to my earlier thesis that i should not get into such stocks in the first place.

Key reasons being

- poor management and poor capital allocation

- management is not shareholder friendly and is not transparent at all

- no visible trigger for the value to get unlocked.

I would however keep tracking new developments and see if i missed something obvious.On the other hand, L&T was a clear miss from my end. I failed to do a sum of parts (the cement business which was destroying capital and the EPC business which was doing well) and also did not realise that once the cement business got divested, the value would get unlocked. As buffett says, i was looking in the rear view mirror and not through the windshield.

Graham idea – Selling below replacement cost – HPCL

Statutory warning – A long post with links to other analysis.

I have analysed the oil & gas industry and specifically refineries earlier (see here). In addition an analyis of the industry is also posted on my spreadsheet.

The oil majors have not been a part of the current bull run and the main reason is the convoluted pricing and subsidy structure. As a result the sector is not doing too well and may have some opportunities.

I have developed an investment thesis for HPCL which is given below

About
HPCL is one of the Oil majors with almost 13MMT refining capacity. It is engaged in the business of refining crude and marketing end products. In addition it is also integrating backwards into E&P, lube marketing via its Lube SBU and into the Gas distribution business.

The problem
The Oil & gas business in india has one of the worst economics possible. The pricing though supposed to be decontrolled, is still controlled by the government. As a result in a rising crude price scenario, where other Oil majors across the world are minting money, companies like HPCL, BPCL, IOC etc have been bleeding.

The typical Gross refining margins for companies like RPL has been around 10 usd per barrel. A company like HPCL should easily be able to make 6-7 usd / barrel. However in the last 1-2 years the Gross margins have been 3-4 and net margins have been around 1 usd/ barrel.

The above is due to subsidized sales of products such as Petrol, diesel and kerosene etc Due to the above situation, O&G companies have been beaten down and now sell below replacement value of their asset.

The opportunity and investment thesis
HPCL now sells at around 9000 crores. The EV is around 10000-11000 crores at best.

The replacement cost for the assets of HPCL can be calculated as follows

1.Refinery – 13MMT ( greefields projects cost around 1200-1800 Crs/ MMT) – 19000 (approximate)
2.Petrol pumps / retail outlets – 7313 (average cost atleast 1 cr/ outlet – 7000 Crs (approximate)
3.LPG distributors – 2202, customers 2.28 crores - ??
4.Other gas assets such as pipeline – 2000 Crs + (1700 crs invested in last 5 years), avantika gas, Bhagyanagar gas etc.
5.Other assets – some value
6. JV’s – MRP (17%) – 1200 Crs and other JV’s

The above assets can conservatively be valued at 25000 – 30000 Crs. So the company sells at 25-30 % of the replacement value of its assets.

The above discount is definitely not an abberation. It is mainly due to policies of the government. However I think the gap is higher than it should be and the main reason is that the market is assuming that the current state of affairs would continue as is.

I don’t believe the government is going to change its ways, however I think the bottom line of company should improve due to the following reasons

1. The company is currently engaged in diversifying its revenue streams via various initiatives and reduce the impact of the pig headed policies of the government. These initiatives are lube marketing, Gas distribution and retail initiatives and oil trading and risk management. The market is currently not valuing any of these real options.
2. The GRM and net refining margins are at their lowest. Going forward the worst case sceanrio is that they would remain at the same level. If that is the case, the bottom line should still improve as the various company intiatives take effect (see page 53 of Annual report)
3. The 9 MMT refinery and expansion of Vizag refinery to 15 MMT and export of the petro-products and E&P activities should help the company improve its margins going forward.

Conclusion
Although there exists a substantial discount to the assets value and possible cash flows, the gap is not likely to close any time soon. However even if the market reduces the gap to 50-60% of asset value, the returns should be reasonable. In addition the company is selling at a 5 year low in terms of its PE and P/B ratio. The key triggers to watch would be crude prices and the level to which the government compensates for the underrecoveries.

Graham idea – Selling below replacement cost – HPCL

Statutory warning – A long post with links to other analysis.

I have analysed the oil & gas industry and specifically refineries earlier (see here). In addition an analyis of the industry is also posted on my spreadsheet.

The oil majors have not been a part of the current bull run and the main reason is the convoluted pricing and subsidy structure. As a result the sector is not doing too well and may have some opportunities.

I have developed an investment thesis for HPCL which is given below

About
HPCL is one of the Oil majors with almost 13MMT refining capacity. It is engaged in the business of refining crude and marketing end products. In addition it is also integrating backwards into E&P, lube marketing via its Lube SBU and into the Gas distribution business.

The problem
The Oil & gas business in india has one of the worst economics possible. The pricing though supposed to be decontrolled, is still controlled by the government. As a result in a rising crude price scenario, where other Oil majors across the world are minting money, companies like HPCL, BPCL, IOC etc have been bleeding.

The typical Gross refining margins for companies like RPL has been around 10 usd per barrel. A company like HPCL should easily be able to make 6-7 usd / barrel. However in the last 1-2 years the Gross margins have been 3-4 and net margins have been around 1 usd/ barrel.

The above is due to subsidized sales of products such as Petrol, diesel and kerosene etc Due to the above situation, O&G companies have been beaten down and now sell below replacement value of their asset.

The opportunity and investment thesis
HPCL now sells at around 9000 crores. The EV is around 10000-11000 crores at best.

The replacement cost for the assets of HPCL can be calculated as follows

1.Refinery – 13MMT ( greefields projects cost around 1200-1800 Crs/ MMT) – 19000 (approximate)
2.Petrol pumps / retail outlets – 7313 (average cost atleast 1 cr/ outlet – 7000 Crs (approximate)
3.LPG distributors – 2202, customers 2.28 crores - ??
4.Other gas assets such as pipeline – 2000 Crs + (1700 crs invested in last 5 years), avantika gas, Bhagyanagar gas etc.
5.Other assets – some value
6. JV’s – MRP (17%) – 1200 Crs and other JV’s

The above assets can conservatively be valued at 25000 – 30000 Crs. So the company sells at 25-30 % of the replacement value of its assets.

The above discount is definitely not an abberation. It is mainly due to policies of the government. However I think the gap is higher than it should be and the main reason is that the market is assuming that the current state of affairs would continue as is.

I don’t believe the government is going to change its ways, however I think the bottom line of company should improve due to the following reasons

1. The company is currently engaged in diversifying its revenue streams via various initiatives and reduce the impact of the pig headed policies of the government. These initiatives are lube marketing, Gas distribution and retail initiatives and oil trading and risk management. The market is currently not valuing any of these real options.
2. The GRM and net refining margins are at their lowest. Going forward the worst case sceanrio is that they would remain at the same level. If that is the case, the bottom line should still improve as the various company intiatives take effect (see page 53 of Annual report)
3. The 9 MMT refinery and expansion of Vizag refinery to 15 MMT and export of the petro-products and E&P activities should help the company improve its margins going forward.

Conclusion
Although there exists a substantial discount to the assets value and possible cash flows, the gap is not likely to close any time soon. However even if the market reduces the gap to 50-60% of asset value, the returns should be reasonable. In addition the company is selling at a 5 year low in terms of its PE and P/B ratio. The key triggers to watch would be crude prices and the level to which the government compensates for the underrecoveries.

Trading v/s Value investing mindset

It must be quite apparent that I have mental block to trading. I had written a post on other blog on the same topic in 2004 which I posted again here. The post was written in jest. I do not look down on trading or consider value investing superior than any other form of investing. It is just that the mindset required for each of the approaches is very different.

Let me illustrate with an example

I typically invest in stocks which are undervalued due to some short term sector issue or due to investor apathy. The near term outlook is generally weak and there is no momentum behind the stock. As a result most of the time the stock drops after I start building a position. This happened almost 70-80% of times I have invested in a stock like concor, blue star, KOEL, asian paints, Gujarat gas etc in the past.

If I operated with a trader’s mindset, I would first not get into the stock and even if bought the stock a stop loss or similar such approach would cause me to exit the stock.

However a value investing mindset results in an opposite approach. I typically buy a stock which is selling at 40-50% discount to intrinsic value with a 2-3 year minimum time horizon. So if the market drops or the stock drops for non-fundamental reasons, I re-evaluate the stock to see if my thesis is intact and sometimes increase my holding.

I personally feel that it is difficult to have the two mindsets at the same time (atleast for me). It may not be impossible, but is fairly difficult and only a few investors would be great at both approaches (rakesh jhunjhunwala is one such investor whose name comes to mind).

I had a major mental block to trading in the past. I have started opening my mind to that approach to see if I can incorporate some aspect of trading into my value investing approach. I know for sure that I do not have the temperament of a trader and frankly would not be going down that path.

As deepak has put in the comment below, I think it is important for every investor to figure out his temperament as that has a major impact on every aspect of investing .


momentary lapse of reason said...
also some interesting statistic related to your trader/investor blog.for a trader to make a higher return than an investor over a long term( say 5 yrs) the trader should predict the market more than 70% of the time.. this is highly impossible unless your an oracle..and a piddly 20% pa is better than a 100% profit the first year and a 50% loss in the second. a 20% pa compounded for two years will give you a 44% return on initial investment. in the second case you'll end up where you started. no gain.
7/11/2007 12:05:00 PM
Deepak Shenoy said...
Trading is a profession and usually involves going full time on it. Investing, on the other hand, tends to have inflows from other income sources. But yes, psychological traits make the trader or the investor. Trading is a mind-game rather than an "art" - it requires a different kind of mindset. Some people thrive in it - some people who run hedge funds have returned more than 100% every year for the last five years. Many others leave it for other stuff - even Wikipedia's Jimbo Wales was a trader before WP.But intersting thoughts on this. Everyone has to make that call one day or the other.
7/13/2007 01:20:00 PM
Rohit Chauhan said...
yes it requires a very different mindset to be a trader. also i remember reading somewhere that there are very few successful long term traders than investors.i think trading is inherently more difficult and time consuming. very few individuals like rakesh jhunjhunwala are good at both due to the differing mindsets required

Trading v/s Value investing mindset

It must be quite apparent that I have mental block to trading. I had written a post on other blog on the same topic in 2004 which I posted again here. The post was written in jest. I do not look down on trading or consider value investing superior than any other form of investing. It is just that the mindset required for each of the approaches is very different.

Let me illustrate with an example

I typically invest in stocks which are undervalued due to some short term sector issue or due to investor apathy. The near term outlook is generally weak and there is no momentum behind the stock. As a result most of the time the stock drops after I start building a position. This happened almost 70-80% of times I have invested in a stock like concor, blue star, KOEL, asian paints, Gujarat gas etc in the past.

If I operated with a trader’s mindset, I would first not get into the stock and even if bought the stock a stop loss or similar such approach would cause me to exit the stock.

However a value investing mindset results in an opposite approach. I typically buy a stock which is selling at 40-50% discount to intrinsic value with a 2-3 year minimum time horizon. So if the market drops or the stock drops for non-fundamental reasons, I re-evaluate the stock to see if my thesis is intact and sometimes increase my holding.

I personally feel that it is difficult to have the two mindsets at the same time (atleast for me). It may not be impossible, but is fairly difficult and only a few investors would be great at both approaches (rakesh jhunjhunwala is one such investor whose name comes to mind).

I had a major mental block to trading in the past. I have started opening my mind to that approach to see if I can incorporate some aspect of trading into my value investing approach. I know for sure that I do not have the temperament of a trader and frankly would not be going down that path.

As deepak has put in the comment below, I think it is important for every investor to figure out his temperament as that has a major impact on every aspect of investing .


momentary lapse of reason said...
also some interesting statistic related to your trader/investor blog.for a trader to make a higher return than an investor over a long term( say 5 yrs) the trader should predict the market more than 70% of the time.. this is highly impossible unless your an oracle..and a piddly 20% pa is better than a 100% profit the first year and a 50% loss in the second. a 20% pa compounded for two years will give you a 44% return on initial investment. in the second case you'll end up where you started. no gain.
7/11/2007 12:05:00 PM
Deepak Shenoy said...
Trading is a profession and usually involves going full time on it. Investing, on the other hand, tends to have inflows from other income sources. But yes, psychological traits make the trader or the investor. Trading is a mind-game rather than an "art" - it requires a different kind of mindset. Some people thrive in it - some people who run hedge funds have returned more than 100% every year for the last five years. Many others leave it for other stuff - even Wikipedia's Jimbo Wales was a trader before WP.But intersting thoughts on this. Everyone has to make that call one day or the other.
7/13/2007 01:20:00 PM
Rohit Chauhan said...
yes it requires a very different mindset to be a trader. also i remember reading somewhere that there are very few successful long term traders than investors.i think trading is inherently more difficult and time consuming. very few individuals like rakesh jhunjhunwala are good at both due to the differing mindsets required

Torrent cables – A good opportunity?

I saw the following post on torrent cables on ranjit kumar’s blog. In addition, I found this analysis on amit’s blog.

The fundamentals look enticing

- RONW – 30%+
- No debt
- A 25%+ growth in topline and bottomline
- Operates in the power cable industry which seems to be doing well and is a growth industry.
- Lower valuation than all its competitors


However I am concerned about the following

- Inventory and debtors has increased in the last few years (debtor days is at 60 from almost 20-25 a few years) back. As a result the company has a very low free cash flow. Most of the cash flow has been used up by the incremental working capital
- Cannot get the annual report for the company. As a result I have no idea on how the company is planning to reduce inventory and debtors.
- The company was in BIFR from 1999-2002 (not sure on dates). Why did the company land up in BIFR and why will it not land up in a similar position in the future?

Comments welcome on the above analysis (which is very superficial as of now)

PS: An apology to all who requested me for prof bakshi’s interview. He has however posted the interview on his website. I would strongly recommend reading the interview (I have done it twice and really learnt from it)

Torrent cables – A good opportunity?

I saw the following post on torrent cables on ranjit kumar’s blog. In addition, I found this analysis on amit’s blog.

The fundamentals look enticing

- RONW – 30%+
- No debt
- A 25%+ growth in topline and bottomline
- Operates in the power cable industry which seems to be doing well and is a growth industry.
- Lower valuation than all its competitors


However I am concerned about the following

- Inventory and debtors has increased in the last few years (debtor days is at 60 from almost 20-25 a few years) back. As a result the company has a very low free cash flow. Most of the cash flow has been used up by the incremental working capital
- Cannot get the annual report for the company. As a result I have no idea on how the company is planning to reduce inventory and debtors.
- The company was in BIFR from 1999-2002 (not sure on dates). Why did the company land up in BIFR and why will it not land up in a similar position in the future?

Comments welcome on the above analysis (which is very superficial as of now)

PS: An apology to all who requested me for prof bakshi’s interview. He has however posted the interview on his website. I would strongly recommend reading the interview (I have done it twice and really learnt from it)

VST industries

About
VST is involved in the manufacturing and marketing of cigarettes. It is the second largest cigarette-maker in India with 12 brands in its portfolio. The company is an affiliate of British American Tobacco (BAT), UK, which holds a 32.16% stake in the company. Some of the major brands of the company are Charminar, Charminar Special Filter, Charms Mini Kings and Charms Virginia Filter. Its products are targeted at the lower-end of the market and have dominance in the small sized (less than 60mm) micro segment. The company is dependent on ITC for the supply of tobacco. Though the major chunk of revenue comes from sale of cigarettes, it is also in the business of selling unmanufactured and cut tobacco.
In order to establish its presence in unrepresented geographies, the company has last year launched a new brand, 'XL Filter' in large parts of Tamil Nadu and the hill states of the North East. In 2005, the company also launched another new brand, 'Shaan', which has garnered 4% share in the micro segment.

Financials
The company is a debt free company with almost 200 Crs in cash and investments. The company has been consistently been profitable with net margins increasing from 5-6% to almost 15% now. The Return on capital is consistently above 25%+ and excluding the low yielding investment, the company enjoys very high return on tangible capital. The company has been working with Negative working capital for some time and this seems to be increasing too.

Positives
The company has strong competitive advantage due to the nature of the product for which users have a very high brand preference. Competition is limited to ITC and the unorganized sector at the low end. As a result the company has a strong free cash flow and high return on capital

Risks
Topline growth is low due to high excise and price sensitivity at the low end. Also the company is not clear of how it will use the excess cash and there is always a risk that the company may simply blow away the surplus cash.

Valuation
At 58Cr net profit and 200Cr cash on the books, the company can be conservatively valued at 1100-1200 Cr (at 15 times PE of Free cash flow) which is at 50% discount to the current market cap. The company can grow at a 4-5% topline via new product introductions and price increases. The net profit has grown at a much higher rate of almost 20% for the last 10 years and a 6-7% growth in the future should look achievable. This level of growth and the high ROC can easily justify a PE of 15.
In addition, the company has a dividend of almost 20 Rs / share which is almost a 50% payout ratio .

Relative valuation
ITC is the largest player, but it has several businesses and hence it is diffcult to compare the financials. However a segment based analysis shows that ITC has around 17% post tax margins and around 110% return on capital. In comparison VST has a 15% net margin and more than 100% return on capital. ITC is curently commanding a PE of 20.

Godfrey philips is the second largest cigarette manufacturer. It had a net profit of around 87 Crs and has an adjusted cash and equivalents of approximately 200 crs (net of debt). The company sells at a PE of around 15-16 (net of cash). In comparison VST sells at an adjusted PE of around 7 and this could mainly be due to the slightly lower growth rates than ITC and Godfrey philips.


Conclusion
The company is a slow grower and the unit volume are more or less stagnant. The free cash flow for the business is equal to the net profit and the return on capital is also high. The balance has a lot of surplus cash and this should increase in the coming years. The catalyst for unlocking value could be higher dividend, better growth rates in the topline or continued good performance of the topline and bottom line.

VST industries

About
VST is involved in the manufacturing and marketing of cigarettes. It is the second largest cigarette-maker in India with 12 brands in its portfolio. The company is an affiliate of British American Tobacco (BAT), UK, which holds a 32.16% stake in the company. Some of the major brands of the company are Charminar, Charminar Special Filter, Charms Mini Kings and Charms Virginia Filter. Its products are targeted at the lower-end of the market and have dominance in the small sized (less than 60mm) micro segment. The company is dependent on ITC for the supply of tobacco. Though the major chunk of revenue comes from sale of cigarettes, it is also in the business of selling unmanufactured and cut tobacco.
In order to establish its presence in unrepresented geographies, the company has last year launched a new brand, 'XL Filter' in large parts of Tamil Nadu and the hill states of the North East. In 2005, the company also launched another new brand, 'Shaan', which has garnered 4% share in the micro segment.

Financials
The company is a debt free company with almost 200 Crs in cash and investments. The company has been consistently been profitable with net margins increasing from 5-6% to almost 15% now. The Return on capital is consistently above 25%+ and excluding the low yielding investment, the company enjoys very high return on tangible capital. The company has been working with Negative working capital for some time and this seems to be increasing too.

Positives
The company has strong competitive advantage due to the nature of the product for which users have a very high brand preference. Competition is limited to ITC and the unorganized sector at the low end. As a result the company has a strong free cash flow and high return on capital

Risks
Topline growth is low due to high excise and price sensitivity at the low end. Also the company is not clear of how it will use the excess cash and there is always a risk that the company may simply blow away the surplus cash.

Valuation
At 58Cr net profit and 200Cr cash on the books, the company can be conservatively valued at 1100-1200 Cr (at 15 times PE of Free cash flow) which is at 50% discount to the current market cap. The company can grow at a 4-5% topline via new product introductions and price increases. The net profit has grown at a much higher rate of almost 20% for the last 10 years and a 6-7% growth in the future should look achievable. This level of growth and the high ROC can easily justify a PE of 15.
In addition, the company has a dividend of almost 20 Rs / share which is almost a 50% payout ratio .

Relative valuation
ITC is the largest player, but it has several businesses and hence it is diffcult to compare the financials. However a segment based analysis shows that ITC has around 17% post tax margins and around 110% return on capital. In comparison VST has a 15% net margin and more than 100% return on capital. ITC is curently commanding a PE of 20.

Godfrey philips is the second largest cigarette manufacturer. It had a net profit of around 87 Crs and has an adjusted cash and equivalents of approximately 200 crs (net of debt). The company sells at a PE of around 15-16 (net of cash). In comparison VST sells at an adjusted PE of around 7 and this could mainly be due to the slightly lower growth rates than ITC and Godfrey philips.


Conclusion
The company is a slow grower and the unit volume are more or less stagnant. The free cash flow for the business is equal to the net profit and the return on capital is also high. The balance has a lot of surplus cash and this should increase in the coming years. The catalyst for unlocking value could be higher dividend, better growth rates in the topline or continued good performance of the topline and bottom line.

Possible arbitrage opportunity ?

I receieved an email on the rumor of the open offer for Lanxess ABS yesterday from mayank. On googling i found the following news item

Lanxess ABS up on open offer hopes

In addition Lanxess ABS has posted the following on their website

Shareholders may take note that Lanxess India Private Limited, Mr Rakesh Agrawal, Mrs Uma Agrawal, Mr Rahul Agrawal, Mr. Vishal Agrawal, Geetganga Investment Private Limited and Tash Investment Private Limited, the promoters of company , have entered into an agreement on June 28, 2007 to sell their share in the Company to INEOS ABS (Jersey) Limited, a company controlled by the British chemical group INEOS. The parties expect the transaction to be completed at the end of September 2007.

So there is a possibility of an open offer. My own intrinsic value calculation is around 300 Rs / share, so even at the current price the stock is available at a 60-70% discount.

However there are some risks
1. The above is still a rumor. Rule no.1 of arbitrage is to avoid getting into such deals based on rumors.
2. Open offer may not be made at a very high premium above the current price ?
3. What happens to the minority shareholder if some decide not to accept the offer ?

I am still trying to analyse the pros and cons on the above. In addition, as i noted in the earlier email, i hold the stock and hence the above post may not be completely unbaised. so please do your own analysis.

Please feel free to leave your thoughts in comments

update : I recieved a comment from ranjit regarding the open offer announcement on BSE. So the open offer is at 201 and for 20% of the capital.

This information changes my view completely. Lanxess ABS holds 51% of the company and other indian promoters hold 19%. As both have agreed to sell out, INEOS would get 70% of the company outright. If the open offer is successful, then they could easily have 90% of the company. I am not sure of the numbers, but i think at 90% they can easily delist the company. So the key point is that investors who refuse to accept the open offer, could in the future be forced to do so. I think company has started doing well and 201 is clearly below the fair price of the company. However the developments are not surprising. This is not the first time an MNC has short changed its domestic shareholders.

Possible arbitrage opportunity ?

I receieved an email on the rumor of the open offer for Lanxess ABS yesterday from mayank. On googling i found the following news item

Lanxess ABS up on open offer hopes

In addition Lanxess ABS has posted the following on their website

Shareholders may take note that Lanxess India Private Limited, Mr Rakesh Agrawal, Mrs Uma Agrawal, Mr Rahul Agrawal, Mr. Vishal Agrawal, Geetganga Investment Private Limited and Tash Investment Private Limited, the promoters of company , have entered into an agreement on June 28, 2007 to sell their share in the Company to INEOS ABS (Jersey) Limited, a company controlled by the British chemical group INEOS. The parties expect the transaction to be completed at the end of September 2007.

So there is a possibility of an open offer. My own intrinsic value calculation is around 300 Rs / share, so even at the current price the stock is available at a 60-70% discount.

However there are some risks
1. The above is still a rumor. Rule no.1 of arbitrage is to avoid getting into such deals based on rumors.
2. Open offer may not be made at a very high premium above the current price ?
3. What happens to the minority shareholder if some decide not to accept the offer ?

I am still trying to analyse the pros and cons on the above. In addition, as i noted in the earlier email, i hold the stock and hence the above post may not be completely unbaised. so please do your own analysis.

Please feel free to leave your thoughts in comments

update : I recieved a comment from ranjit regarding the open offer announcement on BSE. So the open offer is at 201 and for 20% of the capital.

This information changes my view completely. Lanxess ABS holds 51% of the company and other indian promoters hold 19%. As both have agreed to sell out, INEOS would get 70% of the company outright. If the open offer is successful, then they could easily have 90% of the company. I am not sure of the numbers, but i think at 90% they can easily delist the company. So the key point is that investors who refuse to accept the open offer, could in the future be forced to do so. I think company has started doing well and 201 is clearly below the fair price of the company. However the developments are not surprising. This is not the first time an MNC has short changed its domestic shareholders.

An increase in intrinsic value - Lanxess ABS

update 07/03 - just saw this news on a likely open offer for lanxess ABS. thats a lucky break !!

I had posted the following on my old blog earlier.

Tuesday, May, 25th, 2004

Am i missing something

i have been analysing Bayer ABS.
Found the following positiives
1) selling at 6 time current estimates
2) has zero debt
3) has shown a growth of 10 % plus for the past 5 years
4) has reduced debt and capital employed ( returns in excess of 25 %)
5) Parent - Bayer has strong R&D in plastics
6) user industries such as telecom/ IT / Auto are growing
7) moderate competitive advantages in form of patents / good brand for some products / R&D support from parent

negatives
1) Bayer has not been very share holder friendly ( has vijay mallya as chairman !!!!!!)
2) trying to move several businesses into fully owned subsidaries
cant think of too many negatives. am i missing something ? am i wrong ?
Posted in Weblogs at 03:43:46 AM

I have been re-analysing the company and have come up with the following analysis

The company is now called Lanxess ABS. It is the largest product of ABS (60% market share) and SAN in india. The product is used in by various OEM such auto industry, consumer durables etc.

Performance
The topline for the company has increased by around 11% per annum for the last 6 years, but due to input price pressure, the bottomline has increased by only 3% p.a. The company has performed fairly well inspite of the spike in crude prices (which impacts the raw material costs). As a result of the crude price increase the net margin of the company has come down to 4-5%. The company was not able to pass on the increase in input cost immediately. However with stabilization of the crude prices, the net margins have now increased to around 5-6% and we chould see an increase in the net margins going forward.
The company has improved the various asset turnover ratios during the period. As a result the company has a heatlhy return on capital of 20%+ with zero debt. In addition the company holds almost 80-85 Crs of cash on books which is almost 25% of the market cap

Competition
The main competition for the company is Bhansali polymers which is the second largest company in the product space. Both companies have similar margin structure and seem to be operating as a duopoly. The company has decent pricing power and can maintain a resonable return on capital.

Valuation
With netprofit of around 28 Crs and cash of almost 80 Crs, I would atleast value the company at 450-500 crs. As a result the company is available at a discount of 30-40% of the intrinsic value.

caution : i hold this security. I may continue to hold or sell as i see fit. I may or may not post when i make a sale. Hence the above analysis (as always) is not a recommendation.

An increase in intrinsic value - Lanxess ABS

update 07/03 - just saw this news on a likely open offer for lanxess ABS. thats a lucky break !!

I had posted the following on my old blog earlier.

Tuesday, May, 25th, 2004

Am i missing something

i have been analysing Bayer ABS.
Found the following positiives
1) selling at 6 time current estimates
2) has zero debt
3) has shown a growth of 10 % plus for the past 5 years
4) has reduced debt and capital employed ( returns in excess of 25 %)
5) Parent - Bayer has strong R&D in plastics
6) user industries such as telecom/ IT / Auto are growing
7) moderate competitive advantages in form of patents / good brand for some products / R&D support from parent

negatives
1) Bayer has not been very share holder friendly ( has vijay mallya as chairman !!!!!!)
2) trying to move several businesses into fully owned subsidaries
cant think of too many negatives. am i missing something ? am i wrong ?
Posted in Weblogs at 03:43:46 AM

I have been re-analysing the company and have come up with the following analysis

The company is now called Lanxess ABS. It is the largest product of ABS (60% market share) and SAN in india. The product is used in by various OEM such auto industry, consumer durables etc.

Performance
The topline for the company has increased by around 11% per annum for the last 6 years, but due to input price pressure, the bottomline has increased by only 3% p.a. The company has performed fairly well inspite of the spike in crude prices (which impacts the raw material costs). As a result of the crude price increase the net margin of the company has come down to 4-5%. The company was not able to pass on the increase in input cost immediately. However with stabilization of the crude prices, the net margins have now increased to around 5-6% and we chould see an increase in the net margins going forward.
The company has improved the various asset turnover ratios during the period. As a result the company has a heatlhy return on capital of 20%+ with zero debt. In addition the company holds almost 80-85 Crs of cash on books which is almost 25% of the market cap

Competition
The main competition for the company is Bhansali polymers which is the second largest company in the product space. Both companies have similar margin structure and seem to be operating as a duopoly. The company has decent pricing power and can maintain a resonable return on capital.

Valuation
With netprofit of around 28 Crs and cash of almost 80 Crs, I would atleast value the company at 450-500 crs. As a result the company is available at a discount of 30-40% of the intrinsic value.

caution : i hold this security. I may continue to hold or sell as i see fit. I may or may not post when i make a sale. Hence the above analysis (as always) is not a recommendation.