A Hero in the making

Though there are options galore in the current market for long term investors with quite a few stocks at mouth-watering levels, some do catch attention since they were doing quite well not too long ago. One of them is Hero MotoCorp. It has again come down to levels of around 1800 where I personally think it is a screaming buy for a 20%+ annual returns going forward. Post the split with Honda, it had reached similar levels but the moves made by Munjals have been well accepted by the stakeholders as well as the markets. And when things didn’t look as bad as they do now, it had again climbed to levels of close to 2200-2400 in a short span. Of course the timeframe may be longer this time than it was last time, but with Indian markets, one never knows.

Freedom to export where they please (which makes for a good long term business model much like happened in IT) and to tie up with whosoever they prefer to choose without any restrictions are obviously the factors which will make or mar its prospects.

So far, they have made the right moves with intentions to expand in SE Asia, Africa, Central and Latin America which are supposedly lucrative markets for 2 wheelers esp. in the 100-125 cc range which are Hero’s forte. The company is sprucing up its sales network in these export markets. Of course it must be remembered that though lucrative, they are no easy pickings with a strong field of not only global giants such as their erstwhile partner Honda and other Japanese biggies such as Yamaha, not to mention Italians such as Vespa but also our own home-grown giants such as Bajaj Auto and TVS. And the point to note is that this has been a mixed bag for our players at least in SE Asia with Bajaj enjoying reasonable success and TVS Motors still struggling to get its act together. So how Hero gets going in these markets would be the key thing to watch.

In line with this strategy, it has also chalked out moves for capex to cater to these export markets. Its first plant will be set-up at Neemrana, Rajasthan, commencing operations from 1QFY14. The second plant will be set-up in Gujarat commencing operations from 2QFY14. It will also be setting up a R&D center with at a 250-acre location near Jaipur in Rajasthan.

Post its break-up with Honda, it was obvious that Hero would need a strong technology partner for its 2 wheelers since its own R&D is yet to pick up on a significant scale. To address this, it has already tied-up with Erik Buell Racing (EBR) and AVL (Austria). While EBR brings technology for premium motorcycles and development of new models, AVL gives access to know-how on engine technologies and would be focused on modifying existing engines.

The Indian market predominantly favors 100cc motorcycles; almost 75% of total sales belong to this category. Splendor and Passion continue to drive HMC’s sales, contributing 45% to volumes. Hero Honda currently sells around 36,000 scooters a month. With only one model, it is already the second largest player in this segment also. It has recently launched ‘Maestro’ to appeal to the male segment. However the concerns are on margins since they have would already have spent resources on their new brand building. Ad-spends would be high for some time in the near future.

Thus, though near-term concerns remain on margins and factors beyond their control such as the macro-economic situation in the country as well as globally, with the right plans and strategy in place for volume as well as margin expansion, Hero should make a rewarding investment now.

Energetic profitability and growth

Videocon Industries, incorporated in 1979, is well known for its consumer goods and has been a well-entrenched player in the Indian market in this space.  It is engaged in the manufacture, marketing, and distribution of consumer durables, color picture and cathode ray tube glasses in domestic and international market where it has access to facilities in Italy, Poland, Oman, China and Mexico. It is also the third largest picture tube manufacturer in the world.

A few years back, it also made a foray into the telecom space albeit with limited success.  Its handsets may be doing well, but as a mobile service provider, it hasn’t made any waves at least in the major metros against stiff competition from established players such as Bharti Airtel and Vodafone. It hasn’t been able to leverage its brand strength to make many inroads in this area, unlike Idea which in a short time has given the established players a tough time.

The Company has interest in four major sectors:

• Consumer durables
• Display industry and its components
• Color picture tube glass
• Oil and gas.

On the consumer good side, the company is firmly established, at least in India. A few years back, the company acquired Thomson CPT Ltd, which has got manufacturing operations in four countries for CPTs. Though the current market trend in developed and developing markets is towards new generation high-end technology like LCD/LED, there are enough countries in places like Africa and even in the interior rural parts/non-metros of major countries like India which continue to thrive on CPT-based TVs. Also, they acquired the Indian operations of the Swedish goods major Electolux. It has an average market share of 17 per cent across categories like color TVs, refrigerators and washing machines.

However, what is not very well known is that it has a significant oil & gas business where it holds stakes in various oil fields across the world. This company has got 25% stake in the Rawa Oil field, which is on the eastern Coast of Andhra Pradesh and produces close to about 50,000 barrels per day. Besides this it has significant interest in oil fields in Oman, Timor, Southern Australia and Western Australia. It has also taken over the South American assets of a Canadian company called EnCana Corporation. The Brazilian company has got about ten offshore blocks in Brazil. However, its biggest and most profitable catch appears to be its 10% stake each in 6 blocks of deep water Rovuma Block Area-1, offshore Mozambique where state-owned Bharat Petroleum also has a similar 10% stake in these blocks thru its wholly owned subsidiary Bharat Petro Resources Ltd. Videocon bought this stake in 2007-08 for $75 million from Texas-based Anadarko Petroleum thru its wholly-owned subsidiary Videocon Hydrocarbon Holdings. The other partners are Japan’s Mitsui & Co (20 percent Thai group PTT Exploration and Production which bought Irish company Cove Energy’s stake (8.5 percent) and the Mozambican state-owned Empresa Nacional de Hidrocarbonetos (15 percent). Recently, Andarko, announced a significant upgrade in estimated reserves in the basin from 60 tcf to nearly 100 tcf. The new discovery in two gas wells off the coast of Mozambique is being considered as one of the largest gas finds in the world and would make the basin's reserves 20 times the size of India's KG-D6 (to put the find in perspective) and make Mozambique a major exporter of liquefied natural gas (LNG). This can sharply raise supplies and calm LNG prices at a time US gas prices have crashed after supplies surged with shale gas. The good news doesn’t end here. Just one-third area of Mozambique has been discovered so far. Mozambique is now approaching to be as big as Qatar.

In a filing to SEBI on 20^th Aug., Videocon valued its 10 percent stake in the Mozambican block with large natural gas reserves at US $2.26 billion. Videocon’s initial investment here was just $75 million in 2008. The company based its calculation on Cove Energy Plc.’s recent 8.5% stake sale in the block to Thai group PTT Exploration and Production for $1.92 billion after a nearly 6 month aggressive bidding war with Royal Dutch Shell Plc. Videocon also said that the valuation, excluded “the large gas discoveries which took place during the period when the Cove Energy sale process was on, which might or might not have been (taken) into account by PTT, and on which we base our valuation,” which eventually won the bid. The total valuation thus could be far more than US $2.26 billion when other things are also taken into account.

The telecom story is by now well known. Videocon had licenses for 22 circles which have now been cancelled and are under litigation. However, since Videocon was not affected as deeply as some of the others, the impact on it was not too much. It has also forayed into another promising and sunrise sector of Digital TV. As per latest reports, it had 12% of the market share for digital TV. While active base/ARPU for this business are not known, anecdotal evidence praises both the quality and the distribution efficacy of the business (with firms like Edelweiss giving a thumbs up to the DTH operations). Besides its other businesses are doing pretty well, though over the last 2 years, consumer durables has taken somewhat of a beating.

Dhoot has headed Videocon’s transformation from a maker of consumer electronics products into a multi-business group centred on hydrocarbon exploration. The diversification, however, has come at a price: the group had borrowed Rs. 18,656 crore as on 31 December, an increase of 58.5% from a year earlier. Its current liabilities, or obligations due within a year, rose 175% to Rs. 2,511.2 crore in 2011 from Rs. 912.05 crore in the previous year, while cash balances fell 61% to Rs. 504.5 crore in 2011, according to the company’s latest annual report.

The energy assets, tipped to be a cash cow for the firm once the Mozambique block goes into production in fiscal 2016, could help in reducing debt.

Recently, Videocon board has proposed to demerger its Oil & Gas business as a separate entity. In an energy-deficient country like India, Oil & Gas sector especially the private producers (Reliance, Essar etc) would always have a future for a long time to come. When the above proposal is implemented, the shareholders of Videocon would have exposure to 2 high-growth businesses – Consumer durables and Oil & Gas. While the former will take as much time as the economy to bounce back to its former position, the latter should pick up sooner than later especially with the moves planned by the management.

To summarize, the upside triggers for the stock seems.

1. Sale of DTH business-if rumor like this one comes true (http://www.dealcurry.com/2012076-Videocon-To-Exit-DTH-Biz.htm).

2. Spinoff of oil and gas assets-no more expensive capex. Also, it may reduce the complexity discount/conglomerate discount attached to the stock. 

3.  Resolution of telecom 2G auction issues and possible compensation.

Delisting bets - still holding promise

I had written about delisting bets in March ’12 when the de-listing fever was at its peak with 1 major de-listing of Atlas Copco gone thru successfully (and I might add at an astonishing price, way beyond what was generally expected and at very high valuations). This frenzy continued with Alfa Laval, incidentally another Swedish company, offering an astonishing Rs. 4000/share to its shareholder for getting rid of them for good!

However this bubble did not last beyond the next 2 months when Fresenius Kabi, a German pharma company specializing in Oncology (cancer) drugs, announced in June ’12 that it is not going ahead with delisting but would offer its shares for sale through stock exchanges to increase the public holding in the company. This was a rude shock to the hopefuls who had made bets on this very premise. And predictably, it had a cascading effect with the few other hopefuls (AstraZeneca Pharma, BOC (India), Honeywell Auto, Blue Dart Express and Elantas Beck) also tumbling in varying proportions (2.5% to 9.4% in BOC India, showing the pecking order), though not as much as 20% which FK did (it later recovered somewhat, but is still close to its 52 week-low).

Having said all this, there does appear to be a silver lining to this issue. The key thing to do would be to focus on the factors which would lead to a company to go the delisting way, other than the independence factor which it would bring to it. I have 2 such factors in mind:

1.  Business imperatives – Consider the case of BOC (India). Going by comments made by Sanjiv Lamba, BOC’s chairman and member of the executive board of Linde, in May, de-listing could be a preferred choice though he clarified that no firm decision had been taken as yet. The decision could be taken close to June 2013 deadline set by the SEBI for companies to bring down promoter holdings below 75%. Considering that it takes anywhere from 3-6 months for an offer to complete, things should start moving by Dec. ’12 if not earlier.

BOC plans to on bidding for large businesses where PSUs are asking them to bid from (the position of) a 100% owned entity. The option they have to get around this is to bid as Linde Global, otherwise they won’t be technically qualified. Generally, PSUs ask for 100% guarantee for 20 years from the parent company. How would they get 100% guarantee from a parent for a company in which it owns 80%?  As a separate entity, BOC, which is now trying to diversify its client base beyond steel industry, would face challenges in bidding for petrochemical sector as it would then have to source technologies it has not used earlier, something that the oil PSUs won’t be comfortable with. Obviously BOC India doesn’t have the breadth that Linde AG has in its product offerings. So for BOC, de-listing looks to be a business imperative rather than just getting its independence from Indian laws and shareholders as is the case with most others.

2.  Large institutional or single shareholding – As per SEBI rules, if the promoters of a company want to de-list it, they have to buyout at least 50% of the minority shares AND reduce the minority shareholding to less than 10% (take the promoter shareholding to above 90%).

Consider the case of Fairfield Atlas which has been in the news for the last year or so purely for this reason. Needless to say, it has also run up hugely (around double) from levels then. This was not on my radar initially (as you can see from the first list), but came to my notice recently when it started moving up in huge spurts.

Here, the promoter shareholding is 83.91% and public shareholding is 16.09%. Out of this, Reliance Capital Trustee Company holds 4.14%. If the promoters want to delist the company, they have to buy at least 50% of the public shares (approx 8.05% of the total shares). If they are able to buy 8.05% of the shares, 90% condition will be met too. If Reliance Capital is convinced to sell its stake at an acceptable price to both parties, that will leave only 3.91% (8.05-4.14) to be cobbled up from the public, from the remaining 11.95%, which is only about 1/3^rd. I would think this is more than a fair chance of attaining, more so if it is at a good or even a reasonable price (and it would be safe to assume that Reliance will not settle for anything less than that). Being an institution, the price Reliance would expect would be a function of fair valuation of the stock as well as its own acquisition cost, which can be hugely different from what the public would expect. And @160, @P/E of < 12 (on ttm earnings), it is quoting at less than fair valuation (purely my thoughts – considering that other MNCs peers like WABCO @1500 quotes @P/E of about 18, Bosch @8800 quotes @ P/E 23) even after last year’s run-up. 

This makes a very good case for Fairfield Atlas to be considered as a promising de-listing candidate which could succeed in its efforts. Of course, the price is a factor which should be considered, since as already mentioned, it has run up significantly. However, as has been seen before in the Indian markets, once the news is out, sky is the limit and stocks have doubled from already huge levels against all rationale (look at Alfa Laval and Atlas Copco). This could play out the same way since the payout may not be too huge for the promoters.