Year-end rumination

While it has undoubtedly been a tumultuous year in terms of volatility what with the market rising to nearly 20K around Nov. '11 before falling close to nearly 17K a few weeks back, there are indications that the coming year may bring a glimmer of hope. While these figures are not in doubt, there have been individual stocks which have given returns of upwards of 25%, some even doubling or tripling in this year after plumbing to new all-time lows – Wockhardt for one, the realty pack for another, and the de-listing MNC candidates to name a few. So it might well be a stock pickers market going forward for some time to come.

Having said this, how does one go about this exercise? It is well and truly said there is no bad time to buy good stocks and I for one firmly believe it this maxim. And this belief also stems from the happenings around which have only gone to reinforce this. Over the last 10 years, there have been umpteen cases where stocks which were written off by so-called experts have gone on to become multi-baggers and that too multi-fold. All it needed was conviction in the management to turn things around. Sample this: Bata India, the shoe major quoted around 50 in mid ’05 and quotes around 765 today – a whopping 15 times in 7 years. Around that time, its Canadian parent had chalked out a strategic revival plan and handed over the reins to one of its experienced APAC heads. The strategy apparently has worked and Bata not only recovered from its state then but went on to prosper.

These are times to buy quality at reasonable price and hold onto it, wait for the better times. Right now things are not looking that good and are choppy. There is seldom a perfect situation (as per our thoughts) to invest. Hence, our quest for complete clarity is utopian and may lead us to wait eternally. So which are the ones that fit the bill? Here is one of them:

If ever there was a brand which is so up-market and yet is not getting its due, at least currently, it is EIH. With the brand Oberoi synonymous with luxury and all that is good, market is just not willing to look beyond the current troubles it is going thru, mainly that of high interest burden due to the capex for increasing the room capacity and falling occupancy in the luxury segment due to the global economic turmoil. However it appears that Reliance’ Mukesh does not see it in the same light. About 2 years back, when the stock was nearly double its current price, Reliance thru its wholly owned subsidiary picked up 14.2% stake at a 22% premium @184/share (subsequently, it increased it by another 0.6%). At that time, RIL maintained that it was purely a financial investment. Whether it remains just that or turns into something bigger, remains to be seen in the period ahead. At that time it was considered as a white knight to thwart any takeover threats from tobacco-to-hotels major ITC, which also holds a strategic 14.9 per cent stake in EIH (bought way back in 2001 and increased gradually).

With 2 of the most influential Indian industrial houses pitching for it, it does appear that EIH is well on its way to regain its former glory. Things may not happen immediately but how it actually plays out will be seen in the years to come. The other important development to be considered is the interest of global luxury hotel brands in Indian landscape. Already some of the global biggies such as Intercontinental, Sheraton Marriott and others have a significant presence in the major metros and popular global tourist destinations such as Goa. Four Seasons and St. Regis are already in Delhi-NCR, while others like Mandarin Oriental and Fairmont will debut in the country in the coming period.

If nothing works out for either Mukesh and/or ITC (more likely the former, since ITC is already well-established in the hotels business), they may well cash out at a neat profit to one of the global majors. It may make sense to check in now at the current price which is very near to its yearly low, and that too when one of India’s most respected businessmen has seen value in it at more than twice the current market price.

Tuesday thoughts : Still shine left

If you want the definition of a multi-bagger or want to know what a multi-bagger is you just have to look at the current price of Wockhardt. Notwithstanding all the issues it is facing, market apparently believes that the worst is behind it and that it won’t be long before it regains its former glory (at one time, it was touted as the next Ranbaxy or Dr. Reddys and was in the same league before the FCCB issue and ensuing instigation threw the story out of gear). It had gone as low as 75 slightly more than a year or so back and even at the beginning of this year was around 300. Since then irrespective of the direction of the market, its price has been moving in only 1 direction – UP and has nearly doubled.

The above goes to show that it sometimes pays to go contrarian (though not blindly). 

In the current scenario, there are a couple of examples which come to mind. Look at all the gold lending companies stocks. They have gone down anywhere between 25-50% in less than a week. Agreed that RBI’s new guidelines on having a reasonable LTV (loan-to value) ratio of 60% will affect them, but the question is how badly? To understand this, look at what the LTV ratio implies. LTV ratio is nothing but the ratio of the amount of loan u can expect to get for a given value. In the current case, it is the value of gold. This also applies to housing loans wherein the lenders give u 75% of the value of the house; thus the LTV in this case is .75 or 75%? Currently gold loan companies are said to be lending as much as 75% of the gold value. In other words if u got Rs. 21000 for 10 gm of gold @28000 earlier, u would now get about 17000 only @60%.

So how does it affect the gold lenders? 

Higher the loan as a ratio of the gold pledged, more the interest rate they can charge. Gold loan companies charge anywhere between 18-24% as interest depending on the LTV ratio. So the RBI move could have an impact on the margins of gold finance companies. In addition, these companies will now have to maintain a minimum equity capital of 12% as a proportion of their loan book, if half of their assets are in gold. This rule though is not seen to be as damaging as the one capping LTV, as leading companies like Muthoot and Manappuram are adequately capitalized for now. But with the RBI tightening some of the rules, the days of very high margins may well be past for gold loan companies. But that doesn’t necessarily mean that the margins will be low. A good analogy regarding margins may be what IT went thru in late 90s and early 2000s. From consistently 40+ % margins, at least the biggies have now moderated to mid-20s. However the question to ask is which other industry gives you operating margins in 20s? So from 50+ P/E they have come down to 20s, but still are at a premium to the market.

Gold loan business was a hit with these specialized south-based (especially Kerala, with the gold and money both coming from rich sources of both – the Gulf) firms. The reason was simple. It is usually the low income group which form bulk of the clientele of gold loan firms. These people do not have easy access to bank loans and hence are forced to borrow at the high rates being charged by gold financiers. Also, it must be remembered that it is the family jewelry which is given as collateral in most cases. And this is a very emotional issue for the borrower, especially in the rural areas where the social standing is directly at stake. The person would do all that can be done to ensure that the family gold is not lost, whatever be the cost. 

Having said this, it would really surprise me if these companies got hit badly. Definitely there would be an impact on margins but it is not as if the sky will fall and all the loan borrowers would default or would stop taking loans. In a country like India, one of the largest consumers of gold, I certainly don’t see this happening. This knee jerk reaction is overdone. However, nothing would happen soon. With bad news flow not abating in a hurry, these companies would continue to drift in the current range for some time before saner minds would realize that it is not so bad after all. If u need further proof of this theory, just look at home loan lenders. Since 2008 when the real estate market turned belly-up, how many lenders have closed shop or got hit in the margins? When the conventional mid-prized segment dried up, they invented the so-called affordable housing (never mind what the affordable means in Mumbai) and still made money. When nobody was borrowing in the retail segment in 2008-09, did these (real estate as well as gold loan) companies shut shop? What is being said today could also have been asked then. It is truly said that need is the mother of invention. So you can be sure that these companies will bring innovations in their business models with new schemes and other tricks. Besides these companies have not been in the business over the last few years but a few decades and it would be fair to say that the promoters would have built adequate moats around them to survive such taxing times.

The other aspect that I would consider is the reach of these companies. Hitherto, it has primarily been rural and southern parts of India, with recent efforts at urban forays and northwards. So the urban segment is largely untapped by these companies and offers a much better risk reward ratio. They have slowly started to move into these areas and the benefits of these moves are yet to be seen but will likely play out in the coming period.

Another fallout as acknowledged by the promoters of these companies is that these regulations would only serve to strengthen the risk management processes and the regulatory framework which hitherto didn’t exist or was not looked at seriously. The guidelines will also significantly enhance the gold loan companies’ ability to absorb the impact of any sharp decline in gold prices, thereby improving the sector’s asset quality in the long term. Further, slower growth rates will reduce capital requirements over the medium term. They will not be able to grow at super high margins as they did earlier but would still be comfortable going ahead with new ideas in place.

So considering the current scenario it might be a good bet to get into Muthoot and/or Mannapuram and wait it out. I don’t believe that they can go much lower than what they already are and the risk reward ratio does appear promising at this point.

Undervalued CV maker

SML Isuzu (SMLI), formerly Swaraj Mazda, is a Chandigarh-based CV maker with specialization in LCVs (small and mid-sized buses like those used in schools and hospitals, as also police personnel carriers, water tankers and special vehicles.). It was set up as Swaraj Mazda in 1985 as a three-way JV between Punjab Tractors (which was later acquired by M&M and merged into itself) with 29% stake, Mazda Motors (15.6%), Sumitomo (10.4%) and public the rest 45%. It became a sick company in 1994 (mainly due to rupee devaluation) and was referred to BIFR. It then re-invented itself and wiped out all its accumulated losses by 1998, 4 years ahead of schedule.

In 2005, Mazda sold its entire stake of 15.6% to Sumitomo, making it a significant stakeholder in the JV (about 26%). Around the same time, PTL also offloaded about half of its stake of 29% to Sumitomo taking its total stake to about 40% making it a major stakeholder in the company. In 2009, Sumitomo bought out the remaining stake of M&M (about 15%) and thus now is a dominant partner in the JV owning about 55% stake. Sometime last year, Isuzu picked up about 4% stake in the company. Reliance Capital, CDC Financial Services and Actis (the last two being PE majors) also hold about 9%, 7% and 6% respectively in SMLI. Thus the open float in the market is not very high, about 18% of the total equity, with Japanese firms Sumitomo and Isuzu together holding about 60% and financial investors about another 22%.

Isuzu is the world's largest manufacturer of medium to heavy duty trucks and SMLI is a perfect fit for its Indian dreams. Isuzu would certainly want to strengthen its Indian presence through SMLI with which it has a technical collaboration. Isuzu could play this out in 2 ways - either acquiring a controlling stake in SMLI from Sumitomo or buy the stake from other minority shareholders such as Actis who may be keen to cash out. For Sumitomo, auto sector is not a core area, and Actis has held the stake long enough to feel the need to cash out. There is a distinct possibility that sooner rather than later, Isuzu may want a bigger say in running the company and may find a favorable environment to do so now.

With the advent of new players in the commercial vehicle space, SML's margins have come under pressure. It has been working on a range of higher tonnage trucks to get a larger footprint in the heavy commercial vehicle space, currently dominated by Tata Motors and Ashok Leyland. So it might be eager for Isuzu to take control and bring in its technology and products to the Indian market.

SMLI is currently trading about 400 with a P/E of about 12.4. Apart from a reasonable valuation, the other good part is that it has a low equity of 14.5 crore compared to its closest competitor Eicher Motors (27 cr.), and very close to another peer Force Motors, not even considering the biggies Ashok Leyland and Tata Motors which have a huge equity base. Comparing it to peers, it is way cheaper than Eicher Motors (ttm P/E 41) which has been a true blue multibagger over the last few years (it was around 60 way back in 2003 and is now around 2000, so you can make your own math), and may probably deserve a higher valuation than its peers (though 41 looks way too excessive). Force Motors, another strong company some time back is beset with its own problems after its break-up with MAN Truck and Bus AG, the German truck major.

All in all, this looks to be a good time to lock into SMLI. The major risks are of course the growing competition as more and more foreign majors enter the growing Indian market (Mahindra Navistar, Volvo Eicher, Daimler Commercial Vehicles and the latest to join this space is the CV maker from China, Beiqi Foton Motor Co. Ltd, which is setting up a manufacturing unit in Chakan, near Pune) and the shaky economic growth in the near future, though this may only be a temporary blip with the govt. trying to address this issue, albeit in a measured way.

Tuesday tidbits

Adani Enterprises has been consistently moving lower over the last few days today due to the adverse reports about IT dept’s sudden and probably unwarranted interest in it and has now come below 300.Though the budget had some positive news for Adani (reduction in Custom duties on coal), the overall gloom in the market hasn’t helped Adani recover. Technical analysts forecast anywhere around 250 or lower in the coming days/weeks. As analyzed earlier, nothing has really changed in the last few days/weeks to warrant such a drastic reaction (a drop of about 25-30% from the price then). So my personal thinking is that this or further down is as good as any chance to buy in. It must be noted that it has zoomed in a matter of weeks earlier on.

Cox & Kings is the only other (and probably major) listed operator (inbound and outbound tours) after Thomas Cook (TC) in the Travel & Tourism sector, with strong brand equity. In Sept ’11 they acquired a leading UK-based tour operator Holidaybreak plc (HBR) utilizing the huge cash on its books. HBR is a theme travel company in education space. This company does camps, educational tours etc with robust cash flows in a fairly recession proof industry. C&K has a track record of successful acquisitions earlier (once for Visa processing services and also a JV with our very own IRCTC for luxury tourism). Though the lean season period for HBR coupled with losses in Japan (due to tsunami destruction) and Middle-East troubles resulted in losses for C&K, it is expected to benefit going ahead, once the situation in these regions stabilizes. There were reports that it was in the running for Thomas Cook (though the company reportedly denied it). It remains to be seen whether that actually happens. Similar to TC, this has never been a cheap stock and once TC is out (bought out by someone and/or delisted this year) will remain so due to a good brand equity and scarcity premium in this business for a listed entity.

Monday musings

Orient Paper & Industries, a CK Birla group company is a diversified company with 3 lines of business – Cement (constituting nearly 50-60% of the total business, Paper (constituting about 10-15% of the total business) and lighting and domestic appliances such as fans (remember Orient PSPO?). It is in the process of demerging its cement business (3.4 MT) and shareholders will get 1 share of the demerged cement company for every one held in the whole. Post that it is likely that Kumar Birla will fold it under his cement empire at some point as envisaged by CK. With an expected EPS of 12 for FY 12-13, it is quoting at a P/E of just about 5. Also, last month, the promoters were allotted 1.2 cr shares @57 as a part of preferential allotment while the current price is also at 57.

It is a general observation that sum of parts of a company when considered separately is usually greater than the whole. Look at Reliance, L&T (Ultratech cement demerger) etc. Of course a good promoter background and high/significant stake always helps.

 

NESCO, a pure real estate company, has 65 acres of freehold land in Mumbai adjoining the Hub mall on the W. E. Highway, housing the Bombay Exhibition & Convention Centre. Besides, it has about 170 cr of liquid investments on a market cap of nearly 880 cr. (about 18%). Promoter and their associates together hold about 80%. Quoting at a P/E of about 13 (an EPs of nearly 47 on a ttm basis), though not cheap, it certainly looks interesting considering that rental income at a prime location in Mumbai besides being stable, is bound to show a steady, if not spectacular, appreciation. Besides the current figures don’t reflect the accruals from new buildings it plans to commission soon. Also, grapevine has it that a stock-split is on the cards and the share can reach 1000 in the coming weeks