Profitable smoke

This development is not new and first occurred in Sept. ’15.  It has only in recent weeks started making the rounds again indicating that the end game is near.

The beleaguered Lalit Modi, hounded by ED for alleged financial irregularities, is looking to sell his family’s (K. K. Modi group) 47% stake in the cigarette major Godfrey Phillips. Philip Morris Global Brands (PMGB), a subsidiary of global cigarettes major Philip Morris International (PMI), holds 25% stake in the company and may be open to the idea of buying out Modi family and taking a controlling stake in GP. Since Sept. last year, when this first got out, the stock of GP has more than doubled in the last few months from 557 to the current more than 1200.

Though ITC dominates the cigarettes market with an 80% market share, with brands like Wills Classic and Gold Flake, GP is a distant second with reasonably well known brands like Four Square, Red & White and Cavanders. Additionally, GP also manufactures and distributes Marlboro brand of cigarettes under licence from PMI. The company has also forayed into the pan masala segment under the Pan Vilas brand.

Lalit Modi has been out of the country for 5 years because of the alleged financial irregularities in IPL and ED has been investigating the matter for quite some time now. And because of his continued absence from GP board meetings, he had to lose his board seat as well.

However, this deal may not simply sail thru. This is because govt. has been discouraging FDI in this sector for quite some time now. FDI in cigarette manufacturing is no longer allowed; moreover, activity relating to these products, including wholesale cash and carry and retail trading, are governed by restrictions laid down in the FDI policy. Smoking has been under the govt’s scanner for a while nnnow, so much so that there have been some far reaching measures such as ban on smoking in public places and sale of loose cigarettes, not to mention this being a favourite sector for the govt. to raise taxes annually. This has also led to the cigarette companies losing significant ground in the markets in the past few years, with the exception of ITC which, though earning a major part of its revenue from cigarettes, has other diversified interest as well which have served as a good hedge for it not to fall as much as its sectoral peers. So there may be a provision for special permissions to be taken by foreign companies if they do want to invest in manufacturing cigarettes here, and this condition may come under to PMGB’s rescue if the deal does go thru.

So in the current market turmoil, it may be a good idea to start accumulating this stock steadily. Once the news of Modi family’s interest in selling stake gets out, there may be other suitors also who may line up for the substantial stake, leading to a bidding war (remember Mangalore Chemicals and Fertilizers?). Already, the name of Japan Tobacco (JT), the world`s third-largest listed tobacco company and maker of popular brands like Camel and Winston, is doing the rounds, as a probable suitor for the stake on offer. JT surrendered its manufacturing licence and left India in 2011 after revised FDI regulations halted further foreign investments in the tobacco manufacturing sector, but has now been scouting for a re-entry into India. And even if there are no other suitors, the Lalit Modi family, by virtue of their controlling stake, would certainly expect a hefty premium over the market price. Also, since the stake on offer is more than 25%, it would inevitably invite an open offer from the acquirer. As has been seen earlier in numerous cases, the ultimate beneficiary would be the investor who latches on to it at a very early stage and enjoys the heady ride.

The caveat here is that the stock has more than doubled in the last few months since the news of stake sale has started circulating and a regular accumulation rather than a lump sum investment would be the way to go in such circumstances to minimize the risk, by averaging the net price of the total holding.

This is a tactical opportunity and should be viewed as such. Long term investment in a sector such as cigarettes is certainly not a winning proposition.

Opportunities in the current crisis

The current market meltdown has created a golden opportunity for investors (not traders). Quite a few of the blue-chip stocks, though they may not look blue now, are trading at their yearly lows, for no apparent reason. For e.g. it beats me as to how oil prices or for that matter Yuan devaluation will impact the business or profitability of a Sun TV or for that matter NBFC like SKS Micro or Manappuram Finance. It must be remembered that these are purely India-focussed companies and are not impacted by any of the 2 major issues facing the global markets currently – oil prices and Chinese economy and currency. It is only the traders who punt daily who are bearing the brunt of this fall.

If anything, India is heading into a period of lower interest rates and that will add heft to economic growth and corporate earnings. Most of the current turmoil in the Indian markets can be attributed to FII selling. These are the guys who are most impacted by the global issues and hence are pulling out their money from Emerging Markets, irrespective of their fundamentals, and moving to safer havens, or sitting on cash. What is surprising is that the DII haven’t really counterbalanced them by aggressive buying, in spite of attractive valuations.

So here are my picks from the beaten down stocks (except Infosys):

Infosys – Though IT industry has been facing a tough time in recent years, Infy has got its mojo back with Vishal Sikka at the helm. This man has really done wonders for the floundering firm. At this juncture, Infy is any time a better bet than TCS and should do well going ahead mainly for 2 reasons:

·    Rupee depreciation – this should certainly help it in rupee terms cushioning the fall in revenues due to reduction in IT spends by clients. And I don’t think rupee is done yet. Levels of 70 seem likely in the next few months.

·    Focus on niche and futuristic technologies – By his own admission, Sikka has clearly said that new technologies like machine learning analytics and automation are gaining traction. This is a good sign as it will reduce dependence of the revenues on human resources billability. Also, visa issues and costs will also get reined in, if less manpower is required to do the same things now.

SKS Micro – This is another one which has got absolutely nothing to do with China or the world economy at large. But in the current turmoil, this also has got hit, down about 20% from its yearly high, for no apparent reason other than market sentiment.

Sintex Industries – Another victim of market sentiment. Again, same logic as SKS Micro applies. No obvious reason to go down 25% from 100 levels to 75 now. Sintex’s business model is strongly connected with macro-outlook and boost in government spending. The company will be a major beneficiary from government’s strong focus on wide range of infrastructure and social improvement plans viz. education, healthcare, sanitation, housing etc.

Dewan Housing Finance (DFHL) – Another victim of market sentiment. Again, same logic as SKS Micro applies. It continues to perform well on growth and asset quality front and this parameter is under the microscope of the market and everybody else. Look at Axis and ICICI Bank, yesterday’s bluechips and today’s pariahs, solely because of this factor. The stock is trading at a steep discount compared to other HFCs (all trading above 2.4x P/B). Also, it is into Tier 2 and 3 cities where the ticket sizes are small but the reach is wide. All conducive factors for growth. It has come down by about 15% from Diwali i.e. in about 2 months for no apparent reason. 

Textile MNC

Textile was not a fancied sector by investors over the last few years. However, in the last 2 years, it has again caught the fancy of the market and quite a few of the textile stocks have doubled or tripled – Welspun India, Indo Count Industries, Trident and Arvind being among the top ones. It isn’t that these players produce everything that they sell as their brands. They have a set of suppliers to whom they outsource their requirements along with the designs and stringent quality specifications. Then it is these garment manufacturers who do all the hard work of manufacturing to the stipulated quality standards. So while the likes of Welspun and Arvind are players with strong brands, it would also be worthwhile to take a look at their suppliers. If these companies do well, it stands to reason that their suppliers would also benefit. This is exactly what happened in the auto ancillary market and these stocks, riding on the back of a Maruti or Eicher Motors who have done extremely well over the last few years, have given tremendous returns. Subros, Gabriel etc. are some examples. The same story could now unfold with textile sector.

In the recent market volatility, a lot of mid-cap and small-cap stocks have been beaten down quite a bit from their highs touched not too long ago last year. Among them is E-Land Apparels, an integrated  textile player, and an MNC to boot (a rare case of a textile MNC, and one which not too many would have heard of). It has been hammered from its highs of above 60 to below 50 now, more than 20%, in the current market volatility

This was formerly known as Mudra Lifestyle. It started operations in 1986 and is in the textile industry having facilities for fabrics & garments manufacturing, processing, design, development and sampling etc. It manufactures fabrics and garments for domestic and export market. Its product portfolio includes finished fabric, processing and garments – men’s, ladies’ and kids’.

The brand “MUDRA” has built a strong goodwill for itself in the domestic market and commands a premium. The company is gradually moving towards garment manufacturing mainly in the designer shirts and ladies wear segments to capitalize on the huge opportunity unleashed by the removal of quotas. It has positioned itself as an integrated multi product, multi-fibre and multi-market player covering the entire textile value chain at length. It ensures that its target market is a diverse mix of the domestic market, garment export trade and international market (exports) to ensure risk diversification and stability of earning. This integrated textile player has clients like Arvind, Raymonds and ITC in the domestic market for brands such as Allen Solly, Van Heusen, Elements, Lee, Excalibur, Arrow, Zodiac, Killer, Notting Hill, Wills Lifestyle, John Player and Peter England, and caters to Wal-Mart, Carrefour among others in the international market. It has production capacity of 5.4 million garments per annum in manufacturing facilities spread across 4 locations at Bhiwandi, Bangalore, Daman, and Tarapur.

This company was promoted by Agarwal family, led by Murarilal Agarwal, who held 54.5% stake. It came out with an IPO in Feb. ’07 at Rs. 90/share. But within a year, by Mar. ’08, it was quoting at 36, about a third of the issue price. However there were 2 interesting points to note at that time- the promoters, Agarwals, subscribed to warrants at a huge premium to the prevailing market price at @120/share, and the company had only utilised 9 out of the 86 cr. that they got in the IPO with the rest in the bank. That itself amounted to Rs. 23/share of the market price of 36!

Agarwals had aspirations to enter into the retail market, from being just a supplier to the big names, where big investments and deep pockets would be required, and were open to the idea of a strategic partner.  And this is where South Korea’s E-Land came into the picture.  At the end of 2010, they sold out to the South Korea-based $7-billion textile chain E-land, the largest fashion enterprise in Korea, a rare instance of foreign investment in India's textile sector. The whole acquisition was completed in 2011. E-Land is famous for strong brand equity, well-established fashion retail network with around 4,000 retail shops in Korea and same numbers in China, and strong management capacity with profound experience in fashion industry.

Founded in 1980, E-land had initiated franchisee model in South Korea to expand its retail reach before expanding into garment manufacturing. E-Land has more than 1000 fashion designers with fashion design being one of the most important valuable capacities for textile and garment business. E- Land is now successfully operating a lot of oversees subsidiaries in USA, China, Vietnam, Srilanka, etc. among others, E-Land China is a leading apparel company operating in China and one of the largest companies in apparel sales in China.

In Feb. ’15, Mudra Lifestyle was formally renamed as E-land Apparels reflecting its promoters. Post the takeover, E-land first spent the initial few years in stabilizing the company’s operations and financials. And the results are there for all to see. From a loss-making entity, E-Land is expected to make a profit of 20 cr, this year. So this appears to be a clear turnaround story and is at an inflection point for great returns once it starts generating profits. Once the turnaround becomes obvious, it will surely be re-rated and will be difficult to catch.