Beaten down way too much

Over the last year or so, the market has been on what can best be described as a roller coaster ride, going up by 500 points one day and down 300 points the next. After crossing 20K, it again sunk to 18K in a short while and has again managed to come above 19K. How things move from here will be driven by FII money/liquidity and govt.’s reforms push which all of a sudden appears to have moved into 3^rd gear.

Amidst these gyrations of the market, there have been many stocks which though fundamentally good have sunk to new depths largely due to the news flow surrounding them. Some of them are MNC stocks which were very much in the news due to being considered as delisting candidates. However, when the delisting bubble burst due to the unrealistic expectations of the investors who demanded astronomical valuations defying economic rationale, and the MNCs didn’t think it worthwhile to pay them those, a majority of them made a beeline for the OFS route to reduce their shareholding to 75% or below. Of course a few like Fresenius made a smart play by doing the OFS at a relatively low price and then 6 months or so later coming out with an open offer at a substantial premium to the OFS price thereby hugely benefiting the subscribers of the OFS. This also meant that the number of shares that they had to corner to delist also reduced significantly than from the last time. While the spirit of law was followed in letter, the spirit was certainly given the go-by.  It remains to be seen if other MNCs take a cue from Fresenius Kabi and take a similar route or if the regulator sees thru this smart move and takes some concrete steps to avoid them.

One such beaten down stock which has become attractively valued now is Styrolution ABS.

This was Ineos ABS earlier and was considered as a top delisting bet since the parent held close to 87% of the shares (Parent held 83.33% stake in Dec’11 but made an open offer to the shareholders @606.8 for balance 16.67% stake but garnered only 4% of the shares making it 87.33%).  And it reached levels of 800 at the peak frenzy. However, as mentioned above, things didn’t quite pan out as expected and this too went the OFS way to reduce its stake. But the interesting part is that it priced the OFS at around 410, a discount of 23% to its then last traded price and @P/E of just around 11, way too low for an MNC stock.

Styrolution ABS is a leading manufacturer of an engineering plastic namely styrene monomer, polystyrene and ABS. The company is a 50/50 joint venture between BASF (the German MNC) and INEOS ABS formed by combining the styrenic business of two of the largest global chemical companies. In the domestic market, Styrolution is the market leader and holds 60% market share in ABS resins segment and 68% in SAN resins segment. And it has an opportunity to reap the benefits of demand supply gap (met by imports) which has persisted for long and continues to exist. Further, CRISIL Research estimates that the supply of ABS would grow at 17% CAGR in order to meet the demand growth of 10% CAGR during CY2010-15E, thus providing revenue visibility to the company.

As per the public disclosures made by the company, FIIs predictably have cornered a large chunk of the OFS shares, squeezing the public shareholding further. So a re-run of Fresenius story can’t be ruled out.

All in all, extremely cheap valuations for an MNC company and good future prospects (demand as well as pricing power being a leader in its segment) make this a reasonable bet even for a conservative investor. A delisting offer would be an added bonus for this stock.

Bearing the economic brunt

After the initial global liquidity driven euphoria, since December last year (2012), the markets have begun their downward journey once more, as is their wont. And this time, it is not the usual suspects, the midcaps, who have borne the brunt, but some of the large caps as well. These are by no means dodgy companies with questionable promoters but global companies who are suffering the ill-effects of a sluggish economy and more so in the power sector. Considering that this gloom-and-doom scenario is not going to last forever, this also gives an opportunity to load up on such beaten down stocks. It is interesting to note that these are from the much maligned infrastructure sector which is desperately looking for some rope from the government.

Consider 2 of the most promising stocks in the infra space, both catering to the power sector – Siemens and ABB. Both have touched their 52-week lows in the last few days and there seem to be hardly any takers for them in the current environment. And they really can’t be faulted in a trader’s market that holds sway currently. Long term investing seems to be a thing of the past, and not unjustifiably either if the behavior of the markets over the last 5 years is observed. However, as Warren Buffet once famously said, “The right time to buy is when everyone is selling”. Going by that adage, the current market seems to be ripe for the picking.

The reason for ABB tanking was the underperform rating put out by BofA-ML on it. Cost over-runs due to project delays and delay in payment by clients have resulted in a fall in revenues as well as margins. At the investor conference call, management emphasized the cautious outlook for ABB's projects business, but highlighted an improved performance for the product business. ABB currently trades @570, close to its 52-wk low of 560.

Same appears to be the case with Siemens. Siemens builds trains, power plants, wind turbines, light bulbs and other items closely related to a country’s industrial fortune. The company lost its crown in July ’12 as Germany’s most valuable company to SAP, the business software maker, even though Siemens revenues were much higher. It must be remembered that Siemens did a buyback of its shares @930 about 2 years back. The price has nearly halved in the last 2 years since then, for the reasons mentioned earlier. Siemens currently trades @538, its 52-wk low.

And in the last couple of days, Welspun Corp apparently bore the brunt of margin selling when some of its pledged shares were offloaded by brokers in the market. The company's trailing 12-month (TTM) EPS was at Rs 17.81 per share (Dec, 2012) giving a P/E ratio was just 3.48 on the current price of 62. The latest book value of the company is Rs 156.33 per share. So on all parameters, it looks beaten down much more than justified.

In one of the largest private equity (PE) deals in June ’11 and its largest in India, Apollo Global Management, a global PE firm with expertise in oil & gas sector, decided to invest up to Rs 2,250 crore ($500 million) across 3 entities of the diversified Welspun Group. This was Apollo’s largest investment in India. Under the deal, Apollo paid Rs 1,305 crore to buy close to 20% in Welspun Corp, through FCCD worth Rs 788 crore and GDR worth Rs 517 crore. The promoter holding in Welspun Corp was 41.07 per cent on March 31 ‘11. After being converted within 18 months at Rs 225 a share, it would represent 13.3 per cent equity capital of Welspun Corp. And on Feb. a week back, on 19^th, as per the terms of agreement, Apollo converted is debentures in Welspun Corp @225/share against a then prevailing market price of 90, a 150% premium.

So all in all, at such beaten down prices, no better time than now or in the following period, to have some of the better names in one’s portfolio, without expecting any miraculous returns in the near term. The key trigger would be the turnaround in the economy when these stocks will rise to their true potential.

Healthy dose

Shasun Pharma, a leading pharma company in the generics space, is engaged in manufacturing active pharmaceutical ingredients (APIs), their intermediates and enteric coating excipients with a significant presence in some key generics.

What attracted my attention to it today was the crash of more than 11% today on the back of disappointing Q3 results. This is not the first instance of such a crash in this scrip. The earlier instance was in Jan ’11 when it had come down to 76 levels (which was even lower than the current 87), apparently due to forex losses from rupee depreciation. And in the following 18 months, it rose to about 160 following strong performance from its UK tie-ups and operations. Even today, the reasoning give by management for the steep drop in quarterly profits is price pressure on one of the APIs which they were exporting to the US and consequent reduction in price to retain market share. But, the quantities did not move to the extent that they had expected. However, the management has given a strong guidance for the coming quarter following stability in pricing.

Shasun has created a strong product portfolio, building on its R&D expertise, regulatory capabilities and multi scale production capacities. Today, Shasun is one of the largest producers of Ibuprofen worldwide. The company offers derivatives of Ibuprofen like Ibuprofen Sodium, Ibuprofen Lysinate and S+Ibuprofen. It is also one of the major producers of Ranitidine and Nizatidine in the world. Its products are exported to countries across North America, Europe, Asia and Latin America.

Active presence in CRAMS in both API as well as the formulations businesses creates a huge opportunity for Shasun to increase and diversify its revenue base. In addition, the company has several other APIs under development for products, which would turn generic in the next three to five years. Its Greenfield facility in Vizag will enable Shasun Pharma to generate sustainable cash flows over the coming years.

At today’s price, it is quoting @P/E of 7.7 ttm which looks pretty low for a company of its size (10K cr sales) and pedigree. If its past record is anything to go by, it may not be too long before it bounces back to the levels mentioned earlier, giving a huge appreciation over the current price.

Clearwater (PE) checks in

Incorporated in 1986, Kamat Hotels India Ltd (KHI) categorizes its business under four heads - Owned hotels, Management of hotels owned by other parties, Catering services and Others.

It has four brands - The Orchid (which is the flagship brand), VITS, Gadh hotels and Lotus resorts. The Orchid hotel, located at Mumbai, is an environment friendly 5-star hotel (Ecotel) that contributes maximum to the company's revenue. VITS hotels are luxury business hotels and are present in cities such as Mumbai, Aurangabad, Nagpur, Pune, Nasik, Delhi and Bhubaneshwar. The Lotus brand is applied to luxury resorts. They are located at Silvassa, Murud, Udaipur, Konark, Karwar and Goa. The Gadh hotel at Fort Jadhavgadh is located 22 km from Pune and has 38 rooms and 12 tents spread across 3 wings.  Last year, Kamat Hotels absorbed some of the hotels run by the Kamat family, taking promoters' stake to as much as 57%.

However, what is interesting about this company, apart from a very good reputation and pedigree of its founder, one Mr. Vithal Kamat, is a recent development.

Clearwater Capital Partners (who are based out of Cyprus & Singapore) had approx. 23% stake in KHI previously. KHI had issued FCCBs worth $18 million in 2007 to fund their expansion plans (Mumbai Orchid and all that). Anyway, the conversion price back then (at the height of bull market) was set to Rs.225/-. After sanity prevailed, the conversion price was reset to Rs. 135/- in June 2010. Now, KHIL over the past 6 months or so has been converting FCCBs into equity at Rs.135/- (check the various announcements they have made). Clearwater with a complete FCCB conversion would hold approx. 31% of KHI’s diluted equity. Once the percentage holding crossed 25%, open offer rules were triggered and Clearwater made the open offer @135 to the remaining shareholders for the mandatory 26%, which closed recently. Post the closure of the offer, and equity dilution, the shareholding status is as follows:

Promoters (Kamat family & associates) – 51.7%

Clearwater Capital Partners – 41.3%

Public shareholding – 7%

It must be noted that this open offer to acquire 26% @135/share was first announced in January 2012, and made in March 2012, but got delayed due to various reasons. Finally it took place at the end of December 2012.

With the mandatory 25% public shareholding rule to be implemented by June ’13, it remains to be seen how this plays out. Clearwater being a PE would want to make a quick buck on its investment and may not hesitate to sell its stake to hospitality major, local or global. And with brands spanning most segments from budget to luxury, Kamat would be an attractive bet for many hopefuls. Besides, a majority shareholding of the founding family would be an added show of confidence in the long term viability of the business. This could well turn out to be a case similar to that of Wabco where there were 2 equal partners running the company and eventually one wanted total control.

KHI is currently quoting at 112, about 17% below what Clearwater Capital paid for it for such a big stake. However, it must be remembered that it has made a loss of about 6-7 crore each in the last 2 quarters and only a slight profit in the 2 quarters prior to that. So the numbers are not worth talking about at this stage. With the debt of FCCB gone, the interest outgo on this count would stop completely and add straightway to the bottom-line. With the economy slowly on an upswing, hotel and travel tourism segments are doing well and India is now being looked at as a market with tremendous growth potential. With the continuing economic reforms, growing economy and major restructuring of the Company's business, the future outlook of the Company looks promising. Considering all these factors, the stock holds lot of potential at present levels.

Interestingly, Clearwater Capital also has a 27% stake in Vadodara-based Sayaji Hotels.

Profitable holidays

Launched in the mid-1980s Sterling Holiday Resorts was the pioneer in the time share industry which registered red hot growth in the period 1986 to 1995. Mahindra Holidays took a cue from them in this nascent industry and surely but firmly established themselves as the timeshare company in the country. Meanwhile Sterling Holidays sank deeper, not least because of its own doings. So much so that its image for the past many years has been one that of dissatisfied customers coupled with run-down resorts.

The company expanded too fast in the mid-1990s, buying many pieces of land during that time and landing in a lot of debt. Then the crash of 2000 happened and Sterling found that they couldn’t dispose of the excess land that they had bought as property prices had come down. They compounded their problems by overselling their timeshares. Even in the most advanced economies, overselling of time shares has been a problem.

But Sterling Holiday Resorts, which has 19 resorts offering 1523 rooms, has been turning things around. In June ’11, they appointed Ramesh Ramanathan, their President in the nineties (1991-95), and then MD of their arch rival Mahindra Holidays as their MD. And he has started the revival earnestly. The company turned cash positive in the last quarter of the last financial year – the first time in 60 quarters and the trend should continue, if developments over the last year or so are any indication. But things may not happen in a hurry. Sterling wound up the March ’12 quarter with a net loss of Rs 5.91 crore. The comforting factor -- this was lower than the loss of Rs 17.97 crore the immediate previous quarter. Being EBIDTA positive is the start of a turnaround. The tougher task is to do so in the minds of their customers as well and bring back the credibility which they enjoyed once upon a time.

The turning point came when Bay Capital Partners Ltd invested Rs 15.97 crore in early 2009. The accumulated losses at the end of FY 2009 were Rs 203 crore. Bay Capital continued to invest in the company - altogether Rs 78.24 crore - and today has a 32.72 per cent stake. Bay’s Siddharth Mehta took over as Chairman in July 2011. Once Mehta put in the money, Sterling could negotiate with the banks and settle debts. And now, for the first time since 1995, Sterling is a debt-free company.

Then about a year ago the Mumbai-based investor duo – Rakesh Jhunjhunwala and Radhakrishna Damani – invested Rs 120 crore in the company (in a combination of equity and warrants; with warrants issued to them to be converted soon each will have a 7.71% stake).

It is pertinent to read the thoughts of RJ, the astute investor. He says “Any buyer of a Rs 5 lakh car is a potential customer. The entry barriers for this business are high because you need at least 10-12 resorts to offer. There are only two players in the market. And, now Sterling has a good management so long term potential is good.” This logic is obviously unquestionable.

Two things have stood Sterling in good stead: keeping the resorts going and not selling the land. That land is going to come in mighty handy now. It has 150 acres of land across 15 destinations, from Mahabaleshwar to Munnar, which will allow it to construct 2,000-plus rooms. More importantly, they have kept all their permissions to build in green areas alive all these years.

Now, Sterling’s resorts are being renovated at a cost of over Rs 100 crore. This also includes the cost of leasing new properties. At Kodaikanal, its first resort has been renovated and rebranded as Kodai by the Lake. Its Munnar resort has been renovated as well. Around 350 rooms of the company's resorts have been refurbished and another 400 will be done by March 2013.

Sterling is reconnecting with its existing member base of 65,000, many of whom are a disgruntled lot. With renovated and new resorts, it expects its members to take it seriously again. Last year, it enrolled 2,500 members. Greenfield resorts are at least 18 months away.  Mahindra Holidays, a company where Ramanathan was earlier the MD, and the leader in this business has more than twice Sterling’s members at 145,000. It operates over 2,000 rooms across 40 resorts.

Sterling’s time share is 30 per cent cheaper than Mahindra’s but the latter’s resorts are superior. They were the pioneers in the business and even when they started nose-diving, they continued to service their members. Sterling’s turnaround has already begun but the real impact will be felt only next year.

Debts wiped out, new investors and a new management. The results are showing. It should only be a matter of time when they will regain their lost glory.