Midcap carnage (26-July-12)

This is turning out to be a different kind of 7/26 at D-Street. While this has happened before with predictable results, this time I think it may prove rewarding to be wiser by latching onto the ones which have been ground to dust. While in all cases, the businesses may not be sound (as in real estate), in others, there definitely is potential.

Look at Parsvnath Developers @46 (down 20%). Though much has been written about real estate and probably rightly so, in my view, PD surely doesn’t deserve this price. I also believe that it may come back to 55-60 levels in a very short time once this brouhaha dies down.

Another one that merits attention is Tulip Telecom, down 28% @85. If nothing was wrong with it yesterday @108, I just can’t see anything wrong with it today @85!! The only thing for this knee-jerk reaction is that a couple of brokers who are facing a liquidity crisis have sold pledged shares of this company (and others who have crashed), triggering a sell-off in their shares. And this has a good business of enterprise data connectivity going, where it is doing pretty well.

Another on my list is Pipavav Offshore (of Nikhil Gandhi who also owns Everonn) which is again down 20% @62. Their JV with Mazgaon dock was challenged by other bidders (Bharti Shipyard, L&T and ABG Shipyard) but the challenge was rejected and the JV is still on. It is only a matter of time before they start getting orders from Mazgaon Dock. Also they have placed equity with a few PE funds and other investors some time back at much higher prices. Among the prospective investors they are having talks with is DCNS, the French defence major, owned by the French government and specialist in manufacturing surface combatants, submarines, systems and equipments. It is likely to pick up a little less than 10% equity stake as per news reports a few weeks back. They have stated their intent to place their shares with institutional investors @110/share. Looking at all this, it would make sense to buy into this in such times of crises.

There may be other stories like above where there is nothing wrong with fundamentals but only the sentiment which is playing havoc with their share prices. Once the dust dies down, they will be back to their original prices, and probably more. All in all, a good time to lock into these now or on any further fall.

Low profile, high growth?

South India-based financial services companies, be it banks, NBFCs, other lenders, or any other financial service providers, have gained reputation for their integrity, fair business practices, dedicated customer service leading to customer loyalty and conservative style of operation. Families such as the TVS group, Murugappa group, Shriram group to name a few, are still spoken with respect not only in India but also overseas due to these reasons.

While much attention has been focused on Sundaram Finance and Shriram Transport Finance, the listed finance arms of TVS and Shriram groups respectively, by analysts and media alike due to their superior performance and returns over the years, not much is talked about another entity coming from a similar parentage – CIFCO of the Murugappa group. The reasons could be many including its slightly turbulent past few years, but it has silently gone about its business of cleaning up its operations and looks set to join its peers in times ahead.

Cholamandalam Investment & Finance Co. (CIFCO), the financial services arm of the Murugappa group, was set up in 1978 with the primary objective of offering asset finance through leasing and hire purchase to corporates and then to retail customers. It has since evolved itself into a large, composite financial services organization that operates from over 350 branches across India with AUM of over Rs.10000 crore. Today, CIFCO is a pan-Indian, composite financial services provider that offers vehicle finance (new and used HCVs, LCVs, SCVs, MLCVs, MUVs, tractors, and cars and 3 wheelers), business finance, home equity loans, stock broking and distribution of financial products to its customers. It comprises the parent company, CIFCO, and its subsidiaries Cholamandalam Distribution Services Limited (CDSL) and Cholamandalam Securities Limited (CSec).

In 1997, CIFCO entered into a JV with Cazenove Fund Management Limited of U.K and launched its MF business in India. CIFCO held a 51% stake and Cazenove the balance 49%. This venture lasted for 4 years when CIFCO opted to look for a bigger international player in this area and bought out Cazenove’s 49% stake. It was the renamed as Chola AMC.

In Jan '06, Singapore-based DBS Bank (the largest in Singapore then) bought equity shares of CIFCO @150/share from the Murugappa Group's flagship, Tube Investments (17.4%), public shareholders (20%) through an open offer and subscribing to a preferential allotment of 30 lakh shares. The transaction resulted in DBS Bank and the Murugappa Group having equal shareholding of up to 37.5% each in the company. The shareholding of the Murugappa Group in CIFCO was at 55% prior to the deal. While continuing its focus on the core business of vehicle financing, the company entered the retail financing business with new products for personal loans and home equity. CIFCO was then renamed as "Cholamandalam DBS Finance". Under this arrangement, DBS also partnered CIFCO in their existing asset management venture renaming the company as Chola DBS AMC. This carried on the AMC business for a few years, but was unable to establish its credibility in the Indian market, barring a few of its schemes which performed well. L&T Finance which was looking for an entry into this business bought it over and in the process got the license to run an AMC. At a valuation of 1.56% of the AMC’s AUM, of about 3000 crore, this was a steal for L&T Finance and one of the cheapest deals in the MF space. However, it must be noted that Chola DBs AMc was a loss-making entity at this time.

In Jan ’09, the JV went thru a turbulent phase when both partners negotiated with each other to buy the other out. Finally in April ’10, the Singapore-based DBS Bank sold its entire 37.48 per cent stake in the company Cholamandalam DBS Finance to the Murugappa Group holding companies, Tube Investments of India and New Ambadi Estates. Following this, the company was again renamed to its original name i.e. CIFCO and is thus now a subsidiary of Tube Investments.

A few months back, in March ’12, Multiples Private Equity (floated by the former ICICI Venture CEO, Ms Renuka Ramnath) acquired 5% of the total equity share of the company through preferential allotment. Another fund, Creador (floated by a former managing director at ChrysCapital) has also invested around 5% here @160/share. Since then the price has steadily climbed to more than 200 currently.

Over the last few quarters, the company has shown strong loan growth, better NIM and lower provisioning and looks set for growth in the coming quarters. While Sundaram Finance trades at a P/B of 2.32 and Shriram at 2, CIFCO is quoting at 1.87. Considering that even M&M Financial Services trades at a P/B of 2.36, there is still scope for at least 20%, if not more, appreciation here, from the current levels.

Diversified businesses

Kothari Products (KP), the flagship company of Kothari group, is best known for its pan masala which is sold under the brand name of Pan Parag, and has over a period of time become a generic name for pan masala. The company was also involved in the business of packaged drinking water under the "yes" brand. In Nov. 2008, the company hived off the activities of manufacturing of pan masala, beverages divisions into a separate legal entity in the name of “Pan Parag India Limited” Redeemable preference shares were issued for this company to the shareholders of KP. These have since been redeemed.

Consequent upon the demerger, KP has focused on business opportunities in the what they consider to be the most buoyant and vibrant sectors of the economy such as real estate, investments and international trading of Exports & Imports. The core concentration of KP is now on these businesses. So in that sense, it is more of a quasi-holding company which not only has its operations in the above businesses, but also holds stake in other businesses of the group.

 Real Estate - The company itself and through its associates and other promoter group companies has substantial investment in the real estate sector in the Commercial, residential, retail, hospitality segments, land and development thereof. The company has a strategic partner in the Sattva (Salarpuria) group. Sattva is one of the leading real estate development group based in Bangalore, which is well known for its “IT Techno Parks” and beautiful residential buildings. The Salarpuria Group has its offices in Bangalore, Delhi, Pune, Jaipur, Hyderabad, Vizag and Kolkatta. Under the joint development with Salarpurias, KP has embarked upon development of mega residential projects in Bangalore and Pune. 

International Trade – KP has ventured into the import-export trade of various products/commodities including agro-based commodities, minerals, metals and petroleum products. Recently the company has also incorporated its foreign subsidiary in Singapore for “General Whole sale Trade (including General Imports & Exports)” in addition to a domestic subsidiary to pursue the business of international trade vigorously and profitably.

The company’s trading items are being exported directly or through merchant exporters to China & Thailand. The company has exported iron ore and is also in the process of exporting of aluminium ingots to Thailand and also planning export of Literite to Bahrain. The company is also planning various minerals and metal products for export. New developments under process are Soya DOC.

FMCG business – This was the core business of KP before the diversification as mentioned above. This business is now housed in its wholly owned subsidiary Pan Parag India Ltd. which is also involved in the business of packaged drinking water under the "yes" brand.

As has been seen in the past, the hullabaloo regarding pan masala ban, due to the recent Maharashtra government ruling, will soon die down. The gutkha and pan masala manufacturers will move court and get this rolled back as they have done twice in the past. After all, cigarettes also fall in a similar category and the courts couldn’t stop their production.

This company has a tiny equity capital of about Rs 6.63 crore. Promoters hold roughly 75% of the equity capital.  As of March ’11 (current years’ results awaited), this company had a cash and bank balance of Rs 36 crore and loans & advances of close to Rs 322 crore. This makes the total liquid assets available with the company at more than Rs 350 crore. Against the liquid assets of Rs 350 crore, this company has a total debt of only 90 crores. This is besides the other investments the company holds in its subsidiaries at book value which in real terms will be worth many times over.

For the year ending March ’12, the company has an EPS of more than 90. This company has been a regular dividend payer, for the last many years it has consistently paid dividends of more than 100% going even up to 160% in some years (this year it was 150% or 15/share). So here we have a company, which has very little debt, a small equity and a very high promoter stake. It is creating huge value for the shareholders, year after year whereas the market price is not going up in the same proportion.

With a book value of nearly 980 crores, it is quoting at a P/BV of less than 0.5 and a P/E of 5.4. It should not be looked at as a pure holding company since it has some operations of its own, and hence should be looked at in that light. So merely applying a discount to BV to arrive at a fair price may not be the correct way since its operational business is not being considered. And real estate as well as trading operations, if managed correctly, have been known to be good money spinners.

Such companies producing tobacco-related products have a market cap which is more than its sales revenues many times over - ITC (8), Godfrey Phillps (nearly 2), VST (nearly 3), KP commands a Market Cap to Sales of just 0.1. The company thus appears grossly undervalued compared to its peers and carries potential to reduce the huge valuation gap which exists currently. At the current price of about Rs 408, this stock is a pure value play. Also, considering its huge reserves vis-à-vis the equity, a bonus could be distinct possibility. However, considering the diverse nature of its businesses most of which are not doing so well (for e.g. real estate and trading due to general consumer environment and volatile exchange rate), it may not soar too much in the current environment. However, under benign conditions, the returns should be good (last July ’11 it was quoting as much as 670).

Niche technology

Astra Microwave Products Ltd (AMP), a Hyderabad-based electronics company was promoted by technocrats B. Malla Reddy, who has worked for over two decades in ISRO, Bangalore, and DRDL, Hyderabad, P. A Chitrakaar, who has worked as a scientist for over 20 years with Defense Electronics Lab, Hyderabad and C Prameelamma, who has had a distinguished career with Electronics R&D Establishment, Bangalore, and the DERL, Hyderabad. It is engaged in designing and manufacturing high value added RF (Radio Frequency) and microwave super components and sub-systems for defense, space and civil communication systems. Its products are widely used in VSAT operations, radars, satellite applications, antennas, etc.  with European Aeronautic Defence and Space Company, Israel Aerospace Industries, Elettronica, Italy's SIAE Microelettronica among its top foreign customers.

AMP operates in very niche and high-tech space with very few listed peers. The biggest listed competitors/peers to it on the Indian exchanges are the PSU BEL, BEML which work as monopolies in the supplying defense equipment to the government. With privatization being allowed in defense procurement recently (as evidenced in MoD officials’ pronouncements in Defexpo India 2012), quite a few private companies are gearing up to enter this field. The major players/groups who have shown interest and are already active in this space are the Mahindras (thru Mahindra Aerospace and Mahindra Systech, both private companies in the group), Larsen & Toubro, Tatas (thru Tata Technologies which has a JV with HAL, a PSU), Pipavva Defence & Offshore Company (also referred as Pipavav DOC which was formerly Pipavav Shipyard), and Kirloskars. The rising defense expenditure in India is throwing up huge opportunities for private sector as they can enter into partnerships with global majors for manufacturing. Shipyards are another area where private sector smells an opportunity. Pipavav DOC (formerly Pipavav Shipyard) has already entered into a JV with Mazgaon Dock, India's biggest defense shipyard for shipbuilding with more than 85% of indigenous defense vessels being built there. With Mazgaon Dock already executing huge orders for the govt., some of it will surely come Pipavav’s way.

As with retail, this sector (defense equipment and services) is more or less out of bounds for the private sector, a scenario which is undergoing winds of change. As with retail, govt. is taking small but steady steps in opening up this sector to private participation realizing that PSUs such as BEL alone may not be able to supply India’s growing needs for this sector. FDI is currently 26% in this sector but private sector is lobbying for this to be increased to 49 (similar to Retail and Insurance). It may be a matter of time when the govt. gives the nod for this keeping all stakeholders happy. The govt. has already decided to issue licenses to Indian and foreign private companies to invest money and to start manufacturing defense equipments. So far, they have given licenses to 24 companies, including Larsen & Toubro, Tata and Mahindra and Mahindra.

AMP is backed by Strategic Ventures Fund (SVF), a PE fund managed by Mauritius-based Frontline Strategy Limited with a 15%. Besides this, other major players who have found Astra to be investment worthy are L&T which has a near 10% stake, Reliance Capital with 5.6% and Skanda Aerospace, a Hyderabad-based company with 7%.

Recently, a few month back, in one of the largest defense offset contracts awarded to a mid-tier Indian firms, AMP has bagged a Rs 310 crore deal from one of its overseas customers, the first time that they have bagged such a large order in their history. Including the new order Astra Microwave will now be executing orders worth approximately Rs 730 crore outsourced by its foreign and domestic customers – DRDO and ISRO. The order will significantly add to the Astra's revenues. India's defense authorities plan to spend Rs 75,000 crore over the next decade to procure new radar systems in a bid to modernize the armed forces with more sophisticated weapon systems. So there is ample scope for companies small and large to scale up their divisions in this area. Once there is a steady stream of work coming in, the bigger companies may well look at sub-contracting some of the work to smaller players like AMP or even outright acquire them if they appear attractive enough with niche skills and inability to scale up on their own. AMP would fit the bill perfectly here. A couple of years back, L&T was looking to increase its stake in AMP by buying some from SVF, but the deal fell thru. Later BEL was also looking to get into AMP which also didn’t materialize.

AMP @44 is currently quoting at a PE of about 10.6.  It has a reasonable low equity of 16 crores with healthy OPM consistently maintained at 25-30% and PAT margin of 12-15%, This year they also gave a bonus of 1:1.

The major risk for AMP would be adverse government policies, but given the strategic nature of their business this should be largely under control. Also, they have their overseas business to fall back on if this were to happen. Considering the healthy demand scenario both domestically and overseas, as well as sound operating metrics, AMP should do well going ahead. Any M&A activity will be a bonus. 

Diversified infrastruture

Marg, an Andhra-based company incorporated in 1994, is into development of ports, airports, SEZ and commercial & real estate. It is present both in the realty and infrastructure segments. The company has a well diversified portfolio which includes infrastructure projects, industrial clusters, real estate- Commercial and Residential. The company is into Ports, Marine Infrastructure, Fishing Harbours, SEZs, Industrial Townships, IT Parks, Malls, Serviced Apartments, Integrated Townships, High end Premium and Budget Apartments. Broadly, the company operates in three segments, i.e. Infrastructure (BOT assets), EPC and Real estate. The company focuses not on standalone projects, but on those that provide opportunities to exploit the synergies of its infrastructure and real estate business capabilities. The parent company is largely into EPC contracts, a mix of internal and external projects, while infrastructure projects are under wholly owned subsidiaries as SPVs.

MARG is credited with the pioneering development of several residential and commercial complexes (including the first private IT park on the Old Mahabalipuram Road, Chennai’s arterial hub). It has also constructed some renewable as well as non-renewable power-generating infrastructure. The company was awarded the prestigious Karaikal Port project in January 2006 by Government of Puducherry (GOP). The Karaikal Port project is a BOT project expected to be completed by 2015-16 and will possess a handling capacity of an aggregate cargo in excess of 3 cr. tons annually. Located 280 km south of Chennai Port and 360 km north of Tuticorin Port, Karaikal Port has a strong and a growing hinterland which includes areas like Nagapattinam, Cuddalore, Thanjuvar, Trichy, and parts of southern AP and Karnataka having strong industrial clusters. This would give it an assured supply of orders from these areas. Recently, the company has signed term sheet with the PE firm Jacob Ballas for primary investment of Rs 100 cr. in the port. Jacob Ballas has also acquired ~8% stake for Rs 100 cr. from IDFC, who had invested Rs 150 cr. in September 2010. Marg’s stake in Karaikal Port post this transaction will reduce to ~62% from 70%. They have already commissioned first phase of Karaikal Port with capacity of 5.25 million ton of cargo. They have ship repair yard and two integrated SEZ in townships.

The market sentiment towards infrastructure & realty stock currently is quite negative and many infrastructure stocks including Marg have been battered out of shape. Marg has lost over 86% from its high of Rs.630 during the boom of pre-2008. The negative sentiment is more out of fear psychosis and lack of confidence than anything else. While it is a fact that the fundamentals of the economy have taken a turn for worse than what they used to be a few years back and the fact that many of the infra companies are facing a liquidity crunch, the stock prices have more than corrected for these deteriorated fundamentals and the behavior of the market is as irrational as was witnessed in January 2008, albeit on the downside now. Also, the government is expected to provide impetus to the sector through few policy measures. Liquidity position may ease off over the next few months. However stock prices generally respond much before the action takes place which may well happen in this case too. Infrastructure growth in India will continue to happen; the pace of growth is what could be debatable. The stock prices have more than adjusted to the changed scenario after having fallen over 90% in most cases.

Promoters (Reddy family) hold more than half the equity @54.4% while Reliance MF has about 6% stake. Other significant shareholders of note include Ashish Kacholia (co-founder of Hungama) and IL&FS Securities

.

The company at its current market cap of Rs.319 cr. and a price of 83 is going at less than half of its book value of 190. Similar to what Adani did in the case of Mundra port (now called as Adani Ports and SEZ), Marg could also come out with an IPO of this port, unlocking value for its shareholders in times to come. Though there may be short term challenges, the long term potential certainly looks good.

Refined profits

Nagarjuna Oil Refinery (NOR) was formed by the Nagarjuna group (KVK Raju) thru its flagship company Nagarjuna Chemicals & Fertilizers in collaboration with other investors. Recently, NFCL demerged this business and allotted shares in the refinery to its existing shareholders thru a composite scheme of arrangement wherein shareholders of NFCL got shares of NOR as per the terms of the scheme. Now, NFCL holds 51% stake in the project while Tata Petrodyne, a unit of Tata Group, has 30%. Tamil Nadu government holds 5 per cent through TIDCO, Uhde of Germany has 4 per cent and Cuddalore Port has the remaining 10 per cent.

NOR is setting up a refinery over 1,600 acres, located 200-km south of Chennai between Cuddalore and Chidambaram on the east coast. This state-of-the-art project will refine 6 million tonnes of crude petroleum per year (MMTPA) in Phase-I. The refinery will have associated marine infrastructure including single point mooring (for crude oil handling in very large crude carriers) and jetty (for finished product handling). It will have capability of processing heavy and sour crude oil and will supply light and middle distillates.

Some time back, independent oil and commodities trader Trafigura Pte Ltd of Singapore, declared its intention of investing up to Rs 1,250 crore ($250 million) in the Nagarjuna refinery and in storage facilities. This will include buying a 24% stake in the company for Rs 650 crore ($130 million). In addition to acquiring an equity stake, Trafigura will invest a further $120 million into the construction of extensive storage facilities and associated infrastructure at the refinery's 2,500 acre site. This investment was the first of its kind for the company.

This appears to be a case similar to that of MRPL about 10 years back. MRPL was set up in 1988 as a JV between HPCL and Aditya Birla group, with both holding about 38% each and the rest with the public, with an initial processing capacity of 3.0 million tones/annum that was later expanded to the present capacity of 11.82 Million  tones/annum. It was into heavy losses during the late 90s and Aditya Birla group made up its mind to get out. As per the MoU between HPCL and the Aditya Birla group -- the promoters of MRPL -- HPCL had the first right to refuse the Birlas' stake. Once Birlas decided to get out, and HPCL was not too keen on buying their stake, the war for their stake heated up with many renowned bidders such as local major IOC as well as Kuwait Petroleum showing keen interest. Finally in March 2003, ONGC acquired the total shareholding of A.V. Birla Group and further infused equity capital of Rs.600 crores thus making MRPL a majority held subsidiary of ONGC. It also acquired further shares from the public in the following open offer as well as from the lenders who converted their loans into equity as a part of Debt Restructuring package. The current holding of ONGC in MRPL is thus around 71%.  Due to the heavy debt and lack of management attention (due to the tussle between Birlas and HPCL), MRPL stock was languishing close to Rs 8 in 2001. Post OGC coming in and improving not only its operational strength but financial as well, it is around 50 now, down from more than 70 a year or so back, still gaining around 6 times in 11 years, a return of nearly 50% p.a.

So a bad company with a good promoter running it usually has a good chance of turning around. This may well be true of NOR. If Nagarjuna group decides to opt out (as they well be since oil is not their core strength), or for that matter TN govt. as a part of divestment for raising funds since state governments are perennially in need of funds, there could be multiple suitors including international majors for their stake. However, it must be noted that the refinery is yet to be commissioned with the plan being for early 2013, barring unforeseen circumstances. This is a delay of almost six-nine months due to the damage caused by cyclone Thane, which hit Cuddalore last year. Meanwhile, Indian Oil Corporation has signed an agreement with NOR to sell their petroleum products of Nagarjuna Oil. Till then, nothing much may happen, but once it starts going and becomes commercially viable, there will be renewed interest in this.

Since it just got listed some time back, there are no financials to speak of. Also, since the refinery is not commissioned, there is hardly anything to look forward to at this point. But as has been seen in the case of Essar, once the refinery is commissioned, the financials will catch up fast. The Essar Oil grass roots refinery in Gujarat, started in 1996 was completed and commissioned in third quarter of 2006. The refinery project was delayed several times due to environmental concerns and financial problems, including initial cost overruns and a shortfall in equity contributions. According to company reports, the refinery was 60% complete in 1998 but had the misfortune to be struck by a cyclone that caused considerable damage. In 1995, Essar Oil came out with an IPO @45 which plummeted to 15 by Nov ’99 and further sank to 8 by 2000, when there was no sign of the refinery. Since then it rose to about nearly 300 by Dec ’07 when the refinery was going strong. In this year itself, it has again plummeted to about 55 currently. Even considering the worst case, if someone had bought into Essar at 8 in 2000, it would still have multiplied 7 times in 12 years, again a return of nearly 50% p.a.

Since its listing end of March ’12, NOR is currently quoting at the rock bottom price of Rs 6. It may be worthwhile to keep an eye on this one and buy even now as well as when it goes lower with the market and towards the time of its commissioning. There is very little to lose here with the current promoters, irrespective of delays and hurdles which may surely occur in times to come, as has been seen in the cases of Essar as well as MRPL. The only thing to be kept in mind is that this will be a long wait but will in all likelihood be worthwhile.