Demerger bets - 1

Post the demerger of Sintex Plastics Technology from Sintex Industries and the resulting gains that accrued to shareholders of the pre-demerger parent Sintex Industries, there is certainly merit in evaluating other companies which are going the same way. In the case of Sintex, the Sum-Of-The-Parts (SOTP) was always going to be greater than the whole as the market usually discounts the bundled company fairly highly over the individual businesses. The same story is likely to play out in the case of Reliance Capital (RC), ADAG group’s financial services flagship.

RC houses a lot of lucrative businesses under its fold. These businesses individually would be valued way more than what the whole of RC is currently valued at. This is where the SOTP principle comes into play. And at long last, ADAG seems to have realized this. To be fair, it is not easy to demerge an entire unit, much less list it on the exchanges, unless it achieves a certain scale and has the ability to sustain itself through its own earnings rather than relying on the parent. We have seen this happening in the case of L&T Finance. Another recent case is that of Max Financial Services. Both are promising businesses and have highly pedigreed promoters and management. They are sure to stand credibly on their own in the years to come after coming out of their parent’s shadow. A similar case is likely to play out in the case of RC as well. 2 of the most promising businesses that it houses are the MF (Asset Management) and Insurance (Life as well as General/non-Life), both of which are now doing extremely well. This can be gauged by the fact that Nippon of Japan holds half of the MF business and also has a significant stake in both the Insurance businesses. And the names of all 3 companies reflect this. MF constitutes nearly 27%, General Insurance (GI) nearly 11% and Life Insurance nearly 18% of the current RC. If they were to be separately listed, the SOTP is likely to be way higher than the proportion suggests. Of course it is too early to get into the numbers game right now before the Investment bankers crunch the figures and bring out their valuation reports.

The other silver lining is that ADAG group has made its intention of listing both of these businesses (only the General Insurance, GI, for now) in the near future, both having filed DRHP with SEBI. That would be case of huge value unlocking here. That there is appetite for both these areas in the market can be gauged from the fact that 2 other big groups also have shown interest in going in a similar direction (ICICI with listing of ICICI Lombard, its GI subsidiary, and UTI with its MF business).

Apart from the above key businesses, RC still has other related business like Retail Broking, another hot area which is picking up (look at Motilal Oswal and Geojit’s stock trajectory over the 2-3 years), Consumer and Commercial Finance (look at where Bajaj Finance is and still going strong), Commodity (trading in precious metals like Gold,, Silver etc.) to name the key ones. Retail broking is a small part currently constituting only about 3% while the Financing business is a large chunk of about 28%.

This is only half the story. While the above value unlocking of the MF and Insurance businesses will happen over the next few months, the more immediate gains are likely due to the demerge of the Housing Finance business in the next few days. This is nearly 13% of the current RC. HF is one business area which has caught the fancy of the markets with most stocks in this space having doubled or tripled in the last 2 years (just look at DHFL, LICHFL etc.). Most NBFCs in the HF business have handsomely rewarded their investors. And so too will Reliance HF post its demerger and listing on the bourses.

With HF out of the way, rest of RC as explained above still has a lot of value which will be unravelled over the next few weeks and months. So it would be best to start SIPing this over the next few weeks/months to gain the most from the market volatility and participating in the value unlocking.

While short term gains are certainly there for the asking, over a longer term also, these businesses are likely to compound at healthy growth rates, thus giving everyone a choice as to their holding period.

Themes for 2017

Here’s wishing everyone a very happy 2017 ahead. 

2016 was an interesting year with unprecedented events occurring especially in the later part of the year. First we had the shocking BREXIT vote which voted for Britain to separate from Europe, much against conventional wisdom. Next was another stunner in Trump defeating Clinton, going against most predictions of an easy Clinton win. And not to be left behind, our honourable PM Modi outlawed high denomination 5000 and 1000 notes as a war against corruption, terrorism et al.

These events, occurring in quick succession have left the markets going nowhere in the last 6 months. So the recovery which was in sight in October was wiped out by Modi due to the demonetization effect and the predictions are now for at least 1 or 2 more quarters (3-6 months) for things to return to the normal as it existed in October. Whether that actually happens, only time will tell.

On the positive side, we had the GST Bill moving forward and hopes are still alive that it will see the light of the day sometime this year though not in April as everyone, except the opposition parties, wanted it.

This also means that there were at least 3 opportunities when markets in their usual fashion collapsed in response to global events, irrespective of the fact that these had no impact whatsoever in quite a few of the companies which were knocked out of shape. That has been the speciality of Indian markets for as long as I can remember and there is no sign that such knee-jerk reactions will end anytime soon.

The Sensex continues to hover around the 25K mark, about 20% down from the 30K mark that it touched sometime last year. However, as has been seen in recent years, returns of Sensex have not been a true reflection of the stock market returns as is widely perceived theoretically, text-book style. There were many opportunities and there were stocks which doubled or gave returns in excess of 25-50% in some cases. Quite a few companies gave bonus shares (ITC, Berger Paints, PFC, Bajaj Finance) indicating strong confidence of the management in servicing the growing equity, and some are on their way to announcing it. So as has been said in many fora, India continues to be a stock pickers’ market and there are enough opportunities in individual stories to still earn excellent return if money is put in fundamentally sound stocks with proven managements who have seen teh ups and downs of business cycles and more importantly navigated them successfully.

The key theme this year in 2017 would certainly be Digital India and less cash economy (India is still some years away from cash-less economy whatever pundits may say). So most of my choices this time around are centred around this theme.

Sterlite Technologies (ST)

This makes it to the list this year too going by the developments over the last few months which augur acche din for ST.

What I had written about this stock last year still holds good. But the recent developments that I am talking about are the govt’s massive push towards a Digital India and e-payments (and not an optional one at that) which would necessitate a strong demand for ST’s for a long time to come.

The second development is that a few months back, they have demerged their Power products and Transmission Grid business (manufacturing products such as power conductors and high voltage and extra high voltage cables and providing turnkey solutions for power industries) into a separate company, Sterlite Power Transmission (SPT), and intend to focus completely on telecom business which over last 5 years has grown about 28% annually. SPT is for now an unlisted company.

The third important development is the entry of Reliance Jio in India and ST’s major role in this environment.

In 2015, ST acquitted another company called Elitecore Technologies which is into network management, operations and billing support as well as customer management products. ST expects the acquisition to help it look beyond the infrastructure vertical and build new capacities to fully tap opportunities from projects like Digital India and smart cities in the local market, and to expand to markets where Elitecore has a strong presence. ST now has a full end-to-end offering and would be better placed in creating deeper and longer customer engagements.

ST supplies optical fibre to the country’s top carriers that include Bharti Airtel and Reliance Jio to enable their ambitious fibre-to-the-home (FTTH) network roll outs, in addition to the government-driven initiatives such as the Smart City and BharatNet. It is doing several pilots with telecom service providers. They have also supplied products for Jio, and hope to have a far deeper engagement with the telco in future. Airtel is also spending on fibre as part of Project Leap.

These initiatives as well as govt’s moves have created a strong platform for ST to take off from here. Expect this company to do well over the next few years as there are very few companies in India currently who can match it in its offerings.

Currently trading around 96, this can very well give returns anywhere from 25% upwards annually over the next few years, if all the above things play out as planned.

Bharat Electronics (BE)

With Digital India as the govt’s recent motto, BE is likely to be one of the major beneficiaries as they are one of the leading producers of digital devices such as PoS terminals, swipe card machines etc. As is the govt. norm, most of the orders from PSU banks and govt. entities would flow through to BEL for such devices.

The added kicker is its presence in the Defence sector where too major spending by the govt. would directly benefit BEL as it is the major supplier for such equipment, as the private sector is not fully open for such orders yet.

Currently trading at 1375, this again has a long way to go. It gave a 1:1 bonus issue last year and prior to that it was trading around 3000. So the magnitude of where it can go can very well be appreciated.

NBCC (India)

This is one of the few stocks in the real estate and construction sector which stands out. Being a govt company has its own advantages.

NBCC has been getting orders across the board resulting in a strong order book all up till 2021 which very few real estate and construction companies can claim at the current juncture.

The icing on the cake is the announcement of a bonus issue to be declared on 04-Jan-17.

Engineers India

This is one stock which has given excellent returns over the last 1 year, going against the market trend which has either remained flat or been negative.

But being in the hydrocarbon consultancy sector, EI‘s business largely depends on the oil sector. With OMCs (HPCL BPCL, IOC) giving a bullish outlook on their business and planning capex over the next few quarters due to lower subsidy burden due to market-linked oil prices, EI is assured of good business from them as it enjoys a healthy relationship with all of them. Besides, once the oil prices start stabilizing or even moving up slightly (considering that they had nearly touched the bottom a few months back, have just recovered some lost ground, but are still trading at half their prices a year or so back, this is not an impossible situation), its fortunes would again turn positive.

This is again a bonus candidate.

ICICI Bank

This is one stock which has been classified as a fallen angel due to its lacklustre performance over the last 2 years. Once considered as the no. 2 bank behind HDFC Bank, it has ceded this position to the likes of IndusInd Bank and Kotak Mahindra Bank, thru poor management of NPA  and hence concern over the lack of quality of its credit book/loans.

But it must be remembered that it still has sound management headed by Mrs. Chanda Kochhar who has proven credentials and sooner or later is bound to get her act together. And the other major bonus point with this bank is that it has a lot of sound businesses in its fully-owned subsidiaries – Mutual Fund where it is in the top 3 fund houses in the country and some of its schemes have been consistently topping the charts over the last few years, General/non-life Insurance business, Broking business, Home Finance and a few other minor ones which have ample scope for value-unlocking over the next few years. Due to the turbulence over the last few months, its newly listed life insurance business has also not commanded the kind of premium valuations that it most likely deserves. But with the Max Life-HDFC Life merger coming thru in the near future, this situation is bound to get corrected as it will provide a benchmark for the sector as a whole which was missing all this time.

Currently trading at 255, this surely has a long way to go even to get back to its earlier levels, and provides an excellent opportunity for investors to get in at an opportune time. This can well be called a contra or value buy in the current scenario and the patient ones who can wait it out for a year or two are likely to reap rich rewards at the end of that period.

Let’s now pause a bit to see how my picks did last year:

	Price as on 31-Dec-15	Price as on 30-Dec-16	Gain/loss
Axis Bank	449.50	450.00	0.11%
MCX	925.75	1266.55	36.81%
Sterlite Tech	96.65	96.15	-0.52%
Jamna Auto Industries	139.60	168.45	20.67%
Surya Roshni	142.50	174.40	22.39%
Sun TV	426.15	490.00	14.98%
DCB Bank	81.55	107.50	31.82%
Overall	2261.70	2753.05	21.72%

As seen from the above table, except for Axis Bank and Sterlite Tech, most of the stocks have done well giving a healthy overall return of close to 22% YoY.

.

I still believe that Axis Bank is going thru a loss of form but needs just 1 knock to regain its old form, as they say in cricket. As to when that will come, the jury is still out. Again, I have faith is Shika Sharma’s management capability and this is a bet on that. She has steered it well over a long period and only over the last 2 years, it has floundered along with its close cousin ICICI Bank. But law of averages will catch up soon and its recovery should start from the overall economy’s turnaround.

I think enough has already been written about Sterlite Tech’s potential and let’s wait for it to unfold. So it figures in this year’s list as well.

All in all, a healthy return of more than 20%, which is way more than the indices and most of the MFs. So after a dismal 2015, here is something to celebrate and I hope that the celebrations continue this year as well. Here’s wishing all investors a very profitable 2017.

Happy investing in 2017!

Diwali Dhamaka 2016

Here’s wishing everyone a great Diwali and a prosperous new year ahead. As with last year, the market has kept up its volatility with new highs as well as precipitous falls at various times in the year, and not every time for sensible reasons. It thus continues to be a stock pickers market. 

After the initial hiccups, and to some extent the belying of lofty, if unrealistic, expectations, Modi sarkar seems to be settling down with a few accomplishments on the national as well as the economic front. While the surgical strikes against Pakistan will come in handy for the govt. to show that it means serious business with notorious neighbors and won’t take things lying down as was done by oast govts., the passing of GST Bill (the Const. Amendment, not the actual one which will come up in the winter session shortly) will no doubt boost its morale as well as that of the industry no end.

As I have been mentioning over the last 2 Diwali blogs, it never pays to get carried away in the stock market, in either direction, especially in India. So any serious dip in quality stocks with proven managements should be considered as an opportunity to buy into those shares at lower prices, thus increasing the chances of reaping better gains, than would otherwise have been obtained. The recent Tata saga, which is still unraveling, is a classic case in point. Though spat between the top management is always a serious issue, if it doesn’t directly impact the businesses of the companies themselves, then it should be allowed to play its course without worrying too much about the company’s performance.  Tata Motors will not sell any less or more JLRs purely because either Cyrus Mistry or Ratan Tata is at the helm of the holding company. It would have been a different matter if either of them were directly heading the company.

In the last 1 year, the mid and small caps have outperformed the large caps by a wide margin. This has led to the situation where quite a few of these stocks are running far ahead of their fundamentals at elevated levels. This however should not be taken as a sweeping statement. There are pockets in midcaps which are still quoting at reasonable, even if high, valuations primarily because of their growth prospects going ahead. And these companies are likely to give rich dividends in the years to come if one has the patience to hold on to them for a few years through thick and thin. Some of the NBFCs like Manappuram Finance (which has tripled in the last 1 year) and SKS Micro are cases in point.

So given that this is a buyer’s market now, where should u place your bets? The focus this year has been on Consumption theme as well as the economy. Needless to say, management quality, business domain and growth prospects should always be primary factors while deciding on buying any stock. Some of these stocks have been beaten down due to a bad quarter here and there, but their pedigree remains unquestionable. 

Jain Irrigation Systems DVR (JIS)

Jain Irrigation Systems (JIS) is currently the world’s second largest and India’s largest micro irrigation company. Another little known feature is that JISL is the largest global player in mango processing. The stock was once the favourite of cognoscenti investors owing to its dominance in the Micro Irrigation systems (MIS) and soared to an all-time high of Rs. 265 in August 2010. However since then, it has been a downhill journey due to some ill-times moves by the company.

The reason the Company fell out of favour was because it changed its business model. It earlier used to sell irrigation equipment to farmers on credit which created severe stress on the working capital. To resolve the working capital problem, the Company demanded upfront payment from the farmers. However, the impoverished farmers had no money to pay for the equipment with the result that sales slumped and profitability went for a toss. To compound the problems, the Company availed of massive loans of up to Rs. 4,200 crore to enter into unrelated diversification. The huge interest burden itself crippled the Company.

However, that is now all set to be history. Over the last year, the Company has taken a series of strategic decisions which are designed to move it out of the unrelated businesses and reduce debt. The market has lost sight of these developments and has not given the Company any credit for its efforts.

Govt’s  ‘Pradhan Mantri Krishi Sinchai Yojana’ under which nearly Rs. 50,000 crore is be spent over the next five years on irrigation and allied farming related matters, will catapult Jain Irrigation back to the growth path. The fall in oil prices as well as polymers will also improve the margins for JIS.

The govt. has vowed to complete 99 major and medium irrigation projects by 2019 and bring 7.6 million hectares of land under irrigation in some of the most drought-prone regions of India. A long-term irrigation fund of Rs. 20,000 crore under the National Bank for Agriculture and Rural Development (Nabard) will also be created to fund irrigation projects.

All the above, with the addition of a good monsoon this time round, augur well for JIS, having a monopoly in drip irrigation.

The other 2 businesses of JIS – Piping products and Food processing are also high-growth areas due to govt’s initiatives in agriculture and food processing industries.

All the segments JIS is in are thus high-growth areas and have the potential to reap rich returns over the next few years.  Also, JAF Products Pvt Ltd (the promoter group company) infused capital worth Rs 112 crore in the form of equity (at a premium of Rs 78 per share on the face value of Rs 2) in FY16. It has already risen by 38% over that price and if things go as projected above, powered by its growth businesses, it could well be a multi-bagger in the years to come.

For retail investors, I would always go for the DVR which though trades at a discount to the parent, gives a better dividend and would always rise in the same proportion, thus making it cost-neutral and a better option.

L& T Finance Holdings (LTFH)

With a pedigree such as the one it has, this has only flattered to deceive so far. Since its issue @52 in July ‘11, it languished below this price for quite a few years immediately following the issue. However, the last couple of years, it has managed to break its shackles and has given great returns to investors who entered it post the IPO at a lower price. It is only now that the original IPO investors have some reason to smile.

However things are changing for the better at a fast pace as LTFH has embarked on a restructuring drive over the past year or so, with advice from McKinsey. It has been looking to prune several of its unprofitable units, including the asset management and alternate investment business, to concentrate on its hardcore infrastructure, rural, and wholesale financing as the company aims to improve the RoE to 18-20 per cent by 2020. 

On valuations LTFH is trading at P/B of 2.65, cheaper than its peers such as Cholamandalam Finance (5) and  Shriram City  Union Finance (3.55). And the restructuring has started to yield results. Company has improved its asset quality with GNPA coming down to 4.58% in Q1FY17 from 5.45% in the same period last year. Net NPA also improved to 3.13% from 4.43% in the same period. As the company has started focusing more on retail financing and low yielding assets, the asset quality stands improved.

The NBFC sector has had a massive run in the last 2-3 years or so, with some such as Manappuram Finance (up 3 times in the last year alone) & Cholamandalam  (up 5 times in the last 3 years) running up massively and therefore have relatively less steam left, due to expensive valuations. With the economy on the verge of a turnaround in the next year or so, LTFH, with a renewed focus on its core areas should yield good returns.

Kokuyo Camlin (KC)

This is an MNC stock and has been lying low in the current bull market. And the surprise is that it is not even dependent on the economy per se. The kids will go to school no matter what the interest rates are and will need most, if not all, of the things which KC makes. Agreed that it has had a dismal quarter recently, but there are a lot of triggers for KC to give rich returns

• The company has set up an integrated, state-of-the-art manufacturing facility at Patalganga, spread over 56,600 sq.mts. (14 acres) of land and, supposed to be “the largest stationery plant in the Kokuyo Group”. This is likely to benefit KC as economies of size, scale and scope unlock immense new potential in procurement, logistics, production and delivery. This may well be the inflection point the company was looking for.
• Promoters (Japanese MNC Kokuyo S&T Ltd.) hold 75% of the stake and some astute HNIs , among them Ramesh Damani (one of the most astute investors on Dalal Street) and Anand Rathi hold about 8% in KC leaving only about 17% of floating stock.  The thus stock has low liquidity which can work out to the advantage of investors owing to “supply scarcity” and “mis-pricing” of the stock.
• With 75% stake, there is always the possibility of delisting at some point in time. Ricoh India, also a subsidiary of a Japanese behemoth, has already unsuccessfully attempted delisting on two occasions. If this materialises, KC will shoot thru the roof as has happened in other cases unfailingly.

 A good company in a bad time is always a catch. And such opportunities should be grabbed with both hands.

Aksh Optifibre

Aksh is a company whose time has finally come.  I had written about Sterlite Technologies earlier and at that time as well I had mentioned that optical fibre business is likely to see good times ahead. Other than Aksh, the other 3 players in this area are Sterlite (which is the leader), Vindhya Telelinks and Birla Ericsson.

In India from 2000 onwards there was a boom in cell phone/telecom and internet usage but sadly the required optical fibre demand did not materialize in that period.. But instead of foraying into real estate / infra the promoters of Aksh kept improving the company by expanding capacity, doing backward integration and focussing on various facets of the same business - more particularly becoming leaders in production of FRP rods and also FTTH (Fibre to the home). Another foray in a field similar to FTTH was the e kiosk business in Rajasthan.

Another noteworthy aspect of Aksh has been that capacity expansion has been undertaken in a slow and steady manner without adding much of debt...therefore, now that optical fibre cable demand has finally come to India due to Digital India, Smart cities, 4G, FTTH and e- governance. Aksh has some unique features which will serve as at least a temporary moat (for 5-7 years).

•  It is fully integrated Optical fibre cable manufacturer focussing solely on this business and having developed considerable expertise and reputation and supplying quality goods to a host of big guys.
• It has very less debt and that combined with backward integration makes it a low cost producer of Optical fibres
• Its capacity expansion is perfectly time and will enable the company to grow rapidly, while there is no significant capacity addition by other two players Vindhya and Birla Ericcson.

Currently trading at 23, this has the potential to be a multi-bagger going by the prospects ahead.

Aditya Birla Fashion & Retail (ABFR)

This is a play on the brands in the premium apparel segment. Arvind has already multiplied manifold in the last 2 years and so has Raymond. This will be a beneficiary of the re-rating of brands the way it happened with Arvind and Raymond. Post its split with AB Nuvo, this hasn't really established its own identity. This is one stock in the Textile segment which is waiting to be discovered.

This company emerged from Madura Garments which was already known for its premium/upmarket brands such as Louise Phillipe, Van Heusen and the slightly lower Peter England. These brands have now come under ABFR fold. After firmly establishing themselves in the shirts and trousers category, these brands have now also expanded into other related segments of men's dressing such as belts, handkerchiefs and shoes, thus providing a complete wardrobe for a man. And now the logical expansion currently being targeted is women. Van Heusen already has a women's range and is probably only one of the few brands in the women's wear category which is generally catered to either by proprietary brands launched by the retail store chains such as Shoppers Stop or the unorganized sector. So there is ample scope for establishing themselves into this segment. And these brands have already learnt the ropes of marketing premium brands to the white-collar population.

The other major advantage that ABFR has is the recent merger of Pantaloons with itself. Now Pantaloon caters to the unbranded mid-market/economy segment which again is a big market. Here the competition is from local/regional brands such as Cambridge in Mumbai. Given the reach Pantaloons has, due to its long presence in this segment, expanding its share in this market also shouldn't pose major problems.

All in all, here is a company which straddles the entire segment from mid-market to premium in men's as well as women's wear waiting to catch market's eye. And the good part is that this segment is a high-margin business which augurs well for this company.

Though the fundamentals are not anything great to write about currently (it is making losses but these have reduced sequentially), this should be accumulated now as well as on occasional dips for great returns as market re-rates this stock..

Before concluding, let’s quickly look at the performance of last year’s recommendations:

Stock	Last Diwali	Current	Difference	%
Federal Bank	53.70	81.95	28.25	52.61
Motherson Sumi Systems	265.65	331.10	65.45	24.64
L&T	1347.45	1477.90	130.45	9.68
ICICI Bank	262.40	276.85	14.45	5.51
Ashok Leyland	89.50	90.25	0.75	0.84
Eros International	256.15	194.95	-61.20	-23.89
Overall	2274.85	2453.00	178.15	7.83

All prices in Rs.

So since last Diwali, this portfolio has given a return of 7.83% slightly less than 8% which is what Sensex returned. Over the same period Nifty gave 10% and mid-caps a whopping 22%. Given the circumstances, it is at best an average return, and could certainly have been better. While Federal Bank and Motherson Sumi delivered on expected lines, couple of stocks like ICICI Bank and Ashok Leyland didn’t perform as well as expected giving muted returns and in the process bringing down the overall portfolio returns. However, I believe that this set of stocks, except for Eros International which has not yet set its house in order and governance issues still haven’t been settled, certainly has the potential to perform well going forward and should certainly be retained and even averaged by adding more at the current levels as their growth prospects remain strong.

The current set of mid-cap stocks will hopefully return a far better figure next year.

HAPPY MUHURAT TRADING