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Long time, no see!

It’s been a long time, close to 2.5 years since a post was written on this blog. Anyhoo.

Nobody has a doubt these days that it’s a bull market. Whether it’s in the mature bull market stage or the euphoric bull market stage, only time will tell (my personal opinion being, still in mature bull market stage). On the investing scale of Novice to Professional, am still on the Novice stage, so pardon my conclusions/prognosis in my first extended bull market:

a) Re-rating mania: Lesser and lesser percentage of folks want to talk about business economics and earnings. More and more of them want to bet on re-rating – ‘arey boss, sabko pata hai re-ratings se hi paisa jaldi banta hai’. Letting the tape decide (as re-rating is entirely that) your investing actions is a bit fraught with danger (unless of course you are a trader – of whom I have many good friends – and their risk management, trade management is top notch). But hey, all of us have made good money in the past few years only on re-rating, very few on real earnings growth – so yeah – don’t complain.

b) Books: I have read some stellar books in the past few years – and in no particular order – ‘Markets don’t forget, people do’, ‘The Bull’, ‘Lessons from History’, ‘Sapiens’, ‘Short history of financial euphoria’ etc. and it’s been enlightening to say the least. What I am surprised by, is this access to information is so easy these days. If I can take you back to 1990s, I could not get a Tinkle easily and today, we get the best of the books with a single click. What this does to investors/traders knowledge and psychology today in a market is beyond comprehension – given that this investing/trading in India (and mostly abroad) – was a closed circle phenomenon. I am not talking of the incessant ‘guile of insights’ that float around in various Whatsapp groups where you can’t remember what someone posted 1 day ago, much less a month ago. This knowledge of these books – distilled wisdom really – has had a profound impact on my thinking, and hopefully many other thousands of investors who have entered the bull market in the last few years. Greed and fear will continue – as it has for thousands of years – but I am kind of expecting that the % of people (as a total of investing population) who will get hammered will be much reduced. Learnings will be faster. Whipsaws will be faster. Opportunities will be lesser.

c) 3 pillars: If you believe that 3 pillars will continue to stay – capitalism, entrepreneurship and democracy – for any country/industry, I believe that one can make money in the long term. Entry price is definitely a determinant of stellar returns, but these 3 pillars are more important to make steady returns over the long term (better than fixed deposit, that is).

d) SIP mania: The whole mania around SIPs will continue for much longer than people think. We many move across sectors, small/mid to large caps etc., but TINA or no TINA, these SIPs will continue (the avg. or the median SIP amount has not changed by much in the last decade – but incomes have gone up – and therefore the % SIP amount does not pinch anymore for other discretionary or big budget items). I think it will take a massive crash, and not a demonetization or a 2011 crash to take these people out of the market.

e) On the investing front, I only bought a couple of stocks in the last year as I couldn’t find much else/could not understand some sectors. I don’t believe markets are crazily valued in some sectors at this stage. As I said earlier, I don’t believe we are in the euphoric stage yet.

And, in conclusion, I believe what I wrote in Sep 2014 (This time it’s different) still holds true, especially this part –

The fallacy of selling 20% below the top: Which brings me to my next and favorite topic. Nobody wants to leave the party that is going on. Value investors are very famous and take great pride in laughing at the stupid statement of former executive of Citibank saying “”As long as the music is playing, you’ve got to get up and dance.” We laugh and laugh at that stupidity. We quote Buffett. We quote Munger. Why, these days, we have become more exotic and even quote Daniel Kahneman and his super book ‘Thinking, Fast and Slow’. But almost no-one wants to exit the party. These days, the hypothesis is even better. These days, investors say that ‘let the market reach the top and then correct…we’ll all get out 15%-20% from the top’. Let me explain this fallacy through a famous picture:

image

That’s the chart of the IT bubble – starting from 1996, all the way till 2001. All those investors who say ‘let the market reach the top and then correct……’, would they get out at all the points marked ‘Red’ in color – then they would have missed all the returns. ALl of the them plan to get out at the ‘Orange’ market – how would they know in advance? Conversely, in reality, wouldn’t most investors get out at all the points marked ‘Green’ in color – throwing in the towel? Every investor worth his salt wants to get out at the point marked in ‘Orange’. How many can do it? I seriously doubt if it would be in high single digits.

Then again, the lure and the logic is too irresistible. Combine that fallacious logic of immediately getting out at the right moment with your neighbor (rather, twitter/whatsapp friends) making more money than you everyday – and you have got a dynamite waiting to blow up. We all want to dance till the last minute, irrespective of how many times we read Buffett pleading ‘the clock has no hands’.

Let’s enjoy the bull market till it lasts. I am still cautiously optimistically bullish – or whatever hell that means.

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Value Play or Value Trap? (Cash Bargain (almost!)) – Suashish Diamonds

I was about to write an overview on the Jewellery industry, but found that this link explained the industry in a much better way than I ever could. So, do go through the link to get a hang of where we are in terms of Gems and Jewellery industry. If you don’t have the patience to go through the article, bottomline says that we are going to have a 15% growth till 2015.

So, from an industry perspective, we are suddenly not going to have any major surprises.

And this blogpost is also in no way influenced by the way Gold prices have taken off in the last month or so (and my friend tells me that Diamond necklaces have tripled in price in the last 6 months). So, whoever owned diamonds and gold, you can feel richer and now can gloat in public 🙂

Anyway, back to the post and to the stock mentioned. Suashish Diamonds.

This one popped on my radar because the amount of cash is more 3 times that of the share price.

Cash per share – Rs. 448/-

Current share price – Rs. 125/-

Is this an immediate buy? Well, let’s investigate.

Suashish Diamonds has not yet put up their latest Annual report on their website (and their website is very impressive), but they have put up the unaudited results for March 2011 here. This will form the basis for our investigation.

For the sake of convenience, I will note important figures below:

Assets (in lakhs)
Cash and Bank Balances 93122.58
Inventories 8211.98
Sundry Debtors 7158.44
Other Current Assets 2606.17
Loans and Advances 11979.68
Investments 41597.75
Fixed Assets 2851.65
   
Liabilities  
Secured Loans 92791.19
Current Liabilities 4595.45
Provisions 4447.71

We’ll do this valuation in two ways. One, espoused by Graham in his seminal ‘Security Analysis’. And two, deeply pessimistic (so pessimistic that even Roubini would be put to shame!)

Graham (Security Analysis):

So, this stock has a P/E less than 10 (it’s 4.25), P/B is less than 1 (it’s 0.36) and D/E ratio is negligible. No dividends from 2009 though (previous to that, they had a decent dividend history). Anyway, it almost satisfies Graham criteria.

Assets (in lakhs) Weightage Value
Cash and Bank Balances 93122.58 1 93122.58
Inventories 8211.98 0.5 4105.99
Sundry Debtors 7158.44 0.8 5726.752
Other Current Assets 2606.17 0.5 1303.085
Loans and Advances 11979.68 1 11979.68
Investments 41597.75 1 41597.75
Fixed Assets 2851.65 0.5 1425.825
       
Liabilities      
Secured Loans 92791.19 1 92791.19
Current Liabilities 4595.45 1 4595.45
Provisions 4447.71 1 4447.71
       
Net Current Assets     57427.31
Net Current Assets per share     276.5809
Current Share price     124
Discount     55%

According to Graham’s analysis, the stock is quoting at a 55% discount to its value. Good buy?

Our Analysis:

Let’s be really pessimistic.

Assets (in lakhs) Weightage Value
Cash and Bank Balances 93122.58 100% 93122.58
Inventories 8211.98 0 0
Sundry Debtors 7158.44 0 0
Other Current Assets 2606.17 0 0
Loans and Advances 11979.68 0 0
Investments 41597.75 20% 8319.55
Fixed Assets 2851.65 0 0
       
Liabilities      
Secured Loans 92791.19 100% 92791.19
Current Liabilities 4595.45 100% 4595.45
Provisions 4447.71 0 0
       
Net Current Assets 4055.49

We are assuming that we would recover only 20% of our investments. Rest of the stuff is not even worth salvage value. And we have paid off all loans and liabilities (provisions will be zero since we have assumed the loans and advances to be nil, nada). Still, we end up with a positive net current assets value.

Clearly, with a market cap of 257 crore, but cash of 931 crore (and we have not considered any fixed asset, inventory etc.), this is a value buy.

So, why am I not rushing out and buying the stock? Why did I even hint at a value trap?

As with most things, the answer is I don’t know but here are my concerns.

a) I have not yet read the latest AR. The reason I want to read up on the latest AR is i) Where did they hoard this cash? (hopefully not in some obscure bank in Europe etc. which makes the cash fictional) ii) I am interested to look at interest income figure (this should closely match with 3-5% of the cash figure, indicating this cash is present and not a figure made up in the air).

b) Suashish promoter holding is 89.45%. In fact, it had come up with an open offer last year around this time, but it fell flat as the discovered price due to book building came to Rs. 320/- per share and the owner basically said ‘nope, am not paying a naya paisa more than Rs. 220/-‘ (although 220 was just the floor price). In essence, the promoter basically doesn’t care about the minority shareholder interest.

c) Volumes or the lack of it have never been a problem for me. But look at the volume chart for this stock over the last year or two. There are spikes (huge spikes) in volume from time to time, and hence maybe operator driven. Not sure when they’ll drive it up and when they’ll drive it down.

d) Lack of dividend for the past 3 years is definitely a concern. The question is why will this stock run up? I have no catalyst to offer you.

e) Their revenues are up and down a bit, but EPS and Cashflows have largely remained positive. However with increasing gold and diamond prices, I don’t know how fast their inventory (and hence profits) will move (classic price-quantity curve Economics 101).

Do let me know your thoughts.

 

P.S: Another stock I did want to write about, which is in a very similar position to Suashish Diamonds is Polyplex Corporation. However, the brilliant Kumaran has already written about it here. Please peruse his analysis.

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An Arbitrage Opportunity (Piramal Healthcare and Piramal Life Sciences)

The arbitrage opportunity is in the price difference due to swap of Piramal Healthcare and Piramal Life Sciences stock. I will not get into the business and financials of Piramal Healthcare. I think Prof. Sanjay Bakshi (here) and Deepak Shenoy (here) have elaborated enough.

What I will highlight though is from the latest annual report of Piramal Life Sciences.

Since being de-merged from Piramal Healthcare Limited (PHL) in April 2007, PLSL as an independent drug discovery & development
Company has made significant progress. The pipeline of R&D programs has increased from nine to twenty four, with nine additional programs moving into Phase I/II clinical trials and two additional program moving into Phase II clinical trials. The development projects from pipeline would need strong financial support going forward. Hence the Board of PLSL has approved the de-merger of NCE Research unit of PLSL into PHL.
Under the proposed de-merger scheme, each shareholder of PLSL will be entitled to one fully paid up equity share of Rs. 2 each
of PHL for every four equity shares of Rs. 10 each held in PLSL. All assets and liabilities of the NCE division will be transferred
to PHL at book value. The herbal products division that markets neutraceutical products to less regulated markets globally will
continue to be with PLSL.

For every four shares of Piramal Life Sciences, we’d be getting 1 share of Piramal Healthcare. Also, the Herbal products division of Piramal Life (although loss making currently) will stay with Piramal Life (and continue to list).

So, what’s the arbitrage opportunity?

As per today’s prices, 1 share of –

Piramal Healthcare (PHL) = Rs. 365/-

Piramal Lifesciences (PLSL) = Rs. 87/- (and hence 4 shares will cost you Rs. 348/-).

Discount if you buy 4 shares of PLSL to convert into 1 share of PHL = Rs 365-Rs.348 = Rs. 15/-

The Piramals are usually known to keep their promises (read Prof. Sanjay Bakshi’s post). So, if you do trust the management to keep their promise of this conversion, you have an arbitrage opportunity to acquire Piramal Healthcare’s business at Rs. 15/- discount to the market price. What’s more – you get the herbal products division for free. It may be loss making currently, but even if the Piramals sell it for salvage value, is that not a benefit?

All this if you believe that PHL is going to generate good returns over the next 2-3 years (and their quarter results have been encouraging).

Disc: I hold PHL (I bought PHL directly. I have just discovered this arb :))

Risks: It may take a while for this merger to go through, maybe 2 months, maybe 4 months. But then, I am not talking of a trading opportunity here. I am invested for 2-3 years, so this arb should work.

(I thought PHL stock was still cum-dividend (of Rs. 12/-) and hence maybe the arb won’t work, but Ayush indicated that it is ex-dividend. And as this chart proves, the stock did go ex-dividend on 28th July. So yeah, the arb opportunity is still there!)

Do let me know if I have missed an angle?

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Why am I not buying into the PFC FPO?

Or any FPO for that matter. But we’ll get to that later. First, the initial details on the PFC FPO.

PFC is offering more than 22.95 crore equity shares through the public offer at a price band of Rs 193-203/share. This includes a stake sale of around 57,388,335 shares by the government, which has 89% (will be 73.73% post-FPO) stake in the company, along with 15% fresh equity. The FPO shall open on May 10 and shall close on May 12 for QII (Qualified Institutional Investors/Institutions) bidders and on May 13, 2011 for other bidders (retail investors, like us). The company has fixed the price band at Rs 193 – Rs 203 per share. Retail investors will get 5% discount. The company intends to utilize the fresh issue proceeds for augmenting capital base to ensure compliance with requisite capital adequacy norms and for future capital requirements.

Thanks for the news update dude. We have seen this in Times of India too. But what does PFC do? And what the hell is a FPO?

PFC (Power Finance Corporation) is a leading financial institution in India focused on the power sector. It basically helps out initiatives in the Power sector by lending money. PFC’s product portfolio comprise of Project Term Loan, Equipment  Lease Financing,  Discounting of Bills, Short Term Loan, and Consultancy Services etc. for various Power projects in Generation, Transmission, and Distribution sector as well as for Renovation & Modernization of existing power projects. PFC also provides technical, advisory and consultancy services related activities through its subsidiary company namely PFC Consulting Limited.

PFC is the largest listed term-lending NBFC (Non-Banking Financial Institution) in the country, which is planning to raise around Rs. 5000 cr through this issue. After this FPO, it will land up as the fourth largest lender by networth, higher than Punjab National Bank (PNB).

It’s also been awarded the status of Infrastructure Financing Company (IFC), which will enable the company to raise funds through issue of tax-free infrastructure bonds.

What is a FPO then? Is this the same as IPO by another fancy name?

An FPO is a primary market issuance when companies issue further fresh equity (15% in this case) or when promoters dilute their stake in the company (like the Govt. diluting its stake in this case). These companies are already listed on the bourses. Similar to an initial public offering (IPO), FPOs have a price band fixed for the issue. Unlike the corporate actions (such as bonus, rights’ issue that are applicable only to the existing stake holders, etc), FPOs are open to all investors. The price band for an FPO depends on the market value of the existing company shares and the reason for raising funds.

So, why is PFC looking to raise new funds, apart from of course, ‘we need money to make more money’ reason?

Well, in this case, there is a logical reason. Or that’s what they claim.

Currently, NBFCs can lend only 25% of their networth to a single company or maximum 40% of its networth to a group of companies. This prevented PFC’s ability to fund larger power projects of, say, Reliance Power or Tata Power or to lend more to their parent groups, Reliance Group or the Tatas. Through this FPO, since networth will increase, PFC’s ability to lend to these groups will also increase and hence more revenues.

Sounds good man. Is there any downside at all in PFC? Growing power sector, increasing power needs, lot of companies setting up power projects – why not be a part of this growth?

PFC currently lends to these power generation companies and SEBs. We have covered the bottleneck in our power value line (SEBs) already here and I will not dwell further. On the power generation companies front, currently PFC is suffering from too much concentrated exposure, with 54% of their loan book made up by just 10 borrowers. The ground reality on almost all power projects is that these long-gestation projects have upset their lenders and their shareholders.

Instead of recounting PFC’s peers, competition and financial health, I will just point you to a more in-depth and a comprehensive financial review here.

Alright. Thanks for the details. Can we just get to why you will not invest in this PFC FPO or any FPO for that matter?

Let’s assume the FPO price is fixed at the upper band (which usually is the case) at Rs. 203/-. We, the retail investors get a 5% retail discount. Therefore, our effective price is Rs. 193/-. But today’s price in the market is Rs. 215/-. Excellent. So, I can subscribe to the FPO at 193/- and sell it on the market at Rs. 215/- and pocket a gain of 11.4% in a month or so. Fantastic. Where do I sign up?

Not so soon. Let’s imagine you are an investor who bought PFC at Rs. 250/- before the FPO (and its price band) was announced. Your current price is Rs. 215/-. Why would you not sell all your shares at Rs. 215/- and subscribe to the FPO at a much more favorable price of Rs. 193/-? Of course you would. And imagine a number of investors acting in a similar manner. The prices will converge very rapidly to Rs. 193/- as the date of allotment approaches. There might a very short window where you can eke out a 5% gain, but then again, I wouldn’t bet on it.

(I had however tweeted about an arbitrage opportunity a couple of days back on this. You could have shorted Futures/Options on the PFC counter, and subscribed to the PFC FPO, making approx. a 7-9% risk-free gain. Currently, the same arbitrage is not available).

What about fundamentals? I am ok to hold it for a year or two.

Well, given how the power generation projects are being implemented and how SEBs are acting up, I would bet on a 5-10 year timeframe rather than just 1-2 years. With increasing interest rates, atleast for the next year or so, I am not really positive on how many people will pay back (and thereby increasing in NPAs, increase in provisioning for NPAs and hence lower profitability). In fact, look at the last couple of quarter results. Not too positive.

Ok, but then what have you got against FPOs?

I just dislike the philosophy of a FPO. Say what you may, but I just hate dilution. Diluting through rights and bonus issues is one thing (where the first offer is given to existing shareholders), this FPO thing is taking it to a whole new level. For example, for the same kind of earnings that PFC has earned, there would now be 15% more claimants than before, thereby diluting my EPS by 15%. My intrinsic value per share is so much lesser. (so, in this case, you have interest rate risk and dilution risk).

I have a whole another issue with the philosophy of a FPO. In an IPO for example, the issue price is determined through an extensive pre-issue marketing exercise. By comparison the issue price in FPOs is generally a tempting discount to the latest price of the stock in the secondary market. What’s prominently visible to investors is the discount and not the risks of dilution. Also, most of the money raised by FPOs has been through the book-building route. Book-building is a mechanism of price discovery. How can it be applied to listed stocks, which have continuing price benchmarks available in the form of their secondary market prices? It’s illogical (and borderline ridiculous) to discover the price of a stock in two markets simultaneously.

Thanks for the rant, but what does recent history in the Indian market tell us about FPOs?

FPOs that have got listed since 2009 have seen a massive drop in their share prices. The Sensex has risen more than 90 per cent since 2009. However, most FPOs that have been listed during this period have fallen quite a bit. Birla Shloka Edutech has dipped 67 per cent below its issue price since its listing. Shipping Corporation of India (<24 per cent), NTPC (<14 per cent), NMDC (<10 per cent) and Tata Steel (<2.5 per cent). The only FPOs which have given some sort of gain are that of Rural Electrification Corporation (9%)and Power Grid (13%).

So there. I am not subscribing to this FPO.

Disclosure: No position in any of the stocks mentioned above. In fact, bearish on all the power related stocks for now.

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Investing Strategy–Nifty Valuations

One of the most interesting strategies that I have come across is an investing strategy based on Nifty valuations. Valuations parameters we all understand – P/E, P/B and Dividend Yield.

I had read about investing strategy based on a single Nifty parameter, namely P/E. However, Momentum Signal had done a post a while ago (in Feb 2010) which included three parameters P/E, P/B and Div. Yield. I don’t see a reason why I need to repeat the entire analysis again except for linking to the relevant post  here –

Nifty Fundas – http://momentumsignal.blogspot.com/p/nifty-fundas.html

The summary of that post is given below –

 

S&P Nifty Index P/E ratio P/B ratio Div Yield%
Extreme High Valuations 25 to 28 5.5 to 7.0 0.5 to 0.8
Very High Valuations 23 to 25 4.5 to 5.5 0.8 to 1.0
High Valuations 21 to 23 4.0 to 4.5 1.0 to 1.25
Long term Average 17.87 3.7 1.52
Low Valuations 15 to 17 3.0 to 3.5 1.75 to 2.0
Very Low Valuations 13 to 15 2.5 to 3.0 2.0 to 3.0
Extreme Low Valuations 11 to 13 2.0 to 2.5 3.0 to 3.5

 

The table (the blogpost is more illustrative with graphs) indicates when valuations might be rich and when valuations might be cheap depending on Nifty’s P/E, P/B and Div. Yield ratio.

Essentially, valuations are rich whenever Nifty P/E > 20 and/or Nifty P/B > 4 and/or Nifty Div. Yield% < 1.

So, what are the current figures based on some recent corrections in the market?

NSE data suggests (Nifty at 5654) –

 

Date P/E P/B Div Yield
14-Jan-2011 22.50 3.57 1.10

 

Correlating the data between the two tables, we derive that Nifty is richly valued in terms of P/E, not so much on P/B and very close to rich valuations on Dividend Yield.

My personal read into the situation, on a consolidated basis is that even after the recent correction, Nifty is richly valued and I would be wary of investing (except in few pockets) at current levels too.

When I hear analysts and CNBC talking about Sensex levels at 25k in 2011, 40k sometime in the future etc etc., I try to calculate what kind of earnings Corporate India needs to come up with to justify such levels of Sensex. The percentage increase is staggering (even considering Analyst’s speak of India’s GDP growth is 10% and will be 10% for the foreseeable future). Even if India’s GDP growth is at those levels, a EPS growth of 40% y-o-y is remote and hence Sensex at those levels in 2011/2012 look distant  (unless of course, the market goes really irrational like the 1999-2000 boom).

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