SALE????

The markets are making new lows (almost) everyday. The drop is making players worried and scared. The pessimism with India's growth story, Rupee fall, lack of policy measures, fiscal indiscipline, global problems etc etc are some of the reasons that are being given.

However, there are some who believe All Negativity is Priced In now. They say the markets are cheap now. Why are they saying this?

Simple. Because, Sensex and Nifty have fallen about 25% this year. Most mid & small caps have fallen more. Right?

Mungerism in me shouts Anchoring Bias, Recency Bias, Availability Bias, First Conclusion Bias, Reason Respecting, Representativeness Bias, Envy, Vividity. (The above reason of 25% YTD drop is kinda similar to a story from Akbar- Birbal times. Akbar drew a line and asked everyone to make it shorter without doing anything to that line. Birbal came ahead and drew a bigger line near the original line.)

So, what is actually true? Do we have a 'Sale at a discount' on Indian Wall Street or not?

As on date, Price- Earnings Ratio of BSE- Sensex is 16.5 and Nifty is 16.8. Is that cheap?
Reverse-engineering Gorden constant growth model [P= E*(1+g)/ (k-g)], we get g = 4%.
Using Ben Graham's PE model  [P/E= 8.5 + 2*g], we also get g=4%.

So, at current prices, Mr. Market is predicting BSE-30 and NSE-50 companies to grow at 4% per annum every year till infinity.

Is that a discount?
I think, Yes. For a country growing at more than 6% every year for the past decade and expected to do the same in the foreseeable future, paying for 4% growth till eternity is not costly.
Will the discount increase?
Who knows!!!!

Stock Buyback- Why?

Stock Buyback or repurchase is the process of company repurchasing its shares from the shareholders.
So the question is- Why should a company go for buyback?

Who better to answer than Buffett himself?

" There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds — cash plus sensible borrowing capacity — beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively-calculated."

Please note the AND condition and not OR i.e both reasons should occur together.

Let's try to apply the logic to a company which recently occupied (for a very short time) the No-1 position in stock market in terms of market cap.

Coal India- There is a buzz going around that Coal India will soon do a buyback.

Criteria A- Presence of Cash- It has more than 50,000 crores of cash. So cash is there for the buyback.

Criteria B- Undervalued?- A commodity player selling at a multiple of 18x on 2011 EPS and 15x on annualised 1H12 EPS is not dirt cheap. Please note the EPS number will reduce by 26% after the Mining Bill. With slowdown hanging over China, commodities and hence the stock can have a big correction (Ironically, drop in stock prices is called correction, but we still hate it!!!). So, stock does not look undervalued to me!

Why Buyback, then? Because the majority shareholder (GOI) is in need of money & he has no other alternate source.

As of now, Coal India's management is against the plan but looking at the way majority shareholder has handled ONGC and IOCL ( & other Oil Marketing Companies); Coal India may have to agree to the plan.

Precisely the reason why PSUs command lower multiples as compared to their private sector peers!

Was planning to give one more illogical example (according to me) of recently announced stock buyback. But Incentive Caused Bias asks me to stop writing anything.

Whose Bread I eat, his song I sing !!!

IPO Investing

Initial Public Issues (IPO) are the first sales of stocks by the company to the general public. The key reasons for IPO are- Need of money for expansion, paying down debt, get reasonably inexpensive promotions ( by getting coverage by media and stock analysts) and as an exit route for insiders, angel investors and Venture capitalists.

There is a key difference in mindset of 'growth investors' and 'value investors' while thinking about IPOs.
Value Investors believe that the last reason is the key reason for IPOs. And that's precisely the reason we see more IPOs in bull markets and very few in bear markets. And they prefer to avoid IPOs reasoning Its Probably Overpriced!!
While 'growth investors' believe New is the fancy and they try to catch the fancy and make money in the process.

So who's right?

If we look at BSE-IPO Index since inception in May 2004 and compares it with BSE- Sensex till now, we can clearly see that IPO Index has been under performing Sensex.
So, Value Investors seems to be making a good point.

Better to avoid IPOs!!!!

King's Experiment with Truth

Vijay 'King of Good Times' Mallya promoted Kingfisher Airlines seems to be heading the headlines for all the wrong reasons in recent news items.
Accumulated Losses.... Huge Debts..... and Bankruptcy.

What is the reason?
No its not Deepika. (There is a joke going on facebook- Deepika dated Yuvraj and he lost his form, she dated Ranbir and he did some crappy movies and then she dated Siddharth mallya- well company hi duba di bechare ki)

The actual reason was highlighted by Mr. Warren Buffett some 28 years back (in his 1983 letter to shareholders). Here is the relevant portion-
"

Businesses in industries with both substantial over-capacity and a commodity product (undifferentiated in any customer-important way by factors such as performance, appearance, service support, etc.) are prime candidates for profit troubles. These may be escaped, true, if prices or costs are administered in some manner and thereby insulated at least partially from normal market forces. This administration can be carried out (a) legally through government intervention, (b) illegally through collusion, or (c) “extra legally”

through OPEC-style foreign cartelization.
If, however, costs and prices are determined by full-bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous."

Here is another one which you should have listened to, Mr. Mallya (From 1980 Letter)-

When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, generally, it is the reputation of the business that remains intact.

Now what?
Either government bailout or more equity or bankruptcy. Lets see what happens. 

Just wishing that I am not the one to pay the tuition fees for your education!!! 

Reversion to the Mean

One of the most powerful psychology models is "Reversion to the Mean."

See the recently concluded Australia- South Africa test as a superb example of this.
End of Day 1- Aus- 214/8.
Day 2- Aus- 284 all out. ( M. Clarke- 151)
            S.A- 96 all out.
            Aus- 47 all out ( Recovered from 21/9)
So, S.A needed 236 to win the match which looked huge at that stage.
Not many would have put money on S.A to chase this down.
A trend of low scores was established on Day 2, and everyone (most) would have put their money on this trend to continue.
I, in my office, tried to find mispriced bets for mean reversion to occur. Could not find in this case.

But there is always a place to turn to, to find mispriced bets where reversion to the mean is not expected.
Trends are considered to be the destiny.
See the trend below-

Ask yourself, can this trend continue for ever?
If something can't continue forever, it ll surely end one day.

Fastest Way of Making Money

Do you believe that doubling your money every four-five years is a slow and boring process? Do you think you/your fund manager can surely get 40-50% return from stock market every year? Do you think that you can time the market? If your answer is Yes, then this post is for you, my dear friend.

Today, I plan to reveal the Fastest Way of Making Money as a Diwali Gift!! Yes, I have a strategy for that. Just follow my strategy & you ll make money so rapidly that even Jhunjhunwala ll come to you for tips! I am not kidding. Strategy is not too complicated either. In fact, it is very very simple & easy strategy.

Here is the strategy- BE A FOOL. No, this is neither a typo nor am kidding. The strategy is this only. BE A Fool.

Let me explain- There are three kinda people who operate/compete in the market.

1) Intelligent- These investors try to value a business & compare value with price & take their decisions irrespective of emotions. They follow their father's approach which he has given to them in a book called "The Intelligent Investor". As 'magic formula' man and value investor Joel Greenblatt says- "If we don't know how to value a business, we can't invest in it intelligently." So, these 'alleged' intelligent investors try to value a business & buy with a margin of safety. If they can't value, they move on.

2) Greater Fool- These investors (Forgive me Graham for calling them investors) follow the herd & are always late to the party... Because of chasing consensus, they buy at sky-high prices & sell at rock-bottom prices and a result lose everything.

3) Fool- Now since, intelligent investors walk away when they can't value something or if something is not dirt cheap; they leave a lot of money on the table. These guys pick that money & some more from greater fools & hence can make huge money. Read here.
True There Are No Free Lunches, but You Can Make Someone else Pay For Your Lunch & greater fools pay for their lunch.

If you fall in this category of stock market players, there is huge money in the making. Let me give an example. A overpriced IPO has come in bull market. You Subscribe.... Intelligent guys ll avoid it... so less competition... You ll get a lot of shares.... Bull market has become peak of bull market... Sell on listing day to greater fools at huge premiums... Make a killing... Bull market ll run of steam... Greater fools ll lose money... U enjoy!!!

You may ask- "Why ll it list at a premium on listing day?" I ll say- "Buy Low and Sell High. Subscribe only if it ll list up. Don't subscribe, otherwise."

Yes a little problem is there.
"If You find Greater Fool, you make a killing. If you don't find, Then You are the Greater Fool, my dear friend".
Kinda similar to Warren Buffet saying, "If you have been playing poker for half an hour and you still don't know who the patsy is, you're the patsy".

Irrational & illogical Market??

Do you understand the stock market? You think stock analysts understand the market & that's why they are able to justify the movement with a sound, logical and rational explanation? Yes?
Lets discuss the points further with a few examples from recent times (No, I am not suffering from recency bias but would like to take some vivid {Read- widely discussed and in news for a long time} example).

• US downgrade by S&P- Rationality would go something like this- US less likely to meet its financial commitments now....Cost of raising new debt should be higher now.. Bond prices should go down.... Yield should go up.  But on the next day of downgrade, yields actually fell !!! WTF!! But, man, you can explain any damn thing. Here is my favourite explanation to the event- The downgrade of Treasurys made people so worried about the elevated risk in the world that they ran to Treasurys for safety. (I don't know he was serious or surprised). I found the explanation extremely hilarious.

• Lets come to our own Indian markets now. RBI increases repo again. Market says what's repo & moves up. Analysts say hey! This hike was already factored in. Factored In... is another one of the most common explanations used. I have never been able to understand this term. When was it factored in? I mean which day? How much points? Why didn't you tell it then? How do you know? Can you please tell now exactly what all are factored in and what all are not?

As Taleb says if you try hard enough, you can find points supporting your views (Confirmation Bias) and if you try a bit more, you can present a nice, convincing story based on your views and supporting points (Narrative fallacy). But, then presence of one, just one, black swan is enough to conclude - Not all swans are White!!! 

Beginner's Luck

One of the first stocks I had put my hard-earned money in was Blue Bird (India) Ltd. My rationale for that investment was like this-

1) The company had applied for Debt Restructuring under CDR package which was approved. Without debt and interest (for some time, moratorium period i.e), company's profit was expected to swing back to black as it had operating profit in the past.

2) Price-to-Sales ratio, PSR, a very important ratio (for these kinda investments) was just about 6%. Hence, there was huge margin of safety.

3) About 93% of promoters shares were pledged. So, only way for promoters to make money was to run the company effectively. It was not possible to make money off minority shareholders now.

In fact, I was so positive that I placed order at 5% more price than the last day's closing.

Fast forward to today......... So, how did the stock and the company performed? Comp first.

1) Nothing good happened. CDR is taking a lot of time to materialize.

2) PSR proved to be a mirage. Quarterly sales were just not in same terms as annual sales. Probably they were cooking the books earlier.

3) Management seems to least bothered about the company. They are quite busy somewhere else.

And so stock should have nosedived.    

Yes, it was down about 95% of the time I was holding it. But briefly, rather strangely, twice it took U-turn and gave me an opportunity to exit. Couldn't exit first time. In fact, new shareholders gave me some profits also... strangely. See below-

Lessons Learned-

1) Don't invest all money in one go. Something which is cheap, can become even cheaper. Have patience. SIP.

2) Long term view is good. But don't completely ignore quarterly numbers. Do look for very large drops in numbers.

3) Good management can do no harm to your investments. Same can't be said about bad management.

4) Don't feel ashamed to take losses if things are not going well.

Comment Plz... :)

Hi,

Just realized that due to settings problem, it wasn't possible to comment on previous few posts.

Kindly share your comments now on this post. Thanks. :)

Asset-Liability Mismatch

In accounts classes, we are taught that Assets and Liabilities are always equal.
But we, middle class, can make any accounting principle look absurd.

Recently, a known brought a Four Wheeler.... A Car. Great. But.... 
Is it an asset or a liability? In my book, Asset is something which gives you cash flows in the future; while liability is something which eats cash in the future. ( I believe most financial advisers would agree on this). Robert Kiyosaki explains this difference beautifully in his book Rich Dad Poor Dad.

Now, Car will have have running expense, maintenance expense and depreciation.
Petrol is already touching sky and is not expected to come down... Hence running expense will be much higher as compared to a two-wheeler. Same can be said about maintenance. And Resale value of car will go only in one direction with time .... And you already know that direction.

So, in nutshell, car is a liability. Let me know if you disagree.

So, basically, we are purchasing a liability. To make matters worse, the concerned person has taken a loan for purchasing this liability. If you think a bit more, isn't it like taking a liability (loan) for taking another liability (car)? Asset= Liability. Ohh really????  Where is the asset??

What are the possible reasons for buying a liability (car)?
(1) Comfort (2) Social proof {Everyone is having one} (3) Pavlovian misassociation {Car= Status symbol} (4) Envy {big brother of social proof, in this case}.

So, should one never buy comforts? No, one should. But, first, one should add assets. And secondly, not by taking another liability, at least.

Plz share your views on the same.

A Graham kinda Stock...

I have just came across a cheap stock based on Graham's criterion. This stock passes the following Graham's tests-

• Cash Bargain
• Net net bargain
• Book Value Bargain

Current Stock Price= Rs 87/-

Let see each criteria in detail-

Cash Bargain- As of latest Balance sheet, Cash is 339 crs. Add investments of 92 crs. Subtract debt of 34 crs. And we get a Cash per share of 103 Rs/- (I have taken investments at 60% of Book Value to arrive at Cash/ share).

Net Net Bargain- Net Working Capital minus debt comes out to be Rs 225 per share.

Book Value Bargain- Being a financial stock, comparing Price with Book Value makes sense. Book Value stands at Rs 226 per share. Hence, P/B is less than 0.4

Hence, current stock price looks very low on Graham's scales.

Mr. Market should be having some reason for this low valuation. Yes, there is a reason. Some top executives are involved in a bribery case by CBI. Stock has fallen 90% from its highs due to that CBI case. But company has no liability due to that.

I would not like to name the stock here to avoid Endowment Bias. But I expect it to go up by 100%.
P/B less than 1 for a financial stock which is not a cash burn looks absurd to me!!!!

Dealing with Cash Bargains

One of Graham's famous theme was Cash Bargain. When market cap of company is less than net cash (cash minus debt), then essentially everything ( fixed assets, working capital, management, intangibles) is available for free. This strange situation is what he used to call as cash bargain.

But those times and location were different. Such companies were take-over and/or liquidation candidates and shareholders used to receive cash after liquidation (worst case scenario). But this is India.
Hardly any take-overs attempts (Exception- GESCO Corp. in 2000.). Hardly any liquidation..

So, we need to be skeptical even with cash bargains. Lets try to see the negatives. Why should a company deserves to be available at less than cash-

1. Cash is only on the books. Actual availability is uncertain. Market is basically saying- Show me the money!!!
2. Management is fraud. They are taking away the cash from the company.
3. Business is burning cash & is expected to burn cash for a long long time.
4. Cash in balance sheet is not cash of the business but is customer's cash (basically get money from customers in advance while giving to suppliers sometime later)
5. If company can't invest the cash to earn returns at rate more than WACC, then also they deserve to be valued less than cash. (They are not returning cash & are not investing it properly, either)

Plz share if i am missing something and there is some other logical reason for cash bargains!!

PS- As I write this, there are a few cash bargains that are available & I am trying to find whether they deserve to be cash bargains or not!! 

Sensex & Its Ingredients- Cause & Effect Relationship

Sensex and CNX Nifty are two of the most followed things in India. A lot of people actually know Sensex is at 20,000 (or 18,000) without knowing what is Sensex, what is the meaning of 20,000. Even there are people who think today Sensex has fallen, so all stocks have fallen today.
For these kinda people, I have one line to say- " Revise cause-effect relationship from your high school English book. Think whether Sensex is the cause or the effect."

Clearly, fall (or rise) in Sensex is the effect of fall (or rise) in prices of its 30 ingredients & not vice-versa.

But then nothing is black & white. Sometimes, Sensex becomes the cause... movement in underlying stock prices becomes the effect. Read This.

Think now... A lot of money follows Index funds... A number of MFs have restrictions to buy & sell only Index stocks. All these will have to sell RComm & RInfra and buy Sun Pharma & CIL.
Artificially high demand for Sun Pharma & CIL and low demand for RComm & RInfra. So Sun & CIL should go up till Aug 8th. While RComm & RInfra could well become bargains by Aug 8th.

PS- This is going to be my first experience of this kinda price behaviour. Reality may be different than my thinking. Lets observe!

Sezal Glass & Debt pay-down Theme

The developments in Sezal Glass makes an interesting case (if your own money is not involved). Sezal glass is in the business of processing glass since year 2000. It was making profits (small though) in the business. Then, they decided to manufacture glass. Came first indigenous float glass plant. Since it a was capital intensive plan, huge debt and IPO also came with it. CRISIL assigned a rating of 1/5 to this IPO. Read here.
Management, however, was highly optimistic of the business plan (Over-confidence bias, as it turned out).

Result- Huge debt and competition led to losses.. unsustainable losses. And hence, management is now selling float glass business for 686 crs which will make Sezal a debt free company with some free investable cash. This catalyst brings Graham's debt pay-down theme to the mind... Hugely leveraged company becoming debt free.. no interest cost will increase EPS.. & hence stock price. Lets see the positives and negatives of this situation.

POSITIVES-

• Since 2000 till last year, company was in positive. Hence, management seems to have technical know-how to operate in this business.
• After paying all the debt, cash left should be about 45 crs (686 crs from selling float business, total debt 623 crs, cash 2 crs). Market cap is 126 crs. Liquidation value of left over business should definately be more than 100 crs. Liquidation value should provide some comfort to the investor.
• Just 3 months ago, 2 crs shares have been alloted on preferential basis at Rs 10/- per share. With current stock price at Rs 4, some safety is there.

NEGATIVES-

• In current year, company has made operating losses even in left over business. So, if this situation prevails, even debt free nature won't help much.
• Even in previous years, company was earning average PAT of 2-3 crs only with poor ROCE. Even on net market cap basis (market cap- cash), PE is very high.
• Industry is highly competitive with MNCs having big brands. The possibility of some adverse development for Sezal in the future can't be ruled out.
• Insider selling in recent times doesn't gives much confidence either.

So, I think, risk reward ratio is not good in this case and hence I would like to give this a pass. Sorry Graham,don't mind... will apply your theme in some other situation in the future. :-}

When can I win?

As investors, we try to beat the market. But the big question is can we win?

I (and you) can consider stock market as a game... a game between me and Mr. Market. In this game, market is powerful, experienced, knowledgeable (mostly) and has tons of money while I am inexperienced, have little knowledge and have only 'thode se paise'. So how I can win? Lets see how and when case by case.

Case I. Market knows, I don't know
Welcome to the world, my child!!!
For a starter, most of the situations fall under this category.... outside one's circle of competence. Market knows the business (has its own analysts, investors) and correctly values it. I have no idea. So can I win? No, I can't. The best strategy in this situation is to not lose! Just get some experience and expand one's circle of competence over time.

Case II. Market knows, I know
Child is growing!!!
Well there are cases when I can clearly say that I can make money in this. But then market also knows this and hence won't allow me to get huge returns in this case. Let me clarify with an example. I read this announcement. Delisting... Minimum support price Rs 178.5... Market price on that day was Rs 160. So clearly there was negligible downside risk. So, I know this. Time to act. But, hey, wait a minute. Even market knows this. So, not much money, boss. Result- Upper circuit in the stock for 3 consecutive days and  price of Rs200 is on the cards now.

Case III. No one knows
Welcome to the world of UU!!!
There are cases when no one knows due to uncertainties involved. Sold the business.. no one knows what ll company do with cash; did some M&A deal... now what..synergy or realization of stupidity?; building huge and huge assets... will (and when) the revenues come? I can win in this situation with margin of safety and diversification (and decent luck).

Case IV. I know more than the market
Welcome to my world, Mr Market!!!
Here is your chance to win. Load it up, sit back and relax. Though it is easier said than done. But a few opportunities in this category over a lifetime ll make anyone super rich.

A better deal than Prof. Bakshi's

All those of you who know (or have even heard of) Prof. Sanjay Bakshi would (& should) be wondering how a novice like me can boast of offering you a better deal (in the stock market) than the prof himself.
And for those of you who don't know him read this and then start wondering!!!

But, I still say, I will give you better deal (investment operation) in this post. Don't believe me? Read further....

I hereby present to you India's largest cash bargain- Piramal Healthcare. Just click here and read. I don't need to give more details (I even don't have).

Developments after the post-
Since this post is 2 months old, there have been some interesting developments in this case-

1. Piramal life's research division will be merged with Piramal health.
2. Acquisition of Indiareit Fund & Indiareit Investment Management.
3. Plan to start NBFC.
4. Announced dividend of Rs 12 per share.

For complete details- Read this.

But overall the opportunity is still UU (unknown & unknowable) in terms of exact capital allocation, business strategy, M&A plans and the resulting bottom line due to all this. But still it has enough margin of safety in terms of cash per share and promoter's track record.

Back to the Title-
Hey! Remember the title of this post? So I copy paste Prof. Bakshi's post and claim that my deal is better!!! Right????
No my investment operation is better because I give you a hefty discount of 17.3%. (He was offering you Piramal at 450/-..... I am giving at just 372/- )

Remember an investment has two things-

• Business
• Price that you pay for the business.

Business that I am offering {as if I own that business :-)} is same but I am giving a huge discount of 17.3%. (This discount number of 17.3% is exactly what I don't want you to focus on. This is just an anchoring bias. The basic idea is that Piramal Health has become a bigger bargain than it was at the time of Prof's post. It can fall even more from here but it may not. Who knows!!)

So, if in next few years (3 to 5 or may be 7) Piramal Health turns out to be a huge success, my followers will gain more than Bakshi Sir's followers. But if Piramal flops or runs away with shareholders' money, my followers will lose less than Bakshi Sir's followers.

Heads I win, tails Prof Bakshi loses!!!!

The Investor's theory of Relativity

In the previous post, I had tried to value the sugar business of Triveni Engg using the technique of relative valuation. This post is trying to dig deeper into the pros and cons of that valuation technique.

The argument was- Since other companies are trading at a much higher ratio (of EV/crushing capacity), Triveni's sugar division is a bargain. But there is a serious flaw to that thinking.
Lets understand the situation by humanizing it. Imagine you have a known, Ms. Triveni. She approaches you for 100k for a 50% stake in her new business venture. What will you ask her before deciding whether to invest or not? Business details, growth potential, expected profit every year, ROI and bla bla bla. Imagine her replying this- "Hey don't worry! You know Renuka! She had a similar business and she has sold it for 400k (twice that of this plan). And Balrampur. He idea was same to same and he raised 150k for 50% stake. So, you are getting much cheaper."

Your reply would be- "!!!!!!!". Why? Because you don't care about Renuka and Balrampur and their partners. You want return of and on your investment. If Triveni's business can't generate at least 15% returns, then you wouldn't give her your money. Simple. Right?

But what's wrong with Triveni's thought process. Well, clearly, she is suffering from ENVY- the deadliest of the seven deadly sins. Without caring for absolute return, she is just thinking about relative returns- which is obviously wrong.
Coming back to Triveni Engg.'s sugar business, to deserve 2000crs of EV, it needs average Profit of atleast 200 crs (if not more) and not relative cheapness to its peers. So the question is- Will it be able to earn 200 crs every year? Well who knows... Depends on sugar cycle and supply and demand. However, historically, it has earned more than 200 crs in just 1 year out of past 8 years and average is about 50 crs per annum. So, I guess, timing of the sugar cycle is the key here.

Another use of this relativity approach is in the calculation of Relative performance. Mutual funds compare their relative performance against a benchmark and then judge themselves on this relative performance. So, even if a MF loses 10% of your money, it considers itself good if Sensex loses 20% in the same time which clearly is illogical and silly.
On the other hand, value investors argue that if I can earn a good return every year- good enough to make me rich over time- why should I care what return has Sensex or Gold or Dollar has given in that time. If I can double every penny that I have five times in my entire lifetime, I will be rich. Why should I worry about Sensex's return in this time?
Relative performance is another form of ENVY, which you should avoid.

With this, lets come to the Investor's Theory of Relativity- Relativity (Relative Valuation, Relative Performance) is noting but ENVY- the deadliest of the seven deadly sins. Comparing yourself with others and then feeling good or bad about it based on the outcome is ENVY and its the deadliest sin. Save yourself from this SIN. [Time can be relative, Mr. Einstein, but not performance or valuation.]

P.S- The double five times concept was given to me by my friend cum colleague Mr Vivek Turaga.

Leave the Child; lets talk to the Parent

I had discussed opportunity in Triveni Engg here. For a moment (or may be longer), lets forget the Turbines (Resulting company) and concentrate on the parent (demerged company). [Because the child is gonna command 60% of pre-demerger market cap (having revenues of only 23%) while the rest of the business are available at 40% of pre-demerger market cap] So, is the parent available at a bargain? Lets find out using Charlie Munger's saying- Invert! Always Invert!

At present, 25.8 crs shares of Triveni Engg are available at a price of Rs 40 each. Now, I would like to buy only if I find intrinsic value coming from sum of the parts valuation at a premium of atleast 50% (in other words, I would like to invest if I find intrinsic value of atleast Rs 60 in this stock). This means, Enterprise Value of about 2500 crs (assuming whole 934 crs debt belongs to the parent).

Business Segments-
Demerged company is into- Sugar, Co-generation of electricity, Distillery, Gear box and Water treatment and has 22% ownership in Triveni Turbine Ltd. (Too much diversified ??) Lets see each segment into some more detail-

Co-generation- Remains from sugar business are used to produce electricity which is used for captive use and left over is sold to UP Power Corp Ltd as a part of long term agreement. The fate of this business depends on the availability of sugarcane. The historicals are-

in crs	2007	2008	2009	2010
Turnover	152	117	94.8	146.7
PBIT	49.7	47.5	20.1	27

Since Avg PBIT of 36 crs is less than current PBIT of 27 crs, lets assume 27crs of PBIT every year. Calculating EV using earning yield bargain, we can safely assign an EV of 150 crs to this business. (PAT of 19 crs @ 30% tax, AAA bond yield of 9%).

Distilleries-Molasses, the by-product generated during the manufacture of sugar, is fermented and distilled and variants of alcohol are manufactured under this business. Again the fate is linked to the availability of cane.
Financials-

in crs	2007	2008	2009	2010
Turnover	20.7	78.7	53.9	88.9
PBIT	2.1	17.69	9.2	8.1

Taking lower of average and latest PBIT as sustainable, we can safely assign an EV of 45 crs to this business. (PBIT= 8.1 crs, Tax rate of 30%, AAA bond yield of 9%)

Gear and Gear Box- It is one of the largest manufacturers of high speed gears and gearboxes with capacity upto 70.0 MW, has 70% market share for high speed gears in India and is associated with Lufkin Industries Inc (USA) - the global leader in gears & gearboxes. Again lets try to conservatively value this business-

in crs	2007	2008	2009	2010
Turnover	109.4	88.2	73.29	101.44
PBIT	23.2	21.9	24.39	34.53
Margin	21%	25%	33%	34%

As we can see, this is a high margin business. But lets forget that for now. Avg PBIT is 26 crs which gives an EV of 145 crs for this business using same assumptions as above.

Water Treatment- It provides products and services for water treatment, waste water treatment, desalination and reuse & recycling systems.

in crs	2007	2008	2009	2010
Turnover	51.1	66.7	99.74	161
growth in turnover		31%	50%	61%
PBIT	5.8	10.5	14.83	21.94

Look at the sales growth numbers for a moment. But lets forget it now and value this using Graham's approach. Avg PBIT of 13 crs assigns an EV of 73 crs to this business.

Turbine Business- Parent is gonna have 22% stake in the child after the child gets listed. It is going to be listed at an EV of 1900 crs giving parent an EV of 414 crs. But child can be overvalued. Conservatively calculated price (from the last post) is 682 crs giving Triveni Engg an EV of 149 crs. It also has an outstanding preference shares of 2.8 crs in the child.
So total EV of all business except sugar= 150+45+145+73+149+2.8 = 564 crs.

So, if we could value sugar business at 1900-2000 crs, that would make Triveni Engg a good bargain at the current price.

Sugar Business- As a matter of fact, sugar is the main business of the company. Company is among top-5 sugar producers in the country having 7 plants having combined crushing capacity of 61000 TCD (Tonnes Crushing per Day). Since sugar is a cyclical business, it can't be valued using PE approach. Lets try to value this business relatively-
 

	Shree Renuka	bajaj hindusthan	balrampur chini	empree sugars	bannani aman	kcp sugars	Triveni Engg
Crushing capacity (TCD)	94,520	136,000	73,500	2,500	19,000	13,000	61,000
debt	6,507	6,350	972	513	238	42
mkt cap	4,651	1,619	1,884	227	652	191
EV related to sugar business	5,648	6,797	2,352	370	712	210	???
EV per crushing capacity	0.060	0.050	0.032	0.148	0.037	0.016	Median

Using Median EV per crushing capacity to calculate EV of Triveni Engg gives it an EV of 2667 crs for 61,000 TCD. Best comparable for Triveni is Balrampur Chini due to nearly identical size and presence of plants in U.P. Using EV per CC of Balrampur Chini for calculations gives Trievni's sugar business an EV of 1952 crs.

Valuation-
Hence, even after valuating all business conservatively, intrinsic value of Triveni Engg should not be less than Rs 60 { (1952 + 564- 934) / 25.8}.
Do you see anything wrong in this valuation? I see one. Using overvalued companies as comparable for sugar business will make my sugar business and hence whole company overvalued. Are other sugar companies overvalued? May be. But I don't think so. There has been a price correction of atleast 25% in almost all sugar stocks in the past 6 months. Balrampur Chini has done a buyback recently indicating that it thinks that the company is undervalued.
There might be one positive surprise for someone holding this stock for about 2-3 years period. If Turbine business lists and performs well, company could well demerge gear and water business also.

Risks Involved-

• The key risk involved in a commodity business is timing risk. Sugar comps. may not be overvalued now but to say when sugar cycle will improve needs more analysis. In fact, a lot of money can be made by correctly predicting the sugar cycle (or any other commodity cycle).
• Co generation and distillery will also perform in line with sugar business. Hence, wrong entry time will hurt a lot in this stock.
• Company operates only in UP. Any unfavourable development in the state's supply or demand situation will hurt the stock.

Am I missing something?

An Interesting Spin-off

An Announcement worth a second look-
Triveni Engineering & Industries Ltd. submitted this announcement to BSE on 25th April-
http://www.bseindia.com/stockinfo/anndet.aspx?newsid=6bf6e678-eec0-4678-b5dc-946e3863b700&param1=1


Now, spin-offs are considered to be a good starting point for making a good deal of money in the market. Reason- Just after the spin-off, resulting company is expected to be available at a bargain. This happens because shareholders of parent are given something which they have not asked for and hence prefer to exchange it for cash, come what may. Generally, institutions are the first one to get out of these new securities due to small size and their regulations. A view of shareholding pattern of Triveni Engineering & Industries Ltd. - http://www.bseindia.com/shareholding/shareholdingPattern_60.asp?scripcd=532356&qtrid=69.00
makes this case more interesting as about one-fourth of shares are with institutional investors who may prefer to get out of Triveni Turbine Ltd. (Resulting Company) and hence we may see some selling pressure in early days after listing and hopefully this will make TTL a bargain for value investors.

What is Triveni Turbine?
The resulting company supplies turbines to its customers. It is the largest supplier of steam turbines and commands a market share of about 60% in sub 30MW range. Its customer base includes big players from sugar, paper, textile, pharma, refinery space. Apart from making turbines, it also provides spare-parts and service to its customers.
Lets have a look at financial numbers-
 

In crs	2004	2005	2006	2007	2008	2009	2010
Sales	124	162	270	666	548	491	592
Op. Profit	16	15	42	154	128	116	130
Asset	67	86	130	236	307	295	301

A decent growth in sales and operating profit and high return on asset base. Hmm....

Valuation by Graham-
Now lets try to value this company using Graham, father of Value Investing, style. Lets find value using Debt capacity bargain and Earnings yield bargain themes.

Debt capacity bargain-
On an average, this company is earning 86 crs per year. Hence, it can safely service a debt in which it has to pay an annual interest of 29crs (Assuming Interest coverage ratio of 3). This way its earnings have to come down by 75% from average to possess any danger to annual interest payments. Assuming interest rate of 9%, it can easily get a debt of 318 crs (29/0.09) even from the most prudent banker. Hence, Enterprise Value (EV) of this company can't be less than 318 crs as per this theme. For more details on this theme, visit- http://fundooprofessor.wordpress.com/2011/04/24/vantage_point/

Earnings yield bargain-
This company is earning 86 crs per year. Now, Graham wants his yield to be atleast double of AAA bond yield. AAA bond will give you (and me) about 9% pre tax returns. That comes to be 6.3% post tax,assuming 30% tax rate. So, to get double of AAA bond yield, he would not like to pay more than 682 crs of EV for this company. (86/ 2*6.3%).


So, overall, if after listing, I (& Graham) can get this company at less than 682 crs EV, I (& Graham) would be more than happy to invest (Less than 318crs would be even better). In the next post, we will try to dig deeper into the company and try to value using Buffett style. Happy Investing!!