Tuesday 24 May 2011

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!!!!

Sunday 15 May 2011

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.

Saturday 7 May 2011

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 crs2007200820092010
Turnover15211794.8146.7
PBIT49.747.520.127

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 crs2007200820092010
Turnover20.778.753.988.9
PBIT2.117.699.28.1

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 crs2007200820092010
Turnover109.488.273.29101.44
PBIT23.221.924.3934.53
Margin21%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 crs2007200820092010
Turnover51.166.799.74161
growth in turnover31%50%61%
PBIT5.810.514.8321.94

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 Renukabajaj hindusthanbalrampur chiniempree sugarsbannani amankcp sugarsTriveni Engg
Crushing capacity (TCD)94,520136,000
73,500
2,50019,00013,00061,000
debt6,5076,35097251323842
mkt cap4,6511,6191,884227652191
EV related to sugar business5,6486,7972,352370712210???
EV per crushing capacity0.0600.0500.0320.1480.0370.016Median

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?