Current Portfolio

	Avg Purchase Price	Current Price	% portfolio at market price	Annualized return w/o including dividends (%)	Date Position Initiated
Piramal	655	1,460	22%	66%	Initiated in Nov’12
Balrampur Chini	60	130	22%	132%	Initiated in Nov’14
Relaxo	91	496	15%	94%	Initiated in Dec’13
Gold ETF	2,701	2,875	12%	9%	Initiated in Jul’13
Thomas Cook	95	219	12%	43%	Initiated in Jan’14
Shriram Transport	835	1,222	9%	20%	Initiated in Mar’14
Sunteck	228	252	5%	Initiated Recently	Initiated in Jun’16
Max Ventures	62	66	4%	Initiated Recently	Initiated in Jun’16

Recently I did a review of my current portfolio and the summary is given in the table above. I have given when was the position initiated in the last column but most of these positions I have gradually accumulated by averaging up (mostly) as well as averaging down. Let me talk about a few principles which are cornerstones of my investing philosophy. I would generally not consider an investment idea if all of the below criteria are not satisfied.

Concentration (diversification is overrated): as you can see from the table I am a big fan of concentrated portfolio as my investing philosophy has been influenced a great deal by Warren Buffet. Concentration makes a lot of sense to me – firstly since we are investing in only a few ideas, we really go deep into them and try to understand them better than anyone else. Of course, these have to be outstanding ideas as merely good ideas will not do. Being a concentrated investor means we say no a lot and invest only when all the stars line up. After we are convinced about the idea, we initiate a large position above a certain threshold. Because if you start with a small position, that just means you are not still convinced about the effectiveness of the idea. Of course, this is just the beginning of hopefully a long association and hence the work does not stop but merely starts from there. We revisit our thesis multiple times and keep learning more about the company and increasing the size of the position as our conviction in the idea increases.

I don’t understand the rationale for having a widely diversified portfolio, which to me just indicates a lack of conviction in your ideas. But I cannot say it as well as Warren Buffett – “Diversification is protection against ignorance. It makes little sense if you know what you are doing.”

Long term: I really like the following proverb – “People who are at the top of their game play by a different set of rules”. I think this applies to investing as well. And I believe that the most important competitive advantage (if you will) I have as an investor is my long term orientation. And when I say long term, I mean really long term. I have never sold any stock which I have purchased (except one where the investment thesis had changed) because I hate to sell.

Most stock market participants are focused on the short term and want to get rich quickly. No wonder that space is over-crowded and there is more competition in that space and hence it is difficult to win if you chose to play there. If we refuse to play that game, and instead chose to focus on the long, gradual, circuitous path to wealth creation; we are not competing with the majority. Instead we are playing in a space which is not at all crowded. Although the chances of winning are more in this space but that does not mean that it is easy. Because just buying and holding and not doing anything (sitting on your ass!!!) for extended periods of time is not at all exciting. It is in fact quite boring and hence does not appeal to a lot of people which is why the space has relatively less competition and increased chances of success.

Quality Management: The third tenet of my philosophy is the integrity of the management, which in my opinion follows quite logically from the first two. If we are running a concentrated portfolio where we want to buy for the really long term, the quality of the management becomes crucial. Because over long periods of time, there are always opportunities to cut corners or take short cuts which promote short term profits over long term sustainability of business. Investing with such companies can be profitable for the short term, but it is like playing with fire – sooner or later you will get hurt.

That is why I’m not too much concerned with short term performance focusing instead on long term sustainability. We want to invest in businesses being run by honest and hardworking people who have a track record in terms of integrity and fair treatment of all stakeholders including the shareholders. When we invest with such people, we can stop worrying about stuff like fraud, financial shenanigans, etc and instead focus on what is really important – which is the quality of business and its sustainability.  

Business with moat: Which brings me to the final point. We look for businesses which possess a track record of good performance in terms of return on capital. If the company has a demonstrated good performance in terms of return on capital, that means that there is an evidence of presence of a moat. Our talk is to understand if there is indeed a moat which the business possesses and is that moat sustainable. The dream businesses have a moat which is not only sustainable but which becomes stronger with time.

Two investment above namely the Gold ETF and Balrampur Chini might be looking out of place and deserve an explanation. Without going into the details as that would require a separate post, let me try to give a brief on the reason for the same.

Balrampur Chini – sometimes I might make a bet on the cyclical stocks and this is one of them – a bet on the sugar cycle. I started acquiring this one when there was desperation all around and everyone thought that the bad times will never end for the sugar industry. Fortunately for me and to my delight, bad times have ended and sugar stocks have been in a secular rally. Although I’m still holding on because I think that this rally has sometime to go before it peaks.  

Gold ETF – I think the next decade will belong to gold and I’m slowly building a large position there. Many value investors are averse to investing in gold because it does not have any future cash flows. But as Ray Dalio is fond of saying – “If you do not invest in gold, you understand neither economics nor history.” In normal times also Dalio insists on having a small part of the portfolio invested in gold. But currently the times are not normal. We are living in an age of loose monetary policy, a huge and unprecedented experiment called quantitative easing which shows no signs of ending anytime soon. Because the interest costs have been kept artificially low for so long in most developed parts of the world, it has resulted in misallocation of capital at a massive scale. The stress in the economies is slowly building up which gives rise to unintended consequences. Many of the investors I admire have been warning about the unintended consequences of the monetary policy for a long time including Prem Watsa, Seth Klarman, Howard Marks, Jeremy Grantham, Bill Gross etc. I happen to think as most of these investors do, that this loose monetary policy will end (whenever it does) in a disaster at some point. And gold I believe is a good insurance when the period of reckoning comes.

Sunteck Realty

I have been looking at Sunteck Realty stock with a lot of interest lately and my conviction has increased quite a bit over the last couple of weeks since I have been researching the company. It all started when i noticed the beautiful projects of Sunteck (Signature Island, Signia Isles and Signia Pearl) in Bandra Kurla Complex (BKC) where I go for running. I dug a little deeper and found that they have an existing JV with Piramal Realty (Piramal Enterprises being my largest holding) and that Ajay Piramal is invested in the company in personal capacity. That was enough to arouse my curiosity and send me scurrying for more. Here is what i found:

Summary

Business: Real estate is a difficult business due to a variety of reasons but it can earn a good return if it is being run by a disciplined and honest management. Additionally it is a cyclical business whose fortunes are tied to the health of the economy. Sunteck is a quality real estate company which has got a first rate management. It is even more cyclical than a typical real estate company because it plays in the luxury end of the segment. Currently, the stock price of Sunteck is depressed because of couple of reasons - 1) Real Estate industry is going through a protracted downturn, 2) There has been a lot of volatility in reported financial numbers of Sunteck as they use the project completion method unlike the more commonly used - percentage completion method.

Sunteck Realty began operations under the brand name Sunteck in 2000 as a corporate business center operator in Bandra Kurla Complex, Mumbai. It acquired Insul Electronics, a BSE listed company in July 2005. After acquisition the name of Insul Electronics was changed to Sunteck Realty and Infrastructure which was further changed to Sunteck Realty in Nov 2007.

Sunteck caters to the ultra-luxury and luxury residential segment in addition to commercial segment. It currently has city centric development portfolio of about 23 m sq ft spread across 25 projects at various stages of development and 4 rented assets with annuity income streams.

Performance so far
During the last 8 years (FY09-FY16), Sunteck has started recognizing revenues from completed projects in only 3 years - FY14-FY16. Before FY14 none of their projects had reached completion and so they did not recognize any revenues from these as they follow project completion method. Their average return on equity during these three years was 13%. Average over the past 3 years is a better way to measure their returns due to lumpiness of the revenues. While the returns are not great, when looked at the backdrop of dismal state of the real estate industry it is not too bad. I'm sure there is scope for improvement in their performance in the future. This will happen as they get better at execution with experience and the state of the real estate industry improves as the demand comes back.

What makes Sunteck different:

1. Land as an inventory
Many real estate companies purchase and maintain large land banks for future development. In the meantime they show the land as an asset on the balance sheet. When a company does that, their capital in the form of land does not earn any returns which depresses the return on capital.

Sunteck on the other hand does not treat the land as an asset but as an inventory. All the land owned by Sunteck is under development and in this way they are able to churn their assets quickly and earn better return on their capital. Which brings me to the next thing - financing.

2. Financing
In an effort to maintain huge land banks, lot of real estate companies have over-leveraged themselves. However, it is never a good idea to have too much debt and it is outright criminal to do so in a cyclical industry. Because when the downturn comes, which it inevitably will and the demand suddenly goes out, the overleveraged ones are caught with their pants down at exactly the wrong time. In this case, they are forced to sell their assets to bring down the debt to manageable levels, again at exactly the wrong time since they are likely to get depressed prices for their assets (land) due to the recessionary demand.

Here again Sunteck has used minimal leverage historically due to conservative nature of the promoters. First of all their land as an inventory policy has helped them and they do not need as much capital. Secondly, they have used a good mix of equity (very little), debt and customer advances to fund themselves.

3. Timing
Like in all cyclical industries, timing is of great importance in real estate as well. Generally like in other commodity industries, in real estate as well companies follow herd mentality and they all rush in to add capacity at the same time which sows the seeds for the next downturn. In terms of timing, what usually happens is most of the capacity addition takes place at the top of the cycle when the prices are at their highest. Sunteck on the other hand has a contrarian approach and have been buying land at distressed levels in the current downturn from other real estate companies who are forced to sell to bring down their debt.

4. Promoters
The company is led by Kamal Khetan who is a first generation entrepreneur who founded Sunteck in 2000. The promoters have consistently increased their shareholding by buying shares in the open market from 65% in 2010 to more than 73% in 2016. Piramal Group has also reposed their faith in Sunteck - they have an existing JV with Sunteck called Sunteck Piramal Realty. In addition, Ajay Piramal has invested personally in Sunteck by picking up a 3.5% stake in the company in March 2014 and later increased the stake to 4.63% by March 2015. Coming to the remuneration of the promoter, Mr. Khetan has been taking quite modest salary from Sunteck - 2010: 35 la, 2011: 59 la, 2012: 70 la, 2013: 75 la, 2014: 2.97 cr, 2015: 1.6 cr.
However, what really sets the promoters at Sunteck apart is that they voluntarily decided not to take any dividend during FY2014 and FY2015. During these years the dividend was distributed only to non-promoter shareholders and the promoters voluntarily waived their right to get the dividend. They forego of dividend which would have amounted to INR 4.65 cr in FY 2014 and a similar amount in FY 2015. I can think of very few promoters (unthinkable in real estate) who would do such a thing.

5. Valuation
Currently, Sunteck is available at very attractive valuation of INR 1400 cr. Let us look at valuation from couple of perspectives.
a) If as an owner of Sunteck, i want to do a firesale, how much would i demand from a prospective buyer as a minimum consideration. This should be equal to the amount of funds i have put into buying land and construction of the ongoing projects. In other words this would be value of inventory (which is funded through equity, customer advances and debt) less customer advances less debt. At the end of FY16 this value comes to 3768 (inventory)-917 (customer advances)-1208 (debt) = INR 1643 cr. As we can see this quality real estate company is selling at firesale valuations.

b) Secondly, let us try to do a valuation from cash flow perspective. For that please take a look at the table below taken from the Q3'16 update from the company. The table gives details about the ongoing projects of the company. All figures in INR cr. Since the company uses project completion method for revenue recognition, they have yet not recognized any revenues from the projects which are not 100% complete. Revenue to be recognized from the ongoing projects comes to INR 7,600 cr. - inventory for the first five projects and project size for the remaining projects. Assuming that all the projects will be completed over the next 8 years gives us average sales of INR 950 cr per annum and average net profit of INR 235 cr (assuming 25% net margin). This gives us a conservative valuation of 2,350 cr assuming a P/E of 10. This also assumes that they will not have any revenues from any other projects over the next 8 years.

	Completed	Project size	Sunteck Share	Pre sales	Inventory
Signature Island	Yes	2,570.7	100%	1127.7	1,474.0
Signia oceans	Yes	62.9	50%	62.9	-
suntech grandeur	Yes	101.4	100%	57.7	43.3
sunteck kanaka	Yes	69.4	100%	26	45.0
signia skys	Yes	56.9	50%	18.8	38.7
signia isles	No	1,376.0	100%	941.3	417.0
signia pearl	No	1,469.7	100%	883.4	557.1
sunteck city 1st avenue	No	1,208.2	100%	329.5	768.7
sunteck city 2nd avenue	No	1,324.2	100%	232.4	1,061.1
signia high	No	289.6	100%	126.1	162.0
signia pride	No	97.9	100%	10.9	83.3
signia waterfront	No	263.3	50%	26.2	238.7
sunteck center II	No	122.5	100%	0	128.5

Finally let me talk about the big picture and the overall prospects of the real estate industry specifically in Mumbai. Although Sunteck has presence outside Mumbai in a few places including Goa and Nagpur but their focus will continue to remain on Mumbai in the foreseeable future. While a lot of people tend to believe that Mumbai real estate market is saturated with so much development happening, in my opinion we are just scratching the surface. The landscape of Mumbai will be transformed over the  next 10-15 years. Mumbai is developing like a hub and spoke model - with multiple hubs (such as BKC, Goregaon) which contain mixed commercial and residential developments and connected to other hubs through spokes.

So here we have a company which is a quality real estate developer. The company is conservative not only with respect to leverage which it uses sparingly but also in its revenue recognition principles. Additionally this is being run by management with a lot of integrity who are managing the company for the long term benefit of their stakeholders and do not mind taking some short term pains for the same including foregoing personal  wealth. They want to create wealth for their shareholders over the long term and not off of them as is usually the case with real estate industry. It is no surprise that stock market does not like this company because stock market is obsessed with short term performance and abhors too much volatility in revenues. It is penalizing this company for their conservatism.

But i have not doubt that in the future as more of their projects get completed, they will reach a higher plateau in terms of revenues. Additionally, the real estate market which is in the dumps right now will inevitably come back roaring. The reversal in the market sentiment is a matter of when rather than if. And when that happens, the stock market will take notice. The trigger for the correction in undervaluation is three fold here - 1) Even if there is no change in sentiment with regard to the industry and the performance of the company remains as it is, I have shown above that the company is still undervalued 2) Their performance should improve over time 3) The real estate pendulum will swing again from from too much pessimism to too much optimism. As all of this takes place i'm happy to hold on to this and wait for the rewards alongside the management.

Understanding the moat of page industries (jockey)

NPage Industries which is the licensor of the jockey brand in India is a very successful and well recognised story in the Indian stock market. Stock price of page industries has grown at a phenomenal rate. Their revenue and profit have grown at a cagr of 35 and 37% respectively over the past 10 years. Over the same period their average return on equity is 55%. Which means that they definitely have a very strong moat. In this post my endevour is to try to explain the reason behind the strength of the moat. 

I believe that page's moat comes in large part from the specific attributes of their product - which is undergarments, predominantly men's undergarments. I would venture that they were quite lucky to get into this business which lends itself readily to formation of a moat. In fact, men's undergarments business fits quite nicely in the first category of moat which I have described in my post below - product moat. Let us explore various unique attributes of this product which help in the moat formation:

1. Strong demand plus replacement demand

I don't have to do any analysis to prove that there is a strong demand for undergarments. Everyone uses them and everyone buys more of them every year. Replacement demand is very important and in that sense it is not as strong as say Coca Cola for which all the demand is replacement demand. It is also not as strong as Colgate where you have to buy a new product once he existing one is finished. In that sense undergarments do not "perish", although they can develop holes and sometimes people continue using them because what the hell - no one is going to notice (I'm talking about people in general here and not about me). In college people are known to brag about wearing the same underwear for weeks on end as well, again not me. However the replacement demand is stronger than Hawkins where once you have bought the product you can continue to use it for 4,5,6 or more years. So it is definitely not one and done.

2. Standardised product

The beautiful thing about undergarments is that we don't care too much about their design as long as it's quality is good. From this perspective it is much more standardised product, when compared to other garments. So an arrow or a Louis Philippe or a levis has to make thousands of different designs while jockey has to make only a few. Of course the more standardised a product the less is the cost to manufacture it on a per unit basis. In more technical terms this is referred to as economies of scale. Of course the gold standard in terms of standardisation is Coca Cola. If there is a more standardised product, please do let me know. 

3. Unaffected by changes in technology or changes in consumer taste/ preferences

Let me take the change in technology first. While we have seen phenomenal changes in technology in the last 3-4 decades, however this has not really affected the garment industry in any meaningful way leave alone the undergarment industry. There have been a few products such as anti-odour, iron-free shirts etc but that's it. For the undergarment industry I can't even say that.

Let me turn now to change in consumer preferences. Consumer tastes have undergone a sea change in every conceivable product including garments. I laugh every time I see a movie from 70s or 80s or 90s. If this is what the movie stars were wearing in those days, I don't even want to think about the clothing preferences of the average guy. But even here, our mighty undergarments have stood the test of time. Apart from boxers, I don't think there has been any major change in consumer preferences here. And let's face it our ancestors have been wearing boxers since hundreds of years, maybe they called it by some other name. Doesn't change the fact that there have been almost no change in consumer preferences when it comes to men's undergarments.

If we put all the three factors together, they make quite a potent force. But these factors are applicable to all the companies in this industry, what is so special about page? It is quite simple really - page had the good fortune of being in the right place at the right time. The thing about the undergarments industry is that there will be a few big players - like the cola drink or the oral care industry because of the economics of the industry. Additionally it doesn't harm that page is the licensor of the jockey brand which was already a well established and respected brand globally. Additionally there is something unique about men's undergarments from a psychological perspective. I say men because I'm not sure the same thing applies to women's undergarments as well. Anyway, as we all know men are not in general terrifically excited by the prospect of shopping. When we do go for shopping, we want to spend most of the time on shopping for garments which other will be able to see. And when it comes to undergarments, we do not have any time for them. We go like zombies and pick up what is familiar in the least amount of time. If we have been wearing jockey, we are unlikely to change our brand anytime soon.

Page will continue to get bigger, the recurrent demand for their products will ensure that. However more importantly and this is where lollapalooza comes from - they will keep on becoming stronger as they get bigger. Why is that? Couple of points here - 1) due to economies of scale their bottom line will increase at a rate higher than the top line. They can invest a part of that money towards advertising to strengthen the brand. 2) as the brand becomes stronger their products will be ubiquitous. The distributors will want to stock jockey because it sells. The consumers come like zombies and pick it up without thinking. What better product to sell can there be!

So Page will continue to do well, well into the future. But in my view they should keep away from unnecessary diversification. I heard that page has also acquired licensing rights to the swimwear brand speedo and people were quite hung Ho about it expecting it to be another jockey. But if we compare speedo on the three parameters listed above, it will become clear that speedo is no jockey. It falls well short on the very first parameter of demand. 1) how many people are regular swimmers in India. 2) how many trunks do even regular swimmers buy? My guess is it is a "one and done" product and doesnt come close to jockey and all the enthusiasm of investors is probably misplaced.

Finally, Even though we have established that page is a great business, I'm not saying go and buy it. Valuation is as important as any other factor in investing. A good business can turn out to be a pretty bad investment if bought at the wrong price. As investors we will make outsized returns only if we can identify a story which is not known or underappreciated by the market. Page is a very well known story. But this post was to identify the factors behind this compelling story and to see if we can identify similar stories elsewhere which are waiting to be discovered. 

I want to make one more final point before I close. I think this three factor framework is a good tool to compare businesses which fall under the product moat category. We discussed this in the post as well and I hope it has become clear that Coca Cola is definitely a better business than even page. In my view they score above page in both demand and standardisation. What about Colgate? Again scores more on both demand and standardisation in my view. What about Hawkins? Page scores above Hawkins on all three I would think. 

So that's it for now folks. If you think we can make this model better by addin or deleting any factors, please let me know in the comments. I would appreciate any feedback.

A new beginning - search for lollapalooza

"So I have decided to resuscitate (look at me using fancy words like resuscitate, I seriously don't know where that came from) this blog after a long time. It is high time given that investing is one of the very few things I'm really passionate about. When I started this blog I invested in companies like venkys, ess dee aluminium, educomp as you can see from the posts below. I don't know what I was smoking back then, I don't even remember. 

During this period my investing philosophy has evolved and hopefully for the better. In this post I want to give a brief overview of my philosophy as it stands currently. Of course it will hopefully keep on changing and getting better as I learn more. My outlook towards investing in this period has been shaped mostly by warren buffet and Sanjay Bakshi and other investors of their ilk. I like to invest in companies with a sustainable moat being run by honest and intelligent management whose shares can be acquired at a reasonable price. Before acquiring any company I ask the following questions:

Question 1: does the company have a moat or competitive advantage?

A good return on equity for a sustained period in the past is generally a good indicator of the evidence of a moat. The return should be generated by very low amount of leverage.

The next two questions are more qualitative in nature and most of the time is spent on these two questions. I have realised that investing is almost All art and very little science. I must caveat here that I'm talking here of the investing style which I have decided to practise inspired by people I've already mentioned above. There are of course various other investing styles and these lie on a wide continuum starting from pure science to pure art. 

Question 2: is the moat sustainable?

To answer this question I use the porters five forces analysis and that has proved quite helpful to me. I try to identify the most important forces and focus on these to try to understand the origin and sustainability of the moat. I would not go into too many details here but hopefully the construct will become clearer as I talk about the specific investments in the coming posts.

But so far I have realised that the moat of the company would generally fall into one of the following categories. I'm sure this is not an exhaustive list and I will keep on adding to this as I come across other categories.

Category 1: Product moat

Moat derived from the specific quality of the Product the company is selling. Typically the product will have one or all of the following characteristics:

- standardised product

- low cost

- can be sold to a wide set of customers and not focused on a niche customer set

- the product has to be bought multiple times by the customers

- produced on a mass scale and hence lends itself to economies of scale in the manufacturing process

Examples of companies in this category include coca cola, relaxo, page industries (jockey), suprajit engineering, Colgate 

Category 2: Process moat

Moat derived from the specific process which the company has developed and perfected over a long period of time to profitably serve a niche set of clients. This category typically has the following characteristics:

- process tailored to a niche set of clients

- process has multiple steps which reinforce each other

- strong focus on the niche set of clients

Examples include dell in the 90s, Shriram transport, gruh finance, etc.

Category 3: conglomerate moat (if there is a good capital allocator at the helm)

Diversification can be good in a very select few cases when there is a good capital allocator running the show. I picked this up from a book which has chronicled what these extraordinary people have accomplished through their capital allocation skills, the book being - the outsiders.

Examples include Berkshire Hathaway, Piramal enterprises, Thomas Cook ( the latter two are very much work in progress and I continue to hold them).

Category 4: high switching cost moat

There are cases where it becomes difficult for the customers to switch to a different company due to cost or time or any other reason. In such cases typically the customer is locked in once acquired and she continues using the service for her lifetime.

Examples include hdfc bank (or any other bank for that matter), AIA engineering, dish TV, etc.

Category 5: network effects moat

This is self explanatory and has been covered at multiple other places. Examples include Facebook, Microsoft, rating agencies, etc. This is a very powerful moat as it possesses what is referred to as lollapalooza effect (please see question 3 below). Even such a strong blow to the integrity and reputation such as the financial crisis of 2008 was not enough to dislodge any of the rating agencies. They continue to stand tall to perpetrate their misdemeanour for one more or maybe many more crises.

Next question is probably the most important of all.

Question 3: is there lollapalooza effect? OR in other words - will the moat become stronger with time?

This one was proposed by Charlie munger when he explained the moat of coca cola. Please read it here. Link- http://mungerisms.blogspot.in/2010/04/charlie-munger-turning-2-million-into-2.html

Notice how many factors including operant conditioning, Pavlovian conditioning, economies of scale, etc. come together and reinforce each other and the sum of the parts is much greater than the parts. This is what Charlie refers to as the lollapalooza effect. 

This is the dream of any investor. To correctly identify conditions which will give rise to lollapalooza effects. Because when that happens the moat of the company keeps getting stronger with time. Talking about time, I hope you noticed the time period used by Charlie in the above example - more than a century! Ideally that is the desired time period for me - to identify and acquire companies which I never have to sell. Our work will be done if we are able to identify a handful of such companies (or compounders as they are known) over our lifetime. 

Which brings me to another factor of my investing philosophy - concentration, which is again borrowed from others. But it does make a lot of sense for investors of this style. First of all it is difficult to identify these compounders which can also be acquired for a reasonable price. Hence when we do identify them, we would expect to reap the benefits for years to come. And it would be a shame to dilute the results by holding less extraordinary companies in the portfolio.

Another related factor which I should talk about is the management. When I invest in a company which I want to hold onto forever, it becomes imperative that the management of the company should work with integrity. Because over long periods of time it is difficult to sustain success which is built on shaky foundations. Hence I don't have a separate question dealing with the integrity of the management. If the company in question does not have it, I would not look at it to begin with.

Let me end by talking about one final point. What happens to our compounders during a recession or downturn? And again I'm not making it a separate question because some compounders are affected more than others. But we might still want to hold them even if they are adversely affected by a slowdown in demand if their moat is intact. Of course, many times this is the best time to acquire the compounders. However, one thing which has become clear to me is that the companies which fall into Product moat category are least affected by the slowdown. The reason could be that most of them sell products which form a small part of our total budgets and in many cases are essential items such as toothpaste and footwear and we have to keep buying them. These companies usually sell at a premium to other compounders. Other than that I'm not still clear whether one category of moat is stronger than the others. 

I will end this post here and will keep on modifying or changing the construct above as I discover and learn more. Happy investing and appreciate and welcome comments and criticisms and suggestions.

Vardhman Special Steels - Special Situation - Spinoff

So while researching the textile sector in general, i came across Vardhman Textiles and then its spinoff company which has just started trading (May 17th, 2012) called Vardhman Special Steels. And whenever i hear of a demerger/ spinoff, I stop and pay attention, especially after I read the book - You can be a stock market genius by Joel Greenblatt.

In this situation, i really have not looked at the business outlook of VSS in detail. The valuation is that attractive. And there are other factors too:

1. The stock is trading below its liquidating value as defined by Graham. The calculations are given below:

Figures in INR Cr.

Current assets


Current Investments                                18                       100%                         18
Inventories                                              95                       66%                           62.7
Trade receivables                                    105                     80%                           84
Cash                                                       87                       100%                         87
Loans & advances                                  16                        80%                          12.8

Fixed assets
Tangible assets                                        43                       15%                          6.45
CWIP                                                     8.6                      15%                          1.3
Long term investments                             81                       100%                        80
(debt mutual funds)
Loans and advances                                12                        15%                          1.8


Total                                                                                                                   353
Total current liabilities                              188                      100%                       188
Total non current liabilities                        93                        100%                       93

Liquidating value                                                                                                  72
Liquidating value per share                                                                                   38.7

2. The promoters are the biggest shareholders holding approx 75% of the shares of VSS. So their interest are aligned with the shareholders.

3. If that is not enough to convince you of the intent of the promoters, here's more good news. The promoters have lent the company INR 66 cr through their companies. From the latest balance sheet:

Short term borrowings

From related parties
- Vardhman textiles limited              29.8 cr.
- Vardhman acrylics limites              35.9 cr

So, the promoters do have a lot to lose if the company goes down. And the share price does suggest that it is going down.

4. Currently, around 11% of the shares are held by MFs. As generally happens, the institutional shareholders will exit the demerged company after the demerger. If that happens, as i assume it will in this case, the share price will go even lower.

5. If you insist, i will tell you a little about the earnings of the company. First it is not loss making. That should be enough. Maximum i will do is look at the ROE and cash flows.

Net profit margin: 4.9%
Net asset turnover: 1.87
Leverage: 1.48
ROE : 13.6%

Last year, on a net profit of 26 cr

CFO: 5 cr.

Operating cash flow was much below net profit, because of an increase in receivables and increase in "other current assets/ loans and advances."

- Increase in trade receivables is concern and one to look out for.
- Other CA/ Loans and advances consists of advance to suppliers mostly (13 cr. out of 16 cr.) So no problems there.

6. Currently, the stock is trading around 36. Me being a douchebag deep value investor, i will wait till i can get it for 70% of the liquidating value which is 27 (something to do with margin of safety). So i will wait for it to come to me. 

Venkys

Overview

Venky's is the largest and most diversified company in the poultry sector in India. Its business can be broadly classified into the following three segments. From the company's latest annual report:

1. Poultry and poultry products - top line contribution - 65%
The company's major business is poultry and poultry products which consists of production and sale of day old broiler and layer chicks, specific pathogen free eggs, processed chicken products and poultry feed.

Broilers are chickens raised specifically for meat production whereas layer chicks are raised for the purpose of eggs. Modern commercial broilers are specially bred for large scale, efficient meat production and grow much faster than egg laying hens or traditional dual purpose breeds.

The numbers in brackets show the percentage of the overall revenue for last FY (2011).

Products:
Chicks (18.9%)
SPF eggs (2.8%)
Grown up parents (0.4%)
Grownup commercial broiler (17.7%)
Grownup commercial layers (1.0%)
Poultry feed (8.8%)
Processed chicken (15.9%)

2. Animal health products - 9.5%
The company has its animal health products manufacturing facility in Pune

Products:
Animal health products - powder (6.9%)
Animal health products - liquid (2.8%)

3. Solvent extraction: Oilseed - 25.5%

Products:
Refined oil (9.2%)
De oiled cake for poultry (10.6%)
Misc (4.9%)

DuPont Analysis
Let's first start by understanding the overall economics of the business and then we'll get into the details of specific segments. As always i'll do a DuPont analysis and look at the ROIC numbers for the overall business to get a sense of its profitability and capital intensity over the last five years. The numbers are given below:

                                       2007          2008          2009          2010          2011          2012 (9 months)
Net margin                      2.76%        5.04%       3.57%        7.64%        8.48%        3.17%
Net asset turnover          1.72            2.00          2.18            2.28           2.13           1.47
Leverage                        1.99           1.89           1.68            1.51          1.47            NA

ROE                               9.4%         19.1%       13.1%         26.3%       26.6%         NA

First the net margin. The net margin has been fluctuating over the years due to the cost of raw materials. A majority of the cost (~60% of revenues) is constituted by raw materials which is maize or soya. Also the fluctuation in the net margin of the company with the fluctuation in raw material prices tells us that the company cannot pass on the entire cost increase to the consumers. The company in the past has been able to pass on the increased raw material cost but only with a lag. Also the poultry industry in India is highly competitive and this limits the ability of the company to effect price increase. Some source of comfort here should be that the company is the leader in the poultry industry and has built up a good brand name. Hence its bargaining power should be more than that of the other players in the highly fragmented industry.

Net the asset turnover. The company is not overtly capital intensive as can be seen from the asset turnover which has been above 2 for the past 4 years. The assets of the company include Breeder Farms, Hatcheries,  Commercial farms in Uttar Pradesh, Haryana, Punjab, Madhya Pradesh, Himachal Pradesh, Gujarat and Uttaranchal. It has its solvent extraction unit in Solapur, Maharashtra and Chicken Processing and Animal health products unit in Pune, Maharashtra. However, the capital intensity of the company might change in the future as can be seen by the decreased asset turnover in 2012. This is because the company has recently ventured into fast food restaurants under the brand name of Venky's Xpress which will require substantial capital expenditure. The company has outlined a capex of Rs. 250 cr. over the next 3 years. (http://investment.contify.com/story/venkys-india-to-invest-rs-25-bln-to-open-100-outlets-across-india-expects-break-even-in-15-months-2011-11-01)

ROCE
                               2007          2008          2009          2010          2011          2012 (9months)
NOPAT                 1,489         3,120          2,557         5,902         7,694        2,912
CE                          24,273      26,467        26,441       31,113       40,400      49,299
ROCE                    6.1%         11.8%         9.7%          19.0%       19.0%       7.9%#

# Estimated by assuming the fourth quarter NOPAT as the average of previous three.

These nos. are definitely not pretty. Except for 2010 and 2011, the there has been shareholder value destruction in the remaining years. Let look at the segment results to understand the overall performance a little better.

Segment Analysis
First lets look at the net EBIT margin and capital employed in the three segments separately.

Revenues
                                                 2011                                     2012 (9 months)                     Growth*
Poultry & poultry products        59,425                                  51,443                                    16.1%
Animal Health products             8,685                                    7,103                                      6.5%
Oilseed                                     23,485                                  19,424                                    17.8%

* Comparison of the first 9 months of 2012 to the same period last year.

EBIT Margin
                                                 2011                                     2012 (9 months)
Poultry & poultry products        15.4%                                   7.0%
Animal Health products             19.1%                                   18.1%
Oilseed                                     6.9%                                     4.9%

Capital Employed
                                                 2011                                     2012 (9 months)                     Growth
Poultry & poultry products        21,516                                  28,729                                    33.5%
Animal Health products             2,712                                    3,326                                      22.6%
Oilseed                                     6,360                                    5,337                                      -16.1%

Below are the EBIT/Capital employed (per annum) to understand the capital intensity of separate segments.

EBIT/Capital Employed
                                                2011                                     2012 (again projecting EBIT for full year)
Poultry & poultry products        42.5%                                   16.7%
Animal Health products             61.2%                                   51.5%
Oilseed                                     25.5%                                   23.8%


The results look especially terrible for the poultry and poultry products segment. The company has clarified in its latest quarterly report that - "During the quarter the poultry and poultry products segment registered lower profits due to higher cost of feed ingredients and lower realizations from sale of day old chicks and grown up birds." The products of poultry segment are commoditized expect for processed chicken which contributes 16% to the revenues only. So the fortunes of the company are necessarily tied to the poultry industry. Right now the company appears especially fragile as it is getting beaten on both the ends - prices and costs. Poultry products costs (RM costs) are up and the realizations are down. Over the next year, this is expected to change and hence the profitability is expected to go up. The company has grown revenues at a CAGR of ~20% over the last 5 years. Revenue during the first 9 months of 2012 increased at a rate of 15% and this growth is expected to continue. The cyclicality of the industry will make sure that the bottom line will fluctuate with the industry.

Valuation
On a PE basis, the company is trading at PE of 10.58 on estimated earnings of FY12 and at 5.4 on est. earnings of FY13. This might look on the higher side but keep in mind that this is a cylical company and the best time to buy might be when the PE is at its highest.
P/B ratio for the company is 1.31.

But as suggested by Warren Buffet these numbers might be illusory, the only real way of valuing a company is cash flow valuation. And on that basis, according to my model a fair price of Venky's is in the range of Rs 415-540. Here i have assumed a growth rate of 10% for the next 10 years and a terminal growth rate of 3%. The range of values represents differing scenarios for the capex of the company going forward.

Ess Dee Aluminium

I noticed this stock because the private equity firm Sequoia had bought a stake in the company which they later increased. So after doing a very superficial analysis, i bought some shares as the stock has been trading at its near lows.

Now since i'm analyzing my portfolio to see if i should keep this one. So here is the story:

Ess Dee Aluminium is a leading manufacturer of pharmaceutical packaging products with core competency in aluminum packaging. With a total 37,000 MTPA capacity, the company is the largest organized packaging player in India in this segment with a market share of approximately 20%. As far as i have been able to find out, Hindalco is its closest competitor with installed capacity almost one third of Ess Dee. The rest of the industry is mostly fragmented with smaller players.

So far they have done a good job up until FY 2011 that is. Their top line grew at a CAGR of 42% during the past 5 years. Lets do a DuPont analysis to understand the company a little better.

                                      2007                         2008                  2009*                2010#              2011
Net margin                    21.9                           22.8                   -5.29                32.54               16.79
Net Asset Turnover       0.61                           0.67                  0.74                  0.86                  0.75
Leverage                       1.23                           1.27                  1.82                   1.35                 1.31
ROE                             16.4%                       19.4%               -7.1%                37.8%              16.5%

* The figure is negative in 2009 because of the merger of India Foils (That is the reason of the current predicament of the company. More on that later)
# Again the abnormal profit in 2010 because of the tax advantage of the merger.

From the table above, it looks like the company has been able to maintain a ROE of 16%. We can see that the company is capital intensive by looking at the low asset turnover. I generally like a capital intensive company if it can generate more than a rupee for every rupee invested over a long period of time. That in itself is a truism, one may people often forget. Anyway to return to the story, the share price of the company were bid up to Rs 842 at its peak in Jan 2008. After than it declined to sub 150 levels in Dec 08. After that it again soared to above 500 levels in June-July 2010 and is currently trading at around 150. This case is a classic example of the boom bust pattern frequently observed in financial markets.

My first concern in buying the stock was to see if the company has a competitive advantage. This becomes even more important in case of capital intensive companies. After a lot of research into the business model of the company, i'm still not sure about that. The company sells a commodity product and hence it might be difficult to build a sustainable competitive advantage. However, there are a few positives about the company. It has been able to increase its earnings at such a fast pace in the past because of its hub and spoke model, about which you can read more at its website or the annual report. But that alone is not much of a comfort to me.

The recent downslide in the stock prices of the company has been mostly because of the declining earnings over the past 3 quarters starting in the first quarter of 2012. It seems likely that this would continue for the next quarter as well. The management has attributed this to some problems in one of its factories at Hoera, which was acquired as part of the India Foils acquisition. This is a major concern and there is not much clarity about its impact going forward. So i was about to give up on further research and sell my stock.

But then i did a simple cash flow analysis to find out what is the minimum price at which i will still buy the stock. In my modelling i have assumed a zero percent (that's right) growth rate for the next ten years and a zero percent terminal growth rate beyond that. I have taken the cost of funds at the higher end at 16%. And i'm getting numbers in the range of  120!! So, 120 should act as a floor for the stock price. Based on the current market price of 153, the market is currently assuming a growth rate of around 2% for the company over the next 10 years. (I'm assuming a conservative terminal growth rate of 1% in this case.)

Based on the above analysis i'm not selling my shares just yet. If i'm lucky and the stock moves down even further from the current levels, i might start buying more. Meanwhile i will wait for a little more clarity on the situation to decide on the future course of action.