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.