We like companies which are:
- not over-leveraged,
- generate free cash flows,
- able to deploy capital at higher returns (in excess of 20%),
- regular dividend paying,
- command sizable market share and,
- most importantly are available at decent valuations.
Moreover, if we find Promoters/Management themselves buying the shares of the company through open market purcahse, it further bolsters our confidence and comes across as an icing on cake.
The good thing about such companies is their consistency and their ability to deliver market beating returns at all times. They also lend the much required stability to our portfolios during bad market conditions.
We are glad to share with you the details on our latest Alpha stock recommendation for the month of Nov’11, where we luckily could find all the above mentioned traits.
Some key highlights
- Promoters are buying aggressively at CMP. In the last one month itself they have increased their stake by more than 2%. This gives the much needed cushion to the downside.
- Over the last 7 years, the sales of the company have grown at a rate of 25% on annualized basis while the net profit of the company has grown at a rate of 35% on annualized basis.
- The operating business of the company is generating cash flows to the tune of one-fourth of its current market cap and the management has been able to deploy the capital very effectively with Return on Capital employed (ROCE) of 25% and cash flow ROCE of 27%.
- The free cash flow generating ability of the company has helped it pay off all its debt and is now sitting on a cash surplus equal to almost 30% of its current market cap. Considering the way they have been generating free cash flows, the cash surplus would exceed the current market cap of the company in next 24 months.
Given the consistency and trajectory of growth for the last 7-8 years, the above valuation does not capture expected future growth in earnings and rather making the business available almost free of cost.
We would suggest initial portfolio allocation of 3% at around CMP. We expect a decent return of 80%+ over the next 1 year and more.
Also we don’t rule out a possibility of 10% correction, which could be market driven, though the same seems highly unlikely in the wake of the fact that everytime stock comes down to current levels, Promoters start buying aggressively. In that case, the stock would become cheaper and we may consider increasing the allocation to 5% (follow Alpha/Alpha + Weekly for subsequent updates).
For complete details on the stock, refer the attached report at the below link:
For any further details, please drop a mail at email@example.com
This is w.r.t. the Arman Financial Services Ltd (BSE Code – 531179) investment cum arbitrage opportunity shared with you on 11th Nov’11 (Refer the LINK).
Note: The proposed Rights issue of company stands cancelled and therefore the arbitrage opportunity. However, we would still suggest you to continue holding with 3-4% portfolio allocation, as recommended earlier.
The company had its board meeting yesterday. In the same they have authorized the board to:
- Issue, offer and allot up to 13, 58,130 equity shares at a price not exceeding Rs 56.95/- per equity share.
- Issue, offer and allot up to 12, 75,760 (10%) Compulsorily convertible debentures of face value of Rs 56.95 per CCD. (CCDs are interest bearing bond instruments till the time they are converted into equity shares. In the above case, the 12, 75,760 CCDs will be converted into 1 equity share at a price of Rs 56.95/- per share with 18 months from the date of allotment of the CCD.
- Issue, offer and allot up to 4, 28,329 warrants to the promoters of the company with a right to subscribe for one equity share per warrant within 18 months from the date of allotment of the warrants. (The warrant conversion price has not been decided by the company, although it should probably be Rs 56.95/- per share.)
Assuming that all the above shares, warrants and CCDs are allotted and are converted into equity shares at Rs 56.95/- per share, then Arman Financial will get ~ Rs 17.43 crore from the issue of 30.62 lakh shares.
In contrast, if the company had progressed with Rights issue in the ratio of 6:5 at Rs 15/- per share, then they would have been able to raise just Rs 7.33 crore with the issue of 48.91 lakh shares.
Pre issue @ CMP i.e. 30
- Total equity shares – 40, 76,600
- FY 12 (E) Book Value – Rs 13-13.50 crore
- Current Market cap – Rs 12 crore
- FY 12 (E) PAT – Rs 4-4.50 crore
Post Issue @ CMP i.e. 30
- Total equity shares – 71, 38,819
- Book Value – Rs 30-30.50 crore
- Post dilution market cap @ Rs 30 – Rs 21.41 crore
Therefore, post dilution, if the stock still trades at Rs 30, the P/BV ratio would be 0.71, thus leaving enough room for capital appreciation considering the robust performance of the company.
We believe that company has worked out a good plan for raising funds without much equity dilution and therefore suggest you to continue holding the stock.
B-47, 1st Floor, Dayanand Colony, Lajpat Nagar – IV, New Delhi – 110024 Ph.: 011-41730606, Mob: +91-9818866676
As you must be aware that Cera Sanitaryware Ltd is our Alpha Recommendation for Jan’11 (Refer the report on LINK), so we and our members have a vested interest in the stock.
Even as the Indian ceramic industry is reeling under high costs, Cera Sanitaryware is looking ahead. The sanitaryware player is bullishly looking at acquisitions and retail expansion. Vidush Somany, Executive Director, Cera Sanitaryware listed out his plans in a recent interview. Some of the highlights of the same are as below:
- The company is aggressively looking at acquisitions in Italy. The rationale behind the same is Europe’s financial crunch, which is throwing dirt cheap valuations (A sign of a prudent management, making the most of adverse situation).
- The company is aiming to achieve and stabilize at over 30-32 per cent of the market share, from 21% currently, in 3-5 years.
- China is not a threat, as is normally presumed. The company itself outsources some of the products from China. Also sanitary ware being a bulky product, the cost of freight ensures that there’s no dumping of low priced products from China.
- The company has been able to pass on the rise in cost of production to its dealers and distributors and still not witnessing any slowdown in demand.
- In the bathroom products and fittings segment, tastes and preferences are gaining priority over cost. The customers are very much brand and quality conscious.
The complete excerpt of the interview is as below:
Q. At a time when the Indian ceramic industry is reeling under high costs and inflationary pressures, Cera Sanitaryware is looking at acquisition. How is the move set to reap benefits in the long run?
Growth is a continuous phenomena. One of the best ways to combat rising cost is through achieving economy of scales, more so, when we have been able to pass on the ‘Cost·Push’ on account of inflation to our dealers and distributors.
Strategically, we are planning ‘In-Organic’ growth as this could turn out to be a better deal when entire Europe is reeling under financial crunch. According to our information, there may be some units available for sale at dirt cheap price. Needless to add, we are extremely cautious on this front. Any decision on these, when we take, will be well considered one.
Q. Moving on from selling sanitary ware, the company is trying to establish itself in the luxury segment. Why? Please elaborate on the company’s strategy behind it.
We have been selling ‘Wellness product’ for a very long time. This is not a new thing to us. We have been outsourcing these products from China and selling under brand ‘Cera’. The response to these product has been exceedingly well and the market is growing at faster pace than conventional sanitary ware.
Q. From a 20 odd per cent market share, where does the company see itself in next 3-5 years?
We are increasing our in·house manufacturing capacity in sanitary ware from 2 million pcs per annum to 2.7 million pieces per annum. This will make us a largest plant a single location.
Servicing clients from one location would give us better absorption of overheads and put us to Cost advantage vis a vis competition.
Our market share is bound to rise. We are aiming to achieve and stabilize at over 30-32 per cent of the market share in 3-5 years down the line.
Q. Apart from entering aggressively into luxury segment, is the company also looking at some other segments in the near future? If so, why?
We have recently added Faucet ware in our manufacturing range. The current manufacturing capacity is 2500 pcs per day. We have ambitious plan to raise these capacity to 7500-10000 pcs per day in next 3-5 years time span.
The market size of faucet ware is more than double of that of the size of sanitary ware. Besides it has synergy with ‘Cera’s current product range which goes into the bathroom.
With established brand and settled distribution channel of over 6000 retailer dealers, we are poised to capture larger share.
Q. The company has been opening its own ‘Cera Bath Studios’ across the country. What other ways is the company exploring in retailing?
We may like to clarify, we are not selling any of the products directly into the retail market. The ‘Cera Bath Studio’ is only a display centre of all the products company has to offer. This allows end·users as well as architects to have a close look at the entire product range.
Some the studios offer facility to actually ‘experience’ the product – touch and feel Eventually if the customer decides, he will have to go to the dealers to buy the products of his choice. This methods inspire more confidence in company’s products with committed after·sales service.
Q. How do you think the lack of anti-dumping duty in the ceramic and sanitary ware industry is impacting the players?
It hardly matters as there is no dumping at all. Ceramic sanitary ware is a bulky product. The cost of freight is a major concern rather than the any levy or duty.
Some high end and designer products are able to bear this kind of cost. Now a days’ lots of people are obsessed with bathroom to be made very tastefully where cost becomes subordinate to taste and preferences.
We attended the conference call of Sanghvi Movers Ltd, our Alpha recommendation for Aug’11. Sanghvi Movers directly caters to the crane requirement of varied sectors like Power, oil and refinery, Wind power, cement, etc.
The management indicated 22-24% growth in top line for FY 12 over FY 11, however they also mentioned that economic scenario is grim. The policy action on the front of various issues like land acquisition, coal linkages, etc is lacking which is hurting investment growth and even stalling some of the projects.
The management mentioned that they too can get affected if the condition persists for long. In view of the above, they have not committed any capex for FY 13. They mentioned that they will incur capex only if there are confirmed orders and payments from the clients.
The management expressed willingness to retire debt in case they don’t go for substantial capex in FY 13.
For updates on other Alpha Recommendations, refer the attached report.
B-47, 1st Floor, Dayanand Colony, Lajpat Nagar – IV, New Delhi – 110024 Ph.: 011-41730606, Mob: +91-9818866676
This could be an interesting investment opportunity for you if you are a High Net worth individual (explained later on). Well, even if you are not, you may still consider buying the stock as such value buys do not remain a value buy for long. As Charlie Munger says, the markets are quite efficient, if not completely efficient as suggested by efficient market theory.
(Note: This is not a recommendation to buy or sell. We are just sharing some of our findings. Please carry out your own due diligence or seek advice from your financial advisor before carrying out an investment operation)
The stock we are referring to is Lakshmi Electrical Control Systems Ltd (LECS) – (BSE Code – 504258). Without going much deeper into the business of the company, LECS is involved in the manufacturing of LV Switchgear products, control panels and power management systems aimed primarily at Textile Machinery. As far as the management is concerned, they look over a group with a market capitalization in excess of Rs 2000 crore.
Now, what really got us interested and why do we believe that a Control Value investor with some crores in his bank can make a deal out of the same?
Here are a few important facts about the company:
- Market capitalization – Rs 63 crore
- Debt free company
- Cash and Bank balances – Rs 19 crore (as per the latest filing for Sep’11)
- Investments – Rs 10 crore in non-listed entity + ~Rs 8-10 crore in listed entity (10 crore investment in un-listed company so we won’t consider this, however the company also holds 88,800 shares of Lakshmi Machine Works which is a listed entity with the CMP of Rs 1700. At the CMP, the value of the same comes at Rs 15 crore)
- Average operating cash flow from operations (5 years) – Rs 14 crore (this is the period during which we had one of the worst slowdowns and the company could not record growth)
If one is to consider the above stock as a business (which everyone should ideally do while investing in any stock), and say if you were to acquire 100% of the business, then you will have to shell out Rs 63 crore (the market capitalization). Now that you would have full stake in the company, you will be left with Rs 19 crore cash, Rs 10 crore in liquid investments and a steady business delivering you operating cash flows to the tune of Rs 14 crore per annum.
So, you effectively paid just Rs 34 crore for acquiring the business (Rs 63 crore – Rs 19 crore – Rs 10 crore = Rs 34 crore. assuming you sell out liquid investments) thats delivering Rs 14 crore in operating cash flows. Excellent deal. Where does one get such lucrative opportunities of ROI of 40% before tax.
You may think that who would buy out a business as described above. Well, there are certain Control Value Investors who seek such opportunities and at times even turn acquirers of the listed business. The best example that I can site for you is none other than Mr. Warren Buffett. Though he used to invest in companies only for minority stake and remain a passive investor, however in certain cases he bought so much stake in the company that he overturned the bad management and started running the company on his own or appointed a new CEO. Before discussing about Warren Buffett and the most famous Control situation of Berkshire Hathaway, lets imagine a hypothetical situation.
How you too can act as a Control Value Investor if you have some few crores in your kitty?
Well if you have don’t have the above amount i.e Rs 63 crore and just about Rs 15-20 crore, you can still consider acquiring 100% in the company. However, for the same you will have to think like Henry Kravis, who introduced a novel concept of Leveraged Buyout.
From the above calculations you are aware that the market is taking an extremely negative view of the stock and the stock deserves much higher valuations. You also notice that Promoter holding is extremely low at 23.80%.
Now, you believe that business operations of the company are worth more than Rs 50 crores (3.5 times average cash flows), not accounting for the surplus cash and the liquid investments. So you come to the conclusion that market capitalization should at least be Rs 80 crores (50 crore + 30 crore cash and cash equivalents) and thats a very conservative estimate. Since the total number of outstanding shares are 0.24 crore, the minimum value of the stock should be Rs 330, while the CMP is 258.
Taking cognizance of the above situation and considering the fact that market is in bad shape, you borrow Rs 70 crore from bank, add your 10 crores and make a tender offer to all the shareholders of LECS at Rs 330 per share. Since the stock is quoting at 258, your offer price is 28% above the stock price. Imagine that all the shareholders tender their share to you and you now hold 100% equity in the company.
Since now you are the boss of the company, the first thing you would do is retire 30 crore of debt (using the surplus cash and liquid investments of the company) from the Rs 70 crore you had borrowed to acquire the company. This leaves you with the operating business which is generating Rs 14 crore in operating cash flows and Rs 40 crore debt on the books of the company. Using the cash flows from the business, you will be able to pay off all of debt within just 6 years as illustrated below.
So, within 6 years you will be left with debt free company delivering operating cash flows of Rs 14 crore per year against your investment of 10 crores.
Berkshire Hathaway – Warren Buffet’s control value investment case
Berkshire Hathaway was an ailing textile company available at a market cap of less than its net working capital. In 1962, Warren Buffett began buying stock in Berkshire Hathaway after noticing a pattern in the price direction of its stock whenever the company closed a mill. Eventually, Buffett acknowledged that the textile business was waning and the company’s financial situation was not going to improve. In 1964, Stanton (Part of the management group before Buffett took over) made a verbal tender offer of $11.50 per share for the company to buy back Buffett’s shares. Buffett agreed to the deal.
A few weeks later, Warren Buffett received the tender offer in writing, but the tender offer was for only $11.37. Buffett later admitted that this lower, undercutting offer made him angry. Instead of selling at the slightly lower price, Buffett decided to buy more of the stock to take control of the company and fire Stanton (which he did). This is how Warren Buffett became the majority owner of Berkshire Hathaway.
B-47, 1st Floor, Dayanand Colony, Lajpat Nagar – IV, New Delhi – 110024 Ph.: 011-41730606, Mob: +91-9818866676
Many of the entrepreneurs at the Nasscom Product Forum in Bangalore on Wednesday morning had waited for years to listen to Vinod Khosla: About his famous “Fail Strategy”; what keeps him ticking even 30 years after he founded Sun Microsystems; why he’d rather try and fail than fail to not try at all.
And it was worth the wait. Khosla, founder of Khosla Ventures, rarely speaks at conferences. In the whole of last decade, he said, one of the few conferences he chose to be a speaker in Silicon Valley was called FailCon. Such is his conviction about failures being intrinsic to entrepreneurial successes. “My willingness to fail gives me the ability to succeed,” he said, kick-starting the two-day conclave. And if anyone thought that was punditry coming from a highly successful venture capitalist (by the way, he prefers to call himself ‘venture assistant’), he reminded people that he didn’t start out as a VC, but as an entrepreneur, and that even as a VC he’s failed more often than many others.
Why? Because he chooses to make big bets; only such ideas bring “large shifts”.
“You only lose 1x your money if you fail, but if you succeed, you can make 100x. That’s the beauty of product companies,” he told the packed auditorium of entrepreneurs. Adding an irreverent piece of advice, he said we give too much credit to MNCs (Multi-national Corporations) or government. “They are largely irrelevant in the business of innovation.”
In India, the recent successes of companies like Flipkart and InMobi haven’t missed his attention. He agrees with Nasscom Product Forum co-chairman Sharad Sharma’s “prediction” that for the next few years, at least one product company from India will achieve $1 billion valuation every year, but cautions that India needs more companies in newer categories if it has to maintain the tech industry’s decadal 8X or 9X growth. The successes at Flipkart, Naukri.com, and others, he says are “extrapolation of what has happened in the Western market [Amazon and Monster.com].”
“I’d like to see things that open up a whole new paradigm. India is a market of over one billion people; US is only 250 million people. Right behind India is other emerging markets whose GDP (gross domestic product) is rapidly changing,” he said.
Backing that advice with a “cool dozen” sectors that could all be potential product goldmines, he reiterated that India needs to go “beyond outsourcing, replicating Western successes and beyond small shifts”.
Reminiscing about a telecom session that he chaired in Delhi, organised by McKinsey almost a decade ago and where Mukesh Ambani “sat in the front row”, looking at the likely shifts in telecom, he said it was hard to imagine the shift away from landlines then. He was betting that VOIP (Voice over Internet protocol) would come first and mobile later, but he was proved wrong. Today, India has more mobile phones (650 million) than toilets (350 million). Who could have predicted that?
So the bottom line for Khosla, the inveterate geek who considers science and technology as his religion, is that technology drives the market, not extrapolation of past. He studies the emerging areas deeply, even if that means taking a week off, away on the beach, collecting a bunch of books related to the subject — be it genetics or clean-tech, software architecture, education or health.
Soumya Banerjee got a first-hand experience of that scrutiny. As CEO and founder of Attano Media & Eductaion Pvt Ltd, he was one of the seven entrepreneurs who got an opportunity to have a closed door session with Khosla, each getting a few minutes to present their elevator pitches.
I couldn’t help asking Banerjee if Khosla’s five-second rule applied. [Apparently, Khosla prefers presentations where slides leave their message/mark even after being removed in just five seconds.]
Banerjee smiled: “We couldn’t go past the first slide. We got engaged in the discussion. He knows the area so well…” Is Khosla interested in investing in start-ups in India? “Certainly,” he says. But more importantly, “I want to inspire them. It’s painful flying from San Francisco to Bangalore, but I am here to encourage them,” he told Forbes India in an interview.
(Source: Forbes India)
As I was reading today in one of the leading financial dailies, the September 2011 quarter has turned out to be the worst period for India Inc in three years with a sharp fall in net profit and shrunk margins.
Sep’11 quarter has been marked by a moderate growth in top line and a fall in profit. Firm raw material prices, buoyant staff costs and a spike in fuel prices have hit the operating profit margins of most of the companies. Moreover, incessant rise in interest rates has further hit the net profit margins of the companies.
It was an important day since many of our Alpha Recommendations were to announce their Second quarter results. There were a few bad results, while most of the companies recorded very good results and the same is all the more important considering the overall slowdown.
High interest rate coupled with overall inflationary environment has impacted the margins of rate sensitives and cyclical stocks (Read: Sumedha Fiscal and Piccadily Agro), while other companies have done extremely well (Read: ABM Knowledgeware, Cravatex, etc). The important point worth noticing is that almost all the companies recorded a good hike in revenue, with no great signs of slowdown in demand.
So, once the inflation comes under control and interest rates start softening we could again see restoration of margins and thus the profits.
For complete updates, refer the attached report: