Tuesday, February 28, 2017

Cement - 3QFY17 Results Review - A Quiet Quarter – Impacted by Cash Crunch

Sector Review

Cement industry’s 3QFY17 performance was impacted by demonetization drive, which adversely affected demand from IHB and select real estate segment. Despite demand up-tick in Dec’16 owing to calendar year end impact, cement companies under our coverage universe registered a flat YoY growth. Healthy operating efficiencies aided the companies to stay afloat in terms of operating performance. The companies under our coverage witnessed an average EBITDA growth of 4% YoY, despite 2.5% YoY and 6.2% YoY rise in Power & Fuel and Freight cost, respectively. Realizations continued to remain soft despite moderate recovery in Oct’16, as the industry saw an average ~1% sequential contraction in realization.

Notably, most Southern companies recorded healthy volume growth (in double-digit) led by a sharp up-tick in project segment sales and higher banking penetration, which aided in negating the impact of demonetization.  UltraTech, JK Lakshmi Cement and Ramco Cements displayed best operating efficiencies as their operating cost/tonne declined by ~3-4% YoY. Holcim (ACC & Ambuja) group saw maximum contraction in sales volume (down 8-9% YoY), whereas India Cements and Ramco Cements witnessed sharpest recovery (+22% YoY for both) in volume. The companies, which reported EBITDA/tonne above Rs750 are: UltraTech (Rs890), Shree Cement (Rs975), Ramco Cements (Rs1,319) and India Cements (Rs797). Looking ahead, we believe performance of cement companies would improve further on the back of likely improvement in realizations and volume.


Volume Impacted by Demonetization

Contrary to the expected sharp recovery in demand owing to favourable monsoon, demonetization drive in early Nov’16 led to a sudden lull in volume growth. The impact of demonetization was noticeably visible in IHB segment, which accounts for >50% of total cement consumption. Consequently, the companies under our coverage saw a flat YoY growth in sales volume. However, most Southern companies recorded healthy volume growth (in double-digit) led by a sharp up-tick in project segment sales and higher banking penetration, which aided in negating the impact of demonetization.


Overall Realization Scenario Remained Dismal

Realization environment was subdued as the companies in our coverage universe saw ~1% sequential decline (flat on YoY comparison) in average realizations. Notably, as per our channel checks done at Dec’16 end, the trade segment price in Western, Northern and Central regions had witnessed 6-7% YoY improvement. However, increased contribution of non-trade segment sales (which commands Rs20-40/bag lower price than trade segment) impacted blended realizations. Looking ahead, we expect that the increasing contribution of non-trade segment sales in ensuing quarters may prevent the companies to report any significant jump in their average realizations.


Operating Cost Broadly Remained Stable despite Surge in Fuel Prices

Though fuel prices especially petcoke surged significantly in 3QFY17 (to the extent of Rs400-500/tonne), operating costs of the industry largely remained stable barring few companies. A consistent endeavour to improve operating synergies though improving fuel mix, reducing lead distance by setting up new GUs, railway sidings, etc aided industry to withstand the impact of higher fuel prices. The companies, which reported EBITDA/tonne above Rs750 are: UltraTech (Rs890), Shree Cement (Rs975), Ramco Cements (Rs1,319) and India Cements (Rs797) on healthy volume and operating efficiencies. Looking ahead, we believe the operating performance of cement companies would improve further on the back of improved utilizations, unlikelihood of any further rise in fuel costs and expected improvement in realizations in busy season.



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Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

Vinati Organics: Good Performance, Promising Future

Vinati Organics: Good Performance, Promising Future

 December 2016 quarterly result analysis of Vinati Organics are available in public.
Performance summary
  • Total income increased by 8% YoY during the quarter. Net sales increased by 15.3% YoY and other operating income declined by 58.8% YoY. The increase in revenue was led by higher contribution of IBB, ATBS, and volumes from new customised products.
  • Operating profits increased by 5.1% YoY. Operating margins stood at 33.5%. Operating margins declined on the back of higher employee cost which has increased by 49% YoY.
  • Other income increased by 19.4% YoY. Depreciation increased 15.9% YoY.
  • Net profit increased by 7.9%. This is primarily on account of expansion in gross margins and higher other income. The net margin stood at 20.6%.

    Financial Snapshot
    (Rs m) 3QFY16 3QFY17 Change 9mY16 9mY17 Change
    Net sales 1,372 1,582 15.3% 3,142 3,150 0.3%
    Other operating income 150 62 -58.8% 325 103 -68.4%
    Total Income 1,522 1,644 8.0% 3,467 3,253 -6.2%
    Expenditure 1,017 1,113 9.5% 2,412 2,197 -8.9%
    Operating profit (EBDITA) 505 531 5.1% 1055 1056 0.0%
    Operating profit margin (%) 36.8% 33.5%
    33.6% 33.5%
    Other income 15 18 19.4% 27 20 -24.0%
    Interest 20 8 -58.7% 47 19 -59.6%
    Depreciation 46 54 15.9% 92 107 16.1%
    Profit before tax 454 486 7.2% 944 951 0.8%
    Tax 152 161 5.9% 322 289 -10.3%
    Effective tax rate 33.5% 33.1%
    34.2% 30.4%
    Profit after tax/(loss) 302 326 7.9% 621 662 6.5%
    Net profit margin (%) 22.0% 20.6%
    19.8% 21.0%
    No. of shares (m)



    52
    Fully diluted EPS (Rs)*



    26.3
    P/E (x)*



    27.7
    *Based on a trailing 12-month earnings
    We conducted a conference call with the management to understand the details of the capex plan as well as the future prospects of the business. Here are the highlights.
  • Capex Plan: Vinati has been undertaking capex for three major projects. These include:
    1. Rs 5 billion capex for Para Aminophenol (PAP): PAP is a raw material for paracetamol. Although, paracetamol is a mature market, the play will be on the process and technology. The company has developed a novel process along with NCL (National Chemical Laboratory) which has a patented technology and Vinati has an exclusive license for it. As per the management, the company would look to replace about 20,000-21,000 tonne of PAP which is currently imported from China. The revenue flow from this project is expended to start from FY20.
    2. Rs 1.5-2 billion capex for Butylated Phenols: Butylated Phenols are intermediaries which find applications as raw material for products that go into making perfumes, inks, resins, and plastics. As per the management, revenues are expected from FY19 and the revenue run rate would be about Rs 3-3.5 billion.
    3. Rs 2 billion capex for new IB derivatives (PTBT, PTBBA and TB-Amine): PTBT and PTBBA are IB based derivatives which are currently imported into India. These intermediaries are used in the perfume and personal care industries. Sales from these intermediaries are expected from FY18 onwards. TB Amine is used in the rubber and pharma industries. The company started earning revenues from this product in FY17. The full impact on this product on the financials would come in FY18.
    4. ATBS volumes: ATBS volumes were significantly affected in FY16 on the back of oil related demand for ATBS. However, going forward, management expects a volume growth of about 10-12% on account of increased usage in water treatment chemicals, and personal care polymers.
    5. IBB realisations to improve on the back of forward integration to IBAP: The upgradation of IBB to IBAP, an advanced intermediate for ibuprofen manufacturing, would improve IBB realisations.

What to expect?

Vinati's prudent track record of breaking into new products and the forward and backward integration of existing product is a big positive in our view.
We see a clear megatrend in the coming years with Vinati replacing the supply from China to India. The company will venture into new products which would help to reduce revenue concentration from IBB and ATBS.
At the current price of Rs 727, the stock of Vinati Organics is trading at 27.7 times its trailing twelve month earnings.

Vinati Organics is a long-term growth story. We have a positive view on the business as well as the management. However, the stock has run up significantly in the last few months and has crossed our target price of Rs 740.
We have tentatively updated the FY20 financials for the company. We will finalise the new target price after factoring in the details of the company's capex plan and the likely impact on the financials.
It is important to understand that the payoff from the capex will be back ended in nature i.e. there wouldn't be much immediate gain in FY18. Thus, the run up in the stock price has factored much of the upside.
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Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

Wednesday, February 15, 2017

Buy recommendation of Axis Securities (Target price: Rs. 102) on Manappuram Finance

Buy recommendation of Axis Securities (Target price: Rs. 102) on Manappuram Finance

Axis Securities’ buy recommendation is based on this logic:
MGFL believes that the de-monetization scheme will lead Unorganized gold loans to shift towards the organized segment. Also, 2/3rd of customers have already moved to online gold product facility making the demonetization impact negligible. The impact of demonetization is expected to be visible in Q3 FY17 for at least for 10-12 days which should impact both disbursals (although 50% are disbursed through NEFT/online) as well as collections. We thus expect 3Q to be a soft quarter, however long term prospects remains intact. We value MGFL at FY18E P/BV multiple of 2.5x to arrive at target price of Rs.102 and continue to have BUY rating.

Axis Securities’ buy recommendation Report 

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Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

Buy recommendation of Motilal Oswal (Target Price: Rs. 114) on Manappuram Finance

Buy recommendation of Motilal Oswal (Target Price: Rs. 114)

Motilal Oswal has given convincing reasons in support of its buy recommendation. It says:
Manappuram is today geared up to tap financing opportunities across the spectrum and has realigned its business model to derisk it from volatility in gold prices as well as to sustainably grow its AUM at over 20% in coming years. This shall be achieved by: (i) Focusing more
on shorter term products (3 months) which eliminates the risk of any steep fall gold prices impacting the company; (ii) Adopted push approach instead of pull earlier by reaching out to customers through enhanced marketing and branch activation efforts and linked employee incentives to sourcing business, timely recovery and default rates; (iii) Foray into synergistic non-gold businesses -Microfinance, Home Loans and CV Loans (to form 25% of AUm by FY18 from 12% in FY16. Company aspires to reduce its good AUM to less than 50% of the total AUM by focusing on growing its Microfinance AUM to 20% of total and Home Loans AUM to 30% of total in the long run.

 

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Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

Buy Dewan Housing Finance – Target price Rs. 374

Buy Dewan Housing Finance – Target price Rs. 374

Dewan Housing Finance is Rakesh Jhunjhunwala’s all-time favourite stock. He bought the stock when it was languishing at throwaway prices and has pocketed hefty multibagger gains since then.
Edelweiss has recommended a buy of DHFL on sound logic:

DHFL is bound to be key beneficiary of government’s initiative to promote affordable housing, given its presence in tier II/III cities and lower ticket size. However, in view of rising proportion of developer loans, we are building in higher NPLs going forward. The company has the potential to deliver 20% earnings CAGR over FY16-19E with RoE of 16%. Juxtaposing this with inexpensive valuation (1.3x FY19E P/ABV) renders favourable risk-reward. We maintain ‘BUY/SO’ with a target price of INR 374.

Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice. 

Buy LIC Housing Finance – Target price Rs. 645

Buy LIC Housing Finance – Target price Rs. 645

LIC Housing Finance, which is Vijay Kedia’s favourite stock, has been recommended by PL on the logic that:
LICHF net earnings of Rs4.99bn were in‐line with our estimates with strong NII growth of 22.6% YoY at Rs9.15bn (PLe: Rs8.82bn) but was offset by lower fee income (down 45% QoQ). Overall loan book grew at 15.3% YoY, but growth was mainly led by strong growth in developer book (45% YoY) and LAP book (87% YoY). Core retail book growth continues to be slow at 9.4% YoY. Competitive landscape continues to be tough with all asset financiers getting into faster interest rate cuts, while cost repricing has been gradual which will keep spreads steady. We retain ‘Accumulate’ with revised PT of Rs645 (from Rs630), based on 2.3x as we rollover to Sep‐18E ABV.
 LIC Housing Finance Report

UBS and JP Morgan also recommend LIC Housing Finance

Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice. 

Buy IndiaBulls Housing Finance – Target price Rs. 1,010

Buy IndiaBulls Housing Finance – Target price Rs. 1,010

Ventura Securities recommended IndiaBulls Housing Finance on 27th December 2016 on the logic that the Company is:
– focusing on the affordable housing segment,
– growing its loan book using better technology,
– leveraging its financial strength and improving its ratings to increase competitiveness
– and diversifying its funding mix to reduce funding costs.
The stock has surged from Rs. 628 to the CMP of Rs. 795, putting gains of 25% on the table. The target price of Rs. 1,010 implies that more gains are due from the stock.

Motilal Oswal have also recommended IndiaBulls Housing on the logic that “IHFL is among the lowest-levered HFCs (4.6 times) to support growth. Asset quality trend is likely to remain stable, while its improved borrowing profile, better credit rating, and liquidity buffer should help maintain healthy spreads”.

Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice. 

Monday, February 13, 2017

Housing finance sector will see “immense growth” due to Budget 2017: Expert

D K Aggarwal of SMC Investments has conducted a detailed study of the impact of grant of “infrastructure” status to affordable housing in Budget 2017.

He has opined that the macro environment is extremely favourable for housing finance companies. The Modi government’s incentives in terms of allocation related to Pradhan Mantri Awas Yojana (PMAY) of Rs 23,000 crore would provide the much-needed momentum to the sector, he says.
He adds that the reduction in the holding period for capital gains tax in case of immovable properties from three to two years also augers well for the sector.

In the days to come, supported by growth drivers such as rising disposable income, personal income-tax benefits, increasing urbanisation and economic growth of tier II and tier-II cities, the sector is likely to see immense growth,” D K Aggarwal opines.

A similar opinion has been expressed by other leading experts interviewed by ET.
One expert pointed out that affordable housing projects would now be able to attract investments from institutional, pension and insurance funds and external commercial borrowings at attractive rates. The borrowing cost of developer for construction of affordable homes would come down to below 10 per cent from 14-15 per cent in any other normal project, he added.

BloombergQuint @BloombergQuint
Stocks of small housing finance companies stand to benefit as lending rates fall.http://goo.gl/YGi4pI

 NDTV Profit @NDTVProfit
Real Estate, Housing Finance Stocks Gain After PM Modi Announces New Schemeshttp://profit.ndtv.com/news/market/article-real-estate-housing-finance-stocks-gain-after-pm-modi-announces-new-schemes-1644084 
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Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

Housing finance stocks are a “Buy”: Basant Maheshwari

asant Maheshwari is famous for his unflinching bullishness for housing finance stocks.
His theory is that the unending demand for housing by the ever-burgeoning population of the Country augers well for these stocks. He has also pointed out that housing finance enjoy high repayments and low NPAs because borrowers are loath to default and lose the roof over their heads.
A blind buy in this situation would be non-banking finance companies – NBFCs specifically relating to the housing finance sector. You can buy them, buy them 5 percent lower, 5 percent up from here, keep them for 5-10 years. The two which I own, are from western India and southern India,” Basant said.
Basant recommended Repco Home Finance as his “best buy for 2014”. The stock has done well and delivered gains of nearly 125% since then
Basant gave a detailed explanation in support of his theory that demonetization and the crack down on black money will benefit organized players in the housing finance sector.
I am super bullish on housing finance …. they are growing at more than 30 percent. When home prices go down, what happens is you defer your purchase. You say maybe you will get it cheaper later on, so, you defer your purchase. So, to that extent, for a quarter or two quarters, there will be postponement of purchases …. So, all of that demand is going to come back in a lumpy nature.
Once the black component goes out, the ability of these guys to fund more would increase because you need more white money. Thirdly, as the unorganised lending and borrowing finishes, the organised financers would have bigger pie to run on. So, for example, if I am buying a house, I will say give me Rs 5 lakh and I will pay you interest every month and I take cash from you and do it; all that business is going to stop, nobody is going to give cash, nobody is going to take cash. So, I think the entire activity would increase. However, the screen discounts all of that. I am not giving you something which is out of the extraordinary. This is very fair knowledge to everybody and screen discounts all that.
Lower home prices increases affordability and lower home prices encourages people to go and buy it. So, I think that is going to come back with a bang. It might take a couple of quarters but afterwards it is all going to come back. So, out of the NBFC which I own and like, nothing has changed. I still own all of them — the NBFC space, the sector that I am talking about, housing finance is top on the list.

Housing finance companies are growing at more than 30 percent. I think anybody can go and just do the math. Not the 18-20 percent, not the 25 percent, the ones which are growing at more than 30 percent, I think they should do very well.

Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

Not too late for us to rush into NBFC stocks even now

Basant Maheshwari Shows Who’s Boss As His ‘Super Bullish’ Stocks Cheat Death & Fill Portfolio With Mega Gains

Basant stayed defiant and displayed amazing confidence in his favourite stocks even though it appeared that note-bandi had sounded their death knell. Today, he is reaping the rewards because the stocks are surging like rockets and filling his portfolio with massive gains

It is worth noting that several NBFC stocks have still not attained the levels that they were at prior to the note-bandi crises. This implies that the run up, though spectacular, is a mere recovery of lost ground and that more hefty gains will come on the table in due course.
Also, Basant explained that the reason for his “super bullishness” about NBFC stocks in general, and housing finance stocks in particular, is because lower home prices increases affordability and lower home prices encourages people to go and buy it.
He also pointed out that the crackdown on black money means that the developer and the home buyer will perforce have to come to organized sector lenders for their fund requirements.
So, it is going to come back with a bang,” Basant proclaimed with his usual flourish, sending the cue to us to grab NBFC stocks without any more hesitation!


Defiant super-bullishness about HFC and micro-finance stocks

I am super bullish on housing finance … they are growing at more than 30 percent,” Basant roared with his usual flamboyance in reply to a question from Latha Venkatesh and Sonia Shenoy on whether he was taking counter-evasive measures to tackle the menace of note-bandi.
… the small finance segment personally I am super bullish and we own almost all of them …. the microfinance segment .. that’s the place to be,” he added, his eyes sparkling in defiance.
My NBFC Portfolio Has Not Changed Due To #Demonetisation. Its Impact Should Ease In The Next 1-2 Months,” Basant added for good measure.

Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

Buy recommendation of K. R. Choksey (Target price: Rs. 130) on Manappuram Finance

Buy recommendation of K. R. Choksey (Target price: Rs. 130)

KR Choksey is gung ho about Manappuram Finance and has recommended a buy with a target price of Rs. 130:
With a huge beat on PAT at INR 1924 mn (sturdy 20% sequential growth), Manappuram Finance (MGFL) recorded an all-round performance for Q2FY17. Product diversification strategy and rising gold loan volumes (gold holdings up 15% Y-o-Y; leveraging the on-line gold loan product) coupled with improved gold loan quality hinging upon reduction in auction losses and greater thrust on collections emerging from rapidly improving microfinance segment have boosted the earnings for the quarter. Strong loan book traction (clocking 11% Q-o-Q, 40% Y-o-Y growth) and best-in-class asset quality (gross NPAs at 0.9% at 90 dpd).
Therefore, with legacy issues behind and regulatory environment turning favorable in turn aiding traction in gold portfolio, MGFL’s strategy of foraying into higher yielding non-gold products such as microfinance and home finance will form the key levers to growth sustainability ahead. With structural growth story in place and operating leverage flowing through, MGFL stands geared to build a scalable and profitable model. Capital sufficiency (Tier 1 at 21.4%, CAR at 21.8%) with lower gearing levels (leaves ample scope for increase and in turn fuel growth), rating upgrades from agencies and healthy return profile further reinforces our confidence in the company prompting us to MAINTAIN BUY.
Buy recommendation of K. R. Choksey Report

 

Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice. 

Manappuram as an investment candidate in the NBFC sector is impeccable


Kerala-based gold finance company Manappuram Finance has entered the housing finance segment, acquiring Jaypee Hotels’ Milestone Home Finance. The move is reflective of the huge interest in the housing finance space, owing to low loan defaults, a large untapped market and attractive returns on equity.
Manappuram has a finger in almost all the pies. Apart from loans against gold, which is its mainstay, Manappuram also has its finger in micro-finance, SME loans and housing finance.

Home finance segment provided a good business diversification opportunity,” V. P. Nandakumar, the promoter cum CEO of Manappuram Finance, revealed.



(Image Credit: Business Standard)


Impact on demonetization is exaggerated: V. P. Nandakumar


V. P. Nandakumar, the promoter cum MD and CEO, was at pains to emphasize that not only was Manappuram Finance not adversely affected by demonetization, but it would benefit by the shift from the unorganized sector to the organized sector.



V. P. Nandkumar increases stake in Manappuram Finance

V. P. Nandkumar has put his money where his mouth is. To prove his point that the stock price has been unfairly beaten down, he has bought 2.52 lakh shares on 17th November and 1.63 lakh shares on 20th December. Nandakumar’s personal holding stands at about 28.21% while the promoter holding stands at 34.45% as of 31st December 2016.


Buy recommendation of Nirmal Bang (Target price: Rs. 145)

Nirmal Bang has recommended a buy on the logic that “With likely strong growth in AUM, stable margins, contained credit costs and operating as well as financial leverage to kick in, we expect RoA/RoE to improve further by 90bps/840bps to strong levels of 3.8%/21.6%, respectively in FY19E”.
Nirmal Bang has foreseen a target price of Rs. 145 for the stock, which is a whopping upside of 147%.
Report

Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

Housing finance sector would be “the next market leader”.

Vijay Kedia’s sixth sense alerts him that Budget would confer bonanza for HFCs

It is long believed that ace stock pickers have a sixth sense that alerts them to buy stocks when they are on the verge of a tipping point.
We can see a live example of this in the case of Vijay Kedia.
On 30th January, Vijay Kedia suddenly surfaced from the blue to declare that the housing finance sector would be “the next market leader”.

Just two days later, Arun Jaitley, the Finance Minister, declared in the Budget that affordable housing would be conferred the exalted status of “infrastructure” which entitles it to receive several incentives and concessions.
Understandably, real estate stocks and housing finance stocks have taken off like rockets since then and conferred heavy gains on their shareholders.
Vijay Kedia’a fans are obviously thrilled at the fantastic state of affairs.

I love LIC Housing Finance”: Vijay Kedia

I have loved LIC for long,” Vijay Kedia candidly admitted when Nikunj Dalmia grilled him about his favourite stocks.
I am very bullish on the housing sector …. among housing finance companies, LIC is cheaper than its peers …. It may not be a multi bagger but I think that it should give me a 20-25 per cent return every year,” he added with his characteristic wide smile.
Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

The Most Powerful Mental Model for Identifying Stocks


“It’s a funny thing about life; if you refuse to accept anything but the best, you very often get it.” ~ W. Somerset Maugham – English dramatist & novelist (1874-1965)
As I’ve seen in the past 14+ years of investing in the stock market, Maugham’s thought holds a great relevance when it comes to picking up businesses for investment.
Pick up a business with good economics and with good margin of safety, and the probability of making money in the long run is high. Pick up a business with poor economics with any margin of safety, and the probability of losing your shirt, and entire wardrobe, in the long run is very high.
Understanding a business also adds significantly to your margin of safety, which is a great tool to protect yourself against losing a lot of money.
Here is what Warren Buffett wrote in his 1997 letter to shareholders…
If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need.
If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it’s over the Grand Canyon, you may feel you want a little larger margin of safety.

Buffett’s investment approach combines qualitative understanding of the business and its management (as taught by Philip Fisher) and a quantitative understanding of price and value (as taught by Ben Graham). He once said, “I’m 15 percent Fisher and 85 percent Benjamin Graham.”
That remark has been widely quoted, but it is important to remember that it was made in 1969. In the intervening years, Buffett has made a gradual but definite shift toward Fisher’s philosophy of buying a select few good businesses and owning those businesses for several years. If he were to make a similar statement today, the balance would come pretty close to 50:50.
Anyways, any discussion on Buffett’s focus on understanding businesses must start with how he defined various businesses as per their economics. And that’s exactly what I’ll try to do now.
Businesses are Great, or Good, or Gruesome
Buffett created three broad categories of business, which he first defined in his 2007 letter to shareholders. He wrote that either a business is great, or good, or gruesome.
Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag. We like to buy the whole business or, if management is our partner, at least 80%.
When control-type purchases of quality aren’t available, though, we are also happy to simply buy small portions of great businesses by way of stock market purchases.
It’s better to have a part interest in the Hope Diamond than to own all of a rhinestone.

Buffett grouped businesses into three general categories – great, good, and gruesome – based on their return on investment profile, and explained the differences between these categories. I find what follows below as a great mental model while assessing businesses. And the characteristics that Buffett defined to distinguish between these three categories form an important part of my investment checklist.
First, the Great Business
Buffett wrote in his letter…
A truly great business must have an enduring “moat” that protects excellent returns on invested capital.
The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the low-cost producer or possessing a powerful world-wide brand is essential for sustained success.
Business history is filled with “Roman Candles,” companies whose moats proved illusory and were soon crossed.

Now, while most investors search for companies that have had certain competitive advantages or moats that have helped them do well in the past, or they are doing better than competitors in the present. But Buffett here is not just talking about the moat of a business, but in the endurance or sustainability of that moat.
Look at a market like India. We have had several companies doing great business at specific points in their lifetime, but have fallen from grace over years, and are now just a pale shadow of their glorious past. Whatever reasons there may be for the disappearance of moats for these companies – competition, change in industry structure, capital misallocation – the point is that all companies go through a lifecycle, from birth till stagnation or death.
To quote Horace, “Many shall be restored that now are fallen, and many shall fall that now are in honor.”
There are only handful that survive more than a few decades. You won’t find many such companies in a rapid growth market like India, where entrepreneurial spirit is high and any high-return business will attract competitors sooner than later, thereby lowering the average returns for all players over time.
Thus, the idea must be to look for companies that can survive and thrive at least over the next 20 years – businesses that have…
Great brands, and where consumers are willing to pay higher prices for the perceived higher value;Low cost of operations, which enables them to lower prices and still maintain good margins;Operate in simple and growing industries;Clean balance sheets that provide them the capacity to suffer bad times; andManagements with history of making rational capital allocation decisions.
Here is what Buffett writes on enduring moats…
Our criterion of “enduring” causes us to rule out companies in industries prone to rapid and continuous change. Though capitalism’s “creative destruction” is highly beneficial for society, it precludes investment certainty. A moat that must be continuously rebuilt will eventually be no moat at all.

Now, while the management quality must be of great importance for you while picking your businesses, Buffett says the quality of the business is paramount. As he wrote…
…this criterion (of identifying businesses with “enduring” moats) eliminates the business whose success depends on having a great manager. Of course, a terrific CEO is a huge asset for any enterprise, and at Berkshire we have an abundance of these managers. Their abilities have created billions of dollars of value that would never have materialized if typical CEOs had been running their businesses.
But if a business requires a superstar to produce great results, the business itself cannot be deemed great.
A medical partnership led by your area’s premier brain surgeon may enjoy outsized and growing earnings, but that tells little about its future. The partnership’s moat will go when the surgeon goes. You can count, though, on the moat of the Mayo Clinic to endure, even though you can’t name its CEO.

Now, while “growth” rules the roost when investors are searching for businesses to invest in, Buffett has a different take on this. Stability – in industry, business economics, earnings, and growth – is more important for him, than just growth.
Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere.

A Great Business is an Economic Franchise
Buffett terms a great business as an “economic franchise”, and believes that it arises in a business that sells a product or service that:
Is needed or desired (continuous and rising demand)Is thought by its customers to have no close substitute (customer goodwill is much better than accounting goodwill, and allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price)Is not subject to price regulation (price maker)
Here is what he wrote in his 1991 letter…
The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital.
Moreover, franchises can tolerate (short-term) mis-management. Inept managers may diminish a franchise’s profitability, but they cannot inflict mortal damage.

A business that is not a franchise, writes Buffett, can be killed by poor management.
In effect, what Buffett seemingly meant was that since a bad management cannot permanently dent the prospects of an economic franchise (except due to long-term mis-management), any stock market downturn provides a great opportunity for investors to consider such businesses (that may also fall in tandem with the markets) for investment.
You must, however, be very careful confirming that a business is a franchise. After all, there’s many a slip twixt the cup and the lip.
Should You Buy and Forget Franchises?
Not really, Buffett thinks. He wrote in his 2007 letter…
There’s no rule that you have to invest money where you’ve earned it. Indeed, it’s often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can’t for any extended period reinvest a large portion of their earnings internally at high rates of return.

In other words, while it pays to pay up for quality businesses please avoid overpaying for them expecting to keep earning money from these stocks the way you or others may have earned from them in the past.
Trees, after all, don’t grow to the sky. And to repeat Horace – “…many shall fall that now are in honor.”
Buffett’s Other References to a Great Business
Here are a few other references that Buffett has made over the years in his letters, describing the characteristics of a great business…
Our acquisition preferences run toward businesses that generate cash, not those that consume it. (1980)The best protection against inflation is a great business. Such favored business must have two characteristics: (1) An ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) An ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital. (1981)One question I always ask myself in appraising a business is how I would like, assuming I had ample capital and skilled personnel, to compete with it. (1983)Leadership alone provides no certainties: Witness the shocks some years back at General Motors, IBM and Sears, all of which had enjoyed long periods of seeming invincibility. (1996)The really great business is one that earns…high returns, a sustainable competitive advantage and obstacles that make it tough for new companies to enter. (2007)“Moats”—a metaphor for the superiorities they possess that make life difficult for their competitors. (2007)Long-term competitive advantage in a stable industry is what we seek in a business. (2007)The best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow. (2009)
Your “Great Business” Checklist
You can use the above points to create your checklist for identifying the great businesses out there.
Alternatively, and an even better way, would be to invert the points and then avoid businesses that are not great. This, I believe would be an easier task, given the enormous number of “Roman Candles” out there – companies whose moats are illusory and will soon be crossed.
So, if you were to invert Buffett’s points on great businesses, here is how your checklist may look like.
Avoid a business that…
Consumes more cash than it generates.Has managers who boast of certainties and invincibility.Earns poor return on capital.Operates in an industry where it’s easy for new companies to enter and succeed.Operates in an unstable industry (maybe due to technological changes, or government regulations)Requires consistent infusion of new investment to grow.Doesn’t have an ability to increase prices.Isn’t able to accommodate large volume increases in business with only minor additional investment of capital.

Second, the Good Business
Buffett writes that while a great business earns a “great” return on invested capital that creates a moat around itself, a good business earns a “good” return on capital.
So what is the core difference here?
Well, while a great business does not require too much of incremental capital to grow, a good business requires a significant reinvestment of earnings if it is to grow. Thus, with a high level of capital intensity, such a business requires high operating margins in order to obtain reasonable returns on capital, which means that its capacity utilization rates are all-important.
In India, leading companies from the capital goods, automobile and banking sectors will find place in this category. Buffett writes that if measured only by economic returns, such businesses are excellent but not extraordinary businesses.
Broadly, good businesses are ones that…
Enjoy moderate but steady competitive advantage, which typically arises due to their size and thus economies of scaleRequire good managements at the helm, that can execute the plans well to generate high return on rising invested capitalGrow at a moderate to high rates, and thusRequire constant infusion of fresh capital
Third, the Gruesome Business
Here is where we are going to spend a lot of time, for a majority of the businesses out there would fall in this category. Buffett wrote in his 2007 letter…
The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durablecompetitive advantage has proven elusive ever since the days of the Wright Brothers.

Most asset-heavy or commodity businesses would fall into this category. As Buffett wrote in 1983…
…as they generally earn low rates of return – rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses.

Now the question is – Why do such companies earn low rates of return? Buffett answers in his 1982 letter…
Businesses in industries with both substantial over-capacity and a “commodity” product (undifferentiated in any customer-important way by factors such as performance, appearance, service support, etc.) are prime candidates for profit troubles.
What finally determines levels of long-term profitability in such industries is the ratio of supply-tight to supply-ample years. Frequently that ratio is dismal.
If…costs and prices are determined by full-bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous.

Now the second question is – So are all companies from such industries to be avoided at all costs?
Buffett says some of such companies do make money, but only if they are low-cost operators. As he wrote in his 1982 letter…
A few producers in such industries may consistently do well if they have a cost advantage that is both wide and sustainable. By definition such exceptions are few, and, in many industries, are non-existent.

In fact, when a company is selling a “commodity” product, or one with similar economic characteristics, being the low-cost producer is a must. What is more, for such companies, having a good management at helm is also very important.
From Buffett’s 1991 letter…
With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. And a business, unlike a franchise, can be killed by poor management.

Such companies can also earn high returns during periods of supply shortages.
When shortages exist…even commodity businesses flourish. (1987)

But such situations usually don’t last long…
One of the ironies of capitalism is that most managers in commodity industries abhor shortage conditions—even though those are the only circumstances permitting them good returns. (1987)
When they finally occur, the rebound to prosperity frequently produces a pervasive enthusiasm for expansion that, within a few years, again creates over-capacity and a new profitless environment. In other words, nothing fails like success. (1982)

Buffett’s Brush with Gruesome Business
For the Buffett we know today – the man who has compounded money at over 20% over the last 5+ years – it may sound surprising but he had a brush with a gruesome business at the very start of his career.
The company was Berkshire Hathaway (Buffett’s present-day investment arm), and the business it was in was textile. Buffett calls it the biggest mistake of his career. 

What is interesting, Buffett was fairly “happy and comfortable” owning Berkshire’s textile business till a few years after he bought it. This is what he wrote in his 1966 letter…
Berkshire is a delight to own. There is no question that the state of the textile industry is the dominant factor in determining the earning power of the business, but we are most fortunate to have Ken Chace running the business in a first-class manner, and we also have several of the best sales people in the business heading up this end of their respective divisions.
While a Berkshire is hardly going to be as profitable as a Xerox, Fairchild Camera or National Video in a hypertensed market, it is a very comfort able sort of thing to own. As my West Coast philosopher says, “It is well to have a diet consisting of oatmeal as well as cream puffs.”

Buffett had bought Berkshire simply because it was “too cheap and thus a bargain” then, and he was yet to come under the influence of “quality and moats” driven investing, which would have led him to avoid this business.
Anyways, in 1967, here is what Buffett wrote on Berkshire’s textile business…
Berkshire Hathaway is experiencing and faces real difficulties in the textile business, while I don’t presently foresee any loss in underlying values. I similarly see no prospect of a good return on the assets employed in the textile business. Therefore, this segment of our portfolio will be a substantial drag on our relative performance if the Dow continues to advance. Such relative performance with controlled companies is expected in a strongly advancing market, but is accentuated when the business is making no progress.
As a friend of mine says. “Experience is what you find when you’re looking for something else.”

Then, in 1969, on being asked why he continued to operate the textile business despite not getting a good return on it, Buffett wrote…
I don’t want to liquidate a business employing 1100 people when the Management has worked hard to improve their relative industry position, with reasonable results, and as long as the business does not require substantial additional capital investment. I have no desire to trade severe human dislocations for a few percentage points additional return per annum. Obviously, if we faced material compulsory additional investment or sustained operating losses, the decision might have to be different, but I don’t anticipate such alternatives.

Good Managers Vs. Gruesome Businesses
Buffett has mentioned several times in the past that even a great management would find it difficult to bring order back to a business with poor economics, like the textile business, or commodity or airline businesses.
So, while Buffett had a great manager in the form on Ken Chase at Berkshire’s textile business, the business still floundered and was sold off in 1985.
Here are things Buffett has written over the years on why even good managers cannot turn around bad businesses…
In some businesses, not even brilliant management helps I’ve said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. (1989)Good jockeys will do well on good horses, but not on broken-down nags. (1989)When an industry’s underlying economics are crumbling, talented management may slow the rate of decline. Eventually, though, eroding fundamentals will overwhelm managerial brilliance. (As a wise friend told me long ago, “If you want to get a reputation as a good businessman, be sure to get into a good business.”) (2006)My conclusion from my own experiences and from much observation of other businesses is that a good managerial record (measured by economic returns) is far more a function of what business boat you get into than it is of how effectively you row (though intelligence and effort help considerably, of course, in any business, good or bad). (1985)Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks. (1985)

As per Buffett’s estimates, had he never invested a dollar in the textile business and had instead used his funds to buy a business with a better economics, his returns over the course of his career would have been doubled.
Like for Buffett, a gruesome business is not just a terrible investment for you, but also a major distraction that would cost you in terms of opportunity cost.
Lessons Learned
What lessons can we learn from Buffett’s textile endeavours? Well, there are two, in Buffett’s words.
One, “If you get into a lousy business, get out of it.”
Two, “If you want to be known as a good manager, buy a good business.”
Also, if you own the best business in a bad industry (like textiles, airline, commodities, and retailing), please note what Buffett wrote in 1985…
“A horse that can count to ten is a remarkable horse – not a remarkable mathematician. Likewise, a textile company that allocates capital brilliantly within its industry is a remarkable textile company – but not a remarkable business.

Buying a Gruesome Business Cheap
Well, that’s exactly what Buffett did in case of Berkshire Hathaway. Under the influence of Benjamin Graham, and without considering the industry’s economics, Buffett bought just because the stock was trading extremely cheap.
Then, after offloading the textile business, Buffett wrote this in 1989…
Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original “bargain” price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces—never is there just one cockroach in the kitchen.
Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost.
Time is the friend of the wonderful business, the enemy of the mediocre.

This is an extremely important lesson for you if you thought buying a stock cheap would save you from the ills of a poor underlying business.
Summing Up
I have tabulated the distinction between the great, good, and gruesome businesses as under… 

To sum up Buffett’s description of great, good, and gruesome businesses, here is what he wrote…
…think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.

If you have to remember just one lesson from today’s post, it must be – Time is the friend of the wonderful business, the enemy of the mediocre. So please pick and choose very carefully.

Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

The fragile bunch

The fragile bunch
Here's a list of Indian IT majors along with their revenue shares from the US.
As Trump's 'America First' agenda gathers momentum, we have taken a look at what kind of revenue Indian tech firms generate from the USA.
Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.

Sunday, February 12, 2017

My Six Rules for Stock Picking

The whole time I spent getting rich, only a small portion of my net investable wealth was in stocks. Maybe 2% to 3%. And almost all of that was in no-load index funds.
Then I read Mary Buffett and David Clark's The Warren Buffett Stock Portfolio and I became a convert to Buffett's philosophy of stock investing.
What Buffett has been doing with Berkshire Hathaway for the past 10 years or so, I'm told, differs in some ways from the stock investing strategy explained in David Clark's book. I based my strategy on that original concept. I've been doing it now for five years and so far it's produced very good results.
The strategy comprises six simple rules:

1)Invest only in big, simple businesses that dominate their industry because of some advantage they have that others lack.

2)Don't worry about year-by-year profits. Invest for the long term. (And by that I mean 10 years or more.)

3)Don't invest in companies you don't understand. You don't need to know the company inside and out, but you at least need to understand how they sell to their customers, why their customers prefer them, and why it is that they're likely to continue dominating their industries.

4)Whenever possible, invest in 'investor-friendly' businesses-companies with a long-term history of paying dividends to their investors year in and year out.

5)It's also nice if the company has lots of cash and an easy debt load.

6)Never overpay. Even the world's best companies can be overpriced. And if you buy them when they are, it may take you a long, long time to make up for your overpayment.

As I said, I used to put my stock money in no-load index funds. The idea there was to have some of my wealth in the stock market and expect, over time, that the return I would get would be equal to the market, plus or minus a percent.
I still think that's a pretty good strategy for beginners or people that have zero interest in managing their own stocks. But I do think that the portfolio of stocks I have now, based on the six rules above, will give me more power and endurance than an index fund with equal or greater safety over time.

Disclaimer
Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.