Saturday, 19 May 2012

Value Picks in Turbulent Times: Few Interesting Opportunities

Good times are back again! No, I am not kidding. If you are a value investor who wants to create disproportionate wealth over a long period of time, there can not be a better opportunity than a prolonged bear market. A prolonged bear market gives value investor to do a detailed analysis of interesting opportunities (and there are plenty!) and pick the best and to top it, average it over a period of time! Lots of investor (of course including me!), who were awestruck to see early 2012 rally, must be quite content that they are getting a similar opportunity again! 

Warren Buffet put very succinctly "cash in the time of crisis combined with courage is priceless". So, in this time of crisis, if you have plenty of cash to deploy and have courage to weather a feisty storm and conviction in your analysis, you have an opportunity that can generate phenomenal returns in next 3-5 years. So it's time to work hard and find out businesses that have strong economics, represent some barrier to entry/competitive advantage, have strong balance sheet and available at substantial discount to its intrinsic value. The best thing a value investor can get is business at a value where growth component is absolutely free!

I began with initial screening to identify such opportunities. I put following criteria to arrive at 69 companies with market cap ranging from 7 crores to 50, 000 crores. 

Average 3 year CAGR sales growth: 15%

Average 3 year CAGR net profit growth: 15% 

Debt to equity ratio: less than 0.5

Return on capital employed: 25%

P/E ratio: less than 12

However, list of 69 companies was just the starting point. My ultimate objective of the exercise is to find companies that have steady and sustainable businesses (reflected by consistent profit margins), scalable business models and reasonably good management. I am looking for businesses that are trading at at least 50% discount to conservatively calculated intrinsic value. I could eliminate some of them by cursorily looking at financials for last 5 years as many of them lacked consistency in performance over a period of time. For remaining in the list, I started digging deeper. Based on my initial review, I shortlisted 6 opportunities that seems attractive. Following is a synopsis of investment case for each opportunity. 

I would like to strongly emphasize here that, this list is still "work in progress" and not the final outcome and hence one should not jump to conclusions based on the  investment case outlined here. I have excluded two ideas Cera Sanitaryware and Mayur Uniquoters as I have covered them in separate posts.

1) Atul Auto: A three wheeler commercial vehicle manufacturer having strong brand of "Atul Shakti". Enjoys a very strong presence and brand recognition in the markets of Gujarat,Rajasthan and Andhra Pradesh. Debt free company. Last 5 years sales growth @ 26% CAGR and PAT @ CAGR 65%. Expanding distribution network into Kerala, Karnataka, Bihar and other states. Increasing profit margin and ROCE/ROE.  Available at P/E of 6 on TTM basis. Limited competition (Bajaj, Piaggio and M&M)

2)Amara Raja Batteries: Second largest automotive and industrial battery manufacturer and pioneer for VRLA technology in India. Jhonson's control, world's largest automotive battery manufacturer holds 26% in the company. Operates in a oligopoly market where only significant competition in branded battery market is from Exide.Last 5 year topline and bottom line growth of CAGR 22% and 25% respectively.Strong brand "Amaron" combined with well laid out distribution network.  Increasing demand for new automobiles  combined with increasingly higher replacement demand (every 3 years one has to change four wheeler battery and every two year a two wheeler battery!) is going to create very large replacement market, thus volume growth can be sustained. Nearly debt free company. Increasing ROCE/ROE trend. Even in worst years ROE/ROCE is above 20%. Available at TTM P/E of 11.6.

3) Fluidomat: Pioneer in indigenous manufacturing fluid couplings. It is a niche product having application in diverse sectors such as thermal and nuclear power, cement, steel, mining, paper, fertilizer and chemicals and ports. Marquee list of national and international clients for its products and company's products are approved by all major engineering consultants. Steady growth in sales and profit in last 5 years (CAGR 15% and 18% respectively). Consistently increasing ROCE/ROE (20% to 35%). debt free company and trading at market cap of 16 crores. 20% of market cap is available as cash and  cash equivalent. P/E of 5.45 on TTM basis.

4) Narmada Gelatines: One of the pioneers in manufacturing of gelatin in India and 50 year old company. Gelatin manufacturing is oligopoly with only handful (25-30) manufacturers all over the world. In India only 5-6 large units. Significant barrier to entry due to technology, quality, approval from pollution control and raw material procurement. Current market cap of 43 crores (in last week stock price has rose by more than 15%), 18 crores is cash + liquid investments. Company's sales and net profit has grown CAGR 10% and 32% respectively in last 5 years (indicating strong margin expansion). Increasing ROCE/ROE due to margin expansion. Net of cash, it is trading at P/E of less than 3. Dividend yield of 4%. High promoter holding of 75%. Current management may divest (shaw-wallace group) as many European majors are interested in buying operating unit in India which will a trigger for re-rating. Upward trend in gelatin price due to demand supply gap and capacity expansion (underway) may further increase company's margin and ROCE/ROE.

5) Swaraj Engines: Diesel engine manufacturer for tractors of "Swaraj" brand and high-tech engine component manufacturer for Swaraj Mazda (SML Isuzu now) commercial vehicles. "Swaraj" brand is taken over from Punjab Tractors Limited by M & M, India's largest tractor manufacturer. M & M and Kirloskar Oil Engine are major shareholders, 33.23% and 17.39% respectively. 5 year CAGR for sale and profit is 25% and 30% respectively. Pristine balance sheet. Consistently high and increasing ROE/ROCE. Cash + current investment is 140 crore i.e. 28% of market cap of 500 crores. It is in sweet spot due to free substantial cash flow generation combined with high ROE and debt free balance sheet. It has undertook capacity expansion which will drive top line/bottom line growth

6) Wim Plast: Manufactures plastic molded furniture with brand name "Cello". "Cello" is very popular brand in writing products (pen) and  kitchen products and hence strong brand association. One of the three major players in branded plastic molded furniture other two being Nilkamal Plastics and Supreme Industries. Top line and bottom line growth in last 5 years at CAGR 24% and 61% respectively. consistently improving margins and ROE/ROCE. Debt free company and trading at TTM P/E of 5.6. It is expanding capacity (Daman and Haridwar) and increasing its reach in eastern and southern (presently confined to northern and western market). Consistent dividend paying company since 1998. Promoters are buying consistently since September 2011 and bought shares close to current trading price. 

As I said before, this list is indicative of "work in progress" and I intend to study these opportunities closely before allocating substantial capital to any of the ideas. However, the objective of posting these ideas here is to receive critical opinion (a well researched negative opinion will be even more useful!) from readers. 

I look forward to your comments/suggestions.

Tuesday, 8 May 2012

Sources of Durable Moats: Building Blocks of Great Business

Warren Buffet has uncanny ability to transform hardcore business constructs into analogies that is very easy for common man to relate to yet effectively conveying the central idea behind the business construct. One such wonderful analogy he gives is about sustainable competitive advantage by comparing it with "moat". 

Moat is nothing but a big ditch, mostly filled with water, constructed around a castle, that acts as primary defense when the castle is under attacks from the enemy. Similarly, sustainable competitive advantage act as protective barrier for the company to retain its business/market share when under attack from competitors. Wider the moat around the castle, more difficult for the enemy to penetrate the defense effectively. 

Mr. Buffet only invests in businesses which have expanding "moats" built around them. However, the million dollar question here is, how does one identify whether a particular business has built "moat" around it or not. As to all million dollar questions, there is no easy answer! Even though, there can be umpteen factors/characteristics that can lead to sustainable competitive advantage for the business, six sources of "moat" can be attributed to 80% of the great businesses we see around us. 

In addition to describing sources of "moat", I will also try to enlist few companies which apparently possess such moat.