Friday, 26 October 2012

A Year into Value Investment Blogging: Time to Do Reality Check!

It has been almost a year, since I started this blog on value investing and let me take this opportunity to thank fellow investors who have not only regularly read the blog but also have provided their suggestions, critique, inputs, questions and insights. This involvement and interactions, with number of fellow investors ranging from novice to veterans, have made this journey an enriching experience for me. I sincerely thank all the readers from bottom of my heart  for their wholesome participation and look froward to more and more interaction in coming time.

Over one year, I have posted number of ideas which I thought made sense from value investing framework and I had highest conviction in. I also tried to write about ideas where I myself will be willing to put money so as to make sure I had complete buy in before putting the idea into public domain. Most of the ideas discussed (not all) on this blog are/were part of my portfolio at some time or the other. As I started the blog, one of the objective of writing a blog was to document my investment rationale/hypothesis behind businesses that I buy and to keep tab on how my ideas perform over a period of time. Even though, in value investing, one year is not an appropriate time frame to evaluate the performance of a portfolio, it does serve as milestone indicating whether one is traveling on a right path or not. It is like a mid term exams! 

I take this opportunity to acknowledge that the idea of evaluating performance of my idea is derived from the work done from Vishal (Valueinvest30) who took pain to put together buy price/date of post for all the ideas posted on this blog. Thanks Vishal for that. This prompted me to think that I should assess performance of the ideas posted on this blog for the sake of transparency and getting a sense on direction . It doesn't matter, how the portfolio performs, but it gives me and blog readers some idea about what went right and where it did go wrong.  I also plan to make it yearly ritual  of evaluating performance around same time frame to keep things consistent from evaluation perspective.

While I do not carry all stock in my portfolio in same proportion in terms of capital allocation, for the sake of simplicity and to generalize the results,I have done my performance analysis assuming roughly 10,000 allocated to each idea. I have assume closing price as average buying price on the day I wrote the post about a particular idea. Today's closing price is taken as CMP and returns are calculated on CMP. 

Security
Name
 Date 
Blog Posted
Buy 
Price
Buy          
Quantity
Amount 
Invested
CMP
Current Amt
%Gain
J B Chem
24/11/2011
68.5
  140
  9590      
  69      
  9660          
  0.73%          
Cera Sanitaryware
29/09/2011
178
  55
  9790      
 375      
  20625     
  111%     
Mayur Uniquoter
11/12/2011
167
  60
  10020     
 430      
  25800
  158%     
Sintex Industries
29/12/2011
62
  160
  9920      
  67
  10712      
  8%     
Oriental Carbon
07/01/2012
91
  110
  10010      
 160
  17600      
  78%     
Shriram Transport
18/01/2012
534
  20
  10640      
 605   
  12100      
  14%     
Gujarat Reclaim
29/02/2012
1398
  7
  9786      
1625      
  11375
  16%     
Piramal Enterprise
24/03/2012
455
  22
  10010      
 495      
  10890      
  9%     
Narmada Gelatine
30/03/2012
96
  105
  10080      
 134    
  14070      
  40%     
Mazda Ltd
30/04/2012
93
  110
  10230      
  96      
  10560      
  3%     
Atul Auto
19/05/2012
100
  100
  10000      
 111     
  11100      
  11%     
Amara Raja
Batteries
19/05/2012
138
  75
  10350      
 224      
  16800      
  62%     
Fluidomat
19/05/2012
32
  310
  9920      
  38      
  11780      
  19%     
Swaraj Engines
19/05/2012
402
  25
  10050      
 440 
  11000      
  10%     
Wim Plast
19/05/2012
201
  50
  10050      
 362      
  18100      
  80%     
Hindustan Zinc
29/06/2012
112
  90
  10080      
 132      
  11880      
  18%     
GSFC
16/07/2012
71
  145
  10295   
75.5      
  10947      
  6%     
Total


  170711      
      
235000      
  38%     
Sensex
26/10/2011
17289     
   
18625     
7.72%     

As it is evident from the above table that some of the securities performed extremely well even in over all depressed markets while other did reasonably well. There are few securities which performed worse than benchmark and dampened the overall returns. However, portfolio as a whole did manage to perform well as it generated 38% absolute returns (not annualized as many of the opportunities are less than 6 months old) on amount invested. Now, if one would have invested same amount in nifty/Sensex based index funds, returns will be in the range of 7-8%. Thus, at least for this year additional effort put into finding opportunities seems to be well rewarded.

Even though, these are early days, a pattern emerging from the performance analysis is that combination of undervaluation and great business (Cera, Amara Raja, Mayur, Wim Plast, Oriental Carbon) is likely to fetch far superior returns than finding out business available at deep discount but mediocre/average in nature. However, as I said earlier, these are early days and it is not worth jumping to conclusion. 

Among the under performers, I am very positive on Atul Auto, Piramal Enterprise, GRP and Shriram Transport. 

Mazda and JB chemicals remain value play. However, post JB chemical's announcement about dispute with J&J regarding amount put in escrow account from  sale of Russia-CIS business, margin of safety has reduced. I have partially exited (roughly 50%) at marginal gain, rest 50%,I continue to hold. For Mazda, undervaluation remains. 

Disclosure: Views posted here are personal and shall not be construed as investment advise on buying or selling. One must do his own due diligence before making investment decision. My views can be biased as I hold position in many of the companies discussed here.


Tuesday, 9 October 2012

Mr.Ajay Piramal - Businessman Stepping In Shoe of A Value Investor

Let me make a confession at the beginning, I am a convert, hence my views are bound to be biased! Yes, over last few months,  I have witnessed a slow but steady transformation in my feeling towards Mr.Piramal from curiosity to respect to awe. As I watch Mr.Piramal conducting the business of now re-named Piramal Enterprise, it leaves me with a feeling of deep satisfaction that i have made a right choice of making "side car investment" with Mr. Piramal. As an avid student of value investing, it is fascinating to watch some one taking the teachings of this highly intuitive and yet effective philosophy out of investment paradigm and start putting it into practice in making business decisions. In order to demonstrate how deeply value investing principles are ingrained in Mr.Piramal's business philosophy, let me analyze some of the decisions made by Mr.Piramal and how they relate to core principles of value investing. 


1) Mr.Piramal's decision to sell domestic formulation business to Abbott:  



Building business from scratch is like growing a baby. It takes continuous effort, unwavering commitment and complete dedication while end result is deep sense of satisfaction. One gets completely engrossed in the process and becomes deeply attached to the business. Hence, it is very difficult for one to let go of this attachment and sell the business, especially a successful one. Consider PHL in 2010, domestic formulations division was the bread & butter for PHL and Mr.Piramal had worked hard to bring it into top-3 in Indian pharma industry. In FY 10, healthcare and diagnostic business constituted roughly 60-65% of revenue for PHL. Moreover, the business had grown topline and bottomline at 17% and 34% CAGR respectively in last 8 years. (pg.11, AR FY11). In short, every thing was hunky-dowry! So what prompted Mr.Piramal to take decision of selling largest chunk of his business to Abbott? Here is an answer in his own words from interview given to HT in June 2012



"I have an obligation to my shareholders, to create maximum value for whatever they have invested and that’s what my job is and that’s what I am here to deliver. I don’t carry an egoistic or emotional attachment to the businesses. We did a calculation to justify the value that Abbott paid — I would have had to grow the business for 15 years at 20% CAGR with an operating margin in excess of 35%. Now that’s not possible and therefore, the choice was should I leave aside my ego that it is my business and I created it, or should I do what is in the best interest of shareholders. If you look at like that, that’s what a leader ought to do, in my view. Job of a leader is to act like a trustee."


Now this will  surely sound like music to ears of Philip Fisher or Warren Buffet who puts concept of "management as trustee of shareholder wealth" on top of the list in making investment decision.


 Also note similarity with Ben Graham's advice given in his seminal book Intelligent Investors. He tells that some times Mr.Market is brimming with enthusiasm and  offers ridiculously high price to buy out the your interest in the business. At that time, as prudent investor or sensible business man, you shall oblige and sell the business and take advantage of the deal offered by Mr.Market. Here in this case it was Abbott in place of Mr.Market and as Mr.Piramal describes, he happily sold his interest as in his own sense, price offered far exceeded intrinsic value of business.



PHL decided to buy-back shares instead of declaring special dividend: 


PHL decided to reward shareholders by offering buy-back of 20% of shares at 20% premium to market price. Now market did not like this move at all! Market was more interested in special dividend as it meant "cash in hand" of the shareholders even at the expense of getting less value! In spite of anticipating this unpopularity, management decided to act in manner which was in the best interest of the shareholders. Please refer to slide 7 & 8 for analyst presentation for Q3 FY11
As it is illustrated in the slide, for the same amount of money spent by the company, cash in hand of shareholder is much higher in "buy-back" option as compared to paying dividend due to tax efficiency of buy back. Moreover, it also is beneficial to continuing shareholders as number of outstanding shares go down by 20% (thus decreasing equity base) and help in enhancing EPS/ROE.  As Graham puts it in intelligent investor,


"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."



and now read what Mr.Buffet thinks on share buy back. Let's go to 1984 news letter where he penned down his elaborate thoughts on share repurchase and its virtues 


"While we enjoy a low tax charge on these proportionate redemptions, and have participated in several of them, we view such repurchases as at least equally favorable for shareholders who do not sell.  When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.".

So, Mr.Buffet clearly indicates that share repurchase program gives an opportunity to existing shareholders to redeem some of their capital with low tax liability without adversely impacting interests of continuing shareholders. Mr.Buffet puts in necessary conditions for initiating share repurchase (As highlighted) which were met in case of PHL.

PHL's Investment in Vodafone India: PHL bought 11% stake from Essar in Vodafone India at roughly 5800 crores. Mr.Piramal made it very clear that this invsetment was only financial investment and company had no plans to enter into this sector. It was indeed a smart strategy to park huge surplus cash in a way that maximizes return while giving time to PHL to find out good specific opportunities in its area of operations. However what is more remarkable is the deal Mr.Piramal extracted from Vodafone. As he emphasizes that "trust" and "respect" that PHL has created over a period of time that helps him get a better deal than rest of the people.  So here is the deal, 

PHL buys out 11% stake from Essar in Vodafone India in two tranches of similar proportions. PHL has an option to sell its stake in IPO if Vodafone India decides to go public in 24 months from the date of investment. However, if Vodafone decides not to go for IPO, Vodafone will buy back 11% from PHL in the range of 7000- 8300 crores (Vodafone AR, page 59). Now in the worst case, company is getting 10% annualized return at floor price of 7000 crores while PHL will earn 20% return at 8300 crores. So minimum return PHL will earn is 10% CAGR which is still better than money put in fixed deposit. 

Now, if Vodafone decides to come up with IPO by 2014, which is not an unlikely event, considering their plan for expansion and their intent of going public, Vodafone India can at least command valuation similar to that of Bharti (as it is comparable in size with Bharti)  even if one doesn't consider premium for MNC. So, going by FY 12 numbers, Vodafone India clocked EBIDTA of 1.2 billion pound i.e. roughly 10,000 crores. Considering today's situation of  extremely negative sentiments about telecom sector, Bharti is still trading at Market cap of 1,00,000 crores i.e. 10 times last year's EBIDTA (10,300 crores).Hence, it is not unreasonable to assume Vodafone India also getting similar valuation of roughly 1,00,000 crore market cap. This will value PHL's 11% stake at 11,000 crores, cool 80% return in 2 years i.e. 38% CAGR! Reminds you of something? yes,  Heads I don't lose, tails I win big! Low risk- high return game...

PHL's Acquisition of DRG : PHL completed acquisition of DRG in June 2012 at 3400 crores paying 4 times expected revenue for FY 2012. As indicated by PHL management, publicly listed companies engaged in similar business trade at valuation of 3-5 times topline  Hence, DRG was not that cheap by these standards. PHL decided to pay fair price. Now read this sentences from Mr.Buffet 

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”  

                                      and 

“A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital.”

As many of you may be knowing, DRG is in the business of  healthcare information management where they collect "vertical specific" data, organize it into usable information and sell information to customers where information arbitrage is important. Now look at the analyst presentation on DRG put up by PHL. PHL describes reason for acquiring DRG; here are the key points

  • Recurring revenue flow  which is tied into budgeting cycle (predictable business
  • Data gets embedded into client's system ( one of the moat of "high switching cost" mentioned by Pat Dorsey in his extremely useful book "Little book that builds wealth")
  • High value of insights; the risk far outweighs the price (of subscription); reputation of source (hence authenticity) matters ( very high switching cost due to potential negative impact)
  • Quality, accessibility and frequency of data and sources is more important than price (pricing power a key attribute that quantifies moat)
  • High barriers to entry with, 290 analyst with deep industry knowledge and relationship; data collection process with irreplaceable longitudinal data and  network of 125000 advisers and data providers ( again Pat Dorsey's one of the moats, Network effect; difficult to replicate) 
  • strong operating leverage ( as company scales up, higher percentage of top-line flows to bottom-line)
  • Strong free cash flow ( another key attribute (along with pricing power) of great business) 

As can be seen from the above analysis, DRG demonstrates all the attributes of a great business (having sustainable moat). Hence, DRG is a perfect example of buying a company with sustainable moat (in Pat Dorsey's words strong moat) at fair price. 

I am feeling convinced that given enviable track record of value investing principles of generating above-average returns for a long period of time, journey with Mr.Piramal will turn out to be a one big joyride for PHL investors!