Saturday, January 31, 2015

Moktan Capital LLP
Date: 28th January 2015 
Quarterly Letter Q4 (Oct-Dec 2014) 

Dear Investors, 

Here’s wishing all of you a very happy 2015. 2014 turned out to be a very interesting year for investors and markets worldwide. In this letter, I will try to capture some of the key economic and political updates in 2014 and see what we can learn from them going into the New Year. I will attempt to analyse how various asset classes performed in 2014. In my analysis, I will cover stock markets, commodities like gold and crude oil, government securities and bonds and currencies. 

A. Financial Markets: 
Let us start-off by looking at how financial markets performed around the world and how much returns investors made last year investing in them.

If you had invested $100 in the big markets of Europe in 2014, the maximum you would have earned is $2.7 in Germany. The FTSE London would have made you poorer by $2.7. Looking further east, the same $100 invested in Hang Seng would have returned just $1.3. If you had invested in Brazil, one of the key emerging markets, you would have been poorer by $0.7. Clearly, investors who bet on these markets in 2014 were left with very little to show for their effort. 

On the other hand, if you had invested in the world’s biggest market, the US, you would have been rewarded with $11.4, a significant return given the risk profile of the country. An investment in Japan’s Nikkei would have yielded $7.1. However, the star performers of 2014 were those who bet on India. Indian markets returned $30 for every $100 invested, the most around the world. In the same time, Moktan Capital LLP returned $33.4, 10% over the Sensex. 

B. Commodities: 
Let us turn our attention now to a couple of commodities. 

a) Gold
$100 invested in gold in 2014 would have yielded a loss of $7.3. Gold is a strange commodity, which has no value in itself. Unlike oil, it cannot be used to power cars or manufacture goods. Its only source of value is what somebody else thinks it should be worth. In tough times, people do not trust governments, their own currencies or the companies driving their economies. During these times, Gold’s value increases as investors buy something that has universal value and is independent of market cycles. 

When the EU crisis happened in Greece, Italy and Spain, people of these countries withdrew money from banks and put it into gold because they did not trust where the country was headed or what their deposits in the bank would be worth. If we look at returns of gold in the last 5 years, we will see how it becomes attractive during periods of crisis. 

In the crisis years of 2010 and 2011, Gold returned 23.3% and 32.1% respectively. In 2012 it returned 12.1%. As the global economy recovered, people thought less of gold and started selling it to buy stocks, bonds and real estate. In 2013, gold prices fell by 4.1% before falling another 7.3% in 2014. Going forward too, I would not recommend buying it as the next 3-4 years are going to be good years for alternative asset classes. 

b) Oil 
The biggest story of this year has been the dramatic fall in the price of crude oil. $100 invested in crude would have been reduced to $53 by the end of 2014. As we speak crude is trading at $47, the biggest fall in its history. So what went wrong with crude? Why did it go into a free fall? Let me explain a few of the reasons: 

Reason 1: Recession in Europe and China: Since 2013, Europe has entered into a deep recession reducing global demand for oil. Similarly, China is one of the biggest importers of oil but a slowdown in the housing sector reflected in its slower GDP growth has reduced the Asian country’s demand for oil. 

Reason 2: Rise of Shale Oil: From becoming the largest producer of oil in the 1970s, the US oil production had declined by 50% in 2008 as output from oil wells reduced. However, a new technology for drilling oil that used fracking and horizontal drilling increased output in the US by close to 80% from 2008 levels. With oil at $150 per barrel, this relatively more expensive method of drilling became profitable for oil companies thus increasing the supply of oil. 

Reason 3: Geo-political power play: Saudi Arabia is the biggest producer of oil today and commands a very powerful position in international politics thanks to the world’s dependence on its production. As the most powerful member of OPEC, Saudi Arabia has historically calibrated production in order to keep oil prices stable. However, the rise of shale oil was making the US less dependent on the Middle Eastern power. The higher price of oil was also massively profiting countries like Russia, Venezuela, Iran (even with sanctions), Brazil, Libya etc making their economies stronger. 

OPEC reasoned that cutting production would keep prices high and encourage further drilling of shale oil thus reducing member countries’ bargaining power while simultaneously making others stronger. As oil prices fell, OPEC actually increased their output flooding the market with more oil. As prices fell, countries like Russia, Venezuela, and Nigeria, which were highly dependent on oil exports, plunged into recession. As we speak, the S&P has downgraded Russia’s government debt to “junk” status meaning that the country is unlikely to be able to service its own debt. As a result, the Russian Rouble has fallen 106% from 32.87 / US$ at the end of last year to 67.8 currently. If you held your investments in Roubles, you would have seen them fall by 106% with no fault of your own – a scary prospect. With the fall in the price of oil, many of the shale oil refineries in the US are also shutting down as it has become uneconomical to drill for oil at these low prices. 

Reason 4: Speculation: As is the case with most commodities today, speculation played a big role in the price fall. Hedge funds with billions of dollars of capital had predicted that OPEC would cut production to keep prices stable. However, when that did not happen and prices plummeted, the same hedge funds had to sell their positions to cut losses. Since most hedge funds use debt to leverage their capital, the fall was even more pronounced, leading many of them to shut shop. 

C. Government Bonds: 
Most people think that the only returns you can make out of bonds are interest payments. However, this cannot be further from the truth. In a falling interest rate environment (meaning when interest rates are forecasted to fall), bonds also provide capital gains. This is because a bond with a 10% coupon bought one year ago is more valuable today if the interest rate on the same bond is 8%. Last year, US interest rates on 10-year government bonds (also called treasuries) fell from 3.04% to 2.17%. This mean that an investor who had invested $100 in a 10 year US bond would have made 40.1% return excluding interest (43.1% including interest). Interest rates in the Indian government’s 10-year bond fell from 8.924% to 7.860% during the same period returning 13.5% (22.4% including interest). 

That is a phenomenal return considering the fact that these bonds are risk-free when it comes to return of capital. Obviously in an environment of increasing interest rates, the reverse will be true. Going into 2015, interest rates on Indian government bonds are set to fall 75-100 basis points (0.75 – 1.0%). This is because the RBI had increased rates or kept them the same for the last few years as inflation continued to be high. With inflation moderating to below 5%, the RBI cut interest rates by 0.25% in January with further rate cuts forecasted in 2015. As an investor, investing in long duration government securities will be a good strategy in 2015. 

D. Currency: 
Let us now look at how various currencies performed in 2014 and how much investors would have made by trading them. 

The picture is pretty much one-sided. The US$ has performed very strongly against almost all currencies in the world. The table above captures how well it performed in 2014 compared to Europe, UK, Japan and India. $100 invested in the Indian rupee would have been worth $98.2 at the end of 2014 (excluding interest if any). Similarly $100 invested in Pounds, Yen and Euros would have returned $93.7, $86.3 and $86.4 respectively with the Euro being one of the worst performing currencies. Conversely Rs. 100 invested in US$ would have returned Rs. 101.8 and so on. As a European investor, it would have been best to convert your Euros into US$ and hold tight. That itself would have yielded a return of 13.6% in 2014 (excluding interest). 

2015 should show a similar picture as the US economy has rebounded very strongly while Europe continues to lag behind with lower growth, higher unemployment and continuing debt crisis in member countries. The Indian currency should either strengthen a little or depreciate similarly to last year, as foreign investors will continue to invest in equities. With oil below $50, India’s import bill will also be lower leading to lower dollar payments. Further, if the government is successful in selling its stakes in government companies to raise money and reduce its fiscal deficit, it will do even better. I would not convert INR to US$ in 2015. 

Political Update: 
There were two Assembly elections held in December in J&K and Jharkhand. As expected, the BJP juggernaut continued to roll in these two states with a landmark performance in J&K, where it has historically been reduced to single digits. In Jharkhand, BJP won 42 of the 81 seats gaining a simple majority while in J&K, it was the second largest party winning 25 seats out of 87 seats. With no clear majority, the state is headed for a coalition government between People’s Democratic Party (PDP, 28 seats) and the BJP. The next state to go to the polls will be Delhi in February where a keen contest is expected between BJP and AAP. In the last elections held in 2013, AAP had emerged just 3 seats behind BJP (31 vs 28). However, with Narendra Modi’s strong leadership at the centre, voters may well be swayed to vote for the ruling party. 

As I write this letter, there has also been a significant political change in Greece. Alexis Tsipras, leader of the anti-austerity Syriza party was voted to power and sworn-in as the country’s new Prime Minister. Having come to power on the promise of restructuring Greece’s loans with the IMF, EU and the ECB, he is set to drive hard bargains with the ECB on Greece’s debts. Greece had a total debt of Euro 316 billion, which is close to 176% of its GDP (highest among EU countries). The stock markets, predictably, reacted very negatively to the news as investors expect greater uncertainty in the EU following Tsipras’ election. 

Recent New Purchases: 
In Q4, 2014 the LLP made 2 new purchases: 

1.Karnataka Bank Ltd: 
The partnership purchased 7,000 shares of Karnataka Bank Ltd at Rs. 124 per share on 24-Sep-2014. I have been looking at the private banking space for the last one year but was unable to find any company that met our stringent Price/Value metrics. In Karnataka Bank, I found both a low price and a high embedded value. Karnataka Bank is one of the oldest private banks in India. It has been in existence for more than 90 years. It has 1,390 service outlets with 10 regional offices, 618 branches and 758 ATMs in 401 centres across India. 

Let me put down a few points on why I like this company: 

i) Price /Value: At a price of Rs. 124, our cost basis implied a purchase price of Rs. 2,337 crores for the entire company. In the year ended March 2014 the bank earned a total net profit of Rs. 311 crores, implying that we paid 7.5x the profit to purchase the company. In the 6 months ending on 30-Sep-2014, the bank’s profit increased to 210 crores implying a full year profit of around 420 crores (35% higher than FY14). This would mean that we purchased the stock at 5.6x forward profit. I believe this is a very competitive price to pay for this stock. Other private sector banks trade at very high multiples as seen below: 

HDFC: 27x | Kotak Mahindra Bank: 61x | ING Vysya Bank: 31x | IndusInd Bank: 27x | ICICI: 20x | Federal Bank: 13x | City Union Bank: 15x 

All of the above banks are not strictly comparable to this one as it is a smaller regional banking player. However, other similar players like City Union bank, ING Vysya Bank, Federal Bank etc also trade at very high multiples. 

ii) Favourable Interest Rate Environment: All banks in India have to compulsorily invest 25% of their deposits in bonds issued by the government (G-Secs). Thus, in a falling interest rate scenario (like we spoke about earlier) this investment increases in value leading to higher profits. As the RBI reduces rates over 2015 and 2016, profits of the bank are bound to go higher. This is an interesting way of playing the G-Sec market in India.

iii) Dividend History: The Company has a long and consistent dividend paying history in both good and bad years. 

iv) Balance Sheet and Financial Ratios: Karnataka bank operates at a net interest margin (difference between deposits and lending rate) of 2.4%, which is lower than other more profitable peers but not altogether bad. 75% of its deposits are retail term deposits that provide dependable longer-term capital. Its loan portfolio is evenly distributed between retail customers and corporate customers. Gross Non Performing Assets or NPAs (where interest has not been paid for >90 days) in Sep-14 were Rs. 1,061 crores or 3.5% of total loans. Of these the Net NPAs (gross NPAs minus dues received or recovered) were Rs. 702 crores. 

NPAs are something banks have become very good at hiding. Thus one has to be a bit careful in their analysis. How much of the loans are truly bad is something only the bank knows. As investors, the best we can do is to estimate a probable loss and compare it with the bank’s net income (1.7x in case of Karnataka Bank). So, if all NPAs turn bad, it will wipe out 1.7 years of the bank's profits. The present value impact of this at 20% IRR would be close to Rs. 570 crores. If we factor this into our purchase price, the forward P/E still works out to 6.2x. 

While one can never really be sure of the exact extent of bad loans, as investors we can take a calculated guess as to whether they will increase or decrease. I believe the worst of the write-downs for Indian banks are over and things can only get better from here. Needless to say, if we believe the country is headed for more prosperous times, as I do, lenders are bound to pay on time. It is in times of economic malaise that one has to be greatly worried about loans turning bad. 

Current status: 
Post our purchase; Karnataka Bank is up 17.3%, which has made us a profit of Rs. 150,000 in 3 months. 

2. Suzlon Energy: 
In my last letter, I had mentioned that the partnership purchased additional 40,000 shares of Suzlon as I believed the market had punished the stock more than was warranted. This purchase has proved to be a lucrative one so far as the stock is up more than 28% since our purchase netting us a profit of Rs. 144,000. 

Note: Last week, Suzlon sold its subsidiary Senvion to a private equity fund. I will present my analysis of this sale and its impact on our investment in the next quarter's letter.

Portfolio Performance:
Our portfolio performed strongly in Q4 rising 9.8% vs only 3.3% for the Sensex. Except Bharti, which fell 12.7% since my last letter (Bharti is however currently trading at 394 vs 353 used in this letter), all stocks increased significantly in value.  

[Investor Portfolio and LLP Portfolio follows]

will write back again next quarter. As always, do not hesitate to call or mail me if you have any questions or comments.  
Kunal Moktan
(Managing Partner)

Thursday, August 16, 2012


Hi everyone, All my blogs, updates, portfolio etc have now been shifted to my own website at You can also find quarterly letters to my investors and earlier case studies there. Hope you will continue to follow my posts there and thanks for all your support. If you have any comments you can leave it here until i start a comments section on my website. KM

Friday, April 8, 2011

Portfolio Update

Moktan Capital LLP has bought a further 10,000 shares of Suzlon on 9 Feb at Rs. 44.5 per share and 5,575 shares of Kavveri Telecom on 24 Feb 2011 at Rs. 111.9 per share.

Tuesday, February 8, 2011


Moktan Capital LLP has bought 10,000 shares of Suzlon Energy Ltd at Rs. 46.6 per share in Nov’10 and another 10,000 shares in Feb’11 at Rs. 48.6 per share. This implies a total market capitalization of c. Rs. 8,150 cr. With outstanding debt of Rs. 10,500 cr, that’s a total enterprise value of Rs. 18,650 cr.

Let’s get straight to the point - Why did I buy Suzlon?

Before I answer that question let’s look at the historical financials of this company. These financials tell a very interesting story. Let’s break them up into 2 parts:

Part A – FY 2006 to FY 2008
Part B – FY 2008 to FY 2011 YTD

From FY 2006 to FY 2008 Suzlon’s revenues went from Rs. 3,841 cr to Rs. 13,679 cr. That a 3.6x jump and an 89% CAGR. EBITDA went from Rs. 889 cr to Rs. 2,051 cr (2.3x, 52% CAGR). Interestingly profits rose only by 1.4x from Rs. 760 cr to Rs. 1,030 cr. Why? The answer is simple - Debt.

Interest payment went from Rs. 51 cr to Rs. 532 cr (10.4x, 223% CAGR) during this 3 year period. However, such was the exuberance of Mr. Market at those heady 2007-08 times that he valued the company at Rs. 38,621 cr, making Suzlon one of the biggest companies in the world and Tulsi Tanti, it’s promoter the 3rd richest Indian! On Mar-07 Mr. Market valued Suzlon at Rs. 8,604 cr which implied a reasonable 10.2x P/E. The same P/E went to 37.5x in Mar-08 when Mr. Market valued Suzlon at Rs. 38,621 cr!

Now let’s see what happened after Mar-08

In FY 2009 Suzlon actually ended up having a decent year with sales doubling to Rs. 26,082 cr. However, EBITDA did not grow as much possibly due to higher costs. Interest almost doubled to Rs. 901 cr. Even then, profits would have been healthy hadn’t it been for “Exceptional Costs” of Rs. 896 cr that reduced profits to a measly Rs. 236 cr. Closer reading of the schedules to financial statements reveals that those exceptional items pertained to costs of restoration of faulty blades. Thanks to dismal profits Mr. Market brought down the valuation from Rs. 38,621 cr to Rs. 7,604 cr!

In FY 2010, Suzlon’s revenues fell to Rs. 20,779 cr due to continued recession in the US and Europe. The EBITDA fell to Rs. 943 cr because the company was not able to reduce costs in-line with lower revenues. This coupled with higher interest led to a loss of Rs. 983 cr for shareholders. So far in FY 2011, the company has managed to book only Rs. 10,718 cr of sales. However, this is also because Hansen has ceased to be a subsidiary of the company since it now owns only 26% (Hansen revenues were about 4,000 cr last year). I have forecasted FY 2011 numbers on the basis of the last 9 months results


No analysis of Suzlon is complete without understanding its debt. In its hey-days of growth, as often happens with companies, Suzlon decided to go overboard on acquisitions. It made 2 very expensive acquisitions – RE Power and Hansen. There was strong merit in going for these acquisitions for Suzlon – Hansen gave it the capability to manufacture gearboxes and RE Power gave it the R&D strength and European customer base it desperately lacked. However, Suzlon failed to understand the Price/Value equation for both acquisitions and ended up paying too much price for too little value. Worse – it used debt to finance the acquisition. As we have already seen through a cursory analysis of the Income Statement, the interest burden crippled the company on the back of lower sales and higher costs. The good thing was that Suzlon was able to restructure the debt in 2009-10 converting its forex debt to rupee debt and lowering repayment covenants.

From the investor’s point of view there are two good things to gain out of this:

1.The management can now focus more on improving its operations – increasing revenues, lowering costs, streamlining operations etc. Dealing with a debt problem is a full-time job that severely restricts top management from focusing on other important aspects of the business.

2.The company has learned the lessons of over-leveraging the hard-way. The promoter himself has seen his net worth fall by 80% with his company on the threshold of bankruptcy. The confidence this gives me as an investor is that the company will think twice before taking debt in the future. It has hopefully come out chastised from the experience.

Price Vs Value

Now let’s go back to the question we asked at the beginning of this analysis. Even after all these negatives why did I buy the stock? The answer lies with Ben Graham’s concept of Price and Value. I see these two attributes of stock investing as two counterweights on a weighing scale. When you weigh the company with Price on one side and Value on the other, which side is heavier? Knowing the vagaries of Mr. Market as we do, there are many instances when the scales tilt in favour of Price and other times when the scale tilts in favour of Value. If the scale tilts in favour of Value with a decent margin of safety, it’s time to start buying. This is the reason for buying Suzlon.

Now let’s put this concept in numbers.

I bought the stock when the markets tanked in November 2010 and Feb 2011. Mr Market valued Suzlon at Rs. 46.6 per share at these times implying a total market capitalization of Rs. 8,150 cr. Together with debt of another Rs. 10,500 cr, the company’s total value came to Rs. 18,650 cr. This is the weight on the Price scale.

This was the easier part – the weight on the Price scale is very easily available and calculated. Mr. Market gives you these numbers from 9:00 am to 3:30 pm every Monday through Friday. However, much of the Value is qualitative and the investor has to calculate the weight himself through proper analysis and judgment. So, what can we put on the Value scale for Suzlon?

First, the easy part. Let’s look at what we can glean from the asset side of Suzlon’s balance sheet:

Sum-of-the-parts Value:

(A)On 30-Sep-2010, the company had net current assets (current assets minus current liabilities) of Rs. 4,373 cr. We can term these as liquid assets which can be quickly recovered when things go wrong.

(B)Suzlon owns 26% of Hansen Transmissions which is currently trading at a market capitalization of c. Rs. 2,780 cr. 26% of this is about Rs. 724 cr.

(C)On 26 May 2007 Suzlon purchased RE Power at a valuation of US$ 1.6 billion ~Rs. 7,360 cr. The company currently trades at a market capitalization of Rs. 6,000 cr. Suzlon’s 90% stake here is valued at Rs. 5,400 cr.

If we sum A+B+C it gives us Rs. (4,373+724+5,400) 10,497 cr. which is 56% of the Rs. 18,650 cr value we have paid for the company and covers the entire debt outstanding. So, if the lenders wanted their money back today, Suzlon could hypothetically sell it’s stake in RE Power and Hansen, recover its current assets and become a zero debt company half it’s current size.

Now, for the tougher part. Let’s look at some of its competitive advantages.

I like to think of these as the moat that surrounds the Suzlon castle and protects it from enemies. This is one of the most critical aspects while analyzing an investment as it tells us how well our capital is protected in case of war or invasion. Companies build these up over a long period of time and these help them to weather some of the worst battles.

1. Size: Suzlon is the 3rd largest wind turbine manufacturer in the world with a 10% market share world-wide. I can think of very few Indian companies that are the 3rd largest in anything in the world. Suzlon has entered this sector early and established a strong presence across the globe. It is a well known brand in Europe, the US and Asia. Its revenues last year were Rs. 20,000 crores ($4.4 bn). Recently, Suzlon announced that it has crossed 15,000 MW of cumulative installations in 25 countries world-wide, amounting to 9% of the world’s total wind power installations. As of 31-Dec-2010, Suzlon had an order book of $7.3 billion (Rs. 33,580 cr) which is c. 2.4x FY2011 (E) revenue.

2. Cost Efficient Produc
er: Suzlon has production facilities in India, China, Germany and United States and is therefore able to deliver products quickly and cost effectively anywhere in the world. Its manufacturing facilities in India and China give it a cost advantage in terms of capital, manufacturing and labour over its European and US competitors like GE Wind (No 1) and Vestas (No 2) who have higher cost manufacturing locations in Western Europe and the US. Suzlon’s manufacturing units are located in SEZs in Coimbatore, Vadodra and Padubidri (not sure where this is but from its name it’s bound to be cheap)

3. Market Leader: In India, it has close to 50% market share thus controlling half the market. It has held this position for the last 11 years. Its installed base in India has gone from 8 MWs in 1997 to 5,500 MWs in 2010 with 1,600 customers and 40 wind farm locations in 8 states. Some of Suzlon’s biggest customers are state and public sector undertakings like Gujarat State Petronet, Rajasthan State Mines, Gujarat Alkalis, SBI and GAIL. It is also the market leader in Australia and Brazil and No 3 in the US.

4. Track Record: Having been one of the earliest companies to enter the industry it has a long and demonstrated track record of delivering superior products and value to customers. 60% of Suzlon’s order book in 2010 was from repeat customers which gives comfort on the fact that the customer is satisfied with the company’s product and service.

5. Product Range: Due to it’s size, Suzlon is able to offer a wide product range to it’s customers which differentiates it from other smaller competitors. As per the annual report, the group can manufacture wind turbines ranging from 0.35 MW to 6.00 MW. With the acquisition of RE Power, it has also developed new technology that allows it to build offshore wind farms in the sea. Offshore wind farms are seen to be the next big thing in wind energy with the first one already operational off the coast of London. On 26 Nov, RE Power signed a 295 MW contract with a Belgian offshore project development company, C-Power for the delivery of 48 turbines.

6. Superior R&D: Suzlon’s subsidiary RE Power helps it in developing new and improved products for customers. Together they have developed offshore wind turbine generators for installing wind farms in the sea. Since I am not an expert in wind energy technology I do not have a good grip on the R&D but gain some comfort from the fact that Suzlon and RE Power have a JV called SEDT which develops innovative technology in this field.

7. Brand Value: “Suzlon” is now a well know name in wind energy not just in India but across the globe. Over the last 15 years, the company has invested heavily in growing its brand. As investors in the company we inherit the value of this brand.

So, do these competitive advantages make up for the remaining 44% of value and more? This is the toughest question I had to answer before investing in Suzlon. To answer this I had to look at the classic investor dilemma – Risk vs Return.

According to me, the biggest risk of investing in Suzlon is bankruptcy risk. I have invested at a value of Rs. 18,650 cr with Rs. 10,500 cr debt. If the stock falls by 36% from here to Rs. 30, the market cap will fall to Rs. 5,200 cr with Rs. 10,500 cr of debt (2:1 ratio). Here, there would be a serious and real risk of bankruptcy. However, there are some mitigants of this risk which we could see as our Margin of Safety.

However, if Suzlon comes out of this slump and gets back to it’s pre-crisis revenue and EBITDA numbers of Rs. 20,000 cr and Rs. 3,000 cr (15% margin) respectively, we will be richly rewarded by Mr. Market. Even at 10.0x EBITDA, Suzlon would traded at c. Rs. 30,000 cr. Enterprise Value or about Rs. 19,500 cr market cap – c. 2.4x our investment amount. The table below shows our returns at various Revenue and EBITDA levels.

When you analyse it in this manner, it looks like we have a lot more to gain than lose in Suzlon at this price. I think the risk-return equation is in favour of the investor with a decent margin of safety.

Let me also look at the margin of safety in terms of simple probabilities. After studying the competitive advantages and the Price/Value scale, let’s assume that the probability of success is 50% and so is the probability of bankruptcy. If successful, Suzlon will trade at Rs. 111 per share as per the table above. If bankrupt, we may be able to get out at Rs. 10 per share. As per the table on the left below, the expected outcome of this scenario gives us a price of Rs. 61 which gives us a margin of safety of Rs 14 or 23%.

The other way to look at this is – what is the probability that Mr. Market is ascribing to Suzlon’s failure at our purchase price of Rs. 46.6. The table on the right gives us the answer – 64%. At our purchase price, Mr. Market is implying that there is a 64% chance of bankruptcy. I think this number is a bit severe. I think the probability of bankruptcy is more like 33%.


For the company to succeed, I think we need to be sure that there is potential in the sector. These will ensure steady growth that can help Suzlon deliver better results for owners. Let’s briefly go through some of the opportunities in the wind energy sector. I got these from reading the company’s annual report.

1. Demand for Electricity
: Continued development and population growth will lead to a rise in demand for electricity. The International Energy Agency (IEA) estimates world electricity demand to go up by 2.5% every year till 2030. Although fossil fuels will be the biggest contributor to this demand, renewable energy will grow the fastest from 2.5% of total output in 2007 to 8.6% in 2030.

2. Demand for Wind Energy: Over the last 4 years, demand for wind energy has increased by 35% to 37,466 MW. Asia accounts for 39% of the installed capacity with North America and Europe contributing 29% and 28% respectively.

By 2014, the global annual capacity is expected to treble from 160 GW to 448 GW with strong additions from offshore wind farms

3. Increasing Cost Competitiveness: Wind power has the lowest cost of energy compared all other renewable energy technologies. Although fossil fuels continue to have a big cost advantage, advances in technology will continue to reduce the cost of wind energy.

4. Environmental Awareness: Generating electricity from any fossil fuel releases green house gases like carbon dioxide which contributes to global warming. Extensive use of fossil fuels severely damages the climate. I think this is the most significant growth driver for a company like Suzlon. Governments across the world have recognized this and are today actively looking at more environmentally friendly power generation alternatives like wind and solar energy. Prices of fossil fuels like coal and crude oil are also volatile and their reserves are fast depleting.

5. Government Support:
The cost of producing wind energy is still far higher than fossil fuels. Thus, governments across the world have provided fiscal schemes and incentives in order to encourage the production of wind energy. Although none of the recent summits like Copenhagen and Cancun have resulted in binding emission targets, they have led to increased awareness and focus on mitigating climate change. Let’s look at some of these schemes:

European Union – 20% of energy has to be generated through renewable sources by 2020. Fixed tariffs guaranteeing a minimum price per unit of electricity produced.
United States – Green stimulus initiatives with fixed tariffs.
China - 15% of energy has to be generated through renewable sources by 2020 and fixed tariffs.
Australia - 20% of energy has to be generated through renewable sources by 2020 and fixed tariffs.

6. Energy Security: Governments across the world are facing an energy deficit leading to a geo-political risk (US Invasion of Iraq, Afghanistan). Countries are paying special attention to their increasing energy requirements. Wind energy, being the most stable, cost effective and mature form of renewable energy is proving to be an important source for this energy requirement.

7. Offshore Market: Offshore wind farms are those that are installed and operated in water bodies. The offshore market is still in it’s infancy but is expected to become a large part of the wind energy market in the future growing from 3,000 MW to 16,000 MY by 2014. Winds are stronger and more stable offshore and availability of land is not an issue. Many countries in Europe have already installed and operated offshore wind farms. As mentioned earlier, On 26 Nov, RE Power signed a 295 MW contract with a Belgian offshore project development company, C-Power for the delivery of 48 turbines.

8. Indian Wind Energy Market:
India is the 5th largest wind power producer in the world. The cumulative installed wind energy capacity in India is expected to increase ~3x from 10.8 GW to 27.4 GW by 2014.


Since April 2009, Suzlon’s stock price has increased by 5% compared to an 85% gain for the Sensex. As an investor, I think my basis going into this stock is fairly low. I feel comfortable that I am not buying this company at an expensive valuation but at the same time I am aware of the risks involved. For me, the price-value makes compelling sense at this price and I feel comfortable of the risk-return equation. I think the company is in an exciting growing sector with strong competitive advantages and a more chastised management. I will continue to buy this stock at these levels.

Friday, November 12, 2010


Mr Market has become extremely optimistic in the last couple of months. Stocks of most companies are going up - some with valid reason and some just riding the optimism. This is always a trying time for investors like ourselves who look to invest in undervalued companies for the long run. Both the price to value ratio and the margin of safety for companies are near "uninvestible" levels.

However, I remain optimistic that Mr. Market will throw up some opportunities our way and I continue to look out for them. Below is the current list of stocks that I am tracking and reading up on. I hope to publish more detailed analysis on a few of them once the timing and valuation are reasonable:

1. Suzlon Energy
2. TTK Prestige
3. Hawkins
4. Blue Dart


Tuesday, July 20, 2010

Investing in Real Estate – Putting Your Money Where Your House Is!

I recently made a real estate investment – a 1,200 square feet (sf) 2 bedroom apartment in Koramangala (Bangalore). In my first blog, I had mentioned that real estate is an interesting investment opportunity especially in an inflationary environment. I had further pointed out that one has to be extremely careful while buying property in India given the fact that developers are not always dependable and are mostly out to screw the buyer.

I think the best way to invest in residential real estate is by purchasing completed or near completion properties in good established locations thus reducing construction, leasing and liquidity risk. It may entail paying a slightly higher amount per sf and a bulkier upfront amount (instead of a staggered construction-linked payment) but the benefits far outweigh the costs.

Before we go any further I would like to share some numbers from my investment: (click to enlarge)

The table above is a simple quarterly financial model I created to understand how much and under what circumstances I can make returns from this investment. The first box titled “COST OF PROPERTY” lays out all the costs I incurred in closing the deal including registration, stamp duty, brokerage and loan charges. As you can see, the total cost of this apartment came to about Rs. 59.6 lakhs or Rs. 4,946 per sf.

Similarly the rents table shows what rent I was able to get for the property. Currently the rent is Rs. 20,500 per month with a built-in bump of 5% per year. The Yield table show what rental yields I am making on my investment. For e.g for the 1st year I am making a 3.5% yield. This is the annual rent (minus maintenance and property taxes) divided by total cost (Rs. 59.6 lakhs). This goes up to 4.1% by year-4 because of the bumps.

The Sources and Uses table lays out how I have financed this purchase. I have taken a 40 lakh loan from Citibank at 8.5% (fixed for 3 years). I have assumed that I will sell this property after 4 years at Rs. 6,000 per sf – 20% more than what I paid for. Each one of you is the best judge of what this number should be for your own investment. I am pretty confident of this number for Koramangala.

There are also some savings in income tax, which is the benefit you get (in the form of higher monthly take home salary) from taking a home loan. (Refer to the last section for more). In my case the savings are about Rs. 4,500 per month. The EMI on my loan is Rs 34,700. So, the net gap I need to fund every month is Rs. 34,700 - Rs. 4,500 – Rs. 20,500 = Rs. 9,700. The table below lays out these calculations.

There is an interesting point to note here. The monthly interest on my loan is about Rs. 28,000. The total rent and savings in income tax is Rs. 25,000 (Rs. 20,500 + Rs. 4,500). That’s a gap of Rs. 3,000 per month. So of the Rs. 9,700 that I pay, around 30% is interest and the rest is principal repayment. Ideally, 100% of what I am paying from my pocket should have gone towards the loan with the tenant and the government funding the interest (and that’s my immediate plan) because otherwise it would mean that I am making my money work not for me but for the bank. Of course, this % totally depends on what % of the house you are funding with your own equity. In my case it was 33%. Had it been more this gap would have been lower.

Looking at it in this way the cash flows very closely resemble that of a Systematic Investment Plan (read my earlier blog). In a way this is nothing but an SIP on real estate. The only difference is that this SIP is on ONE asset with the price being fixed upfront. However, it is an asset that you fully understand and have thoroughly researched. I think the risks are a lot lower when you understand what you are getting into. According to me, this is one of the best ways to invest monthly on a real asset.

Coming back to the model, if I sell the property after 4 years for Rs. 6,000 psf (Rs. 72.3 lakhs) and repay the loan, I stand to make about 12% per annum and 1.5x my initial capital. This seems a reasonable rate of return for an asset that is comparatively less risky.

A sensitivity table on the right shows how the returns would vary if I were able to sell at higher or lower prices. For e.g. If I sell for Rs. 6,500 psf I make 17% and 1.8x my capital. At Rs. 7,000 psf I make 21.2% and 2.0x my capital and so on. I am confident that my returns here will be between 12.0 and 20.0%. Even if I am not able to sell at my price, the investment always gives me the option to hold it for a longer period of time and keep earning rental income. Perhaps, I may even want to stay there in the future. This flexibility is an added advantage of a residential real estate investment.

Now that we’re done with the numbers, I want to spend some time to understand why I think real estate is a good investment today.

The biggest drivers of my real estate investment were

1. Inflation
2. Capital Appreciation
3. Regular Income / Retirement Planning
4. Other Ancillary Benefits

Lets look at all these reasons one by one.

1. Inflation

Inflation scares me. Period.

Prices of food, petrol, travel etc are going up rapidly every year. It used to cost me Rs. 18 to travel from my house in Colaba to my office in Nariman Point in 2007. In 2008 it rose to Rs. 22. Today the same journey costs me Rs. 27. That’s a 50% increase in 3 years. On 16th July, Mint published an article on inflation which compared the cost of ordinary household groceries in 2000 and 2010. The results were the following:

The story is the same for all vegetables, grocery items, meat products etc. Newspapers give us a variety of reasons for this - bad monsoons, high government debt, rising nominal incomes, higher money supply, demand pull, supply push and so on and on. Whatever the reasons may be, as investors we cannot let external factors affect our investments and returns. We must do all we can to protect our investments.

My own opinion is that inflation is not going to go away any time soon, especially in a developing “growth” country like India. Our country has a large fiscal deficit that keeps growing every year due to oil and farm subsidies, infrastructure spending, rural development etc. The government borrows to fund this deficit every year. There are 4 primary ways to deal with this debt:

1. Default
2. Reduce expenditure
3. Print more money to pay off the debt
4. Borrow more

Of the 4 options, option 2 is the most difficult to execute. It’s political suicide. It makes the government instantly unpopular. Just look at the furore the recent oil price rise created in India or the protests on the streets of Greece when the prime minister announced budget cuts.

Option 1 junks your debt rating, currency and everything else you hold sacred and should be a last resort. Options 3 and 4 are the most likely ways to deal with this problem. However, with option 4 you are only postponing the problem. It’s like paying your debt with a credit card. It will end up becoming a much bigger problem later and you will again be faced with the remaining 3 choices.

Option 3 seems like the least harmful way to deal with this problem. Option 3 means more paper money in the system means more inflation means real assets will become more valuable. This is one of the main reasons why gold prices have shot through the roof in the last year. With European countries defaulting on their debt, investors are seeking the safer haven of real assets like gold.

Gold has already gone up 3x in the last 5 years and is at peak valuations right now. Maybe gold is still a very good investment. I frankly don’t know because gold prices have no fundamentals. I have always maintained that an SIP is the best way to invest in Gold.

I think right now the best REAL ASSET to invest in is property. It is affordable (you can easily get a loan), interest rates are low, it is fairly liquid and prices in most cities are below the 2008 peak levels.

My thesis for investing in real estate is that returns from real estate are closely linked to inflation. Rents go up every year almost in line with general price rise. When I started out in 2007 I used to pay Rs. 37,000 rent for my apartment in Colaba. The following year (which was the boom year), my landlord increased the rent to Rs. 49,000 (33% more). Last year (recession year) I renegotiated my rent down to 42,000 (down 14%).

My point is that rents move pretty closely with general economic conditions and is a good way to hedge against inflation. I think the basket of goods that a particular rent buys today will be more or less the same 10 years from now. Also, the cost of construction (steel, cement etc) will continue to go up and the cost of building the same house or apartment will always increase over time. This is why I like owning this asset class and this was one of the main motivations for purchasing the property.

2. Capital Appreciation

More often than not, this is the main driver for real estate investment in India. Historically property has been seen as a ‘safe investment’ that appreciates over time. This has held true in most cases. With increasing urbanization (more people moving to the cities), scarcity of land, improving infrastructure and rising incomes property prices have rapidly increased in almost every part of the country.

In Koramangala (Bangalore) itself prices have risen from Rs. 2,000 per sf in 2000 to 5,500 per sf today. I think, as long as the property is well located, the purchase prices is reasonable and the rental yield is healthy, this trend of rising home prices will continue for some more years.

3. Regular Income / Retirement

Retirement is something all of us think about. People plan their retirement by investing in insurance, provident funds, fixed deposits, post office schemes and equities but other than equities all these asset classes get their returns eaten away by inflation. I think good real estate is one of the best ways to invest in your retirement. There is no better way to get monthly inflation-adjusted “cash” returns month-on-month than rent. What’s more you can always enter into a reverse mortgage with a bank to get EMIs paid to you once you are retired.

A rented property today yields about 3.5-4.0% per annum, meaning total rent divided by total cost of apartment is around 4%. Like I pointed out earlier, the property I purchased is giving me a yield of 3.5%. However, this 3.5% grows by ~5% every year. In 10 years the property will probably yield around 3.5*(1.05)^10 = 5.7% and in 20 years around 9.3%. If you were to invest one crore in an apartment today (and pay off the debt in 20 years) the yield will be around Rs. 9,30,000 per year in 20 years, that’s Rs. 77,500 per month. Bear in mind that this does not factor capital appreciation.

4. Other Ancillary Benefits

Real estate investing has other ancillary benefits too. I can think of the following:

i) Tax benefits – If the property is “let out” (like mine is) the entire interest (minus the rent) can be set off against your taxable income reducing your tax. If the property is self-occupied you can set off up to Rs. 150,000 per year from your salary. So if you’re in the 30% tax bracket, you will save around Rs. 45,000 per year (Rs. 3,750 per month). The top right hand side of the model provides detailed calculation of how the tax benefit is calculated.

ii) Safety / Stability – Buying a house gives you that feeling of security. If nothing else, you can always stay in the house yourself with your family.

If you’re worried about inflation like I am and want to plan your retirement and have your own little cash flow stream other than your primary income, there is no better way than investing in good quality real estate.


Wednesday, June 23, 2010

Interesting WSJ Article: So That's Why Investors Can't Think for Themselves

Write to Jason Zweig at

From February through May, the Dow Jones Industrial Average gained more than 1000 points in an almost uninterrupted daily march upward. Then came the "flash crash" of May 6 and day after day of losses through May. Now, in mid-June, the market has been up six of the past seven days.

What accounts for these sudden moves? Why do investors so often seem to resemble a school of fish, all changing direction together?

Sometimes the most interesting answers to financial questions come from scientific labs. A study published last week in the journal Current Biology found that the value you place on something is likely to go up when other people tell you it is worth more than you thought, and down when others say it is worth less. More strikingly, if your evaluation agrees with what others tell you, then a part of your brain that specializes in processing rewards kicks into high gear.

In other words, investors often go along with the crowd because—at the most basic biological level—conformity feels good. Moving in herds doesn't just give investors a sense of "safety in numbers." It also gives them pleasure.

That may help explain why market sentiment can change so swiftly, why true contrarians are so hard to find and why investors care so much about the "consensus view" on Wall Street.

In the experiment, researchers from University College London and Aarhus University in Denmark asked 28 people to submit a list of songs they wanted to buy online and then to decide which they would most like to own. Then the participants viewed the ratings of the same songs by two professional music experts. Meanwhile, a magnetic resonance imaging machine recorded the patterns of activity in their brains. Finally, as a way to measure the influence of the experts' views, the participants had the chance to change their minds about which songs they wanted the most.

The brain scans showed that as soon as people learned they had chosen the same song as the experts, cells in the ventral striatum—a reward center wired with dopamine neurons that respond to pleasures like sugar and sex—fired intensely.

"If someone agrees with your choice, it's intrinsically rewarding in the same way food or money is rewarding," says one of the experimenters, Chris Frith of University College London.

Why might other people's estimates of what something is worth lead you to change your own? Their appraisal could make you unsure that yours is correct. You might become more popular once you agree with others, or joining the experts may make you feel like one yourself. "We are very social creatures," says Prof. Frith, "and we are desperately keen to be part of the group."

"When someone influences you, it happens very quickly, in under a second," says the lead researcher, Daniel Campbell-Meiklejohn of Aarhus University. "That mechanism can travel quite quickly through a population."

The experiment also showed that learning that the experts agree with one another—regardless of whether you agree with them—triggers activity in the insula, a brain region associated with pain and heightened body awareness. This suggests that the agreement of others may have a special ability to grab our mental attention. No wonder a consensus opinion is almost impossible for many investors to ignore.

Benjamin Graham, the founder of value investing, wrote that "the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities." Rather, he added, "the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion." Herding, Graham understood, is part of the human condition.

Thus, if you buy individual stocks, you should note which way the herd is moving—and go the other way. You should get interested in a stock when its price gets trampled flat by investors stampeding out of it. The list of new 52-week lows is a rough guide to what the voting machine has been trashing lately. Then run your own weighing machine, studying the company's financial statements, products and competitors to determine the value of its business—while ignoring the current price of its stock. And make a permanent record that thoroughly details your rationale for making the investment. That way, you set in stone exactly where you stood before the herd began trying to sweep you away.