tag:blogger.com,1999:blog-42468668318244282662024-02-07T09:58:07.684+05:30Investing on the 'V 'CurveA series of blogs on investing in the post recession period. The answer I am trying to find here is - what is the right investment option today?( I define investing in the exact same manner as Benjamin Graham did nearly 7 decades ago. “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return”)Kunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.comBlogger12125tag:blogger.com,1999:blog-4246866831824428266.post-34985980176652180742015-01-31T11:52:00.002+05:302015-01-31T11:52:28.732+05:30<div dir="ltr" style="text-align: left;" trbidi="on">
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<b>Moktan Capital LLP</b></div>
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Date: 28th January 2015 </div>
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Quarterly Letter
Q4 (Oct-Dec 2014) </div>
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Dear Investors, </div>
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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. </div>
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<b>A. Financial Markets: </b></div>
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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.</div>
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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. </div>
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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. </div>
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<b>B. Commodities:</b> </div>
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Let us turn our attention now to a couple of commodities. </div>
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<u>a) Gold</u></div>
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$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. </div>
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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. </div>
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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. </div>
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<u>b) Oil </u></div>
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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: </div>
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<u>Reason 1:</u> 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. </div>
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<u>Reason 2:</u> 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 $150 per barrel, this relatively more expensive method of drilling became profitable for oil companies thus increasing the supply of oil. </div>
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<u>Reason 3:</u> Geo-political power play: Saudi Arabia is the biggest producer of oil today and commands a very powerful position in international politics thanks to the world’s dependence on its production. As the most powerful member of OPEC, Saudi Arabia has historically calibrated production in order to keep oil prices stable. However, the rise of shale oil was making the US less dependent on the Middle Eastern power. The higher price of oil was also massively profiting countries like Russia, Venezuela, Iran (even with sanctions), Brazil, Libya etc making their economies stronger. </div>
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OPEC reasoned that cutting production would keep prices high and encourage further drilling of shale oil thus reducing member countries’ bargaining power while simultaneously making others stronger. As oil prices fell, OPEC actually increased their output flooding the market with more oil. As prices fell, countries like Russia, Venezuela, and Nigeria, which were highly dependent on oil exports, plunged into recession. As we speak, the S&P has downgraded Russia’s government debt to “junk” status meaning that the country is unlikely to be able to service its own debt. As a result, the Russian Rouble has fallen 106% from 32.87 / US$ 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. </div>
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<u>Reason 4:</u> 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. </div>
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<b>C. Government Bonds:</b> </div>
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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 $100 in a 10 year US bond would have made 40.1% return excluding interest (43.1% including interest). Interest rates in the Indian government’s 10-year bond fell from 8.924% to 7.860% during the same period returning 13.5% (22.4% including interest). </div>
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That is a phenomenal return considering the fact that these bonds are risk-free when it comes to return of capital. Obviously in an environment of increasing interest rates, the reverse will be true. Going into 2015, interest rates on Indian government bonds are set to fall 75-100 basis points (0.75 – 1.0%). This is because the RBI had increased rates or kept them the same for the last few years as inflation continued to be high. With inflation moderating to below 5%, the RBI cut interest rates by 0.25% in January with further rate cuts forecasted in 2015. As an investor, investing in long duration government securities will be a good strategy in 2015. </div>
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<b>D. Currency:</b> </div>
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Let us now look at how various currencies performed in 2014 and how much investors would have made by trading them. </div>
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The picture is pretty much one-sided. The US$ 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). </div>
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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. </div>
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<b>Political Update: </b></div>
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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. </div>
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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. </div>
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<b>Recent New Purchases:</b> </div>
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In Q4, 2014 the LLP made 2 new purchases: </div>
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<b>1<u>.Karnataka Bank Ltd:</u> </b></div>
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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. </div>
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Let me put down a few points on why I like this company: </div>
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<u>i) Price /Value:</u> 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: </div>
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HDFC: 27x | Kotak Mahindra Bank: 61x | ING Vysya Bank: 31x |
IndusInd Bank: 27x | ICICI: 20x | Federal Bank: 13x | City Union Bank: 15x </div>
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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. </div>
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i<u>i) Favourable Interest Rate Environment</u>: 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.</div>
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<u>iii) Dividend History: </u>The Company has a long and consistent dividend paying history in both good and bad years. </div>
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<u>iv) Balance Sheet and Financial Ratios:</u> 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. </div>
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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. </div>
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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. </div>
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<u>Current status: </u></div>
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Post our purchase; Karnataka Bank is up 17.3%, which has made us a profit of Rs. 150,000 in 3 months. </div>
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<b><u>2. Suzlon Energy:</u></b> </div>
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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. </div>
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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.</div>
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<b>Portfolio Performance:</b></div>
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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. <span style="font-size: 12pt; line-height: 24px;"> </span></div>
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[Investor Portfolio and LLP Portfolio follows]</div>
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<span style="line-height: 24px;">I </span><span style="line-height: 24px;">will write back again next quarter. As always, do not hesitate to call or mail me if you have any questions or comments. </span></div>
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Regards,<span style="background: black; border: 1pt none black; line-height: 0px; padding: 0cm;"></span><o:p></o:p></div>
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Kunal Moktan<span style="font-size: 12pt;"><o:p></o:p></span></div>
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<i><span style="font-size: 12pt;">(Managing Partner)</span></i></div>
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Kunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com0tag:blogger.com,1999:blog-4246866831824428266.post-74971113535370220572012-08-16T11:06:00.001+05:302012-08-16T11:06:34.771+05:30Update
Hi everyone,
All my blogs, updates, portfolio etc have now been shifted to my own website at moktancapital.com 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.
KMKunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com0tag:blogger.com,1999:blog-4246866831824428266.post-9418601040930636742011-04-08T18:12:00.002+05:302011-04-08T18:15:04.894+05:30Portfolio UpdateMoktan 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.Kunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com7tag:blogger.com,1999:blog-4246866831824428266.post-60401700562993058582011-02-08T18:10:00.011+05:302011-03-21T19:33:09.282+05:30SUZLON ENERGYMoktan 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.<br /><br />Let’s get straight to the point - Why did I buy Suzlon?<br /><br />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:<br /><br /><span style="font-weight:bold;">Part A</span> – FY 2006 to FY 2008<br /><span style="font-weight:bold;">Part B</span> – FY 2008 to FY 2011 YTD<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhCWM46euemKV4fcOHuoErdLTHGH5vZ6M-NaAwQ2z2rIueSwnwoaXxSfLFzRDWE8knsM6SQ0a1_4lUkRXH1DKe1HH5wkQkgdpfkSMMo7M9awdCeLewYqWieelN3YbgkigbE-fK260Mkwxk/s1600/T1.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 202px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhCWM46euemKV4fcOHuoErdLTHGH5vZ6M-NaAwQ2z2rIueSwnwoaXxSfLFzRDWE8knsM6SQ0a1_4lUkRXH1DKe1HH5wkQkgdpfkSMMo7M9awdCeLewYqWieelN3YbgkigbE-fK260Mkwxk/s400/T1.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5571306253656881938" /></a><br /><br />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. <br /><br />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!<br /><br />Now let’s see what happened after Mar-08<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgE-reUKk-HDRW1IOCf06ycND4fIbnV-hI0bp2o6AZuxT_uKWt2zCAT04a04N22BS6BwUwpQF0X5Ar4gZQrDuIuwFSMFcoFmdNAABp1oxRh9PYlMaLrKjY1FD2lnvrz5FKhPM0wgJcYMkg/s1600/T2.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 176px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgE-reUKk-HDRW1IOCf06ycND4fIbnV-hI0bp2o6AZuxT_uKWt2zCAT04a04N22BS6BwUwpQF0X5Ar4gZQrDuIuwFSMFcoFmdNAABp1oxRh9PYlMaLrKjY1FD2lnvrz5FKhPM0wgJcYMkg/s400/T2.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5571306363514366754" /></a><br /><br />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!<br /><br />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<br /><span style="font-weight:bold;"><br />DEBT</span><br /><br />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.<br /><br />From the investor’s point of view there are two good things to gain out of this:<br /><br />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.<br /><br />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.<br /><br /><span style="font-weight:bold;">Price Vs Value</span><br /><br />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.<br /><br />Now let’s put this concept in numbers.<br /><br />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.<br /><br />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? <br /><br />First, the easy part. Let’s look at what we can glean from the asset side of Suzlon’s balance sheet:<br /><br /> <br /><span style="font-weight:bold;">Sum-of-the-parts Value:</span><br /><br />(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. <br /><br />(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. <br /><br />(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.<br /><br />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.<br /><br />Now, for the tougher part. Let’s look at some of its competitive advantages.<br /><br />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.<br /><br /><span style="font-weight:bold;">1. Size:</span> 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.<br /><span style="font-weight:bold;"><br />2. Cost Efficient Produc</span>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)<br /><br /><span style="font-weight:bold;">3. Market Leader:</span> 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.<br /><br /><span style="font-weight:bold;">4. Track Record:</span> 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.<br /><br /><span style="font-weight:bold;">5. Product Range:</span> 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.<br /><br /><span style="font-weight:bold;">6. Superior R&D:</span> 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.<br /><br /><span style="font-weight:bold;">7. Brand Value:</span> “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.<br /><br />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.<br /> <br /><br /> <br /><span style="font-weight:bold;">RISK</span><br />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.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgaG1NqfN5xJY4YPL6TiFIQk8uEhm2ZBahwopvY30eQsy2WEsD3LNHKw-l0NYqGgaCENlzG4u4PaDcRhEF23Jjce0RBvSnsEN6l3YDVUN117zYwHHCNpIo9lf7vD1gN7CbVASb4JNrpl0I/s1600/T3.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 75px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgaG1NqfN5xJY4YPL6TiFIQk8uEhm2ZBahwopvY30eQsy2WEsD3LNHKw-l0NYqGgaCENlzG4u4PaDcRhEF23Jjce0RBvSnsEN6l3YDVUN117zYwHHCNpIo9lf7vD1gN7CbVASb4JNrpl0I/s400/T3.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5571299376504910066" /></a><br /><br /><span style="font-weight:bold;">RETURN</span><br />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.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiuFXA2tWYu26xjuqDsj0G65uxdb-2sb2u1geXckWmgRfvEoSTnmoulpvbiRNXnzNRezGgc_CE2Ecej8JijXIWdD_Iz82WlcI4edGa00cnOzhzU0Hck70jbhQGxfraZGhK231PlRPTeXHw/s1600/T4.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 64px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiuFXA2tWYu26xjuqDsj0G65uxdb-2sb2u1geXckWmgRfvEoSTnmoulpvbiRNXnzNRezGgc_CE2Ecej8JijXIWdD_Iz82WlcI4edGa00cnOzhzU0Hck70jbhQGxfraZGhK231PlRPTeXHw/s400/T4.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5571299529938157458" /></a><br /><br /><br />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. <br /><br />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%. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhhxCc1boR8qwbBvwMj_JOg3i9NEvGcbEToyaL-iCsO6N2mh1VZmXPSx-DXJ80JUVurTdmy-gEr0kWnWPWyZl5c_6OXd2B1fhUzaEnFlofu6owkzZlJsa0qJSNsMBGs4awdNLk4KDrF-p0/s1600/T5.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 73px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhhxCc1boR8qwbBvwMj_JOg3i9NEvGcbEToyaL-iCsO6N2mh1VZmXPSx-DXJ80JUVurTdmy-gEr0kWnWPWyZl5c_6OXd2B1fhUzaEnFlofu6owkzZlJsa0qJSNsMBGs4awdNLk4KDrF-p0/s400/T5.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5571299677503939986" /></a><br /><br />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%.<br /> <br /><br /><span style="font-weight:bold;">THE OPPORTUNITY</span><br /><br />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.<br /><span style="font-weight:bold;"><br />1. Demand for Electricity</span>: 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.<br /><br /><span style="font-weight:bold;">2. Demand for Wind Energy</span>: 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. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg6wZxN0BeHQqF8X9NzuGdDxRnOum88fLQTWkKUjgeBwZ4Op8lWzE_qvS0uxVChiVfYqtZ7N7FwHu_1Y-gobpNJrkM3YXoTTJIESlTyA8qvAJEsdP43Zz9Y2jKGG3AiCVrP9pwsVgn_a8E/s1600/T6.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 109px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg6wZxN0BeHQqF8X9NzuGdDxRnOum88fLQTWkKUjgeBwZ4Op8lWzE_qvS0uxVChiVfYqtZ7N7FwHu_1Y-gobpNJrkM3YXoTTJIESlTyA8qvAJEsdP43Zz9Y2jKGG3AiCVrP9pwsVgn_a8E/s400/T6.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5571299824911277458" /></a><br /><br />By 2014, the global annual capacity is expected to treble from 160 GW to 448 GW with strong additions from offshore wind farms<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMJd6E6xICTbGZEwzlXGIsQ3pvyFgVkBXIF8g6gWKeb3RqAcFA2Zz2aTs0JGuaQCnZievYSF-H9rKMFhoQvxIOwJO5St5oF_B4jZQOadKDcZlhTYtMDwf4VZo3vFMvWQkR9alRm8H1-V4/s1600/T7.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 186px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMJd6E6xICTbGZEwzlXGIsQ3pvyFgVkBXIF8g6gWKeb3RqAcFA2Zz2aTs0JGuaQCnZievYSF-H9rKMFhoQvxIOwJO5St5oF_B4jZQOadKDcZlhTYtMDwf4VZo3vFMvWQkR9alRm8H1-V4/s400/T7.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5571300019840294882" /></a><br /><br /><span style="font-weight:bold;">3. Increasing Cost Competitiveness:</span> 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.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhu9KJDpjbODv7wDHA7yD2VHnVCnog2NV2D_Uye7mr17r5RrFkX9DKsNK7KdcO7xgRKE2keH3Rl0nrOcLjHi28ShYaUNNHN_HXxJZwpG5VCceI2IZphNvrPncsr790Cst9FoYQd9Pa2u10/s1600/T8.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 202px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhu9KJDpjbODv7wDHA7yD2VHnVCnog2NV2D_Uye7mr17r5RrFkX9DKsNK7KdcO7xgRKE2keH3Rl0nrOcLjHi28ShYaUNNHN_HXxJZwpG5VCceI2IZphNvrPncsr790Cst9FoYQd9Pa2u10/s400/T8.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5571300181625005842" /></a><br /><br /><span style="font-weight:bold;">4. Environmental Awareness:</span> 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. <br /><span style="font-weight:bold;"><br />5. Government Support:</span> 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:<br /><br /> 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.<br /> United States – Green stimulus initiatives with fixed tariffs. <br /> China - 15% of energy has to be generated through renewable sources by 2020 and fixed tariffs.<br /> Australia - 20% of energy has to be generated through renewable sources by 2020 and fixed tariffs.<br /><br /><span style="font-weight:bold;">6. Energy Security:</span> 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.<br /><br /><span style="font-weight:bold;">7. Offshore Market:</span> 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.<br /><span style="font-weight:bold;"><br />8. Indian Wind Energy Market:</span> 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. <br /><span style="font-weight:bold;"><br />Conclusion</span><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhaMWk-vYQBT1Y3N4-sfuTLuqje59mkBA7C9uq2bnrSohrLVr2voAJpZxtXllp3k_jo4JbGpPifkjshdOtO-x_7fxoiCncxwbPvXpQRNqFB1fmEqlCPATU9_OlK9GhRpS87Him34lB2Ne4/s1600/T9.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhaMWk-vYQBT1Y3N4-sfuTLuqje59mkBA7C9uq2bnrSohrLVr2voAJpZxtXllp3k_jo4JbGpPifkjshdOtO-x_7fxoiCncxwbPvXpQRNqFB1fmEqlCPATU9_OlK9GhRpS87Him34lB2Ne4/s400/T9.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5571300339199606594" /></a><br /><br />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.Kunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com17tag:blogger.com,1999:blog-4246866831824428266.post-4137389144516918972010-11-12T12:21:00.002+05:302010-11-12T12:29:34.335+05:30UpdateMr 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. <br /><br />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:<br /><br />1. Suzlon Energy<br />2. TTK Prestige<br />3. Hawkins<br />4. Blue Dart<br /><br />KMKunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com10tag:blogger.com,1999:blog-4246866831824428266.post-83746675122737024592010-07-20T12:49:00.003+05:302010-07-20T12:57:35.153+05:30Investing 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. <br /><br />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.<br /><br />Before we go any further I would like to share some numbers from my investment: (click to enlarge)<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAV4hJypToV-DwXiNmJZ2yN3SKN7fFUYSjkIK40c92_RTy_U8r_GCC5iuB91K3smX2ftskaz15nWdymv8mGn2e0noQHg_F_kqQLmXYEmp9OIWGKpQm2XE1GOq8Vlkojw2r0QtHIbmyZsk/s1600/Table+1.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 297px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAV4hJypToV-DwXiNmJZ2yN3SKN7fFUYSjkIK40c92_RTy_U8r_GCC5iuB91K3smX2ftskaz15nWdymv8mGn2e0noQHg_F_kqQLmXYEmp9OIWGKpQm2XE1GOq8Vlkojw2r0QtHIbmyZsk/s400/Table+1.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5495885133855934466" /></a><br /><br />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. <br /><br />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.<br /><br />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.<br /><br />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.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhpBaTWgsunaOntsLvzd5jJGGspGI5psvwIRh31IviEdLTFA6m4kl5cktR56k2c5mf2Cmc6SIYPyQYMM6fePCLjRxK4ZS9P57T-JT-HObeDdUdfs9LY98lOgIKrcSNAadUdSEb6u-UCMGE/s1600/Table+2.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 143px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhpBaTWgsunaOntsLvzd5jJGGspGI5psvwIRh31IviEdLTFA6m4kl5cktR56k2c5mf2Cmc6SIYPyQYMM6fePCLjRxK4ZS9P57T-JT-HObeDdUdfs9LY98lOgIKrcSNAadUdSEb6u-UCMGE/s400/Table+2.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5495885550903491298" /></a><br /><br />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.<br /><br />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.<br /><br />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. <br /><br />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.<br /><br />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.<br /><br /> <br />The biggest drivers of my real estate investment were <br /><br />1. Inflation <br />2. Capital Appreciation <br />3. Regular Income / Retirement Planning<br />4. Other Ancillary Benefits<br /><br />Lets look at all these reasons one by one.<br /><br /><span style="font-weight:bold;">1. Inflation</span><br /><br />Inflation scares me. Period. <br /><br />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:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhi87ub1WWKH8_9x2gWA3bKEFpweHdqdx6rwQJq5Ae94ds8QUKM0Ke9vQ4pBC2rfyziEXjLFUsU6UGjJ3U1AUORjyS4M0so00F8abmyeIMtpVoKbA_cdgi5DS-8PMHDvZXnbe_064_8UJU/s1600/Table+3.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 185px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhi87ub1WWKH8_9x2gWA3bKEFpweHdqdx6rwQJq5Ae94ds8QUKM0Ke9vQ4pBC2rfyziEXjLFUsU6UGjJ3U1AUORjyS4M0so00F8abmyeIMtpVoKbA_cdgi5DS-8PMHDvZXnbe_064_8UJU/s400/Table+3.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5495885687529933090" /></a><br /><br />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.<br /><br />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:<br /><br />1. Default <br />2. Reduce expenditure <br />3. Print more money to pay off the debt <br />4. Borrow more<br /><br />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. <br /><br />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. <br /><br />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. <br /><br />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. <br /><br />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.<br /><br />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%). <br /><br />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.<br /><span style="font-weight:bold;"><br />2. Capital Appreciation</span><br /><br />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. <br /><br />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.<br /><br /><span style="font-weight:bold;">3. Regular Income / Retirement</span><br /><br />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.<br /><br />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.<br /><br /><span style="font-weight:bold;">4. Other Ancillary Benefits</span><br /><br />Real estate investing has other ancillary benefits too. I can think of the following:<br /><br />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.<br /><br />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.<br /><br /><br />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.<br /> <br />KMKunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com9tag:blogger.com,1999:blog-4246866831824428266.post-88960155231485590522010-06-23T11:20:00.002+05:302010-06-23T11:27:40.417+05:30Interesting WSJ Article: So That's Why Investors Can't Think for ThemselvesWrite to Jason Zweig at intelligentinvestor@wsj.com <br /><br />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.<br /><br />What accounts for these sudden moves? Why do investors so often seem to resemble a school of fish, all changing direction together?<br /><br />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.<br /><br />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.<br /><br />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.<br /><br />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.<br /><br />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.<br /><br />"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.<br /><br />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."<br /><br />"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."<br /><br />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.<br /><br />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.<br /><br />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.<br /><br />http://online.wsj.com/article/SB10001424052748703438604575314932570154178.html?KEYWORDS=jason+zweigKunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com4tag:blogger.com,1999:blog-4246866831824428266.post-2466291736336382052010-05-17T14:38:00.003+05:302010-05-17T14:44:10.169+05:30Update on Bharti and Mr. MarketLately, the telecom industry and Bharti have frequently been in the news. Given my previous blog recommending Bharti as a long term investment I thought I would spend some time to analyse the impact of the recent TRAI recommendations on our investment.<br /><br /><span style="font-weight:bold;">Recent TRAI recommendations:</span> TRAI has made a slew of recommendations last week on the telecom industry. Some of these are good for us and some are not. Mr. Market seems to have focused on one bad one with particular severity. TRAI has recommended that any player holding spectrum above 6.2 MHz would have to pay a one-time fee per MHz for the excess spectrum based on the current 3G prices. Bharti has spectrum >6.2MHz in 13 circles, the most amongst all players. If you remember, this was one of the competitive advantages we had said was in our favour giving us a “moat” from competitors. There is now a cost to protect this moat. As per current prices for each sector Bharti has to pay the following as per Thursday’s Mint:<br /><br />a. Delhi – Rs. 945 cr<br />b. Mumbai – Rs 833 cr<br />c. Karnataka – Rs. 265 cr<br />d. Tamilnadu – Rs. 264 cr<br />e. AP – Rs. 211 cr<br />f. Bihar – Rs. 40 cr<br />g. Maharashtra – Rs. 235 cr<br />h. Kolkata – Rs. 73 cr<br />i. UP – Rs. 58 cr<br />j. MP – Rs. 54 cr<br />k. Rajasthan – Rs. 52 cr<br />l. Punjab – Rs. 32 cr<br />m. Orissa – Rs 15 cr<br />TOTAL – Rs. 3,078 cr <br /><br />Lets take a re-look at the small model we had created earlier for analyzing the right price to buy Bharti:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiu4dYo5b1NKr_-DcisBnQ5m5J0jIsWh9sVBmP-DmD9T-zlTEmxCjG4nkNlbCouhiiWxt02XMmmrC3iiyL1ilxzN82vg6I5NMCdaYKZHZQ8rTwCO58_MiOqgiRZSXL4hQbbv0VctZJAk9E/s1600/Table+4.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 244px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiu4dYo5b1NKr_-DcisBnQ5m5J0jIsWh9sVBmP-DmD9T-zlTEmxCjG4nkNlbCouhiiWxt02XMmmrC3iiyL1ilxzN82vg6I5NMCdaYKZHZQ8rTwCO58_MiOqgiRZSXL4hQbbv0VctZJAk9E/s400/Table+4.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5472164376613611474" /></a><br /> <br />At my recommended price of Rs. 275 the market cap was Rs. 104,413 cr. At the current price of Rs. 260 the market cap is 98,718 cr, a difference of 5,700 cr or 185% higher than the cost of excess spectrum. The future cash flows have not changed because this is a one-time fee that does not impact cash flows going forward. Thus, Mr. Market seems to be mispricing the impact of the bad news on the stock. If we were to buy the stock at the current price and assume the recommendations will be fully accepted and therefore pay the new fee we would still be better off (98,718 cr + 3,078 cr = 101,796cr which is < 104,413 cr). What I am trying to say is that its like buying the company at 101,796 cr compared to 104,413 cr.<br /><br />The same Mint article also says that analysts at ICICI Securities estimate the impact to be Rs. 8.8 and Rs. 4.1 on the EPS for the next 2 years. As long term investors, this is precisely what we like about Mr. Market. He makes decisions with a short term horizon. We have analyzed the company’s long term strengths and are in it for the long haul and not for the next 2 years. Also, Mr Market has ignored other recommendations of TRAI which facilitate consolidation, give discounts on spectrum fees and cracks the whip on only “urban centric” players who have not helped (unlike Bharti) the rural Indian. Finally, this is just a recommendation and has not been accepted yet. <br /><br />What makes me drool right now is the fact that Bharti is available at a <span style="font-weight:bold;">42 month low</span>, that’s lower than what it was available at during the recession. I feel that Mr. Market has over reacted to the recommendations as he frequently does. Let me re-quote Ben Graham here from my earlier blog:<br /><span style="font-style:italic;"><br />“It is customary to refer with great respect to the 'bloodless verdict of the market place', as though it represented invariably the composite judgment of countless shrewd, informed and calculating minds. Very frequently, however, these appraisals are based on mob psychology, on faulty reasoning, and on the most superficial examination of inadequate information</span>”<br /><br />I plan to buy more at the current prices.Kunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com1tag:blogger.com,1999:blog-4246866831824428266.post-19198574678531376832010-03-10T15:11:00.019+05:302010-03-10T16:24:43.866+05:30Taking On Mr. Market!<span style="font-weight:bold;">Note:</span><br />I have bought 2,000 shares of Bharti Airtel on 2 Mar 2010 at Rs. 277 per share and plan to buy a significantly higher quantity if the stock is available at similar or lower prices. I think this stock has significant upside potential with low risk. My logic for this purchase is laid out below. (Its a bit long - but then i plan to commit a significant amount of my net worth in this company)<br /><span style="font-weight:bold;"><br />THE NUMBERS</span><br /><br />TABLE 1 (click to enlarge - recommend opening in new window)<br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj50q8_CG5hZSyAInuFBgDinwdh_J9PsFZ-YUPzwFBwxCXwh8gN5sBZk-0VNHCmVYZMxltEq9qmPZtYPWcmD4fJ7pS_N8w4HFJaBKOSh-SQpGjfhuhDKoCXVqMVQuA_tufPdeYDOQU167o/s1600-h/Table+1.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 145px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj50q8_CG5hZSyAInuFBgDinwdh_J9PsFZ-YUPzwFBwxCXwh8gN5sBZk-0VNHCmVYZMxltEq9qmPZtYPWcmD4fJ7pS_N8w4HFJaBKOSh-SQpGjfhuhDKoCXVqMVQuA_tufPdeYDOQU167o/s400/Table+1.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5446944470756594802" /></a><br /> <br />The table above captures the Revenues, EBITDA (operating cash flow), PAT and Market Capitalization of Bharti over the last 7 years. I have forecasted the 2009-10 numbers by simply doubling the half yearly revenue as of Sep’09 (which is in-line with its Q3 numbers). An analysis of this table reveals a lot about the telecom industry in general and Bharti in particular.<br /><br />Bharti experienced tremendous growth in the last 7 years. Its revenues went from Rs. 50 billion ($1.1 bn) in 2003-04 to Rs. 396 billion ($8.7 bn) in 2009-10. That’s an 8x jump! <br /><br />Similarly EBITDA and PAT went from Rs. 17 bn ($0.37 bn) and Rs. 5.8 bn ($0.13 bn) to Rs. 166 bn ($3.61 bn) and Rs. 97 bn ($2.11 bn) respectively in the same 7 year period. Again, that’s a 10x jump in EBITDA and a 16x jump in profits.<br /><br />In the last 7 years Bharti generated about Rs. 597 bn ($13.0 bn) of cash from operations and Rs. 318 bn ($7.0 bn) in profits (see blue boxes). However, none of this cash reached the shareholder in the form of dividends. The main reason for this was that Bharti ploughed back all of the $13.0 bn to build infrastructure – towers, underground cables, generators, sub-stations etc. as it increased it’s reach to the smaller towns and villages of India. No other telecom company (barring probably BSNL) has spent so much on building ground-up telecom infrastructure – no wonder Bharti is the largest owner of telecom towers today.<br /><br />So, how was the shareholder benefited by all this growth if no cash ever made it to his hands? In the first 4 years of the analysis, the market cap of Bharti went from Rs. 256 bn to Rs. 1,665 bn (See brown box) which means that if someone had bought Bharti on 1st April 2004, he would have made 6.5x his capital on 1st April 2008 – that’s a 550% return in 4 years! By not giving money to shareholders and reinvesting it in the business, the company and management actually made the shareholders much richer. <br /><br />However, all this was the past. All good things come to an end and the same seems to be true for the Indian telecom industry. At ~500 mm users, most urban cities have crossed the 100% penetration limit. Most of the new growth is coming from rural India (as per Bharti’s latest annual report 60% of all new customers are from rural India) which does not spend as much as urban India. In the last 2 quarters, Revenues and EBITDA have been flat for Bharti – which means new customers are not adding enough to the revenues and old customers are spending lesser. <br /><br />If lower growth were not enough, the industry is now plagued with competition. This is generally the case when the going is good and there’s money to be made. Till Jan 2008, there used to be only 3-4 players in every circle. In Jan 2008 the government issued new licenses and spectrum to 6 new players – Unitech-Telenor, Shyam-Sistema, S-Tel, Swan-Etisalat, Datacom and Loop Telecom. The government also issued new licenses to existing players like Idea, Tata and Spice in circles they were not present before. Today, there are 12 telecom operators in the country of which 10 have a pan-India license which means that potentially there could be 10 service providers to choose from in every city.<br /><br />This is going to put tremendous pricing pressure on incumbents since new players will try and garner as many of the new subscribers as possible and try and convert subscribers from other service providers using lower prices. Tata Docomo, Uninor and MTS have already started the price war by coming out with a 30p per minute scheme and forcing others to follow suit. This will impact both revenues and profits of Bharti and other incumbents. All this has been telling on the company’s stock market performance. The chart below shows how Bharti has continuously under performed the market since Jan 2009. While the Sensex has gained 73% to 173 Bharti has lost 19% to 81.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsYS784lkQLD1W1Nt7ukXKCmk2JtD4rSi9XlNkNXOXDEgNNCcbWCXaJJAFgbL_Vhyd5-TqhP5tm9KPrI_6K8LiaDCQwPiqqqBITmWzvsQvi-Y1wuZTpVdWKoRMEiP358ChK9KsoXIhKJQ/s1600-h/Chart+1.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsYS784lkQLD1W1Nt7ukXKCmk2JtD4rSi9XlNkNXOXDEgNNCcbWCXaJJAFgbL_Vhyd5-TqhP5tm9KPrI_6K8LiaDCQwPiqqqBITmWzvsQvi-Y1wuZTpVdWKoRMEiP358ChK9KsoXIhKJQ/s400/Chart+1.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5446944749103031762" /></a><br /><br />In the short term, the merger with Zain Telecom has also spooked the market, and since announcement in early Feb the stock has tanked 15% from Rs. 320 to Rs. 275. Markets generally tend to react negatively to big cross border mergers as seen in the Tata – Corus, Tata – Jaguar deals. However, all these stocks are now back to their old prices.<br /><br />Bharti currently trades near its all-time low of Rs. 280 per share with a market cap of Rs 1,100 bn. It’s P/E ratio is at ~11.0x as Mr. Market has come to the conclusion that growth in the stock is more or less over. This is a classic case of a big corporation being “currently out of favor” with the investment community. Ben Graham and Buffet have taught me that these situations present interesting long term investment opportunities and generally merit a thorough analysis of the company and its operations to see if the market is mispricing (as it frequently does) long term value in the current stock price. In the 1937 edition of Security Analysis, Ben Graham wrote:<br /><br /><span style="font-style:italic;">“It is customary to refer with great respect to the 'bloodless verdict of the market place', as though it represented invariably the composite judgment of countless shrewd, informed and calculating minds. Very frequently, however, these appraisals are based on mob psychology, on faulty reasoning, and on the most superficial examination of inadequate information”</span><br /><br />In our analysis, we need to understand 3 things:<br /><br />1. Are the long term economics of this industry intact?<br /><br />2. Is Bharti positioned to take advantage of these economics and does it have the competitive advantages that make it better positioned as compared to its peers?<br /><br />3. What is the right price to pay for the inherent long term value of Bharti?<br /><br /> <span style="font-weight:bold;"><br />QUESTION 1 – ARE THE LONG TERM ECONOMICS OF THIS INDUSTRY INTACT?</span><br /><br />If the last few quarters are any indication, revenues and profits from mobile telephony have more or less plateaued. The growth story here is, for all practical purposes over. If we see the same table on top, the red circled CAGRs on the right (cumulative average growth rates) tell the story. In the last 6 years Bharti’s wireless revenues grew at a CAGR of 48%. In the last 3, 2 and 1 year the rates were 32%, 22% and 8% respectively. The only growth here can come from rural India which is going to be nowhere as exciting or sexy as that experienced by urban India in the last decade.<br /><br />As investors, we can assume that mobile (or wireless) revenues are going to remain flat or show very little growth in the next 5-10 years. For Bharti, this is going to be a cash cow spitting out Rs. 100 bn ($2.2 bn) of cash EBITDA every year (since incremental capex on towers is going to be much lower). Bharti knows this as much as anybody else. It has to find newer un-penetrated markets to deploy this vast cash pile or it will remain a cash machine doling out huge dividends to its shareholders. Thus, the rush to enter new markets in Africa, Bangladesh and Sri Lanka.<br /><br />The other indicator of future growth is the rush of foreign operators to enter India. As a Telenor or a Docomo or for that matter Etisalat, why would I want to enter a market that is saturated unless I saw value there? All these firms must have done their own research to see the potential for growth in India. However, my own experience of seeing foreign PE funds investing in India has made me fairly cynical about the quality and depth of their research. The other day I read an interview of the Sistema CEO saying there is a 700 million untapped subscriber base in India. I guess he was talking about India’s 1.2 bn population minus the 500 mn subscribers we currently have. Taking decisions on the basis of that number is a bit naïve as it assumes the whole of India’s population will start using cell phones in the future. Included in that are people below poverty line, children and senior citizens.<br /><br />I think the real growth, if any should come from non-voice services because this is one area where there is still scope for growth. Around the world, telecom companies seem to derive almost 25% of their revenues from non-voice services like net browsing, data transfers, wimax etc (see the 2 graphs below by Motila Oswal and Deutsche Bank) whereas only 10% of revenues in India currently come from these services. Bharti’s non-voice revenues stand at 9%. With the upcoming auction of 3G and WiMax airwaves this segment is set to ride the next growth wave. Bharti stands to gain here more than others because of its captive subscriber base of 110 million users and lower incremental capex on infrastructure.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9ntM7yW19ZCGlpFtBnGbp6GUrJ-XHAZQQQwtZ8A9b7-2w-XwzcLzlQWi_OyI5_b4iESrAA9f3NxJf-H-_8u3p46dURGGqI2xOBW8RRq3Z1k8_fDCW1qB0Bv0a7uq6WZRQ3T07qY-SUGE/s1600-h/Chart+3.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 242px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9ntM7yW19ZCGlpFtBnGbp6GUrJ-XHAZQQQwtZ8A9b7-2w-XwzcLzlQWi_OyI5_b4iESrAA9f3NxJf-H-_8u3p46dURGGqI2xOBW8RRq3Z1k8_fDCW1qB0Bv0a7uq6WZRQ3T07qY-SUGE/s400/Chart+3.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5446946287966178610" /></a><br /><br /><br />Source: Motilal Oswal Research (Jun 2009)<br /> <br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQepvnEBvBN2V7HX18K17wQ94qoiD2L5XAVZ-BSwt2cHRYOfn-J-NusBTwcsnJ08Z2UFv-juz92k1rEld8HV2hDZ5-xy-NiDSZBzXYCBtaHBvLAgRwhKQY5bJ8PiBPES59IUAY_ZIwKwA/s1600-h/Chart+2.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 243px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQepvnEBvBN2V7HX18K17wQ94qoiD2L5XAVZ-BSwt2cHRYOfn-J-NusBTwcsnJ08Z2UFv-juz92k1rEld8HV2hDZ5-xy-NiDSZBzXYCBtaHBvLAgRwhKQY5bJ8PiBPES59IUAY_ZIwKwA/s400/Chart+2.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5446946286255541378" /></a><br /> <br />Source: Deutsche Bank Research (Feb 2009)<br /><br />Passive infrastructure is the other area of growth for Bharti. Being an incumbent, it enjoys superior infrastructure which it can share with new players who cannot spend billions on infrastructure as it did. This leads to infrastructure sharing which will bolster the revenues of Bharti. Having spent huge capex over the last 10 years it can sit pretty as new incumbents lease tower space from it and pay rents. <br /><br />I think these are the core areas of growth which can lead to higher revenues and profits in the next 5-10 year period. <br /><br />This answers our first question. Though the next 5-10 years is not going to see the kind of growth the last decade witnessed, there is still some milk left in the udder. Maybe it’s going to be 10% or 15% and not the 41% of the last 7 years but its definitely there.<br /> <br /><span style="font-weight:bold;">QUESTION 2: IS BHARTI POSITIONED TO TAKE ADVANTAGE OF THESE ECONOMICS AND DOES IT HAVE THE COMPETITIVE ADVANTAGES THAT MAKE IT BETTER POSITIONED AS COMPARED TO ITS PEERS?</span><br /><br />In Buffet terminology this is the “moat” that keeps away potential competitors from coming in and destroying shareholder value by eroding margins and growth. This is the key to long term value investing as it helps protect investors like ourselves from nasty surprises in the future. I want to spend some time here because the next few points are going to help me sleep well when the market goes crazy (as it will) in the future.<br /><span style="font-weight:bold;"><br /><br />Competitive Advantages / Barriers to Entry</span><br /><br /><span style="font-weight:bold;"><br />1. SPECTRUM</span><br /><br />Being the earliest entrants, Bharti, Vodafone and IDEA have been allotted spectrum in the 900 Mhz band. Among the three, Bharti has the highest (15 of the 23 circles) allocation in the 900 Mhz band followed by Vodafone (9 of the 23 circles) and Idea (9 of the 23 circles) while none of the new entrants – Tata Docomo, Unitech Telenor, Swan and BPL have 900 Mhz spectrum. All new entrants have been given spectrum in the 1,800 Mhz band.<br /><br />A little read on the internet and broker reports tell us that the 1,800 Mhz band is commercially less viable as it requires double the number of towers for similar coverage. This is because network signals in the 1,800 Mhz have half the wavelength Vs 900 Mhz. Thus, incremental capex and opex is going to be double here for new entrants leading to massive capital expenditure and lower margins. This a double whammy for new players as it affects both the balance sheet as well as the income statement. Motilal Oswal estimates the impact of this to be 10-15% on the bottom line. Also, new entrants would have to price their product at a much lower price (what Tata Docomo, MTS and Uninor are doing now) in order to get higher subscribers. This will put even more pressure on their bottom lines till eventually they will have to increase rates or go out of business.<br /><br /><br /><span style="font-weight:bold;">2. NETWORK</span><br /><br />I think there are 4 aspects to this point as outlined below:<br /><span style="font-weight:bold;"><br />1. The Reach Aspect</span><br /><br />As per their latest annual report Bharti Infratel (Bharti’s tower subsidiary) exclusively owns 27,548 towers in 11 circles and 35,066 towers in the remaining 12 circles through Indus Towers (where it has a 42% stake). Indus Towers is a JV between Bharti, Vodafone and Idea and owns towers in 16 circles (4 circles common with Infratel, 12 circles on exclusive basis). Therefore, together with Indus, Bharti owns towers in all 23 circles in India. This is the highest across all private telecom operators in India.<br /><br />Bharti covers 5,060 census towns and 414,906 non census towns and villages in India covering 81% of the country’s population. Its national long distance infrastructure consists of 101,337 route kilometers of optical fibre while its international infrastructure includes ownership of the i2i submarine cable systems connecting Chennai to Singapore and joint ownership of transatlantic and transpacific routes. Any player, especially new (and on the 1,800 Mhz band) will find it extremely difficult and costly to replicate this network reach (up to 5 years or more as per industry analysts). Higher network coverage also means quality of service (roaming, network and data coverage) are far better for a customer using Airtel compared to a new entrant or an incumbent with lower reach.<br /><br /><span style="font-weight:bold;">2. The Value Aspect</span><br /><br />In Feb 2008 KKR bought a 2% stake in Bharti Infratel for $250 mm implying a valuation of $12.5 billion for the whole company (see table below). However, Feb ’08 was the peak of the market and valuations were most probably stretched. Having said that, as late as Dec 2009 Citigroup sold its stake to JP Morgan at cost for $50 mm valuing Bharti Infratel at $10 billion. If we go ahead and buy Bharti shares we will automatically become owners of the tower company as well. Therefore, while analyzing Bharti, we will treat the Infratel arm separately by subtracting its “value” from the enterprise value of Bharti or by treating it as an ‘extra gift’ that we get with every one share of Bharti.<br /><br />Table 2<br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijpKPIZZbYu8497aZSgatfiSUN2ylp3xGzsElqBZMrQ4zVYEkZA1xBVmWyXcjfB5Z9smSn4uD89XrlntBALYA-GpOFkqSrprhjyOIKJcME5fpINVNHrzQOlnK_WfBBU8U8oHdnSYYJp7I/s1600-h/Table+2.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 71px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijpKPIZZbYu8497aZSgatfiSUN2ylp3xGzsElqBZMrQ4zVYEkZA1xBVmWyXcjfB5Z9smSn4uD89XrlntBALYA-GpOFkqSrprhjyOIKJcME5fpINVNHrzQOlnK_WfBBU8U8oHdnSYYJp7I/s400/Table+2.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5446946721316673970" /></a><br /><br /><span style="font-weight:bold;"><br />3. The Cost Aspect</span><br /><br />The setting up of a tower involves both passive (tower itself, repeaters, shelters, generators etc) and active infrastructure (electronic components on the tower such as antennas, feeder cables, nodes, radio access networks etc) spending. As per industry experts, the cost of setting up one tower is Rs. 30 lakhs. Clearly, new entrants will have to spend substantial amounts of capex on the construction of these towers. Amongst the incumbent private players, Bharti has spent the most on the setting up of these towers across the country. As we pointed out earlier, Bharti has spent close to Rs. 596 billion ($13 bn) in developing this infrastructure in the last 7 years alone.<br /><span style="font-weight:bold;"><br />4. The Revenue Aspect</span><br /><br />As a new player it makes more sense to lease towers from incumbents than to spend on constructing them. This does 2 things – 1) makes new players dependent on incumbent players and 2) generates additional revenue for incumbent players. Also, new players still need to spend on active infrastructure to cater to their customers, so it’s not exactly ‘capex light’<br /><br />For the year ended Mar 2009 Bharti’s revenues and EBITDA from passive infrastructure (tower business) were Rs. 42,489 mm (9% of total revenues) and Rs. 15,022 mm (9% of total EBITDA) respectively, a growth of more than 700% from Mar 2008. As new players enter the market, revenues from this segment are bound to go up even higher.<br /><span style="font-weight:bold;"><br />3. SCALE</span><br /><br />At 141 billion minutes, Bharti was 5th in the world in the number of mobile minutes carried on its network for the Apr-Jun 2009 quarter (see table below) and almost double its nearest competitor in India - Vodafone. This is a significant achievement given the fact that compared to the other players; Bharti is a single country operator (Vodafone operates in 30 countries). Despite such high volumes, Bharti’s EBITDA margin from the mobile phone business in FY09 was 41%. This gives you some indication of the scale and cost structure that Bharti has built-up over the years. As per Macquarie, it is “likely the lowest cost producer of voice minutes in the world and this remains the biggest entry barrier for greenfield players”. This is a huge benefit for the investor as this provides a safety float around the company which makes it difficult for competitors to match its products and services at the same cost.<br /><br />On 14 Dec, 2009 Economic Times ran an interview of Vodafone CEO Vittorio Colao. Let me quote verbatim a few lines from the interview that will give you an idea of Bharti’s scale advantage. <br /><br /><span style="font-style:italic;">Q: In your last quarterly results, you have said that despite the price wars, Vodafone will be looking to leverage its brand and scale in India. How do you plan to do so? I believe your operating costs in India are much higher that that of your closest competitor Bharti Airtel.<br /><br />A: …In terms of networks, we have been able to use our global scale to get the best deals from western and eastern equipment companies. Yes, Bharti has scale and they are ahead of us, but we are patient. Give us another 15 YEARS and we will catch up with them<br /><br />Q. You must be joking about the 15-year period.<br /><br />A: I am serious. In our sector, it takes time. I am not obsessed with being number 1, but we are happy to be among the top two leaders of the market here. Bharti is a very well run company. I admire them. But right now, they are well ahead of us</span><br /><br />These words coming from its biggest competitor are manna for the investor’s ear!<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnQInZ1VFyGrm4TO-SoHEokKWacEWusPeab0kOseUfAqAg-eOfvbheHzy24DXueVhm3v7x_k_xe2zNZwQ1FfmrzI_21LtbE4ajoHkwtmmRT-g5p7BcdiJj9XYsEx3srMJWR_N4WDdEm8Y/s1600-h/Chart+4.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 241px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnQInZ1VFyGrm4TO-SoHEokKWacEWusPeab0kOseUfAqAg-eOfvbheHzy24DXueVhm3v7x_k_xe2zNZwQ1FfmrzI_21LtbE4ajoHkwtmmRT-g5p7BcdiJj9XYsEx3srMJWR_N4WDdEm8Y/s400/Chart+4.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5446946726136296034" /></a><br /> <br />Source: Macquarie Research (Oct 2009)<br /><span style="font-weight:bold;"> <br />4. BRAND</span><br /><br />Airtel was voted the 2nd most trusted brand in an economic times brand equity survey and 8th in the Top 50 most valuable brands in the world (by Brand Finance Plc). Over the years, Bharti has spent substantial amounts of money on marketing and advertising the ‘Airtel’ brand resulting in significant brand recall amongst consumers. In FY09 alone it spent $521 mm (Rs. 2,500 crore) on sales and marketing. <br /><br />New players will find it extremely difficult to match the advertising budget of large scale players like Bharti and Vodafone who have already built up a significant brand presence throughout the country. Also, as an investor in Bharti it’s heartening to know that it is this brand that makes ordinary subscribers go to local kirana stores or airtel outlets month after month to recharge the currencies in their cell phones. <br /><br /><br /><span style="font-weight:bold;">5. LEADERSHIP & MANAGEMENT</span><br /><br />Sunil Bharti Mittal is the founder, owner, chairman and managing director of Bharti and owns close to 45% of the company. A short wikipedia search reveals that he’s a first generation entrepreneur who started his first venture as early as 1976 with a capital of Rs. 20,000 making crankshafts for bicycle manufacturers. After selling his bicycle parts business in 1980 he moved to Mumbai and stared a generator importing business and in 1984 started assembling mobile phones in India. He got his first big break in 1992 when the government was auctioning mobile phone licenses in Delhi. Understanding the potential of mobile connectivity, he bid and won 1 of the 4 auctioned licenses and has since built Bharti into the largest telecom operator in India with more than 110 million customers and $8 billion in revenues.<br /><br />No doubt, Sunil Mittal has the vision and the entrepreneurial flair required for success but the best thing about him is that he has built-up and maintained a squeaky clean image of himself and his company. In the post Raju era, an investor needs to be doubly sure that the person at the helm of affairs is passionate and committed (financially and emotionally) to creating shareholder value. He is also conservative (Bharti has very little debt with most capex funded by internal accruals). All this has led institutional investors to own close to 27% of the company. <br /><br />One of the best tangible ways to measure management performance is to see how effectively management reinvested earnings to create shareholder value. Buffet always says that “for every dollar retained by the corporation, at least one dollar of market value should be created for owners”. I did this exercise for Bharti for the last 7 years. The results are laid out in the table below:<br /><br />Table 3<br /> <br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWS3E6EHykTruN_38SaWMxNCVEtS_wy3rbyN0u_LHo3WegxT2ZwkaM8gQ7Nl-agoZBs0_pskmLIwhEOmAIMz61ragxDLk6_BSzJzWVRG6WkWyaRuqsxSJd5PmlzA0hX9-oCFhyHZn9c7Y/s1600-h/Table+3.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 81px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWS3E6EHykTruN_38SaWMxNCVEtS_wy3rbyN0u_LHo3WegxT2ZwkaM8gQ7Nl-agoZBs0_pskmLIwhEOmAIMz61ragxDLk6_BSzJzWVRG6WkWyaRuqsxSJd5PmlzA0hX9-oCFhyHZn9c7Y/s400/Table+3.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5446956677654970306" /></a><br /><br />In the last 7 years Bharti retained Rs. 318 bn from shareholders and reinvested it into the business. At the end of 7 years, Bharti’s market value increased by Rs. 788 bn. That’s Rs. 2.5 of value for every Re. 1 invested in the business. The other option would have been to return everything to shareholders so that they can invest that money on their own. Clearly, in this case it would have been far more profitable for shareholders to invest it back in the company than to invest it on their own. This number gives you confidence in the management especially in light of the recent Zain merger. If Bharti can reinvest future earnings and create similar value, it could mean a windfall for equity shareholders in the future.<br /><br />These 5 competitive advantages create a fairly secure moat around the company. As shareholders I think, we can rest assured that the company is far ahead of its competitors especially with regards to its first mover advantage in spectrum allocation, the depth and reach of its network, the scale of its operations, its brand and finally its strong management team. These attributes should keep the company ahead of the pack for a few years to come. (15 years as per its nearest competitor).<br /><br /><br /> <br /><span style="font-weight:bold;">QUESTION 3: WHAT IS THE RIGHT PRICE TO PAY FOR THE INHERENT LONG TERM VALUE OF BHARTI?</span><br /><br /><br />Now that we know what the potential of the industry is and the inherent competitive advantages that Bharti enjoys, we need to answer the all important question – What is the right price to buy this value? <br /><br />In the first table we saw how Bharti has performed in the last 7 years. Now let’s try and extrapolate this table 5 years forward and see, with the help of some basic assumptions, what we can expect:<br /><br />We will make the following basic assumptions in our forecasts for the 5 year period:<br /><br />1. The growth rate of profits, EBITDA and Revenue<br />2. The P/E ratio at which the company will trade 5 years from now<br />3. The value and timing of sale of the Tower business<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjkCY1HLzUPcyq8wo1EfAMIpxG4EKVx6YvvcCUNPnf9e0CPQ6IQyPsHbbtr7EOlZuub1jsQNzaIgGqW9vrErxdwfZB1FFsNK5J_3VvXnA0qY4-WagJa_TKi-KV2x8RGM1O0FDzvZpl6qOs/s1600-h/Table+4.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 244px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjkCY1HLzUPcyq8wo1EfAMIpxG4EKVx6YvvcCUNPnf9e0CPQ6IQyPsHbbtr7EOlZuub1jsQNzaIgGqW9vrErxdwfZB1FFsNK5J_3VvXnA0qY4-WagJa_TKi-KV2x8RGM1O0FDzvZpl6qOs/s400/Table+4.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5446947274601178850" /></a><br /><br />Let’s start by assuming a 10% annual growth in profits over the next 5 years (see red circle). The 2009-10 profits is most likely going to be around Rs 97 bn. If we grow this by 10% every year it becomes 156 bn in 2014-15. Remember this number was 60%, 34%, 23% and 23.1% for the last 6, 3, 2 and 1 year respectively but of a much lower base. The 10% number may seem to be conservative given the fact that Bharti is going to earn incremental revenues from non voice services, Zain merger and tower revenues. There is also a strong likelihood that the industry will consolidate in the next 5-10 years with only the strong players remaining profitable.<br /><br />However, we need to be mindful of the competition and risks involved. Here, it’s best to apply Ben Graham’s “Margin of Safety” approach which advocates that investors will never know everything about a given company. However much we try to analyse the risks, we will end up making errors on macroeconomic events, interest rates, regulatory changes etc. Like Buffet said "It is better to be approximately right than precisely wrong." We should err on the conservative side. 10% is not an unreasonable number given our discussion of future growth.<br /><br />Our second assumption is that Bharti will trade at a P/E of 10.0x after 5 years. This seems reasonable given the fact that Bharti is likely to be a stable cash flow generating company after 5 years. A P/E of 10.0x implies little or no growth in the business going forward. I think this number too can surprise us only on the higher side.<br /><br />Our third assumption is that the tower business trades at $9 bn, a 25% discount to peak valuation of $12 bn and a 10% discount to the most recent transaction, which was when Citigroup sold its Bharti Infratel stake to JP Morgan for an implied valuation of $10 bn in Dec 2009. We also assume that this is the same value at which this company trades after 5 years. Here again, we are being conservative. If the tower business is IPOed at a higher valuation this number could increase by 25 to 50%. However, our objective is to see if it makes sense to buy this company at the most punitive of assumptions. The tower valuation at $9 bn also implies that our going-in P/E is 7.17x (green circle) for the wireless business.<br /><br />Armed with these 3 assumptions we can calculate the going-in price at which we make a reasonable return on our investment. Starting with Rs. 275, the model tells us that we can make a 12.4% IRR (78% return over 5 years) or 1.78x our investment in 5 years if these 3 assumptions turn out to be true. The stock price at the end of 5 years would be Rs. 481.9 (see green circle). A small sensitivity table below tells us what will happen at different growth scenarios:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjKvUXkS1_4XiEje-SfyLs0IgX0kMju3Flc9iP8_mMqpkIGPsS5ur67NlTfaSkhZPAC-b4L8rt5EAlu3trLfhDelHmE5QBfb8e3tL0bGHq-oZIj0O4PdbyAOlBPwGWt6r5xyrMLViq1XrY/s1600-h/Table+5.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 94px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjKvUXkS1_4XiEje-SfyLs0IgX0kMju3Flc9iP8_mMqpkIGPsS5ur67NlTfaSkhZPAC-b4L8rt5EAlu3trLfhDelHmE5QBfb8e3tL0bGHq-oZIj0O4PdbyAOlBPwGWt6r5xyrMLViq1XrY/s400/Table+5.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5446947282909960530" /></a><br /><br /><br />If the growth in profits turns out to be 20% instead of 10%, we can make a 20.6% IRR (153% return over 5 years) per annum and 2.53x our initial investment (see the 20% column). For this to happen, the stock price after 5 years needs to be Rs. 685. <br /><br />What I like about this sensitivity is that even if the company grows by only 5%, we will not lose money. We still end up with a 8.5% annual return. However, a closer scrutiny reveals that at 5% growth the retained earnings (Rs. 533 bn) will be much higher than the difference in market cap (Rs 491 bn) implying that Bharti will not be able to create even Re 1 of value for every Re 1 invested. We can, at the least, expect Mr Mittal to create value equal to reinvested earnings. Otherwise he is better off declaring all profits as dividends. From our earlier analysis (Table 3) we also know for a fact that in the last 7 years he reinvested Rs. 318 bn and returned 787 bn or 2.5x. Even our conservative 10% growth case assumes that he will only create Rs. 785 bn of value for Rs 617 bn of investment or 1.3x (see green circle).<br /><br />Now, if we do the whole analysis at Rs. 250 per share going-in price instead of Rs. 275, our return becomes 14.6% going in (1.96x capital). See the table below for numbers at Rs. 250:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh26kwFAMDfhbVskjVqnNHfTUMpU4UWuK6qA-MwYvWEUho14HOWrMwmyCFVtcEQhtBhCHIeaUIySuhyDhJJpLFD0k2QJEPGvi2cruHLIJkUt36z07CBwxSRnrLdQcVd9USx-WGE90YKBa0/s1600-h/Table+6.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 97px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh26kwFAMDfhbVskjVqnNHfTUMpU4UWuK6qA-MwYvWEUho14HOWrMwmyCFVtcEQhtBhCHIeaUIySuhyDhJJpLFD0k2QJEPGvi2cruHLIJkUt36z07CBwxSRnrLdQcVd9USx-WGE90YKBa0/s400/Table+6.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5446947284954110386" /></a><br /><br />At 300 we make only a 10.4% IRR and 1.64x multiple. So obviously, the margin of safety reduces the higher up we go and increases lower the price. This leads me to conclude that between Rs 250 and 275, there is a chance of making significant returns with a high margin of safety. <br /><br />The upside potential is high if non-voice revenues kick-in post 3G auctions, if Zain does reasonably well, if Mr Mittal is able to create greater value for every rupee reinvested in the business and if the tower business is “IPOed” at a higher valuation. If any / all of these add a 10-15% growth to the PAT the stock could trade at around Rs. 800 in 5 years. <br /><span style="font-weight:bold;"><br />Concluding Note</span><br /><br />The urban Indian today is hopelessly addicted to his cell phone and is not going to stop using it any time soon. In fact he will probably use it even more, not just to talk but also to check mail, news, sports updates, transfer money, browse photos, follow social networking sites etc. As an investor in Bharti that would make me feel really good. Every time you talk to someone using Airtel the cash registers are ringing and I am likely to get 20% of it. So in a way investing in Bharti is no different from investing in a cigarette manufacturing company – it has consumers who are hooked to the product and who shell out cash at fixed intervals so that they can keep talking on their mobile phones. Every time you see someone talking on the phone there is a 25% chance that he/she is using Airtel, making the investor the ultimate beneficiary. <br /><br />What’s even better is that it’s the market leader in the industry, it is led by Sunil Mittal who has a history of creating shareholder value and creating and managing a highly low cost and profitable business model. It has a brand that is recognized throughout the country and used by 25% of all cellular subscribers. Finally, it’s a company with high entry barriers and significant competitive advantages. <br /><br />At the prices I mentioned above, especially in the Rs. 250-275 range, I am willing to bet 50% of my hard earned net worth in this one company. Right now the price may be around Rs. 290 but as investors we need to be patient and wait for the right price to pay. I would advise you to wait for the stock to come in investment range and add slowly to your position, as I will be doing. I think it’s only appropriate to end with a quote by Ben Graham:<br /><span style="font-style:italic;"><br />“It requires strength of character in order to think and to act in opposite fashion from the crowd; and also patience to wait for opportunities which may be spaced years apart.”</span><br /><br />KMKunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com7tag:blogger.com,1999:blog-4246866831824428266.post-16236342082103079102010-02-11T17:32:00.007+05:302010-02-13T14:35:22.076+05:30Riding the 'V'In the last few weeks, there have been quite a few news articles on investing in company fixed deposits. Since my piece on Mahindra, some new companies have also hit the market with their deposits like Unitech and JP Associates. Here I would like to reiterate that as investors we need to be very careful of every issue and should deeply analyze the issuers / issue before we commit any of our hard earned capital. <br /><br />In this blog, I am going to analyze, with the help of some data the pros and cons of an investment technique that has oft been written about and discussed in the investing world – Dollar Cost Averaging (also known as Systematic Investment Plan). At the end of the blog I would like to answer the question – Is dollar cost averaging helpful?<br /><br />Simply put, dollar cost averaging means investing a fixed sum of money every period in a particular asset class. The benefits of doing this are the following:<br /><br />1.It is simple and does not require you to be an expert on anything (stock market movement, GDP, interest rates, fiscal deficit, inflation etc)<br /><br />2.It removes the emotional aspect of investing because it is mechanical and does not require you to think or react to anything<br /><br />3.You end up saving a fixed amount every month which becomes a large sum later<br /><br />4.It is a very passive and cheap way of investing<br /><br />In order to verify the effectiveness of this technique I decided to look back at the Sensex for the last 10 years starting 1st Jan 2000. I took 10 years so that I would capture at least 1 full business cycle. What would have been the result if an investor had invested a fixed amount of Rs. 10,000 every month for the last 10 years starting 1-Jan-2000 into the Sensex? The results are below:<br /><br />(click on table to enlarge)<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgeolJTz8kfiMpa6Uz4nyR4fz9IbFAotg-Nly3108N9a2u9rzy-RQFw5OuuYXe2dsZGYeTFbi5i-AWd700IsIHV6hfnuvneR7ha-0sMiGnf3YEkQ_pPWG_bJhPtFV72jKgMzh6PfaaxElY/s1600-h/Table+1.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 127px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgeolJTz8kfiMpa6Uz4nyR4fz9IbFAotg-Nly3108N9a2u9rzy-RQFw5OuuYXe2dsZGYeTFbi5i-AWd700IsIHV6hfnuvneR7ha-0sMiGnf3YEkQ_pPWG_bJhPtFV72jKgMzh6PfaaxElY/s400/Table+1.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5437651493580867474" /></a><br /><br />The Table is divided into 3 parts – Part A, Part B and Part C. Part A lays out the performance of this Systematic Investment Plan (SIP), Part B lays out the performance of the Sensex and Part C compares the returns from the SIP and the Sensex.<br /><br />Let’s look at Part A first. This part of the table shows the investment amount every year (Rs. 120,000 in this case), the number of units (or ‘shares’) of the Sensex that the Rs. 120,000 would have bought each year and its market value at the end of the year. For e.g. In the year 2000, the investor would have been able to purchase 26.2 shares of the Sensex whose value at the end of the year would have been Rs. 104,073 – a loss of 13.3%. <br /><br />There is also a ‘cumulative’ column which shows the cumulative market value of the SIP at the end of every year. For e.g at the end of year 2 the cumulative market value of Rs 240,000 (Rs. 10,000 per month invested for 24 months) would have been Rs. 198,418 – a loss of 17.3% (the cumulative returns are in the purple boxes). As you can see the number of units bought varies considerably over the 10 years. In some years the 120,000 would have got the investor 37 shares of the Sensex (Year 2002) while in others it would have got him only 8 (Year 2007). This is an important aspect of dollar cost averaging.<br /><br />Now lets look at Part B. Part B tells us what happened with the Sensex in those years. In the beginning of 2000 the Sensex was at 5,375 and closed the year at 3,972 – a fall of 26.1%. This table also has a cumulative column which shows us what the cumulative results would have been. For e.g At the end of year 2 (2001) Sensex had fallen by 39.3% from 5,375 to 3,262.<br /><br />Part C simply tells us the difference between the SIP performance and the Sensex performance. In year 1 the SIP gave 12.8% more returns than the Sensex (-13.3% vs -26.1%). In year 2 that number was 22.0% and so on. At the end of 10 years, the SIP would have given a 199.6% return compared to 224.9% by the Sensex.<br /><br />Now, if we plot the cumulative returns of the SIP with that of the Sensex year-on-year over the 10 years, we get the following graph:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhVcB6rQDC8BN31aE6sPM3kT4LQPfTH1sDhA2vVMzhuY8BWcvk4Pd3Oyesw-BELs4zfi0I-Nzs26lkkvhWVHIDcJwRUr29nfY75Sb0_bs_lkx1wVXSA0Z2OGnBpVp-cPlja8r-QTqn_R44/s1600-h/Chart+1.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 246px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhVcB6rQDC8BN31aE6sPM3kT4LQPfTH1sDhA2vVMzhuY8BWcvk4Pd3Oyesw-BELs4zfi0I-Nzs26lkkvhWVHIDcJwRUr29nfY75Sb0_bs_lkx1wVXSA0Z2OGnBpVp-cPlja8r-QTqn_R44/s400/Chart+1.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5436961891224039362" /></a><br /><br />This is a very interesting result because what it means is that this mindless investing technique would have beaten the benchmark index 8 out of the last 10 years! – A feat which 90% of highly paid highly educated highly cocky fund managers fail to accomplish. <br /><br />Now, lets pause a while and analyze the numbers. The Rs. 12,00,000 invested in the SIP over 10 years would have grown to Rs. 35,95,109 or 2.99x the invested amount at the end of Year 10 (See Red Circles on the Table). Remember that this excludes dividends that you would have received over the 10 years. So, the actual returns will be higher than 200%. On the other hand, if you had invested in the Sensex on 1st Jan 2000 and sold on 31-Dec-2010 you would have ended up making 225% i.e. 25% more than the SIP.<br /><br />However, to make that 225% return, the investor would have had to do a Rip Van Winkle for 10 years. For a normal person, it would have been emotionally torturing to see the Sensex go up and down day in and day out every day for 10 years. Imagine reading about it in the newspapers every day, watching it on television news channels and having dinner table conversations with your father /mother / uncle /aunt /brother / wife / friend.<br /><br />Just think about how many things happened in the last 10 years economically, socially and politically that you would have thought would have been relevant. The government changed thrice from NDA to UPA to Congress, the markets went through the tech bubble and bust, outsourcing took off, inflation reached 12%, interest rates fell to 4%, real estate prices rocketed, Lehman collapsed, Saddam died, 9/11 happened, Iraq and Afghanistan got invaded, the price of oil reached ~$160 per barrel, Sensex reached 21,200 from 3,000 and crashed to 7,700, then there was Godhra, Kargil war, terror attacks on Parliament and Mumbai and so on and on. An investor would have had to be exceptionally stable to be able to live through those moments and still believe that his Rs. 100 would ultimately become Rs. 325. That’s a lot to ask from the common man.<br /><br />On the other hand, all a brainless investor had to do was keep checking to see whether Rs. 10,000 was being debited from his account on the 1st of every month. She would know that whatever the situation may be she would be indifferent because she would be buying the asset at low as well as high prices. The investor would have bought at the bottom of the tech boom and at the height of the 2008 bubble but in the end would have been just 25% worse off than a non-existent Dravid of the investing world. At the same time she would have ended up saving a sizeable amount over the years.<br /><br />Now let’s look at how we can execute this investment technique. In order to invest in the index every month, we will have to start an SIP on an index fund. Index funds buy stocks in the same weightages as in the index. Since it’s a passive investment technique, these funds have the lowest commissions in the mutual fund industry. There are only 2 things an investor needs to be careful about while choosing an index fund:<br /><br />1. The Tracking Error or how closely the fund mirrors the benchmark index, and<br />2. The Fee or what % of the assets managed goes in administrative costs. <br /><br />The 22-Jan Outlook Money magazine has a detailed list of index funds and their respective tracking errors and fees. I have listed the results below:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZlhLTdHj11Q2tlzagcLLp-AkjWSorX95HLrX9UawptdZIDOQlTLk25aPVDOzF5ED5nZ4BlpxYsagmMhiS0w3w9wG7PSNpk9EylKzMGqT1lmJtUF4Kqf921kZIK4ddA48DgkluRY__Lu4/s1600-h/Table+3.bmp"><img style="cursor:pointer; cursor:hand;width: 373px; height: 400px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZlhLTdHj11Q2tlzagcLLp-AkjWSorX95HLrX9UawptdZIDOQlTLk25aPVDOzF5ED5nZ4BlpxYsagmMhiS0w3w9wG7PSNpk9EylKzMGqT1lmJtUF4Kqf921kZIK4ddA48DgkluRY__Lu4/s400/Table+3.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5436960422286047922" /></a><br /><br />Before I end, lets look back at the advantages of an SIP again – 1: It is simple – all it requires is for you to give a standing instruction to your bank, 2: Its strips out the emotional aspect of investing as I have pointed out above, 3: It makes you save a fixed amount every month – Rs 10,000 per month becomes Rs. 12,00,000 at the end of 10 years and 4: Its cheap – the average cost of investing is only 1.3% per annum.<br /><br />Starting 1st Mar, I will be investing a fixed sum every month in an index fund for hopefully a long period. Investing, after all is all about analysis and patience.<br /><br />KM<br /><br />Note:<br /><br />I had briefly mentioned this in my first blog. If an investor wants to invest upfront and ensure safety of principal she could invest in the post office monthly income scheme and divert the monthly interest into an Index Fund SIP. Rs. 4,50,000 invested in post office MIS would yield a monthly income of Rs. 3,000 which could then be invested in an SIP. <br /><br />Read the PDF of this entire blog by clicking <a href="https://docs.google.com/fileview?id=0B4-TZ8BGkMv-NTk1MjBmN2ItMTk2NS00NjQ1LTg3NzItODkwZDI5MDA4OWM2&hl=en">here</a>Kunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com3tag:blogger.com,1999:blog-4246866831824428266.post-76802261400219633432010-01-12T02:19:00.003+05:302010-01-12T17:10:02.980+05:30Analysis of Mahindra Finance’s Fixed Deposit SchemeI had mentioned in my previous blog that bank FDs should only be used as a means to park ‘transitory’ funds before deploying them in higher yielding securities. Since stock markets have continued their upward movement (Sensex is currently at 17,500) equities have become more and more expensive and risky. Interest rates on government securities have also gone up since my last blog. The 10 year bond is currently trading at 7.66%. I currently invest in a monthly SIP on Fidelity Flexi Gilt Fund, which invests in government securities (as recommended in my previous blog). I think the next 6 months will be a good time to buy government securities at such high interest rates.<br /><br />Between all this, Mahindra Finance has launched an FD scheme that seems interesting. Since it also has a 1 year investment option, I thought I’ll take some time to analyze the issue. The key terms of the issue are mentioned below: (For the full terms and conditions click <a href="http://www.mahindrafinance.com/prod_fixeddeposit/forms/Mahindra_Invest_Form1.pdf">here</a>)<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhMhP2GMPGukVdrk6PfYd60w-4s0HyuE7QB64jfDSbDU30a98YjTDLE1QfoBCM1jiIwdO9tPOBo9mEXxQVYA4KmUPaqBDKZC74MhQ5HluNHzR4icgi9FaD3OTJO1qJjNym8oK8Q_ViXJxY/s1600-h/Table+1.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 319px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhMhP2GMPGukVdrk6PfYd60w-4s0HyuE7QB64jfDSbDU30a98YjTDLE1QfoBCM1jiIwdO9tPOBo9mEXxQVYA4KmUPaqBDKZC74MhQ5HluNHzR4icgi9FaD3OTJO1qJjNym8oK8Q_ViXJxY/s400/Table+1.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5425796461495671378" /></a><br /><br /><span style="font-weight:bold;">Key Questions</span>:<br /><br />I think the key questions to ask as an investor in the FD are the following:<br /><br /><span style="font-style:italic;">1. What does the company do?<br /><span style="font-style:italic;">2. Are the returns adequate?</span><br /><span style="font-style:italic;">3. Is my capital safe?</span></span><br /><br />Let’s try and answer each of these questions<br /><br /><span style="font-weight:bold;">Question 1 – What does the company do?</span><br /><br />Mahindra Finance is a non-banking finance company that provides loans to customers in rural and semi-urban areas to finance the purchase of utility and commercial vehicles like tractors, cars etc. They are placed between the organized banking sector and local money lenders in rural India. The company was originally started to provide finance for Mahindra utility vehicles but has today diversified into personal loans, construction equipment finance, rural housing finance etc. Its primary business remains financing utility and commercial vehicles in rural and semi urban India.<br /><br /><span style="font-weight:bold;"><br />Question 2 - Are the returns adequate?</span><br /><br />The asset class we are dealing with here is a fixed deposit. The natural comparable is the FD rates at banks. Below is the comparison between the Mahindra FD rates and the ones being offered at various banks. I have also included the rates offered by Post Office term deposit schemes.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhU8s_HmfrfZrt4N1f6ULydyHz8FHmchjSslshTXpRs-ydhyHr4nyye2huGAyYvNpDtSH2ufy6LGBLr_y7XirgmpZnyix9nXl7Qda6-OMnckz8qsbcrNiujkhjHp5pjpmnLEF9RDImpiNs/s1600-h/Table+2.bmp"><img style="cursor:pointer; cursor:hand;width: 352px; height: 152px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhU8s_HmfrfZrt4N1f6ULydyHz8FHmchjSslshTXpRs-ydhyHr4nyye2huGAyYvNpDtSH2ufy6LGBLr_y7XirgmpZnyix9nXl7Qda6-OMnckz8qsbcrNiujkhjHp5pjpmnLEF9RDImpiNs/s400/Table+2.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5425796689183317090" /></a><br /><br />Mahindra offers rates 125-150 bps higher than what banks are currently offering for a similar tenure product. I think 150 bps over bank rates is not too bad. However this return has to be seen in conjunction with the risk of investing in the FD, which leads us to question 3.<br /><br /><span style="font-style:italic;"><br />Note: I am not sure if one can buy 1 share of the company and ask for 0.25% more interest by qualifying as a ‘shareholder’ though the offer document seems to imply so. In that case the returns would be 150 bps to 175 bps higher.</span><br /><br /><br /><span style="font-weight:bold;">Question 3 – Is my capital safe?</span><br /><br />To answer this question, we need to look at where we stand in the company’s capital stack and whether the company is earning enough to be able to repay our principal and interest obligations.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj9PQowSzfxFJm-Nj9cjT8Y-d6e2lINDxHD3KEzU3n_LxF6YbaVQ1lxrTSRwphB5vaWNlqRTrBnC2_i0Wsw60cTbVEH_pqbGvzTDA-XALk22ixwKt6U3cIprrzdvt00-XcTJEQ98K4zmFw/s1600-h/Table+3.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 168px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj9PQowSzfxFJm-Nj9cjT8Y-d6e2lINDxHD3KEzU3n_LxF6YbaVQ1lxrTSRwphB5vaWNlqRTrBnC2_i0Wsw60cTbVEH_pqbGvzTDA-XALk22ixwKt6U3cIprrzdvt00-XcTJEQ98K4zmFw/s400/Table+3.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5425810317767881170" /></a><br /><br />As of Mar 09, there was Rs. 4,467 crores of senior secured debt ahead of us in the capital structure (the blue box is our position in the stack). This means that the company’s profits will first go to service these debt holders. A quick read through the notes to accounts reveals that this includes non-convertible debentures and bank loans which have a charge over the company’s fixed and current assets. However, we do have Rs. 3,260 crores of equity buffer below us. The current equity value implies that assets would have to fall by 38% (or in other words 38% of the loans would have to go ‘bad’) before our capital is affected. Even at its lowest point in Mar 2009 the equity value was Rs. 1,700 crores implying a 25% buffer. From a balance sheet point of view, our capital seems to be relatively safe.<br /><br />Now let’s look at the company’s ability to pay interest and repay our capital.<br /><br /><span style="font-weight:bold;">Earnings</span><br /><br /><span style="font-weight:bold;">Last 10 years Analysis</span><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigixsvje-HbkxnlnfrEpU7MyPv5bBTMED_5E3co8JLxq8_DYxv2s4KD9N20DOMbe5ob4EP_i243L_wl13LZRZd6OmBKyuaLKo2qBlEfMERv9aT3cXz7g-IG_YmKJZm9QV41I-HnljhuXk/s1600-h/Table+4.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 59px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigixsvje-HbkxnlnfrEpU7MyPv5bBTMED_5E3co8JLxq8_DYxv2s4KD9N20DOMbe5ob4EP_i243L_wl13LZRZd6OmBKyuaLKo2qBlEfMERv9aT3cXz7g-IG_YmKJZm9QV41I-HnljhuXk/s400/Table+4.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5425797044506136994" /></a><br /><br /><span style="font-weight:bold;"><br />Last 2 years Analysis Using Cumulative Deductions</span><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHY9DC4wtw98S2gB2TLQUi7Luv8h6Qx-pSIotIe2gjAeZOKJPYgrIy8RqfgAQpj288HUXYmUtQqS2A5t772LAhVboSyKxVEmJJheyC3-B6Q0q8Golsof4t_HRgKPdC-4FIKEla_JE4P_c/s1600-h/Table+5.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 149px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHY9DC4wtw98S2gB2TLQUi7Luv8h6Qx-pSIotIe2gjAeZOKJPYgrIy8RqfgAQpj288HUXYmUtQqS2A5t772LAhVboSyKxVEmJJheyC3-B6Q0q8Golsof4t_HRgKPdC-4FIKEla_JE4P_c/s400/Table+5.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5425797182239787026" /></a><br /><br />Ideally, we would have liked to look at a longer term average in order to counter the effect of prosperous and average years in earnings, but we will have to be content with 2 years in this case. The company earned about ~2.2x of its interest obligations in the last 2 years (data for prior periods is not available) which means that even if earnings halve, the company will have enough to pay interest on its debt. For an NBFC, this number seems conservative since the variation in earnings will probably not be as high as say a commodity company. Also, the history of earnings shows a growing trend with no wild fluctuations. <br /><br />The other way to look at this is that the company had Rs. 1,126 cr and Rs 983 cr left in FY 09 and FY 08 respectively to pay interest on debt after paying its operating expenses. This translates to a 22% and 20% yield respectively, meaning it could theoretically pay ~21% interest on debt. <br /><span style="font-weight:bold;"><br />Other Reasons to Feel Safe</span><br /><span style="font-weight:bold;"><br />Dividend History</span><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2GSYOELCnujuzQUVoL55L5qM3YDTDMqhA_uV4mE22EUjV4BKVJuWQ1i0twNZ7NyCyt15fy4GGKs2Cl1q4xvbF0S6GpF7iWahpN0zmHuYgVxvITva5d_fWMMUcw0H2XzGtwRkqP-UbSHQ/s1600-h/Table+6.bmp"><img style="cursor:pointer; cursor:hand;width: 400px; height: 34px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2GSYOELCnujuzQUVoL55L5qM3YDTDMqhA_uV4mE22EUjV4BKVJuWQ1i0twNZ7NyCyt15fy4GGKs2Cl1q4xvbF0S6GpF7iWahpN0zmHuYgVxvITva5d_fWMMUcw0H2XzGtwRkqP-UbSHQ/s400/Table+6.bmp" border="0" alt=""id="BLOGGER_PHOTO_ID_5425797351682236722" /></a><br /><br />It looks like the company has had a good history of paying dividends to it shareholders. Also, the dividends have been progressively higher over the years. Even in a bad year (FY09) the company managed to pay 55% to the equity holders (higher than the 45% in FY08 – a good year). Though not conclusive, this is a good sign for us because it means that the company has had enough cash flows in the past to service the lowest stack in the capital structure. It also means that we can monitor the health of the company in the future by looking at the company’s dividend policy. If it is lower or stops altogether we will hopefully receive a timely warning of impending trouble.<br /><br /><span style="font-weight:bold;">The Mahindra Name</span><br /><br />The company is a subsidiary of Mahindra & Mahindra Ltd, a six decade old conglomerate with revenues in excess of $6.3 billion. The issue has the strong backing of a big business house which provides good confidence to any debt investor. In fact, for some, the backing of M&M itself would be enough to trust the company’s credentials. However, the past year has seen some of the biggest business houses like the Tatas dither in the wake of one of the worst economic downturns we have seen. Therefore, though it is comforting to know that the company has the backing of M&M, it should not be the only reason for investing in the issue.<br /><span style="font-weight:bold;"><br />Final Word</span><br /><br />I think this is the best debt option available right now. I would recommend this issue to anyone looking to invest in debt.Kunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com1tag:blogger.com,1999:blog-4246866831824428266.post-1039336131838840712009-12-01T18:38:00.002+05:302010-02-11T11:31:39.246+05:30Investing on the V CurveThis first blog is born of my own frustration at the disappearing investing opportunities in the post recession ‘V’ era. I have a large part of my net worth in cash right now and face a world with limited investment opportunities. With an ever increasing threat of inflation (see small note on inflation at the end), a day doesn’t go by where I am not thinking of ways to putting this cash pile to work. <br /><br />In this blog I am going to examine various asset classes that are currently available to the Indian retail investor and argue the pros and cons of investing in each of them. I intend to focus on each of these asset classes separately at different points in time as each becomes more relevant or attractive. There are also some asset classes on this list that are going to get more attention than others (equities, real estate and bonds) primarily due to my own personal and professional experience of investing or having invested in them. <br /><br /><span style="font-weight:bold;">1. Equities</span> – As I write this, the Sensex has crosses 17,000 - up almost 100% from its Mar 09 lows of 8,500. Almost every listed stock has doubled since the panic at the beginning of the year (some deservedly so while most rising just as part of the V euphoria). Now when I look at any stock, it seems overvalued on most parameters – EV / EBITDA, P/E, P/BV etc. In order to earn a 20% return on equity the Sensex would have to reach 20,400 in a year. I find that difficult to believe. I feel that the risk of Sensex falling is a lot higher than the 20% reward. Nobody wants to buy a stock for Rs. 100 and see it fall to Rs. 75 in 6 months. <br /><br />The fundamental rule of making money in stocks – buy low sell high – works best when you get the first part right – buy low! Having said that, one should always keep a close eye on individual stocks that have the potential to become multi-baggers over a period of time. What I am trying to say is - don’t completely write off Equities as being overvalued. The case in point is Bharti Airtel. The stock has reached its 52 week low of Rs. 275 (last seen during Jan 09). Currently it trades at an EV/EBITDA of 7.2x and P/E of around 11.0x. I know there is a lot of talk about competition in the telecom industry and such but from a long term point of view (long term meaning forever!) this stock may be worth looking at. (I am currently going through the Bharti financials and hope to put a small piece on the stock in a few days)<br /><span style="font-weight:bold;"><br />2. Gold</span> – This is one asset class whose rise has astounded me. Rs. 100 invested in gold a year ago would have become Rs. 142 today – that’s a 42% return on investment! Of course, part of that rise can be attributed to the worst economic recession since 1929. Gold as an asset class tends to shine in times of uncertainty, chaos and fear. The reason this happens confounds me. Maybe people just perceive gold to be a stable and safe asset especially when other asset classes are in turmoil. Others consider it a safe inflation hedge. Whatever the reason, the fact is that gold has generated superior returns and continues to do so. <br /><br />But, will gold produce the same kind of returns in the coming years? This is the question that the investor needs to answer. With the run-up that it has had, the current price of gold (Rs. 18,000 per 10 grams) looks expensive. Pundits point out that it could go up further. I myself would be very apprehensive to put my money in gold because the chances of it falling are higher than rising. I say this because a) it has already run up a lot b) economies around the world are slowly getting out of recession which would mean investors would divert monies to riskier asset classes like equity and c) the coming year(s) will be a lot less chaotic and fearful than the last. If you do want to invest in gold I would advise you to follow a disciplined SIP which over a long period of time effectively neutralizes the risk of ‘timing the market’ and averages out the cost.<br /><span style="font-weight:bold;"><br />3. Bonds / Government Securities</span> – As an Indian investor it is extremely difficult to purchase good quality corporate bonds. This is because we do not have a thriving secondary bond market like the West. The only way to purchase bonds is through an IPO most of which are so over subscribed that you end up getting a fraction of what you applied for. For e.g. if you had applied for Rs. 1 lakh worth L&T Finance 9.5% bonds you would have ended up receiving Rs. 6,000 worth of bonds. Thus there is no asset class between equity and risk free government bonds in India. You could invest in FMPs but then you do not get to pick and choose the issuers and after the FMP disaster last year it is best to avoid them. <br /><br />So that leaves us with government securities. Right now, the 10 year government bond is trading at 7.3%. This used to be around 4.2% in Oct last year. Contrary to popular perception government bonds are not totally ‘risk-free’ – they carry interest rate risk (i.e. the risk that interest rates will increase or decrease). When interest rates fall, the values of the bonds go up. This is because if you hold a 10 year bond of face value 100 with a 7% coupon and interest rates fall to 6%, the bond in your hand will be worth Rs. 107.4 (since the new investor will have to pay Rs. 107.4 for the current market return of 6%) i.e. for every 100 bps (1%) fall in interest rate the bond value increase by 740 bps (7.4%). (for a 10 yr bond). However, interest rate risk is zero if you hold the bond till maturity. Interest rates fall when there is a ‘flight to safety’ i.e. investors are scared and want to retreat to the safe haven of government bonds. This happened last year in October when interest rates fell to 4.2% levels. If that were to happen again an investor in the 7.32% bond would make about ~23% returns.<br /><br />Should one invest in government securities today? Let’s look at the pros and cons. Pros - a) it is the only asset class that is cheap right now – interest rates have moved up from 4.2% to 7.3% b) If markets and economies improve, interest rates will fall and monies will chase riskier asset classes c) It is a relatively safe asset (the government is not going to default on interest and principal payments) d) As the Indian government de-leverages its balance sheet the amount of supply of debt will reduce e) although your downside is protected (if you hold to maturity) there is a chance of an upside like the 23% above if interest rates fall. Cons a) Chances are high that interest rates will increase especially if there is high inflation and monetary tightening b) The government could continue to run a high fiscal deficit if the recovery takes longer. My own view is that this is an asset class worth investing through an SIP. What the SIP does is that it neutralizes the timing risk and to a certain extent interest rate risk because the purchases will be made in times of high and low interest rates. If the economy recovers fully in the next 3-5 years, interest rates should eventually go down increasing your returns on your g-sec portfolio. It’s also a great hedge against a market meltdown and worse comes to worse you will end up getting c. 7.3% on your investment. <br /><br /><span style="font-weight:bold;">4. Real Estate</span> – We as Indians have always liked this particular asset class. All of us secretly harbor a desire for our very own apartment or a piece of land in which to build a house for retirement. The last decade has seen a huge shift in our attitude towards owning real estate. Affordability has increased greatly since the early nineties when our parents would not have dreamt of owning a house till they were way past 40. Today, 21 year olds are busy paying EMIs from their monthly BPO salaries to finance their dream apartment. The real estate boom fueled by excess liquidity and easy access to finance came to an abrupt end sometime in the middle of last year. <br /><br />Developers were left with massive debt obligations supported only by high price land bought at the peak of the market and whose prices had fallen by half (effectively meaning equity value was zero since Equity=Asset-Debt). Even some of the biggest developers like DLF and Unitech came close to bankruptcy (except a few, most developers are still near bankruptcy). However, if newspapers are to be believed the demand for real estate among middle class Indian consumers is back (lower prices, affordable housing, latent demand etc) and the hey days of 2007 are close. <br /><br />I myself, think this is all hogwash. Ground realities tell a different story. I was recently on a 4 day Goldman Sachs sponsored real estate tour in New Delhi, Gurgaon, Noida, Bangalore and Mumbai. What came out of the tour was that developers are still struggling to sell their apartments and debt and cash flows are hard to come by for this sector (RBI has increased the risk weightage for loans to the real estate sector and the IPO market has all but dried up). There’s still a long way to go before the Indian real estate sector comes back to its boom years. (Unitech’s market cap has tripled since Jan 2008 to Rs. 20,000 crores but its debt is still around 12,000 crores)<br /><br />So should I put my hard earned money in real estate now that prices are low and developers have sobered up? Yes and No. Of the asset classes that are currently cheap or ‘out of favour’, real estate is definitely up there. Prices have fallen from their 2007 peaks quite a bit but so have rents and peoples confidences. I say a big NO to any hole-in-the-ground development and to any projects which are not at least 50% complete. Even for those that are, I would really try to understand how the developer plans to finish construction (i.e. where is the money going to come from). Chances are high that the upfront money you pay is going to pay the lender who already has a 1st mortgage on the property. <br /><br />So be really careful of buying into development projects. However, there’s no harm in buying apartments in projects that are complete and ready to be let out. In fact this is a great opportunity to buy apartments in completed projects which are available at a below par price. It guarantees a continuous monthly rental stream and also provides a great hedge against inflation. The basket of goods that the rent you receive from the building will buy today will be the same 20 years from now, but the same cannot be said of other asset classes like fixed deposits. There is also the added upside of increase in value. Also, lets face it – this country is going to face an acute shortage of housing over the next decade and sitting on a nice 3 bedroom apartment in a good location is not a bad position to be in. The two drawbacks of real estate investment are that the yields on the rent are very low – about 2-4% depending on where you are in the country and they require huge upfront monetary commitments.<br /><br /><span style="font-weight:bold;">5. IPOs</span> – This is not strictly an asset class but given the current market its worth analyzing its merits and demerits. My philosophy about IPOs (borrowed greatly from Benjamin Graham) is that It’s Probably Overpriced. I would never invest in IPOs simply because everything about the issue is decided by the seller – the price, the timing and the amount. I find the argument that sellers leave something on the table hard to believe. No one likes to not take what is readily available. Every IPO (other than maybe one) that took place post May 2009 is currently below its offer price. Don’t risk your hard earned money on punting in these issues.<br /><span style="font-weight:bold;"><br />6. Post Office Monthly Income Schemes</span> – This is another interesting option available to the retail investor. The MIS currently pay 8.0% interest rate per annum (i.e. Rs. 80 will be paid every month on a deposit of Rs. 12,000). However there is a limit of Rs. 4.5 lakhs per borrower and your capital is locked in for 6 years. These two conditions make investing in MIS schemes a bit depressing. Inflation can also play havoc with your investment. But it’s a good way to earn a decent monthly income to pay your household utility bills. Also, if you combine the MIS with the recurring deposit scheme where you transfer the monthly income to a recurring deposit, the yields increase to 10.5%. The other option for the more aggressive investor is to transfer the monthly incomes to an equity index fund to get an equity kicker. Worth thinking about. <br /><br /><span style="font-weight:bold;">7. Fixed Deposits</span> – Currently fixed deposit rates in India range between 6.00% in HDFC to 7.50% in ICICI (3 years). This is the favorite and most traditional saving instrument used by Indians. Fixed deposits are considered to be safe but do nothing to counter the threat of inflation and interest rate risk. I would advise you to park only your short term ‘transitory’ income in these deposits while you look out for better opportunities.<br /><br /><br /><br />(1) Small Note on Inflation<br /><br />You might have noticed that the word inflation appears while analyzing almost all the above asset classes. So I thought it might be worth spending a couple of lines on the subject. Governments around the world have pumped in billions of dollars into the economy to stimulate demand and India is no different (low CRR, low SLR, low Repo rate, high government spending in agriculture, loan subsidies to farmers etc). Sooner or later this flood of money that is sitting quietly in banks and mutual funds is going to rear its ugly head in the form of inflation. To make matters worse we already have a low base from last year and the monsoons have not been adequate in many parts of the country. Consumer Inflation (which I think is the right metric to look at instead of WPI) is already at 12.0%. So what required Rs. 100 to buy last year now requires close to Rs. 112. Think about it – inflation is an investor’s worse enemy.<br /><br /><br />KMKunalhttp://www.blogger.com/profile/14952884797629906467noreply@blogger.com3