AuthorRohit Chauhan

Analysis: NIIT tech Annual results

By Rohit Chauhan
In Company analysis, Uncategorized
September 2, 2008
6 Min read
7 comments
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Warning: Parts of this post are boring as I would be discussing about Hedge accounting, reserve adjustments etc. However if you are invested in IT stocks, I would recommend you to get a good understanding of these concepts as they are now critical to understand how the company is doing.

Results summary
The company had an average performance for the year 2007-08. The ROE was maintained at 30% level. The sales growth was lower at around 6% (reduced partly by the rupee appreciation) and the net profit growth was around 3%. The net profit margins were maintained at 14.3%. The operating margins also held steady at 19%.

The key segments of BFSI, Insurance and travel now contribute to more than 80% of the revenue. Europe continues to the major geographic segment with the contribution to revenue at 50%. The other performance parameters such as % revenue from top customers, no. of new customers etc showed decent improvement.

The company completed the accquisition of ROOM solutions during the year. This business was not profitable during the year as it is in the investment mode as per the management. In addition the company made another small accquisition of Softec in the airline IT solution space. Thus the company is pursuing a strategy of both organic and inorganic growth in the focus verticals, especially in Insurance and transportation.

The positives
The company did not perform as well as the tier I vendors. However the company is now pursuing a strategy of focusing on key verticals. It is growing through accquisitions in these verticals and accquiring the required IP and customers via these accquisitions. This strategy makes sense for mid size companies such as NIIT tech, which cannot compete with the Tier I companies on scale alone.

The company maintained its margins and ROE inspite of the slowing markets and currency fluctuations. The company performed as expected and as the valuations are currently discounting a terrible performance, the stock price did not suffer.

The cash and equivalents for the company now stand at 220 Crs which is almost 30% of the mcap. The company continues to sell at around 2.5 times earnings (or slightly higher than book value), which means the market expects the company to be out of business pretty soon.

The negatives
The volume growth for the company was poor for the year 2007. The company is definitely not performing as well as some of the Top tier companies.

The accquisition for ROOM solutions was done at 100 Crs. The company is currently making losses. NIIT tech Management has paid quite a bit for the company and must have seen a lot of value. I hope they are right. Although subsequent poor performance of ROOM may not hurt the company a lot, it would definitely put the capital allocation skills of the management into question. I would personally rethink my entire thesis about the company if the accquisition turns out to be a dud

The performance of the accquisition is more critical than it seems on the face of it as the company has a large cash holding. This cash holding would grow further in the future and the management would be looking at new accquisitions with this cash. A poor track record would hurt the performance in the long run.

The accounting
The company accounted a forex loss of around 6.7 Crs in the P&L account with net impact of +.8 crs ( still trying to figure how they arrived at this number).

Now for the dry part,
The company maintains effective and non-effective hedges. The effective hedges are used to hedge the revenue and recievables. The company booked a loss of around 15.5 crs against reserves in the year 2008. These reserves have increased to around 65 Crs in Q12009. So if the rupee remains at the current levels, the company will close the hedges (which cover 27 months of revenue) over the next 27 months and take a loss of 65 Crs on the P&L account.

So the question is – Has the company already incurrend a loss of 65 Crs ? Yes and No. If the company were to close the contracts then it will have to account for the losses. However NIIT tech is not in the business of derivatives. These derivatives and contracts are used to hedge forex revenues. It is possible that the exchange rate could go in the opposite direction and the losses could worsen or they could go in the intended direction and the company could make profit and come out smelling roses.

The valuation impact
How should one account for forex gains/ losses? I think it would stupid to consider these losses as an ongoing one and capitalize it.

For ex: 2008 net proft was 137 Crs. So would you net the above loss of 15 Crs and say the Net profit is 122 crs and use this number for the final valuation ?

I would rather do the following

Say we take the appropriate PE as 15. The value of the company is 137*15= 2055. I would net off 15 crs from this value to arrive at the final value of 2040 Crs. I would apply the same logic if the company made a profit.

Over the long term, I think the forex gains or losses should be a wash (net impact should be minimal). Unless the treasury department is foolish (which doesn’t look likely) or very smart, the hedges should end up serving their purpose of reducing the impact of exhange losses or gains.

Ofcourse I am assuming the company will not start looking at Forex hedges and derivatives as a source of profit. That is a different ballgame completely. If the company gets in exchange speculation (and some companies have tried that stunt), I will take a very dim view of it.

The employee benefit (AS15) impact is not too high for the year and hence I would not concern myself too much about it.

Reading up

I am currently reading AS30 standard to get a better understanding of the new accouting standard for mark to market accounting. It is quite a dry read. However if you are interested in understanding the accounting and results of IT companies, then it is important to understand these standards. I would say, that if you are into fundamental analysis, the understanding all the AS standards is crucial.

Ofcourse reading AS standard is as entertaining as getting your dental work done. But investing is not always fun ..is it ? 🙂

I have still not changed my mind about the company. The market expects a far worse performance and as long as the company can do better than what is expected, the returns for an investor should be good.

The analysis for NIIT tech is uploaded here. Earlier posts on NIIT tech here, here and here

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Infosys accquisition of Axon group: My view point

By Rohit Chauhan
In Uncategorized, Views on news
August 29, 2008
3 Min read
7 comments
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Infosys recently announced the accquisition of the Axon group. Most of the analysis I have seen is centred around whether the deal is EPS accretive or dilutive. I think this kind of analysis is superficial and misses the point. A deal can be EPS dilutive and still be adding value and vice versa (more on that in a later post).

In this specific case, Infosys is accquiring an ERP (SAP in this case) consulting firm with net margins of around 10%. ERP consulting is a high margin, high growth business for Infosys. The typical gross margins are sometimes in excess of 50%.

How do I know ? disclosure : I worked with infosys in their ERP practise in the past. The ERP business for Infosys has seen phenomenal growth in the last 8 years and has done exceedingly well. Their Oracle and SAP practises have done very well too (I have personally seen the practises grow in the last 6-7 years). Infosys has managed to constantly increase the offshore component of ERP projects and thus maintain high margins.

Axon has gross margins in the range of 25-30%. In addition they are based out of UK, US and Malaysia. I am not sure of how much offshoring Axon does, but any improvement in the onsite/ offshore component of their existing projects due to the backend infrastructure of Infosys will enhance their margins. This is a good deal where Infosys gain the front end part of the business ( clients, onsite consultants, relationships , Knowledge etc) and Axon (which will be now be a part of infosys) will see improvements in margins due to higher offshoring.

Is everything hunky dory then ? Not necessarily. Integration of Axon into infosys will be a challenge. Infosys has an ‘Indian’ company culture (I do not mean it in a negative way). They are very conservative on expenses and there are other typical ways of doing things. Axon (about which I do not have any special insight) must have a more European culture. Integrating two such diverse culture will be a challenge. The key asset for an consulting company are its people. If the integration is poor, then employees from Axon (or even from exisiting practise in Infosys) could leave. I think that may not be a major issue in the long term. The company will work on retaining the key employees.

So overall, there is more to this deal than just plain EPS numbers. The ERP practise (especially SAP) is doing well for the company. Addition of Axon will provide further scale to the SAP consulting business of infosys and will add value down the road.

Additional disclosure : I hold infosys stock

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My personal investment journey – II

By Rohit Chauhan
In General thoughts, Investing Philosophy, Investment process, Uncategorized
August 26, 2008
8 Min read
26 comments
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In the previous post, I described my investment journey till 2003. By mid of 2003, I had spent close to 6-7 years on reading and studying about the topic. I had read dozens of books on warren buffett and other value investors. In addition I had been analying companies for the past 5 years. So I understood the basics of investing, valuation and other aspects of investing.

What was missing was the experience and the softer aspects of investing. I had allowed myself to be swayed by the surrounding euphoria (partly though) in 2000. In addition by 2002-2003 when there were values all around (companies like L&T, blue star etc were available at a bargain), I was still not confident enough to go the whole hog.

If you have gone through this phase or are going through it, you will understand. If you have not seen a lot of success (mine was relative, I had done well compared to the market) and even if you feel that your are doing the right thing, it is not easy to jump in again completely. So during this phase, I increased my holdings, but I was very cautious (maybe overcautious) about it.

The market had gone nowhere for the last 10 years and so unlike today, no one was interested in stocks.

So what were the key learnings for me till 2003 ?

  1. Do not over pay for a stock. I learnt this from SSI. Yes, sky is the limit for these hot companies. However for every Infosys or PRIL or L&T, there are 10 pretenders. In addition this kind of early stage investing requires a different mindset. I do not have that kind of mindset.

    2. focus on companies with sustainable competitive advantage which have a profitable growing business and are available at a reasonable price. I have made the best returns from this group. Ignore the long shots ..companies which will be the next HDFC, next infosys, next L&T etc. Buy HDFC if it is available at a reasonable price otherwise find something else.
    Valuation and price matters. Promise is all great, but if a company does not meet the promise then the stock price gets killed. I learnt it from SSI and a lot of other investors are learning that lesson now via other companies.

    3. Be honest and brutual about your mistakes. Do blame others like analysts, media, friends etc. If you have made a mistake, accept it and move on. In short – don’t whine !!

2003 – 2006 (Beating the market and making some money)

By the end of 2003, the market was up 73% and I beat the market by a few points. As I had beaten the market during the bear phase too, I had gained in absolute terms by the end of the year.

The portfolio mix was roughly the same, with a new addition by end of the year of kothari products which was a small position (I started experimenting with a few graham type stocks)

By 2004 year end, my portfolio was doing fairly well. I had done better than the market with good gains in asian paints, concor, blue star etc. In addition I created a new position in BayerABS and Balmer lawrie by the end of the year.

I did no major additions or sale during 2005. Most of the stocks did well and the valuation gaps closed for several of my earlier picks as the market started recognizing these companies. I was able to do better than the market and was now fairly confident of my approach, which was now working well.

2006 was also a year with almost no activity in terms of buying or selling. To certain extent, I was still riding my earlier picks and to a certain extent I was finding it diffcult to find ideas which were as attractive as my exisiting one. I had done most of my picks during the bear market of 2001-2003 when good companies were available at throwaway prices. I was still searching for similar opportunities in 2006. That ofcourse was a foolish thing to do then. I was not going to get those kind of opportunities in a bull market.

By end of 2006, most of the companies I held, seemed to be fully valued. I liquidated almost 60-70% of my portfolio and ended the year with small holdings in asian paints, reliance (which I got through my RPL holdings), Bayer ABS and balmer lawrie. In addition I started building a small position in Merck and KOEL.

As an aside, in 2004, I discovered blogging and created my blog. This was my first post.

2007 (rethinking the approach)

I began 2007, with a fairly liquidated portfolio and few holdings.The really good companies seemed to be fairly valued and so I was not interested in them. As this time I started exploring graham kind of opportunities.

Till 2007, my approach was always to buy good companies and hold them for a long time. However I was always split between the idea of buying and holding even after the company was selling at or above my estimate of intrinsic value.

In 2007, I read a book by Mohnish pabrai (Dhando investor) and also a few other books and comments by warren buffett. I kind of realised that if one is interested in making higher returns then you have to look at buying undervalued companies and selling at intrsinsic value. The portfolio churn is more and you have work harder at finding new ideas, but the returns are higher. So I had a slight change in approach in 2007.

I built a position in KOEL (kirloskar oil) and sold when it hit intrinsic value. I created new positions in cheviot, India nippon, novartis, VST, manugraph, HPCL, grindwell norton etc. In addition I bought and sold IGL (after I felt I was wrong in my analysis), and did the same with MRO tek when it reached intrinsic value.

2007 was a crazy year. Anyone could have made money. I did well too (maybe too well). However I did not go whole hog as I was not comfortable with the valuation for most companies. I had not forgotten my earlier lessons. Frankly I don’t care how well others are doing or what they are recommending. Maybe some people can trade profitably by looking at the tides, but that’s not for me. Real estate companies, Capital goods companies looked like IT companies of 2000 and so I stayed away from them.

2008 (Doing more of the same)
Jan started with a major high in terms of the market and low activity from my end. I have been analysing companies since then and looking for new ideas constantly.

2008 has seen the market tumble from the all time highs. As I was not comfortable with the valuations by the end of 2007, I did not add much to my holdings. I try not time the market, but time the price (this is a quote by warren buffett). What that means is that my buy and sell decisions are based on the discount at which good companies are selling to their intrinsic value. If there is a big discount I will buy irrespective of the market level. Ofcourse, most of the times this approach takes you out of the market at highs and makes you more active when the market is tanking.

My activity levels in terms of buying or selling are higher this year. My portfolio was in a semi-coma state for a long period as there was not much to do. However with a slight change in approach and better values, there is more activity now.

Future ?

I don’t know how things will work out. What I know for sure is that I plan to keep reading and learning. I plan to add arbitrage to my portfolio and make it a higher percentage. However overall, I plan to develop my approach further and deepen my understanding of various areas such as accounting, options pricing, and economics etc . The focus is to learn topics which would improve me as an investor.

If you have been with me for these two posts, you can see why I have a strong preference for value investing. This approach has worked for me and allows me get a good night sleep. It fits my temprament of slow and delibrate thinking. I do not like fast paced action and thrills (in my portfolio, movies are a different matter).

Even among valueinvestors, there are varying styles and each one selects a different set of companies for his or her portfolio. I think it is driven a lot by one’s experiences. In my case, I have stayed away from high growth, hot sexy companies due to my bad experience with SSI and other IT companies. On the other hand the boring, dull but solidly profitable companies have given me great returns. Hence my preference for those kind of companies.

 

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My Personal investment journey – I

By Rohit Chauhan
In General thoughts, Investing Philosophy, Investment process
August 20, 2008
8 Min read
13 comments
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There is a certain level of curiosity in knowing what the other guy is making or getting in terms of investment returns. A lot of people and friends I know like to flaunt the returns they are getting from the market (The stock I bought last month doubled !!). Maybe it is an ego thing or maybe just a topic of discussion.

I personally prefer to discuss about specific ideas, both in person and on my blog. I find that more interesting and educational for me and others. As a result of this quirk, I have never discussed about the overall returns I have made from the stock market on my blog. I am not selling anything to anyone and just like to share my ideas with like minded people. I am happy if people read what I have to say and can learn something (maybe) with me.

I have been asked about my investing experience and the kind of returns I have made. I have made 32% returns (annualized and unleveraged) over the past 8-9 years following a value approach. These may not be the fantastic returns some of you expect or may have achieved. However they are far more than what I have targeted for myself. Investing is side thing for me and is not my profession. I primarily invest for myself and my family and prefer a buy and hold (not buy and forget) approach. My personal portfolio is low on risk and volatility as I prefer a good night’s sleep.

It may be possible to get higher returns through alternative approaches. However I have found that value investing suits my temprament and the returns I have made are more than satisfactory for me.

A word of caution : I tend to hold a number of stocks which I discuss on this blog. However the purchase price for the stock and portfolio weightage of the stock makes a lot of difference to the overall returns. So please do not buy the stocks I discuss without your own analysis.

In terms of personal disclosure, this maybe as far I would like to go. I am not intending to disclose my overall portfolio and returns on an ongoing basis. Investing rationally is diffcult enough. I do not want to do it publicly and make it more diffcult for me.

However more important than the returns is my investment journey till date. I will be discussing the details in this and the next post. It is likely to be a long post, and maybe boring (no excitement in the way I invest). However what I have gone through may echo what you have or are going through.

1997-1999 (The start)
I had completed my MBA and was working in sales and marketing. I was responsible for handling the finances of my entire family and for me capital preservation was more important. I knew the basics of finance, however that was not sufficient to invest intelligently. An MBA education teaches you about corporate finance, but does not teach you to be an investor.

So during this phase I started learning the basics such as what is an FD, what is a mutual fund etc. Internet was not common then and so my learning was based on economic times and a few books I could get. There were no live quotes then, so one had to look at the papers to get the daily quotes.

During this period I came across the book – The warren buffett way and was competely struck by it. I was completely bowled over by warren buffett. I started reading any books I could get on him. I think I must have read around 20-25 books on him till date. These books led me to other investors like Benjamin graham, Phil fisher etc. By the end of 1999 I had read quite a few books on these masters.

This was more of a reading/ learning phase. The two stocks I bought during this phase were Reliance petroleum and Arvind mills. I read an article in business world on RPL and hence bought that stock. Arvind mills had given a presentation in my college some time back and I liked what I had heard and so went and bought a small amount of the stock.

Well, RPL did well and Arvind mills tanked as the denim industry went into a downturn.
Prior to these two stocks, I bought the following stocks also
IFCI – because the dividend yield was high
Karur vyasa – It was cheap on P/B basis
Larsen toubro – It was a well known company then though not a hot stock.

So by the end of 1999 (before the IT boom), I had a hodgepodge of stocks in my portfolio with most of them doing badly. The good thing was that I was learning and constantly re-evaluating the stocks I had. I soon realised that I had goofed up in some of my picks like IFCI and arvind mills and sold them at a good loss. The rest I held on.

2000 ( The greed phase)
By start of 2000, I felt I had learnt a lot and was ready for the dive ( don’t laugh). So starting from Jan 2000, I started looking at stocks. However all the reading for the last 2-3 years had made me wary of the IT stocks due to the high valuations. I luckily avoided picking any specific stocks during the early part of the year.

However it is not easy to avoid greed, especially if you are new to the market. Thinking that mutual funds are safe, I setup an SIP for some IT and general funds. Well, by the end of the year the IT funds and other funds had tanked and I got an expensive lesson.

Toward the end of the year, I started analsying a few companies and picked up SSI and asian paints. My analysis for asian paints was correct and I have benfitted from it. However in case of SSI I ignored the high valuations. I built a DCF model and pretty much made assumptions to justify the price. I paid for it by losing 90% of my investment on it.

So by end of 2000, after 4 years of learning, all I had to show was a drop of 15% in personal investments and ofcourse a lot of learning in terms of what not to do.

The reason, I think I never gave up was because I was already in love with investing and reading and so was not very dissapointed by the losses. By the way, I had still done better than the market averages. Why is that important? I will come to it by the end of my investment journey

2001-2003 (rebuilding the portfolio)
By 2000, I had got an expensive lesson for being greedy and for ignoring valuations. However I never letup on my learning. I was actually enjoying the process and knew by then that I was fairly passionate about it (money or not). Access to information through the internet made the learning process easier too.

By mid 2001, I started re-analysing my portfolio and identifying my mistakes. Overall, I think I did not have too many. I sold off SSI and exited the IT funds. The rest of the portfolio remained the same. I started analysing stocks and picked up the following companies during the 2001-2003 phase

– Blue star
– Concor
– ICICI bank (had bought the IPO, just increased the holding)
– Marico
– Pidilite
– Gujarat gas

In addition I moved into a few good mutual funds and exited the poorly performing funds. By Mid 2003, my portfolio had done much better than the market, but was below cost in absolute terms as the market had been dropping for the last 2 years.

It is easy to look back and regret that mid 2003 was an all time low (index was around 2900) and one should have invested heavily into the market. But if like me, you were new to the market and had faced only a bear market, it was a very diffcult thing to do. It was difficult to see a bull market over the horizon.

In hindsight (which is always perfect), my portfolio was well positioned for bull run. It however did not feel that way at that time.

By the way, I was not done doing stupid things. I was sick of L&T’s performance (due to the cement division), their management and the stock price. So I sold it after 4 years at a 10% gain. What happened after that ? see here

To be continued …..

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How i analyse stocks

By Rohit Chauhan
In Investment process, Uncategorized
August 15, 2008
5 Min read
20 comments
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I have been asked via emails and comments on the process I follow in analysing stocks. I have written about my approach earlier, but may have never put it formally in a single post.

My approach essentially consists of the following steps

1. Idea generation – This is typically the first step in the process. It involves searching for undervalued ideas. I do not have a strict formula for the search process. I use icici direct website to run a few screens to generate some ideas. Some of the screens are as follows

PE less than 13
ROE greater than 13%,
debt / Equity less than 0.7

Once I get this list, I export it into excel and then add additional parameters to it such as Net profit performance for last 5 years, ROE for last 5 years etc . A few companies get eliminated at this stage if they had losses for the last few years and have only been profitable for a year or two. Once I have shorter list, I start looking at the Profit and loss statement, Balance sheet and ratios. A few companies get eliminated if I don’t like what I see at this point of time. For ex: If the free cash flow is poor for the company, I will remove the company from the list.

In some cases the elimination is not really scientific and is driven by my whims and fancy ( I am not as rational as I should be). So highly cyclical companies, which seem to have a very low PE due to sudden profit spurt are eliminated if their normalised PE is not attractive. After all this number crunching, I may be left with a 10-12 companies.

Another source of ideas are blogs of other value investors, articles or suggestions by some other investors I admire and follow. If I see them talking about a company, I add it to the list and start investigating it.

2. Annual report review – Once I have a list of interesting ideas, I start scanning the annual reports of these companies to look for any red flags or hidden value. Some companies get eliminated at this stage if I find something fishy. Once I like the numbers I see, I start reading the Annual report from the beginning, starting with the Director’s report, Management discussion etc.

3. Valuation template – Once I have a rough idea of the company and if the company still looks good, I start updating my valuation template. I start with the Quantitative numbers, follow it up with an industry analysis, competitive analysis etc. I keep referring back to the annual report to update the worksheets and answer some of the questions in the template. I also use this stage to generate more questions on the company.

4. Broad research – After updating the basic numbers and the qualitative worksheet, I may end up with some open questions. For ex: How is the industry expected to do over the next few years? . How will competition impact the company etc ?. At this point, I start doing some research on the net to find answers to these questions though I may or may not be successful at this stage in finding answers . I may even download the AR of the main competitors and review it to get a feel of the industry. This stage is fairly unstructured and I just trying to gather as much information about the company and industry as possible

5. Valuation – If I am still comfortable with the company, I start the DCF calculation and other valuation exercises. Over time I have realised the valuation exercise is fairly redundant. If the undervaluation is not perfectly obvious by now, then plugging some numbers and making a bunch of assumptions is not going to make the company an attractive buy. The numbers being plugged into the model are dependent on the qualitative analysis done during previous stages.

During this stage I go through a DCF valuation, comparative valuation and a probability based valuation exercise. If the numbers match with each other in all the approaches, then I am more confident of the Intrinsic value estimates

6. Portfolio inclusion – I typically try to keep 12-15 companies in my portfolio. So if a company has to get added, another has to go out. This prevents my portfolio from becoming a zoo of mediocre ideas. I compare the discount at which the new company is selling to my estimate of the intrinsic value. I then compare this discount with that of the other companies in my portfolio. If the new idea is better than an existing one, then it replaces it. Else I may make just a very small token investment to track the company and wait till it become more attractive or some other company goes out of the portfolio.

Although I have listed the steps in a very linear and logical fashion, in reality it is not so neat. Multiple steps are going on at the same time and I may sometimes skip a step too.

As you can see, the process is a bit elaborate and time consuming. I however do not find it cumbersome as I enjoy doing it.

Come to think of it, why should it be easy? is there any competitive profession in the world where you can make good money without any effort ? why should investing be any different ? Have you ever heard that someone has become a heart surgeon in a day?

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Analysis – Ashok leyland, Suraj diamonds etc

By Rohit Chauhan
In Company analysis, Investment ideas, Uncategorized
August 8, 2008
3 Min read
6 comments
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I had suggested to the readers of this blog a few weeks back to send me a list of companies to analyse. I am posting on a few from the list

Ashok Leyland – I have written on Ashok leyland here and here. I have been analysing the annual results of the company for 2007-2008 and the key points are summarized below

Postitives :
The company has maintained its ROE and capital efficiency (Wcap ratio) inspite of tough market conditions. The sales growth was around 6%, which is decent in view of the slowdown in the Commercial vehicle markets. The netprofit growth and margin were also satisfactory. The company has also improved its market share in the current year.

In addition to the above, the company is investing in capacity and also in R&D (at 2%+ of sales). The company is also investing in several JVs for exports, electronic components for vehicles etc.

Negatives :
Competition in the industry is increasing with a lot of foreign players coming into the country. As a result the obsolence of models will speed up. There would also be a higher spend on R&D and Marketing to manage the competitive pressure.

The company is also expanding internationally which in itself carries a higher risk.
The company is a cyclical industry where the demand could be weak for some more time. This is strictly not a negative as the long term competitive advantages of the company are still intact.

I have uploaded a detailed analysis of Ashok leyland in google groups here (valuationtemplatev2ALLaug2008.xls)

A valid question would be – Why not invest in tata motors which is the clear industry leader. To that my response is – Tata motors as a company is too complex for me (maybe not for others) to analyse. The company has a lot of moving parts now. It a heavy vehicle, car manufacturer combined. In addition with foreign accqusitions of Jaguar and other brands there are additional unknowns too. In comparison AL is a much simpler company to understand and analyse. Hence my preference for Ashok leyland.

Suraj Diamonds
The company is in the diamond cutting and jewelry business. The revenue has grown by almost 300% in the last 5 years and so has the net profit. However the net margins are very low at around 2-3%. In the addition the ROE is less 10% even after improvements in the last few years. The company has low free cash flows. The net profits in aggregate are around 130 crs in the last 5 years. However around 50% have been used up for fixed asset and working capital. There has been a huge increase in the debtors position which is now around 1 years sales. The company looks cheap from a net profit perspective, however I am not too impressed by the ability of the business to generate free cash flow. There is fairly high increase in debtors which is quite risky in my opinion.

I would personally not proceed further with this stock untill I see the company is able to improve its free cash flow generation. The risk in such stocks is that the faster the company grows, the more capital either in form of debt or equity would required. This is fine in the short term, however if the business model generate poor free cash flows, then the stock only appears but is not really undervalued

A few additional companies have been emailed to me, which I have analysed in the past. I am providing the list and the links below

Maruti
HPCL – see here and here
Kothari products – It is still a net cash situation and an arbitrage opportunity too.
VST industries

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Analyst speak

By Rohit Chauhan
In Uncategorized
August 5, 2008
1 Min read
3 comments
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Analyst recommendations –

Neutral – We are as clueless as you are about the future of the company, but I have to give some rating as I am being paid to do that.

Hold – Same as neutral

Buy – Holy Cow !! The stock price has gone up recently. Now that the whole world knows that the company is doing well, we are recommending the stock. Doesn’t matter if the company is overpriced …that is your problem.

Sell – (The opposite of buy ..literally and figuratively) Oh @##!! , The whole world knows that the company has gone to the dogs. The stock price has dropped like a stone. Better cover my ****.

Underweight or overweight – (Play of words) Means we are confused, but as we have to give some rating and have to generate some commision for the brokerage, sell a little or buy a little (we don’t care which, both will generate commisions for us)

I have nothing against individuals, but the profession forces honest, intelligent people to indulge in smoke and mirrors and put out garbage.

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And now on Twitter

By Rohit Chauhan
In Uncategorized
August 3, 2008
2 Min read
5 comments
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Twitter is supposed to be a microblogging tool. It is like be cross between an SMS and a blog. This tool allows you to post entries (tweets ?) of about 140 characters. So one can use this to post or inform others about what you are doing, thinking etc almost on a real time basis

I originally thought that this tool would be a waste of time for me. However I read a few posts on this tool and have seen some other bloggers use this tool to communicate and discuss topics which are of interest but too short for a post.

So I have decided to give twitter a shot. You can follow me on twitter here. So what am I planning to write about ?

My initial thought is to post on interesting books, articles or posts I have read. I also plan to write on various developments in the business world and my thoughts on the same.

In the past, I would have a quick opinion on something, but found a post too long for it and in addition I was not wanting to clog my archives. I tend to post on a topic which interests me and after I have done some analysis or thinking on it.

It is still an experiment and if I realise it is taking too much of time or there is not much value being added, I may discontinue it. What I will not be writing on twitter are real time updates of what I am doing …like drinking coffee, reading something etc etc. I have not desire of boring anyone to death 🙂

If you are new to this blog, you can subscribe to this blog via RSS (click on the link or you can see the link at the top of the side bar under subscribe). Alternatively you can subscribe via email (you can be assured that I will not be spamming you)

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Arbitrage Process – II

By Rohit Chauhan
In Arbitrage, Uncategorized
July 31, 2008
2 Min read
2 comments
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In the previous post, I detailed the arbitrage process. In this post, let me provide some other resources to understand the process better.

Joe Ponzio (Fwallstreet) is a value investor and writes extremely well on value investing with a lot of clarity. He has written several posts on arbitrage with examples of specific companies such as the tribune company. In this post, and this post he talks of the 7 broad steps in a merger or accquisition. These steps are mainly around the due diligence of the deal, signing a definitive agreement, getting shareholder approval and follwed by the regulatory approvals. Once all the approvals have been taken, the probability of the transaction happening is high

As Joe’s indicates,correctly in this post – ‘In arbitrage, the goal is to earn high rates of return on an annualized basis in low-risk, high-certainty situations’. So by investing in a transaction which is past the major approvals, an investor can be confident that the transaction will happen , which reduces the risk component of an arbitrage transaction.

I would recommend you to read his arbitrage related post to get a good understanding on the process.

What are the kind transactions which can be considered for arbitrage ? I have written on these transactions in the past and am listing them here again

Spin-offs

Mergers : These can be friendly in nature or hostile. Friendly mergers have lower risk and lower return. Hostile mergers have higher risk and correspondingly higher returns. Mergers can involve cash merger where the target shareholder is paid cash for their holding or stock for stock exchange or a combination of the two.

Bankruptcy or restructuring

Recapitalizations

Arbitrage helps in generating positive returns during a bear market. However the downside is that this investment category requires a lot of work for the small returns you get in return. As a result arbitrage may not be suitable for someone who is able to devote only a few hours a month on investing.

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Arbitrage process – I

By Rohit Chauhan
In Arbitrage, Uncategorized
July 28, 2008
4 Min read
5 comments
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I have been reading a book on risk arbitrage and came across the following steps in a typical deal (merger, spin-off, recap etc)

Deal announcement – This generally involves a press release or filing of an offer with BSE/ NSE with the requisite details. An investor has to be on a constant lookut for such announcements.

Gather and analyse information – After the investor comes to know about the deal, the next step involves gathering and analysing information.
The following are the various types of information which needs to be considered

Financial information: This involves reading all the filings with the stock exchange, Financial details of the companies involved such as the annual report, quarterly reports and analyst reports.

Legal information: gather and analyse any legal information which may impact the deal. For ex: check if there is an legal dispute in which the target or the acquiring company is involved, which may impact the success of the deal
Any tax and accounting implication should also be studied

Interpret and estimate – This stage involves the interpreting the information from step 2 and coming up with values for the following three variables

Returns estimate – The formulae used for the returns would as follows: Final target company price-Current price / Current price. In addition if the deal involves a stock for stock merger, then the investor should add the dividends to be received. If however the deal involves a mix of cash and stock, then the total return can be calculated as follows

(% of cash* amount of cash+% of stock * amount of stock)- Current price / Current price

If the transaction involves shorting the accquiring company stock and using borrowed money, then the return should be reduced by the dividends which needs to paid for the shorted stock and also by the interest cost of the borrowed capital.

Risk estimate – The risk in the transaction is the downside risk of the target company + Upside risk of the accquiring company

Downside risk = Current price – estimate of target company price if the deal fails

If the deal fails, and the investor has shorted the accquiring company stock to hedge, then he may incur an upsideside risk too

Upside risk = estimate of the accquiring company price if deal breaks – current price

The estimate of the prices for the target and accquiring company is done based on several factors such the pre-deal price, price of other companies in the industry etc.

Probability – This is the probaility of the deal coming through. The investor may assume there is an 80% probaility of the deal coming through. His estimate of returns my be 15% and estimate of risk may be 30%.

Based on these numbers the risk adjusted return is = .8*.15+.2*-.3 = 6%. This could be the absolute returns. If the investor expects the deal to complete in one month, then the annualized return is 72%.

It is important to consider the time it will take for the transaction or deal to happen and use that to estimate the annualized returns. The longer the time for the successful closure, the lower the annualized returns.

Estimation of probability is a very subjective exercise. An an investor one has to analyse the various subjective elements of a deal and estimate the likelyhood of the deal being successful.

The earlier one invests in a deal, the more the uncertainity and hence higher the spread. In the event that there are multiple scenarios possible for a deal such as possiblity of a white knight appearing, then the risk/return of each scenario needs to wieghted with the probability of that scenario to arrive at the estimated returns for a deal.

Next Post : Other resources to understand the arbitrage process

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