Pidilite declared a 1:10 split recently. The stock market reacted favorably and has bid the shares to 93 (930 pre-split). The split is hardly a value creation event. Just divides the cake (or pizza if you like the analogy) into more slices. Really does not enlarge the cake. So the company now sells at a PE of 26. Definitely not undervalued …I would say overvalued or at best fairly valued
Time to look at selling the stock ?? I think so ….
I was going through a report on the Retail industry specifically the Lifestyle / Garment (Non – Food sector).
Key points and my thoughts
· There are about three main publicly listed companies – Pantaloon, Trent, and Shopper’s stop
· All companies showing rapid growth (50 %+) and expected to show it for the next 2-3 (or more) years due to new stores being opened and share of organized retail rising ( current 3-4 % may go up to 7-8 %)
· All companies have raised debt or equity to fund expansion . In addition all the three do not have excessive debt and should be able to grow easily
· Margins are competitive ( 7-10 % OPM) and Net margins in the 3-4 %. For companies which have higher % of in-store brand , the margins are higher.
· New formats coming up such as central from Pantaloon ( A form of Superstore), Big bazaar (For groceries etc ) which have been fairly successful. Other companies in the space are also expanding through similar formats ( Trent has launched its hypermarket – Star India bazaar )
Positives
Strong growth in the sector due demographic changes in India ( Young middle class is now shopping more in such places)
A few successful formats are coming up which are driving growth
Development of organized retail will improve / streamline supply chain and help in developing the sector further
Negatives
· Competitive advantages depend on economies of scale / Brand and location advantages. Companies like Pantaloon if they can achieve scale would be able derive these advantages and face foreign competition. Companies which do not scale up or develop a niche will have a tough time facing foreign competition
· Foreign competition – Walmart / Carrefour are expected to enter the market. Their huge expertise and deep pockets cannot be matched by Indian players. Also reliance and other large industrial houses may enter the sector (Will the existing players get wiped out or relegated to niches ?)
· Valuation – Currently all the companies are trading at PE of 40-50 which reflect the opportunities ahead. But somehow the market is not considering the risks to these companies from expected competition
An important sector to follow, but not worth investing now as there is no margin of safety in the valuations (which reflect great times ahead, but no risks at all)
I was reading an interview (or maybe annual meeting transcript) of warren buffet sometime back and he was asked about the discount rate he uses in the DCF (discounted cash flow) calculations.
He indicated that he uses the long term treasury risk free rate. In addition, for him a decision to buy is really a go/No go decision. If he can understand the company, its economics and predict its future for 10 years or more, and if the value is screaming at him, he goes ahead. Otherwise he passes.
I have changed my decision process after reading the above comment because it makes sense for a small investor like me. If I can understand the economics of a company (which rules out a huge number as my circle of competence is small) and if the decision is a slam dunk , I go ahead and commit my money. Else I pass. Now that has resulted in my leaving a lot of companies which were close and later did very well in terms of stock price. But in the end I would rather be sure of my decision than tweak my DCF model, fiddle with my discount rate and build hypothetical assumptions of good growth and at the first downward blip , not have the confidence to hold on to the stock.
The above go/No go approach has resulted in my leaving out pharma companies, a lot of commodity companies etc. But then for a retail investor like me who needs a few good ideas a year and does not have to show a quarterly performance like a fund manager, why take the risk and the heart burn ?
Cannot find much to invest !! I typically run screens provided by icicidirect. Most of the companies being thrown up below a PE of 10-11 (I keep a cutoff at 10-11 as I think that would be the approximate value of a company with no growth and returns at cost of capital. So any company having growth and a ROC of greater than Cost of capital would be worth more).
Sample of some companies which came up
– EID parry: In commodity industry (sugar etc) and selling at 16 times peak earning (the screen was wrong and did not consider the 1:5 split.
– Banks: Several banks like Karnataka bank etc came up. Need to check if any banks would have value
– Tata steel, Essar steel, Gujarat ambuja cements – Commodity companies selling in low teens of Peak earnings. Would not be looking at investing at peak / uptrend of business cycle. Also PE is generally a poor indicator for cyclical companies. Generally during downtrends these companies would sport a high PE on depressed earnings and that could be a good time to invest.
– UB holding – A Loss making holding company selling at a CAP of 1100 crores. Tangible assets appear in the range of 300-400 crores. They could have some undervalued assets on balance sheet such as land holdings at cost, Investments in subsidiary companies. Looks unlikely to be worth more than 800-900 crores. I will need to look closely.
Any good ideas ??