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A follow up on sulzer

By Rohit Chauhan
In Uncategorized
March 19, 2010
2 Min read
4 comments
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A disclosure first – This idea was originally brought to me by ninad during our discussions and I have been analyzing it with ninad and arpit since then. Its amazing how soon one forgets the source of an idea, especially a successful one 🙂

Since my last post on sulzer, the price has corrected to around 1200 levels and is steady at this level. This is roughly around 85-90% of my estimate of fair value. I am now planning to exit this stock over the next few weeks.

The delisting process would take a few months and I plan to keep a track of the stock. If the price drops or some new information comes up to indicate a higher price for delisting, I may initiate a new position.

The returns ofcourse would be 8-10% at best, as the major gains are generally made at the time of the announcement. However an 8-10% gain over a period of 2-3 months is not a bad deal and actually fairly good from an arbitrage point of view. So stay tuned!

On options trade
I have received several responses via comments and emails. The key point of the post is a focus on risk. The most critical aspect when dealing with options to understand and manage risk. I am looking at two ways of doing so

Position size – I have created a small position as I am still a novice in options. If I lose money, it will sting me but not kill me. On the other hand a gain would pay for my coffee for a month – I have expensive tastes !

Focus on downside – My focus has been on much I can lose. One of the reason to post was to hear from other readers on the likely risks in this approach. If you feel that risks which I have not considered in the post, please leave me a comment or drop me an email at rohitc99@indiatimes.com.

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Selling covered calls – An options approach

By Rohit Chauhan
In Uncategorized
March 14, 2010
4 Min read
19 comments
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Some of you, on reading the title must be wondering – Rohit is again on his options trip ! this dude is going to get kicked big time, one of these days 🙂

Well, in the spirit of learning and experimenting lets look at an options strategy, that I think marries the value investing approach with options quite well.

What are covered calls?
You can read about call options here. Selling covered calls mean selling a call option in the market while holding the underlying stock. Selling a call option without holding the underlying stock is naked selling (no its not selling without wearing your clothes :), but you could lose them if the naked selling bet goes wrong).

How does it work with value investing ?
The logic is as follows – Suppose you hold a stock which is a mid to long term holding. Lets say you bought the stock for 60 Rs and think the fair value is 100. Now let’s assume that the stock is selling for 95 and you plan to start exiting at 100-105 as you really do not want to hold above fair value. In such as case, one can sell a call on the stock for a strike price above the current quote, say around 110-115.

If the stock continues to climb, the call will get exercised and you will get the 110 exercise price + the premium amount. If the stock drops back and if you had planned to hold on to the stock for the long term as long as the price was below fair value and the fundamentals are good, then you pocket the premium and continue holding the stock.

An example
Lets take the example of a favorite of mine – Infosys technologies. My own estimates of fair value for the stock are around 2700-3000. The stock is currently selling for around 2700 which is close to fair value.

The first option for me is to sell the stock once the price crosses 2700 and be done with it. The other option is to start selling covered calls with a strike price of 3000 or higher. If the stock keeps rising and the call gets exercised, then I will end up exiting at 3000 + premium as planned. On the contrary if the stock drops from here, I can pocket the premium for free. The flip slide is that I will lose money on the stock as it drops.

The risks
If someone ever tells you that there is no risk in an investing strategy, ask him what he is smoking or drinking.

There are several risks in the above plan and it works only for a very specific situation. I would sell a covered call on a stock which I think is selling close to fair value and I would not mind holding it if it dropped below this price – the second part of the statement being the key. As a corollary, the reason I would not mind holding if the price dropped is because I think the company will continue to do well and will increase its intrinsic value at a good rate.

A valid question would be – why not sell and move on? . One reason for trying this approach is plain experimentation – with limited amounts of the stock. The second reason is that I would continue to hold on to the stock for the long term as the company is still doing fine and selling covered calls increases my returns. At the same time if the stock gets too overvalued, I would exit it by selling via the covered call.

If you do not want to hold the stock for the long term and would regret holding it if the price drops, then one should just sell the stock and move on. In summary this is a strategy of trying to be a bit too clever and squeezing out a few percentage points of returns.

As an aside which options should one sell in this case ? – I would prefer to sell the ones with the longest duration (May 2010 exercise) as I would also benefit from the time decay and the premium is also worth the effort.

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A delisting idea – Sulzer india

By Rohit Chauhan
In Investment ideas, Uncategorized
March 5, 2010
2 Min read
18 comments
A

I had analyzed sulzer here. I had written the following

Sulzer has tried to delist the company in the past and current holds 80% of the stock. I will have to stretch my imagination on the point, that the company will suddenly start looking at improving the returns for the minority shareholder. In such a scenario, it is quite difficult to put an appropriate number on the intrinsic or fair value of the company.

Well, one part of the comment came through – the company announced delisting yesterday. I had also written that it is difficult to put an appropriate number on the fair value. That did not stop me from evaluating the stock. I have uploaded a detailed analysis here.

I typically use this spreadsheet to do a detailed analysis of a company to ensure that I am evaluating the company from all aspects (I need to get a life !!)

My fair value estimate of the company is between 1250-1300 and it remains to be seen if the stock will appreciate still further in response to the delisting offer. You can read the guest post by ninad on the delisting framework here.

I have been building a position in this stock for quite some time now and have built a 60% position ( I am too slow !!). I am definitely pleased with this outcome. The stock however is now a delisting play and my approach will be different. It is likely I may exit the stock if the price approaches my estimate of fair value

An offer to my broker
I recently opened a new account and have a new broker. The broker is quite good and provides me good service. To appreciate the business he gets, he has been sending me 4 line stock recommendations. For ex: One of the recent recommendations was Tata motors.

I could not believe that someone would buy a stock based on a 4 line recommendation – apparently quite a few do. I think people do more research when buying a pressure cooker than a stock !

My offer to my broker is (in jest) – if you don’t give me advise and don’t send me recommendations, I will give you 1% extra commission on my trades

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Company analysis – Sesa goa ltd

By Rohit Chauhan
In Company analysis, Uncategorized
March 1, 2010
5 Min read
8 comments
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About
Sesa goa ltd is the largest private sector iron ore producer and exporter. It has access to 240 Million Mt of ore with mines in Goa, Karnataka and Orissa. The company achieved a turnover of around 5221 crs in 2009 with a net profit of 2710 Crs. The company exports almost 85% of its production to china

The company has three divisions with Iron ore accounting for 85% of the revenue, Pig iron representing forward integration represents 12% of the revenue and rest is accounted by Metallurgical coke. The company is principally a mining operations and logistics company.

Financials
The company achieved a topline growth of 30% and a profit growth of around 16% in 2009 inspite of the severe recession in Q3 and Q4 of the financial year. The company was able to achieve this performance due to the increase in volumes and pickup in demand in china, which account for 84% of its total volume.
The company has around 4000 crs in cash and equivalents on an asset base of 4800 crs. This translates to a stated ROE of 60% and 300% on the invested capital.
The company has a 10 year topline growth of almost 35% per annum, with majority of the growth coming in the later years. The net profit has grown by an even higher rate, with the last 5 year CAGR coming to around 33%.

Positives
The company has clearly been able to manage the business well during the downturn. It has been able to keep costs under control and maintain its profit levels. The company has a very strong balance sheet with a lot of surplus cash to re-invest in the business.
In addition, over a 10 year period the company has become fairly efficient and profitable. The net profit margins are close to 50% as the mines are owned by the company and the business enjoys considerable operating leverage (overheads do not increase in proportion to volumes).

Risks
China accounts for almost 84% of the total demand for the company. China currently accounts for almost 40%+ global steel production and hence the demand supply situation in china will have huge impact on the fortunes of the company.
In addition, iron ore export is a sensitive topic and the government can and has imposed export tariffs to favor the domestic steel industry. This can impact the net profit levels of the industry and the company in particular.
Finally, the company at the current rate of production (without growth) will exhaust the reserves in around 16 years. As a result the company needs to constantly explore and add to existing reserves on an ongoing basis. The cash on the books is not really free cash as it will be required to sustain the business in the future.

Management quality checklist
– Management compensation – Fairly low, based on the size of the company. Good for the shareholders.
– Capital allocation record – This is difficult to evaluate as the company has kept the dividend low and retained most of the profits which is now held as cash and equivalents. It remains to be seen how the capital will be deployed. The management has stated that the intention is to acquire mining assets with the excess capital.
– Shareholder communication – The shareholder communication is actually quite good. I have rarely seen Indian companies (outside of some IT companies) discuss their operations with honesty and detail. The company has actually detailed all the risks to the business quite clearly and with complete honesty.
– Accounting practice – appears conservative.
– Conflict of interest – doesn’t look like conflict of interest, but a 1000 Cr intercompany deposit with a fellow subsidiary is not something good over time.
– Performance track record – good in terms of operational performance. Capital allocation (investing the surplus cash) performance needs to be seen.

Valuation
Sesa goa is a mining company and it would be silly to value this company using a PE approach or Discounted cash flow. I have seen valuations where the company is said to be cheap as it sells at a PE of 13-14. That is stupid. The simplified equation should be
Company value = value of current reserves + future value from reserves to be added.
The company achieved a profit of around 130 crs per Million MT of ore . As the existing reserves are around 240 Mn MT, the asset/ cash value of the company is around 19000 crs (if the company were to develop no new reserves). This is the current cash or baseline valuation of the company. If the company sells below this price, it’s a bargain as it was in early 2009.
The company currently sells for 30000 crs which includes the value the company will generate through additions to its reserves and new mines. I need to evaluate the average reserve additions over the years to get a sense of the company’s capability to add to its reserves.
My current thought is that the company seems to be fairly valued till I can get a better sense of how the reserve addition will work out in the future.

Conclusion
The company is performing fairly well and has a strong balance sheet to support additions to ore reserves. At the current price however the company does not look undervalued to me. In addition there was a recent FCCB conversion which has added to around 3% to the equity base. Finally there seems to be some fraud investigation going on regarding the company. I have not been able to find much in terms of details and not sure how it impacts the company.
The company was bargain at any price below 200.

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