2004-2007
Inflation – 3-5%
Sensex – 300% up
Interest rates – around 7-8%
Salary hikes – 20% minimum
Real estate – 200% or more up
A few more years of this, and I could have retired. Ahh ..life was good !!. All I had to do was to buy a house, anywhere or pick a stock which I heard from my panwala or barber.
how I long for those times again 🙂
I want a new bubble !!!!!
I have posted on NIIT tech earlier here. I had done a quick back of the envelope calculation and uploaded the same in the google groups – see the file valuationtemplatev3NIITtemp.xls. I have been asked on the logic of the valuation via comments and emails. So here goes,
Following are the assumptions in the valuation
– Topline will grow by around 10% per annum for the next 2-3 years
– PBT margins will drop from 17% to around 10% in 2-3 years
– New tax rate will increase from around 15% to 25%
– Net margins will drop from the current 14.5 % to 7% due to the above factors.
I personally think, the above assumptions are very conservative. It is possible that the company can do worse than this, but based on current facts, I think that is a low probability.
So based on the above assumptions the net profit for 2010 is around 90 Crs. I have taken a multiplier of 14 and added the cash on books to arrive at a rough valuation of around 1550 Crs (I have also added the pending options to the share count).
To see what a PE of 14 means, please look at the spreadsheet quantitative calculation – worksheet ROC and PE. Look for the DCF calculation with ROC of 25% (approximate ROE for NIIT tech). A growth of 8% for 3-4 years gives a PE of 14. So I am talking of a growth of 7-8% in profits after 2010.
The valuation is dependent on the assumptions above. Ofcourse these assumptions are not set in stone. If the US market goes into a deep recession or the management does something very negative, then the netprofit could be lower than what I have assumed. If you believe that the market is pricing NIIT tech correctly, then your underlying assumption is that the company is going to fall off the cliff in the next 2-3 years (basically shutdown in the next 3-4 years).
Based on the past performance and this quarter’s result, I don’t see any reason to believe that. However I can and will change my mind if the future invalidates my assumptions. So as I have said before, please do not consider my analysis as a recommendation for the stock.
As an aside, I have received the maximum number of emails and comments on this stock. Its not too surprising as a lot of readers of this blog are from the IT industry and tend to invest more in IT stocks.
I received a list of companies to analyse based on my earlier post. In order to do a better analysis, I am trying to club all the stocks from the same industry. As there are several cement companies in the list, I decided to take a stab at the cement stocks first.
My earlier analysis of the cement industry is here and here. In addition I have analysed the industry and updated my analysis in the file business analysis in the google group. Please have a look under the column commodity – cement.
The cement industry is a cyclical commodity industry where the profit and return on capital is dependent on the demand cycle picture. From the mid 90’s to 2002-2003 period, there was an excess of supply and hence prices were depressed. Most companies had poor to non-existent profits and accordingly the stock prices suffered. Since 2003, the demand has increased rapidly and so have the prices. The profit margins are now in excess of 20% for some companies and ROE in excess of 40% for companies such as ambuja cements. I personally think these are fairly high returns for this industry and the best of the companies in the industry would earn around a max of 20% over a business cycle.
Valuation of cement companies should not be done on the basis of peak earnings alone. This holds true for most commodity companies. Case in point – sugar companies. In 2006-2007, these companies appeared cheap based on their peak earnings. However when the cycle turned downwards, the stock prices got wacked. The economics of the cement industry are not as bad (there is lesser government intervention), however the valuation approach should be similar to the sugar industry. One has to be careful in extrapolating the peak earnings and assuming that the stock is undervalued.
Due to the cyclicality and commodity nature of the industry, analysis and valuation of cement companies is more diffcult as one has to figure out where the industry stands in terms of the business cycle . High returns can be made if one can predict the key turnaround points in the business cycle.
Mysore cement –
This is an interesting company. The company was taken over by the heidelberg group and made a tender offer to buy shares from the public at 54 Rs/ share in 2006 . SEBI directed the group to set the price at 72.5 per share. This was recently overturned by SAT and the heidelberg group can now initiate a tender offer to buy the shares from the public at Rs54 per share.
In addition the company alloted 66.5 Million shares at Rs 54 per share in 2006 to the group. This capital was used to pay off the accumulated debts and wipe out the accumulated losses. The company has also become profitable from 2007 since the new management took over.
In addition a recent news, indicates that indorama cement would be merging with mysore cement taking the capacity to 2.8 Million tonnes. The company further plans to expand the capacity to 5.9 Million tonnes.
The financial look good, with the company solidly in the black, no debt and cash of almost 180 crs on the books. The impact of the new management can clearly be seen from the P&L account, balance sheet improvement and aggressive plans of the company to expand capacity through mergers and greenfield projects.
So if everything is so good, then one should go and buy the stock? I would hold on that before I can figure out the following
– Cement is a cyclical industry. Currently the industry is on an upswing and hence all cement companies are making good money. How will mysore cement fare when the cycle turns south (supply exceeds demand)
– What is the cost structure for mysore cement? Cost is critical in a commodity industry such as cement.
– Future plans of the management. Scale is important in the industry. Mysore cement is still at 2.8 Million tonnes and even after capacity expansion would still be one of the smaller companies
One interesting development is the tender offer. The stock is quoting at around 30 Rs and the tender offer should be around 54 Rs. The stock may be a good arbitrage opportunity, even if the long term prospects of the company needs a more thorough analysis.
Ambuja cements
Ambuja cements has been one of most profitable cement companies in india and has made money even during the downturns. They have the highest net profit margins in the industry at 30% and ROE of almost 40%. Net profit margins have grown from 10% to around 30% and the profit as a result has grown by 8 times in the last 5 years.
The company sells at around 560 Crs/ Million tons of capacity compared to say 170 Crs/ Million tons of capacity for Mysore cement. The difference is high and understandable as Ambuja cement is a well run company with huge capacity and a very efficient cost structure.
The company is currently selling at a PE of 7 based on last year’s net profit numbers. Based on normalised profit margins of around 12-15%, the company is selling at a PE of around 12-13. I would say the company is undervalued by 20-25% at best.
If you believe that the net margins are sustainable, consider the following fact : Net margins in 2003 and before were around 10% and have expanded to around 30% in the last 2 years.
Grasim, ACC, Ultratech etc
Grasim has a blend of cement, VSF and other businesses. The cement business seems to be doing well in line with industry. The other companies such as ACC and ultratech have also been performing well in the last 2-3 years. Most of the top cement companies now have margins in the range of 18-22%, ROE in excess of 30% and high profit growth rates in excess of 20-30%.
The valuations of these companies are fairly close. Most of these tier I companies are selling at 7-8 times profit in comparison to the smaller companies which are selling at 4-5 times or lesser.
I am reaching the following conclusions after looking at the complete sector
– The cement industry has enjoyed very high growth rates and great profits for the last few years. The profits margins are not sustainable. New capacity, cost pressure and competition are bound to drive the margins to long term averages of around 10-12% in the next few years
– Most of the companies appear undervalued in terms of the last 2 years profits. However on the basis of normalized profits they are selling at 12-13 times earnings. At best, these companies appear undervalued by 20-25%. There may be a bit of undervaluation, but not by a huge amount.
– Considering the level of undervaluation in some sectors such as pharma, IT etc and the better economics enjoyed by those industries compared to Cement, I am personally not too keen on investing in the cement sector. If I had to pick up one cement company to put my money in for the long term, I would prefer ambuja cement (if I had to that is !!)
I receive several comments and emails with questions which require a detailed response. Instead of replying through an email or a comment, I am posting my reply as I thought others may find the discussion useful
Question : Does the increase in inflation and interest rates, impact the intrinsic value calculation ? Would you not increase the discount rate and reduce the instrinsic value as the long term government bonds rates have increased?
My response : You can find my approach to calculating intrinsic value here. In addition my valuation template also has the format for calculating intrinsic value. You can download it from here.
As some of you would have noticed, the discount rate I use is around 12%. This is strictly not as per finance theory. The typical textbook way to calculate discount rates, is to use the CAPM model (use the cost of equity and debt to calculate the discount rate). I am however more influenced by buffett and munger and their way of looking at stocks. For me, the discount rate or hurdle rate is my opportunity cost.
What is opportunity cost ? It is the return I can normally get from other investment options (debt and equity included). So if I have to invest in a stock, the expected return should be more than my opportunity cost (with a margin of safety to compensate for the risk).
When the long term rates were around 10-12 % in early 2000, I had a hurdle rate of around 13-14%. However when the rates dropped to around 8-9%, I dropped the hurdle rate to 11-12%. If you believe that the long term rates are likely to stay around 10% or higher for quite some time, then it would make sense to increase the discount rate you are using. However in my case, I plan to hold the discount rate at 11-12% till I get a strong feel that the long term rates in india would be above 10% for quite some time to come. Even in that case I may bump up the discount rate by 1-2% at best.
The market is ofcourse adjusting the valuation due to rise in the inflation and interest rates by dropping the prices. However we cannot be sure if this rise in inflation is temporary (6-12 months) or we are in for long term inflation
From prashant
Wondering what you did with your mutual fund investment(I guess you hold diversified equity funds) during Dec 07 / Jan 08 when valuations were sky high? A friend of mine informed me in Dec, 07 that he is swapping all equity funds to debt / balance funds. I ignored the info and thought SIP would take care of any correction. At the peak, gains were around 60% on the total money invested (during SIP of 1-1/2 years – infact I invested extra money in MF during all corrections) and now around -8%.
Actually I was not tracking the market and was taking care of monthly SIP money only. Now looking at current situation, I think I missed the opportunity. I should have done the same as my friend did. Lesson Learned – at a very high cost!!!
My response :
I have done this swapping in and out, jumping up and down and sideways and all around in the past. So after all the jumping and hopping, I decided to do some analysis in 2007 to see how I would have done in the last 8-9 years if I had just done an SIP. Well to my utter surprise, my returns were only 1% better than what I would have got through a dumb SIP plan in a decent mutual fund. With expense loads factored in, I have fared worse than an SIP plan.
I have seen from my past experience when I tried to time mutual funds, I ended up second guessing myself. When the market tanked, I was out and still waiting to get in.Then finally the market resumed its upwards course, but I was still twidling my thumbs. So this jumping in and out over the last decade has costed me a lot.
So this is what I decided – find 4-5 decent mutual funds. I don’t mean the top 5 or top 3 funds which is diffcult to find in terms of future performance. You can find the top 5 funds for the last X years, but that is no assurance that those funds will do equally well in the next X years. So I look at the funds with long histories (more the better) and if they have beaten the market by 3-5%, I set an SIP in them.
Will this give me the highest possible returns ? No it would not. Will I have bragging rights that I was smart to recognize the market top and jump out at the right time ? No, I will not. But I think I will end up following a fairly intelligent investment policy and make good returns. In addition this frees up my time and energy to pursue other activities.