Value investor india

Analysis – Maruti Suzuki Ltd

May 16, 2008

4 Min read

About
Maruti Suzuki is india’s largest car company with brands such as Maruti 800, Alto, Swift etc. The company sold around 760000 cars in FY08 and currently holds a 50%+ market share

Financials
The company has achieved a 10%+ growth for the last few years. In addition the ROE has been 20%+ for the last few years and net of cash the ratio is upwards of 50%. The net profit margins have gone up from 5.8% to 9.8% in the current year. The company is a zero debt company and has almost 3000 Crs + cash and investments as of 2007.

In addition the efficiency ratios have improved from 2003 onwards. The company is now working on 0 Wcap. The recievables ratio is up from 14 to around 19 (2007). The total asset ratio has improved to around 5.

The company has thus improved its profitability and asset turns in the last few years. The improvement in net margins is really commendable as this has happened in times of rising raw material prices and higher competition.

Positives
Maruti is one the most well know brands. I really doubt if there is an indian who is not aware of maruti suzuki (rather their cars).

The company has a strong balance sheet, great brands and has been able to add new successful models consistently in the past few years. In addition the company now has full support from the parent for new models.

In addition to the above the company has the largest dealer and service network.

Risks
I see competition as the biggest risk. There will be swings in the demand. However as India prospers, the unit volumes are bound to go up. However with China and India being the high growth markets globally, there is bound to be intense competition in this sector. This could have an impact on the margins going forward.

The risk to margins is not from the pricing alone. Higher competition means, shorter product cycles and hence the amorization of the development expenses is now over shorter period. Case in point – The Company has rightly hiked its depreciation rates.

In addition during the year 2000-2002, the company had quite a stumble. The company was suddenly faced with slowing demand and increased competition. As a result the company made its first loss in years. However the company has learnt from it and has become far more efficient.

Competitive analysis
The firm has competitive advantage from a high market share and well know brands. The high volumes drives economies of scale for the company in manufacturing, purchasing, distribution and such scale driven activities.

In addition the company has increased the lead by expanding its distribution networks (more dealers), opening new service centres and by expanding into allied services such as insurance and used car sales. All this results in higher customer lockin and more repeat business.

Valuation
It is quite apparent that the company has considerable competitive advantage. However what is not easy to figure is how competition will increase and impact margins in the future.

With an assumption that the margins will remain between 7-9% (which is slightly higher than the global averages) and a 8-10% growth, and CAP of 9 years , the intrinsic value comes to around 1200-1300. I think the growth and CAP assumptions are reasonable. However the net margins are a wild card.

Added note: A 6-7% margin assumption would give an intrinsic value of around 1100.

Conclusion
The company sells at around 40% discount to the above intrinsic value. However I still have my doubts on the net margins. As a result although the company appears undervalued at current prices, I do not have any investment in the company. I would be prefer to have a higher discount to intrinsic value to make a commitment in order to reduce the downside risk from net margins.

Disclaimer – I may change my mind based on new information and may invest in the company. I may however not post when I do so. So as usual please make your own decision and read the disclaimer.

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The three risks for IT industry

By Rohit Chauhan

In Industry analysis, Uncategorized

May 5, 2008

2 Min read

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I had recently posted on NIIT tech and uploaded the valuation (see here). The way I see it, there seem to be three key risks for the IT industry which I have tried to include in my valuations.

Risk 1 : US slowdown – This is a medium term risk and should not impact the long term economics of the IT industry. On the contrary I think the slow down will not really impact the industry much in terms of overall growth. There could be a bit of a slow down and some pricing pressure. But not much beyond that.

Risk 2 : Rupee appreciation – I think this with cost pressures is the most critical risks as this would impact the margins of the IT companies. In the scenario I have built I am assuming that margins will drop by half in the next 2 years due to the appreciation and cost pressure

Risk 3 : Taxation issues – The tax holiday enjoyed by the industry would be taken out by the government. In response to the slowdown and rupee appreciation the government has extended the tax holiday and there has been a sudden rally due to that. However I think the tax breaks are bound to go, only question is when. However this risk is definable and can easily be worked into the valuation

In my valuation I have assumed the worst case scenario for all the three risks. However as we saw recently if the rupee appreciates, the tax breaks could get extended a bit and that could mitigate the impact. So it is quite likely that the worst may not come to pass. The stock price assumed the worst in march. Since then there has some correction as the market realised that things are not as bad. However it would not take much to change the mood again.

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Berkshire hathaway annual meeting and quarterly results

By Rohit Chauhan

In Uncategorized, Warren buffett

May 4, 2008

4 Min read

1 comment

Berkshire hathaway (warren buffett’s company) is having their annual meeting over this weekend. This meeting is called the woodstock of capitalists. I have been reading and following buffett for the last 10 years and tend to read his every interview, speech and the Q&A session of the annual meetings.

You can find a great compilation of everything buffett here

His letter to shareholder are a must read and I would recommend reading them multiple times.

Berkshire declared their quarterly results and reported a 65% drop in profits. Although as an indian investor, we cannot invest in this company, I would recommend reading the letter to shareholders and analysing the company to learn how a great company works and what it means to be shareholder oriented (the company is a gold standard).

I cannot explain the company in detail here. However if you have been following the company and have an idea about it, below is my analysis of the cause of the drop in profits.

Buffett has called derivatives as financial weapons of mass destruction and has cautioned against them. I am pretty sure that media, seeing a drop in profits due to derivatives, would crow about how the world’s greatest investor has himself got burnt by the same. However one has to understand that though buffett has warned against using derivatives if the company cannot understand the risks behind it, he himself understands them better than most and clearly knows what he is doing.

The quarter’s loss have been due to mark to market loss on the put options and CDS written by buffett. The put option buffett has written is similar to supercat insurance written by the company. The company gets a premium and insures a low probability event. if the event occurs then the company has to pay the insured amount. now over the years buffett has indicated the they could lose money on specific policies, but over a long term , they work with the odds on their side and would make a profit.

In case of the put, although we do not have the specific details, i would assume a similar approach. In addition buffett has indicated that he looks at the exposure also (total max loss) and no matter what the odds would never risk a huge amount. The puts are deep puts and the odds of the markets being lower 20 years later is low (we dont know what is the strike price of the puts, but they are based on the index and not on a company).

Berkshire accounts for MTM losses or profits which are accounting or book keeping losses/ profits if the options are closed today (unlikely to happen). So the company gets to keep the premium, invest it and get a good return from it for the next 20 years. This is on a low probability event that the market would be way lower 20 years later, in which case the company may well exercise the put and buy the index at the ultra-low valuations.

You would think that if the above is such a good deal, then why are other companies not doing it?

It is explained in the current year’s letter to shareholder and I can think of the following reasons

– The accounting as we can see in this quarter is very volatile. There are almost no companies which would risk a billion dollar hit to their results via such derivatives. The CEO would lose his job for such results
– There is counter party risk too. The buyer of the put option should believe that the company writing the put will be around 20 years later to pay up. Very few companies can do that

ofcourse media is going to make a show about this drop as they dont understand the company or how the options in this case are different from the one’s written by banks and other financial institutions.

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Business scalability and valuation

By Rohit Chauhan

In Investment process, Uncategorized, Valuation

May 1, 2008

2 Min read

3 comments

My pervious post was about business scalability, a term used by Rakesh jhunjhunwala frequently. I attempted to lay out my understanding of the term in that post.

Business scalability is a critical factor in valuation. As I detailed on my post on intrinsic value, the DCF formulae can be used to calculate this number. There are two key variables in the formuale – Free cash flow and the duration of the same before the terminal value is applied. This duration also referred to as CAP (competitive advantage period) is the time period during which the company is able to earn above its cost of capital. Beyond this period the company earns its cost of capital and hence is valued at its terminal value.

A company with a scalable business will be able to grow its free cash flow faster (higher growth) and also have a higher CAP at the same time. Now higher the growth and CAP, higher is the intrinsic value. If you can identify such a company much before the market does, as Rakesh jhunjhunwala and other top investors are able to, then the returns are very very high.

However identifying such companies is not easy. The most common error I have seen with analysts is that they identify the market opportunity, pick a company most likely to do well and stop at that. The analysis should also involve analysing the business model in detail, identifying the key drivers of performance and doing an assessment of these drivers. If this sounds complicated, then it is. The value is not easily apparent and requires quite a bit of analysis and digging around. All this has to be done before the market recognizes the company and bids up the price.

I think this approach to investing is a very advanced form of investing. It is not easy for a novice investor to practise this form of investing easily. One should have a keen understanding of business models, valuations, economics and other aspects of investing. Graham or deep value investing requires much lesser expertise and also has more diversification of risk. However this form of investing, where an investor can correctly identify a scalable business, is the key to long term riches.

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Analysis – Maruti Suzuki Ltd

The three risks for IT industry

Berkshire hathaway annual meeting and quarterly results

Business scalability and valuation

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