Time for Capsules

I had seen the capsule brothers long time ago, nearly 6 months ago as i remember, but at that time i found better opportunities and hence decided against putting the money in these companies. I call these companies as brothers because both have exactly the same capacity, but one is a case of pathetic capital allocation while the other is a case of good capital allocation. Both the companies have a total capacity to manufacture 3.5Bn capsules a year, i guess this should be the critical mass required to set up a manufacturing unit as it is really difficult to find exact capacity among competitors. I will present a small comparison of the two brothers below.

1. The companies have starkingly different RoE, Medi-caps has an effective RoE of 6-7% while Natural capsules has an RoE of 18%. Thats a huge difference!! And as it turns out, the difference is partly about operational efficiency but majority cane be attributed to capital allocation. Medi-caps has Rs.44cr of its assets invested in mutual funds out of a total asset base of Rs.57cr and the best part is the market value of these investments is only Rs.27cr but the company refuses to mark it to market as it believes the fall is temporary in nature and hence is carrying it at cost price. Which essentially means the company is never going to give this money back to the shareholders and is going to put the free cash it generates in more such stupid mindless capital allocation activities.
2. The EBITDA margins of the companies have a difference of nearly 6ppt. Natural capsules reports an EBITDA of 27% while medi-caps has that number at 23%. A further look at the number reveals that both the companies in 2010, earned a gross margin of 4443 and 4487 per lac of capsules sold respectively. So no major difference here, the difference stems from the fact that the employees in medi-caps are paid much more higher than those in natural capsules. For every lac capsules sold, medi-caps pays Rs. 897 while natural capsules pays only Rs.567.
3. Similar is the case with power and fuel expenses, natural caps uses only Rs.537/Lac capsules while medi-caps uses Rs.639/Lac Capsules.
4. On an asset turnover comparison, both the companies generate 1.2 times the gross fixed assets, but the story changes at the net fixed asset level where in Medi-caps due to its 70% depreciated assets is able to show a higher net fixed asset turnover as compared to natural capsules. On the working capital front, Natural capsules scores a strong upper hand than medicaps, the company has been able to bring down its net working capital cycle to a negative region while for medi-caps it stands at nearly 40 days.
5. The best is the fact that Medicaps has shown a 6% CAGR over Fy08-10 in revenues and (-12%) CAGR over the same period in profits while Natural capsules has shown a revenue and a profit CAGR of 20% over the same time period.
6. One more sweetener to the entire thing is the fact that Natural capsules is planning to double its capacity over this financial year to 7.35Bn capsules while medi-caps still decides to put its money in mutual funds.
7. Both the companies are almost debt free with natural capsules having a leverage of 1.2 while medi-caps being completely debt free.

I believe in comparison to medicaps, natural capsules is a far far better company and is still cheap despite its recent run-up today of nearly 17-18%.

AlphaGeo

This one is the most wierd result, that I have seen till now, I have seen profits doubling, quadrupling, margins expanding, revenues falling but revenues falling to zero is truly amazing, how can a company not have any revenues in a quarter i.e. 90 days. Well the company i am talking about Alphageo, just reported some crazy numbers, they reported zero sales and hence a total loss of -5.4cr. The company is into collection of seismic data for exploration and drilling purposes. The comapny during January 11, 2008 was quoting at a price of 901 and PE multiple of 50!!! and P/B of 12!! and as it stands today the company is at a PE of ~11. I really would want to see how the market reacts to the zero revenue. As of today the price was up 2% and the stock was quoting at 202.

IPO Gradings and Market Performance

Mr. Buffett had once said, a company might be a brilliant company, but a bad investment which I believe is very true. The fundamentals of the company might be pretty strong, the company might generate a loads of cahs, have high returns on invested capital, low debt on books and a leader in its field of operations. But that does not make it a good investment. The above criterias just satisfies one of the three things that Graham had mentioned, i.e. thorough analysis. The other two criteria, namely the adequate returns and safety of principal are both guaranteed by the valuations at which the stock is being offered.

And the IPO gradings only take care of the first criteria, they leave out the other two parameters on valuations. That is the sole reason why there cannot be a correlation between the investment performance and the company performance. The very act of coming out with an IPO is akin to a bride getting ready for the marriage, she would obviously dress herself in the best possible way after all she is the bride. Similar is the case with the owners who come out with an IPO, they would want the best value for their shares, would dress the IPO nicely, will promote with all the rigor. The valuations of IPOs are generally on the higher end.

For example consider the company Aster silicates, whose price went from somewhere to nowhere. It came out with an IPO price band of Rs.112-118, went on to reach a high of Rs.255 and presently trades at around Rs.48/share. At the offer price band and post issue equity, the company had and PE of 37.7-39.7. The company is a commodity space with no entry barriers, and neither did the company had high Returns to justify such a high PE. The valuation grading commented nothing on this, and it is not supposed to comment. The valuation part is something what the brokerages had to take care of and most of them did it correctly.

I would have been more surprised had the results of the study thrown some correlation, because then SEBI would have come out and said, IPOs with high gradings have performed well. This would have given further leeway to companies to come out with higher valuations as the subscribers to the issue would obviously have something at the back of their mind which would jingle like "High grading=high fundamentals=Good stock performance".

If sebi is so interested in correlations, would it not make more sense to do a correlation between IPO gradings, brokerage recommendations and the stock performance as it would capture the true definition of investment.

For the article that prompted this post refer the link below

Sebi study finds IPO grading futile
http://www.business-standard.com/india/news/sebi-study-finds-ipo-grading-futile/412080/

Seasons Or Quarters

Today morning I received a forward from one my colleague, I could not help locate the similarities between the images in the mail and the quarterly results of the companies.

One Picture taken at different seasons!!
Lessons on Life




You cannot judge a tree, or a person, by only one season,
and the essence of who they are and the pleasure, joy and love that come
from that life can only be measured at the end, when all the seasons are up.

If you give up when it's winter, you will miss the promise of your spring,
the beauty of your summer, and fulfillment of your fall
Moral
Don't let the pain of one season destroy the joy of all the rest.
Don't judge life by one difficult season

I reproduce the last paragraph of the forward with certain modifications

You cannot judge a company, its management, by only one quarter,
and the essence of who they are and the returns, dividends and wonder that come
from that company can only be measured at the end, when all the quarters are up.

If you give up when its Q1, you will miss the promise of Q2,
the beauty of Q3, and the fulfillment in Q4.
Moral
Don't let the pain of one quarter, destroy the joy of all the rest.
Don't Judge company by one difficult quarter

I guess nothing summarizes value investment better than the above description of nature, buy when the market sees a fall and winter in the results to reap the benefits in summer and spring.

The Gods of the Copybook Headings

The Gods of the Copybook Headings - Rudyard Kipling

Kipling wrote this poem after his son was killed in World War I, a war that many Britons blamed on the greed of the bigwig industrialists whose factories profited from the war effort while in high-flown patriotic prose they promised a glorious victory and a paradisaical future to the men who went off to be slaughtered in the trenches. In this poem Kipling criticizes those who suspended their judgment and common sense and followed suit with idiotic policy because of such rosy promises of prosperity.

How similar is this poem to the present day markets... (Read the link after going through the poem)

AS I PASS through my incarnations in every age and race,
I make my proper prostrations to the Gods of the Market Place.
Peering through reverent fingers I watch them flourish and fall,
And the Gods of the Copybook Headings, I notice, outlast them all.

We were living in trees when they met us. They showed us each in turn
That Water would certainly wet us, as Fire would certainly burn:
But we found them lacking in Uplift, Vision and Breadth of Mind,
So we left them to teach the Gorillas while we followed the March of Mankind.

We moved as the Spirit listed. They never altered their pace,
Being neither cloud nor wind-borne like the Gods of the Market Place,
But they always caught up with our progress, and presently word would come
That a tribe had been wiped off its icefield, or the lights had gone out in Rome.

With the Hopes that our World is built on they were utterly out of touch,
They denied that the Moon was Stilton; they denied she was even Dutch;
They denied that Wishes were Horses; they denied that a Pig had Wings;
So we worshipped the Gods of the Market Who promised these beautiful things.

When the Cambrian measures were forming, They promised perpetual peace.
They swore, if we gave them our weapons, that the wars of the tribes would cease.
But when we disarmed They sold us and delivered us bound to our foe,
And the Gods of the Copybook Headings said: "Stick to the Devil you know."

On the first Feminian Sandstones we were promised the Fuller Life
(Which started by loving our neighbour and ended by loving his wife)
Till our women had no more children and the men lost reason and faith,
And the Gods of the Copybook Headings said: "The Wages of Sin is Death."

In the Carboniferous Epoch we were promised abundance for all,
By robbing selected Peter to pay for collective Paul;
But, though we had plenty of money, there was nothing our money could buy,
And the Gods of the Copybook Headings said: "If you don't work you die."

Then the Gods of the Market tumbled, and their smooth-tongued wizards withdrew
And the hearts of the meanest were humbled and began to believe it was true
That All is not Gold that Glitters, and Two and Two make Four
And the Gods of the Copybook Headings limped up to explain it once more.

As it will be in the future, it was at the birth of Man
There are only four things certain since Social Progress began.
That the Dog returns to his Vomit and the Sow returns to her Mire,
And the burnt Fool's bandaged finger goes wabbling back to the Fire;

And that after this is accomplished, and the brave new world begins
When all men are paid for existing and no man must pay for his sins,
As surely as Water will wet us, as surely as Fire will burn,
The Gods of the Copybook Headings with terror and slaughter return!

Some Notes:

“They denied that the Moon was Stilton; they denied she was even Dutch.” Stilton is a British cheese. The Dutch are famous for their cheeses.

“The Cambrian measures” are a part of the ocean off Britain that now separates it from Europe.

“Feminian Sandstones” are a building material used to construct medieval churches and, earlier, pagan temples.

“The Carboniferous Epoch” is an era of geological change that formed many of the mountain ranges of the world.

Parichay Investments - A Misinvestment

I came across a company recently called Parichay Investments as it has been new highs daily. So i got inquisitive as to what the business model is and what doest the company do. Well the first thing that came to my notice was the horrendous P/E of 533.46. I agree to the fact that Investment companies should not be looked on a P/E basis for valuation but on a P/B or market cap of investments. But on checking the balance sheet to my amazement, the company had no investments but all the funds raised were simply in loans and advances. The company still trades at a P/B of 6 which is very very high given the company has no fixed assets and nothing to say in terms of working capital. Now comes the most astonishing part. As of June 2010, the promoter holding was 74.94% out of a total shareholding of 12Lakh shares which would ~9Lakh shares. The promoters Omni Bagadiya has been selling shares in the open market crazily. Every day there is some disclosure on the company stating X no of shares sold. I wonder, why the promoter selling so heavily has not been taken as a negative or bad sign. To put things in perspective Omi Bagadiay had a holding of 8,10,730 shares which is ~67.56%. Now according to the latest disclosure available on BSE, he has only 57580 shares with him which means out of his 67.56% his shareholding is down only to 4.80% and this selling has been across the board with other promoters also selling a chunk of their shares, read as Anurag Agarwal and Ritu Agarwal.

How close eyed can the person buying the shares be. I would not blame the management as the person buying the shares is neglecting all the information available to him and betting on something totally virtual. When the capital gets eroded which certainly would, he would justify his stance by saying "The management were frauds and cheaters" but never will he say " I was blind", well that is how the human brain works, External Locus of Control. We tend to attribute things outside our own control as the reason for our problems.

Note: Instead of saying the investor I have used the word "Person buying the share" primarily because a person buying these shares is clearly neglecting the three requesite qualities for a purchase to classify as an investment and him as an investor, as highlighted by Mr. Graham

1. Thorough Analysis

2. Safety of principle

3. Guaranteed return

As is said, "Return of capital" is more important than "Return on Capital"

Cenlub Industries

Its been sometime since I posted something on the blog. Recently I came across this company called Cenlub industries.I will give some of the quick financials about the company over the period FY06-10

1. The company's revenue has grown by 17% CAGR over the time period, PAT at a CAGR of 14.59%, EBITDA at a CAGR of 18.92%. 
2. The margins were 12% in FY06 and now stand at 14% in FY10.
3. The PAT margins have remained almost flat at 7% over the period. 
4. The RoE of the company has also remained stable at 13-14% with the decrease in asset turnover being compensated by the leverage. 
5. The D/E ratio of the company stands at 44%. The leverage has increased from 1.1 to 1.4.
6. The company has reduced its working capital cycle from 2.6months to 1.9 months
7. Now a thing that strikes when we see the working capital cycle going down, PAT increasing, leverage increasing is why has the return on equity remained stable. The only reason being that the equity is not being deployed in business or part of the equity deployed, is not in productive resources as the business itself. A closer look at the balance sheet reveals the same. The % of assets in cash and bank balance, investments and loans and advances has increased from 25% in FY06 to 49% in FY10. 
8. The book value has grown from 1.31 in FY06 to 5.38 in FY10, registering a CAGR of 42% while the total assets has grown by 22% over the same period.The per share book value has increased from 13.18 in FY06 to 23.05 in FY10.
9. Over the past one year i.e over June 2009 to June 2010, the promoters have increased their shareholding from 31.09% to 35.45% and the promoters have purchased the shares at a price range of Rs. 19-21.

Valuation Parameters

1. The EV/EBITDA for the company stands at 4.72 at the market price of Rs. 27/share. 
2. The cash on books per share is Rs. 7.3 and including some listed and unlisted investments the value per share of cash and investments comes to Rs. 10.78/share.
3. The TTM P/E of the company stands at 9.55

Ok financial data is fine!! what does the company do? Its all in the name, Cenlub - central lubrication systems i.e exactly what the company does. As the plants and machines become more sophisticated and automatic to attain wider performance and better efficiency, it becomes absolutely necessary to go  for central lubrication system. These lubrication systems are supplied to power plants, steel plants and refineries. The company has also bagged good amount of order from public sector like BHEL and other private sector making turbines.

On the day I am writing this there is one more announcement, the promoters have bought another 4000 shares. As Mr. Lynch says.. promoters buying is always a good sign but promoter selling is not always a bad sign. The reason i got excited was not only because of the promoter interest, very good valuations but the fact that this company operates in the capital good space supplying its products to the power sector and has tremendous opportunity to grow given the massive power generation capacities that India plans to add over the next years.

Disclaimer: I have investment in the company.