Wednesday, May 28, 2008

Stock Idea - Abbott India

CMP - 540.6
Sensex - 16525
Abbott India is the subsidiary of Abbott Laboratories which is a century old company with operations across 130 countries. Abbott in India has a strong brand equity and has a network of 18 distribution points, which cater to 11,000 stockists and 70,000 retailers.

Abbott India’s product portfolio in India covers

1. Primary Care, which markets products in the areas of Pain Management, Gastroenterology, with well-known brands like Brufen, Digene, Cremaffin.
2. Specialty Care – Metaboloics & Urology provides solutions in the areas of Thyroid, Obesity, Diabetes and Benign Prostratic Hyperplasia.
3. Specialty Care - Neuroscience has a varied portfolio, with specialty products in the Neurology and Psychiatric segments.
4. Hospital Care, offers products in the field of anesthesiology and neonatology namely Forane, Sevorane and Survanta.


Let me start the discussion with assumption that I am going and buying this business out. The current equity base of the company is about 14.47 crores. At the current market price of Rs 540 the company has a market cap of Rs 826 crores.

The company had approx Rs 167 crores as of Nov 07 ( FY 2007) of cash lying on its balance sheet.

So we are buying the business for about Rs 659 crores. The business did a topline of about Rs 620 crores for FY 07. The company has increased topline from Rs 459 crores in FY 2005 to current Rs 620 crores in 07 on a net block which has gone up marginally from 31 crores to 36 crores.

Net profit has increased from 59 crores to 68 crores but more imp EPS has increased at a faster pace from 38.72 to 46.43 in the same period due to reduction in share capital from 15.3 crores to 14.5 crores.

The business generated a bottomline of approx Rs 51 crores from operations excluding the other income generated on the investment portfolio so is available on a PE of 10.9 on current years earnings.

Management Philosophy

The parent Abbott limited has a track record of increasing dividends for 35 consecutive years. The parent spent > $ 1 billion is share repurchases worldwide in 2007 and has plans to increase that to $ 2.5 billion worldwide. It generates about $ 4 billion of operating cashflows every year. The presentations available on the parents website will give you a flavour of the same.

The Indian company paid a dividend of 17.5 % dividend for the FY 2007 and hence provides a dividend yield of 3.2 %. The company carried out a share buyback of 5 % of the companys capital at Rs 650 per share through the year and has filed for buyback of a additional 5% of the company at Rs 650 per share which should happen in the first half of calendar FY 08.

Investment Rationale.

Beyond the stable earnings growth which is defensive in nature and not subject to economic cycles, good ROCE etc what is it that interests me in the stock ?

There are other MNC pharma companies like Pfizer, Merck etc which deliver similar numbers and are sitting with cash on their balance sheet and have a strong product portfolio. So why Abbott ?

I believe the key challenge for a value investor is not finding out companies that have cash on their balance sheet and are cheaply available. It is in finding out what the management would do with that cash. In India where shareholder activism is non existent or at a very nascent stage, it is imp to have managements that use that cash judiciously.

I like Abbott on that variable where it derives its philosophy from its parent. The management consistently maintains a high dividend payout ratio and utilises cash for share buybacks. The public shareholding is about 34% so effectively 1/7th of your portfolio in Abbott will deliver 20% assured return this year as the company finsishes it 5% share buyback program.

The stock wont be multi bagger but I believe that one wont lose money on this one.

Disclaimer - I m not recommending buying the stock based on my statements. Kindly do u r own analysis to reach that conclusion.

Tuesday, May 27, 2008

Interest Rates

News article in today’s Economic Times

“Sensing tight liquidity conditions country’s largest bank, State Bank of India has decided to raise interest rates on longer tenure deposits by 25 to 50 basis points.

SBI will offer 8.75% for 2 to 3years, 8.85 % for 3 to 5 year deposits and 5 – 10 years is 9%. The bank was offering 8.5% for all the three slabs earlier.”

The interesting part is not the rise in the interest rates in the short term 2-3 year range which is anticipated considering tight liquidity conditions and inflation which could clearly take sometime to cool down.

What is interesting is the offer of 9% for the the 5- 10 year term. Clearly the largest bank in the country is signalling that we could be in a high interest rate scenario over a much longer time horizon.

Are we making a structural change from a low interest rate environment which has fuelled asset price rise over the last 3-4 years to a higher interest rate zone ?

Saturday, May 24, 2008

Ranbaxy Laboratories

Was running through the 2007 Ranbaxy balance sheet dated Dec 31st 2007. A few interesting things that stuck me.

The PBT for the year was about 998 crores out of which Rs 443 crores was on account of other income namely foreign exchange gain which is nearly 50%.

The consolidated balance sheet size is about Rs 7274 crores. Out of this Rs 4269 crores is invested in its Netherlands subsidiary which is about 58 % of the balance sheet size. The subsidiary clocked a net profit of about 105 crores. Not exactly the greatest of ROCE.

The Fixed asset base of the consolidated company is about Rs 4204 crores. Out of which Goodwill is about Rs 1929 crores which is nearly 45% of the total fixed asset base.

To be honest I haven’t dwelled too much into understanding the company or can claim any great understanding of the business but prima facie the way the balance sheet is looking at this point of time I m a lil sceptical. Not very comfortable in the way the company is allocating capital.

Thursday, May 22, 2008

Come on baby, light my fire

You know that it would be untrue
You know that I would be a liar
If I was to say to you
Girl, we couldn't get much higher ( than $ 135 a barrel :-))
Come on baby, light my fire
Come on baby, light my fire - The DOORS

Well how much higher is oil going to go. At over $ 135 dollars a barrel it sure is going to burn down a few economies including us.

Are we at the beginning of the beginning or are we nearing the end of the end of the bull run that we have seen in oil. I for one have no clue on this one.

But I know that the current subsidy situation that exits in India and countries like China, Indonesia etc is unsustainable. Demand needs to start contracting as it is in the countries that are passing thru the cost to the consumers.

We are anyway burning down the oil marketing companies with the subsidy bill.

I don’t think markets in India have factored in the implication of oil other than downgrading a few auto stocks or companies which use petroleum derivatives as inputs, or the interest rate sensitive’s.

Sustained oil prices at this level will start affecting both the world and the Indian economy in a more dramatic fashion and could induce some paradigm shifts. Both politically and economically.

I m more worried with oil at $135 than I was when the markets were sub 15000.

Monday, May 19, 2008

Infosys - Cost of Capital

The management states that

“ Our policy is to earn a minimum return of twice the cost of capital on average capital employed and thrice the cost of capital on average invested capital. The current cost of capital is 13.3%. At present we earn 41.4 % on average capital employed and 71.1% on average invested capital. We aim to maintain adequate cash balances to meet our strategic objectives while earning adequate returns”.

So Infosys is effectively stating that it cost of equity capital is about 13.3% since it is virtually a zero debt company.

As per its current balance sheet over 55% of the capital employed is in cash and equivalent assets which at max might earn about 5-6 % on a post tax basis clearly lower than the 13.3 % cost of capital.

Infosys has defined for itself a hurdle rate of twice the cost of capital as the basis for deciding capital outlay for both organic growth and acquisitions. Considering that the company has today deployed over 50% of the capital at less than cost of capital, it might make sense for the company to either return money back to the shareholders or should be open to look at options which can deliver returns around the cost of capital.

Infosys - Dividend Payout Ratio

I just started reading the Infosys balance sheet. In the letter to the shareholder the management has stated and I quote

“ We have decided to increase the dividend payout ratio upto 30% of net profits effective fiscal 2009. Our current financial policy is to pay dividend upto 20 % of net profits.”

Infosys this year is paying out Rs 33.25 per share as dividend ( special dividend of Rs 20) which on a consolidated EPS of Rs 81 is higher than the 30% defined for next year onwards signalling a higher dividend payout philosophy.

The higher dividend payout ratio is good from the shareholders perspective as Infosys is already sitting on about 8400 crores of cash and cash equivalents on it balance sheet which is earning far lower than the cost of capital.

Sunday, May 18, 2008

Reliance Naturally Resourceful Limited

The stock is currently at Rs 110. It has come down from a 52 week high of Rs 248. I am not going to dwell into PE ratio’s ( just about 263 times ) to discuss whether it is currently undervalued or overvalued.

This post is about something different.

I just ran through the FY08 results that the company has posted on the BSE site.

As on Mar – 08

Equity - 816 crores
Reserves - 913 crores
Total networth - 1729 crores

Scenario 1
Let’s examine how much debt the company can take on its balance sheet.

1) Debt equity ratio
Let us assume that the company can leverage its balance sheet and take debt in a 2:1 ratio or let me be more generous maybe 3:1.

Networth - 1729 crores
Total Debt - 5187 crores

2) Interest Cover Ratio
Let’s assume a interest cover ratio of 2:1 and RNRL can borrow at 8%.
EBIDTA – 170 crores ( Mar 08 )
Total Debt - 1060 crores

Assuming we have a Corporate banker who is willing to take risks then he would potentially open to lend about Rs 5187 crores to RNRL on the balance sheet.

Scenario 2
Loan against shares
Current market Cap - 18054 crores
Haircut ( 60% ) – 7221 crores
(I have been ultra conservative there are bankers, NBFC’s who would give more)

So you can borrow about 7200 crores by placing RNRL stock as collateral.

The banker won’t be willing to lend more than 5200 crores for the companys balance sheet / operations but the same banker would be willing to lend over 7200 crores against the company’s stock.

Imagine the gap when the stock was at Rs 250.

I rest my case.

Monday, May 12, 2008

Stock Idea - Bihar Caustic & Chemicals

CMP - 72
Sensex - 16860
Not the most endearing or sexy sounding name with context to the stockmarkets. But then whats in the name.

Bihar Caustic is part of the Aditya Birla Group. It is a subsidiary of Hindalco and was promoted alongwith the BSIDC ( Bihar State Industrial Dev Corporation). Hindalco owns 56.31 % of the equity and BSIDC owns about 8.69 %.

The company’s current installed capacity covers ..

Caustic soda (100%NaOH) 92,750 mt
Liquid chlorine 65,785 mt
Hydrochloric acid (100%) 29,040mt
Sodium hypochlorite 1,800mt
Compressed hydrogen 17,42,400nm3
Aluminium chloride 12000tpa

The company also has a 30 MW captive power plant and has just commissioned a stable bleaching powder plant March 08.

Investment rationale.
The company has a captive customer in the form of Hindalco. It nearly meets 80 % of Hindalco’s caustic soda which is required in the aluminium manufacturing process. The Aditya Birla group has a large chemicals business portfolio spanning multiple companies and is amongst the largest caustic soda mfgs in the country.

BCCL benefits from group initiatives in R & D and developing best practices in manufacturing.

Financials ( Rs in crores)
Year--------Sales--------Net Profit--------Cash Profit
Mar 05--------107.9--------26.4--------34.7

Mar 06--------111.5--------26.1--------35.4

Mar 07--------143.2--------33.7--------49.6

Mar 08--------174.7--------49.2--------66.5

Current Equity Capital – 23.3 crores
EPS - 21.07
Cash EPS - 28.54

Current Stock Price - Rs 72
Current PE = 3.31
Current Book Value - Rs 86.4
P/BV - 0.83

One of the counter arguments would be that it is in a commodity business and subject to the vagaries of commodity cycle.

The company has constantly worked towards moving up the value chain by producing value added products so as to reduce its exposure to the commodity cycle. The bleaching powder plant commissioned in mar 08 is a case in point. The company also sells excess power that it generates to JSEB.

Anyway the margin of safety on the stock is high with a strong promoter background and captive customer coupled with attractive valuations. I currently hold a position in the stock.

Disclaimer - I m not recommending buying the stock based on my statements. Kindly do u r own analysis to reach that conclusion.

Wednesday, May 7, 2008

Damn Right, I’ve got the blues

Who hasn’t got them. We all have the blues and the blue chips too.

Pick up any pink newspaper and hear the ultimate gospel about stock investing.

“ Pick bluechips at any price and hold them for the long run” and voila you will get rich. Warren Buffett picked his Coke and American Express and he surely made his money.

But how do u define a bluechip.

Are these the companies which are in the BSE Sensex?
Then you would have had companies like Asian Cables , Hindustan Motors, Scindia Shipping, Premier Auto in your portfolio and if you had held on these stocks, I m not sure that rich is the word that would have been associated with you. Run through the list of BSE Sensex stocks since inception and you will appreciate what I mean.

Are we talking about pedigree MNC companies?
Indian subsidiaries of the Unilevers & Pfizers of the world. The benchmark that I can look at some of the MNC funds that some of the fund houses run. Run through this performance table for the last one year and you will find UTI MNC fund, Birla MNC fund & Kotak MNC fund at Nos 216th ,227th & 228th rank out of 241 funds.

Or are we talking about companies like Infosys, Bharti, Reliance etc.
Prof Bakshi’s post on Infosys that you can read here is a classic example of how the blue chip strategy need not be a sure shot path to success.

The key is not just the company but more importantly the price. There is a wrong price for the right company.

Buy bluechips at the right price and hold on to them is the mantra.

Else listen to Buddy Guy
Damn right, I've got the blues,
People, from my head down to my shoes
Ahh, you damn right, I've got the blues
From my head down to my shoes
Well you know I just can't win, cause I don't have a damn thing to lose

Monday, May 5, 2008


This post is about the maze that we wade through in the mutual fund jungle.

Like monkeys we jump from one fund house to another buying a few LION and some TIGER funds along the way. I forgot to mention about funds called CHINA – INDIA , HIFI, SMILE, TIPS, COMMA, ACE :-)

This post is not about the level of innovativeness that fund houses display in naming their funds (maybe not as much in picking their stocks).

This post is also not about how we pay 6% initial issue expenses out of a Mutual Fund NFO to send our friendly neighbourhood advisor on a jungle safari in Kenya.

Its not about how a Rs 10 NAV is not cheaper than a Rs 200 one.

Its not about how we pay 2.5 % of our portfolio to the same friendly neighbourhood advisor everytime we move from one fund to another.

It is about something more sophisticated ……

Its about how intelligent and informed mutual fund investors like me look at equity fund investing.

On an average a fund manager holds more than 25 stocks in a fund. Its called diversification so as to reduce risk ( A latter post on how I m not such a strong proponent of diversification. Once upon a time Warren Buffett put 40% of his portfolio in Amex and the rest is history ).

An average mutual fund investor like me would have spread his mutual fund investment across 10-12 equity funds. Partly because we get enamoured by TIGERS and LIONS and partly because we want a flavour of Large Caps, Small caps, Micro caps etc. Of course the friendly neighbourhood advisor helps with his persuasive skills.

I was aghast to see that my mutual fund portfolio currently has about 26 different equity funds across 8 fund houses.

So if each fund has a minimum of 25 stock and one is invested in about 10 equity funds, on an average one would be invested in atleast 100 – 150 stocks cumulatively after taking out duplication.

At 100 -150 stocks with no stock being more than 1-2 % of portfolio, I don’t see how on a average the mutual fund portfolio can beat the benchmark index. It is as good as the benchmark index. And we pay 2.25% yearly as management fees for active fund management.

Time for me to stop monkeying around and clean my mutual fund portfolio.

Sunday, May 4, 2008

Comfortably Dumb

I want to reach a state of being “Comfortably Dumb” and hence attain my state of nirvana when it comes to stock investing.

The stock markets are made of millions of participants vying with each other to make money. So what options does the average investor have?

Passive Investment Strategy
Buy an index fund, search for the lowest tracking error and the lowest fees and the markets should compound at about 15 % on a long term basis. The Indian equity market has given around that kind of return in the last 20 years. So if we go with Goldmans Sachs forecast on the BRICS story, there is a lot of steam left for the next 25 years. Though I don’t how they manage 25/50 year forecasts when they can’t figure the sub prime crisis hitting them and their brethren a few quarters down the line (That’s for another post). Anyway running with a passive investment strategy will generate markets returns and history tells us that equities would provide better returns than all other asset classes.

This is what I call the “Comfortably Dumb” state.

Active Investment Strategy
This one is the action packed one which all of us follow including me. We get up every morning watch CNBC, read ET , discuss, write blogs etc to come up with brilliant stock picking to ensure that we over perform the market. What does this mean? It means if the markets gives 15 % returns we want to top that and get more than that. I target about 3 – 4 % more than the market but then there are brave hearts that target maybe 50 % above the market return.

So far so good but here lies the catch ….

Every participant who refuses to accept the “ Comfortably Dumb” strategy believes that he is gifted with superior intelligence and insight ( that includes me ) to generate returns above the index. Where do these returns come from – Not from thin air? So let’s assume the index generates 10 % return this year and I make 15 % on my portfolio this year then somebody somewhere has only made 5 % on his portfolio.

It’s a zero sum game. If somebody makes 5 % more somebody has to lose 5%. (Warren Buffett made a lot more at the expense of a lot of people). But then who is losing, since we believe that we are all superior intelligent beings. Assuming all men are equal, (Women are obviously a superior species as they don’t waste time on this :-)) mathematically, we all theoretically have a 50% probability of outperforming the market.

There is an interesting saying in the stock markets that the investor comes walking to a broker’s office and the broker goes home in a car. So the third variable in this zero sum game is the broker (and his brokerage) and various taxes like STT, Service tax, Edu cess etc. Factoring in these costs the mathematical odds of outperforming the index goes below 50 % lets say about 49 %.

So we have a 49% probability of making more returns than the index and 51% probability of lower than it. (Most fund managers underperform the index and of course charge us for that)

But with our testosterone induced ego’s we soldier on believing in our superior intelligence.

“Comfortably Numb” to the odds stacked against our success.