Friday, December 11, 2009

A Safe & Cheap company revisited

This post is related to my earlier call on ICC(Indian Card Clothing). I thought it was safe & cheap at 72.5/- per share and asked for your views. Since then, it has gone up to 142/- per share, close to 100% return. I think due to this rise in share price it has become overvalued. If you had bought it based on my theory (a highly unlikely case :)), please sell it. I too committed a mistake of double counting in the valuation, i.e. i did not subtract the non-operating earnings from my owner's earnings. Either they should have been subtracted or I shouldn't have excluded the investments on balance sheet from calculation of EV. Anyways, share price seems overvalued or at least fully valued to me. Remember share price can go higher from here but as i said in my first post, i look for undervalued companies, now ICC doesn't fit the bill.

I fully assure you that in future, this kind of mistakes wont be repeated.

Wednesday, July 1, 2009

A Safe & Cheap company?

For quite some time I have been reading legendary investor Mr. Marty Whitman's books and shareholders' letters. Mr. Whitman believes in taking positions in companies which are "Safe & Cheap" . "Safe" refers to restricting investment in companies that are extremely well financed, apparently well financed and, whose businesses are understandable. "Cheap" refers to companies that are available at prices that seem to represent substantial discounts from what the common stock would be worth were a company a private business or a takeover candidate. Extremely well financed business means both "quality and quantity" of resources supporting the business must be exceptional. Searching for potential "Cheap" stocks by screening for stocks trading at lowest P/BV, I came across a company "Indian Card Clothing Ltd." Here are some details about it:
BSE Code: 509692
Current share price: 72.55

Market Cap: 32.81 Cr.
EPS (TTM): 18.91
P/E: 4
P/BV: 0.37

Background:The company pioneers in the manufacture of card clothing for the over the last three decades. It manufactures flexible and metallic card clothing and raising fillets and sheets and saw tooth wire. Its product range includes cylinder wires, flats tops, doffer wire, Lickerin wire, sundries, interlocking and metallic wires, raising fillets, raising brush fillets, raising brush sheets, yarn raising fillets, etc. Indian Card Clothing has also developed card accessories such as web catchers and Accura carding elements. Its R&D is engaged in developments that include special alloy steel wires in the Tenace series, a new generation of Triumph tops and specially developed AeroDoffer wires for better doffing. The Indian Card Clothing Company is a subsidiary of Multi Act Industrial Enterprises.

This is a condensed snapshot of its balance sheet:

Sources Of Funds:
Equity Share Capital 4.55
Reserves and Surpluses 74.31
Debt 0.27
Total Assets: 79.12

Application Of Funds
Net Block 20.94
Capital WIP 24.63
Investments 30.27
Inventories 10.23
Net Current Assets 3.28

In Investment section of its balance sheet, ICC has common stocks, bonds, mutual funds and bonds at cost basis of 30.27 crore. I calculated the present market value of the investments, it is certainly more than 31 crore even after recent market meltdown. These resources are of high quality, liquidity and currently do not support the earnings of company.
I did some calculation to get the Owner's Earnings of ICC and for the last 7 years it has come around 6.9 crores annually. These 7 years contain both up and down periods of textile industry on which the business of ICC is heavily dependent.
Management has not issued additional equity, hasn't raised debt to finance operation and managed the company conservatively in the last several years. Annual reports also don't show any litigation or contingent liabilities.

The investment operation I propose is buying whole of ICC by paying 33 crore. In return I will get 31+ crore of high quality liquid assets which I can sell without harming the operations of company and will get annual OE of 6.9 crore for free!!. This valuation implies that Mr. Market is not putting any value on the operations of ICC at all.
I think by this analysis, ICC is a "Safe & Cheap" play.

Now the question is why ICC came to this price if it was generation OE of 6.9 crores annually and has so much of liquid assets. I can think of two reasons, one is its heavy dependence on textile sector which has been facing lot of headwinds and consequently suppressed earnings in last year. Second one could be the lower valuation given by Mr. Market due to recent and ongoing recession.

My analysis and proposition is dependent on the outlook of textile sector. It is here I seek your opinion. Please give your views...

Tuesday, May 5, 2009

Owner's earnings

Legendary investor Warren Buffet analyses companies not taking into account their reported earnings but by their "Owner's Earnings". This term signifies the net profit that is going to owners of business after taking care of all the needs of operations of business. As per Mr. Buffet,

Owner Earnings" represent:
a) Reported earnings plus
b) Depreciation, depletion, amortization, and certain other non-cash charges less
c)the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume. If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in (c).”

What are the implications of using OE as measure of viewing businesses? Many businesses have high reported earnings (declared net profits) but not any real earnings for their owners (shareholders).

Let’s discuss why OE is a better yardstick to judge business.
Suppose you want to analyze a restaurant business in your locality. Here are the details of that business:
Cost of premises: 50 lakh.
Debt: 25 Lakhs
Interest on loan = 10%
Revenues: 40 lakhs
Cost of raw material: 5 lakhs
Personnel cost: 8 lakhs
Depreciation rate: 15%
Tax rate: 30%

So my reported earnings (NI) would be: (Revenue - Cost of raw materials - Personnel cost – Depreciation-Interest)(1-tax rate)
Putting values we get
(40 – 5 – 8 – 7.5 – 2.5)(1-0.3) = 11.9 lakhs

Using standard P/E multiple of 10-12 we can get the value of this business to be around 120-145 lakhs.
But think from the perspective of an owner of a business. Depreciation shown on the income statement is a non cash expense but never goes out from the coffers of business so we can add that expense to NI.

Earnings available to owner: 11.9+7.5 = 19.4 lakhs.
Now suppose to maintain my premises in good condition I have to invest around 10 lakhs every year on it (painting, fittings, electrical appliances like bulbs/fans/AC etc), so these 10 lakhs are not going into owner’s pockets. Further suppose to keep operations owner has to invest in more cutlery, tables/chairs, more raw material availability to keep customers happy. Suppose this investment is 5 lakhs. Above two expenses are also not going to owner’s pocket so must be deducted from 19.4 lakhs we calculated above.

So Earnings available to owner: 19.4-10-5 = 4.4 lakhs!!!!

Depreciation addition to NP is simple. Expenses to maintain premises is Capital Expenditure (Capex) and expenses to increase raw material and other inventory is Change in Working Capital

So essentially we have done is calculating Owner’s Earnings defined by Mr. Buffet.

OE = NP + Dep + ΔWC - Capex
OE = Owner’s Earnings
NP = Net Profit or Reported Income
ΔWC = Change in working Capital(+ve for increase in WC and –ve for decrease)
Capex = Capital Expenditure
ΔWC and Capex can be calculated from Cash flow statements of company.
If you start calculating OE for companies listed on NSE/BSE, you will be surprised to know the differences in reported earnings and OE.
Here are the calculated OEs for some of well known companies listed on Indian bourses.

Wednesday, February 18, 2009

Debt Capacity Bargain

In Security Analysis - 1934 edition, BG (Benjamin Graham) talks about companies which are debt-free and their stock price is trading at very low multiples of CFO/Profit. His logic is : A Common Stock Representing the Entire Business Cannot Be Less Safe Than a Bond Having a Claim to Only a Part of Thereof.

BG gives example of a company called The American Laundry Machine to illustrate his point. For simplicity I will take a ficitious company A. Company A is debt free and earns Profit before tax of 100 crore annually(say 5 year average). Now suppose A goes to bank and asks for loan. The appraiser from bank will see the fundamentals of company and will conclude that A can support interest of 40-45 crores annually and if current interest rate is 10%, A can support loan of 400-450 crore easily for forseeable future. If industry of A is stable, without undergoing rapid changes and A has dominant position in the industry, it will add-on to comfort of bank in extending loan.

Now come to think of it. If a bank opens its credit line of 400-450 crores for A and in return expects the annual interest payment and can have claim on SOME PART OF "A" for return of loan, VALUE of whole of A must be lot more than 400-450 crore. So if A trades at market cap less than 400 crore, any investor buying shares of A is virtually getting the upside of equity claim and downside of a fixed claim of a bond. Investor can just buy the shares of A and wait for the market value to reach in a zone where he is not getting the benefit of fixed claim so that he can sell.

Will publish the modified post some time next week....

First Post


Finally after long procrastination I finally got down to start my blog. I have started this blog to discuss themes of Value Investing and stock ideas based on them. I would be sending the email invitations to people who I think would be interested in sharing their thoughts. If you find this blog helpful, please let that know to your friends. However if you do not like anything, feel free to write to me. Inititally I would be adding the investment valuation methods from Security Analysis - 1934 edition but as time and our knowledge progresses we can add more content. I would be very grateful if you mention any points/concerns through which my views on any stock are proved WRONG.

Apart from aforementioned points I would be posting book reviews/articles reviews.

Thanks in advance for taking your time out for visiting my blog