Aditya Birla Capital : Creating market in under penetrated sector in India

Before discussing about the business, I want to express my opinions about what makes a financial institution worthy of investment. In my honest opinion, financial institutions are leveraged bets. That means, leveraged companies involve the risk of bankruptcy if strict underwriting discipline is not followed. This is because, such companies raise money from financial markets and lend it to retail and corporates. If end users don’t repay the borrowing, company would default. So, what does make financial institutions like HDFC, HDFC Bank and Kotak Mahindra Bank successful? Few essential points :

• First of all, cost of capital needs to be contained so that higher net interest margin can be earned. Now, question is how can a company contain the cost of capital? Rating agencies (ICRA, CRISIL etc) will tell that if you eliminate provision pressure by using strict underwriting discipline, cost of capital will be contained. So, the reason behind success of any financial institution is underwriting discipline.
• Underwriting discipline can be maintained by great quality people who set up the impeccable processes. Such processes will ensure that default rates will always be down. So, financial institution must invest in great quality people and flawless processes.
• Growth in lending book has to be maintained. This will ensure net interest income will keep flowing. However, growth should be matched with equally strong underwriting discipline. So, growth with stringent underwriting is the key.
• Understanding of the sector in which company is lending. Management needs to have deep understanding of the sector so that they can maintain margin of safety in lending.
• How to keep competition at bay ? This can be done by quick turnaround time, use of technology to keep default less and to maintain customer-centric institution. At the same time, I would say, if financial institution can become partner in solving problems of industry, that would be great. Money is commodity — anyone can lend. But, if you act as solution provider to the sector, people will come to you to solve their problems.

And you can sense what makes many of public sector banks fail to deliver.

With that said, lets look at ABCapital business model. Primarily, ABCapital works to meet customer requirements in -

1. Finance
2. Insurance
3. Asset Management

Financing solutions

In last 10 years, this division is catering to corporates, mid-corporates and SME. They entered into housing finance and became profitable last year. A very good asset quality is maintained with NPA less than 1%, NIM around 4%. This division continues to grow at healthy rate in the long run. I am saying this because, Indian economy is growing at 6–7%. With this much rate, people will need access to finance. Hence, NBFCs like ABCapital will gain heavily. With very good processes in place, this should not have asset quality problems in the long run.

Insurance

Before I dive into specifics, I want to talk about specifics of insurance business. Many Indians don’t have access to insurance and slowly private players are eating market share from PSUs. Insurance is very tough to enter business because of requirements of capital and IRDAI regulations. Insurance business collects money from customers in the form of premiums with the guarantee that if something goes wrong, then company will pay the insured amount. This premium money is invested in the capital markets. Such money is called “float”. In insurance activities, cost of capital for that float matters. Cost of capital can be minimized by having good underwriting discipline.

ABCapital is taking many steps to increase the market share in insurance market. They are aligning with bank partners like HDFC Bank, AU Small Finance bank etc. These partnerships are generating growth in the business. Their persistency ratio (retention of customers) is at 60%+ in 2016.

Asset Management

Asset management business doesn’t require lot of capital to run. Company needs investment in fund managers. Indian customers are slowly turning towards stock markets via mutual funds and PMS. ABCapital’s market share stands at number three in terms of asset under management. I think it is attributed to their mutual funds. They have performed very well over the years.

ABCapital also works in other financial services as well like brokerages, MyUniverse etc. Recently, they formed joint venture with Vaarde Partners for asset reconstruction company. This JV will help in acquiring distressed assets through NCLT proceedings under IBC.

Overall perspectives

Financial services like lending, insurance and asset management are not penetrated in India. So, players like ABCapital will have great growth opportunities going ahead. It is also visible from results that the company has posted in these many years. So, this company has lot of headroom for growth.

ABCapital is currently investing a lot in these three business divisions. That’s the reason, management has raised capital. This step will yield good returns over the long run.

ABCapital has a great underwriting discipline in their NBFC and insurance business. Their book is a rare combination of good asset quality and growth in loans. Asset management business is in sweet spot.

Risks in overall business

Risks in NBFC

1. Increase in cost of capital due to weak economic conditions, inflation etc.
2. Shift to weak underwriting discipline in order to favor growth.
3. Increased corporate loan book. If assets turn into NPAs then it will be a problem.
4. If MSME problem happens like demonetization, GST etc. then EMIs will be due.
5. Bajaj Finance is playing as a major competitor in retail space.
6. HFC should continue to face lot of competition from peers. But, it is going to generate lot of demand in future.
7. P2P lending can act as disruption force for entire banking and finance industry if they start lending at discounted interest rates.

Risks in AMC

1. If people find other asset class other than equity like gold, real estate etc, AMC’s assets under management will decrease.
2. Failure to generate satisfactory returns over short term or long term. In short, if fund managers don’t perform well.

Risks in Insurance

1. If underwriting discipline is not maintained, then profitability hits.
2. Currently, only few players are present. If competition rises, then it will hit top line growth. Also, it will hit ability to raise premiums.
3. If persistency drops, then profitability hits.

References

Annual reports of ABCapital

https://www.adityabirlacapital.com

Call to action

If you like the article, please share and comment your views on it. Next stock will be shared in Dec-2018. So, please stay tune.

Disclaimer

Investment in equity market is subject to market risk. Please analyze annual reports carefully. Views expressed in this article are personal. Views should not be treated as recommendations to buy or to sell stock.

Related materials

I have written other blog-posts on quality stocks. They can be found at

Karnataka Bank

Apollo Tyres

Huhtamaki PPL

Bodal Chemicals

SPTL

Originally published in medium

Sintex Plastics Technology Ltd : Demerger , a very good opportunity

Introduction

Sintex Plastics Technology Limited (SPTL) was demerged from Sintex Industries last year where capital intensive textile business became a part of Sintex Industries. The plastics and infrastructure business spun out as part of SPTL. Textile business is capital heavy and didn’t generate satisfactory earnings. However, plastics business of Sintex generates significant free cash flow. Having both the businesses together in a company was putting lot of stress on balance sheet. The entire group is leveraged because cash flow generated from plastics business was dumped to textile business requirements. Hence, entire earnings of the group looked subdued. This is the reason, Sintex didn’t get deserving market valuations. As both of the businesses are demerged, plastics business creates very good investment destination for long term investors. Lets analyze what SPTL is all about and how this is a sound investment opportunity.

Business model of Sintex Plastics Technology Limited

This company deals with following subsidiaries, all of them in plastics

1. Sintex Prefab and Infra Limited: Infrastructure group primarily dependent on Govt. Policies. This group manufactures prefabricated structures like anganwadis, police-chowkis etc. They had order from Govt. of Madhya Pradesh in Kumbh-Mela. 31% of revenues comes from this side of the business.
2. Sintex Wausaukee Composites, Inc.: US based subsidiary in composites. This subsidiary is liquidated and business is shifted to India to improve margins.
3. Customer-specific custom molding: Mainly dependent on automotive sector. Group occupies the pole position in this space with more than a 60% market share.
4. Sintex NP: Automotive and aeronautics division.
5. Application-based custom molding.
6. Sintex-BAPL Limited: Custom molding for diverse and automotive sector. 69% of the business comes from custom molding side of business.

Positives of SPTL

1. Strong presence of business across 4 continents and 9 nations.
2. SPTL enjoys Fortune-500 clientèle. This is very hard to build as company has long term relationships with 80 Fortune-500 clients.
3. Custom molding business on strong footing. Exposure of Government dependent prefab business is being controlled by company. This business puts pressure on the balance sheet in terms of working capital. They want to focus on selling prefab products for CSR activities.
4. A dominant brand position in India with long order book.
5. Very good free cash flow on financial statements.
6. Currently, management is focusing on building and enhancing retail products portfolio in entire India. In this year, they focused on Northern India. In next few years, retail dealership should be spread to rest of India. Retail business is growing more than 35% YoY. This should generate more revenues in coming years.
7. Electric vehicle market is boon for plastics and composite manufacturers.
8. New plants for TVS, Suzuki and Ford will add to the revenues. Also, new orders coming in from Tata-Motors and Cummins. Company is betting big on Auto and Electric sector in India.
9. Entire free cash flow is being utilized to repay debt. Company doesn’t have lot of capital expenditure planned (figure is below 200Crs per year).

Negatives of SPTL

1. Debt-To-Equity of 0.89 as of last quarter. 3000Cr of debt is present on their books.
2. Prefabricated business is dependent on Govt.’ schemes. Cash doesn’t come easily from this business having receivables spanning many months.
3. Overall, 50% of promoters shares are pledged.
4. As business is under transformation, near term balance sheet looks subdued.

Investment rationale

1. Management’s focus to cleanup the balance sheet should result in improvement in RoE to 20%+, RoCE to 15%+. Also, huge scope for margin expansion is observed considering the focus on retail and value added products.
2. Products of SPTL are in great demand, in India as well as abroad. This generates constant revenue stream. Management has target to increase the revenues to 10000 Cr in coming 3–4 years.
3. Promoters are continuously buying shares and reducing pledged shares by significant amount. Stake of promoters in the company set to increase from 28% to 41% after issue of warrants.
4. SPTL generates lots of free cash flow. As majority of their capex is behind, free cash flow is being used to repay all debt. Company is expected to repay ~300Cr of debt in FY 2017–18. In my opinion, SPTL is currently highly undervalued at Rs. ~50 because with ~6000Crs of revenues, market capitalization of SPTL is only ~3000Crs.

References

1. http://www.sintexplastics.com
2. Annual report of last financial year.
3. Quarterly reports of last three quarters.

Call to action

If you like the article, please share and comment your views on it. Next stock will be shared in Sept-2018. This will be high quality stock with huge potential for earnings. So, please stay tune.

Disclaimer

Investment in equity market is subject to market risk. Please analyze annual reports carefully. Views expressed in this article are personal. Views should not be treated as recommendations to buy or to sell stock.

Related materials

I have written other blog-posts on quality stocks. They can be found at

Karnataka Bank

Apollo Tyres

Huhtamaki PPL

Bodal Chemicals

My journey as a value investor

Since long time, I wanted to write about my investment philosophy. But, personal things didn’t allow me to do the same. So, without further ado, I want to start on this topic. I joined workforce in Jul-2011 after completion of B.Tech in Computer Engineering from College of Engineering, Pune. One obscure mutual fund agent visited my office for investment purpose. This was mainly for tax-saving purpose as one can submit a proof of mutual fund investments as part of Section 80-C. He made many points clear about the investments long term holding, patience etc. I didn’t look at the performance of mutual fund I bought for three years. The investment doubled within three years. So, I had started taking interests in reading investments related books starting with “The Intelligent Investor” by Ben Graham. This book changed the way I was looking at stock market and built a foundation of how a good investment could be.

After that, I read as many books as possible about investments. Simultaneously, I started building portfolio. Here is a list

1. The Intelligent Investor
2. Security analysis
3. Warren Buffett and the Interpretation of Financial Statements
4. Value Investing: From Graham to Buffett and Beyond
5. The Little Book of Behavioral Investing: How Not to be Your Own Worst Enemy
6. The little book on value investing
7. Aswath Damodaran: How to Value a Company Pick a Stock and Profit (Business)
8. The Warren Buffett’s portfolio
9. Letters to shareholders of Berkshire Hathaway

What is value investing ?

Value investing is mostly mistaken with analysis of ratios like P/E, P/B etc. In my opinion, definition of value investing is very simple. Value investing can be defined as investing in a business which is available at significant discount to its intrinsic value. Forget about P/E, P/B etc. Now, someone might ask how do I figure out intrinsic value of a business. This is unanswered question till date. However, I have simple ways to look at my investments. Invest in business, not in stocks. So, next question is how can I find out business to invest. What characteristics should one look in the business while investing?

Characteristics of business to invest

I check following things while making investment :

1. Clean, focused and hungry management for expansion with good capital allocation skills : Management is the jockey of horse. If jockey is bad, don’t expect good returns. I look at their future plans for company and their hunger to make the company big. Also, making company big shouldn’t come with lot of debts. So, I evaluate capital allocation decisions. Management must be focused on their core competencies and should not have conglomerate forming tendencies. Essentially, great management will lead the company to awesome path. 
2. Business with strong fundamentals, predictable earnings growth for next 7–10 years and good future demand to the products : A business with strong fundamentals will protect the downside of the earnings. This is really important factor to evaluate because, in my opinion, risk in business comes from permanent capital loss. Evaluate what would be downside, great business will take care of upside. All these factors can be figured out if you look at what company is doing, their annual reports and thinking a lot about future demands of the product/service. E.g. NBFC, Housing Finance space are very good bets because they have high penetration capacity in Indian market. Great quality business will earn lot of money than the one with poor fundamentals. Characteristics of great business in short :

Business with less capital requirement

Business whose products/services don’t get obsolete easily. Meaning, such business does same boring thing for last decade or two.

Business shouldn’t be regulated.

Business whose products/services are so much desired that customer doesn’t have any other choice or very few choices.

     3. Reasonable price : Such wonderful thing should not be available at infinite price. I look at difference between current price and projected price. If this difference is too much, I have figured out an ideal investment destination.

     4. Minimum holding period : It should be at least 5 years. If you sense fundamentals of business have changed, you can sell the stake.

     5. Diversification : Concentrated holdings of 10–15 businesses in your portfolio will always return satisfactory performance. I don’t want to diversify beyond 20 stocks in my portfolio. I want to hold businesses which I really understand well and matching these simple criteria.

With that said, investor should read a lot about new opportunities and focus on analyzing the business very well. Focus on reading at least last 10 years annual reports of the business, watch management interviews. This will help evaluate the business.

I wanted this blog to be very simple and short. If you have any comments, please post.

Originally published on medium.

Bodal Chemicals : A turnaround story

Introduction

4–5 years back, Bodal chemicals was in lot of debt. The company had debt-equity ratio of 8.78. However, Chinese government’s crackdown on specialty chemicals companies changed picture of Indian counterparts. Chinese government imposed strict pollution control norms on chemical companies. This led to under-utilization of their capacities. So, this move vacated Chinese dominance in chemical sectors. So, who would be favored by this event? Obviously, Indian chemical companies. Bodal is the beneficiary of this favorable event. Generally, I don’t believe in turnaround stories, unless they show consistent earnings growth and strong, predictable business model. However, Bodal deserved a serious analysis.

Business model

Bodal chemicals manufactures specialty chemicals for textile, paper, plastic and leather. 71% revenue comes from domestic markets and 29% revenue comes from exports. They export to more than 50 countries. Bodal has wide customer base of 375+ customers worldwide. The company has total 9 Manufacturing Units in Gujarat-India. Bodal Chemicals has a modern, well–equipped and in-house R&D Lab for testing and new product development; and constant improvement in the existing product lines. Expansion in new plants and inorganic growth through acquisitions and joint ventures will drive revenues growth in long run. These expansions happened without using significant debts. Their long term debt is negligible.

In detail, Bodal has following divisions :

1. Sulfur and bulk chemical division
2. Dye intermediates : Nearly 70% of production is being exported worldwide to various clients including several multinationals. Apart from being leader in indigenous market, products are being exported to China, Korea, Thailand, Taiwan, Japan and European belt. Today, Bodal is one of the largest manufacturer & exporter of Intermediates in India. Bodal enjoys 25% share for dye-intermediates in Indian market.
3. Dyestuff : Bodal has invested more than 0.5 million U.S.D for making International level Dyestuff, technical service laboratory, dyes quality control laboratory, paper, leather and textile dyestuff. Bodal enjoys 9% share for dyes in Indian market.
4. Trion : TRION T.C.C.A, the compound is a disinfectant, algaecide and bactericide mainly for swimming pools and dyestuffs, and is also used as a bleaching agent in the textile industry. It is widely used in civil sanitation for pools and spas, preventing and curing diseases in animal husbandry & fisheries, fruit & vegetable preservation, wastewater treatment, as an algaecide for recycled water in industry and air conditioning, in anti-shrink treatment for woolens, for treating seeds and in the organic chemical synthesis. Main market is US. It has received license in USA for environment protection. Trion Chemicals manufactures specialty chemicals and its base products.

Positives of Bodal Chemicals

1. As other countries are regulating their dyestuff industry with mandatory norms for waste treatment, it eliminates their domestic companies’ ability to dump the goods to global companies. This level-playing field of competitive pricing only adds to advantage to expand market share globally with quality conscious products and solutions.
2. Bodal will continue to make sustained investments for capacity expansion and keep a comfortable debt profile. E.g. SPS processor and Trion Chemicals.
3. Large population, low per-capita consumption of chemicals, strong GDP growth outlook and favorable initiatives by the Indian government.
4. Certain recent developments in China have presented a substantial opportunity to the large and organized Indian manufacturers of dye intermediates and dyestuff.

Negatives of Bodal Chemicals

1. Revival in Chinese Market : If Chinese player starts to manufacture at the capacity utilization level of pre-crackdown period, Indian companies in this sector are going to be disrupted. This is the primary threat for Bodal.
2. Unfavorable commodity cycle : Bodal is a commodity player. If demand from end industry turned down, Bodal will get hurt. This had happened in last couple of quarter.
3. Unorganized players may turn up the heat : This segment has many unorganized players which could sell products at lower prices. However, after the advent of GST, unorganized players have to conduct their business in formal sector. This has turned negative for unorganized players because they have to pass all the pollution control tests, which may not easy. So, for this sector, Government’s regulations act like strong barrier to entry.
4. Increase in raw material prices : Bodal uses crude as raw materials. If crude prices increase, their turnover decreases. They pass on cost to consumers.
5. Scalability of growth : In last 2–3 years, Bodal could show stellar growth in earnings. But, considering some of the headwinds in the sector, growth may slow down.

Management quality

Management has very good experience in chemicals sector and built the company from scratch. Mr. Suresh Patel is a first generation entrepreneur. The important thing is company has negligible long term debt. This management could make the company almost debt-free. Company is expanding in organic and inorganic ways which I believe, moat-widening acquisition. So, overall management is hungry for growth, with little debt on their financial statements.

Investment rationale

I bought bought Bodal Chemicals at Rs. 171.9 per share. The main reason is favorable outlook for the company in next few years. Their expansion plans will add significant revenues. Management could achieve significant return on equity (30%+) in last 3 years, with less debt. Given the commodity nature of the business, I don’t want to allocate too much investment capital to this stock. So, I have very small holdings in this company. But, I believe that in the long run of 3–5 years, this business may grow satisfactorily. Recent correction in the stock gives very nice opportunity to accumulate shares at cheap valuations.

References

1. https://www.bodal.com/
2. Annual reports of 2013, 2014, 2015, 2016 and 2017.

Call to action

If you like the article, please share and comment your views on it. Also, I have decided to revamp my investment strategies. As part of the same, I want to concentrate my holdings to 2 businesses per year. Earlier, I invested in a company per quarter. That was 4 businesses per year. These new strategies will be applicable since year 2018. So, I will share 2 businesses where I have invested in. Also, I will share 2 blog posts on my investment philosophy. Also, I will share updates on business performance and my views on the businesses in my portfolio. So, next stock will be shared in Jun-2018. Please stay tuned.

Disclaimer

Investment in equity market is subject to market risk. Please analyze annual reports carefully. Views expressed in this article are personal. Views should not be treated as recommendations to buy or to sell stock.

Also published on Medium.