Deja Vu all over again?

The elephant or so to say "bear" in the room today, (recent market free fall) might be construed as a possible parallel to the 2008 but here are few reasons, it might not turn out to be the same?

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• Government Action: The government of all nations is much more receptive and active to the idea of bailing out and systematic risk consequences (Lehman crisis). This can be evident from the  New Reform Bill passed by US and EU and the recent bailout of Greece by EU and desperate action by Greece on the ban of naked selling. While we still agree that there are Dangerously over leverage AAA super powers (DOLTAS), but the chances of them bursting are quiet minimal if not low.
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• Economic environment: In, autumn of 2008, the common conception was regarding "worst global recession since the 1930s." Today, many people are counting on stimulus package (75% unspent) and foresee this to be major economic boost. Some relief can be seen from the recovering commodities (Oil!!!!) owing to consumption.
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• Earnings Forecast: In contrast to the "worst earnings recession since the 1930s" that was taking place in late 2008, Most people are of view that Earnings will be robust in the current year and 2008 scenario is unlikely to repeat.

PE Ratio Thesis : While President Obama said " What you’re now seeing is profit and earning ratios are starting to get to the point where buying stocks is a potentially good deal, if you’ve got a long-term perspective on it". Many people are of view that its time again to be a stock pickers market with PE of S&P being close to 12.In August 1982, the PE Ratio dropped below 7 (see chart), in both July 1932 and July 1921 it went below 6.  This would imply that there is further downside of 50% of S&P, if we were to see the same level of PE which isn't the case right now seeing the earnings.

Comments welcome!

Prepare for a smooth take off!

Wow! What a year it has been. We started at the 21000 (or thereabouts) on the Sensex in January 2008 and now we stare with questions such – Is there a bottom? It can’t pierce 8000 levels and of course the all familiar; how low can it go?

We are absolutely awed by the way things can turn in the stock markets and yes, we must admit, it can be a humbling experiance to us. We also believe strong in the idiom – keep it simple stupid (the KISS principle) cause no matter where you enter in a stock, if you enter the right stock (right business model, strong franchise and transparent management), it will all come back one day.

Meaning, imagine you invest a company at its 52 week high and the stock tanks 50% or even 70%, what would you do? If the answer to the question we put before (Is the business model right…) is affirmative, believe it will all come back one day. You will need to be patient. The fact of the matter should be that if you had the courage to buy it at the levels you bought it, you should be buying it even more at the current price.

At this moment all we can quote is what Peter Lynch said “If you believe that this business will be around after the next 20-25 years you shouldn't bother what is the current stock price is.

Its Déjà vu all over again!!

That’s what Yogi Berra, famous for his often very subtle quotes (on second thoughts of course) had said no so long ago. Now we don’t profess and don’t want to beat our drums with a trademark “we told you so” attitude, but nevertheless it does not stop us from just drawing your attention to what we wrote just few months ago in our earlier post.

We had a definitive feeling that this would happen (the Bond rally) and was the only way stocks could rally. Only, as mentioned in the post, we thought the government could be a little lethargic (as always) to step in and help the market. We were wrong.

The Bonds have rallied and how. It’s been an incredible 30% on the gilt funds in only two months! Wow, we say with a dazed look. But if what we said is indeed coming true, what is in store in the next coming months?

Happy New Year 2009?

At the outset, we can certainly tell you that it’s going to get a little rough as we head into 2009. What does that mean? That the situation is not going to turn around (for equities) like a bond rally for sure. Buyers are not going to return in droves to buy real estate, nor will car buyers flood showrooms. People will continue to stash their cash into bank vaults and “saving for the rainy day” will remain the mantra for the next few months.

We believe it will not be until there is any meaningful turnaround happens in the corporate earnings. But the first indications could come from decline in interest payouts of corporates over the next 2-3 quarters.

Next could be the outperformance of the "safety net" stocks or the ones like high dividend yield, stable cash flows - consumer staples and pharma/healthcare and finally growth stocks. Within the growth bandwagon too, we could see the last coach (realty sector) of the train not coming good until 2 years from now.

To summarise:-

• we are indeed in the middle or the last leg of the bond rally
• typically it has been witnessed that stock rally starts 6-9 months after the bond rally completes
• the cycle normally upturns with the value picks / absolute bargains starting to outperform

While we go into 2009, if you are thinking of entering the stock market, it would be akin to coming to the airport 3 hours before you flight takes off. For one there will be no one around, second you could end up first in the que, you could end up with the choicest of seats (we hate tele-check in) and yes when you know that its a large aircraft (like the A-380) you would be sure that you will almost certainly enjoy the flight and it will be a smooth and a perfect take off!


So stay tuned...

Caution: Sharp turn ahead!

When we started writing in late 2007, we had said that 2008 could be full of uncertainty (refer: Ab kya hoga?). At that moment we did not know and did not have an iota of conviction where we could end up after 2008. At this juncture, however, we believe that 2H 2008 could be far more correction oriented(bumpy ride) than most people think it will. The reason for this ‘pessimism’ could be in what we are seeing lately on the macro front and its effect on the corporate performance has still to show up, according to us.


What’s up with the Sensex?

There are umpteen articles published recently comparing our markets with those of the rest of the emerging markets. The BRIC economies which had a spectacular run in the last four years have all corrected recently, but the arguments put forth are that the Sensex is amongst the cheapest of the lot, in terms of valuations. For the record the Sensex trades at around 16-17x FY09 earnings compared with other emerging economies which trade more than this multiple.
For one, Sensex companies have had a spectacular run in the last four years making them from ultra cheap in 2003 to overvalued by early 2008. For instance, the erstwhile (consolidated) Reliance Industries Ltd. was trading around 16-17x 1yr forward earnings in 2004, while now it trades at around 22-23x 1yr forward earnings. Sure it has corrected from 28x it was trading in early 2008. But we believe that to make an entry into Reliance Industries, we still have time on our side, right through 2008. This is true for most of the Sensex companies.

Secondly, sector wise we think that it would be prudent to move away from high beta sectors (read; rate sensitives, high growth, high multipliers), to defensive yield oriented and low beta sectors.

Thirdly, we believe that the near term could throw up certain sectors which could end up gaining from the current slowdown. Counterintuitive you might say. We meant in terms of relative performance.

Slippery when wet!!

Its like running while wearing rubber gripped shoes on a concrete surface. When the surface is dry the rubber provides grip and powers us forward. But what if we hit a patch with water on the surface. Just can’t imagine that, can you? The same, we argue, is that case with rate sensitives, high capex sectors, and ultra growth movers. A little lower octane (capital) provided than before can slow these sectors more than a few percentage points.
As a result of the successive liquidity squeeze, which in all probability does not seem to be over, the octane for certain sectors suddenly has been cut.

Real estate, banking, capital goods, construction, autos and manufacturing in heavy industries are the ones which could have visible lack luster performance in FY09. This situation could get complex as a result of commodity inflation, resulting in another set of industries such as Metals, cement, transportation & logistics and processing companies getting margin squeeze.

We believe that it is indeed a time to get defensive, albeit move into a watch mode from here. This situation could persist for maybe a year before the next leg of performance by the heavyweights of capital consumption.

The formula (if we can call that) to get over this trying phase is to look back at those sectors which display a secular demand which is devoid of economic cycles. FMCG, F&B companies, Pharma, IT and related services and of course medical care.

These stocks will display continued growth, could be available cheaper than those stocks in the cyclical sectors and could assure you decent returns which may not be provided by cyclical or growth stocks in this period of pain.

One could therefore look at stock such as ITC, Indian Hotels, Apollo Hospitals, PVR, and TCS.

Therefore, if the hare is resting bet on the tortoise.

Picking beaten angels - Part II - LMW (BSE: 500252)

Amongst all the clutter and noise at present in the market, we believe that there are companies which are plugging away slowly, beaten down more than necessary due to market pessimism and worthy of mention as a result of attractive fundamental story. LMW or Lakshmi Machine Works, (BSE: 500252; NSE: LAXMIMACH), is one such name. Below, we present our case:

Investment Rationale:

Lakshmi Machine Works Ltd (LMW) is a Coimbatore, Tamil Nadu based textile machinery manufacturer. LMW is India’s largest and world’s third largest textile machinery manufacturer. LMW is a 40 years old company and sold almost 2.3mn spindles in 2007 with almost 60% of the domestic market. Swiss based Rieter is world’s largest textile machinery manufacturer and has a long association with LMW. LMW acquired the technology to manufacturer textile machines from Rieter’s only. In 1999, both the companies called off their collaboration, but Rieter still continues to hold 13% in LMW and has its own production unit in India as well. Before we start narrating the entire script, here are the following major pillars of our investment thesis:

1. Orders of Rs.4500 Crores in hand, leading to a sales visibility for next 2 years.
2. Gets 10% of the order as advance from the customer, leading to negative working capital
3. Debt free with a cash of ~ INR 600 Crores at FY 07 end
4. Gets 1.75% of the textile machinery bill amount as subsidy from GOI under the EPCG scheme. Sales of textile machinery to 100% textile EOU are considered to be deemed exports.
5. Stable OPM of 17-18% and PAT of 11-12%
6. Implementation of VAT in TamilNadu is saving Rs.2.5-3 Crores every month for the company
7. Exploring other major Asian textile manufacturing hubs like Pakistan and Bangladesh
8. Textile Up-gradation Fund Scheme (TUFS) has been extended till 2012 by GOI

9. No price change since June 2005 with iron & steel, aluminum, brass, copper and pig iron as the biggest raw materials
10. Invested ~Rs.400 Crores in last few years to double the production capacity to 3.5mn spindles in 2008 from 1.8mn spindles in 2006
11. No plans to expand the capacity going forward

One Immediate Trigger

Voltas provides presales, order booking and installation services to LMW. In its latest results announced by Voltas, the company has gone on record saying that “Textile Machinery division achieved 20% growth in equipment sales”. Applying the same logic to LMW, the company should post the same growth in its textile machinery business also leading to Rs.2000-2100 Crores of sales in FY08 with Rs.1682 Crores of sales in FY08.

LMW is scheduled to announce its results on May 19, 2008.

Indian Textile industry – Key Facts

1. Accounts for 14% of industrial production and 4% of GDP
2. Employs approx 35mn people, second largest after agriculture
3. India’s textile exports in 2006-07 - $17B. Target to export $50B by 2012
4. India’s expected domestic textile market in 2012 - $50-60B
5. Installation of 38.8mn spindles (21mn supplied by LMW) out of which:
1. 29.8mn are active
2. 10mn are waiting to be scrapped
3. 15mn are fit for modernization
6. 6. India’s textile machinery market (3.9mn pa) is second largest after China (7mn pa). Pakistan is third largest with 1.1mn spindles pa.
7. 7. India is expected to add 3.5mn – 4.8mn – 5.4mn spindles every year under worst, base and best case scenario till 2012 to reach its $50B export target.

Business Profile

1. More than 4 decades old
2. Sold 2.33 mn spindles in 2006-07, with ~60% of the Indian market
3. Third largest textile machinery manufacturer worldwide with Rieter of Switzerland and Schlafhorst of Germany bigger than LMW
4. Long-term association with Rieter has helped the company to learn the technology with 90% of raw material and components locally procured. Reiter holds 13% of LMW. Reiter has its own production unit in India.
5. Large localization helps the company to sell the products at 15-20% less than its global peers.
6. Invested Rs.410 Crores in last 2 years to increase the capacity from 1.8 mn spindles in 2006 to 3.5 mn in 2008.
7. Takes 10% of the order as advance, leading to negative working capital. Similar amount on Rieter BS seems to make this a worldwide phenomenon.
8. Increased capacity and improvements in production has helped the company to decrease the delivery period to 10 months from 18 months.
9. Worldwide textile machinery demand peaked in 1HFY07. LMW is expected to end FY08 with an order book of Rs.4500 Crores as against Rs.5400 at Q2FY08 end.
10. Plan the production at the beginning of the quarter by getting an approval from the customers.
11. Irrespective of the date of arrival of the order, the customer is charged at the time of delivery of the machinery.
12. The pricing is done as per the prices prevalent at the time of delivery, as per the competitor’s rates and the market conditions. Due to this practice, the margins are expected to remain stable going forward.
13. The company has been following the current pricing rules since last 40 years and has never faced any issue with any customer.
14. No price hikes since June 2005.
15. The company gets 1.75% of the bill value machinery sold as exports or to EOU’s as benefit under EPCG scheme from GOI. The company previously used to share (50:50) the benefits with the customers but now has stopped the practice.
16. Implementation of VAT in Tamil Nadu is helping the company to save Rs.2.5 Crores - 3 Crores every month.
17. Holds investments worth Rs.60 Crores. JV with Rieter had sales of Rs.121 Crores and PAT of Rs.9.85 Crores in 2006-07. LMW has invested Rs.12.5 Crores in the JV.

Product Profile

1. Textile Machinery Division – 90% of the sales
2. Machinery tools & Foundry Division – 10% of the sales.
3. As the technology in the machinery tools division is highly guarded by some of the world major’s, the sales mix is not expected to change dramatically going forward.

Shareholding Pattern

Association with Voltas is strategic as the same provides presales, order booking and installation services to LMW. Voltas charges 3%-4% of the bill amount as commission.

We would like to resist from giving any projections considering the uncertain economic environment we are in. Also as per our philosophy, is it what he have that matters and not the uncertain future.

Conclusion

LMW with its leading position and strong order book is a strong defensive investment available at cheap valuations. We expect the company to do well in future and the share price to mirror company’s financial performance.

Sasken Communications – UPDATE… (BSE: 532663; NSE: SASKEN)

Wow!!! We like this! While the prices of real estate in Bangalore have stabilized, why has Sasken communication gone up in Value?
For starters, the stock is up > 60% since we last wrote about it last month. Yes we agree that the stock was close to 80% down from its 52wk high, but what the heck!
Wasn’t it a golden opportunity to average out to a decent price and maybe exit at the next up move if you felt skittish? We hear people screaming out “Falling Knife” and won’t fall for that one. Well that’s where those who test the business model WIN.

IT is the next in thing…
Well, we are not saying this. Its’ the GURUS who are saying it. We always maintained this ever since we starting writing on it late in 2007. (Refer: Ab kya hoga?)

We believe that the long term IT story is pretty strong. Margin may come under pressures, business model will change, and the sector will look more like cyclical over a decade from now and probably there will be a shakeout with some bruised and battered companies.
The trend could also change, slower growth, more controlled performance, steady dividends and yes acquisitions. Finally there will be winners.

Let get fundamental…

1. There are a few things that we look at in a company when we invest into it (at least this is the philosophy that we believe in).
2. Is the company in a domain in which it has a first mover advantage?
3. As a result has the company able to maintain a top slot in the sector?
4. Are there catalyst that we dethrone the company in the near future?
5. Is the business model in for a fundamental change in the future/is threatened by forces (external or internal)?
6. Is the company favorite / dumped by the street for a longer lengths of period in time (in simple terms – valuations)
   

The results are good or bad?

Sasken reported Q4FY 2008 numbers yesterday and while we see them in the comfortable, the street seems to be reiterating its SELL mantra. We believe that the street has got it right as far as next 2-3 quarters are concerned.

Citi (analyst Surendra Goyal, a good friend of ours) has a SELL report in the market reiterating very valid concerns in the short term. But we disagree with him certain macro fears he puts forth.

Metrics would continue to drag, performance might be subdued and risk could look overwhelming. We believe the opportunity might come over a longer period (12-18 months) is

1. Telecom space (where the company operates) improves as a result of continued penetration in the domestic and Asian markets. We would see revenue growth steady and continuous
2. Margins hitting bottom and then reverting back to saner levels of higher double digits (possibly mid-teens).
3. Employee costs stabilizing over the next 18 months as a result of overall lackluster employment opportunities

Sasken for now has done two important things to keep nervous investors some comfort.

a) Given a 40% dividend on a INR 10 FV share. This translate into a dividend yield of little under 3%, so this is a positive, a minor one you would say. But we conclude a positive nevertheless.
b) Sasken board has approved for a buyback upto INR 40 crores, an authorization for buying shares upto INR 260 / share. CMP at around INR 144. We believe that even though this also will not really lift EPS materially. The signal from management at the moment is the company is undervalued. We believed this for the last 3-4 months.

Time to speculate, then?

Well we believe that there will be lots of activity in this counter from now on. The triggers are the buyback, dividend stripping and bullish traders getting in the make a quick buck while the undertone is positive.

The safety net is therefore stronger than before. However, we think that investors should look at this counter only for a fundamental story rather than a speculative opportunity.

Easier said than done.

We think we could see this counter moving up nicely to around INR 220-240 effortlessly. So a good 40-50% from here in the next 3-6 months. Over a longer term however, we continue to maintain that the upmove could be a lot more painful than it appears. Investors who entered this counter at various levels starting at INR 300-400 price band have caught a falling knife and made a few deep cuts to themselves.

But were they intelligent enough to buy some more when it reached INR 86 (all time low) a few weeks ago?

We don’t know that for sure.

Until next time….

Sasken CT Realty Ltd.

We know anything with a suffix - realty, developers, real estate has been shunned over the past few weeks in the markets. But we have a deal for investors, or rather a game...
Suppose you were asked to play a game which in which INR 5,000 is deposited into your account. If you win (of course after a length of time during play) you could win big time. You could get twice, thrice or even four/five times worth what you bid. Incase you lose, however, you will get the INR 5,000 deposited into your account and nothing else...

There will be NO catch in this game. No you would ask, who the hell will sponsor such a game. Well, for one, there are enough people willing to give away free money in the market. Especially the stock market. Anyways, lets get back to out game.

Is it possible to find such an investment in the market. I think we have found one. It's name is Sasken CT (Realty) Ltd.
Weird, isn't it? What do you get when a cross a IT company with a real estate player. The idea would, according to market pundits, would be a disaster. We are no pundits. Coming back to Sasken CT Realty.

This company is a IT (rather a communication vertical player) company, which according to us is available for free in this market. Please explain, you would say.

Let's therefore get our arms around what we mean....

The background:
1. 52 Wk high @ around > INR 500 sometime in mid-2007
2. 52 Wk low @ INR 86.5 on 19 Mar 2008 (could be tomorrow, day - after.....)
3. Revenues - 9M FY 2008 - 412 crores with a operating margin of 4.5 %
4. Revenue mix - US constitutes only around 30% of FY 08 mix EMEA > 50%
5. Cash flow positive.
6. Has net cash of around INR 10 crores
7. Enterprise value - INR 240 Crores
8. Institutional holding @ 30% with average price of acquisition > INR 300 (holding period >1 Yr)

We'll stop at that. You can buy this company tomorrow @ INR 240 crores from the market. Keep this datapoint in mind.

We looked at the Q3 FY 2008 income statement and balance sheet. Go ahead and take a look:

http://www.sasken.com/results/Q3FY08/Sasken_Q3FY08_Media_Release.pdf

Break - up value of this company:
Net Cash - INR 10 crores
Receivablies - INR 112 crores
Land - INR 180 crores ( two buildings - 1. Domlur, which is close to city center & 2. on route to Electronic city). Combined sq feet of > 5,25,000 and we value it at INR 3500/sq ft
Total value - > INR 300 crores

We would like to discount this value by 10%. Even after this, we have INR 30 crores surplus.

So the deal is, forget IT man - lets buy it break it up and make cash instantly without having to worry about running and understanding the business, you see.

However, we believe that, Sasken with all the people who run it are more than capable to generate a long term sustainable multi million $ profit enterprise.

We believe that the street has gone overboard in taking a very pessimistic view (resulting from the US slowdown) on some valuable companies and here we would like to twist the term of Alan Greenspan. We call this kind of moments as - Rational Antipathy. Or simply put - Seeming display of rationality in hammering the good guys...

Financial analysts would go only by numbers, so let us throw them in as well - Sasken trades at
1. 0.6 x PEG with a 7.5 x 1 yr forward Price / Earnings
2. 0.5 x Price / Sales (or INR 130 sales per share)
3. 4.5% Dividend Yield (We've now started of talking about dividend yield on IT companies.....When was the last time that happened)
4. 0.6 x Price / book (or INR 140 BVPS, we really like this - our original premise of selling the land.. Wow)

To quote Warren Buffett, "We simply attempt to be fearful when others are greedy
and to be greedy only when others are fearful."

Are you ready to play this game, and yes we can rename this company to Sasken CT Realty Ltd. by appointing the best lawyers and consultants and paying them their worth.

Are you game???

P.S: If you are still digesting what it's all about - BSE ticker 532663.

Caveat Emptor!!

Literally “Buyer beware”.

The Indian stock market continues to be in the push-pull mode with research houses split between where to invest in 2008. While the general tone of the market seems to be bullish, with research houses almost unanimous in putting Sensex targets around 23-24,000 by the end of the year 2008, the individual stock recommendations seem to be in disarray.

Everything in today’s market is up for sale. We believe that the situation is quite similar to one witnessed during the annual exhibition sale of wares by small traders/hawkers. During these sales, where a large number of buyers are visiting stalls of traders, one tends to play oneself to the mob psychology. We loosen our purse string to things we would not have bought in ordinary course, or unassumingly pay a price for an item which is not worth half of what we ended up paying.

This is precisely what’s happening in the current market scenario, we believe. Every time we loosen our purse string to buy a new idea, hot tip or the next growth company, we need to very careful of what we are buying. Like always, it is easier said than done.

What we said was evident with investors rushing to invest in mid-caps stock a few weeks ago as if there was no tomorrow, resulting in stock prices shooting by 40-100% in select mid-caps. Over the past week, however, the same stocks have pulled back around 20-30% and we believe that a very small percentage of investors have made money during this period.

5 questions to ask before you buy a mid-cap stock

1. Do you really understand or made efforts to understand the business model?
2. Have you done a gut check on the recent reported numbers by the company?
3. Did you bother to check 3-4 basic valuation ratios of the company at the CMP?
4. Have you decided the time horizon till which you will hold this ticker?
5. Will you buy more of the stock if it tanks 35% or more after you bought?
   
   If the answer to ALL the above questions is a thumping YES than go straight ahead with your investment, else take time out and ponder a little more because the stock markets always opens in a few hours after they closes.
   
   And always remember the golden words 'Caveat Emptor'.