Hi Guys,
Hope you all had a great Diwali! Wanted to share an update with you all. We started a SEBI Registered Investment advisory by the name of VRDDHI Capital a year back.
Going forward, we will be blogging on our website. You can subscribe to our blog here for future updates!
Thank you!
Rajat & Rohit
A brief about the opportunity – Pennar Industries is a manufacturer of engineered steel products having applications across railway coaches & wagons, metro coaches, solar, auto, white goods, hydraulics etc. To read full analysis please click here
Disclosures: Vrddhi Capital & its representatives including the Investment Advisers have vested interest in above mentioned securities & may be invested in the same in their individual capacities & may do transactions in above mentioned securities. Vrddhi Capital has not received any compensation & has not been associated with above mentioned securities at any point of time. Vrddhi Capital and its associates do not receive any compensation from the client’s brokers on buying/selling of the said security.
We have been analysing the banking space for the last 5+ years now and today wanted to talk about something which is perhaps not given its due attention. It is the ‘Other Income’.
Other income, also known as non-interest income, which includes loan processing fees, distribution (MF, insurance etc) fees, brokerage, income from dealing in forex, treasury gains, loans write backs, forex profits, dividends, and few other smaller heads. CEB, (commission, exchange, brokerage) income is looked at separately as it represents the ability of a management to generate extra sources of income using the already existing infrastructure and sales personnel (may be some are specially hired for generating CEB but not much). Thus, CEB flows directly to PBT, contributing massively to profitability. We can call CEB as core other income (OI).
Now let’s understand why is it important?
OI is generated using the already laid out infrastructure and is a measure of how effectively management is able to sweat its resources. Since there isn’t much aditional cost for generating OI, it directly adds to ROA/PAT (adjusting for taxes).
Lets take a look at the ROE tree below comparing New Private Banks with Old Private Banks:
Highlighted row at the end of the table above shows contribution of total OI to PBT for the last 5 years for the private banks under study. For few banks, almost all of PBT is coming from other income which essentially means core lending is not profitable enough to keep the bank afloat.
If we just remove CEB income, ROEs fall below 10% for most of the banks including Yes, IndusInd and Kotak
However, one can argue that some components of OI such as loan processing fees is an integral part of lending operations and most of other non-interest income is generated using the various resources such as branch infra, personnel, customer deposits which are into place only because of core lending operations. Lot of other income is generated because of cross selling. We also agree that existence of OI relies on core lending operations of a bank, however, an efficient and focused management can use the resources in a way that brings all the difference into the profitability of the bank. From the first table, it is pretty evident that new private banks are much more focused on generating other income than their old counterparts. In my view, this is making all the difference to their return ratios.
Role of management in generating OI becomes quite evident when we look at CEB (core OI) metric for 5 largest PSU banks. As expected, none of the banks including country’s largest lender, SBI, comes closer to any of New Private Sector lenders.
Its amazing to see how private banks specially new private banks have been able to generate high core OI (CEB). Table below shows this stark comparison of new private banks vis-a-vis old private and PSBs (public sector banks). A major outperformance in PBT is being generated by outperformance in core OI thereby reiterating the significance of OTHER INCOME.
Other takeaways from the comparison table –
Of total of 38 listed scheduled banks (barring 3 listed SBI associates), 37 banks have declared their results (J&K Bank is expected to declare on 30th Nov). Our listed universe^ has an outstanding (o/s) loan book* of ~7,100,000 Cr and GNPAs* (gross non-performing assets) of ~619,000Cr, 8.7% of loan book. Clubbed with restructured loans (RLs), total gross stressed assets come out to be ~860,000Cr, 12% of gross advances (up by 30 bps qoq).
Pace for stressed assets (GNPAs + RLs) formation has slowed down for the listed universe, it grew by just 2% sequentially (qoq) as compared to 6% in the previous quarter (June’2016).
After a poor show in June’16 quarter, Sep quarter seems to be showing signs of positive asset quality trend though no conclusion can be drawn by looking at just one quarter.
# qoq change within 20bps is classified as stable
However, further digging throws some surprises (positive or negative, your call!), increase in GNPAs for the listed universe is led by private banks while the PSBs have reported flat GNPAs. It is mainly, ICICI and Axis, which have led this deterioration in asset quality. Similar trend is visible when we look at stock of restructured loans. It is only the ICICI bank which has led the increase in restructured loans. Pace of GNPAs has picked up for private banks while it slowed down for PSU banks, counterintuitive, isn’t it?
Going granular, for the first time in last 3 quarters, PSBs have shown improvement as a lot. During the June’16 quarter, all PSU banks deteriorated in asset quality but in the latest quarter 4 PSU banks (Corporation, PNB, UCO, Vijaya) have shown reduction in GNPAs as % of advances.
Private banks have reported more stabilization in GNPAs than their public counterparts. Only Karnataka bank reported improvement in GNPA % (by 28 bps).
I could not resist putting up following two charts, which show ki koi itna nichey bhi gir sakta hai. Some of the banks have more than 1/4th of their advances in bad assets.
The chart below shows naked exposure (NNPA + RLs) of banks to their net worth. Not surprisingly, most of the PSU banks have bad loans in excess their net worth, an indication of quantum of capital requirement for these banks. Though ICICI and Axis have reported very poor numbers in this quarters, their naked exposure to net worth is still very low at ~20%. This number stands at 95% for 38 banks put together.
Notes
`^ total of 38 listed banks which does not include 3 state bank associates
* For the banks whose numbers are still not available, have taken them to be at par with last quarters numbers
Moving onto next indicator of asset quality, slippages – addition to GNPAs. It indicates incremental stress recognized during the quarter. This indicator is highly encouraging for PSU banks, as many as 12 banks have shown reduction in slippages ranging from 23% to 73%. Only 4 banks have shown increase in slippages. Amongst the private banks only 1 bank has shown improvement of above 20% (RBL) while 5 banks have reported increase in slippages ranging from 15% to 175%, counterintuitive, yet again, isn’t it 🙂
My take – Overall, asset quality seems to be moving in the right direction after a long time. Number of banks reporting stable or improved asset quality is equal to number of banks reporting deteriorated asset quality. Slippages data points to even better picture, only 9 banks seems to be in negative territory, rest all have either stabilized or have improved from where they were in last quarter. Data is especially encouraging in the PSU space. This could be because of cleaning exercise that happened in last 2 quarters of FY16 under AQR scheme of RBI. Private Banks are marred primarily because of Axis and ICICI banks, both the corporate lenders are expected to see more stress in asset quality from their pending watchlist. Barring these 2 banks, most of other private sector banks have stabilized or improved.
Some of the macro indicators seem to be in favour of banking sector – low inflation leading to lower interest rates which would result in profits from large investment books of these banks. It would be a good opportunity for these banks to clean up their balance sheets. We expect growth in the economy to pick up as interest rates go further down resulting in increased consumer demand and capex from corporate India after a long pause. However, effects of demonetization seem to be uncertain. I’ll try to give a shot at what I understand could be the possible effects of demonetization on the banking sector –
I’m sure there would be many more possibilities which can play out for the banking sector because of demonetization. Would be great to have your comments pouring in.
Thanks.
Career Point is a test prep company based out of Kota, Rajasthan, hub of medical and engineering test prep centres in India. Company is witnessing a revival in its core test prep business and is expected to take benefits of high operating leverage embedded in business model. As per the latest con-call, management is trying to monetize assets worth 35-40Cr and plan to utilize some of the proceeds to either pay dividends or buy back shares.
Key positives
Key negatives
Valuation – at CMP of 118 it is trading at 0.6x book value. Downside looks limited from here.
Key things to track
About the company – Career Point is one of the few listed entities into education space in India. Offerings of the company are summarised below:
Business Mix – test prep business is the major contributor to revenues and company is one of the top 5 players in Kota test prep industry. Below is business mix info about the company:
Key characteristics of engineering/medical test prep business –
Test prep industry
India sees 12l students appear for engineering exam every year, of this, 2lacs students clear for advance level and 10k get selected across IITs
Kota coaching market is estimated to be INR 600Cr industry (expected to grow by 15% every year) with presence of 150 institutes. It has ~1.2lacs students across engineering and medical, of which Allen has 50-55% of market share. Other players amongst top 5 are CP, Resonance, Vibrant, Bansals.
Disclaimer: This is not a recommendation to Buy/Sell/Hold. Registration Status with SEBI: I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”
At the moment public sector banks (PSBs) are going through a rough patch – increasing stressed assets and scarcity of capital are two major causes of worry. This has meant very low valuations for these banks and inability to grow at historical rates even if the economy starts to pick-up in near future.
Last 3-4 years have been very challenging for banking sector as a whole and more so for PSBs. Low credit off take in the economy coupled with crippled risk management at PSBs ensured poor asset quality. Below is a snapshot depicting how situation has deteriorated over last 4 years –
A look at previous down-cycle of 1998-2002 shows that PSBs had stressed assets at ~13% of loan book. Couple of the banks# had stressed assets as high as ~30% of their respective loan book. Credit growth slowed down to 16%. Banks* traded at an average P/B valuation of 0.6x during this period. What followed after that is history – from 2002-2008, loan book grew at a CAGR of 24%, stressed assets declined from 11% to 3%, stock prices** returned an average of 800%. During the same time period benchmark index BSE SENSEX returned 350%. What triggered this outperformance? There are several reasons for that, all intertwined with each other, namely 1) decline in interest rates, 2) GDP growth, 3) declining NPAs 4) recapitalization by promoter
There are similar examples of banking crisis in other countries. Common measures undertaken to improve the situation of banks were, recapitalization by respective govt, interest rate cuts and regulatory reforms. Please see below for a brief summary of banking crisis in Sweden, Japan, Spain and Mexico.
Changing Scenario
Economic growth seems to be the top priority for the Modi govt. As per Madan Sabnavis, chief economist, CARE Ratings, 8-10% real GDP growth (base year 2004-05) will require credit growth of 18-20%. Historically, credit growth has seen a multiplier of 1.3x of nominal GDP growth rate. PSBs form 76% of total credit in the system and their full-fledged participation will be crucial for the desired economic growth rate of 8-10% (base year 2004-05). As per some estimates PSBs are expected to grow at a meagre rate of 8-10% for next 4-5 years because of scarcity of capital. This will lead to slow credit growth of ~12-13% in the system which will not be sufficient to grow the economy by 8-10%. From the above argument, we can deduce turnaround of PSBs should be the indirect top priority of Modi govt. In fact there are some early sings of changes already in place such as declining interest rates, improving macro numbers such as inflation, IIP etc and announcements around banking reforms which include more autonomy to banks, top management hiring from private sector, performance linked salary structure for top management, longer duration of MD, separate posts for chairman and MD for better board governance, construction of bank board bureau, recapitalization and reforms in industries causing maximum NPAs etc.
Is there a pattern that we can draw between last down cycle and the current one? Table below compares two down cycles on few key metrics:
In addition to this, the other pattern that emerges between the two down cycles is recapitalization^^ by govt of India. Until 2002, recapitalization was done to the extent of 12,000 Cr, which provided enough liquidity to grow by the time economic growth picked up, which acted as a strong catalyst for turnaround of PSBs. Between FY02 – FY08, loan book of PSBs grew at a CAGR of 24%. We see similar pattern emerging this time around, by fiscal 2015 end, govt had already infused ~65,000 Cr of capital into PSBs and has further plans to infuse 70,000 Cr during next 4 years. Capital being the life-line of a bank, these recapitalization plans might, once again, provide required breathing space to PSBs. Using this capital, they, once again, have an opportunity to improve their balance sheet enough to attract outside capital which can further provide them breathing space to grow like before.
Inverse Relationship between growth of GDP and of Stressed Assets
Banking is a cyclical industry in-tune with economic growth. Asset quality of banks deteriorates sharply when economic growth engine slows down because of poor cash flow generation at borrowers’ end. Asset quality situation reverses when growth picks up as visible from the chat below:
Current valuations of PSBs seem very attractive if we compare them to last down cycle and how they improved during the ensuing economic recovery. Chart below demonstrates strong correlation between asset quality (stressed assets) and valuations (P/B):
We might question quality of the book PSBs carry on their balance sheet making P/B metric irrelevant. Well, that has always been the case, is this time any different?
Comments Invited!
Notes –
# Bank(s) refer to PSBs unless stated otherwise
* There were 10 PSBs listed on stock exchange starting 1998
** There were 17 PSB stocks listed in 2002
^^ During whole of 1990s govt infused ~16,000 Cr of capital, 2% of GDP and over the last 15 years govt has infused 81,000 Cr of capital into PSBs, majority of which came during last 5 years
Source: Ace Equity, RBI, Press Search
Disclaimer: This is not a recommendation to Buy/Sell/Hold. Registration Status with SEBI: I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”
With the aim of understanding the origin (in terms of market cap) of multibagger stocks of the last decade, we performed an analysis wherein we looked at the returns of all the listed stocks. We did this analysis with a hypothesis that small/micro cap companies, as compared to mid and large cap, would be the home to majority of multibagger socks today. Though the hypothesis turned out to be correct but it amazed us how small rather micro cap companies turned out to be the den for ~98% of all the 50x+ stocks (46 in total) in the last decade.
Before running into the analysis, few points to help a reader:
– There are four market cap categories – A) below 50 crores, B) 50-500 crores, C) 500-1,000 crores and D) above 1,000 crores
– Returns are expressed in the form of ‘number of times’ stock price has become from starting date, 01 June 2005
– There are three time periods across which this analysis has been performed A) 10 year: Jun 2005 – Jun 2015, B) 5 year: Jun 2010 – Jun 2015 and C) 3 year: Jun 2012 to Jun 2015
– Stock prices are split and bonus adjusted
– Market cap in INR cr is as on starting date
– Source: Ace Equity, there could be some misses because of the availability of data on the database
Top gainers – Symphony Ltd, Manappuram Finance, Optiemus Infracom, Caplin Point, Bliss GVS, Urja Global, Dhanuka Agritech, Shilpa Medicare, Mayur Uiquoters, Cera, Ajanta, Pharma, Kitex, Relaxo, EPC Industrie, Ashiana, Poddar Developers, Amara Raja, SCUF, Vinati, La Opa
Top gainers – Cigniti Technologies, Ajanta Pharma, Arrow Coated, Avanti Feeds, Caplin Point, Indo Count, Kellton Tech, La Opala, Stampede Capital, Optiemus Infracom, Kitex
Top gainers – Indo Count, Arrow Coated, Atlas Jewellery, Marksans Pharma, Smiths & Founders, Trinity Tradelink , Cressanda Solutions , Pressman Advertising, Nutraplus India , PI Industries
For the 10 year period there were 261 stocks which became 10+ baggers. Of these, more than 50% belonged to <50 crore market cap, 24% belonged to 50-500 crore and rest 20% to above 500 crore.
Based on this analysis one can not overlook the importance of analyzing smaller companies.
Starting today, we intend to initiate a series of posts, Catch Me If You Can, where our effort will be to understand, of course with the benefit of hindsight, whether there was a way to figure out the improving fundamentals of these (multibagger) companies while they were small. To perform this analysis our major focus would be on management commentary for the last ten years and on the financial statements.
Catch Me If You Can #1 – PI Industries
Products and services
Operating segments – Agrochemicals and custom synthesis and contract manufacturing (CRAMS)
Agrochemicals – PI has a portfolio of herbicides, insecticides, fungicide and specialty plant nutrient products & solutions
CRAMS – For agrochemicals, pharma intermediates and other niche fine chemicals for global innovators
Salient features of this compounding engine
Diversification into new business line (2005) – Entered CRAMS, which is a high margin low capex business. CRAMS also provides cushion, to P&L, against cyclical nature of domestic agrochemicals business
Focus on core business (2011) – Exited polymer compound business, which had a low margin and volatile earning profile
Introduction of new products at regular intervals – Strategic introduction of 4-5 new products every year leading to top-line growth irrespective of how monsoons had been
Business model
Distribution network – Well penetrated network of 9k distributors and 40k retailers
How were numbers behaving – was there any clue?
FY09 proved to be the inflection point in the history of PI, a look at below table shows how improvement started taking place in FY09. In this year, company’s gross margins improved by ~200 bps, EBITDA margins by ~400 bps, for the first time in last 3 years revenue grew by ~24%, debt levels declined and all of this resulted in improved ROCE and ROE of 18% and 30% respectively. PI recorded such returns ratios for the first time in the last decade.
If we go back and take a look at the annual reports for the year 2008 and 2009, there are quite a lot indicators which point towards improving business profile of the company, in terms of both – growth as well as margins. For e.g. in 2008, management talks about depressed earnings during the year because of high investments in fast growing highly profitable CRAMS business indicating margins improvement from here on.
Posting some clippings of management commentary from annual report for the year FY08 and FY09.
Snippets from FY08 annual report
Snippets from FY09 annual report
Stock price performance
During whole of FY09, PI was available in the P/E range 5-10x TTM earnings. It continued to trade in the P/E band of 3-13x TTM earnings till FY12. Table below shows average TTM P/E of PI for the years – FY08 till FY13. This was a long window of opportunity to buy this business at an attractive valuation without taking any undue risks on business quality.
As mentioned above this whole analysis has the huge benefit of hindsight. But what we are trying to do through this look-back is to find clues which could perhaps have helped us if one was in the past. Using these clues we can perhaps learn a few mental hacks that can be given much more importance when we read the annual report of a new company which mentions similar things.
Comments invited!
Disclaimer: This is not a recommendation to Buy/Sell/Hold. Registration Status with SEBI: I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”
Disclaimer: This is not a recommendation to Buy/Sell/Hold. Kindly do your own analysis. MT Educare, is one of the largest coaching institutes in India. It is an undisputed market leader in the Mumbai market and is slowly expanding into adjacent markets of Maharashtra, Karnataka & Andhra Pradesh in an asset light model. It provides coaching for Science, commerce, Engineering entrances, CA and MBA entrances. The company has 128 coaching locations in 7 states and has serviced ~ 82,000 students in the FY gone by. Coaching business has strong economics and MT Educare has executed very well in the Mumbai market. This expansion in Mumbai is driven largely through standardizing its teaching methodology and not on ‘Star teacher’ concept. The sector in general has not seen many scaled up players owing to lack of standardization and low entry barriers leading to local players becoming leaders in their respective markets. MT’s strategy of slowly expanding outside Mumbai is an interesting one in our view, they have executed well in Karnataka with revenues reaching ~10% of the overall pie in two years. Further they have walked their talk on selling their PuC college in Mangalore which they had bought to establish credibility in the market. In our view the approach (asset-light, variable cost model) taken by MT to expand in new markets is a low risk high reward model. Company has recently also expanded in Andhra Pradesh in this similar fashion by partnering with an educational institute which has around ~35K students under various PuC colleges. The business has an attractive profile with strong pricing power, improving profit margins and negative working capital. All these points coupled with the positive management feedback through scuttlebutt and initial success in Karnataka give us comfort that MT can expand beyond its ‘home-turf’. We like MT Educare because of the following reasons:
Risks
Valuation & Upside As mentioned above in the note, MT Educare has an attractive business profile with expanding margins, negative working capital, high return ratios and pricing power. The business is facing growth challenges as it looks to expand beyond its core market of Mumbai. We believe that the strategy adopted by the company is both scalable and economically prudent. Company is currently trading at P/E of ~15-16 and an EV/EBITDA of 8.5 If the thesis of expansion outside Mumbai plays out well, we expect the company to increase its revenues and earnings at a CAGR of 25% over the next 3-4 years. In the event of that happening, we feel the business will also get re-rated as it will allay the investors’ fear of being a non-scalable business. A business with such a profile (High ROCE, negative working capital etc) and similar growth (>20%) should command an earnings multiple of greater than 20X (P/E) Revenue Mix 
About the Industry
Key Metrics to track
Disclaimer: This is not a recommendation to Buy/Sell/Hold. Safe to assume I have vested interest in the company as I am a shareholder in the company. Registration Status with SEBI: I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”
Motilal Oswal in their most recent wealth creation study, have talked about the secret sauce of finding 100X stocks. While some of it is intuitive for many investors, it is still worthwhile to share the same, as it puts everything in perspective and summarizes it in a nice framework.
Framework for finding 100X Stocks
This is a key factor in differentiating between transitory multi-baggers and 100X stocks
Interesting debate on buying Quality v/s Growth- The report has an interesting section which dissects quality only and growth only stories, and goes on to say that these could either become quality traps, if there is no growth and one buys it at a high valuation owing to the quality, or they could become transitory multi-baggers.
While quality to a large extent is the return on capital it earns, growth is dependent on trends, tailwinds, demand-supply mis-match etc. We found this segment particularly interesting as it distinguishes clearly that quality alone or growth alone- doesn’t make the cut to find enduring multi-baggers or the proverbial 100X. It may good to dissect the two when analysing a company next time and asking the question – Is there growth in the company, and will that be quality growth i.e. will the company earn ROCE/ROE going forward.
Some other Interesting takeways from the study
The entire report can be found here – MOSL Wealth Creation Study_2014
Armchair Investing 