Indian IT Sector Mid Caps – A Treasure Trove

This is a partial summary of the report, “Indian IT Sector Mid Caps – A Treasure Trove”. The 11 page full report with eight IT firms’ analysis and investment recommendations, is available only to Subscribers.

Date: October 14, 2012

India has a competitive advantage in the global IT services. This is borne out by the success of the famed large caps like TCS, Infosys, Cognizant, Wipro, etc. Beyond this set, there is a terrific bunch of mid-caps that are rapidly establishing themselves.

A comparison of eight Indian mid-cap IT stocks provides interesting insights for investors. The market price has appreciated by an average of 13.4% CAGR over the last 5 years (Sensex and Mid-Cap indices have been flat in this period). This makes this entire category an attractive investment option. Within this group, there are a few standout investment opportunities, some firms are rated BUYs, and there is one HOLD and one SELL.

The last year has seen USD/INR fluctuations, but overall INR is weaker by 8.2%. This boosts financials of software exporters, and makes Indian services more competitive. INR is unlikely to strengthen very fast from here. Invest in this sector to get above average returns.

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Indian Equity – Winds of Change

  • December 16th 2011

The Indian Stock market has been buffeted by a lot of changes in the last few quarters. As a long term investor, one needs to track the key moves and tweak the overall outlook and investment strategy in line with these. While there is a lot of noise and headline grabbing information flying around, there are three key themes that are re-shaping the economy and markets right now:

Inflation is starting to fall, and Interest rates are peaking

The economy has been attacked by inflation that has been eating away at cash in hand and fixed investments. Inflation definitely impacts corporate results.

Cost of input like raw materials and services rises, and corporates need to raise prices to protect margins. Inflation tests corporate pricing power, and on an overall basis depresses earnings.

JainMatrix Investments

Inflation and Interest Rates - JainMatrix Investments

RBI tries to fight inflation, by raising interest rates, which slows economic growth. As we can see, the interest rates have been raised sharply by RBI. I believe from here on, the inflation rates will start to fall. And RBI will arrest the rise, and even start to drop interest rates.

  • This situation is good for Interest rate sensitives in our economy, such as Banks, NBFCs, Automotives and Real Estate. These businesses prosper as interest rates fall.
  • Infrastructure sector is also debt intensive, and may stabilize (it has fallen sharply in the last year) on lower Interest rates.

Some of my reports in these sectors are:

  • Yes Bank (see link to report).
  • Mundra Port and SEZ (see link to report).
  • L&T Finance (see link to report). It has fallen since the IPO, but should recover in a better environment
  • Muthoot Finance (see link to report). Same as above.
  • Bharat Forge (see link to report)

INR has weakened against the USD

The persistent inflation, trade deficit and increasing fiscal deficit are taking their toll on the INR. The rupee has weakened against the USD, and currently is in the 52-53 range. India has a trade deficit,  and the situation is worsened when inward flow of FDI/FII capital stops. In response, we have to recalibrate our sectoral expectations.

Petrol and imported goods will get expensive. Exports in unhedged USD denominations will get more lucrative. The gainers will be exporters, like IT services, Gems & Jewellery, Auto exporters, Engineering exporters and Petroleum.  The losers will be importers, as well as firms with large USD (or foreign currency) denominated debt.

Some of my reports in these sectors are:

  • eClerx Services (see link to report). A good buy at these levels.
  • Bharti Airtel (see link to report ). This firm is a good long term buy, but may suffer in short term due to USD denominated debt

The Power sector is in trouble

The power sector extends across generation, transmission, distribution, power focused lenders and EPC firms focusing on these sub sectors. The power sector is a key driver of GDP, as most firms depend on the Utilities for supply. There is an overall 9-15% shortage of power generated, and demand is growing at 5-6% per annum.

The State Electricity Boards face a complex situation of supply shortfall, political pressure to provide free power to Agriculture, Transmission and Distribution losses and thefts. In addition, the power price has to be approved by State level Tariff Boards.

  • The current situation is that many of the Indian SEBs are in crisis due to losses and Cash Flow problems. They are unable to pay for the fuel, or pay the EPC contractors of new plants.
  • Another issue is the supply of fuels. There is a Coal shortage as Coal India Ltd is unable to produce enough. Many utilities have been forced to procure Coal from Australian and Indonesian mines at higher tariffs. Gas too is in short supply. The Reliance wells have underperformed

Until the Central and State governments free up the market, and restructure loans and help clean up this mess, investments in this critical sector will dry up and suppliers / EPC players will face financial pressures.

  • Except Fuel suppliers

The only sub-sector in Power that may remain in good shape would be the Upstream resource rich companies. These firms either produce raw fuels domestically or import this. The sheer demand growth will ensure that this subsector will be protected and be a defensive play within Power.

Some of my reports in these sectors are:

  • BGR Energy (see link to report).
  • Coal India (see link to report).
  • Petronet LNG (see link to report)

As a long term investor, it does not make sense to react to short term events. But if a theme is to pan out over 1-2 years, it makes sense to adjust the portfolio weightages accordingly.

In depressed times, I recommend that retail investors should choose a safe, large cap portfolio and invest in a SIP fashion. See link to report.

Gold also is both a good protector of wealth as well as a hedge against global financial uncertainties. See link to report.

Good luck with your choices.

:-)

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Mundra Port: Infra play at good valuations

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There is an update to this report. Read this latest Sept 2012 update called ‘Adani Port – The Great Australian Adventure’. Click this LINK

Introduction

  • Mundra Port and SEZ (MPSEZ) is a Gujarat based infrastructure and exports play. Promoted by Adani Group, it includes the following businesses –
  • India’s largest private port, with volumes having recently crossed 50 MT (FY11) and 15.08 MT in Q1 FY12
  • An SEZ area adjacent to the port, which is being developed on an area exceeding 100 sq km
  • The port has got ranked 5th in India among all ports, major, public and private. The port deals in a number of container and bulk products.
Mundra Port and SEZ

Fig 1 – Mundra Port – Cargo details

Fig 1 – Business Segments in Q1 2011.  MPSEZ handles a broad range of products. A broad-based customer group means lower business risks.

  • Connectivity and logistical facilities extend the Port, berthing and storage to Roads, Rail connection, Air strip and Pipelines based evacuation
  • Port has also recently added specialized car exporting facility
  • The SEZ facility enjoys a series of Indirect and Direct Tax benefits designed to encourage industrialization by the Gujarat Government
  • Power supply will be by a plant being set up by Adani group, that will meet all the SEZ needs
  • The SEZ area is organized into Industrial clusters that include – Engineering, Auto & Auto Ancillaries, Textile & Apparel, Chemicals & Pharma, Plastic Processing, Stone & Minerals, Food & Agro, Global Trading Hub, Timber & Furniture and Metals and minerals

Current Business Outlook

  • The port has rapidly increased business throughput over the last 5 years, venturing into new categories of goods, and working closely with manufacturers and exporters to improve infrastructure
  • Capacity building is ongoing including ICDs under development
Mundra Port and SEZ

Fig 2 – Mundra Port – Quarterly Sales and Net Profits

Fig 2 – Mundra has shown steady revenue and profit growth.

  • Sales have grown by 32% over the last 5 years
  • Profits have grown an astonishing 128% CAGR over this period
  • Major competition to MPSEZ is from Kandla, JNPT and Pipavav on the Western shores. Mundra is able to provide port access to North India based industry. Additionally
  • Kandla and JNPT have not invested sufficiently in infrastructure due to government constraints.
  • Pipavav is at an early stage of development. Also it is in South Gujarat and logistically more remote.
Mundra Port and SEZ

Mundra Port in Gujarat Map

Additional Developments include:

  • MPSEZ is also developing Dahej Port and Mormugao Port in terms of terminal creation or port operator.
  • Acquisition of Australia Queensland based Abbot Point Coal Terminal (APCT). The coal terminal, has capacity of 50 MT a year, will facilitate the transport of coal from Australian mines to India.

Overview of Share IPO and Stock performance

  • The IPO in Nov 2007 was amazingly successful. It was oversubscribed 115 times, and eventually provided huge listing gains. However it was aggressively priced.
  • Business performance over the last 4 years has justified investor confidence in this stock
Mundra Port and SEZ

Fig 3 – Mundra Port Valuations and stock performance

Fig 3 – IPO investors have received a 12% CAGR return over the four years since listing

  • Debt-equity is 0.94 as of Mar’11 (down from 1.7 at IPO time). This is good, for an infra company.
  • Healthy return Ratios. Return on Capital employed – ROCE is 15.4%; Return on Equity – ROE is 23.4%
  • PEG is in the range of 0.84, indicating indicates safety and undervalued status
Mundra Port - EPS and Cash Flow

Fig 4 – Mundra Port – EPS and Cash Flow

  • For an infrastructure company, cash is critical. MPSEZ comes out excellent on this count as it has improved Cash flow from operations and EPS (Adjusted for stock split) rapidly in recent years
Mundra Port and SEZ

Fig 5 – Mundra Port – Price and PE chart

  • Fig 5 – PE has fallen to attractive levels, and combined with robust business performance gives us a very good entry point for long term investments
Mundra Port and SEZ

Fig 6 – Mundra Port – Price and EPS chart

  • The chart – Fig 6 plots the adjusted market price against the EPS over a 4-year period.
  • EPS shows us a steady quarterly increase indicating stable business improvement

Projections and Investment Advice

  • EPS may slow a little to 40-50% growth range over the next 3 years as competition intensifies and an interest rate driven domestic slowdown takes shape.
  • Even this is very high. Also, MPSEZ is well placed to capture market share from the increase in Indian exports (oil, containers, manufactured goods and minerals) as well as imports (Coal, oil, commodities).
  • SEZ revenues are lumpy, driven by sale of land to industries. However the infrastructure provided and industrialization will drive this business.
  • The recent fall in prices has not affected MPSEZ, and it is expected to ride out this slowdown
  • As long as it stays over 150, MPSEZ share price is in positive territory. Invest

Risks

  • Adani group is a complex group of interconnected firms with cross holdings in group companies like Adani Power, the holding company Adani Group, Adani Enterprises Ltd. and MPSEZ.
  • Recent shareholding reports for MPSEZ indicate the Promoter group has 77%, Institutional is 15% and Public Retail has 7%. Thus unless the Promoters sell more holding soon, it is possible that the promoters may try to buy-back from others and de-list this firm.
  • Intensifying competition. It is possible that Indian government may finally able to grow capacities at Kandla and JNPT (they have both been running close to 100%), overcoming the current lethargy.
  • Pipavav Port is owned by A.P. Moller-Maersk Group, is one of the largest container terminal operators in the world. Over the next few years, APM Terminals will transfer a lot of India business from other ports to Pipavav, and also build good infrastructure here.
  • Recent rumours against Adani Group were that it has powerful political linkages, and interests in illegal mining in Karnataka/ Andhra Pradesh. These rumors affected investor sentiment in Adani Industries. This could also affect MPSEZ in the future. However MPSEZ is a different business, and the possibilities of this are remote.
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Disclaimer:

These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

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Future Ventures IPO note – April 2011

Update on April 29th

  • Future Ventures has got a dull response till today. The overall subscription is 1.52 times the offer.
  • QIB section is oversubscribed 0.26 times, HNI is (strangely) 7.8 times and Retail 0.6 times.
  • Poor response may be not just because of poor reviews (see my IPO note below) but also concurrent investments in Muthoot Finance IPO as well as the falling Sensex over the last few days.
  • Good luck with your investments !!

IPO Note – Published on: Apr 23, 2011

Future Group – Promoter

  • Future Ventures is a part of Future Group, which owns companies like Pantaloon Retail India (Big Bazaar, Food Bazaar), Future Value Retail and NBFC Future Capital Holdings, Future Generali Insurance, Futurebazaar India, etc.
  • The core business of the Future Group is Retail, but subsidiaries are present in consumer finance, capital, insurance, leisure and entertainment, consumer brands, retail real estate development and retail media and logistics. The key promoter is the well-known Mr. Kishore Biyani.
  • Two of these group companies are listed entities, Pantaloon Retail India and Future Capital Holdings.
  • These two have not exactly outperformed in the last few years in the market.

Pantaloon Retail – Financial snapshot

A 5-year view of the share price of Pantaloon Retail. (click on graphic to enlarge)

Future Ventures IPO

Chart 1: Pantaloon Retail Share Price

A view of financials of Pantaloon Retail. (click on graphic to enlarge)

Future Ventures IPO

Chart 2: Pantaloon Retail financials

  • While revenues are high/have grown fast, there have not been corresponding EPS growth (due to dilutions), and the P/E still remains very high
  • Current market cap – 6000 crores

Future Capital Holdings

  • Had IPO in Feb 2008
  • The stock has suffered an average 40% fall in share price annually in the last 3 years
Future Ventures IPO

Chart 3: Future Cap Shares

A view of financials of Future Capital. (click on graphic to enlarge)

Future Ventures IPO

Chart 4: Future Cap Financials

  • Sales have not increased steadily; Profits have increased, but P/E still remains very high
  • Current Market cap – 1060 crores

The short profiles of group companies show that while the ‘BigBazaar’ brand is very good, and revenue growth high, the group has not been able to translate it’s ambitious plans into profitable businesses, and benefit shareholders.

Future Ventures – Business Profile

  • Future Ventures is like a holding company, that invest in and operates businesses in ‘consumption-led’ sectors in India, sectors which will grow as the purchasing power of Indian consumers increases, and caters to their changing tastes, lifestyle and spending habits.
  • Future Ventures has so far invested around Rs 450 crore in apparel makers, and Rs 250 crore in processed foods and consumer goods space.
  • The Company has 14 companies in its portfolio, and owns brands in fashion, FMCG, food processing and home products.
Category Company Products/ Market Remarks
Retail distribution 1.   Aadhaar Retailing Limited Rural and semi-urban retail distribution of agricultural and consumer products Majority stake
FMCG 2.   Future Consumer Enterprise Ltd. Brands such as Tasty Treat, Clean Mate, Care Mate, Premium Harvest and Fresh and Pure, being marketed through Big Bazaar and Food Bazaar. Majority stake
FMCG 3.   Future Consumer Products Ltd Brand ―Sach. Majority stake
Fashion 4.   Indus League Clothing Limited Ready-made garments under brands like Indigo Nation, John Miller, Scullers and Urban Yoga Majority stake
Home Products 5.   Indus Tree Crafts Private Limited Domestic retailing and distribution of a wide range of environmentally and socially sustainable products. Majority stake
Fashion 6.   Lee Cooper India Limited A manufacturer and retailer of denims, trousers, jackets, shirts and shoes under the Lee Cooper brand. Majority stake
Fashion 7.   Biba Apparel, Holds 17.3% stake in Biba, which will be upped to 28% soon
Food Processing 8.   Capital Foods A food processing company with brands like Chings Secret, Smith & Jones, Raji, Mama Marie and Kaeng Thai.
Consumer 9.    Amar Chitra Katha Stake to increase to 26% from 13.7% presently
Fashion 10.     AND Designs India Ltd; Global Desi Luxury clothing brands
Fashion 11.     Holii Accessories Private Ltd A joint venture with Hidesign India Private Limited for leather handbags and wallets
Fashion 12.     Celio Future Fashions Ltd A JV with a French brand of men‘s apparel and accessories
Fashion 13.     Turtle Limited Manufacturer, distributor, exporter and retailer of men‘s wear products.
Retail 14.     SSIPL Retail Ltd A retailer of Nike branded products, wholesaler of footwear, sportswear and apparel, and a manufacturer and distributor of footwear.

Strategy

  • Future Ventures tries to exercise operational control or influence in the business ventures in which it invests
  • They pursue appropriate longer-term value creation strategies, which may include unlocking value in their business ventures through public market or private sales.
  • Future Ventures is also looking to invest in more ‘mature opportunities’ in companies which, it believes, have unrecognized growth potentials or are undervalued or in which it can identify hidden assets or recovery potential.

Financials

  • The company had consolidated net worth of Rs 738 crore as of December 31, 2010, with the value of investments pegged at Rs 112 crore.
  • For the nine-month period ended in Dec 2010, it had a total income of Rs 399 crore (primarily through retail sales of merchandise from its subsidiaries) with a net loss of Rs 14.67 crore.
  • Company officials claim that most of the companies that Future Ventures has invested in are breaking even at the EBITDA level and the results will improve going ahead. /This does seem like a tall claim :-).
  • The company is not expensive at around 1.1x post IPO book value (at upper band).
  • Market cap after successful listing would be about Rs 1800 crores

Negatives/ Challenges/ Concerns

  • For many portfolio companies, this is very early in the investment cycle. It is actually Private Equity companies that invest in such early stage, high risk businesses.
  • Most businesses are small and are many years and crores of rupees away from break-even volumes, a national recognized brand and profitability. Even with Pantaloon’s clout in distribution, it will take many years of investment to start making profits.
  • Intellectual Property – royalty payments to be made to Future Group for ‘Future’ trademark.
  • While there is a common ‘consumption‘ theme in the Portfolio companies, there are few synergies among them. Eg. A high-end fashion label from a well-known designer has little rub off on Amar Chitra Katha comics for kids or Chinese food sauces.
  • It’s possible that Pantaloon Retail may soon launch a number of Retail formats, but Future Ventures is a shaky ‘backward integration’ for Pantaloon Retail.
  • Maze of portfolio companies, difficult to value and project financials.

Offering

  • The IPO has been priced at Rs 10-11 a share. It is open for subscription from April 25-28 for Institutional investors and till April 29 for Retail.
  • The company will raise Rs 750 crore rupees through its initial public offering of shares, of which Rs 120-150 crore will be invested in existing businesses, while the remaining amount will be used for new acquisitions
  • Besides various privately held group firms of Kishore Biyani, Pantaloon Retail is the largest shareholder of Future Ventures with 18 per cent stake that will fall to 9.5-10 per cent post issue. Promoters’ combined holding will drop down to around 31-32 per cent post IPO while that of  Bennett Coleman & Co Ltd (Times of India Group) will see its 12 per cent stake drop to around 6.5 per cent, according to industry estimates.
  • This is the second attempt by the company to raise money via an IPO. It had earlier filed for an IPO just when the financial crisis began, then cancelled it.

Investment Advice

  • Avoid the issue for the following reasons:
  1. This is an investment vehicle in a clutch of firms that need heavy investments to grow in terms of brand and scale of business
  2. There is a bad record of profitability in the current business
  3. Poor track record of the promoter, of shareholder value creation in previously listed firms.
  • Watch subscription figures of IPO till April 28 to set expectations
  • Check back on the website www.jainmatrix.com for updates.
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Disclaimer:

These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

Also see: https://jainmatrix.wordpress.com/disclaimer/

Performancing Metrics

This is a good time to add Small Caps

This may be a very good time to add Small Cap stocks to your portfolio.

Let me substantiate the logic and reasoning for this.

If we list out equity-oriented investments in order of Safer to Riskier (and generally Lower to Higher return), they are:

  1. Sensex/ Nifty / ETFs /Large cap Mutual Funds
  2. Mid Cap and Mid cap oriented MFs
  3. Small Cap and Small Cap MFs

Taking this further, there is a pattern to valuations of Large, Mid and Small caps.

  1. Generally, Large Caps will have higher valuations than Mid Caps, whose valuation again is higher than Small Caps. This is because Large Caps are stable, have higher liquidity, and fall lesser in bad times. Large investors (FIIs/ DIIs) prefer this safer characteristic. However, Large Caps also rise lesser in good times.
  2. In bullish times, the Large Caps tend to rise to higher valuations first. Once this happens, the Institutional investors stop investing in them, and the action moves to mid and  small caps.
  3. Typically Mid and Small caps ‘catch up’ with large caps with a time lag.

This can be observed in the graph below, which captures NIFTY and NIFTY MIDCAP valuations over a 6 year period. (The period of 2005 to 2007 seems to be an exception as Midcap PE is higher than Large Cap PE).

Indices patternTable 1 – NIFTY and NIFTY MIDCAP

  • Further, this cycle has repeated in the last 6 months, where the Sensex/ Nifty fell about 15%, but small and mid caps fell further.
  • Now the cycle is reversing. I expect that as the larger indices recover their levels, the beaten down mid and small caps will rapidly recover.

In particular, there are some solid stocks in these categories, available at low valuations

Hanung Toys and Textiles

  • Export oriented Manufacturer of Toys and Textiles
  • Excellent client roster
  • EPS growth has been 57% CAGR, but recent fall has resulted in P/E of 4.0
  • See price Trend chart

Hanung Toys and TextilesTable 2: Hanung Toys and Textiles

Mundra Port and SEZ

  • Largest private port in India. Recently crossed 50MT of cargo handling
  • Significant business from Coal, Petroleum and passenger cars.
  • SEZ includes 14000 + acres land, under development, for an extended port complex industrial area. This will fuel future port operations growth
  • Growth data: Revenues 28% pa; Cash from Operations 51% pa; EPS 48% pa
  • Debt equity is at 0.91, reducing every year
  • Share recently crossed its 200 DMA, at 150 levels. Positive for investors
  • See Price Trend Chart

Mundra Port and SEZTable 3: Mundra Port and SEZ

IRB Infrastructure

  • Largest domestic Roads and Highways portfolio – as a builder and operator
  • Is experienced in this since 12+ years. Operates 9.3% of Golden Quadrilateral
  • Has over 8000 crores of orders on hand. Debt equity is 1.59, not high for an infra focused firm. Good cash flow from Road Tolls.
  • See price Trend chart

IRB InfrastructureTable 4: IRB Infrastructure

KEC International

  • A top player in the Power Transmission Engineering Procurement Construction (EPC) space in India. Also executes in 20 other countries.
  • Of late, has extended offerings to Cables, Railways, Telecom, etc in related spaces.
  • Order book of 8000 crores ties up 18-24 months of revenues visibility
  • Recently acquired a US based firm. Debt equity is at 1.6, but has good cash flow from operations
  • See Price Trend chart

KEC InternationalTable 5: KEC International

Yes Bank – see report (click on link)

Binani Industries

  • Holding company (with 95%) of Binani Cements, which is getting delisted.
  • Binani Cement is a 1800 crore turnover (2010) cement firm with a market Cap of 1650 crores.
  • It has over 8 MT cement capacity, with ongoing expansion to 15 MT in  3 years. Excellent growth and profit prospects. DE is 1.46 times, and falling
  • Binani Industries itself is other than cement, into Zinc, Glass Fiber, composites, etc. Market cap currently of this firm is Rs 620 crores.
  • Once the demerger of Binani Cement into Binani Industries is complete, the latter’s valuation should reflect the cement business, and the market price should appreciate considerably.
  • No Price Trend here, but I believe the stock is seriously underpriced

Diamond Power Infrastructure

  • The company is an 848 crores turnover firm (2010 revenues).
  • In the business of: manufacture of Power Transmission equipment (cables, conductors, wires and distribution transformers) and turnkey services provider (EPC).
  • As an EPC player, has the advantage of in house manufacture of high proportion of equipments
  • Has seen growth of 86% pa of revenues, and 65% pa of profits over the last 4 years. This may may slow going forward, but even so this is a very attractive growth phase for the firm.
  • Recent equity dilution has allowed capital infusion, so DE ratio has dropped to 0.7, and cash is available for funding growth plans.
  • See Price Trend chart

diamond power infrastructureTable 6: Diamond Power Infrastructure

BGR Energy

  • An EPC and power plant services company that specialized in balance of Plant (BOP) services, for Power, Oil and Gas industries.
  • It has strengthened it’s portfolio with recent JVs and strategic alliances
  • At 3000 crores of 2010 revenues, it is not really a small company
  • Over the last 4 years, it has seen growth of 58% in revenues and 72% in profits
  • The recent bad media reports on BGR energy were overplayed, and this is an opportunity for investors to enter into the stock
  • See Price Trend chart

bgr energy systemsTable 7: BGR Energy Systems

Risks:

  • Investors must note that small caps in general display high volatility compared to the overall market.
  • High growth rates of small firms typically slow down as they become  mid-sized
  • Economic slow down can affect such stocks more seriously than large caps
  • Investors are advised to establish targets and exit criteria for investments in Small Caps

Disclaimer:

These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

Also see: https://jainmatrix.wordpress.com/disclaimer/
Performancing Metrics
Performancing Metrics