Hi
Have you thought about impact of EVs on Castrol’s future business sustainability and growth.
If Yes, what are your views?
Regards
Narendra
Instead you can simply check for the PE, as it would be available on almost every stock screen. i,e. when you’re looking for a return of >= 10%, the PE should be <=10, or if you’re looking for a return >=20, the PE should be <=5, and so on.
Thank you. But that calculation was a specific example. I don’t really value companies at the ‘no growth’ level every time. I consider the entire shebang.
Dear Narendra,
IN a country where the government is not able to phase out 20 year old vehicles,I do not think EV’s would have a meaningful impact till 2025. I may sound pessimistic but look around,battery powered 2 wheelers are hardly there,E-rickshaws drive with headlights off to save battery life. If that is the future with electric vehicle I am better off with the petrol vehicles. Anyway my simple assumption is any moving thing requires lubrication which castrol does efficiently.
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Nope, I doubt EVs require most of these specialty fluids. Engine oil is required for an internal combustion engine to form a film of lubrication between all moving parts to reduce friction and wear.
You’d still require some like break fluid but that is negligible quantity compared to volume of engine oil.
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I was not referring to PE, per se,…but was actually referring to the roundabout calculation, and hence was suggesting to use readily available PE, instead.
Portfolio Update
I wish I had a ton of money to deploy, but reality sucks. I stopped my Mutual Fund SIP for the month and saved a little extra in order to raise some liquidity.
Added to my position in KMCH (A little)
Added to my position in DHFL (Increased allocation by almost 50%)
Entered Heritage Foods with a small-ish stake. I have plans to add more in the coming months if liquidity permits.
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How did you value the company (Castrol)? When do you think the market for engine oil starts to decline? How do you even make a valuation model for a scenario like this one? Is it worth paying 20PE for a company that does not have a terminal value?
Really not sure what people were thinking paying 50PE 2 years back for a company (even though it has the highest quality of brand recognition and profits) that as of today (unless they make investments in batteries or something) has nil terminal value.
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Dear Abhishek,
EVs may be the future but for Indian scenario they are not the future atleast till 2030. Moreover Castrol lubricants are used not only in CArs but Trucks and industrial automation too. In India anything which requires good maintenance and regular upkeep has a low market share.
I understand majority of their sales come from autos. I am not saying that EV’s will replace everything by 2025 or even 2030 but EV’s will start to eat share of combustion engine vehicles (lets call them CEV’s). With a 5 odd percent growth you can expect that growth to slow down at a certain date onwards until the point where they dont exist (worst case scenario). Its like the Kodak story. The first digital camera was 0.01 pixel (thats 0.01 * 10^-6 MP as compared to 12 MP in iphones today) and it was the size of a television. Noone believed it would replace traditional cameras until Moore’s law did its trick. In the same way we are looking at EV’s as they are today but they are likely to be a lot better 5 years from now and the rate of adoption might be 5x of what it is today. Im not saying it will happen in the 2 years but at the same time Im saying it probably wont take a 100 years. As an investor it is our job to factor this risk and make a fair assessment of it.
That said, even in a declining market (at the moment it is actually growing at a small pace) Castrol which throws out free cash like there is no tomorrow, has a value. Im just saying that I havent built a model to value it. It might be a good idea to build one where it grows by 3-5% for the next 10 years and then starts to decline at x% until a certain year and give it 0 terminal value and see if thats more than the market cap of the company with enough margin of safety.
Hi Dinehs,
What is your rationale of choosing Heritahe over Hatsun or Parag ? Thank you in advance.
Disc- I am invested in Heriteh from lower 2015 levels and would like to know your views.
Hatsun has just recently diluted their equity to a massive extent to pay back their debt. Even after that, they still have considerable debt left over. On one hand, they have amazing brands under their name. But on the other, they’ve spread themselves too thin and therefore compromised their financial position. Even if we put aside these things for a moment, I still think the company is overvalued. I don’t go by price metrics a lot, but a P/E of 100+ and a P/B 28.75 is not something I am willing to pay.
Parag is alright. But Heritage has the stronger brand and a way better financial position. Whatever wealth they have created, they have managed to do so with very little debt, amazing return ratios and most importantly, without a lot of value-added products added to the mix. I think that’s where I see value in Heritage Foods and scope for margin expansion. I don’t know how successful their value-added products will be compared to the ones in market already. But I do know that the Heritage brand is going to make things a lot easier.
Of course underlying the entire theme of investing in this industry at all is the fact that some consumer goods increase drastically in consumption as a country moves from being poor to being adequate. Milk is one of them. Considering how most of India is still largely poor, I think milk and milk-related products will play a superior role in the society in the coming years.
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Hey Dinesh… it’s was awesome going through your thread. I am basically from Coimbatore and interested to know your conviction behind KMCH when you started. Coimbatore has some reputed hospitals and even our own GH is of good standards. KMCH is far from city and was considered OKish in service, from my own experience . Although KMCH has many branches now and standards may have improved as of now , what made you invest .
As I have claimed myself several times, I am more a numbers guy than a story guy. This is one of the primary reasons I joined VP too, in order to access more stories.
So, whatever research I do about a company or reviews I hear, I try to match it with a corresponding set of numbers from the financial statements of the company (It’s not always such an easy, linear process… but I hope you get my drift). Only if the story and numbers are somewhat consistent, I consider an investment. Let me try to explain this with the example of KMCH.
Story A
With KMCH, I must have started by talking to at least 4-5 people from Coimbatore. All them had nothing but positive reviews for the hospital. Well, mostly, because almost every one of them seemed to complain that the fee was on a higher side, but they couldn’t help but pay it anyway.
I could immediately link this to the hospital’s pricing power. I’m not saying KMCH is the best one out there, but hospitals in general have a decent pricing power. Consider what you do when you visit a hospital. If the doctor prescribes you with a bunch of procedures, do you have enough knowledge to pick and choose what procedures you want? Most likely not. You end up paying for whatever has been prescribed to you. You, as a patient, lack any kind of bargaining power.
Numbers A
Sure enough, KMCH has been able to consistently maintain its GPM over the last decade. In fact, there’s even a slightly increase over the period (65% 10 years back and 70% as of today).
Story B
I also talked with a bunch of my MBBS friends. Almost all of them had applied to KMCH post their MBBS, but finally ended up turning it down because of the low salary. According to them, KMCH was their ‘fail-safe’ option. They did attest to the hospital’s quality, however.
Numbers B
KMCH procures talent (Read: Doctors) at a lower cost than most Multi-specialty hospitals. Narayana Hrudalaya, known for its vision of delivering value to their patients, provides about 19% of their Gross Costs towards Employment. KMC provides 21% of its Gross Costs. So, I was pretty surprised to see that KMCH only provides 17-18% of its costs towards talent.
I tried to understand why, but I couldn’t get in touch with the right people. Employee Reviews were mostly positive, so I went along with it as such. Maybe the next time you visit, you can help us all out and interact with a few doctors there, especially the newer ones (If any).
Story C
Of course, a common thread in all the interactions I had was the fact that the promoters of KMCH were keen businessmen, ready to take on risks wherever necessary.
Numbers C
This is what attracted me the most in KMCH. The company has the best-in-class capital returns ratios. Pick any financial ratio you know that deals with capital allocation and you will find KMCH pretty close to the top, if not at the top itself (Within the industry, that is).
I could go on, but I basically start out analyzing a company like this. I end up with a generic competitive ratio analysis, common size statement analysis, that sort of stuff.
But, as you may have noticed, my allocation to KMCH is pretty low (At 5-6% or so). This is primarily because of the below reasons:
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Their recent plan to open a medical college. Running a hospital is one thing. But running an educational institute is a completely different ballgame.
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A second reason is that their investor relations is quite abysmal. For instance, they’re going to build a massive structure for Rs. 600 Cr and the investors don’t have the slightest clue of the actual schedule or the break-up of costs associated with the project.
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Another big reason is the new competition in ‘Royal Care’. A bunch of experienced doctors have left KMCH and started their own company, thereby taking a chunk of loyal patients with them. As I understand, they are also poaching talent with attractive salaries and perks. It’s too early to comment on whether they will gain a good amount of market share from KMCH, but this is definitely an area of concern for me.
On a more general note, India’s healthcare penetration is lackluster. While developed countries have Per Capita spending towards health in the $300-500 region, India sits at a sad $130 (This is on a PPP basis, mind you). Whatever growth we have witnessed has been mostly in Tier-I cities (These are the massive healthcare conglomerates you see everywhere in big cities). There’s an immediate need for an equal amount of growth in Tier-II and Tier-III cities as well. This is why I’d much rather that KMCH not open a branch in Chennai. The opportunities in the lower rung itself is massive. The “triggers”, if that’s what people call it, are too many:
- The emergence of India’s middle class, and therefore increased spending on health
- The acute growth in medical travel in India (~25% is the most recent estimate)
- The growth of the ancillary Healthcare Insurance industry
- The government lending support via schemes like the Ayushman Bharat or Section 35(D) of the IT Act (Related to deductions and carry forward of losses for capital formation in hospitals)
I personally believe that the Healthcare Industry is in a sweet spot (Of course, this also means more competition), especially Secondary Care hospitals having a foothold in Tier-II or Tier-III cities. Don’t believe me? Look at past decade’s data of how PE investments have grown in this space.
I initially bought KMCH at 1000 levels. I bought again quite recently too. So clearly, I think KMCH offers a lot of value. But the uncertainty of the several recent changes prevents me from involving in this counter further. I might very well change my mind when these things become clearer.
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Thanks for the detailed explanation. I do agree with opportunities in healthcare as you mentioned. But with recent curbs by govt like capping prices of healthcare instrument like stents and bills, I am also little cautious about it.
Also doctors in South India, tend to be entrepreneurial in nature, as they gain expertise and also tend to marry another doctor. So they open new hospitals 
I have seen many such hospitals popping up in past decade in Coimbatore.
I hope you understand success and growth of hospitals/Medical colleges in TN depends a lot on Political alliances and friendships. Its not uncommon to see IT raids in popular hospitals of TN
As mentioned above, coimbatore by itself has lot of healthy competition and reputed hospitals ( like KG group, Ganga hospital), so people are getting second opinion and almost all the reputed hospitals have separate counters for Amma insurance ( TN Govt’s own insurance scheme).
The above is just a field level observation being in the city for so long.
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It’s true that healthcare is one of the most regulated industries in India. But it’s always been that way, so much so that it’s become a regular business activity for most of the players.
This is not just in South India. It’s the biggest disadvantage for large hospitals across the country. It happens everywhere.
However, these new hospitals tend to be general consultancy or for a specific speciality. Building a Multi-specialty hospital from the ground up has its own Barriers to Entry. That’s why I feel that the existing players in Tier-II and Tier-III are set to make large gains.
The operation of the medical college is, like I said, an important tracker for me. The promoters are indeed politically connected (You must also know this, I assume). But that’s besides the point. I’d like to understand how the college’s business economics ties into the hospital’s. That’ll probably take another 1-2 years and I’m willing to just skinny dip into the company with a small allocation until then.
Yes, competition is bound to crop up, as I’ve mentioned. Growth attracts the moths. But it’s ultimately a question of whether KMCH is losing business rapidly to competition. I highly doubt that’s the case. The demand here is massive and the supply stringent.
If at all KMCH stands to lose form this, once again, I would much rather see it first on their financial statements as deterioration of metrics before taking further calls.
I want comment regarding KMCH’s lack of experience in education sector …Actually they started with a college for nursing and paramedical sciences during mid nineties and in the last 15 years they have also built an arts and science college and an engineering college…They have enough experience in running an educational institute…
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I appreciate your views . I will track KMCH and get your feedback in this thread🙂
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Hi Dinesh,
I’m quite amazed by your ability to play with numbers on an excel sheet and try to find probable value of an underlying asset with a given set of data and future projection that are assumed with an underlying justification. Great job.
I’m interested to know your current portfolio allocation and any further qualitative analysis you may want to provide.
Thanks!
Dinesh just went through your blog on DHFL. In your blog, you assume growth rate for next 5 years @ approx 19%.
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Given that the company has reduced disbursements in light of what is happening, shouldnt your model in a conservative sense flatten out (or even decrease) earnings for the next 2 years or so before picking up pace?
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Apart from that, dont you also think that securitization of their book (to manage near term liquidity) and the fact that it is unlikely that they will be able to raise short term funds from money markets (CPs and as well as NCD’s) at rates what they were previously used to doing will also add further pressure to their NIM’s and profitability (this is just guesswork from me - for all you know they are raising funds at similar rates?)? Granted that they are a AAA company but do you think MF’s will be able to add their (DHFL) instruments to their liquid fund/bond portfolios without worrying about redemptions of relatively uninformed (or those going by news perception) or “conservative” investors (which seems to be in the majority these days) which means even though they feel the rating is warranted, but still market perception might prevent them from adding DHFL money market instruments? All this is likely to happen in the short term and hence affect valuation the most because near term earnings are discounted the least.
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Their 10 year ROE is 17% + however their ROE has been decreasing every year since the last 5-7 years and currently stands at about 14% (as per numbers posted on ratestar.in). You might say its because of 6k cr investment. However even if i take last 5 years and remove stake sale, its still about 15 odd percent. With above mentioned points, shouldnt it be difficult for them to even maintain this? Lets assume they do, even then, if I assume your growth rate of 17-19% some equity dilution will be required (or further increase in gearing which is not ideal given that they are already close to 10)
Do you think it would be a good idea of adding a probabilistic “negative value” of these events in the valuation of the company to reflect a conservative value over and above the desired MoS? How would one make an informed guess about when market perception of DHFL would change? I am not as informed as you and had bought DHFL during the 2013 crash but sold in the middle of 2017 when the P/BV touched historical highs at a price close to 350. I have no investment in DHFL and your conviction in this story is inspiring. Im not sure if I have the courage to invest and this is more of an academic excercise from a learning point of view for me more than anything else - to test my hypothesis (backed with no data unfortunately!) against your data!
Would be interesting to hear your thoughts
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