Guru Mantra 16- Competitive Advantage: Racing for Uniqueness (The Second Part)

Guru Mantra 11: The Guru- Dispel the Darkness (Know Risk, Earn Rewards)

Disclaimer: International Travel House is a live case study. I am not advocating for any buy, sell or hold. Neither I hold any shares of this company, a simulation for educational purpose. Opinions expressed are mine and exclusively obtained from publicly available information.

It was 11 March 2016 , 10 in morning something shattered my so called ergonomic chair. A news that I wont be able to see my Guru again, an incident which took away a lifespan of value investing to oblivion. To me personally it was one of defining moments of life, otherwise on paper spine chilling story of an individual started from scratch and ended with few hundred crores of wealth to realise philanthropy is the best way to abode heaven.

Guru is considered as someone who teaches you at home, at society, at schools, at office. Unfortunately traditional education system captivates pupils in surrounding of pedigree, money based jobs. I always felt we don’t have a guru when we need the most. May be a sanguine debate between admiration and inspiration is unwarranted; however we are not trying to put some sort of cardinal rule for divine direction for mankind.

I along with many others promised him that we will continue to promote equally nerve wrecking story of value investors and their philosophies. Apologies for moving away few days, had to stand high and pay the last respects! But I will continue to upkeep the commitment made to my Guru.

Let us cover two key subjects today:

Progress tracking- Financial Planning KPI

Risk Management

Financial Planning KPIs

Value investing is a fascinating subject, with efforts and bit of luck you can amass wealth. Great, but how do I know that I am garnering enough wealth.

We split financial planning KPI to three types: I. Growing II. Commendable III. Freedom
I won’t be talking about personal financial planning however the KPIs are not possible unless you maintain one.

We use three ratios to identify prosperity: 1. indirect income to direct income ratio 2. Net worth days 3. Indirect Income to expenses ratio.

KPI 1: Indirect Income to Direct Income ratio….You are growing buddy!

The percentage or number is derived by dividing indirect income (dividend+capital gains pulled out for expenses not reinvestments+ rent +interest and all other income) to direct income (salary if you are employee). The objective of this KPI is to determine how effectively you are using your surplus money to generate further money or application of money. Also the percentage helps effort estimation e.g. if we spend 80% time in employment and 20% for indirect income generation it will tell us the benefit of 20% against 80%.

KPI 2: Net worth days….Commendable effort, on the way.

Net worth for us is how many months and years you can survive with your savings. Savings can be any asset class, so it is net worth divided by expenses in months or years.

KPI 3: Indirect Income to Expenses Ratio……throw the locks to ground, freedom has arrived.

Assuming you don’t indulge in direct income activities how many days or months you can manage expenses. This is arrived by dividing in indirect income to expenses.

Let’s use this example for one Mr X:

Situation 1: Salary and expenses go up by 10%and indirect income grows by 10%

Situation 2: Salary and expenses go up by 10% whereas indirect income grows by 12%

Situation 3: Salary and expenses go up by 10% whereas indirect income grows by 15%

** II- indirect income, DI- direct income, Ex-expenses

Story telling: at even 10% yield in five years you are able to survive 2.36 years from a paltry half a year. Similarly for 12% the number went up to 2.57 and @ 15% it was 3.09. (refer to net worth)

By putting money into fixed deposit @10% you are able to service 3% in first year, by the time you reach year 5 it have become 15%. @ 12% it was 24% and @ 15% 36%. That is one third of income was supplied with little effort and asset selection. (II/DI Ratio)

When you invested in fixed deposit @10% you were able to manage 0.04 years in 1 (this is without liquidating your assets) which is barely 13-14 days. By year five you moved to 2 and half months. When we apply 12% it was around 4 months and with 15% you almost serviced 6 months expenses in as little as five years. (indirect income to expenses ratio)
Is this value investing, no this is pure compounding on mathematical formulas without knowing or building capabilities for value investing.

Compounding is eighth wonder of world; those who know receive it and those who don’t pay it- “Albert Einstein”.

Imagine a 25 year old approach will throw a shock of your life, the secret….start as early as possible even if small amount!

Risk Management

We touched upon this subject last time, a RISK is basically what can go wrong for a DEFINED OBJECTIVE.

How to define objective:

Three mundane questions will help us:

-have we considered all scenarios applicable to wish list?
-what makes us think our scenarios will be accurate?
-does my wish list require validation?

Step 1: I have a wish list getting married in 2019. (Not me , I am married with 8 year old daughter :)).

Turning wish list to objective:

  • what all can happen if I want to get married in 2019? Spouse from same community? Funding required for marriage? Do I need to select place?

  • did I check how much marriage costs now? do I know the repercussions of getting married outside community? does the current place I am staying convenient for marriage?

  • do I need to validate plan from restricted set of people like parents, friends etc.
    If I get action plan for wish list scenarios I will put it as defined objective.
    Now what are the risks? Pretty much same when you build the scenarios? For better grasp

let us split the risks to four categories:

Operational risk: like location, number of people etc. Remember operations drive financial requirements.

Compliance: the paper and documentation required otherwise marriage will be null and void.

Financial: like funding requirement.

Strategic: this is second level thinking, post marriage what other options available for failure of a marriage or job change etc?

To make it light I have taken marriage as an example.

Risk Mitigation Strategy

As we discussed last time, risk can be mitigated in four ways (in order of preference)

Treat: the best possible solution, it captivates your experience and knowledge which becomes a weapon to fight next risk in life! Examples are making recurring deposit to meet marriage expenses or consulting a lawyer to find out documentation requirement.

Terminate: don’t get married at all or postpone the date. Why this second in order? Terminating is not easy, master stroke of behavioural finance is required. The mental trauma to social stigma, all these becomes experience for life time!

Tolerate: you need tolerate this risk as very much controllable.

Transfer: May be financial roadmap can be out sourced to financial manager.
Managing risk is not only key to your achievements in life. Investment is a span within it.

BACK TO THE STATUS ON OUR CASE STUDY- INTERNATIONAL TRAVEL HOUSE (ITH)
What I did on this case study?

I dug six year annual report from BSE website, went through circulars, google what I could on company.

Abstract is most powerful thing to me, what does this mean?

To me abstract is free flow writing from sources. It becomes easier later on to classify and categorise them , improvise with further intelligence gathering.

Initial Information gathering and impression

Not a great website, poorly managed. When I was clicking various tabs, they were over lapping each other.
Thrust looks like on Car rentals, domestic packages and conference & exhibitions within India.
Online booking can not be done, only request can be placed for car hire. For others you need to connect via telephone only on working days.
Domestic packages are detailed, however appears standard packages are combined and placed on various themes. Not sure whether they change the package frequently.

Summary of Annual report studies

Group auditor Deloitte where as ITH is managed by EY.
Management Compensation available for all six years.
Long term tenured employees. No stake holding in business.
Except one director there has been no major change. A good amount of directors come from ITC Hotels.
Conversation around IT system been there for last five years. Why company is not able to implement these IT system? Is this a too complex process to implement?
All committees have been formed, well attended, no material disclosures. Either copy paste work or good performance.
Number of employees in six year has been between 700-750. There has been no increase much.
There has been a shift in activity during 2015, director talks about destination management, detailed event management. A Volvo bus service also launched.
As per directors business segment are flip flopping, more indication of cyclical behavior. But one year car rental is doing well, next year MICE. Cyclical or management efficiency?
Borrowing capacity increased, mortgage taken in 2014.
Customer care launched in 2014.But now website says 9-6, contact a land line. Possible facility withdrawn?
2011 saw acquisition (didn’t specify what) and alliance with GlobalStar.
2010 director spoke about ITC synergy.
Dematerialisation has been around 90-95%.

Industry View

Overall tourism is growing well, supported by government and a huge potential of extrinsic value waiting.

Growing at 12-14%. 13 million jobs employed over all. 12% contribution to GDP.
FTA- 16.94B. ITC is expanding by spending 9000 Cr. Total number of hotels to 150, 5 more by 2018.
Medical tourism is growing at 27% CAGR.
USA and UK sends the maximum foreign tourists.
The most visited place by foreigner and locals are Maharashtra, Karnataka, Tamil Nadu, Delhi, AP.

Car rental

Highly unorganised industry. However in last few years the model has become more aggregators based with help of advanced technology. This trend will continue further though the number of players is expected to come down. 800B potential by 2019.

Domestic Tourism and Outbound

Increasing middle class income, changing lifestyle, low cost airlines, diverse product and EMI offering working as a boost.

Inbound and foreign tourist

Culture, diversity, economical still holds the key. International events also fuelling the growth.

MICE

This is one of most happening sectors where Indians spent a lot of money outside due to unavailability in India. Current segment is around 4.8B USD.

The next step without going anywhere else I pulled out four year financials, all three elements i.e. Balance Sheet, Profit & Loss Account, Cash Flow Statement:

Basic Analysis of Financials

Balance Sheet

Commentary on Balance Sheet

Overall texture of asset has been changed mildly i.e. five years back non- fixed asset to fixed asset was around 78% which is 72% now. The decrease has come on account of increased tangible assets and decreased receivables. Trade receivables consists of a whopping 48% of asset base, efficient collection can lead a humongous rise in further liquidity and investing abilities.

On part of liabilities, share holder quota on rise. Five years back equity owners were funding 64%, now the funding is 75%. The increase in shareholder corpus have primarily come from decreased current liabilities scene. Trade payables has been knocked off largely from 24% to 13%.

Vendor have become smart and there is no improvement in receivables cycle.

Key balance sheet items for further analysis
-Reserves

  • Trade Payables
  • Tangible Assets
  • Receivables
  • Current Investments

Profit & Loss Account

Commentary on Profit & Loss Account

Clearly a service industry with 98% share. As expected on expense front employee takes the big pie of 22%, depreciation 10%. All other expenses bundled to 61% which needs to be evaluated separately.

The PBT has been in same range, without any major change to components.
Tax as a portion of revenue has gone down from 5.26% to 3.03%.

Key PL items for further analysis

  • Sale of Services
  • Employee Expenses
  • Taxes
  • Depreciation

Cash flow statement

Commentary on Cash Flow

The cash that is generated from operations has been mostly used for fixed assets. Apart from this company has paid dividends across the year.

Other peculiar item is current investments, the total purchase and sale is 3 times for than revenue from operations i.e. almost 500 Cr plus, however I didn’t see dividend income or gain more than 1 crore also.

Key Cash flow items for further analysis

  • Capital Expenditure
  • Dividend
  • Current investments

Key balance sheet items with explanations

Reserves

The composition of reserves are retained earnings except a 11.89 Cr securities premium.

Trade Payables

It doesn’t come with a schedule, presumably against vendor. Among the other expenses 72 Cr pertain to car hire and service charges. Perhaps the trade payable are arising out of them.

Tangible Assets

Motor vehicle is biggest asset, almost 75%. Apart from that land and buildings have been shown. A good amount of land is leasehold. Plant and machinery also consists of 7 Cr.

Receivables

A huge chunk of asset is receivables i.e. around 50%. Almost all of receivables have been shown as good.

Current Investments

On balance sheet figure is only 11.50 Cr, the rest 550 Cr transactions shown in cash flow is perhaps debt funds bought and sold. Question is if customers are not paying on time who is giving money for these short term investments?

Key PL items for further analysis

Sale of Services

Operations revenue mostly come from transport and commission. Transport obviously refer to cab hire charges. Commission is received from airlines, hotels.

Related Party Transactions- Sales

As expected 63.50 Cr has been sold to ITC around 30%. However this number is going down from the levels of 90 and 80 Cr previously. And 65.80 Cr of receivables is due to ITC. The receivables have fallen from 90-100 Cr.

Employee Expenses

Usual accounts like salary, benefits etc. The number of employee on payroll haven’t changed much.

Taxes

Tax Rate % — 38.70 38.31 39.15 33.56 34.07 31.35 30.85 30.57 29.88

Effective tax rates have gone down from 38% to 30%, recently there was a decrease in corporate tax rate.

Depreciation

Depreciation have gone down despite of increase in fixed asset. The recent capex plan and low depreciation indicates assets are new.

Other expenses

70% of other expenses goes to car hire and service charges with another 6% on maintenance, 9% for fuel. Hence it makes full 85% cost for car hiring charges.

Key Cash flow items for further analysis

Capital Expenditure

Its been a significant portion of cash generated from operations. The last year bulk value was very high, arguably the next couple of years of capex plan may be mild.

Dividend

Company has paid dividend for the balance that is retained after capex plan.

Review Comments from Basic Analysis of Financials

Tangible asset base has gone up with new fleet addition which enhances reproduction value of assets. Though receivables has come down, a significant portion is due from parent. Hence timely payment from ITC can literally add 30-40% of revenue as additional cash. Vendors have been paid quicker now, perhaps due to small taxi and cab drivers.

Tax expenses have gone down, a portion attributed to reduced tax rates. Going forward depreciation will rise, this will also reduce the taxes as well.

Cash has been mostly used for fixed assets and dividend. I am not sure where is massive current investment comes from and why with so paltry returns!

Car hiring has been the major source of revenue with major customer parent company. The expenses are again spent similarly. In addition ITH receives some amount for ticket booking, may be again directed from ITC.

Permanent employee has not gone up despite increase in size of revenue, largely due to temporary nature of hiring drivers.

Moral of the story is ITC Hotels is using ITH as car service provider and ticketing agency for its guests. Apparently the other business like MICE and holiday package has not brought much revenue.

Finally I did a entry check valuation to keep myself joyful:

Entry Check Valuation-17 Mar, 2016

Adjusted EPS is 22.99, the Current Market Price is say 180. My earnings yield is 12.78%.
The last 9 year CAGR of EPS is 11.33% (from 8.75 to 22.99 in 9 years).
If I expect safe 10% earnings growth for next ten years my EPS would be around 59.63 in 2025 i.e. 159% increase post tax.

The 159% return in 20 years, if we bond rate of 8% it gives a multiplier of 73%. If we buy today we will pay 73% of 22.99 a share which is 16.78 a share. The current PE is 8.85 we will get 148.50 which is a roughly intrinsic value as entry check point.

**There are different stage gate I apply while documenting investment on concentration **
bands.

Let us talk about why popularity may be illusion and what is investment planning to avoid such illusion. I call it CAP plan (C stands for Capability Building, A for Active Investment and P for Portfolio Management).

Thank you guys for good wishes, If I am unable to navigate freely within forum….apologies, can assure you unintentional.

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