My Top Picks - All small cap - Value picks

I just started posting on this forum today. Found it very interesting. I am a professional with more than 10 yrs experience working in a multi billion dollar fund abroad mainlyfocusingon US equity. I make investments in small caps in my personal portfolio and i am here to share my views and benefit by hearing others views.

My Picks: Will first post two today and post the balance later on the same thread.

AK Capital Services

a. At this price trading at TTM PE of below 2 and Price to Book of below 0.25 and dividend yield of 5%.
b. Legendary invest RK Damani, Guru of Rakesh Jhunjhunwala, holding 1.3% stake in company which he bought in March 2013 qtr.
c. FORBES included it in Asia’s 200 fastest growing companies.
d. Promtoer bought 10% of total capital from open market from Mar to May 2009 which shows their confidence in the company.
e. RBI introduced Base rate system since july 2010 according to which banks can not lend below a certain rate… So base rate system increased the cost of bank borrowings for corporates… So more and more corporates are going for money raising through Bonds instead of bank borrowings… what I said above is also evident from the Primedatabase link below in which private placement of bonds is showing a huge increase since 2010.
f. Entry in this sector is not easy as it requires a Brand value… AK Capital has a strong brand value in market and no new player can come so easily.
g. In last 2-3 years, AK Capital invested a lot of internal accrual in its subsidiary AK Finance ltd which will start contributing to its bottom line now.

Many of you may wonder what is so special about this company and why I am so bullish on this… I will like to tell you that there is a special thing about this company… That special thing is that there is no risk involved by investing in this share, even if India GDP tanks to 3%…!!.. I will tell you why… If India GDP stays at these low levels or even it goes further down, that low growth will bring the inflation down and RBI will be forced to cut rates to support growth which in turn will bring the bond yields down which in turn increase the bond prices up which in turn will result in capital gains for AK Capital’s huge bond holding of 500+ crores… And if India GDP goes up from here, that will result in increased fund raising activities which will result in more merchant banking fees for AK Capital… So it is an extremly safe bet wherever economy goes… No other company has this kind of safety (barring defensive sectors like FMCG which are trading at high valuations)… All other small cap stocks are closely linked to GDP growth… If GDP tanks, small caps are the first to be affected… If GDP goes up, Small caps are the first to be benefitted…You will not believe but in March 2013 quarter, more than 2,000 companies posted net loss… If suppose there are approx. 8,000 listed companies in india, that means 25% companies posted loss in this quarter…!!.. I think this 25% is all time high figure … Amongh these 2,000 companies, 1,600 companies are those whose market cap is less than 100 crores… what I am trying to say is in India, small cap stocks are in a very bad situation because of GDP tanking to 5%… But AK Capital is not in problem because of reason explained above… So those who want to invest in small cap stocks but also do not want to take the risks associated with small cap stocks, should invest in AK Capital Services (BSE 530499)… There is no certainty about other small cap stocks… any good looking small cap stock can come in loss making list any time because of low GDP (low demand)… But AK Capital is very safe bet whichever side GDP growth of India goes from here…Happy Investing…!!

Disclosure - AK Capital is the biggest constituent of my portfolio.

2). First Leasing company of India:

Broadly both the promoters Irani (MD) & Mutthiah (Chairman) are 70+ and as per highly reliable sources they have been trying hard to sell the company as Irani has only daughters and Ashwin mutthiah has settled down in Singapore and has shown no interest to manage the show. Got an offer at 120 very recently but they rejected it as it was below book value and they want minimum 200 Rs. which would make it a 7 bagger. Heard that they are scouting for buyers and may find one in the next 12-18 months.

Current market price Rs. 32 (cum 1.8 Rs dividend) and book value Rs. 160 and EPS of 15 trading at a PE of 2 and dividend yield of close to 6%. Profitable in every year with steady growth and no major hiccups since its inception in 1974 and never missed paying dividend to shareholders from 1975. Close to zero net NPA as they are very conservative and lend only to highly credit worthy lenders on very conservative terms. Also Capital Ratio of 20% against norm of 12% showing their conservative nature.

Mutthiah may be not be that trustworthy but Irani is known to be a man of high repute.

FAROUK M. IRANI, MANAGING DIRECTOR

Mr. Faoruk Irani introduced Corporate Leasing to India during September 1973, when he pionered First Leasing Company of India Limited. Mr. Irani worked towards ensuring the interest of the Leasing Industries by being instrumental in incorporating the Association Leasing and Financial Services Companies. He is the Chairman of the Association Leasing and Financial Services Companies and has shouldered this responsibilities for the last fifteen years.

Over the last thirty four years Mr. Irani functioned as the Companys CEO / President / Managing Director and groomed the First Leasing Company of India Limited from a fledgling start up Company to one of Indias Premier Leasing organisation.

Mr. Irani authored a widely acclaimed book entitled, Inside Leasing?and has been honoured by being invited to address the World Leasing Convention on six separate occasions at Washington, Sydney, San Francisco, Istanbul, Dublin and Hong Kong, Taipei, Taiwan. Mr. Irani was invited by the World Bank to address a Seminar on Rejuvenation of the Leasing Industry in Indonesia.

Recently company repaid all public deposits and changed its status such that it can’t take any more public deposits. This is to facilitate the sale as companies which take public deposit need central government approval to sell promoter stake. Conmpany is also raising NCD’s and is planning to raise more debt and make an EPS of around Rs. 25 in the current year as making 25 Rs with a book value of 160 is not that difficult to get a better price from potential buyers. Listed in both BSE and NSE and volumes are large enough that it will never get into illiquid category.

Try calling the company and collect more information to determine the likelihood of sale in the next 6 months and update the thread. I will also share what i can gather. If sale happens this is a 5 bagger. Even otherwise it could give 50% return in a year.

Downside Protection:
1). Last 38 years there has been no large drop in earnings. So assume things continue and earnings just grows by 5% on a conservative level. (Book value every year grows by close to 10% & even if we assume that ROE drops a bit from the already low 10%). So based on low PE multiple of 2 where it currently trades the stock will appreciate by 5%.

2). If you look at the valuation which the stock got in terms of book value the stock has never traded below 0.30 times book value over the last 10 years and now cum dividend the stock is trading at 0.2 times. So even if it goes back to 0.30 times which is the lowest the stock has traded in 10 years should appreciate by 50%+ further increase in value for the time it takes to reach 0.30.

3). Also in terms of PE ratio i don’t see over the long term a risk of PE dropping below 2 or earnings dropping. Infact it should increase to around 3.5-4. Historically earnings has only been growing though at a very slow pace but with low volatility.

4). Also worst case scenario i receive a dividend of 1.80 Rs per share and they have maintained this level for a very long time and this gives a next of tax return of 6%. (They have paid dividend for every year since their second year of inception. So it is fair to assume they continue to pay dividend).

5). Historically there have been spikes in stock price and even 6 months back the stock was trading in the mid 60’s and 2 years back the stock was trading at 100. If we assume that nothing works in the next 2 years i will definitely get one opportunity to sell at around 65. If i sell at 65 in 2 years i make close to 50% net IRR including dividend which is not bad.

6). The worst thing which can happen to a NBFC which can create large downside is large NPA’s and this company has historically managed their NPA’s very well at close to 0% and is very conservative and will not do anything stupid and start booking NPA losses.

Views and more information after calling company from members would be highly appreciated and would encourage me to post more such ideas.

1 Like

Sriram,

Nice to see someone of your caliber presenting an investment case at ValuePickr. Thanks for contributing.

As a starting influencer piece, we have some guidelines to follow - to ensure a holistic look. Please have a look at these two threads on starting a new idea/discussion

http://www.valuepickr.com/forum/transparency-accountability-credibility/249813886

http://www.valuepickr.com/forum/site-navigation-some-pointers/626565665

As experienced investors, we have a responsibility to ensure investment hypothesis is not one-sided. That enough attention is drawn to possible downsides/RISKS.The responsibility is bigger if we are making an investment case for firms with a chequered history.

Request you to present/deliberate more on the negatives/risks/possible downsides - you must have done enough due diligence - to effectively negate the viewpoint that this seems more like a one-sided picture - several ValuePickrs alerted us on the same.

ValuePickr Forum is visited today both by novices and wannabe stock pickers, as well as verysophisticatedinvestors. Hope you understand we need to ensure a balanced picture is always presented.

Thanks.

Dear Moderator,

This is the first time i am posting on this website. In future i will mention both risks & holdings.

On disclosure: I hold both and AK Capital in much larger quantity than First leasing. I bought both of them in the last 2 months (June & July 2013). AK Capital i had earlier bought it in 2012 at 150 levels and sold at 270. Now back again. First leasing this is the first time i bought it.

Disclosure:

Source of news on First leasing: One Mr. Girish Gulati (Very smart HNI small cap investor) whom some of you may know. He used to recommend stocks in www.valuenotes.com 7-8 years back very actively. He got a mandate to find a buyer for First leasing few months back. The max buyer he could find was 120 Rs. and the management feels it is not fair to sell below book value. So they are scouting for buyers at higher prices.

Risks in First leasing: They keep searching and never find a buyer and keep making 15 Rs. EPS and paying around 1.8 Rs. dividend. Chances of dividend or EPS falling to me by a significant margin is low. This is because the company only lends to high quality borrowers and has a history of low NPA and their earnings has been fairly consistent with very little volatility. With higher book value EPS should only grow assuming that ROE is maintained. In terms of leverage they are taking much lower leverage than the 8.33 times they are allowed and they are taking only 5 times and maintaining a Tier I capital ratio of close to 20%. Key risk is the management team is old and they do nothing and the stock keeps languishing at current levels. So risk is more of a oppurtunity loss. I am not able to see much downside risk at 30 Rs. (net of dividend). If somebody throw more light on possible downside risk it would be helpful.

Risk in AK Capital:

1). They have a very large bond portfolio worth around 500 crores. So if interest rates go up and stay high for quite sometime they will get into trouble as they also have borrowings. They are betting that interest rates will drop from here and they have very successful making such bets making huge EPS in the last downturn in 2008 & 2009 when most small caps had a huge drop in EPS. I am speaking about an environment of high interest rates and low GDP growth. They can survive and prosper in both low rates & low growth or high rates and high growth. But not low growth and high rates. I assume that we can’t have such an environment for a long time as with low GDP there will be more and more pressure to reduce rates and inflation will also ease. But this can’t be ruled out.

2). There is always a quality of management issue. Last time when i bought in 2012 also this fear was there. But the good part about the management is they keeps the books clean, pay dividends & income tax. Also they never sold a single share and bought heavily in 2009 when the foreign PE investor had to exit due to legal issues (They wanted to start banking operations inIndiaand had some restrictions in terms of holding). Further the management did not sell a single share when the price went to Rs. 1000 which is 8+ times current price and they did not sell a single share. Also they are holding 64.3% including 5+% held by am care which is part of management group and holding this quantity for the last 10 years. Also AK Mittal is seen as a visionary and has huge experience in bond market. But as an investor if you try to contact them they hardly respond. So for management quality i will give them 5 out of 10 as this is the biggest risk in this stock.

http://www.valuepickr.com/forum/transparency-accountability-credibility/249813886 Link: …/…/…/transparency-accountability-credibility/249813886

http://www.valuepickr.com/forum/site-navigation-some-pointers/626565665 Link: …/…/…/site-navigation-some-pointers/626565665

downsides/RISKS.The verysophisticatedinvestors.

I think A K Capital is an interesting recommendation.

The company has a strong balance sheet, especially relative to its current market cap of around 75 Crores. The net worth is around 300 crores or so. The dividend yield is also nice.

Pros

  • Primarily, the income is from merchant banking and brokerage services. While these fees do vary significantly from year to year, based on the state of the economy and the number of bond issuances and placements, it is also a business around relationships, and balance sheet strength, and this company seems to have both going for it, given the track record of 15 years or so. So at least a significant part of this income is relatively sticky.
  • Good dividend yield
  • ROCE around 20% before tax and 14-15% after tax, at least in the last couple of years.

Cons

  • There is a significant income from trading in securities. The company has traded securities and shares to the extent of around 8000 crores last year, for a profit of around 10 crores. Given that this 10 crores is less than 10% of their overall revenue, one wonders why they would bother, especially when they pay pretty high brokerage fees.
  • They have an “inventory” on their books in terms of Bonds, which is around Rs. 500 crores. This is sharply up from the previous year (almost double) financed mainly through working capital loans from banks. It is possible that this inventory buildup was in anticipation of an interest rate cut. However, given the huge whammy bonds have taken in the last couple of months, one wonders how much of a hit they would have taken on these bond inventories. Unless of course, they were prescient and got rid of the bonds in a hurry. Otherwise, they would face losses on their bond portfolio of around Rs. 25 crores in the current quarter, and would have to pay higher interest on the working capital loans of around 2.5 crores. At this point, we have no means of finding out, unless the management is willing to answer. Also, these have been lumped as inventory, so we have no idea of knowing what the quality of this inventory is. It is possible, that they do a lot of trading on a day to day basis, and this is simply inventory, which is churned around daily. But still, owning 300-500 Cr. of Bonds in this bond market is asking for it.
  • A large reason that their profits for 2012-13 increased in the face of a decline in revenues is that they reduced brokerage charges paid by around 50 crores. One wonders how they managed to pull this off, especially given that their proprietary trading was higher. In fact, one wonders why they need to pay brokerage charges at all, when they themselves have a broking subsidiary, and receive income from brokerage charges.
  • They have around 50 Crores invested in equity shares of various companies, most of which are dogs in this current market (Punj-Lloyd, JP Associates, Electrosteel Castings). My feeling is that if they would actually put MTM losses on to the P & L, they would be looking at a loss of around 40 Cr. on their equity investments. Indeed, the choice of these particular bunch of shares is peculiar. Perhaps, it is a quid pro quo investment for getting merchant banking mandates. If so, this has not played out very well.

All in all, though, one has to agree with Sriram. At this price, it seems like a bargain. Promoter integrity has been questioned, but the biggest names in bond trading seem to willing to do business with these guys since a couple of decades, so they must be having some faith in them. The stock has fallen significantly from its peak, and is now trading around its post 2008 lows. I think the dividend yield and the net worth put a brake on any further declines, and if and when their is another market upswing, there is a possibility of another great run. The only thing is that it is extremely thinly traded, so it would be very difficult to build a significant position here.

Regards

Samir

Sorry, while I was posting the above, I just saw that Sriram had already posted the cons.

Regards

Samir

Hi Samir,

Just on the trading part and brokerage. Nobody pays such high brokerage on trading. This brokerage is more in the nature of sales commission which they had to pay for raising bonds. Last year i believe they had some bond issues for which they had to depend on some other intermediaries hence high brokerage. Current year the same is not the case. So current year the gross sales is lower but if expenses is far lower leading to growth in profits. I think that brokerage was more of a one off event.

Also they trade and hold predominantly bonds. What i heard from somebody in April 2013 was that they the bonds which they hold had a MTM gain of 100 bps which would become a small loss by now. So big risk is if yields stay high for a long time. Else they will just hold and it will be short term pain.

Equity they have been holding some duds in the balance sheet for a very long time. When i asked they said they will not sell until it reaches cost price. (Which means they have to hold for atleast 5 yrs). Their main equity holding is UCO bank. If PSU banks rally than may be they can get out. But they have not been allocating new money into stocks.

Regards,

Sriram

Pros

Cons

Thanks for the clarifications, Srirram,

Regards

Samir

Dear Samir,

Are you based out of Mumbai. If you or anybody else based out of mumbai wants to attend the AGM on 17th August (this coming Saturday) i can send give your proxy and also mail you the list of questions.

Thanks,

Sriram

I am not from Mumbai, but just incidentally, I am going to be in Mumbai Thursday through Saturday. I have work on Saturday, but I will be free after 3 p.m. I would really like to attend, if the timing is suitable.

Regards
Samir

Ok, I just checked, and it seems the AGM is in Delhi, so that kind of rules it out. Bummer.

Regards

Samir

Yes Corp office in Mumbai and regd. office in Delhi.

AK Capital is conducting its AGM on Saturday, August 17, 2013 at 9.00 a.m. at

Tivoli Garden, Resort Hotel, Chattarpur Road, New Delhi - 110 030.

If it is possible for anybody else to attend i can send you the proxy and questions for mgt. Overall with respect to ak capital if only management is reasonable this is a 5 bagger. If i were in India i would definitely.

Thanks,

Sriram

Hi,

I have looked into First Leasing. Just wanted to know the clients. Never understand the Book in this case. Any ideas ? about the book

First Leasing’s operations are primarily focused on corporate financing. The major clients
being CitiBank, Johnson & Johnson, Volvo, Seimens Public Communications, ABB, ANZGrindlays, IDBI Bank, TELCO, Knoll Pharmaceuticals, Bayer etc. The quality of debtors is very good and NPA ratio is close to zero. They have a 35+ yrs track record of steady growth.

AK capital has an eerie similarity with Yes Bank - how they both have/had significant gains on trading portfolio but are most likely sitting on losses now as yields spike. And the possible/plausible ‘quid pro quo’ linkage between curious investments & financial advisory fees.

At 7-8x trailing p/e, Yes is a better, more assured investment than a speculative AK. The 500 branches of Yes are for real and visible and it is one of the few banks with an individual person promoter. There is some inherent franchise value.

In AK Capital, though, Safety of capital is not assured as 2x PE is just optical as it is backward looking. Real PE given yield spikes may well be 4-5x or more. Not too shabby but given micro cap nature & opaque biz (=lack of investor interest, coverage), a wider discount for corporate governance is required.

One would make money in such a speculative name consistently if they are a diversified set of say 6-10 opportunities. Putting a concentrated bet here is gamble. It can work but it can also give a 50% or more capital loss.

Dear Jain,

Good set of issues raised by you. It is very helpful to me.

Response to your queries:

1. Agreed both Yes bank and AK Capital trade at low PE but AK Capital is trading at a price to book of 0.25 which is extremely cheap compared to Yes bank which is trading at a price to book multiple of 2. For Yes bank there is limited competition as the market has not been opened to competition in a big way (License Raj) and things may change in 3-5 years with entry of more smart private players similar to them like what happened to telecom sector. Although i agree that even in that case yes bank is like Airtel in telecom and would outperform. But for AK Capital the market has been already been competitive. I think if they have performed reasonably well in a highly competitive environment in the debt market it is because of their first mover advantage and the repute & contacts they have built over time. I think AK Capital also has an inherent franchise value which is definitely not as big as Yes bank but yes bank's market cap is 150 times higher than AK Capital. Even if AK Capital loses market share i think the overall debt market in India is still in infancy and there is huge scope for growth when compared to developed markets where debt market is many a times equity market. So they will still grow. But at what pace is a matter of debate and i think they will lose some market share. Overall if Yes bank trades at a price to book multiple of 2 and is considered cheap relative to history i think AK Capital deserves a multiple of 1 and not 0.25.

2. In terms of PE Yes bank is trading at 7 times as you rightly pointed out. AK Capital over the last 5 years when the economic environment has been tough has made an average EPS of 73 which is also somewhat closer to current EPS of 70. So they trade at a PE of 1.65 times last 5 years EPS.

3. AK Capital also offers a higher dividend yield of 5% which will definitely be maintained in worst case scenario considering that they pay less than 10% of earnings and they have maintained this dividend for the last 4 years.

4. Earnings growth: Many believe that AK Capital has not grown its earnings. This is the view one would develop if you give a cursory look. AK Capital's profit has grown 35 times in the last 10 years. Profit has grown from 1.30 crores in 2003 to 45 crores to 2013. Here one might argue that profits have growing to 40-50 crores level and stayed there for the last 5 years. So profit growth happened between 2003 to 2009 and stopped growing after that. That again is totally baseless.

Year 2005 2006 2007 2008 2009 2010 2011 2012 2013
Profit before tax 7.03 12.96 17.78 40.82 59.91 83 84.8 58.5 68
Less: Profit on sale of Inv 1.83 3.04 3.96 14.68 46 78.37 65 9.5 6.3
Profit excl trading income 5.2 9.92 13.82 26.14 13.91 4.63 19.8 49 61.7

Their growth in profits from their core business has been fantastic. One can do your number. But it is faster than more than 90% of companies. As i pointed out in my original post they have a business model where they can make huge profits both in recession and boom. Recession from profit on bond portfolio and good times from core operations. 2009 to 2011 they made these huge profits of around 200 crores on a small capital base. Consider the volume of profit they can make current capital base which is twice that and 550 crores bond portfolio once interest rates fall. They are in a unique position as regards bond market and with their track record if they market their Debt PMS properly which they recently started they can itself manage huge sums.

They have not benefited a lot from fall in interest rates as they did not actively book profits. A large portion of MTM gains have now evaporated. But is this short term or long term trend and whether indian interest rates will remain high forever is question one should ask. AK Mittal is more knowledgeable than both of us and knows when to book profits or losses on his bond portfolio. Also being the issuer he gets to know more than a normal investor about the companies he is investing. Although some times he may be forced to support bad issues to earn fee income and maintain brand value.

Overall they have a PE of less than 2 if we exclude any trading gains based on last year profits assuming that they have no profits or losses from trading in future. One should not forget the fact that there has never been a year when they made losses from trading. (Booked not MTM).

Overall one can argue that they have a chequered history and promoters are not investor friendly etc. But if a company is trading at a market cap which is well below the income tax on profits (current not deferred tax) that they paid over the last 5 years it is definitely worth looking. If you add the fact that they have been paying decent dividends, not sold a single share when the stock touched Rs 1000 compared to current market price of 120, bought large quantities in 2009 & never reported loss for a single quarter in the last 60 quarters for which i could find data on BSE.

http://www.bseindia.com/corporates/Comp_Results.aspx?Code=530499 Link: http://www.bseindia.com/corporates/Comp_Results.aspx?Code=530499

If they are speculators they could have atleast sold the 5+% stake which they hold and is shown as part of public investors (AM Care). But even in the shareholding pattern of AM Care there is no change in the last 10 years.

Regarding why books are 100% genuine and why it is trading at a forward PE of less than 1 and not 4-5.

Tell me one reason why a company should keep declaring huge profits and keep paying large taxes & dividends. There is no deferred tax etc. The market cap is less than 80 crores and they have paid more than 100 crores in taxes in the last 5 years & around 20 crores in dividend including dividend tax. Inventory has been given as security to banks. Will any banks lend 430 crores if the inventory is not real. Also if books are not real why did they not sell when the stock touched 1000 Rs. That too why hold 5% as public shareholder and keep holding for 10 long years.

There is no large net block, no large receivables etc. If you look at the balance sheet the main items in the asset side are:

1). 150 crores in Investments (Detailed break up available security wise. So not possible to manipulate).

2). 43 crores fixed assets and 2 crores goodwill. This number looks reasonable for their size and more than 80% of fixed assets is office buildings. So no plant & machinery etc where there can be any manipulation.

3). 23.5 crores net current assets excl cash & investments which looks very reasonable and low.

4). Cash & bank balance 50 crores.

5). Net non current assets: 7.26 crores.

6). Inventory of 467.71 crores. (This is the only place where they can manipulate).

Total Net Assets: 742 crores

Financed by 318 crores net worth, 4 crores minority interest and 420 crores of bank debt.

Reasons why i am confident there is no manipulation here:

*Working capital loan from NBFC is secured against mortgage of Company’s

immovable property together with all structures and appurtenances thereon held by

the Company situated at 8th Floor (part), Mafatlal Centre, Nariman Point,

Mumbai 400 021. The above loan is repayable in lumpsum at the end of the term of

loan of 12 months.

**Working capital demand loan from the NBFC is secured against pledge of shares.

***Working capital demand loan is secured against pledge of government securities

and other debt securities, corporate guarantee of the holding company, A. K. Capital

Services Limited and demand promissory note. The above loan is repayable on

demand.

**** Bank overdraft is secured against debt securities and personal guarantee of two

directors of the Company, the loan is repayable on demand.

*****Loan from Clearing Corporation of India Limited is secured against pledge of

government securites and Cash Deposit.

Term loan from NBFC is secured against mortgage of the Company’s immovable

property together with all structures and appurtenances thereon held by the

Company situated at 8th Floor, Mafatlal Centre, Nariman Point, Mumbai 400 021.

The above loan amount is repayable in lumpsum at the end of the term of loan of 24

months, with a put and call option at the end of one year.

**Vehicle loans from banks are repayable in 36 equated monthly installments

alongwith interest from the date of loan. The loans are secured by hypothecation of

motor vehicle purchased there against.

***Vehicle loan from NBFC is repayable in 36 equated monthly installments

alongwith interest from the date of loan. The loan is secured by hypothecation of

motor vehicle purchased there against.

So almost all assets are pledged with banks to raise 430 crores of debt. Also if you look at it the directors have given personal guarantee and if the books are not clean the directors will tomorrow go bankrupt and get into trouble personally. But the good thing is no shares of ak capital has been pledged.

Three more solid reasons why inventory is not manipulated:

1). It is only in the last 2 years the company has started showing large amount of inventory and is making a bet that interest rates will fall. At the end of 2011 the net amount of inventory was 0.89 crores and gross borrowings was only 31.5 crores. So balance sheet as end of 2011 is super clean and they made 85 Rs. EPS in both 2010 and 2011. If only they manipulated there should be a place where they should hide and there is no such place. At that time they felt interest rates were low and had no reason to hold large inventory. I also aksed them regarding high receivalbes of 60 crores in 2011 March balance sheet. That figure came down in first week of April and this was basically money lying with broker against sale of investments which was transferred back.

2). I checked the auditors file. Suresh Surana & associates is a reasonably good mid sized audit firm and for audit & certification fees of below 2 lakhs till last year and below 4 lakhs for current year there is now way they will agree to anything which will make them spend the rest of their life in prison. Being a CA i know that even if an auditor signs manipulated accounts he will charge fee in crores and not such a paltry sum unless books are clean.

http://ss-associates.com/About-Us/About-Us.aspx

3). This is not the first time they are raising debt and building inventory. They did exactly the same thing in last cycle and we have the results to see. Only worry is whether interest rates will fall as predicted. Debt levels moved from 1 crore in 2007 March to 101 crores in 2008 March. That time they borrowed less as their net worth at that point was only 100 crores which is less than 1/3rd of current level. And the debt level was brought down to 18 crores by March 2010 once interest rates dropped.

As regards cash flow these guys have a great track record of predicting interest rates and trading aggressively in bond market. Even in 2008 & 2009 they did a similar thing by borrowing and investing in debt market and it paid off big time and made close to 200 crores (pre tax profits) from trading. Cash flows improved when they sold their investments. If cash flows goes into some receivables it is bad. But what is wrong when it goes into bond investments.

Being the debt arranger they can get how much ever allotment they want in good issues. So what they do is they take allotment and sell it in the open market and make large gains similar to IPO trading in equities. If you look at the volume of trading they have done it is close to 7900 crores buy and 7700 crores sell (Check Note 32). And the good thing is even in a rising interest rate environment where one should make loss they are making gains by trading which is due to their unique status as leading debt arranger who trades in debt market. And whenever interest rates fall they are making huge gains.

So the key trigger for AK Capital is fall in interest rates. Whenever interest rates fall significantly this company will make 150 Rs. EPS for close to two years. They made 65 Rs. EPS in 2009 & 85 Rs. EPS in 2010 & 2011 with a a balance sheet which is half the current size last time .

My bet is that over the medium term interest rates will fall rather than raise from current levels.

The good part is fee income is steadily growing. Unknown part is a new business strategy by one of the subsidary to buy and sell bonds in huge quantity. What i understood by reading the CARE report is that they place bonds with institutions after taking them in their books for a small margin. So this is more like their basic business of raising debt for corporates. But they seem to be increasing inventory. Is this fully due to what we hear from many sources (Bet on interest rate or is any issue for them in disposing these bonds). I also find in the CARE Report they have a risk management policy which makes sure that they trade only in high grade bonds, have a diversified portfolio etc. But just 2-3 line info and not too detailed one. If somebody gets to know more information on this it would be super helpful

Year 2005 2006 2007 2008 2009 2010 2011 2012 2013
Profit before tax 7.03 12.96 17.78 40.82 59.91 83 84.8 58.5 68
Less: Profit on sale of Inv 1.83 3.04 3.96 14.68 46 78.37 65 9.5 6.3
Less: Profit from trading in shares 0 0 0 0 0 1.63 2.68 7.99 9.76
Profit excl trading income 5.2 9.92 13.82 26.14 13.91 3 17.12 41.01 51.94










Fee based Income 11.71 19.8 35.93 68.14 78.69 75.72 84.5 129.88 113.87

AGM Notes - A friend of mine Mr. Girish gulati attended. If somebody is interested in meeting the management. Do let me know you can join when we go on a weekday.

MET THE CFO- MR VIKAS-SITS IN MUMBAI-02266349300…vikas.agarwal@akgroup.co.in

he was easy to approach, and friendly , answered few queries

rest he said …he can arrange a meeting with mr mittal… on weekday in mumbai…so Dnyanesh sir you have to do it…choice less choice:)

i have never seen such a lavish agm in delhi…it was a similar experience like attending gulf oil agm in hyd…that was very lavish too

Notes

new growth engine driver will be the nbfc…subsi…main business iS BUYING DEBT IN WHOLESALE…SELLING IN RETAIL…

THEY HAVE EXTREMELY GOOD CORPORATE REALATIONS

THEY CHURN THE DEBT A LOT…EXTREMELY COMPETENT GUYS.

THEY DON’T HAVE MUCH LOOSES ON THE BOOKS…ON THE DEBT SIDE…BUT HAVE TAKEN A HIT…due to recent mkt cond (but i m sure they must have taken a hit)

SAY THAT YIELD WILL SETTLE AT 9 % (current 10 year gsec yields)

LAST YEAR THEY PAID BROKERAGE FEE OF 70 CRS (IT WAS FOR NHAI AND OTHER TAX FREE ISSUES)

ULTIMATE GROWTH WILL COME IN NBFC ONLY -

REASON FOR FORMING SUBSI WAS TO HAVE FEE BASED AND FUND BASED MODEL–BOTH GOING FOR THEM.

i found the guys genuine…and co. can grow in a big way…needs to be more researched…vision of the promoter has to be known

co. had no idea abt risk of getting into illiquid stocks…so kept mum

I HAVE NEVER SEEN SUCH A SHALLOW BOARD…AK MITTAL AND SOME OTHER YOUNG MITTAL WAS THERE…WHO KNEW NOTHING…AND THEY HAVE INDEPENDENT DIR…FROM LIC…

ONE MAN SHOW…MASSIVE NEGATIVE…BIG INVESTORS WILL NEVER TOUCH CO. OF THIS SORT…FORGET FUNDS ETC

WEAK DIVIDEND POLICY AND ONE MAN SHOW- IS KILLING THE STK PRICE-

MR. MIttal is a very competent and a royal person…i know one ex-employee…and he says that he never looks on petty issues…and is a gentleman

SOME COMPANIES ARE NOT EVEN WORTH RESEARCHING…THIS ONE IS…SO REQUEST IS TO DNYANESH SIR…TO KINDLY MEET…I WILL ARRANGE THE MEETING

SORRY FOR NOT TAKING OUT THE INFO SRIRAM WANTED…DUE TO LACK OF SUPPOURT…AND AGM CULTURE IN DELHI

i explained what the div policy should be and cfo listened to it…so frequent explanation to them by Sri can be helpful.

sri u have to work on ur investment …get a stk split and raise div rate …and knowing your ability , i am sure u can do it…just constant perseverance.

CHEERS

Great work, Sriram

Hi Sriram,

Your next few picks with your knowledgeable supportive comments are awaited eagerly.