PI Industries - Superior Business Model

Stock Opportunities Not-so-Hidden Gems
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Mahesh, I really respect your opinions, and didnt mean to come out as brusque, but we as investors can’t think in terms of 2-3 quarters. One favourite way ofanalysis and investing is for me to think:- “Will I be still this confident on this stock, if I cant sell it for the next 10 years from today?”. And this includes even nerve wracking 25-45% declines in bear markets.It will be strange to see, how less of our stocks and how fewer of analysis of ours pass this test. One grand reason I believe being a long term investor is difficult today, because “falling in and out of love” is so easy :smiley: [I mean relationship with a company]. Decades before, people had to pass through arcane paths, sign n number of documents to do one transaction. So it would take huge mental commitment to really “take a stand”. But I digress!

So, if we are buying a stock we will have to think evenabout the weakest of effects, as it can be powerful over time.

I am highly interested in P I Industries, let me be absolutely frank with you. And that makes even more of a reason for me, to think really long term.

I do agree, that P I Industries has a good advantages going on for now- but anything can change. So if you cant really sell your stock for 10 years from today, you will have to be that much sure that its a company which has things going for it.

Soham

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Happy not to sell …10 years from now?

That usually applies to really mature businesses…the HDFC, ITCs of the world, and there are very very few. Where there is so much more visibility of the company’s products, plans, Management talk, and active tracking by hundreds of analysts. The companies have demonstrated over many decades their ability to go to the next level …scale up, ability to fund that growth, and the Management bandwidth to meet whatever challenges are thrown along the way. Of the relatively newer companies (15-20 yr tracks), I might have some confidence to think of Airtel that way!

A mature way of investing in small companies would be to think of the size of the opportunity before the company, is it in a dominant position to take advantage of these opportunities, does it have the right size/stature/BS to be able to fund that growth, and does it have the Mgmt quality/depth to steer it through the inevitable challenges that will come before it…things like that. In short, do we think it can successfully make the transition to the next level? Do we see that transition happening in the next 2-3 years?

A good 2-3 year visibility is all that we can get! Expecting anything more is perhaps not realistic from companies of this scale.

Build some conviction by the homework that we do, take initial positions, and track the company wholeheartedly…watch every performance…are they walking the talk…if we see that they are…our conviction level goes up, and we can take bigger positions!

That’s how we have seen an unheard of Mayur Uniquoters start getting that respectability from the marketplace…its stable…its one of the first to rebound in the small and midcap space…has been walking the talk so far. There is good visibility for next 2 years…but can I take a call for next 10 years…no way! despite having met the Mgmt a couple of times, visiting the factory, meeting up with industry professionals from US inducted into the company…and a ring of friends on top of developments in the company.

PI is that way a much older and bigger company than Mayur…but its just earning its laurels…has still to demonstrate that it can make the transition to the next level successfully…beyond the initial successes. And that is where most midcaps struggle/fail.

PI certainly has the potential and the promise…that is all we can be sure of now!Building up conviction (or, otherwise) will come with our exposure and experience with the business as it grows.

Is the business well-poised to compound at 25-30% growth for next 2-3 years? .We certainly think that’s achievable given the current information set.

That to my mind should be the investment premise for smaller companies in their growth phases.

Invite more views.

-Donald

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See this way of thinking is to, put your analysis [in this case, my analysis] on the dock! Many times, we think we know a lot about a company, but in essence all we might have hadis hope, and “over-information” bias[humans tend tohave almost twice the confidence and less performance whenpresented with more data)- a cognitive loophole]. See, even 2-3 years is a respectable time, but not enough to really,really grow. Take for example, if I would have bought P I Industries in 2008. 3 years down the lane, what now?

And 10 years is too long a time, I agree, and thats what makes the onus on us to do the homework even more thoroughly- so that company is robust enough to keep growing[which points to “market capacity”, internal accruals etc], business has inherent strength to not get disrupted fast, business economics is strong to not ask for much cash to add marginal profit and even if it does get disrupted, management should have the ability to steer clear into new growth areas.

I would be lying to say, its easy. Hell, its tougher than playing 3-D chess. But we got to do, what we got to do.

Too many people, unwilling to put in requisite homework chase quarter to quarter data- what really changes on a quarterly basis? Is it really important to puton growth every quarter for it to grow strongly over a longer period of time? Even corporate strategy change of successful companies take more than 3 years to really show effect on bottomline.

This way of thinking is a filter, filter for our own cognitive loopholes.

Soham

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now!Building

__

Just to add the valuation aspect… is the company with all the ingredients mentioned by Donald is available at a valuation which can atleast be termed reasonable if not undervalued… and while considering valuation aspect we need to factor-in both, TTM and near term forward to factor in upsides/downsides from the valuation it will command when forward becomes TTM.

Rgds.

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And forward valuation is easy to estimate?

For instance, Pfizer’s Lipitor has gone for a patent regime change. How much is Pfizer going to do an EPS of next year?

Its possible, it works for you. Markets are generous to accept and understand diverse ways. I am not contending that, but I know, I can’t predict fwd earnings. So I have made peace with it.

And yes, valuations do change. And you have got to sell out when valuations become horrendously costly. If markets are ready to pay a price which says, 55% growth till eternity- its best to cash out[my beliefs]. But we are talking about the business and not its share price.

Soham

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Point is how do you do real homework on the company? after it has passed your primary investment criteria filters.

In my opinion, it is actually field-level scuttlebutt - talking to distributors, suppliers, competition, end-users, industry insiders. That will give me the real confidence. Have we done it for PI Industries - frankly, NO. Can we do it, Yes! for that our network of interested parties has to grow, your actual contribution to ValuePickr has to grow, ValuePickr has to grow.

How many of us have tried to reach out to farmer friends,acquaintances in our network? I tried the 2-3 I knew. One of them got back with very positive feedback on PI and thats there on this forum.

For me conviction goes up first from field level primary feedback. If competition talks about the company with respect, thats another great positive. And when I meet Management & employees face to face, discuss hardcore all that we know or hazard of the company its products and prospects, the industry and marketplace - see how the company answers - tries to gloss over or transparently answers in enough level of detail, that gives another big big boost of conviction, if things go right. I have many seniors advising me that on the other hand its quite possible to get fooled by smart talking management. But for me it has worked, and I think it has worked because we ask 2nd, 3rd level of details to the management (not open ended questions without backup data with us, where we can be caught blank!)

So far our screening of companies to meet has been really top-notch, or we have been plain lucky. Every time we have met a company, our conviction levels have up a few notches be it a Manjushree or Mayur Uni, Suprajit or Gujarat Reclaim, or BKT or …

Ayush and me keep joking that someday soon we will fall flat! and meet a company where our conviction levels go down after meeting Management. And no matter how weel we transcribe the discussion…it is impossible for us to transfer the conviction back to every member. To each his own, your conviction will only come from your homework!

While it is important to think about possible headwinds and a few years ahead too, and do that exercise threadbare as possible, many of us keep with the theory but fall short on the practice.

To me homework and conviction comes more from - what stands on its own merit -where the data and facts speak for themselves. If you are a good analyst, you will have all the data, collect all the facts that are out there, be able extract the most information out on that basis - that’s what we pride ourselves on.

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Just loved the discussion in the last few posts. I agree with Soham on the moat part. As I have mentioned in multiple posts here as well as in TED, I don’t believe there is any moat that any non-patent holding business has that cannot be disrupted by someone with deep pockets and an iron will. Also, agree about the futility of quarter to quarter financial forecasting.

For the 10-year outlook, I am not so sure. I think Donald has a more practical approach on this. I lover Walter Schloss’ approach of holding (or thinking of holding) for atleast 3-4 years and then taking a call on what to do. But he was into buying really really cheap stocks which sometimes took a long time to get noticed by others so that the prices moved. So, I typically look at a 3 year timeframe for my stocks. Unless I get a huge price appreciation much before or the management does something silly like deworsifications or book-cooking.

However, I think it is very important to make forecasts for the future (with a margin of safety inbuilt). That, I think, helps in clarity of thought. Let me put it this way. Quarterly orannualresults are like report cards you get at school. It is not essential that you get a progress report every semester or trimester, but without it you will not know if you are on the right track. So, even if you are on a 10 year journey, you have to use the quarterly and annual reports to validate if the path that the company has taken is the right one. Also, delving to some extent into the numbers gives a much better understanding of the mechanics of the underlying business.

Coming back to PI. As others have mentioned, this company has a lot of promise. It seems to on the right track. 10 years down the line it may be big winner or it may not. That cannot be predicted now. But unless you track it closely you will not know. For now it has passed my (and some others primary filters) and we have some positions in it. We track the company very closely. If at some future point in time I come to realize that things are not going as we thought it would, I will move out of the stock. Tracking and monitoring a company does not give a buy signal to me, it gives a sell signal!!

@Soham - loved your posts. We have a paucity of skeptics/contrarions here, so would hope to see greater participation from you.

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Soham your intent of finding small companies to hold for 10+ years is great. Definitely, one should make the effort to find the businesses which have the robust business models to steer for long periods. The problem is all things are dynamic in nature & the investment process itself is also dynamic.

You do need to acknowledge that: while “Robust Business Models” & “Moats” gives us clues on what we hope to expect - things can and do change - external circumstances, macro environment, regulations, management, competition, currency, weather conditions etc. etc.

The point Donald is making is for most companies even the management would not know what 10 years will bring. I have to agree with Donald that the way to do is do your homework, build your thesis, invest and then see if management delivers on your investment thesis. If there is a positive loop one will have more conviction and can invest more. It’s also this feedback loop with collaboration that provides us an opportunity to build a stronger understanding on a company.

Do you have an example of few small companies where you have the clarity & certainty that you seek?

BTW, looking at the uncertainty from a different angle- it’s precisely because of the uncertainty there is inefficiency in pricing and therefore the opportunity for investors to make above average returns.

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@All

I absolutely understand and I have got no illusions that peering into the future is impossible, if not the attempt to do so, is insane. But, such an exercise when done right tells a lot of things.

How do we do homework? I believe, nothing is enough. Donald, I am a firm believer in scuttlebutt as well, and not only management talk [because essentially I see management’s words as that of a salesman] but his actions. But at the end, scuttlebutt can be a huge value addition. No doubts about it.

And when you are buying with 3-4 years ahead, valuation is THE single most biggest thing you should remember[or rather I should remember]. No single doubts about it. If I am to die today and somebody comes upto me and asks, what would I like to pass on- it would be, contrarianism and margin of safety. No doubt about it.

But when every piece of the puzzle[we can see-its like an iceberg, we see just part of it] points to a great thing, I think its more prudent to take a step back, go for a walk, drink a cuppa’ and try to kill the story and see, if it survives or not.

I am just trying to kill mine. :wink:

Soham

P.S: Please dont say, I am going to hold for 10+ years. I am training myself for that. But at the end of it, valuations will signal me to get out. If overnight P I Industries’s price show 55% growth till eternity, then I will sell out, even if I bought an hour back.

This is a theoretical exercise, aimed to put your analysis through rigors of bear markets, so that we build enough confidence to survive 45-55% declines and shakeouts

Soham

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Dear Soham,

Appreciate your line of thinking. In case, you want to hold on to something for more than 10 years, the endeavor should be to find companies with the least number of variables affecting their performance. Hence, VST Industries and Nesco continue to top my buy list.

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just wondering whether all the equity valuation techniques like dcf have any meaning in the real world,where u were always taught that the price u pay today is the npv of all future earnings till eternity,all reaserch analysts use dcf to arrive at prices with odd figures and just in a quarter or a year later the life time earnings go for a toss,maybe the infra sector was the flavor 3 years before ,then the power,then consumer etc,people get caught in the flavor,the latecomers get thrashed badly,has anything changed fundamentally in the argument put for infra 3 years back,except for the temporary slowdown we have.If we are convinced about the management and ability of Pi,we have to look at a 10yr perspective and hope we could discuss stocks which could be long term wealth creators

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Valuation has many inherent assumptions built into it. How well (and accurately) one can make those assumptions will drive the results of the valuation exercise. How there are too many moving parts in the valuation exercise to be able to be able to precisely value a company.

A margin of safety is necessary because valuation is an imprecise art, the future is unpredictable, and investors are human and do make mistakes. It is adherence to the concept of a margin of safety that best distinguishes value investors from all others. )-- Seth Klarman

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Thats a very good question and I would like to add some of my own 2 cents. Just perspectives. Before I start, let me tell something, old artistes of yore, used to pinch their nose and twist their ears and murmur their guru’s name beforedelivering a performance. This is to drive them in their minds, thatat the end they can never be perfect, and hence its futile tohave pride.

At this I would also say, that thesefollowing points are my own perspectives, and I can be very well wrong.

1). DCF is a sword. As good as the man weilding it. Use it carefully, and think a million times before plugging in a number.

2). True blue valuation exercise wont give you an exact answer. It will however if done right, can give a good picture of the “zone of value”

3). DCF can yield really bad results for volatile earnings. Consider, a company which is growing at a steady clip of 5% pa but its earnings drop by 150% in the fifth year. Discounting for 5 years, DCF will put very low weigtage on the fifth year as for the first[almost by thefourth power of the discounting factor]. Which gives a skewed estimate of the value in present terms. But this “estimate”, hides a core problem. What if the company goes bankrupt due to that drop in earnings? The real intrinsic value will be markedly different.

Hence the continuous “hammerring” of the stability factor in earnings.

4). THis ironically should also point to how boring businesses should be. Nobody wants to enter a crematory/final ritesbusiness or a coffin business for that matter, but everybody wants to be the next Cafe Coffee Day.

5). Discounted Cash Flow can be a knife in the hands of a serial killer or a brush in the hands of an artiste. Use it carefully. DCF is more dependent on the discounting factor than the cash flows. Estimate that discountingfactor properly. A mere 1.5% decrease in discounting factor can turn an “avoid-its-costly” to “buy-its damn cheap”.

6). To give an estimate ofhow an utter startup in say a high flying SSD technology, will have as a discounting factor, Ashwath Damodaran found itto be about 14.6% when the base interest rate regime is about 2%. You can understand how much of an uncertainity it presents.Though he borrows heavily from CAPM as well, but as a starting point for thinking, it gives a good idea.

7). DCF at the end of it, works best with steady earnings, a proper discounting factor[which reflects the risks inherent in the company] and spews out a number. Often peoplecommit the mistake of thinking it as a precise number. Its more of a range depending on how good you are. With time, the error margin decreases.

8). Cling to margin of safety. Always.

All these points explain to a huge extent,why Buffett repeatedly looks for dull+boring [less chances ofdisruption],monopolistic[less chances of competitive destruction], “moat-ed” [stable earnings] businesses. Sticks to his circle of competence [to estimate the earnings and its stability properly].

Just my 2cents

Soham

P.S: Ways to get better? build a niche,read entirely on them, go and talk to people out there and try to think of scenarios where your company will face volatility in earnings.Try to kill the company, cling to margin of safety. Opt for extra pessimistic numbers. Opt for extra pessimistic discounting factors.Calculate with earningsvolatility in your DCF calculations and check if things are still hunky dory. BottomLine: Spend hours making your hypothesis, spend days breaking them!

Soham

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Good to see this discussion. To be very frank

1). When I was reading up like mad, learning the ropes - I was most excited by DCF. As a concept it was really fascinating. Applying it was tough. As others have mentioned, its a dangerous tool in the hands of a novice. I liked Glenmark a lot in 2007/08 timeframes. I thought the business model had predictability built in it. 3 In-licensed molecules were bringing in/and going to bring in $69 mn additionally for the next many years till drug discovery. DCF analysis with this additional $69 million (that by the way went straight to the bottomline) showed it as cheap by half, with conservative discounting 15% plus, if I remember correctly. All other valuation measures showed it up as cheap. I went for the kill:)

2). For something like a year, I was overjoyed with the results. The stock doubled in less than 5-6 months. It went from 220+ levels to 400+ levels. everything looked rosy for this company. I thought I have latched on to a real long -term winner, never to let go kind of business at very cheap levels.

3). Suddenly one of the MNCs discontinued further research on a stage 3 molecule, citing some adverse side effect studies or something like that. Stock took some hit, but I was sanguine…so what others in the pipeline would come up. 3-6 months later another molecule was aborted. Suddenly 2 of the 3 in-licnsed molecules are out. The whole outlook on the company changed…prices crashed…the stock retraced itself to almost where I had picked it up.

4). Lesson for me - a) You cannot take predictability as guaranteed in R&D and Hi-tech businesses b) DCF works best only when there is a complete predictability in earnings/cashflows - however conservative your assumptions might have been. Even a 20% growth with 15% discounting will go for a six if predictability goes out.

5). Realised DCF has very little practical use for me - in making/swinging my investment decisions. At best it is just another valuation tool among others.

6). Realised what the Gurus meant when they say - You don’t need complicated modeling to tell you the intrinsic value of a business. if there is good Value, that will SCREAM out at you! Margin of Safety will be so high …as to be self evident.

7). We don’t find too many such situations -of under-valuedness screaming out at you - but sometimes you do. When the whole market crashes…that is obviously those times…like in 2009 Mar timeframes.

8). But even where markets are going nowhere, like say in 2010-11 timeframes, you come across situations where the Value just screams at you. We have to be very choosy, and develop a refined feel for under-valuedness. Something that among our friends I see Ayush Mittal very good at, Hitesh Patel(probably writes more often at ValuePickr/TED than he updates his blog) goes one better - to spot and be early in such opportunities!

We didn’t have any doubts about screaming UNDERVALUATION for

Manjushree -@30-40

Mayur Uniquoters - @220

Ajanta Pharma -@180 (Hitesh’s find; I got in later)

Astral Poly Technik -@120 (Again Hitesh/Ayush’s find; I got in slightly later)

Avanti Feeds -@ 35 (just 4-5 months back) ; quotes 120 now. I missed this entirely despite pointers from Ayush to look at it, look at it, mujhe to bahut accha lag raha hain!!

Now developing that sense of that UNDERVALUATION is the skill. It’s more an ART form. The number crunching and modeling will not take us there. The numbers and modeling are there for us more to AVOID mistakes!

Ayush and Hitesh, and a couple of other seniors have helped/keep helping me develop this feel slowly. They have helped me relax my theoretical thresholds (this was very very important for me). They have helped me see a few things that work fast in the market. They have certainly made me more practical - especially to appreciate that Excellent Businesses don’t sprout overnight. They mature from Good Businesses, achieve scale - economies of scale start kicking in, gradually improve efficiencies, to become better businesses, to hopefully Excellent businesses. Some of them fail to go to the next level, along the way!

They have helped me see clearly what they always maintained - There is Money to be made in every market. You need to keep getting better at the Science part of it to eliminate mistakes, but more importantly develop the ART side - spot what makes the Winners stand out from the average Joes - and sometimes Valuations will just SCREAM out at you.

Start taking a piece of that ACTION -even with incomplete information! Information will never be complete. Work very hard at gathering all you can, and question all you can, but build your own hypothesis for the Investment, keep moving and refining it with time with performance, with every new information set that comes in.

PI Industries is one such opportunity. Astral Poly Technik is another in my books. PI to an extent we have been able to transfer that conviction to a larger set of fellow investors -becaue of the great early work put in by Mahesh, Hitesh in confirming the promise, and then us collaborators taking the homework to the next level.

I may be wrong, but Astral is another extraordinary story in the making. Somehow fellow investors are unable to fully appreciate the power of the size of the opportunity before it, the power of the dominant position that it has - growing at 40% is no joke (everyone keeps talking of competition…how much has that affected/stopped Astral from growing) even when everyone is saying Realty and Infra is slowing. There are developments in the pipeline 2-3 years away which can propel the company a few levels higher, very fast. And next 2-3 years, it will have an unchallenged go. Its not easy to transfer that conviction…simply because this is an ART…that -something special- can’t be deciphered from the numbers, strictly speaking!

Those new to ValuePickr forums (and interested in discussions of this nature) are nudged to read the Capital Allocation thread in conjunction with this. I have a sense that helps you think about the ART side more concretely!

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WOW ! Lotof wisdom in couple of earlier posts.

Donald, I see that you are not very sure about using DCF for high tech companies. How frequently have you been using it since your experience with Glenmark?

Others, how often do you use DCF (or any other valuation methodology)while making a buy/sell decision?

I personally dont like it, or never used it extensively. Stupid numbers in, stupid valuations out. So not really reliable. Afterall how do you quantify the management capabilities and enter it in DCF (or other valuation tools)?

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Frankly I have stopped using DCF altogether. It was a useful concept to have while understanding how companies are valued. Its still pretty useful as a Valuation tool in Corporate M&As, Buyouts etc., I am sure - that’s because the focus there is on long term earnings/cashflows that can be generated by the business.

It is not useful for me anymore in stock valuations because:

a) My investment interest has shifted completely to finding quality small emerging businesses that can/potentially dominate a niche of their own and go on to the next level. Usually companies with annual sales less than 500 Cr, or 1000 Cr typically

b) Typically the investment premise is that I can see these companies compound earnings at >25% for next 2-3 years. If after 2-3 years they can still compound earnings I stay invested, else I cash out and invest in something that can compound at that rate from there on

c) These are not mature businesses, it is not practical to invest with a 10 year plus horizon. And without a 10 year plus horizon, it will not be meaningful for me to calculate discounted cash flow earnings say for smaller number of years. The very idea

d) DCF as a concept is certainly very powerful. It helps you to think about valuations in a very concrete way - That only 2 things really matter - what rate are earnings/cash flows likely to compound, and what rate should you discount that growth - given company standing, cost of borrowings (needed to fund that growth), etc.

And in general, the problem I have with DCF is - its use as an exact tool. It can only be a broad indicator for me. I prefer most valuation parmaters showing up things as cheap, with a big margin of safety! And I use the concept of compounding at a certain rate and the discounting it should be accorded as a framework all the time - in thinking about businesses.

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Afterall how do you quantify the management capabilities and enter it in DCF

You dont. And you do.

The proof of the pudding is in its taste, and a corporate management serves exactly in the same way- by delivering consistently stable cash flows.

I am not a big fan of EBITDA or EPS two of the very widely used and abused parameter to calculate [EV/EBITDA and PE]. I am a huge fan of Enterprise Value and not of MV. So I am willing to see EV/Free Cash Flow to Firm as a better metric. But anyway, I digress.

Management’s quality and skill is in constantly delivering a stable free cash flow. If it grows it, then great! Take a series of numbers which are very stable, and one which are erratic, DCF will give high premium to stability. Does it work? Not on a year to year basis [every year has its winners and losers], but on a 5 year term? Definitely!

Take a look at companies like Nestle, GSK,Gillette etc which have been adding economic value over a continuous basis, and market even in such conditions are awarding it such high multiples.

DCF like every other mathematical tools will give you just one perspective-. You need to look at the company with different perspectives.

As of me, when the stock is not straight away deep value, like pBV>1 or EV is not negative, or stuff like that, I resort to DCF. But just DCF wont help, its just one of the tools in my checklist.

Soham

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PI Ind. gets acknowledged as an Indian PowerBrand at Indian PowerBrands Conclave, London…

http://www.piindustries.com/content/pi-indian-power-brand

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PI Ind. MD, Mr. Mayank Singhal is confident of crossing 1000 cr. revenue mark in FY13 with PAT of more than 130 cr.

Agri-Input head expects future growthdriven byfiveproducts :

Nominee Gold,

Biovita(L),

Kitazin,

Simba,

Maxima

(source - co.'s inhouse magazine)

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Link to pdf of my Q3FY12 as well as 9’Month’FY12 estimate for PI Industries Ltd.

http://www.scribd.com/doc/76999128/

Rgds.

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