Sahil's Portfolio

[greengoblin]

Thanks Sahil for adding clarity to my thoughts!
My apologies for the delay in response.

@sahil_vi

Besides, does it matter whether sirca can set prices or not?

I have heard of few instances where bigger players have played out small players through price wars, because of scale they can have. An instance could be TaxiForSure. Amazon has done it.
I am not saying, Sirca would fall the same fate. I am only trying to build a narrative (which you rightly pointed out).

@sahil_vi

If your question is: why won’t ICA pidilite and asian paints price sirca out of the market? i do not have an answer for that.

I think they have a mention of this in one of their ConCalls. Quoting it directly here:

Harshil Shah: Also lastly what are the competitors that you are most competing with fearful of and why are people deciding to go with you versus the more traditional established brands
such as Asian Paints?

Apoorv Agarwal: So our major competitor in the market stands as ICA Pidilite which was ICA before
and was taken over by Pidilite in early 2017. He acts as a major competitor for us in
the market.

Harshil Shah: Why would people be choosing you over something like an ICA Pidilite, is it a pricing difference, is it working capital you are providing to these retailers or is it the quality?

Apoorv Agarwal: No, working capital is in fact we think that ICA Pidilite is providing a lot more in terms of credit that they supply to the market is even higher than ours, but then our presence, see, Sirca brand started from the Northern part of India 15 years ago and ICA before being ICA Pidilite was majorly a South centric brand, but now moving forward with ICA Pidilite, their marketing strategies and their core mission with the
company seems to be that they are positioning again their brand as a local
manufactured brand and they are moving towards 100% local manufacturing and they are stopping imports vis-à-vis we, Sirca Paints, we are focused majorly to keep focus on our premium Italian wood coating range which we are going to keep on importing from Italy and do a vertical and horizontal expansion of the product lines from the new facility. So our major edge is that we want to keep the position of our pure Italian
brand in the market and enjoy the specification of architects and interior designers and also the end users giving them the feel of a pure Italian product. Besides that, we want to increase the product portfolio from this new facility so that we can take over the increasing chunk of the Italian PU in future because the Italian PU market is growing at a tremendous rate in the coming years and is taking over Indian PU at a massive rate.

@sameernics

Even the Sirca management has confirmed that the pie is so sizeable that there is enough for everyone and not a threat.

That’s what I found it in the Q1 ConCall. The industry is growing at 20% CAGR, and there is enough for everyone.
Sirca is in good sector, has tailwinds, and if executed well, can capture good market share.

[sahil_vi]

Valuation of portfolio stocks - Part 1

In this post we will understand how richly my portfolio stocks are valued. As I have started in the posts above, I’m an investor who is looking for both growth of fundamentals and also an increase in valuation of the stock.
Note of caution: In many of the cases, the comparisons would not be apple-to-apple because many of these are unique companies. For example, chemcrux does not have a peer in the listed space per se. In such cases, I pick a couple of random peers from screener. I use EV/EBITDA valuation from tikr.com for most valuation exercises. EV/revenue also paints a similar picture.
In this part I’ll analyze top 5 stocks in my Portfolio from valuation perspective.

@sahil_vi

the level of under-valuation (industry + company (both) is great, only one of them is good, none of them is bad).

In order of position size:

1. Chemcrux

Explanation:
Chemcrux is 100 times smaller than any of these competitors in market size. It is a BSE SME company. Very illiquid. Valuation is much lower than competitors. I expect rerating over time as it grows and enters BSE main board and as the sales/profits growth story story pans out.
Current Under-valuation compared to peers average: 3x
Current Under-valuation compared to peers peak: 4x
Current Under-valuation compared to self (past history): Between average and peak valuations.

2. IDFC First Bank

Explanation:
Peers trade at average of 4.5x tangible book value. Indusind valuation started falling around 2018 when they started reporting provisions which were very large compared to their NII. IDFC First is available at book value. I am up 40% overall. Meaning I bought it at 0.6x BV roughly. As the focus of the bank shifts from corporate to retail assets and liabilities, I expect a rerating over time.
Current Under-valuation compared to peers average: 4.5x
Current Under-valuation compared to peers peak: 6x
Current Under-valuation compared to self (past history): 1.16x undervalued compared to average and 2x compared to peak valuations.

3. Caplin Point Laboratories

Caplin is undergoing a transformation in business model wherein they are entering the large LatAm markets, taking up government tenders, starting backward integration, building new injectables facility. In general there are lot of uncertainties. This, along with general midcap route has corrected caplin’s EV/EBITDA multiples went down drastically. I believe the company has delivered until now, and their strong focus on cashflows and returns will result in a re-rating as they prove their mettle both in larger LatAm countries and USA/West (injectables). Do note that my buying prices here were 70% smaller. When i bought it, the undervaluation was much larger.
Current Under-valuation compared to peers average: 1.5x
Current Under-valuation compared to peers peak: 2.6x
Current Under-valuation compared to self (past history): 1.33x undervalued compared to average and 3x compared to peak valuations.

4. RACL Gear tech

The company makes gears for auto sector (2 wheelers and trackers) and has long-term contracts with many multi-national clients. The headwinds for the auto-sector have resulted in valuation fall for RACL geartech. Another factor at play here is that similar to Chemcrux, RACL is a very small company. This also keeps RACL’s rerating limited since institutions are unable to own it. As RACL grows its sales/profits, i expect a reasonable rerating over time.
Current Under-valuation compared to peers average: 2.6x
Current Under-valuation compared to peers peak: 4.6x
Current Under-valuation compared to self (past history): near average valuations and 2x compared to peak valuations.

5. KEI Industries

KEI is the most boring company in my portfolio. It makes wires. I have purposefully excluded havell’s from the comparison since they have created a distinguished brand for themselves which gives them a very rich valuations which would skew my analysis. KEI’s end industries which, some of which are power sector, housing, and auto are all in a cyclical down-turn. KEI in that sense also sits in an industry with some headwinds. As the headwinds turns, government capex for National Infra pipeline happens and more infra gets created, KEI would grow both its earnings and also its multiples.
Current Under-valuation compared to peers average: 1.6x
Current Under-valuation compared to peers peak: 2.3x
Current Under-valuation compared to self (past history): near average valuations and 2x compared to peak valuations.

[sahil_vi]

Valuation of portfolio stocks - Part 2

Continuing from the previous post.

6. Lincoln Pharma

Lincoln is also a turn-around story. From being a pure trading and marketing company, they have started manufacturing their own formulations (FDFs). They also recently got EU GMP certification from Germany FDA. Like RACL and Chemcrux, due to their small size, their valuations have been rather muted compared to peers.
Current Under-valuation compared to peers average: 3.3x
Current Under-valuation compared to peers peak: 6.8x
Current Under-valuation compared to self (past history): near average valuations and 2x compared to peak valuations.

7. Poly medicure

One thing worth mentioning is that Poly medicure really does not have a listed peer which is even comparable. I have added lal path labs which is into diagnostics and apollo hospitals which is a hospital chain. Polymedicure is one of the 2 purchases which i did near the average valuation of the company (fairly valued) due to the large size of opportunity ahead. They have given consistent 15% sales growth in last 9 out of 11 years. Are just getting into dialysis. Also have an untapped market potential in USA. The opportunity size and strength of past performance made me purchase poly medicure at near historical average valuations.
Current Under-valuation compared to peers average: 1.2x
Current Under-valuation compared to peers peak: 2x
Current Under-valuation compared to self (past history): near average valuations and 1.5x compared to peak valuations.

8. Astec Life sciences

Comparing astec with two different types of peers: PI industries and Bharat Rasayan. Astec is owned by Godrej group, and is the second company that i bought near long-duration historic average valuations. Again due to the large growth runway in front of them. Given the industry tailwinds with Make in india, import substitutions, China-to-india migration growing farmer income in India I also realized it would be very difficult to find it near average historic valuations again.
Current Under-valuation compared to peers average: Not under-valued
Current Under-valuation compared to peers peak: 2x
Current Under-valuation compared to self (past history): near average valuations and 2x compared to peak valuations. (I do not value bajaj finance because I intend to sell out of bajaj finance eventually and deploy the money into IDFC First).

9. Sirca Paints

Small wooden coating maker with strong lineage from Italy. It recently raised capital in IPO to start manufacturing plants in India. Also intends to diversify into wall paints. Due to their small size (both business and also brand recognition), trades at a much larger discount to other paint companies. Rerating would depend on management capabilities to operate well and scale up the business sustainably.
Current Under-valuation compared to peers average: 1.33x
Current Under-valuation compared to peers peak: 1.66x
Current Under-valuation compared to self (past history): Company has only been listed for 1 year so I dont think it is reasonable to look at this.

10. NCC

NCC is the second largest listed construction player in India after L&T. In the last few years, construction and infra has fallen out of fancy. That, coupled with the better perception in quality of management of L&T has resulted in much lower valuation for NCC. The National Infra pipeline will provide the required impetus to improve NCC’s cashflows and valuations. If they can grow their scale of operations successfully, I believe an even bigger re-rating is possible.
Current Under-valuation compared to peers average: 4.33x
Current Under-valuation compared to peers peak: 10x
Current Under-valuation compared to self (past history): 2.2x

I only intended to analyze these top 10 holdings since they impact my net worth the largest.

In conclusion, my portfolio is definitely under-valued as per my understanding.

[sahil_vi]

Portfolio Update

I’ve also done some interesting analysis on Average market cap of my portfolio and also the position weighted valuation upside potential.

Instrument	Avg. cost	Net chg.	Cost %	Market Cap (in cr)	Position Weighted Market Cap (in cr)	Valuation Upside vs Avg of Peers (in %)	Position Weighted Valuation Upside
CHEMCRUX	181.5	24.44	0.2472495817	111.4858868	27.56483888	200	49.44991634
IDFCFIRSTB	23.74	41.76	0.1308151901	18094.78	2367.072086	350	45.78531654
CAPPL	314.28	73.61	0.08669632894	4135.011113	358.4902837	50	4.334816447
RACLGEAR	76.34	44.82	0.06998841462	119.1904807	8.341952782	160	11.19814634
KEI	303.58	36.54	0.07402614333	3722.303808	275.5477952	60	4.4415686
LINCOPH	174.55	39.04	0.04874528909	485.1085112	23.64675462	230	11.21141649
POLYMED	348.61	21.74	0.05128879934	3732.846831	191.4532321	20	1.025775987
ASTEC	1018.67	15.05	0.05134452926	2294.856397	117.8283214	0	0
SIRCA	200.54	31.07	0.03824617276	721.42083	27.5915857	33	1.262123701
NCC	26.2	38.94	0.0340850236	50.2421032	1.712503273	333	11.35031286
RAIN	85.71	39.02	0.03403525355	4005.929095	136.3428125	100	3.403525355
GAEL	177.08	7.35	0.04100882924	2197.012475	90.09690943	0	0
KPRMILL	485	16.7	0.02642777898	3892.937246	102.8816851	0	0
SHBCLQ	37.72	10.55	0.02749061162	160.1396789	4.402337717	0	0
Total					3732.973098		143.4629187
Cost and position Weighted Market Cap	3732 cr
Position Weighted valuation upside (vs average of Peers)	143.46%

[rkirana]

Excellent analysis and great way to build a portfolio.

With companies that are mostly mid-cap or small-cap, it makes sense to have 20-25 stocks in portfolio with max of 5% in any company because we don’t know what we don’t know in these. In case, any of these turns out to be a DHFL or Yes bank, portfolio will be hit a lot. You have a number of gems in your portfolio and these will turn out to be better than most MFs definitely.
Just cut out the risk by having more companies in portfolio.

[sahil_vi]

Given the concerns wrt Caplin’s accounting hygiene I have decided to exit it. We as investors always need to find the best use for our capital. Despite investors’ attempt to let management explain glaring inconsistencies in the accounting, they did not. The auditors compensation has gone up more steeply than the sales in the same period. These could simply be coincidences with some very innocent explanation. But when investing in a small cap company (4k cr) we have to be “better safe than sorry”.

There are a few other portfolio updates too that i will post soon. Major update is that i intend to redeploy majority of caplin capital into Alembic Pharma (which is trading at a similar valuation, but has much better management integrity, better growth visibility, better business model as well imo).

Will post a more holistic update soon.

[sahil_vi]

Some portfolio updates:

1. I have switched my october expiry put option for December expiry put option for same strike price (9500). Additional money I put in was 4725 Rupees (This gets me protection until end of December). I will re-evaluate the option in November beginning.
2. I sold out of Caplin point completely because of shoddy accounting practices. This is bad accounting at best and potentially siphoning company funds at worst. As an individual investor it is difficult to evaluate what is really happening. The other key reason for me to exit was that caplin is at a cusp of change with the older business model (selling with negative WC to smaller distributors/retailers in small LatAm countries) having run its course. They are trying to adapt by changing their business model (US injectables plant), but it is difficult to take a leap of faith especially if the accounting is questionable (few other instances are there as well). Will keep watching for how the story evolves.
3. Selling caplin created a lot of liquidity (since it had run up 70%+ since my buying price). This ~14-15% of PF was partially re-deployed into several stocks. Primary among them are NCC and IDFCF. Both are severely undervalued. Also invested in Polymed which has great industry and company tailwinds with lots of encouragement from government to make in India as well as their move up the value chain. And as I will also explain in future posts, all of my PF stocks have a good growth path in front of them (with regular caveat of exdcution risks). This combination of earnings growth and under-valuation is precisely what I would like most of my PF companies to have (admittedly some like Polymed don’t).
4. Apart from these 2, a large portion was deployed into Alembic Pharma. Coincidently alembic is priced similar to Caplin at around 17-18 P/E and 4x Revenues. What is very different is the immaculate proven history of competence. Alembic is most likely one of the best when it comes to USFDA compliance due to their innovative compliance processes (including mock inspections). Alembic is in the middle of executing a large capex (3x net fixed assets in last 5 years and 3x CWIP for a total of 6x fixed assets that they will have in next 1-2 years). 15% YoY growth in Filed ANDAs each year for last 5. US business has grown at CAGR of 45% in 5 years. Indian business focussed on Niche and high-margin products. Only 1.5% of indian business market share. Only 1-5% market share for many products it competes in (notable exception is the high margin azithromycin). All of this front-end backed by 10-15% R&D expenses year and year. And despite that, a high OPM of 27% means that alembic ticks most boxes for me. Expectation is of a 3x market cap in next 5 years on the back of little valuation-expansion and largely driven by earnings growth. Would be glad if it falls in a future market crash. Happy to buy loads on dips slowly.
5. Sold out of Shivalik Bimetals. The company has a unique business model but currently management is unable to walk the talk. Anyway this was a tracking position.
6. Have taken a keen interest in CRAMS and biosimilars. Am studying a few companies in Detail: Biocon, syngene and Neuland. I have a severe bias for small companies because i find it difficult to imagine how a 50k company would become 500k company. Biocon and Syngene are already pricing in a lot of growth but neuland is the opposite. The market currently is practically discounting their CRAMS business which is at an infant stage but the management’s conservative approach along with the sheer detail of their investor presentations along with their good clientele make me very interested in Neuland. Have studied FY20 AR, Q1-FY21 concall and a few online blogs. Intend to study last 5 years of AR and last 5 concalls. Specifically very interested in finding out why the margins and return ratios fell in 2018 and 2019.

Will post a table form of PF soon.

[sahil_vi]

@sahil_vi

Specifically very interested in finding out why the margins and return ratios fell in 2018 and 2019

From Q4-FY20 concall:
"Pritesh Vora;Mission Holdings;Analyst

Right, sir. And sir, last question is, what happened in 2018 where the gross margin and the EBITDA margin fell during that period of time? Is there any product – particular product liable for that fall during that period of time?

Davuluri Rao

No, I think we had clarified that on previous calls. I think the year the margins fell is because our product mix had – it had temporary roadblock. Second, we had some imbalance in capacities where we received more orders from one unit versus the other. So we’ve invested a lot in rationalizing those capacities, the impact we saw in FY '20, where – both in FY '19 as well as FY '20 in terms of sales growth. We also saw lower growth in our CMS business that year, which impacted the margins, which you’ve seen that has come back to the normal levels in FY '20 as well. So we had mentioned in those calls that the pressure on margins was more temporary in nature and that the organization was taking the necessary steps in terms of cost reduction, product rationalization, focus on specialty APIs as well as CMS business, which you’re seeing come back in FY '20."

[sahil_vi]

While i continue to do deeper dives into Neuland and also Suven Pharma,

Wanted to add some thoughts regarding Portfolio structuring. Currently 33% of net worth is in this core high growth small-cap oriented PF. This is also extremely risky both due to concentration and higher uncertainty surrounding the companies involved. They need to be tracked day-by-day because there isn’t much institutional research. Even if there was a market fall i would be uncomfortable taking the % of PF deployed in this core-PF strategy beyond 40% because the risk of permanent loss of capital is high and I do not have enough trust in my own skills. Towards that end, I am thinking about starting a satellite “coffee can” PF which would contain companies which provide good/essential products or services and are likely to be around after 10 years. I fully understand that many of these are extremely overvalued companies. Which is why the plan is to build up a position slowly over time, adding higher %tages in the event of a crash which increases margin of safety.
Have added the proposed companies in Coffee can thread to enable better feedback gathering;

Coffee can method

Hi everyone, I’m thinking of constructing a coffee can portfolio of large companies as a way to ensure that i can deploy capital in a less risky way than my core portfolio (which consists of mid and small and microcap companies). Towards this end, looking for feedback on the following portfolio I had in mind: Kotak Mahindra Bank Bajaj Finance ITC Britannia Biocon PI Industries Motherson Sumi Larsen and Toubro Infotech My primary criteria for picking has been to think about the next 10 years…

Please feel free to comment either here or on that thread regarding any aspect of it. I expect this to be between 10-20% of PF with 40-50% PF in safer assets like Fixed deposits and liquid funds. With this, I also plan to stop investing in Mutual funds except when doing so for specific goals (because i still do not trust my investing skills enough to tie investing for medium horizon goals to my own stock picking).

[AVB]

Looks like a reasonable tactic at this point. As far as mutual funds are concerned - I am enticed with the ELSS variants for the extra few percentages obtained from tax break.

Because otherwise every fund manager seems to copy everyone else. Probably their core idea is to generate a few more percentage than standard FD to lure the middle income strata.

Would like to ask a rather witty question here. Has anyone heard of Max Fashion ?

I went to the mall today and in a kind of witty Peter Lynch like moment, got to know from my fiance that they are the next big thing right up with the Reliance Trends and Pantaloons of our world.

But upon checking Moneycontrol found nothing. But did find that their parent company is Dubai based Landmark group. So that’s a start maybe.

[harsh.beria93]

Hey!

Its always a good idea to diversify investment styles, as different styles perform at different points over a market cycle. However, why is your coffee can so India centric? Instead of buying Indian franchises, why not go for global franchises (which are more dominant) and live off the royalty paid by the Indian subsidiaries to their International parent, which is then passed to you as dividend or a buyback? You can participate in India growth story, have the franchise element, pay much reasonable valuations and the cashflows will be more internationally diversified.

About the Indian coffee can, how does Kotak Mahindra, Bajaj finance and Biocon make it to the portfolio? I ask this because Kotak and Bajaj did horribly NPA wise in the 2008 downturn. They have barely had a decadal track record of maintaining low NPAs (Kotak’s 2009 NPA was ~5%, their current NPA is inching up and has reached ~3%). In lending financials, the only Indian company to have a track record of maintaining NPAs below 2% over 2 decades is HDFC, that makes much more sense over Bajaj or Kotak in a coffee can kind of an arrangement.

Biocon is also a very recent story, their re-rating was due to their biosimilar portfolio, the first of which was approved in 2017 December. How can you extrapolate this 2-3 year track record for the next decade? In principle companies in a coffee can portfolio should have a consistent track record of atleast >1 decade because the holding period is atleast 1-decade, or am I missing something?

If you are not averse to leveraged companies (as you okay with investing in lending financials), why do you not consider utility companies like Power grid? They get regulated ROEs of 16%, return most of profits as dividend and compound book value at ~15%. This is probably one of the very few companies which will be around even after few decades (irrespective of government), because they transmit almost all of India’s power (be it solar, wind or coal based).

About auto-ancs, why go for Motherson when they already such a big company? Instead, you can find much smaller players which have the exact same (or a little better) track record (in terms of sales and profit growth) and are much smaller in the auto anc space and have a much cleaner corporate structure (eg: suprajit). If you are looking at pure book value compounding, even a company like Swaraj Engine makes more sense (debt free balance sheet, most earnings returned as dividend & long term sales growth at 1.5x GDP).

In IT, why do you choose L&T info over its larger peers (such as HCL tech)? HCL has grown sales at a very similar pace, have superior margins (showing they are not undercutting to get orders), and are growing faster than most Indian IT companies.

Looking forward to your thoughts!

[sahil_vi]

Hi harsh, Always good to get your insight on everything.

@harsh.beria93

However, why is your coffee can so India centric?

I do not have a way to invest in global stocks. Last time i tried using vested, they needed me to open a bank account with ICICI bank to enable me to invest in global equity. This was after covid, so difficult to do.

@harsh.beria93

You can participate in India growth story, have the franchise element, pay much reasonable valuations and the cashflows will be more internationally diversified.

This makes sense. As of right now though the purpose of even the coffee can PF is capital growth, not so much dividend investing. I have considered dividend investing in the past but I believe I’m not there yet. There are enough and more opportunities for even the largest companies in India to grow 3-4x in 10 year period. Are such opportunities available in Global markets? I’m not so sure. Global nominal GDP growth rates are typically much lower than Indian ones. I do agree that for a dividend growth type of PF these global giants (eg: Pharma in US, few swiss companies) make a lot of sense.

@harsh.beria93

I ask this because Kotak and Bajaj did horribly NPA wise in the 2008 downturn.

Bajaj finance changed their entire business model since Rajeev Jain and Sanjeev bajaj joined around 2007-08. I think one fallacy i observe in some investors behavior is that they prefer to rely on last 10 years (which might or might not be indicative of next 10) instead of thinking about the next 10. I agree i cannot project earnings and cashflows for 10 years (or even 2 for many companies). But what im interested is in the direction of the company.

Kotak bank is a misnomer. This is a diversified financial services company. Banking is one of their large operations, but other 2 valuable ones are AMC and Insurance. There is a lot of value unlocking in the future for Kotak bank if and when they decide to list their insurance and AMC operations. Even if they do not, they are one of the most prudent bankers in India now exemplified by provisions for covid-19 high capital adequacy ratios.

@harsh.beria93

In lending financials, the only Indian company to have a track record of maintaining NPAs below 2% over 2 decades is HDFC, that makes much more sense over Bajaj or Kotak in a coffee can kind of an arrangement.

The past has almost no predictive value for the future. I agree that HDFC Bank is one of the best run franchisees in India, but i have had some very bad experiences with them off late. I’m an unsatisfied customer. How can I be a stockholder for them? I was begging them to give me a 1.5cr Home loan, but they just didn’t care enough. Haven’t heard great things about HDFC Bank from other people either. having said all of that, would HDFC bank grow earnings and AUM by 10-15% over the next decade, undoubtedly.

@harsh.beria93

Biocon is also a very recent story, their re-rating was due to their biosimilar portfolio, the first of which was approved in 2017 December. How can you extrapolate this 2-3 year track record for the next decade? In principle companies in a coffee can portfolio should have a consistent track record of atleast >1 decade because the holding period is atleast 1-decade, or am I missing something?

I disagree with this. I think investing has always been and should always be about the future. Not about the past. Pharma is a tricky space. Generics companies are not distinguished in any way. Same for APIs. They need to be monitored carefully. Biocon is the only Indian listed biosimilar company. Biocon valuations are very high, which is why I’m looking to build a position slowly over time. However, given that most global pharma innovator company pipelines are moving away from synthetic chemical towards biologics, i think biocon is a safe investment for the next 10 years. Am i overpaying for biocon? Definitely. Will it matter after 10 years? Probably not. The risk of execution being bad is definitely there. Which is why i plan to build this position slowly over time. I am also open to expanding my list of companies beyond the 8 to about 10-15 since this is a low churn PF with exits only on major events. This would reduce the risk posed to PF by biocon even more.

@harsh.beria93

If you are not averse to leveraged companies (as you okay with investing in lending financials), why do you not consider utility companies like Power grid?

Im not sure how commodity companies can create value. If their output is not valuable, how can they be valuable? You’ve brought up a brilliant point about leveraged balance sheets. For a financial institution, this is unavoidable. Money is the product. They’re simply platforms for matching sellers with buyers with the guarantee being provided by the platform. However, they are also very well regulated by RBI (true for kotak not so much for BF). Power finance’s main business is not that of debt. I’m ok with high D/E for financial institutions because managing that risk is their bread and butter. Not so much for utilities since managing debt is not their primary function. Btw did you see their interest outgo? It is almost as much as their NP. Will the company be around after 10 years? Probably yes. Does that necessarily imply a good investment? probably not.

@harsh.beria93

About auto-ancs, why go for Motherson when they already such a big company?

In their latest AR they have guided for a 4x increase in Sales in 5 years. They are known to set aggressive targets and underachieve. However, these aggressive targets ensure that even if they miss, they still multiply the revenues significantly. The entire purpose of this PF is to buy large companies with well diversified operations. Motherson espouses this ethic in everything they do. Not more than 10% revenue from any 1 country, any 1 component or any 1 client. Are you sure Suprajit or Swaraj engines would be around after 10 years?

@harsh.beria93

In IT, why do you choose L&T info over its larger peers (such as HCL tech)? HCL has grown sales at a very similar pace, have superior margins (showing they are not undercutting to get orders), and are growing faster than most Indian IT companies.

L&T has much better return ratios due to better asset turns. To be fairly honest, I have not studied HCL tech a lot but could see a 3 negatives which put me away (of course deeper study can help me become interested):

1. They have a fairly non-trivial debt. Their dividend payout is also significantly lower than industry consistently.
2. Asset turnover is much lower than peers. (LTTS is 2.0 and HCL is 1.2 TCS is 1.8).
3. Earnings fell in between in 2019/20 which is strange for an IT company. Their are considered to be one of the stickiest and more consistent earnings companies. Im sure there is some good reason for this, but the point is to pick companies which do not need many deep dives.

Overall, thanks a lot for your thoughts, Harsh. Key actionables for me:

1. Look to add more companies to guard against execution risk of Companies like Biocon.
2. Consider adding HDFC Bank.
3. Find if there are global cos which are growing at 10-15% PA.

PS: I definitely do not want to invest in Global tech. My future is already intricately tied to my employer Google. I certainly do not want to invest in any other global tech company.

[sahil_vi]

@AVB

I am enticed with the ELSS variants for the extra few percentages obtained from tax break.

Hi AVB thanks for adding your views,
I generally max out my 80C with my EPF deductions.

@AVB

Because otherwise every fund manager seems to copy everyone else. Probably their core idea is to generate a few more percentage than standard FD to lure the middle income strata.

This is especially true for large-cap funds and very visible when you superimpose their NAVs on top of each other.

@AVB

Has anyone heard of Max Fashion ?

I have.

@AVB

But upon checking Moneycontrol found nothing. But did find that their parent company is Dubai based Landmark group. So that’s a start maybe.

Definitely worth following up on.

[harsh.beria93]

I need a little bit of clarification, doesn’t coffee can mean having a very long established performance (consisent sales growth over the last decade along with high ROE)? If that is the case, then we need consistent YOY sales growth for over a decade, thats why my comment on Biocon. I am actually long that stock, but never thought of it as a coffee can thing. Let me play a little of devil’s advocate here. Feel free to ignore if it looks like a banter.

About biocon, the one thing which they have done well is being early in investing in the first round of biosimilars (which require $50-100 mn/molecule investment and a waiting period of 7-8 years). Others have been caught on the back foot and Biocon is milking this opportunity. But in 10-years everyone will be in this business line making it similar to a generic business line (this is also what happened with Reddy’s in 2000s when they were the first to get a FTF, everyone figured out that business model and now its more or less a commodity). Nobody in India actually has been successful in making a patented blockbuster drug yet.

About global investing, this is a misnomer that India offers higher growth. For example, Suzuki’s EPS growth over the last decade has been higher than Maruti’s. Starbuck’s EPS growth over the last decade has been higher than that of Tata consumers. Your argument is true for consumer staples, but not for every brand owner. I was talking about owning the brands but instead through the international subsidiary because the global parent already owns the Indian subsidiary (eg of Suzuki owning 56% stake in Maruti). Also, Indian growth optically looks higher because of 4% inflation differential, which simply means that Indian rupee is devalued by 4% more than USD. So a 4-6% growing company in USD is similar to an Indian company growing at 8-10% (which is almost all of India’s FMCG and IT).

About Bfin and general qualms in investing, past is not a very bad predictor (atleast better than human intuition). For instance, if you look at 1997 financial crisis, the NBFCs that went bust then again went bust now (eg: LIC housing, DHFL, even CARE ratings went through the same mess in 1997). About Kotak, I can apply the same argument for SBI. Nobody buys a bank because of its franchise value (remember Yes also had/has a very strong franchise value and diversified business lines) but on the quality of their loan book. That’s because banks work on a NIM of 3.5-4%, with Opex and employee costs accounting for 1.5% of costs, so their net return on assets is 1.5-2%. So they need to add ~10x leverage to achieve ROE of 15-20%, so its the leverage book which counts and not other business lines. I will recommend reading about Edelweiss, they also have very good ARC and AMC businesses, but they were butchered because of their corporate and RE book. Its not the other business lines which matter, its the loan book which matters in lending financials. Plus, Kotak is current trading at a higher valuation than HDFC (premium valuation for what?).

About utilities, I am talking about Power grid and not power finance. On one end you are saying that commodity companies cannot create value, and on the other end you are bullish on lending companies. How are lending companies not commodity businesses? Will you ever prefer taking a loan at higher interest rate from a bank just because its well known? About power grid, if this guy is not around and doing well after 2-decades, we will not be having this discussion on an online forum because we wont have electricity. Utility businesses create a lot of value (probably the only real value in the world) as they create the basic infrastructure on which industries are built. That’s why they get regulated ROEs. These are annuity businesses and are valued accordingly. Just for context, one of Berkshire’s large bet is on utility business because this is scalable (can take in a lot of capital) and the ROEs are greater than cost of capital (it has to be to make it viable). Power grid will always be leveraged, otherwise our electricity bills will go through the roof (because of cost of equity is higher than cost of debt).

About Motherson, don’t take me wrong here. My family bought shares of this company in 1996, we have done well here. But an auto ancilliary is dependent on an OEM. Motherson already has annual revenues of ~$8bn, the next 20 years cannot be like the last 20 because they will become larger than OEMs which is just not possible. About Swaraj and Suprajit, these two have been around for 25 years now (look at what anyone would have made if they invested in Swaraj in 1989 IPO). Suprajit has grown sales for 20%+ in last 20 years, I am willing to bet that these guys will be around in the next decade (as they are moderately leveraged unlike Motherson). All these 1 component, 1 country, 1 client non-dependence criteria also applies to Suprajit. They are just less discussed because of size.

In IT business, employee costs are the biggest contributors. These are not manufacturing companies where we should compare asset turnovers. What matters is client concentration, geograhic and industrial diversification, and product stickiness. Once ROE is much higher than cost of capital, its growth which drives value. About dividends, I am happier if my company can redeploy capital and grow at higher pace. HCL is probably the only one which actually acquires IP and tries to monetize it (thats why they have the higest industry sales growth). Also, earnings did not fall for HCL in 2019-20.

[sahil_vi]

@harsh.beria93

I need a little bit of clarification, doesn’t coffee can mean having a very long established performance (consisent sales growth over the last decade along with high ROE)?

Hi harsh, The principles of coffee can investing are: “Find a set of companies that you expect to provide growth and protection of capital over the next 10 years”. The ROE and past sales growth filters are all implementation details. Many large companies showing good sales CAGR in last 10 years, might not be geared towards next 10 years. Example: Saudi Aramco. IMHO, even LIC is such an example although a few people might disagree. My point being, it is important for us to have an opinion about the next years for the company.

@harsh.beria93

Let me play a little of devil’s advocate here.

Please, that would always be very helpful. It is only through spirited discussions (including healthy disagreements) that we test our own conviction in our statements/ideas. I also want to avoid confirmation bias.

@harsh.beria93

About biocon, the one thing which they have done well is being early in investing in the first round of biosimilars (which require $50-100 mn/molecule investment and a waiting period of 7-8 years). Others have been caught on the back foot and Biocon is milking this opportunity. But in 10-years everyone will be in this business line making it similar to a generic business line (this is also what happened with Reddy’s in 2000s when they were the first to get a FTF, everyone figured out that business model and now its more or less a commodity).

This is an excellent question. But i ask you a counter-question. Does this risk not exist for all companies regardless of industry and even company? Eg: HDFC Bank (the one you think fits into Coffee can PF). We should also note that if currently generics-focussed companies start investing right now, due to the large gestation period of 7-8 years, in 8 years they would be where biocon is today. So they would always be 5-8 years behind biocon, unless they carry out some serious innovation. We should also understand that the pie for biosimilars is also growing faster than overall pharma space. You’re right that competition in Biosimilars will definitely be higher 5 years later, but this is also why i will definitely evaluate the financials at least once a year (target is once a quarter if time allows). The PF is coffee can in the sense that I do not intend to monitor each and every NSE filing. However, major shifts in company unit economics should still be reasonable triggers for exit, as long as such activities are infrequent.

@harsh.beria93

About global investing, this is a misnomer that India offers higher growth. For example, Suzuki’s EPS growth over the last decade has been higher than Maruti’s. Starbuck’s EPS growth over the last decade has been higher than that of Tata consumers.

Fair point. These businesses are definitely worth evaluating. I think the largest barrier to entry I face right now is entry into global stocks in India.

@harsh.beria93

Its not the other business lines which matter, its the loan book which matters in lending financials. Plus, Kotak is current trading at a higher valuation than HDFC (premium valuation for what?)

The AMC and the insurance businesses are causing Kotak valuations to be high. I agree that the manner in which the bank manages leverage matters a lot, which is why the net and gross NPAs are a key monitorable.
Valuations being high -
Please see the evolution of the valuations for HDFC, which held HDFC AMC (Listing in July 2018) and HDFC life insurance (Listing in November 2017).

We can see a clear fall in valuation in the valuation since end of 2017 and another one near July 2019 with the listing of the 2 subsidiaries.
I believe something similar will happen with Kotak when its subsidiaries get listed.

@harsh.beria93

How are lending companies not commodity businesses?

Due to their differentiated business models. Please read the Bajaj finance thread. It’s a good primer on how far a differentiated lending model based on technology can go in creating value.

@harsh.beria93

Will you ever prefer taking a loan at higher interest rate from a bank just because its well known?

The answer might surprise you, but for a few people (co-owners in same society where I bought a flat) i know the answer is an emphatic yes. Based on better customer experiences.

@harsh.beria93

About power grid, if this guy is not around and doing well after 2-decades, we will not be having this discussion on an online forum because we wont have electricity.

If you read my previous answer carefully, you’ll observe that I do not doubt that at all. The question is whether they would have created value for investors.

@harsh.beria93

Power grid will always be leveraged, otherwise our electricity bills will go through the roof (because of cost of equity is higher than cost of debt).

Sorry I did not understand this part, can you please clarify a lot more if possible? Thanks!
Power consumption in India per capita grows at 5% PA in last several decades. Population at 1% PA. Is it really possible to expect value creation in such a sector, specially given all the political interventions, reducing cost of power and so forth? I agree they have a high ROE, but what good is a high ROE without commensurate opportunities for reinvestment?

@harsh.beria93

the next 20 years cannot be like the last 20 because they will become larger than OEMs which is just not possible

It is if they add auto unrelated businesses, which they intend to. Please see their latest annual report for latest 5 year plan.

@harsh.beria93

Suprajit has grown sales for 20%+ in last 20 years, I am willing to bet that these guys will be around in the next decade (as they are moderately leveraged unlike Motherson). All these 1 component, 1 country, 1 client non-dependence criteria also applies to Suprajit. They are just less discussed because of size.

Thanks, i will study suprajit more. It definitely sounds like an interesting company.

@harsh.beria93

Once ROE is much higher than cost of capital, its growth which drives value. About dividends, I am happier if my company can redeploy capital and grow at higher pace. HCL is probably the only one which actually acquires IP and tries to monetize it (thats why they have the higest industry sales growth).

Thanks for adding this. You make a good case for me to study HCL more and understand it better.

@harsh.beria93

Also, earnings did not fall for HCL in 2019-20.

Earnings fell for a few quarters at least, please see:

Updated set of to-dos for this coffee can PF:

1. [High priority] Consider adding HDFC Bank, HCL, Suprajit and any other companies which fit the bill.
2. [Medium priority] Evaluate global cos for figure out how to invest in a low-cost overhead manner.

[sahil_vi]

@sahil_vi

The primary motive is to hedge the equity risk.

Hedging explained - What is hedging, as a general concept?

Hedging Explained - The Insurance of Investing

Keywords: Hedging specific risks.

Hedging is not about removing all risks, it’s not about preventing your portfolio from going down. It’s about preventing your portfolio from being hurt too badly from specific risks

[Investor_No_1]

@harsh.beria93

About utilities, I am talking about Power grid and not power finance. On one end you are saying that commodity companies cannot create value, and on the other end you are bullish on lending companies. How are lending companies not commodity businesses? Will you ever prefer taking a loan at higher interest rate from a bank just because its well known? About power grid, if this guy is not around and doing well after 2-decades, we will not be having this discussion on an online forum because we wont have electricity. Utility businesses create a lot of value (probably the only real value in the world) as they create the basic infrastructure on which industries are built. That’s why they get regulated ROEs. These are annuity businesses and are valued accordingly. Just for context, one of Berkshire’s large bet is on utility business because this is scalable (can take in a lot of capital) and the ROEs are greater than cost of capital (it has to be to make it viable). Power grid will always be leveraged, otherwise our electricity bills will go through the roof (because of cost of equity is higher than cost of debt).

Very interesting take on Utilities…I liked your quote on “real value”. Although I can see real value in other sectors as well, which initially I could not…but thats a separate very long discussion we can have…
Regarding Powergrid…how do you compare it to say an NTPC or NHPC? I am aware many investors would say that powergrid is like monopoly and whether power generated by hydro or coal, it will be transmitted by powergrid…but can any government regulation of being a PSU play a spoilsport in this ever green everlasting story? Pls note US is very different than India in terms of policies, regulation, subsidies etc etc. Golden PSUs such as ONGC which could have been a behemoth much greater than RIL are struggling to grow now…in this context of being a PSU can you think of possible risks to the powergrid story?
NTPC and NHPC investment looks little simpler in terms of new capacities/commissioning as signs of growth…your thoughts? Also a Tata Power with being only innovative player in otherwise boring segment and vision of being a service and product oriented Power company (Solar - catering to retail segment as B2C cnsumer durable) …your thoughts would be good to know…Thanks

[harsh.beria93]

@sahil_vi

Find a set of companies that you expect to provide growth and protection of capital over the next 10 years

Then why is this coffee can investing and not just investing? Why attach a tag to it? And how is it different from what you are trying to do in your normal portfolio?

About HDFC bank, I don’t consider it to be a coffee can (for that matter any company). The idea of investing for me is to have a hypothesis which is different from what’s in the price, and constantly reevaluate based on new data.

@sahil_vi

We should also note that if currently generics-focussed companies start investing right now, due to the large gestation period of 7-8 years, in 8 years they would be where biocon is today

This isn’t true, lupin started investing in 2016, cadila in 2008 (except that they don’t plan to sell to US), Reddy in 2016. So competition is coming. For all the hype around biosimilars, price erosion in US is around 40% for the first player (link). For context this number is 62% for the first generic player (video). In UK (&Europe in general) biosimilars price erosion is in the 60% range i.e. closer to generics (link, also covered somewhere in biocon thread). In India, this number is more like 70% (this is based on Cadila’s commentary saying that emerging markets are super competitive price wise; another data point is even biocon complains that they do not want to sell their biosimilars in India due to bad pricing). It will be interesting to see if Biocon can actually pivot to the next wave of biosimilars which starts in 2023. And if you plan on checking a pharma company once a year, good luck with FDA inspections.

@sahil_vi

Please see the evolution of the valuations for HDFC, which held HDFC AMC (Listing in July 2018) and HDFC life insurance (Listing in November 2017

Valuations are a function of market mood. I remember that repco home used to get 6x P/b in 2017. Focusing on business performance helps me stay more rational than what holding company discount market is currently giving. The hdfc folks are not stupid, they have always wanted to do a reverse merger with hdfc bank, but rbi doesn’t approve. At some point in the next decade hdfc will either be demerged or reverse merged with hdfc bank. Oh and by the way, the PB of almost every nbfc has come down from 2017 level.

I personally think that the last few years of high valuations have distorted people’s vision of financials. Lending is a commodity business, there will always be people who go for convenience but larger loans will always be a function of interest costs. Again I can be wrong in my assessment of lending financials, atleast globally it’s true.

About power grid, look at growth in book value (from ~16’000 cr. in FY10 to ~64’000 cr. in FY20). Utilities are valued according to their book (paper on utility valuations) and they have compounded their book by 15% over the last decade. At the same time, sales, profits and CFO has increased by >15% in the last decade. Also what are you talking about in terms of reinvestment? Utilities have the highest reinvestment opportunities, I think you should first try and understand how utilities (be it gas, power, road) actually work. A 5% electricity demand growth doesn’t mean a 5% higher demand for towers carrying power. Just like an annual growth of 5% in vehicles sold doesn’t mean we just need 5% more road construction. That’s because the average density of grid network in India is still low as we are not fully electrified as a country. The way it works for power grid companies is that they first have a capex which is later commissioned which is when revenue starts getting recognised as power flows through the grids. Power grid did a capex of ~1 lakh cr. in the last 5 years and has plans to do about 1.6 lakh cr. until FY22. For context, a 1.6 lakh cr. CAPEX is to add 63’000 ckm transmission lines which is ~40% of its current network (this is growth CAPEX and not maintenance CAPEX). Some part of revenues have been recognised and some part will be recognised as grids get commissioned. Just for context, revenues are 38’000 cr. as on date, so a doubling of revenue is easily feasible in the next 7 years, and if there is no subsequent capex (which will probably not be the case), the incremental revenues go to shareholders as dividend (debt/equity will be 0.7 as per regulatory guidelines). Also, other growth drivers are their consultancy business, cross-border transmission network and telecom services vertical (called powertel).

Market valued them at 4-6x book in the last decade which was wrong. Its probably much fairer now at 1.5x P/B (12-15% growth in book at 16% ROE)

@Investor_No_1

Regarding Powergrid…how do you compare it to say an NTPC or NHPC?

I rate power grid a little bit higher because they are the carriers and are independent of the type of power supply. However government can do things which are not in the best interest of shareholders, recently government asked power grid to give a 1000 cr corona rebate to discoms. The AGR case has luckily been settled, otherwise power grid could have suffered really badly. Government interference is something to be watchful about. However, government has also started realizing that they can be smarter and are planning to list assets of power grid as invits. This should be good for shareholders as it will lead to value unlock. Let’s see if government can execute. About NHPC, my buy limit order is at 15. That guarantees me a 10% yield and I will be happy to own NHPC instead of FDs.

[Investor_No_1]

@harsh.beria93

About NHPC, my buy limit order is at 15. That guarantees me a 10% yield and I will be happy to own NHPC instead of FDs.

Agree, infact at 20 also it has a 7-8% yield which is way better than FD. Why I havent bought it yet is because of my history of faltering whenever I buy companies for div yield. Also, one point to note is that in case of Powergrid, the dividend percentage have increased by huge percentage in last 2-3 years…is that milking sustainable is another question…

[sahil_vi]

@harsh.beria93

Then why is this coffee can investing and not just investing?

High quality businesses expected to grow sales 10%+ CAGR over next 10 years with high probability.

@harsh.beria93

Why attach a tag to it?

Its an interesting question. I think this is just what everyone chooses to call it. I’m ok with calling it “low risk low churn investing”.

@harsh.beria93

And how is it different from what you are trying to do in your normal portfolio?

For Core PF, the expectation is, 4x-5x returns in 5 years as a combination of valuation gap bridging and high(er) earnings growth. Smaller companies (most of my PF companies do not even hold 1% Market share). Much larger opportunity sizes. Much higher probability of failure. Need much more monitoring.

@harsh.beria93

for that matter any company

@harsh.beria93

About HDFC bank, I don’t consider it to be a coffee can (for that matter any company). The idea of investing for me is to have a hypothesis which is different from what’s in the price, and constantly reevaluate based on new data.

The question posed by Coffee can hypothesis is following: Is it possible to construct a PF of companies to hold for a long duration, where even short term business variations are essentially noise? Of course 1 in 20 choices can go dud and lead to losses, but most picks are expected to break even with very high probability and deliver at least risk free returns with high probability.

@harsh.beria93

40% for the first player. For context this number is 62% for the first generic player. In UK biosimilars price erosion is in the 60% range. In India, this number is more like 70%

Do you have any data to back up these numbers?

@harsh.beria93

I remember that repco home used to get 6x P/b in 2017.

Repco also got beaten up due to the larger mid-cap and small-cap downturn. Valuation is a complex function of several variables including future expectations of returns. In some sense, valuations have a momentum of their own.

@harsh.beria93

Oh and by the way, the PB of almost every nbfc has come down from 2017 level.

Could this be because their businesses are doing worse?

@harsh.beria93

Lending is a commodity business, there will always be people who go for convenience but larger loans will always be a function of interest costs.

I think we can agree to disagree. Lenders do not provide a commodity. They provide a differentiated product for a market segment they know best. There is enough room for several businesses to exist with varied business models servicing varied customer needs and creating value for shareholders.

@harsh.beria93

atleast globally it’s true.

From what I can see, you seem a bit pessimistic (or under optimistic) about probability of indian companies fundamentals growth to beat their global peers in most things. I disagree. Take the case of financials: When GDP grows at X% and credit grows at 1.5X to 2X and good private sector lenders grow at 3X, then value is bound to be created. The key monitorable as always is the financial institution’s ability to manage NPAs.

@harsh.beria93

Utilities are valued according to their book

Says who?

@harsh.beria93

Utilities have the highest reinvestment opportunities

Can you please share any data to back your claims? I see a lot of statements and almost no hard data. Its hard to respond to anything this way. I shared with you a precise demonstration of how power per capita grows at 5% in India and population at 1% Per annum. Can you please explain to me why Power Grid’s revenues would grow much more than 6%? Also, please understand that since you’re more well versed with power grid (and are making a case for me to consider investing in it), i don’t think it should be unreasonable to expect you to share some knowledge resources with all of us which demonstrate why power grid, despite having 85% of the interstate power transmission has high reinvestment opportunities

Looking forward to your views.