Super observations - especially the first one! Thanks a lot for writing in. Hope you participate more often. We can do much better with your diligence
My reactions:
1). Merger - Enhanced ownership: Think this must have eluded most of us at VP who are invested. This is something that should certainly be raised and cross-checked with Management.
We will be there again this AGM, and be certain we will raise it - especially to see how they handle the question (even if the answer is what seems the obvious one).
2). Dilution: Most of the dilution was around 2007 I think for the Barings stake, and that was done at a significant premium. Not sure when Tano Capital came in, who had exited in between and again came back in last year. Usually we donât have a problem if dilution is done at a premium
Most of us at VP have been invested over last 2 years or so, and we havenât had any reason to complain, so far. We are also confident of the excellent prospects before the company - especially 2017 onwards which should see us do above-average compounding.
3). Recent ~75 Cr, 5% dilution: Agree, this was avoidable, unless they have bigger capex plans (in the anvil) for which they need to keep more room.
Again, good to ask this question. Will revert after AGM
Shilpa veterans - Ayush, and others, please let us know your reactions to these very pertinent observations
I have been tracking and been invested in Shilpa from about 2005 or 2006âŚfollowing are our understanding about your questions:
1). I donât have the specifics but from all I remember - Shilpa Organics was having its own production facility and they were doing some job work for Shilpa Medicare.
In early stages of growth these things are normal as often the promoters have had floated 2-3 companies and for investors its important that the promoters donât own un-listed cos and are more focused on the listed one. So in a way the merger is good. The negative and questionable could be the % of dilution but even if the promoter got a bit more to increase his holding during early growth phase, I think its ok. (The important thing to see when these mergers happen is that the co shouldnât be just a defunct paper co, being merged to increase promoter holding and from all I remember, they did have some operations and manufacturing facility).
2). Yes, the co has gone for dilutions 3-4 times by now and we really donât like cos which dilute their equity. As we have had this question several times, what we have observed is that Shilpa has been smart in diluting equities - most of the times (except the recent dilution to Tano), the dilutions have been at premium valuations and for specific business needs (just ahead of aggressive growth or next phase of growth).
One interesting observation is that after raising money from Baring fund in 2011/12, the co had a period of stagnancy for about 2 yearsâŚyet Shilpa kept sitting on the money and didnât do much. Usually we see after getting big money, ppl get aggressive and take wrong decisions but that didnât seem so for Shilpa. Also, baring didnât panic in this period
Another interesting thing is that Tano was one of the earliest investors in Shilpa and they exited in 2010 or so after a good 4-5 time return. But they came in again a year back by buying from open market and then again doubled their stake by taking a pref allotment recently. Also many of the big investors have been invested in the company without much change for years. So perhaps this indicates the confidence and comfort of the funds with the company.
3). Yes, the recent growth hasnât been much - at the same time we like the efforts the co has been putting into R&D and building a pipeline.
4). Yes, debt might have been better.
Do share if you have any further observations, it helps
Some observations and a comment from Q4 and FY 15 results release:
Observations
PAT grew about 5% y-o-y on Standalone, but declined by about 2% on Consolidated basis - which is what should matter to a shareholder. Given dilution of 5%, earnings have been declining faster for a share-owner @ 7.5% last year. A risk-free investment earns 8%.
Borrowings have gone up by 60% over the course of the year (or say 30% on average). Interest expensed have gone up by 15%, indicating a good amount of it has been capitalized towards CWIP over and above last year.
Effective Tax Rate (Tax / PBT) has gone up from about 22% to 32.4% this year.
The firmâs ROE (on opening equity) for FY 15 is about 18%. It may be pertinent to note that this is despite a 220 core non-performing asset by way of C-WIP.
C-WIP investments have doubled and largely in its subsidiaries, which have meagre revenues ( likely to show revenues in post completion of these projects?)
Goodwill-on-Consolidation has gone up along with minority interests. May need to understand the underlying transactions in the subsidiaries that led to these increases.
The firm has 160 crores in debt and 65 crores in cash equivalents; implying possibly more capex is likely to come soon.
Trade receivables have gone up by about 20% even as revenues have gone up by only 7%, while payables have gone down by close to 20% creating cash flow pressures. Of course the impact of USD INR fluctuations needs to be weighed here.
Comment
At a PE ratio of about 50 these observations, where the negatives prima-facie outweigh the positives, seem to have been given a resounding slap by the market - possibly the buyer / holders of the stock know better.
The burden of over-performance in subsequent years dramatically increases for a stock highly priced in relation to earnings; for every year of under-performance. Earnings for Shilpa Medicare need to grow 4 times in the next 5 years to get the earnings yield to a risk free rate of 8%. Now if there is one year of flat performance, it would now need to grow 4 times in 4 years to attain the same yield! Pretty much like the run-rate requirements going up in slog overs for every maiden over. If you have 5 overs to get 60 runs a maiden over increases run rate to 15. The risk of getting from 12 to 15 is far higher than the run-rate increase of 25%. Even if you have a 2x of Dhoni in your team!
Fantastic observations again from you Krishnaraj. Followed up by that excellent Summary paragraph.
I have only 3 things to add:
Obviously newcomers to Shilpa Story have to be cautious. Unless you have a long horizon, do not BUY Shilpa. The company to its credit has always maintained that they will have flattish growths - all that they are doing today and tomorrow, is a build-up to FY17 and beyond.
Those who want to STUDY Shilpa must pay heed not only to the BS & PL, but try to get a feel of what FY17 and beyond holds. For that a study of Shilpaâs Pipeline for the next 5 years is extremely important - also the past 5 yrs pipeline success is an invaluable exercise. Do we all know that Shilpa sometimes gets an astonishing 50% of the total market for a molecule. Can they do it again? This (past and present pipeline) is all available in public domain by the way. We hope some young turks at VP will take the bait and do some work on that front - to try and UNDERSTAND what the Market may be knowing (and factoring in?) more than what is apparent in the Shilpa Story.
@ananth - Please wait for 2 weeks - for some folks at VP to put their hands up for this exercise⌠You may then like to share your ground-breaking work on Shilpa Pipeline that you had produced before Shilpaâs last AGM? Thanks.
3.Finally, for those who like to buy long-term, an understanding of the DNA of the company and the basic Business Model it pursues is more important than everything else. That will give you the conviction to HOLD through flattish times - instead of selling out after making a 2x or 3x in last 1 to 2 years,
Shilpa Medicare, in a sense is like PI Industries. Those who have seen Mr Singhalâs fabulous interview on You Tube might recall what he said of PIâs CSM Business Model. He said something on the lines of - Ours is a unique model. We first need to invest for 5 years, and then after 5 years the returns are almost Vertical. It works out the same as a linear 25% grower every year. With a difference - after those 5 years - nobody will be near us. We believe in taking those kind of Risks to build a uniquey differentiated business model.
If you study Shilpaâs trajectory - there is a similar story - they will invest heavily for 2-3 years, and consolidate during that period. Post that consolidation there is a huge rise. We long-termers in the Shilpa Story believe a similar exercise is on the way currently - with 2 key differences. a) they have moved up the value chain from API to Formulations (not to be ignored) b) There are multiple âOptionalitiesâ that could play out in the next 2-3 years creating a Disproportionate future.
They might or might not create that disproportionate future (Refer our Business Quality Insights PDF), but it stands to reason some of that extraordinary valuation being accorded to Shilpa Medicare - might also be factoring these things in? Shilpa is no more an unknown - fairly big Institutions (both buy and sell side) are party to the story.
Disc: Invested in Shilpa from more than 2 years. It is one of the higher allocations in my Portfolio. My last purchase was more than 6 months back. My views should be taken as being positively biased.
@Donald Thank you for your comments and hope to learn by being here and listening around.
From what I gather, the case is that there is a market reserved in some sense for Shilpa (via first to file for some drug that has a huge market as it will get off-patent), which will be exploited in a few years from now. Shilpa is gearing up by investing to exploit that market. Up to the time the investment is made the firm will not have much to show by way of top-line. But when ready they will grow so much as to make good for earlier years. There is increased confidence they will be able to pull this off as this has been done earlier.
@diffsoft
Actually much more than that one promising molecule
a) 9 out of top 20 Oncology molecules going off-patent in next few years - shows a dominant presence
b) Shilpaâs Capex investment philosophy has been very conservative from what we have observed so far - they invest only on advance contract-out basis. The kind of frenetic expansion indulged in may be surprising - but if the script is running along earlier track - there is a good chance - all these are backed up by firm contracts. A good guess is not only do they supply the Formulations this time for contracted customers, they might get to supply the APIs to competing formulation players - capacities are reportedly 3x next largest which is DRL
c) the real joker in the pack though is USFDA - it can tilt everything the other way - it is the SINGLE BIGGEST RISK FACTOR in our opinion - which can even prove catastrophic - even with just delays (no bans)
d) so Margin of Safety in Shilpaâs investment case is critical to possess to play a higher risk-reward game. Those invested from more than a year or two have it. New entrants may not have that comfort. Disc: last bought more than 6 months back. Invested from more than 2 years
Carrying this further, to arrive at some bounds of valuation.
If we know that there are already built-in contracts (soft or hard) against the Capex made by the firm, then it may be possible within reasonable band to arrive at what earnings may be expected.
Let me make an assumption in the absence of any better understanding on my part that the firm will continue to derive its earnings power from these capital investments similar to the older ones. In other words, Net Fixed Assets (NFA) is directly indicative of its earning power. GFA is better but letâs take NFA to make our case to buy more solid. So at about Rs 293 crores the NFA produces a âPBIT and Other Incomeâ of Rs 107 crores.
Its C-WIP is Rs 221 crores at March 31 2015 and I do not know its future C-WIP; but if earnings are going to kick-in from FY 2017 (as stated in the forum), we may assume that a similar addition will be made in FY 16, that was made in FY 15. This figure is about Rs 110 crores. In other words, the total assets to be added will be about Rs 331 crores.
Apply our assumption on earnings in proportion to Fixed Assets, an addition of Rs 331 crores is about 13% higher than its current NFA, should produce an incremental earnings of 13% over 110 crores which is about 124 crores or about 234 crores overall. Assuming the same rate for Taxes at 30% (let us forget Interest expense for the moment because that would decline over time and we want to make a good case), and no dilution on share count from today, the EPS would be about Rs 42.5 in FY 2017. At a price of Rs 1000, the earnings multiplier will be 25. If we assume an investor wants at the bare minimum a risk free rate of return / growth at 8% on the share price in end FY 2017, he would want reasonable comfort that the share price would be at least Rs 1,166. This translates to a multiplier of 27.5 on FY 17 earnings.
If he expects the current multiplier to hold (i.e. 50) then he will see his price more than double.
I am of course no wiser on what will ultimately prevail in FY 17.
You will have to study the company in detail to understand its BQ/MQ and why it is valued so highly. Its not that simple to arrive at earnings based on net fixed asset addition. Majority of the capex addition during FY15 would have been incurred for the JV with its Italian Company (ICE) and its formulations facility. The margins for the formulation business are much higher than APIs. Even in API business the margins will vary going forward depending on the molecule and market to which it is supplying like US, Europe etc. For eg. if Shilpa is manufacturing APIs for a molecule which has limited competition and is highly complex to manufacture, the margins will be higher as compared to molecules which have higher competition. One more example I can give is for a company I am following - Torrent Pharma. Torrent has received approval for the generic version of Abilify (Aripiprazole) along with Teva, Alembic and Hetero Labs. Torrent is procuring API from Hetero (at the time of submitting ANDA, you have to specify the plant from which you would be procuring APIs [can be multiple plants as well]). The competition is limited currently and prices havent come down much for the generic version of Abilify. So the generic players are expected to make pretty good margins till the the USFDA doesnt give approval to others players and some of this margins will also flow to the API manufacturers like Hetero (please note it is the API supplier to Torrent and also competing with it in the generic space for the same molecule).
My attempt is simplistic; but a dependable assessment of the value of the stock is necessary for an investor. So maybe it is a starting point.
Ultimately all knowledge about the business - past, present and future - has to be compressed to a number, which is value. Purchasing a stock without a high degree of confidence that value is much higher than price, is speculation. That confidence has to be rooted in facts and reasonable expectations.
I donât know how to value these stocks but maybe someone can share the quantitative assessments of value which can include qualitative factors or insights they have. But only qualitative assessments like âvery high marginsâ or âlong runwayâ or âhuge marketâ seduces us to ignore the price that we pay - which could be exorbitant - or substitute subsequent increases in price to think we are getting value at whatever price we buy.
Well-made point.
I would like to add a lot this time :):
From your comments so far, it would appear that your approach to Valuations is primarily based on the âTangiblesâ in the business, and which is perfectly right in its own way - and probably the more scientific way of going about it.
What Ankit has been hinting at is that at VP we have been coached into adding an additional layer of Valuation on top of the Tangibles - wherever possible - to put a Value to the âIntangiblesâ in the business, if you recall our ART of Valuation thread
We have been coached that the best way to go about thinking about Intangibles in the business - is to think like an acquirer of 100% of the business. How would someone armed with a war-chest allocate Capital between 2 businesses that have similar levels of Tangibles - but disproportionately different count on the Intangibles?? Why should/could a NIcholas Piramal be sold to an Abbot Laboratories for 9x Sales? There were one or two which followed at 10-11x Sales later
Surely there is more to a business than the sales and margin figures - there is Intellectual Property for example which we can easily appreciate, and there are Strategic Assets that others cannot replicate at similar cost/time efforts, there is an Architecture of business processes within some businesses - that deals with customers, suppliers, vendors - in a manner that reduces the external bargaining powers to being negligible or managable versus another that is exposed to higher competitive intensity from multiple forces, and yet is managing a steady job.
Where will the 100% Acquirer of the business like to allocate more Capital??
If we bring in that paradigm into our Valuation thinking, we believe we will do a far better job of separating the Wheat from the Chaff.
When we start thinking this way, there are many many small things together that may (or may not) add up and give us the FEEL - that required comfort and conviction - Yes it is a business that has a long runway, Yes it will be very very difficult to dislodge this guy from its perch, yes we may expect a certain consistency in performance, and YES there is a big Gap between Perception & Performance.
We have been coached - the ART of Investing is all about developing that FEEL about longevity, sustainability and predictability in the bsuiness, keeping FAITH and staying invested from lower levels - by first doing an enormous amount of hard work on the company - that is an enabler for that kind of a feel after a few such intense efforts. When will you take the first step of compiling Shilpaâs Pipeline prospects , e.g??. Once you do that I can guarantee that this whole approach to Valuing the Intangibles in a business like Shilpa will shift a few gears up :). Without that kind of effort, the assessment into Shilpa is incomplete âŚ
And everyone who canât appreciate how to go about putting a Value to the Intangibles so described above - please DONâT HIDE under the excuse that it is too abstract to put a finger on. Through our Business Quality Insights PDF we have shown live examples of how to go about doing that in 6 highly well known, well-dissected businesses in VP Portfolio. We have slotted the 6 businesses into different categories, based on how we value the âquantifiedâ Intangibles - we have taken great pains to record that, we could be quite wrong in our assessment - but we have stuck our necks out and shown what we think the stable PE ranges should be for this category of business with these kind of Intangibles, and we have also tried to show if there is a âGapâ between Perception (as captured in PE) and business Performance.
So anyone serious about understanding Valuation at a more granular level has an easy option - pick and choose the business you are most familiar with - and try and create a BQ Sheet on that business like we have shown, share it on VP, get others who are tracking/invested in that business to add value to your efforts, get BQ experts in at the last stage:)
I confess even after going through all the posts, some links and the BQ Insights sheets, it remains out of my mental reach. So automatically my mind cannot come to terms with such a high price.
But hats off to @ayushmit to you and many others who have spotted these stocks and are working hard to âseparate the wheat from the chaffâ and share the same.
Good to know I have a looooong way to go so thereâs lot to do!
This requires some practice, and is an ART Form. Good thing is its very simple - nothing complex - here - but requires hard work at getting into the real insights into the sources and sustainability of business performance.
If you have read the insights shared in Shilpa BQ sheet - and they have not carried their weight - they might have seemed like motherhood statements - its because its unconvincing for a person not familiar with the business. The insights can only come from hardwork that leads up to greater understanding of the business, industry structure, competitive forces at play. To understand Shilpa, you have to know the Oncology industry map - and how strongly positioned Shilpa is there, the kind of relationships it enjoys with customers and even competitors- that can only come from grunge work. Any unwillingness to delve deeper - can be injurious to health
I will be happy to work with someone like you who is so strong on the BS side of things - there is lots to learn there. if you choose to develop this side of your investment armoury, let us know⌠You may choose a business you know very well - I can familiarise myself - and we could attempt a BQ Sheet for that business, together ?
I have been trying to nail down the ârealâ objection - thatâs hindering a real investigation into Shilpa by someone as obviously competent as you. So I hope you will excuse me for stubbornly persisting - this might serve to re-assure many others who legitimately hold similar views as yours.
Price we pay - obviously we started off this dialog (since your first post) agreeing with your observations that folks should be cautious; they should not buy Shilpa at current levels; and completely agree with you its dangerous to buy at any price - you always run the risk of being SEDUCED into ignoring the price - by a sleekly packaged BQ Sheet )
Seduction - Seduction is indeed needed - Yes, we want to seduce most of VP wannabe do-it-yourself analysts (and established practitioners in the larger investment community) to the VP way of âSeparating the wheat from the chaffâ - that is crucial to our objectives of seeing being jumps in VP bandwidth - broadening & deepening its moat. We do deck up - in our collective wisdom of the moment (we reserve the right to be entirely wrong though) - what we deem as our most outstanding candidates.
Risk and Reward however go hand in hand. One runs the risk of getting seduced by someone well past the prime, yes. How will someone know for sure - only the one who resists getting hooked but continues to dig deeper to deduce - if the obvious attraction might endure for many years ahead. Attraction is pretty individual :).Besides Mr Market is very good at decking up the bride attractively from time to time - it adds to the allure by moderating the price suddenly, even whimsically. Again only the one who has dug deeper - can decide for himself - whether the freshly decked up (now older) bride is NOW worth getting hooked up for good. It always pays to be prepared, no? Who knows if better prices may come along or not?
Having backed up our seduction efforts this way, its imperative to mention VP tries to allay the said seduction risks in its own way. Remember the VP Portfolio - it probably went some way in allaying risks (for the newbies, uninitiated and borrowed-conviction folks) through 6-monthly Updates/Reccos; now with increasing clarity from SEBI on the RA Guidelines, FAQ to RA Guidelines and the Insider Trading Guidelines, it may be time to revive that, post a comprehensive review of all 3 regulations.
@Donald Thanks for your response. Sure we can work on a business together and talk that offline - though I am yet to finish the book by John Kay you recommended that was inspiration for the BQ sheet
The objections I cited were more like notes to myself. I may be competent but I know - or at least hope to know - where it stops. My mind shuts itself at anything that appears to it as complex and overcoming is a time consuming process. Elroy Dimson said âRisk means more things can happen than will happenâ. The formidable challenge is to first get the confidence that I am reasonably sure of all that can happen and then of the odds of its occurring and the impact if it happens.
- at the same time we like the efforts the co has been putting into R&D and building a pipeline.
