ValuePickr Forum

The harsh portfolio!

As of today, I have reduced allocation in Indigo from 2% to 1% and increased allocation in HDFC from 3% to 4%. Cash continues to be at zero.

Over the past year, I have been testing out a deep value strategy i.e. buying companies which are ridiculously cheap. I have categorized them as:

  • Net nets (working capital bargains): Mcap below 2/3rd of net working capital
  • Companies with above average return on capital over a business cycle (20%+) trading close to or below their book value
  • Companies with moderate return on capital (12-15%) trading below half times their book value

The idea is to buy a bunch of these companies and hope for mean reversion over a 2-year time frame. If it doesn’t happen, sell it. If mean reversion happens, see if the business can find a place in the model portfolio, if not sell it. Last year, a large number of companies started meeting these criterion. As this was still experimental, I bought small positions in a few companies which are stated below.

  • Time Technoplast (bought it below 0.5x book value, this business should trade atleast at its book value given they make 12-15% ROCE).
  • RACL geartech (bought it around its book value, a business that has grown during an auto downcycle speaks a lot about their business characteristics).
  • Atul auto (bought it at ~1.3x book value, this should trade at a large premium to its book because they make >30% ROCEs).
  • D.B. Corp (this was a recent buy below its book value, DB should trade at a premium to its book value because they make 20%+ ROCEs).

Going forward, deep value bets will start to be part of the model portfolio, given the very attractive risk reward they offer (low downside, potential optionality for large upside). I will initiate their positions at 1% size and see how business develops. The current model portfolio (without deep value bets) are stated below.

Companies Weightage
HCL Technologies Ltd. 6.00%
I T C Ltd. 6.00%
PI Industries Ltd. 6.00%
Power Grid Corporation of India Ltd. 6.00%
Larsen & Toubro Ltd. 6.00%
Ajanta Pharmaceuticals Ltd. 4.50%
Kolte-Patil Developers Ltd. 4.50%
Ashiana Housing Ltd. 4.50%
NESCO Ltd. 4.50%
Maruti Suzuki India Ltd. 4.00%
Suprajit Engineering Ltd. 4.00%
Manappuram Finance Ltd. 4.00%
HDFC Bank Ltd. 4.00%
Housing Development Finance Corporation Ltd. 4.00%
HDFC Asset Management Company Ltd 3.00%
Reliance Nippon Asset Management Co 3.00%
CARE Ratings Ltd. 3.00%
Lupin Ltd. 2.00%
Avanti Feeds Ltd. 2.00%
Cera Sanitaryware Ltd 2.00%
National Aluminium Co. Ltd. 2.00%
NATCO Pharma Ltd. 2.00%
Wonderla Holidays Ltd. 2.00%
Maithan Alloys Ltd. 2.00%
Cadila Healthcare Ltd. 2.00%
Inox Leisure Ltd. 2.00%
Jubilant Ingrevia Ltd 2.00%
InterGlobe Aviation Ltd. 1.00%
Jamna Auto Industries Ltd. 1.00%
Ashok Leyland Ltd. 1.00%
Cash 0.00%
3 Likes

Hi Harsh…

I see that you have consciously been fully invested with zero spare cash.
Just wanted to know your thoughts on it since it means that you wont be able to add any meaningful quantity to your portfolio if a correction sets in…

I have shared this before.

1 Like

As of today, I have reduced position size in Natco Pharma to 1% from 2%. This generates 1% cash.

In the past few weeks, I have been working on a comprehensive portfolio allocation framework capable of handling different types of stocks (cyclicals, core compounders, special opportunities, Graham net nets, deep value, etc.). The underlying idea is to create a Swiss army knife which can take advantage of different variants of market inefficiencies. I will post the details in the coming weeks, and this will also result in significant churn in the underlying portfolio. Updated portfolio for now is below.

Companies Weightage
HCL Technologies Ltd. 6.00%
I T C Ltd. 6.00%
PI Industries Ltd. 6.00%
Power Grid Corporation of India Ltd. 6.00%
Larsen & Toubro Ltd. 6.00%
Ajanta Pharmaceuticals Ltd. 4.50%
Kolte-Patil Developers Ltd. 4.50%
Ashiana Housing Ltd. 4.50%
NESCO Ltd. 4.50%
Maruti Suzuki India Ltd. 4.00%
Suprajit Engineering Ltd. 4.00%
Manappuram Finance Ltd. 4.00%
HDFC Bank Ltd. 4.00%
Housing Development Finance Corporation Ltd. 4.00%
HDFC Asset Management Company Ltd 3.00%
Reliance Nippon Asset Management Co 3.00%
CARE Ratings Ltd. 3.00%
Lupin Ltd. 2.00%
Avanti Feeds Ltd. 2.00%
Cera Sanitaryware Ltd 2.00%
National Aluminium Co. Ltd. 2.00%
Wonderla Holidays Ltd. 2.00%
Maithan Alloys Ltd. 2.00%
Cadila Healthcare Ltd. 2.00%
Inox Leisure Ltd. 2.00%
Jubilant Ingrevia Ltd 2.00%
NATCO Pharma Ltd. 1.00%
InterGlobe Aviation Ltd. 1.00%
Jamna Auto Industries Ltd. 1.00%
Ashok Leyland Ltd. 1.00%
Cash 1.00%
6 Likes

Hi Harsh,

Would you mind sharing your thoughts on reduction in NATCO allocation when Company got approval for a blockbuster drug ? Is it because you think that CMP already factors in potential opportunity ? Or is it because of some other business risk ?

Thanks and Regards,
Prasobh

1 Like

As of today, I have sold my stake in Indigo (fair valuations, slightly hazy future) and reallocated the remaining 2% cash in Amara Raja Batteries. I used to own Amara Raja but sold it in April 2019 when the news of discontinuation of collaboration with Johnson Controls came out. Over time, it became clearer that the true edge of Amara Raja was not superior technology, but a superior distribution and higher brand spends. Sales growth has been subdued over the last few years due to auto slowdown and this seems to be coming back (also reflected in Castrol’s numbers). Additionally, the industrial segment seems to be coming back. Given the giant CAPEX spend by Amara Raja over the last few years, its now time to sweat out the assets and generate free cash. Recently, Exide is growing at very similar rates to Amara Raja and this remains a key monitorable. Lets see what happens going forward! Updated portfolio is below.

Companies Weightage
HCL Technologies Ltd. 6.00%
I T C Ltd. 6.00%
PI Industries Ltd. 6.00%
Power Grid Corporation of India Ltd. 6.00%
Larsen & Toubro Ltd. 6.00%
Ajanta Pharmaceuticals Ltd. 4.50%
Kolte-Patil Developers Ltd. 4.50%
Ashiana Housing Ltd. 4.50%
NESCO Ltd. 4.50%
Maruti Suzuki India Ltd. 4.00%
Suprajit Engineering Ltd. 4.00%
Manappuram Finance Ltd. 4.00%
HDFC Bank Ltd. 4.00%
Housing Development Finance Corporation Ltd. 4.00%
HDFC Asset Management Company Ltd 3.00%
Reliance Nippon Asset Management Co 3.00%
CARE Ratings Ltd. 3.00%
Lupin Ltd. 2.00%
Avanti Feeds Ltd. 2.00%
Cera Sanitaryware Ltd 2.00%
National Aluminium Co. Ltd. 2.00%
Wonderla Holidays Ltd. 2.00%
Maithan Alloys Ltd. 2.00%
Cadila Healthcare Ltd. 2.00%
Inox Leisure Ltd. 2.00%
Jubilant Ingrevia Ltd 2.00%
Amara Raja Batteries Ltd. 2.00%
NATCO Pharma Ltd. 1.00%
Jamna Auto Industries Ltd. 1.00%
Ashok Leyland Ltd. 1.00%
Cash 0.00%

Valuations + inherent uncertainty in my understanding of future sales growth. Revlimid opportunity has been known for a while now, the approval is simply a confirmation. Natco is an optionality position for me and I scaled it up when prices became very attractive in 2019/20. However, I don’t put more than 2% in an optionality bet. I will hold on to the rest of shares to see how business numbers come out (we have to wait for FY23 for revlimid numbers).

6 Likes

Hi harsh, eager to learn this new way of building portfolio. Please plan detailed post so we understand and learn.

Thank you for sharing knowledge!
Utpal

1 Like

Hi Harsh,

Looking at your value-picks, you must hv anticipated or considered this - Why DB Corp over Jagran Prakashan or not both as a value bet on newspaper stocks?

I took a position in Jagran whn it was avlbl for less than cash + Music Broadcast valuation. M still holding that & whn thr was sm recent news over Google paying news cos. for content, it seemed to be a kicker for these cos. just as it happened in music industry. The news source is shared on VP bt I can share again if u want.

Still it vl be nice to know ur views on the question above.

1 Like

In this series of posts, I will share my thoughts on position sizing, how I have approached it in the past, how the results were, and what refinements I have brought about it.

The past results
I benchmark myself against three portfolios:

  • Nifty 50: Reflects opportunity cost
  • Banyan tree PMS: Quality and valuation driven firm with one of the best publicly available track record across market cycles (including 2008)
  • A microcap maverick like Mittal Analytics (public track record starts in 2019)

Here is how returns have fared over this 2-year period.

All the 3-strategies has outperformed Nifty. My strategy is much more closer to Banyan Tree (quality + valuation). A more small cap focused strategy creates much higher drawdowns and produces excess returns in good times.

What do I want? Drawdowns like Banyan Tree and outsized returns like Mittal Analytics which is impossible for someone like me.

What can I get? Behaviorally, I want absolute controls on longer term drawdowns by selecting good companies and not overpaying. However, I want to spice up the returns with positions in bombed out cyclicals which can produce excess returns in good times.

Position sizing

I used to size a position anywhere between 1% to 6%. My expected returns were 15% and I used to allocate 6% into companies that were no brainer opportunities to generate 15%+ returns. These were generally large companies with good institutional coverage and whose performance could be studied across cycles. This is how this part of portfolio has done.

6% companies IRR Returns until 28.05.2021
Ajanta Pharmaceuticals Ltd. 24.20%
Bajaj Auto Ltd. 20.69%
HCL Technologies Ltd. 38.10%
InterGlobe Aviation Ltd. 19.52%
I T C Ltd. -0.20%
Larsen & Toubro Ltd. 17.60%
Lupin Ltd. -1.10%
Natco Pharma 20.70%
PI Industries Ltd. 59.60%
Power Grid Corporation of India Ltd. 19.70%
Reliance Industries Ltd. 0.00%
Reliance Nippon Asset Management Co 26.00%
AVERAGE 20.40%

Out of the 12 companies, I was right on 9 i.e. a hit rate of 75%. For me, anything >60% hit rate is good. As its clear that I have been right more often than wrong in large positions, I should ideally increase my %. This is one change which I am bringing about in my portfolio.

In the next post, I will illustrate my thoughts on position sizing and the refinements I have brought into it.

21 Likes

From now on, I have increased my expected returns to 19%. Earlier, I wanted a doubler in 5-years (15% returns), now I want it to happen in 4-years.

Objective function: Weighted average portfolio returns > 19%

I look at each company from five different lenses which are stated below.

  • Business quality (high/medium/low)
  • Promoter quality (high/medium/low)
  • Financial projections (high/medium/low)
  • Valuation projections (high/medium/low)
  • Is it a cyclical business (Yes/No)

Business quality: This is something I have written about in the past.

High quality business:

  • Over the last 10-years, (#ROCE>20% and #positive FCF) > 14

Medium quality business:

  • Over the last 10-years, (#ROCE>20% and #positive FCF) < 14 AND
  • If ROE over a cycle > 12% but < 20%

Low quality business:

  • Over the last 10-years, (#ROCE>20% and #positive FCF) < 14 AND
  • If ROE over a cycle < 12% or free cashflow is generated <50% over last 10-years

Management quality: I define a high quality management with the following attributes

  • Achieved organic sales growth greater than category average
  • Is able to find new avenues to grow
  • Treats minority shareholders in a fair manner

The first two criterion can be easily checked by looking at the past, however the third criterion is more subjective as different shareholders have different expectations. I bring in my own subjective judgement and categorize each management as High or Medium or Low.

Financial projections: The important metrics are future sales growth, margins, reinvestment requirements and ROIC. This is more a reflection of my understanding of the business and is a speculation on my part. If I have high degree of certainty in my speculation, I give it a High rating.

Valuation projections: This is done by comparing how market has valued a business or a sector in the past. Some examples are stated below.

  • An auto-ancilliary company generating 14-16% margins with sales growing at >12%, the business having ROCEs > 18% gets valued at >2.5x EV/sales in a bull market (examples are Suprajit, Amara Raja).
  • Generic pharma companies with reasonable ROCEs of >18% over a cycle gets valued at >4.5x EV/sales, even more if they have a branded business in some markets (numerous examples like Sun, Lupin, Alembic, Ajanta, etc.).
  • Good lenders who generate 15%+ ROE over a business cycle trade at P/B > 2.5x in good times.

If I have a high level of confidence in my exit valuation, I give it a High rating. However, if a company has limited track record (such as RACL Gear) or I have applied a very high terminal multiple on that company (like 30x exit EV/EBIT for HDFC AMC), I bring down my level of confidence to Medium.

Cyclicals: If margins are all over the place, it generally implies a cyclical company. This is rather binary and easy to judge.

Now that I have summarized my thoughts on the five different lenses, here are my thoughts on how I size a given company in the portfolio.

4 different position sizes

  • 8%: High confidence bets
  • 2% and 4%: Most discretion is restricted to changing position sizes between 2-4%
  • 1-2%: Deep value + optionality

Hard constraints

  • More than 50% of my bets should in non-cyclical businesses
  • <30% bets should be in cyclical businesses
  • <20% bets should be in special situations

Order of weightage (in non-cyclical): Business quality > Promoter quality > Exit valuation
Order of weightage (in cyclical): Promoter quality > Business quality > Exit valuation

Non-cyclical businesses

R means expected returns over 3-5 year period

  • High on business + High on promoter
    o R > 19%: 8% allocation
    o R > 15%: 2-4% allocation (discretion based on available opportunities)
  • High on business + Medium on promoter
    o R > 26%: 8% allocation
    o R > 19%: 2-4% allocation (discretion based on available opportunities)
    o R > 15%: 2% allocation
  • Medium on business + High on promoter
    o R > 26%: 8% allocation
    o R > 19%: 2-4% allocation (discretion based on available opportunities)
    o R > 15%: 2% allocation
  • Medium on business + Medium on promoter
    o R > 26%: 4% allocation
    o R > 19%: 2% allocation

Cyclical businesses

  • High on business + High on promoter
    o R > 26%: 8% allocation
    o R > 19%: 2-4% allocation (discretion based on available opportunities)
  • High on business + Medium on promoter
    o R > 26%: 4% allocation
    o R > 19%: 2% allocation
  • Medium on business + High on promoter
    o R > 32%: 8% allocation
    o R > 26%: 2-4% allocation (discretion based on available opportunities)
    o R > 19%: 2% allocation
  • Medium on business + Medium on promoter
    o R > 26%: 2-4% allocation (discretion based on available opportunities)
    o R > 19%: 2% allocation

You will see R values are divided into 15%, 19%, 26% and 32%. This reflects doubling in 5-, 4-,
3-, and 2.5-years.

Special situations

There are many different kinds of special situations. My one hard rule here is to sell after 2-years if nothing happens (basically bite the bullet and move on regardless or price). I currently invest in 2 types of special situations:

  • Companies with in-built optionality
  • Deep value bets

Companies with in-built optionality
Companies with leadership in multiple areas (like a research based company like Praj or a Natco with multiple Para IVs)? Allocate 1-2% when they are available at no-growth valuations i.e. current earnings stream and cashflows account for their market cap (10-12x normalized earnings). What should be the exit criterion? Can it be price based i.e. sell when <20% of peak price. I don’t have a comprehensive framework here, any help will be appreciated.

Deep value company identifiers (allocate 1-2%)

  • Sustainable dividend yield of 8%+
  • Net nets:
    o Adjust working capital: Cash & short term investments + 75% account receivable + 50% inventory – total liabilities (including off-balance sheet items)
    o Market cap < 0.66 * Adjusted working capital
  • Cyclically adjusted ROCE and ROE > 20%, P/B < 1 (maximum 1.2)
  • Cyclically adjusted ROCE and ROE > 12% & <18%, P/B < 0.5 (maximum 0.6)

Further thoughts
All of these rules do not take care of one special scenario which is: How do I make enough allocation if I am able to spot a PI/Ajanta/Avanti early on? For now, I will keep on with my 8% rule for these opportunities and keep thinking about it. In the next few posts, I will summarize how I have applied these to a few of my portfolio companies.

26 Likes

I will give an example from each category of business, I cannot give my projections for all the companies I track because that would be >100 posts!

High quality business + High quality management + non-cyclical + 19% expected growth rate + moderate confidence in projections

Ajanta Pharma

Business quality (HIGH)

Year ROCE & ROE > 20% Positive FCF
FY10 No Yes Total # years 12
FY11 No Yes # ROCE & ROE > 20% 8
FY12 Yes Yes # Positive FCF 12
FY13 Yes Yes
FY14 Yes Yes SUM 20
FY15 Yes Yes AVERAGE 83.33%
FY16 Yes Yes HIGH BUSINESS QUALITY Yes
FY17 Yes Yes
FY18 Yes Yes
FY19 No Yes
FY20 No Yes
FY21 Yes Yes

Management quality (HIGH)

  • Organic sales growth greater than category level growth: True for IPM
  • Able to find new avenues to grow: Created new sources of cashflows regularly (malarial tender business, US generics, Franco Africa branded generics, etc.)
  • Treats minority shareholders in a fair manner: Conservative guidance + 20% payout + regular buybacks

Financial projections and exit valuations as on 05-03-2021
FY20 sales: 2588 cr., @15% growth: FY25 sales: 5176 cr., EV: 5176*6 ~ 31’056 cr. (20% net margins in good times with operating leverage benefits + 30 P/E) (share price: 3588)

Cyclical?: Branded pharma is not cyclical

Confidence in projection (Medium)

  • Business quality (high/medium/low): High (Specialty business gets high gross margins + branded focus in non-US markets)
  • Promoter quality (high/medium/low): High (conservative guidance + didn’t pay dividend to fund capex + strongly believes in free cashflows)
  • Financial projections (high/medium/low): Medium (unsure about 15% growth, sure about 20% net profit margins)
  • Valuation projections (high/medium/low): Medium (unsure about exit P/E multiple of 30x; sure about 25x exit P/E)
  • Is it a cyclical business (Yes/No)? No

SUMMARY:

Companies Projection date Price 4 years fwd Price (FY25) Price return % Dividend yield % Total returns % Confidence Business Promoter Financial proj. Valuation proj. Cyclical?
Ajanta Pharmaceuticals Ltd. 01.05.21 1’841.70 3’588.00 18.14% 0.50% 18.64% High High Medium Medium No

This comes in the 4% position size category (high quality business + high quality management + non-cyclical + ~19% expected IRR)

15 Likes

In this post, I have given my outlook for a high quality business + Medium quality management + Cyclical business

Nippon Life Asset Management

Business quality (HIGH)

Year ROCE & ROE > 20% Positive FCF
FY11 Yes Yes Total # years 11
FY12 Yes Yes # ROCE & ROE > 20% 6
FY13 No Yes # Positive FCF 10
FY14 No Yes
FY15 Yes No SUM 16
FY16 Yes Yes AVERAGE 72.73%
FY17 Yes Yes HIGH BUSINESS QUALITY Yes
FY18 No Yes
FY19 No Yes
FY20 No Yes
FY21 Yes Yes

Management quality (Medium)

  • Organic sales growth greater than category level growth: No (have underperformed growth in AUM since FY17)
  • Able to find new avenues to grow: Yes (Were able to build ETF business through Goldman acquisition. Need to see if they can grow their foreign asset management business significantly)
  • Treats minority shareholders in a fair manner: Yes (Very good dividend redistribution).

Financial projections and exit valuations as on 27.04.2021
Quarterly sales will grow by 10% from 300 cr. in FY21 to 440 cr. in FY25 translating into annual sales of 1’760 cr. At 50% core margins and no other income (for conservativeness), PBT ~ 17600.5 ~ 880 cr. and PAT ~ 880.75 ~ 660 cr. At 50x PAT, Mcap ~ 33000 cr. (share price: 535)

Cyclical?: Yes (A large part of AMC business profitability comes from equity AUM which depends on equity markets which is inherently cyclical in nature).

Confidence in projection (Medium)

  • Business quality (high/medium/low): High (Although inferior to HDFC AMC, mutual fund is still a very good business)
  • Promoter quality (high/medium/low): Medium (has been consistently losing market share to bank backed AMCs)
  • Financial projections (high/medium/low): High (Sales should easily grow @10%+ given the underlying compounding of equity + extra inflows)
  • Valuation projections (high/medium/low): Medium (50x exit multiple is a little stretched)
  • Is it a cyclical business (Yes/No): Yes (AMC business is inherently cyclical)

SUMMARY

Companies Projection date Price 4 years fwd Price (FY25) Price return % Dividend yield % Total returns % Confidence Business Promoter Financial proj. Valuation proj. Cyclical?
Nippon Asset Management 28.04.21 340.65 535.00 11.95% 2.30% 14.25% High Medium High Medium Yes

This comes in the 0% allocation range as expected returns are <19%. I will be trimming my stake subsequently.

19 Likes

In this post, I will give my take on a medium quality business + high quality management + cyclical business

Manappuram Finance

Business quality (MEDIUM)

Year ROE > 20%
FY10 Yes Total # years 12
FY11 Yes # ROCE & ROE > 20% 7
FY12 Yes
FY13 No
FY14 No SUM 7
FY15 No AVERAGE 58.33%
FY16 No HIGH BUSINESS QUALITY No
FY17 Yes
FY18 No
FY19 Yes
FY20 Yes
FY21 Yes

Management quality (High)

  • Organic sales growth greater than category level growth: Yes (in-line with growth in Muthoot finance who is the category leader, detailed work here)
  • Able to find new avenues to grow: Yes (have managed to grow other business segments like MFI, vehicle finance, home finance, etc.)
  • Treats minority shareholders in a fair manner: Yes (In tough years of 2013-16, quarterly dividends were never cut or stopped + management has been very transparent in communications + conservative provisioning)

Financial projections as on 26.05.2021
FY21 Book value is 86:

  • Based on trailing book, sell price is ~215 (2.5x P/B)
  • Based on 1-year forward book growth ~ 16%, sell price is ~250
  • 4-year growth of 16% means book value will be 156, sell at 2.5 P/B @390 share price

Cyclical?: Yes (70% of book is gold loan which relies on gold prices which is cyclical)

Confidence in projection (High)

  • Business quality (high/medium/low): Medium (Cyclically adjusted ROE ~ 18-20%)
  • Promoter quality (high/medium/low): High (They have a better gold business model compared to Muthoot + High promoter integrity + Decentralized control of different business units + High dividend distribution)
  • Financial projections (high/medium/low): High (Should be able to grow book at 16%)
  • Valuation projections (high/medium/low): High (Should be able to get 2.5x P/B; can even get 3x P/B)
  • Is it a cyclical business (Yes/No): Yes (Majority of book is still gold loan which is driven by gold prices)

SUMMARY

Companies Projection date Price 4 years fwd Price (FY25) Price return % Dividend yield % Total returns % Confidence Business Promoter Financial proj. Valuation proj. Cyclical?
Manappuram Finance Ltd. 26.05.21 160.30 390.00 24.89% 1.87% 26.76% Medium High High High Yes

This comes in the 4% allocation range. I might increase the position size to 8% if forward returns > 32% (at price ~ 135) and NPAs in other loan books are well provisioned and in-line with industry.

6 Likes

hello harsh ,would you please share how we get track banyan PMS and miittal microcap maverick,thanks in advance.

https://www.sebi.gov.in/sebiweb/other/OtherAction.do?doPmr=yes

DB Corp has better readership and are the more dominant player compared to Jagran. It was bizarre that at one point DB Corp’s market cap came below Jagran. Although, Jagran is more share holder friendly.

3 Likes

Interested to know that u have invested in Alembic pharma now…It would be very helpful which aspect of the company made u to invest in it now…
Thanks in advance

Last year, there was a lot of buzz around Alembic Pharma because of the sartans opportunity and how there will be consistent shortage in US markets going forward. This was an exact replica of 2016 (the abilify shortage) when there was lots of buzz around Alembic. I never subscribed to that belief, for me Alembic’s business is lumpy in nature but is of high quality (shown in ROCEs > 20% during the pharma downturn despite R&D > 10% of sales). Now, that the buzz is gone, I revisited the story.

The main competitive advantage of Alembic Pharma is their vertical integration and their very nimble supply chain capabilities. This combined with 70%+ gross margins means they can do operating margins of 25%+ despite spending large amounts in R&D. So I was always interested in Alembic but preferred Ajanta over it (and still do) because of Ajanta’s branded business (~68% of sales) and debt free balance sheet.

Last year, I chose to buy shares of Cadila because they were reasonably cheap. Now that the valuation arbitrage in Cadila is more or less over, I switched to Alembic because now Alembic is trading reasonably cheap. For any generic pharma company with 70%+ gross margins (Ajanta, Alembic, Natco, Sun, Torrent), EV/sales of 3.5x is cheap. That’s why I made the switch. Here are my detailed valuation notes on Alembic.

Business quality

Year ROCE & ROE > 20% Positive FCF
FY11 Yes Yes Total # years 11
FY12 Yes Yes # ROCE & ROE > 20% 10
FY13 Yes Yes # Positive FCF 7
FY14 Yes Yes
FY15 Yes No SUM 17
FY16 Yes Yes AVERAGE 77.27%
FY17 Yes No HIGH BUSINESS QUALITY Yes
FY18 No No
FY19 Yes Yes
FY20 Yes No
FY21 Yes Yes

Promoter quality (Medium)

  • Organic sales growth greater than category level growth: True for US and developed markets, False for Indian market
  • Able to find new avenues to grow: Yes (Created large US sales despite being a late entrant)
  • Treats minority shareholders in a fair manner: Yes (Dividend payout ~ 20% of PAT)
  • Red flags:
    o Promoter takes very high remuneration (~10% of PAT)
    o Related party transactions are also pretty high (>150 cr.)
    o Promoter entity has been previously linked in Panama papers

Projections as on 06.06.2021
By FY25

  • US sales will reach $500mn (~4000 cr. at USD/INR ~ 80) implying 16.6% growth from FY21. This should be achievable given the large number of things they are trying (injectables, oncology, ophthalmology, dermatology)
  • Rest of world generic sales will grow @15% from 779 cr. in FY21 to 1’362 cr. in FY25
  • India sales will grow @10% from 1’497 cr. in FY21 to 2’192 cr. in FY25
  • API sales will grow @10% from 955 cr. in FY21 to 1’398 cr. in FY25
  • Consolidated sales ~ 8’952 cr.
  • Sell at EV/sales ~ 4 (given they are mostly in generic sales and not brands), EV ~ 35’808 cr. Assuming debt free balance sheet, market cap ~ 35’808 cr. (share price: 1821)

Confidence in projection (Medium)

  • Business quality (high/medium/low): High (Produces >20% ROE/ROCE and FCF over 75% of time)
  • Promoter quality (high/medium/low): Medium
  • Financial projections (high/medium/low): Medium (US sales of $500mn will not pan out unless they get injectables right)
  • Valuation projections (high/medium/low): High (In good times, should get >4x EV/sales)
  • Is it a cyclical business (Yes/No): No

Expected returns ~ 18% which comes in the 4% position size bucket.

As I had mentioned before, I am reshuffling my portfolio significantly which will probably take a few more weeks at the end of which I will start sharing the model portfolio again.

27 Likes

Was going through eldeco thread. They have a listed vs unlisted tradeoff.

Probably got confused between the two as both of them are large names in my hometown lucknow.

Sorry about that.

Congrats.

24 Likes

Over the past few months, I have made significant changes to my portfolio. In-line with my portfolio allocation strategy, I have simplified the structure into 5 kind of bets (core compounder, cyclical, slow grower, turnaround and deep value). I am sharing the current model portfolio structure.

Core compounder (44%)

Companies Weightage
I T C Ltd. 8.00%
Housing Development Finance Corporation Ltd. 4.00%
NESCO Ltd. 4.00%
Manappuram Finance Ltd. 4.00%
Alembic Pharmaceuticals Ltd. 4.00%
Amara Raja Batteries Ltd. 4.00%
Avanti Feeds Ltd. 4.00%
Eris Lifesciences Ltd. 4.00%
Ajanta Pharmaceuticals Ltd. 2.00%
HDFC Bank Ltd. 2.00%
HDFC Asset Management Company Ltd 2.00%
PI Industries Ltd. 2.00%

Cyclical (12%)

Companies Weightage
Kolte-Patil Developers Ltd. 4.00%
Ashiana Housing Ltd. 2.00%
Ashok Leyland Ltd. 2.00%
SWARAJ ENGINES LTD. 2.00%
National Aluminium Co. Ltd. 1.00%
Jamna Auto Industries Ltd. 1.00%

Slow grower (8%)

Companies Weightage
Power Grid Corporation of India Ltd. 4.00%
Cochin Shipyard Ltd. 4.00%

Turnaround (6%)

Companies Weightage
CARE Ratings Ltd. 4.00%
Lupin Ltd. 2.00%

Deep value (6%)

Companies Weightage
SJVN Ltd. 1.00%
ATUL AUTO LTD. 1.00%
Jagran Prakashan Ltd. 1.00%
D.B.Corp Ltd. 1.00%
Time Technoplast Ltd. 1.00%
RACL Geartech Ltd 1.00%

Cash is a little bit high at 24% and I am looking to deploy it soon.

The broad changes are summarized below:

  • New additions: Alembic Pharma (4%), Cochin Shipyard (4%), Eris Life (4%), Swaraj Engines (2%).
  • Exits due to valuations: HCL Tech, L&T, Maruti, Suprajit, Nippon asset management, Cera sanitaryware, Wonderla Holidays, Maithan alloys, Cadila Healthcare, Inox leisure, Jubilant Ingrevia, Natco pharma
  • Increased position size: ITC (from 6 to 8%), Avanti feeds (2 to 4%), Amara Raja (2 to 4%), Care ratings (3 to 4%) and Ashok Leyland (from 1 to 2%)
  • Decreased position size: PI Ind (from 6 to 2%), Powergrid (6 to 4%), Ajanta (4.5 to 2%), Ashiana (4.5 to 2%), HDFC Amc (3 to 2%), Nalco (2 to 1%)

Among new positions, I have already shared my assumptions about alembic pharma. I will subsequently add my thesis for Cochin Shipyard, eris life and swaraj engines.

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