Company Research

I first heard about IL&FS Investment Managers (IIML) when Prof. Sanjay Bakshi mentioned it in his interview with Safal Niveshak.

Since then, I have wanted to analyze the business, but could not do so until March this year, when a “back-of the envelope” analysis led me to buy a few units of the stock at almost the current price.

But then, I lost that envelope 🙂 and decided to do a re-analysis of the company, which I present here.

Before I begin, please know that this analysis is just to cheer you up on a hot Friday afternoon and remind you that the weekend is here. 🙂

My mind generally goes off to sleep as the weekend approaches (though my entire week is like a weekend), so be very careful of whatever conclusions you draw from what you read below.

[Read more…] about IL&FS Investment Managers: A Business on a Treadmill

I received a couple of emails from readers yesterday, asking about my views on Hindustan Unilever (HUL) after the parent Unilever announced an open offer to buy an additional 22.5% stake in the former.

Email 1: I have 300 HUL bought at Rs 400. Given the confidence the parent has shown in the Indian business, do I buy more?

Email 2: Given an MNC’s confidence in the Indian consumption story, does it makes sense to buy other FMCG companies as well, despite their high valuations?

[Read more…] about What to do with Hindustan Unilever?

I have written three posts on Opto Circuits (OCIL) so far – two in June 2012, followed by one in August.

The reason for the first post was requests from a lot of readers who wanted me to research the company.

The second post was my research report on OCIL.

The reason for the third post was requests from a lot of readers who were worried after seeing a 10% fall in the stock from the time I wrote my research on the company.

Now, I’m writing a fourth post on the OCIL…after requests from a lot of readers who want my view on the stock after it has fallen 52% since my second post and 46% since the third one.

“Too much of the past Vishal,” you might be thinking. “Tell me straight what I must do with Opto Circuits. I’m already sitting on a big loss!”

[Read more…] about What to do with Opto Circuits 2.0

Hero MotoCorp Ltd. (HML) has been one of the biggest wealth creators in the Indian stock market history.

Over the last 10 years, the stock has returned around 24% per year, which is an amazing long term average.

On the business front, the company has been at the forefront of the 2-wheeler revolution in the country. Since 2001, it has been the largest 2-wheeler manufacturer in the world.

As far as its financial performance is concerned, its sales and profits have grown at average annual rates of 18% each over the past 10 years.

This growth has been without any damage to the balance sheet. Debt remains minimal, its working capital cycle is small, and cash generation has been tremendous.

In fact, the company has not seen a single year with negative free cash flow over the past 15 years, which in itself is commendable.

So the past ten years, as a whole, look beautiful.

Now, as an investor, it is easy for me to draw patterns from the past – especially if the past has been a great one – and expect the future to be the same.

This pattern-forming skill gets enhanced when you work too much on the excel sheet, which gives you the flexibility to “tweak” future growth rates any way you want!

Anyways, here is a view an analyst friend of mine recently shared with me about HML – “A company that has grown its sales and profits at 18% per year across market cycles is bound to do good in the future. If not 18%, even if it achieves 15% growth, I can earn a handsome return on my investment.

“You see the balance sheet is clean,” he continue, “…the cash flows are solid, the brand is well-known, and now the valuations are also decent.”

HML’s P/E, by the way is at around 16.4 times its trailing 12 months earnings, which is almost near its average P/E for the past three years.

As compared to this, its closest competitor Bajaj Auto is trading at almost 20x P/E, or at a 22% premium to the former’s valuation.

So, on a relative basis, HML looks much cheaper than Bajaj Auto.

“What is more, HML is near its 52-week low price,” my friend told me. “I have thus bought the stock and expect to make a lot of money from it!”

Now, I am not a sadist. But my fried may start hating me when he reads what follows next.

Is Hero MotoCorp a value trap?
If you have been reading me for some months now, the right side of your brain tells you – “Oh, you know the crap Vishal writes when he analyses companies! You’re already reeling in deep losses from his ‘recommendation’ on Opto Circuits. And now, he says that a great stock like HML can be a value crap…oh sorry, value trap!”

But then, the left side of your brain tells you – “What’s wrong in knowing Vishal’s reasoning for the same? He’s always told you to do your own research before buying stocks because it’s your responsibility as an investor. So, at least listen to him and then do what you think is fine.”

Now I can see you holding both your brains together, and then reading out the three reasons I, Vishal Khandelwal, think HML can be a value trap.

Here I go…

1. Exit of Honda, and especially when it was driving all innovations at HML, will continue to be painful for the latter.

Just look at the history of TVS Motor. After the exit of Suzuki from a joint venture, the company took many years to find its bearings.

I think it will be worse for HML as Honda has already become a strong name in the motorcycle market in India, and is leaving no stones unturned to shake up the hegemony of HML.

HML is also facing immense competition from Bajaj Auto, which has emerged as a more profitable 2-wheeler company, and thus commands a greater pricing power than the former.

After Honda’s exit, HML has faced trouble in retaining its core customer group. This I think will remain a challenge, again led by rising competition and better product launches by rivals.

2. HML is not defending its leadership. As Mr. Chetan Parikh highlighted in the second part of his interview, the company has not launched any marquee models for long. Splendour was HML’s trump card when I was in college, and it’s still the trump card.

Bajaj was guilty of doing this – not defending its leadership – with its Chetak model years ago, and paid a heavy price of it. In a market that is even more competitive and fast evolving, HML’s slow steps can cost it heavy.

What is more, HML, with a 32% share ,does not have a market leadership in the most vibrant segment of the Indian motorcycle market – the 125-150cc range. In fact, Bajaj Auto and Honda are tightening the noose here.

In the premium range (bikes more powerful than 250cc), Hero is a very small player anyways.

The company is now also getting squeezed in its dominant business of selling entry-level bikes (75-110cc), where it has a near-70% (and declining) market share.

Sales here are getting impacted for two reasons:

1. Despite high interest rates and rising fuel prices, but due to improved income levels, more first time consumers are settling for the middle-of-the-road bikes (110-125cc) instead of entry-level bikes (75-110cc). Bajaj Auto and Honda are dominant players in the former category.
2. Scooters, which carry engine power comparable to entry-level bikes but with a much cheaper price tag, are gaining market share. HML’s scooter market share at 16% is just half of Honda’s and isn’t serving a major purpose for the former.

3. HML is losing its moat. After the exit of Honda in FY11, HML has raised its spending on advertising. In other words, it is resorting to spending more and more money to protect its moat, which is weakening.

Led by higher advertising costs, the company’s profitability is on a consistent decline. This – declining margins – is one of the key factors to identify a potential value trap.

With competition intensifying, rising advertisement spends, and no major development on new launches, margins may remain under pressure. A lower margin will also reduce the company’s pricing power.

So, what to do with HML?
Considering the above factors, I believe HML’s valuations at 16.4x training 12-months earnings, which seem cheap and especially in comparison to Bajaj Auto’s valuations, are not so cheap for the kind of prospects I see for the company over the next five years (at least).

Also, my intrinsic value calculations (you can see my last StockTalk report for greater discussion on the methods I use) suggest that the intrinsic value for HML (after adjusting for 25% margin of safety) is around Rs 1,350. This is around 25% lower than the stock’s current price, which suggests that I value at the current price anyways.

As far as HML’s business is concerned, any reduction in interest rates and an improvement in consumer sentiment (especially in the rural areas where HML’s entry-level bikes are in greater demand than in urban areas) can help HML return to a high growth part in the future, competition poses a huge risk for the company.

I see intensifying competition hurting HML on two major fronts:

1. Margins will remain weak as it continues to spend money towards advertising. Competition is eating into its market. Will HML’s profit margin recover sustainably? Well, that is a “too-hard” question. You should avoid situations where you have to answer this question.
2. Sales growth to taper down as first time consumers shift to cheaper but equally power scooters, or to more powerful but slightly expensive bikes than what HML sells.

The company will also be spending a large part of its cash flows towards R&D (for most Indian companies, R&D is a sophisticated term for T&A, or trial & error) in a bid to come out with marquee models, so dividend may no more be a lure to buy the stock.

In all, I think HML has the potential to become a value trap unless it gets its act together. At least that is what the direction of its business is hinting at.

But please don’t believe me!
With the growing influence of stock analyst recommendations and the proliferation of financial bloggers, there is good reason to question their usefulness.

Here are two reasons you must doubt my above analysis of HML:

1. Your level of conviction differs from mine. While I may be convinced based on whatever little analysis skills I have, that HML has the potential to become a value trap, you must not based your conviction on mine. This is simply because of the second reason.
   

2. I make mistakes…and a lot of them! I don’t have a flawless process of analysing companies or stocks. I have a process that remains in evolution, and thus I am prone to make mistakes. But that must never hurt you because you must take my analysis with a pinch of salt, do your own research, and then add your won spices to the story. Then, if the story turns sad, please do not blame me for you ate your own cooking. 🙂

Whatsay?