Inviting questions from readers

We are up for interesting times ahead. It is very hard to say anything with conviction at this point of time, a few exceptions notwithstanding:

1. The time tested strategies of value investing will continue to give good long term results irrespective of the directions the general markets take.
2. The financial misadventures of any kind, to name a few – excessive leverage by corporates or individuals, irrational fascination with the short term, and driving while looking at rear view mirror – will produce disastrous results.
3. The top 100 companies of any listing of businesses(e.g. ET-500, Fortune 500) will have very little overlap with the top 100 of the current or previous issue.
4. Defaults by individuals, corporates or sovereign governments will rise and the coming few years will see many previously credit worthy entities shocking the investors even though they think that they have already seen the worst.

 Needless to say, all of ‘us’ are under extreme pressure to decide our next course of action. I’m under similar pressure, although of a different kind, from an internal source(!), to make Unfair Value more interactive and less pedagogic.

 So we are inviting questions from the readers which we will take up for discussion in the forthcoming issue of Unfair Value. Short of giving our opinion on any XYZ stock or the short term direction of the Sensex, we will respond to you with the sense and sensibility your query or concern merits.

 To be fair to the readers posting the questions, your questions will be sorted by our editor, Seema. She plans to interview me, over-the-coffee, and the transcript will be made part of the next issue of Unfair Value.

 I don’t know if the experiment will succeed but I’m willing to ‘cooperate’ with her for at least this month. Don’t be surprised if I get fired for being reticent, uncooperative or showing signs of undeserved megalomania.

 You can post your questions to her at: editor@unfairvalue.com . Please provide all and only relevant details to get a meaningful answer.

 Regards

Kamlesh

 

The right price to buy

Every morning scores of analysts are paraded on the silver screen and asked a question. “Is it right time to buy?”.

I’m not planning to indulge in my favorite task of analyst bashing, I’m questioning the questioner. Inherent in the question, is an assumption that it is possible to time your entries and exits from the markets when the wisdom of most successful investors of this century suggests otherwise. When you are buying a consumption item, say a shirt and you see a sale where you are getting a really good shirt at throw away price, would you instead wait for the festive season to come, hoping that prices will go down further? For sure, buying shirts is not same as buying stocks but I hope you get the point I’m making here.

Since I became value investor, I have always ignored the timing aspect. I’ve always asked myself “Is it the right price to buy?”. You can amaze yourself with your innate ability to learn if you focus your mind on right questions. To a novice in quantum physics the question “What was there before Big Bang(or before God, for religiously inclined people) excites very much but the people who are well versed with modern physics know that this question itself is wrong.

To give you an example, in January when Sensex fell from 20,728 to 16,729 within a week, I found an excellent opportunity staring at me to buy Castrol at 235 Rs. I was of the view that the market is going to go much much lower than this. Had I asked myself if this is right time to buy, I would have been hesitant to buy. But I focused on the question whether it is right price to buy. Castrol, with its brands and strong leadership position in Indian markets has been my all time favorite. Its virtual monopoly ensures it a RONW of 50% and it was available at P/E of 13.3. The company had paid Rs 9 as dividend for last year which I expected to grow this year. Moreover the book closure date was in April which meant I will get dividend in 3 months. I bought the stock at 235.

The company paid Rs 14 as dividend giving almost 6% dividend yield, net profit rose 75% and 26% in next two quarters. The markets meanwhile crashed and Sensex lost one fourth of its value. On September 29th, I sold the stock at 332 because I needed cash for many other lucrative opportunities available now. Nonetheless, it gave me 47% gain(including dividend) against 25% loss in Sensex.

I’m not boasting my lucky strike but trying to demonstrate the value of right thinking in value investing. The same line of thinking has kept me out of harm’s way by making me sell out a huge chunk of my portfolio last year when to most people, it seemed like once-in-a-lifetime opportunity to make quick buck.

You should accept the fact that you can never time your entries and exits. At the peaks and bottoms the markets behave like senseless maniac who knows no reason. No price is too high and no price is too low. It gets irrational. Do you think Warren Buffett is lying when he said “I have no idea what the stock market is going to do next month or six months from now” or do you think “Oh! I can of course do better than the old man who is past his prime”.

If you buy the stocks which give you outstanding value for the money invested in them, you are bound to do well. I will just repeat what Warren Buffet said last week to CNBC, "You know, five years from now, ten years from now, we'll look back on this period and we'll see that you could have made some extraordinary (stock market) buys. That doesn't mean it won't get more extraordinary a week or a month from now. I have no idea what the stock market is going to do next month or six months from now. I do know that the American economy, over a period of time, will do very well, and people who own a piece of it will do well."

And yes, Indian economy is going do quite well in next decade notwithstanding the low IIP figures, high inflation, falling ruppe and slowing global growth.

Sky isn’t falling.

Dirty business of forecasting

Forecasting is a dirty business. The problem is not that one can’t have strong basis to be able to make predictions. On the contrary, quite a few long term forecasts need only common sense. But forecasting is dirty because the subject of forecast may not be amenable to reason. That is especially true for financial markets.

One and half years ago I wrote a post about subprime mortgage crisis which began with “This is getting serious” and described the impending crisis. The post ended with ominous lines “If it goes like this we can see a synchronized meltdown here too. Keep watching as the drama unfolds”.

And Mr Market said “to hell with you” and continued its climb. Sensex rose from 12529 to 17302 in next six months.

I was amazed. I looked at the valuations and decided enough is enough. It doesn’t make sense. I wrote a post painting the doomsday scenario that you saw unfolding last week. I didn’t hedge my bets. I wrote “I'm not reading out from pages of financial history. I'm writing about a not so far future, (before the end of year) when we are going to see a 1000 point drop in Sensex almost without a reason. The reasons will be invented later but if look carefully the reasons are being present now”. In the theatrical style I concluded the post “On the eve of that Black day, the high-flyer portfolio manager will come home and say ‘You were right dad’” [about Fixed Depsoits]

In few days market rose a thousand points. I got an email from one of the readers which read this.
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Subject: Congratulations
Congratulations on the excellent forecast. You were right about 1000 points, just the sign was opposite.
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The markets were no less brutal and Sensex touched a peak of 21,206 within weeks.

The reluctant forecaster thought of retiring from the dirty business. Its true. I really don’t want to make prediction but sometimes I succumb to the irresistible lure of the sin. I’m not paid to make forecast by any company. I’m not a celebrity whose reputation rises and falls with the crystal gazing capability. When I make forecasts, I do because I feel an urgent sense to act. I’m just verbalizing my own ideas. Unlike most analysts, I bet my ass on my forecasts. I don’t mince words. I don’t hedge my bets.

Four months ago when oil prices crossed $135 per barrel, most people were talking about oil at $200. People were referring all sorts of demand and supply data along with half cooked analysis of geopolitical equations to support that hypothesis. I was amazed that so many brilliant people were busy charting not only the price level but the route the prices will take to that point. Some will say it will have minor correction to $120 before shooting like a rocket to $200. If you could keep your mind away from all this, it was quite evident that the high oil prices had begun to pinch the consumers badly.

In June 2008, I wrote about oil - “As we talk about the 200$ oil, I'm getting signals which suggest that oil may surprise people once more. It may correct to as low as 70-80$ per barrel in coming 12 months. However by this time the damage would have been done and the economies of the world would have shaved 2-3% in their GDP growth rates.”

Oil has plunged below $78, market has plunged below 11000, subprime was nominated “word of the year, 2007” by American Dialect Society and dirtiest word of the year, 2008 by global investors.

I can sit back and relax like python..wait for the prey to come near the water mark and make my kill. If you are a python, you need just one kill to sustain for next 6 months.

Life is beautiful.. Forecasting?...as dirty as usual.

Container Corp: Hard to contain

Before the long textual analysis bores you to sleep, read the numbers carefully. Here follows 10 year record of financial performance of an excellent business, Container Corporation of India(CONCOR).

Description (in Crores)	1998-99		2006-07	2007-08	9 year CAGR
Paid Up Capital	64.99		64.99	64.99	0.0%
Reserves & Surplus	407.36		2564.84	3118.93	25.4%
Net Worth	472.35		2629.83	3183.92	23.6%
Fixed Assets	352.78		2025.33	2244.24	22.8%
Income from operations	684.77		3057.34	3347.3	19.3%
Other Income	31.59		84.6	164.47	20.1%
Total Income	716.36		3141.94	3511.77	19.3%
Gross Profit	220.26		975.83	1054.84	19.0%
Depreciation	12.27		93.58	106.34	27.1%
Net Profit Before Tax	207.99		882.25	948.5	18.4%
Provison for Taxation	66.51		186.17	197.98	12.9%
Net Profit	140.66		703.82	752.21	20.5%
Dividend	29.24		142.98	168.98	21.5%
Earning Per Share:(in Rs.)	21.64		54.15	57.87	11.5%
Physical (TEUs)*
International
Handling	576790		1715661	1977399	14.7%
Domestic Handling	225156		389605	470370	8.5%
Total	801946		2105266	2447769	13.2%

It has not only grown its revenues at a rate of 19.3%, it has achieved this superb feat without diluting any equity, without taking debt, while maintaining the profit margins and distributing 20% of its profits as dividends.

What are the factors that explain this achievement? To understand this we’ll have to go deep down and analyze the business of CONCOR: transportation and handling of containerized cargo.

India’s merchandize exports in dollar terms grew at a rate of 11.11% compounded between 1992 to 2004. The growth rate accelerated further and exports rose from $ 63 billion in 2004 to $ 155 billion in 2007-08. Buoyed by this impressive show India has set an ambition of achieving $ 660 billion merchandise exports by 2015, maintaining an annual growth rate of at least 23 percent. Given that India accounted for mere 1.5 per cent of the global trade in 2007-08 (down from 25% in 17th century!), which is very low for a economy of India’s size, such optimism is not completely unwarranted.
While the increased level of economic activity, especially merchandize trade, helps CONCOR, there is another factor fueling the fire. In India, the level of containerization has been increasing since past decade. Movement of cargo in containers has many advantages in terms to reduced time in handling, safety of the goods and cost. A container bound to a different country gets loaded and sealed, dispatched to container terminal on trucks, gets moved on freight trains to the ports and loaded on ships and gets transported to its destination. The standard sized containers allow setting up for specialized container handling machines, container depots which handle the cargo in most efficient manner. The container traffic in India has grown at a CAGR of 15% since 1991, roughly keeping pace with the growth in merchandize exports. The expansion of current ports as well as creation of new ports in Mundra, Pipavav, Vizag, Tuticorin, Vallarpadam , Ennore is boosting container traffic. Even in domestic sector there has been growth, although in single digits.

Such a business environment throws up an opportunity waiting to be capitalized. If you have a monopoly in such a sunshine sector then you are bound to make good returns. This explains the numbers you saw in the beginning of the article.

CONCOR is a subsidiary of Indian Railways, owned 63% by Govt Of India. It has an outstanding infrastructure for handling containerized cargo with a terminal network linking manufacturing hubs and industrial towns of India(map), 6722 High Speed Wagons, 1357 Container flats and a container fleet (owned and leased) 13,517 Containers. In recent years it has expanded its business in allied areas. It has become a port terminal operator in JNPT, Mumbai and it is building and managing container terminal in Cochin Port. It has also taken new initiatives in warehousing, refrigerated cargo storage and movement and logistical consultancy services.

Because CONCOR moves its containers on freight trains, it faces competition from cargo movement by road sector. The movement by road, although less competitive on long hauls, has advantages in door step to door step delivery and flexibility in timing for the consumer. Improvement in road network due to golden quadrilateral and NS-EW corridor and increased usage of larger multi axle trucks by truck operators have made the competition tougher. However, it would be foolish to assume that only one of these modes of transport will become predominant. You are more likely to see a win-win situation where alliances between train-based operators with truck operators will be formed and the customers will get holistic solutions for the cargo movement.

The business environment has seen one more significant change. In 2006, fourteen new operators (besides CONCOR) signed the Concession Agreement with Indian Railway Administration for running container trains with Indian Railways for a period of 20 years, extendable by another 10 years. Out of the 14 players, as many as seven have commenced their train services. This development effectively ends the monopoly of CONCOR in this sector.

But does this mean that the past performance can’t be used to gauze profitability of the company in future? Well, I think it will be a mistake to underestimate CONCOR. The physical terminal network is not easy to replicate. Also, this is a volume driven game where the incumbent operator has advantages in providing wider coverage and total logistics solutions. Moreover, CONCOR is not ignoring this threat. It is fine-tuning its strategies to accommodate the new realities. It is emphasizing on a hub and spoke strategy for container movement which will result in better utilization of its assets.

Given the rate of growth of Indian exports, it is hard to imagine a scenario where CONCOR is not earning significantly higher profits 5 years later. It provides a good vehicle to participate in India’s export growth.

I bought CONCOR 7 years ago at Rs 65(adjusted for bonus) but even today at a rate of Rs 732, it looks quite attractive to me and I’ve bought more. For sure it is an expensive stock, quoting 12.6 times profits and 4.4 times the book value. However, I feel more comfortable owning stake in a strong business rather than buying commodity stocks at low P/E. If you survive long enough in markets, you will see how ephemeral the earnings can be and how foolish the fascination with P/E turns out. And when you do get this wisdom, you tend to emphasize a lot more on stability, competitive advantages and track record.

As per my calculations the stock should give decent returns in next 5 years with an above average dividend yield. If it falls, I’ll be quiet happy to buy more because I find one striking similarity between attractive stocks and attractive women. “You can never have enough of them”

Reference :
CONCOR Presentation : http://www.concorindia.com/concor.rm
Annual Report: http://www.concorindia.com/upload/news/photo/img1/pic44.pdf

Bottom Fishing

Excuse me if this question violates your sense of propriety but I can’t help sharing this informative question with you. “Do you think we have successfully placed our bottom or we are still at risk of violating it?”. The question was asked last week by CNBC-TV18 anchor to an analyst. The analyst gave an elaborate answer about the market finding its bottom(as if it left it somewhere and forgot it!), followed by an esoteric monologe about something called double bottom!

But apart from the fact that it ticked my funny (and dirty) bone, it was laughable even from mathematical point of view. Sensex, like any other index, is a weighted average. It moves only because its constituents move. Tata Motors may be falling due to Singur, TCS may be falling due to fear of reduced expenditure on IT by US financial giants. Every stock out there is dancing to its own tune and yes, they are all, at the same time dancing to the cacophony created by this synchronized global fall in equity markets.

How would you guess where is the bottom of this market? Let me take the analogy little further. After enough booze has gone down the throats, there are 30 people shaking their bottoms on the dance floor. I put a machine that notes the direction of an individual’s bottom at any given moment on a scale of 0 degree north to 360 degree. Then I create an average which points the direction towards which an average bottom is pointing. I give it a name SX(pronounced ass-x). Its is not exotic enough for me, so I change it to a weighted average. I put weightages based on the weight of the individuals. So if a fat ass moves northwards, you would see SX inching northwards.

I list an exchange traded fund(ETF) of SX, I report it daily on newspapers, I create charts depicting the swaying aggregate bottom and soon there a bunch of analysts talking about tops and bottom of the SX, there are chartists discussing moving averages of our average, we have futures, derivatives, everything!

Now answer this.
Isn’t an effort to predict the movements of SX really, really, asinine?
The effort to predict direction of Sensex is no different. Don’t have to worry about buying dot on the bottom. Don’t try to time your entry and exits based on your gut feel about how low the markets can drop. If you were to completely ignore the market movements and devote your energies into analyzing businesses and their attractiveness at the given price, you will be better off even when you are completely wrong about market movements. Few years ago when Sensex crossed 6000 levels, I believed it was overpriced. I kept believing the same as Sensex kept moving upwards and crossed 21000. I will still be uncomfortable buying Sensex ETF today. But I don’t let my decisions about specific businesses be affected by my feeling about general market movements. I don’t try to time my frequent purchases and rare sales on the Sensex levels. And believe me, my personal experience suggests (I don’t need to quote Ben Graham on this) that ignoring Mr. Market improves your performance considerably.

And once you have invested in the business you like, you need to wait to let your business produce the returns for you. The market prices will follow the course of business in the long run. You need to avoid the temptation o booking profits or trying to sell fearing a market downturn in the hope of busing twice the number of shares at lower levels using the sale proceeds. You own a piece of business. No businessman shuts of his shop and sells his stake just because other people think his business is worth 10% less today than it was yesterday. This is what Charlie Munger calls “Sit on your ass” investing.

There are always enough opportunities to buy equity stake in businesses that are producing handsome returns. The fall of prices increases the chances that that you can do so at the right price. Don’t worry whether market has hit its bottom or not. Show your boot to the bottom of Mr. Market and do what you think is right.