Archive for the ‘Investment ideas’ Category.

 

In an earlier post, I discussed about a new mental construct – value trade. This is basically an investment operation where one buys a super cheap stock in the hope that it will become merely cheap (as my good friend neeraj puts it).

The idea is to buy a stock which is selling at dirt cheap price due to various short term reasons such as selling pressure, unexpected bad results or sheer neglect. The hope is that the market will get over this extreme pessimism (temporary) soon and will price it at slightly more reasonable levels (though still cheap). 

In such cases, I am out as soon as the stock recovers (as I have done with some ideas in the past – Globus spirits).

About

Infinite computers is a 1400 Cr IT services company. The main business segments of the company are application management services, infrastructure management services, Product engineering services and a new division – Mobility solutions.

The application management services involve the usual ADM and other support services. This is the bread and butter of the Indian IT industry. This segment contributed to around 68% of the revenue for the company and is characterized by repeat revenue, moderate levels of margins and high levels of competition

The infrastructure management services contributed around 16% of the revenue and is similar to the application management services in terms of profitability and competitive pressures. These two segments are being commoditized across the industry and the days of fantastic profits are gone.

The product engineering services involves some kind of IP based revenue sharing model. I could not find any revenue data for this segment, but based on the other segments would assume around 14-15% of the total revenue.

The mobility solutions segment is a new segment referred to as Infinite convergence solutions. This is a messaging platform (details here) acquired from Motorola and supports around 100 Mn+ global subscribers.

Financials

The company has grown from around 350 Crs in 2007 to around 1400 Crs for the year 2013 which translates to around 25% CAGR growth.  The net profit for the company has grown from around 3 Crs to around 120-130 Crs for the current year.  The net margins have improved from around 9% to around 11% levels, mainly due to a small reduction in the manpower cost (as % of sales)

The company has been able to deliver an ROE of 20%+ in the last five years. In addition the company been able to maintain receivables at around 25-30% of revenue which seems reasonable for a company of its size.

The company is a debt free company and has around 130 Crs cash on the books (30 % of market cap). The management has been investing capital into the business, has a 30% dividend payout ratio and the rest has been accumulated as cash on the books. In addition, the company also did a small buyback in the last one year.

Positives

The company has a very strong balance sheet and good returns ratio. The management has invested capital sensibly in the past and has a reasonable dividend policy in place. In addition, the top management is a buyer of the stock at the current levels (though one should not read too much into it)

The company has a high level of repeat business, which provides a high level of confidence to the sustainability of the revenues.

Risks

The company has been able to grow the topline and profits since 2007 and now has considerable cash on the books. At the same time, the company was not very profitable from 2005 to 2008 (average 2-4% margins) and had a very low topline growth of around 5% per annum during this period.

The company operates in a highly competitive, global and fragmented industry – IT services. The industry is facing commoditization and is very likely to have lower profitability in the future. The company is focused on the telecom industry which has its own competitive pressures with the additional risk of a very high proportion of revenue from the top 5 clients. This exposes the company to a high level of topline and profit risk, if there is any loss of  business from the top few customers.

 Finally, the company is also expanding into the product space which is a high risk, high return kind of a business. The company has invested in excess of 80 Crs on various product related businesses and these intangible assets may incur a write down if these ventures were to prove unsuccessful.

Catalyst

In case of a long term idea, a buy and hold strategy works quite well as the company is growing its intrinsic value. In case of mid cap IT companies, the economics of the industry over the long term is not very clear (atleast to me). As a result, the returns have to come over the next 9-12 months and this is usually driven by a catalyst.

In case of infinite computer solutions, the 2013 profits have been a bit suppressed by the forex losses and once this headwind dies down , we should see a better growth in the net profits. A consistent dividend payout of 30% – growing with the profits should serve as another catalyst.

What can go wrong?  A loss of any of the top 5 customers would hit the topline and profits. A sudden slowdown in north america would impact the company as this region accounts for almost 80% of the revenue. If any of this happens, the stock is likely to drop in the short term

Finally, if the management does an overpriced acquisition or has to write down the intangible assets, the market is not going to like that.

Conclusion

The company sells at a PE of around 4 and an EV/EBDITA of 1.7 (after excluding cash). At these levels, the market believes that the company will soon be out of business. The company does face multiple risks (which company doesn’t), but none of the risks appear to be fatal. In addition, as far as I can tell, the management seems to be doing a good job of managing the business and a fair job of allocating capital.

If one believes that the company is not going out of business, then one does not need any fancy calculations to realize that the stock is cheap.

Why a value trade?

I am not comfortable with the economics of the IT services industry. This industry is commoditizing and the wage arbitrage game is slowly coming to an end. The super high returns on capital are likely to trend down – as has already occurred for several mid cap companies in this space.

At the same time, I cannot resist an undervalued stock which can deliver above average returns in the medium term (9-12 months).

Note: This idea was emailed to me by chaitanyya and it is not an original idea. I have a small starter position and will add or reduce based on the price and performance of the company.  Please do your own due diligence.

Disclaimer : Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

 
 

About
Triveni turbine is a Bangalore based company in the business of manufacturing and servicing steam turbines upto 30 Mw. In addition the company has a JV with GE (general electric) for turbines in the range of 30-100 Mw.

The company has around 2500 turbine installations globally and is a market leader in India in the sub 30 Mw range with a market share of around 55%.

Steam turbines have multiple applications such as co-generation, captive power plants, and Industrial drives and in ships. The company supplies industry specific turbines to multiple industry segments such as sugar, cement, steel, chemicals, municipal solid waste and textiles.

Financials
The company was spun off from triveni engineering in 2011, which also has a sugar, water management and gears business. The turbines business has grown from around 280 crs in 2006 to around 670 Crs in the current year at a CAGR of around 13%. PBT has risen from around 37 Crs to 140 crs in the current year at a CAGR of 20%+.

The company has been able to maintain an operating margin of roughly 25% during this period and a return on capital in excess of 100%. The company is able to earn such a high return on capital due to negative working capital and high operating margins.

Positives
The company earns a very high return on capital which points to the presence of a sustainable competitive advantage. It enjoys a very high market share in India and is now expanding into export markets too

The company also has the following four growth engines working for it
–      Industrial demand for power via captive power plants. Additional demand from co-gen opportunities
–      Service demand from the install base and for turbines of other manufacturers.
–      Demand from the JV with GE in India and abroad for the 30-100 Mw range
–      Export demand for sub 30 Mw product range

In addition to the above growth opportunities, the company is currently running at around 40-50% of capacity and can expand sales with minimal capex.

Risks
The key risk for the company is a delay in the revival of the capex cycle. The investment cycle has slowed down in India and in the export markets. As a result the company has struggled to grow the topline and profits in the last 2 years. If the capex does not revive, the company could face stagnant profits for some more time.

Competitive analysis
The key competitor for the company in India is Siemens. However companies like Siemens and BHEL have a very wide range of products and are not as focused on a single product in a narrow range (below 30 Mw). Most companies in this sector enjoy a decent return on capital and hence triveni turbine should continue to earn a high return in the foreseeable future.

Management quality checklist
– Management compensation : reasonable at around 1-2% of profit
– Capital allocation record : In the short operating period as an independent company, management has used the free cash to pay down the debt and the company should be debt free by the end of the year
– Shareholder communication – fairly good. The company shares adequate details via the annual report and quarterly investor updates and conference calls.
– Accounting practice – appear conservative
– Conflict of interest – none

Valuation
The company is currently selling at around 20 times earnings. On the face of it, this does not appear to be cheap. At the same time one has to look beyond the raw numbers. The topline and profits for the company have stagnated in the last 2 years with a complete collapse of investment demand.

During this period, several capital goods companies have made losses and have seen their working capitals blow up. During one of the worst downturns in the sector, the company has remained solidly profitable and continues to operate with a negative working capital.

In addition the company expanding its export business has a thriving and growing turbine services business and should see additional revenue from the JV with GE. We may not see a PE expansion as the company is already operating very efficiently, however as the topline and profits start expanding, we should get a return commensurate with the growth.

Conclusion
The company operates in a niche and has a sustainable competitive advantage due to its customer relationships and service network. In addition the company has formed a JV for the 30-100 Mw range which should enable it to expand the target market for its products. The company’s performance has stagnated in the last 2years due to the macro economic conditions. However the long term prospects remain intact and the company and its stock should do well in the long run.

Disclosure: No position in the stock as of writing this post
Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer towards the end of blog.

 
 

About

IL&FS investment managers is a private equity/ fund management company promoted by ILFS (50.5% ownership). The company is in the business of raising funds from investors (institutional – both in India and abroad) in the form of individual fund offerings.

These funds have their individual mandates such private equity investments, infrastructure or real estate type investments. The company is responsible for investing the funds, managing the risks of individual investments and then finally working out exits from these investments. The company has been fairly successfull in managing the funds, generating 20%+ returns on most of the funds in the past for the fund investors.

The main source of revenue for the company is the fixed 2% management fee on these funds and an override on the returns over a threshold (a percentage of the gains made, above a threshold)

Financials

The company has delivered a 35% growth per annum over the last 8 years. The company earned around 225 Crs in 2012.

The company has grown the net profits at around 40% over the same period and made around 74 Crs in 2012. The main cost for the company is compensation for the employees and overhead expenses incurred on launching and operating the funds. The company has been able to maintain net margins in excess of 30% in the last 10 years.

Finally, the company has been able to maintain a high ROE of 30%+ and if one excludes the excess cash on the balance sheet, the ROE would be in excess of 50%.

Positives

The business requires minimal incremental capital to grow. The main assets of the company are the brand, its relationships with clients and the skills/knowledge of its employees.

The company needs very little capital to grow (some extra office space and maybe a few computers) and hence the entire profit is truly free cash flow. The company has consistently maintained a high dividend payout ratio in the past (over 50%) and used the excess capital to acquire a new fund (saffron) in 2010.

The company has a long operating history in raising and investing funds in various opportunities in India with good results (returns in excess of 20%). As a result the company has a good reputation with current and potential investors which should help the company raise additional funds from the clients in the future.

Risks

The company operates in a very competitive environment with minimal entry barriers. The company now faces stiff competition from a large number of Indian and international competitors such as hedge funds and other private equity funds. This has resulted in higher competition for raising India specific funds and investing the same in attractive opportunities (businesses) in India. This could result in lower returns for the fund investors and hence lower income for the company in the future.

The slowdown in the investment cycle, recent actions by the government such as the GAAR fiasco and other global macro-economic factors have made it difficult for the company to raise new funds. In addition the exit timelines for the fund investments have increased due to weak stock markets, resulting in lower returns for the fund investors. All this has impacted the revenue of the company which depends on the volume of funds managed (AUM) and the carry (excess returns over a threshold). It is unlikely that the investment cycle will turn around quickly, due to which the company may face a longer period of low revenue growth or even de-growth over the next few quarters.

Management quality checklist

Management compensation: fairly high at 25% of revenue. However this kind of compensation is typical of the industry.

Capital allocation record: extremely good. The company has maintained a very high dividend payout ratio and has indicated that they will dividend out almost the entire profits to the shareholders.

Shareholder communication: Quite good. The company provides adequate details of the business in its annual reports and conducts quarterly conference calls to keep the shareholders updated on progress.

Accounting practice: conservative

Conflict of interest: none

Valuation

The company is currently selling at a PE of around 7 which is on the lower side of the past PE range of the company (6-23). A company earning an ROE of around 30% and with a 15%+ growth prospects can easily support a PE of 15 or more. The company thus appears undervalued by most objective measures.

Conclusion

The company has performed extremely well in the past and has rewarded the shareholders well. The period from 2003-2008 was a bull market for private equity and stock markets resulting in high returns for the company’s funds. This resulted in good profits and high growth for the company.

The markets have slowed down considerably since the 2008 financial crisis and the Indian government has made it worse in the last few years. As a result, the company has struggled to raise new funds which is needed to drive the topline and profits for the company. It is likely that the company will take a few more quarters before it can raise and deploy new funds and a result the topline and profits could stagnate for some time.

The long term prospects of the company are good, though it will take time for the company to start growing again. This would test the patience of most investors.

Disclosure: No position in the stock as of writing this post

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer