I got the following comment on my previous post on Indo nippon electricals

Hi Rohit,
In the absence of latest annual reports, it is difficult to evaluate this.

What is the catalyst that you have in mind which will unlock the value or force the reevaluation?

Earnings are not growing significantly where they would make the market to take notice. In the absence of takeover attempt, it might be a long time (years!) for market to re-evaluate the price.

Some months ago, I had made a purchase of Kothari products (pan parag fame). Its book value is more than the market cap. Tobacco business is a cash minting machine. That’s all the analysis I did at the time of purchase hoping that somehow market will recognise the Graham bargain.

However, later I noticed that the promoters own more than 80% of outstanding shares. There is no incentive for the current owners to reward shareholders. There is no way for a hostile takeover. Ergo, the value trap stays as is. I have moved on in due course – hopefully, wiser.

Best Regards,Ravi

I decided to post my thoughts on ravi’s comment. I have posted on value traps earlier here

i agree, value trap is always a concern in such situations. i have also invested in kothari products in the past (see post
here) with a clear understanding that the underlying business was at best stagnant and the value unlocking would happen if the management did something about the cash. After holding the stock for more than a year (with a small gain), I realised that the management was not interested in any value enhancing measures. On the contrary there was a lot of apathy towards investors. The management had not bothered to update its website with the latest results and there was no way to access their annual report. As a result, I bailed out.

Indo nippon electrical has similar risks. However there are some key differences

1. The underlying business for Indo nippon is healthy and has a small amount of growth
2. The management has been pro-shareholder in the past and has given bonus shares and decent dividends in the past
3. The management has been very rational and efficient user of capital and has kept the return on capital fairly high.
4. They have updated their website with the latest annual and quarterly results

Value unlocking can happen via various actions on part of the management. In case of Indo nippon electricals I expect continued decent performance and passage of time to unlock the value.

However due to the concern of value trap, I have classified this idea as a graham idea. The key approach in such kind of investing is to invest in a group of such stocks (more than 10-15) where the entire group could do well, with some indivdual stocks performing well and some performing poorly. In contrast, focus investing which involves investing heavily in a select few stocks would not work in the above kind of idea. However with valuations being high, I am not able to find too many good ideas in which I can invest heavily.

see here a post on value traps and critical thinking titled ‘Value Delusions and Strategic Thinking’ by rick. he discusses about value traps and how to avoid them towards the end of his post.

3 Comments

  1. RaviAranke says:

    Rohit,

    Thanks for your comments and analysis. I appreciate the discussion.

    My comments are below:

    1. The underlying business for Indo nippon is healthy and has a small amount of growth

    I don’t agree with this. The net profits for year ending March 03 (27 Cr), 04 (25 Cr), 05 (18 Cr) and 06 (20 Cr) do not show this trend. There is nothing unusual in the income statements such as 1-off gains or write-offs. So it looks like that profits have been steady to somewhat declining. The quarterly results for 07 show that 07 yearly profits would come to about 20 Cr which would translate to EPS between 20-25. At the current price of 200, that is a PE of 10 or 8. Sure, it has been cut in half compared to last year but given the business, I think a PE of 10 is not screaming bargain.


    2. The management has been pro-shareholder in the past and has given bonus shares and decent dividends in the past

    If 25% of earnings are paid out as dividends (I cannot really confirm this based on the info. on their site) that is a 2.5% yield. Not too tempting.


    3. The management has been very rational and efficient user of capital and has kept the return on capital fairly high.

    No comment as I am unable to verify this.

    4. They have updated their website with the latest annual and quarterly results

    I would have liked the latest annual report. One doesn’t know how much cash is on balance sheet which might make this a bargain.

    IMO, this is not yet a screaming buy. Another price cut in half will take it there.

    Regards,
    Ravi

  2. Rohit Chauhan says:

    hi ravi
    the company has almost 80 crs of cash and equivalents on the book which is about 100 rs / share. that makes the company available at a PE of 5 excluding the cash on hand
    i would recommend looking at the performance for last 10 years( or 5years). the company has done ok in this period
    the last 2-3 has been bad for the profit ( growth of 2-3 % v/s topline of 6-7 %) due to increase of rm cost and intense pressure on pricing at the same time. the rm such as copper and steel which are main rm cost have gone through the roof ( on checking i realised that copper has gone up 300% and steel the same )

    during this period the company has still been able to maintain an ROE of 20 %+

    you can find the 2004 AR on the edifar data base. latest results are available on moneycontrol.com and icici direct.

    the risk is that the pricing pressure may worsen from OEM. the current price seems to discount that. so any improvement in topline and margins would result in the stock doing well.

    in the end as i noted, this is a graham play and should not be a core holding

  3. RaviAranke says:

    Rohit,

    If the company has 100 Rs/share in cash on the books then I agree with you. It is a decent Graham bet.

    The steel and copper prices have gone through the roof as you have noted and it is reasonable to bet _as if_ this rise in prices would someday revert to mean. When that happens, the bottomline will go up and market should notice the bargain.

    Regards,
    Ravi

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