The book values of PSU Banks

With share prices at a discount to the PSU Bank book values, these shares are generating a lot of buzz. Every time one thinks that the mess is clear now, new skeletons fall off the closet. Experts have been calling the bottom for PSU Banks from quite sometime now. Many are citing the huge discounts at which PSU Banks trade to their book values viz-a-viz their private sector peers.

We had written about investing in PSU Banks last year: Should you invest in PSU Banks

The recent scams and defaults have further sent the PSU Bank shares spiraling lower and investors see a good opportunity to buy into PSU Banks. Does it necessarily mean that PSU Banks are a valuepick because they are trading at deep discounts to their book values? This article addresses this point through historical facts and figures.

Courtesy: The Economic Times

Understanding PSU Bank book values

PSU Bank book values are reported by the management. It may or may not be a true reflection of the books because if the figures in the balance sheet and revenue statement are incorrect then the book value is incorrect too! So why will figures be incorrect?

Incorrect figures can be because of management misstating facts and figures, not accounting for losses and bad debts, assets being carried in the balance sheet even when they are obsolete.

PSU Bank book values

The loans that banks give are assets for them. So when the value of this asset erodes, the book value falls. As the banks start reporting NPA’s, the PSU Bank book values erode (due to write of off assets).

Price-to-Book Ratio

While the book value is determined from the numbers reported by the companies, the premium that investors pay on this book value is determined from their perception of the asset quality. Strong balance sheets and a capacity to earn higher ROE’s results in investors paying high premiums over the book value. The below table shows the premium that investors pay for different companies:

It is interesting to note that for Eicher Motors, the market is paying nearly 11x the book value per share and for Corporation Bank, the market is paying just 0.37x of the book value!

So are PSU Banks cheap/under-valued?

First, lets look at the historical PB Ratios for these banks.

10 Year PB Ratio Chart

From 2011, Corporation bank has always traded below its book value. That means, investors were never ready to pay even the book value of the company!

Andhra Bank’s PB Ratio
Andhra Bank is another PSU bank which is trading much below its book value since 2012.
PNB’s premium has nose-dived

PNB was one PSU bank which along with SBI used to trade at ~ 1x the book value. The 12,000 Crore Nirav Modi case has led to a sharp re-rating of the stock as investors fear that the book value is massively over-stated.

Should you invest in PSU Banks?

Most of the PSU Banks are trading at multi-decade lows. We must understand that these banks cannot command more than 1.3x to 1.5x of their book values for long due to high dependence on a slow management decisions. This means that if you are to gain any meaningful return from these stocks, you will have to go for those PSU Banks, whose book values will grow over the next few years. But what if further defaults erode the book values even more? The stocks will keep going lower and you will miss out on the returns that other quality stocks offer.
However, if you get the right PSU Bank whose asset quality will not further deteriorate, then a revival in India’s core manufacturing sector can see the book values appreciate and also a re-rating to occur. Re-ratings can happen sharply. Imagine a 0.3x PB Ratio moving upto 0.6x within few quarters! However, the asset quality of PSU Banks is anybody’s guess and you never know how many more skeletons will fall out of the closet as a probe for all NPA’s above Rs 50 Crores begins.
For reviving the PSU Banks, the Government will have to reduce the number of PSU Banks to 3-4 and privatize/merge most of them. Till major reforms kick in, these banks won’t offer much to shareholders.
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Astral Poly Stock – A Mega Bagger Story

Rs 10,000 invested in the Astral Poly Stock in February 2009 would be worth Rs 27.5 Lakhs today (excluding dividends). This stock has turned into a mega-bagger and is the type of story every value investor would like to invest in! The stock that we are talking about is – Astral Poly Technik Ltd.

About the Company

Astra Poly Technik Ltd. (est. 1996) operates in the plumbing and drainage systems industry. The company caters to the residential, commercial, industrial and agricultural sectors through a vide range of products. It has it’s plants in Santej and Dhokla (Gujarat) and also in Hosur (Tamil Nadu). The company was the first in India to introduce CPVC pipes and has created a strong brand image in the CPVC segment for itself.
About the Promoter
 
Sandeep Engineer started an API manufacturing unit in 1987. Due to many regulatory hurdles he could not expand his business and shifted his focus to CPVC pipes. In 1999, he started his own CPVC plant in India. In 2002, he was staring at bankruptcy and this is when he decided to focus on the plumbing industry and since then there has been no looking back.

Astral Poly Stock – Creation of a mega bagger

In a previous case-study (Read: Titan: How it became a multibagger) we saw how a stock with ‘heated up valuations’ became a multibagger over the years. In case of Astral, we see the advantage of buying cheap!
Astral Poly Stock returns
During the 2009-18 period, Astral Poly stock has seen it’s PE ratio expand from 2.5 to 81.91; it’s PB Ratio has expanded from 0.6 to 10.55 and it’s EPS (Standalone) has expanded from 1.2 to 9.58. This has resulted in a stellar 85.63% p.a. CAGR which has catapulted the stock price from ~ Rs 3.1 to Rs 785!
So what helped Astral Poly become the multibagger that has created enormous wealth for it’s shareholders? Lets study in detail.

Balance Sheet

The book value of Astral Poly has appreciated by ~ 27.15% p.a. CAGR which is a very healthy sign. Investors tend to focus a lot more on PE ratios and ignore others aspects like book value. While it doesn’t mean intrinsic value, the book value is a close proxy to the intrinsic value.

Revenues and Profits

 
Astral’s revenues have grown at a staggering 29.69% p.a. CAGR and it has been able to maintain it’s margins. This demonstrates the company’s pricing power. Talking of pricing power, it is interesting to note that the piping industry is totally fragmented with many local and national level players cutting prices. The PVC pipes industry was completely congested and Astral managed to create a niche by aggressively pushing itself in the CPVC segment.
 
 
CPVC pipes are nearly double the cost of PVC pipes but the CPVC pipes could function better where hot water was used. They are also more resistant to corrosion While PVC pipes would leak often due to difficulty in fittings, CPVC did not face any such issues.

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Despite rapidly increasing competition, the company managed to maintain it’s margins at comfortable levels and expanded its distributor base and presence aggressively over the years. Sustaining pricing power is a crucial factor in the creation of multibaggers like Astral Poly.

Another interesting point to note is that high growth years do not sustain for long when competition intensifies. In the piping industry, a general slowdown in real estate activities and the entry of new players in the industry has slowed down Astral’s revenue growth rate (which is still at a decent pace).

The growth has fallen to the lower tens (~ 12% p.a.) and is expected to increase to ~ 18% to 20% over the next 3 years because of a pickup in the real estate sector. The return ratios for Astral are very good – The company has maintained a high ROCE and ROE. Investors at times forget the importance of Return on Equity which can be the single most important ratio to look at while investing.


Efficiency

At Alphamultiple, we pay a lot of importance to the turnover ratios (Read: D-Mart: Still a multibagger?) and Astral Poly Stock shows why! The fixed asset turnover was maintained and the inventory turnover increased dramatically from 4 to ~ 8 over the last 9 years. One factor is also the rapid expansion of the distributor network.

Cash Flows

Over the last 9 years, Astral Poly has earned a PAT of Rs 572 Crores and in this period it’s cash flows from operating activities stood at Rs 763 Crores. Investors should study cash flows carefully before investing. A company earning only profits but no positive cash flows from operations raises red flags!

Astral has always been a positive cash flow generating company. Moreover, it has demonstrated it’s ability to convert its profits to cash.

Key Learnings

  • First Mover Advantage – Astral identified a product that was a better substitute to an existing product (although it costed more). Astral used its first mover advantage to create a niche for itself in the CPVC industry.
  •  Branding – Salman Khan appealed to everyone! From the plumbers to the distributors. The companies objective of using a celebrity to endorse their product paid off well.
  • Dealers and Distributors – We are a fan of the franchise model of business. Having a strong dealer network helps create a moat and also helps penetrate the markets at a faster pace (with lower costs)
  • Financial Health – The Debt to Market Cap ratio in FY09 was roughly 0.5 but the interest coverage ratio was at a healthy 4x. Investors should note the interested coverage ratio
  • Pricing Power – As discussed in this article, Astral managed to maintain its margin despite growing at a high rate of growth

The Astral Poly Stock has created wealth for it’s shareholders and as long term investors, our goal should be to identify such companies for investing.


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Titan: How it became a multibagger

A PE Ratio of 107.66, heavy debts amounting to approximately 200% of the market capitalization PAT margins of just 2%. How did this company go onto give 100x returns over the next 15 years?
We continue our case study on multibaggers with Titan Industries. Ace investor Rakesh Jhunjhunwala invested in Titan Industries in the year 2002 after a broker friend of his shared the idea with him. We have taken 15 years data of Titan Industries to study the making of this Tata group multibagger.
Apart from the market capitalization of Titan Industries, what else has changed in the last decade-and-a-half?

Balance Sheet

The book value has appreciated at a CAGR of 28.76% p.a. over the last 14 years in-line with the networth of the company. In the long run, to make profits from long term investing in the stock market, you need to invest in companies who’s intrinsic value is going to appreciate. While book value is not equal to intrinsic value, we will consider it as a substitute to gauge the management’s performance.
Note how Titan Industries went from being a debt-laden company to a debt free company in this period. Back in FY03 the company had loans of Rs 467 Crores in its books. This is a huge amount for a company with a market cap of ~ Rs 213 Crores. Will you, as a value investor, go and invest in a company having debts double the size of its market cap?

Revenues and Profits

How was Titan Industries able to repay its debt and clean up its balance sheet? For a company to become debt-free it has to repay it’s loans either by using cash flow from operations, selling its assets or by diluting equity (Issuing more shares).
Titan has hardly diluted equity and it has consistently increased it’s gross block while reducing debt. The debt has been repaid over time through the cash that Titan has generated from its operations. The company has not only made profits but it has also managed to convert the profits from mere numbers to cash.
Titan Industries has grown its sales at a CAGR of 21.84% over the last 14 years and at the same time, its adjusted PAT has grown by 40.99% p.a. This clearly demonstrates the company’s pricing power because it has been able to push up revenues without compromising on it’s margins.
The Profit After Tax margin has improved considerably over the years as the company first reduced it’s debt, thus lowering interest costs and later maintained its margins in the 6% to 7% range. Many investors see lowering EBIDTA margins as a negative sign but Titan Industries has defied the conventional thought process over time. Margins in any business will fluctuate regularly. For sustained periods of time you will also see margins trend lower as revenues are being pushed up aggressively.
The above chart gives a clear picture of revenue growth rate being higher than profits till FY06. As the company managed to sustain margins later, the gap between the growth rate of revenues and profits narrowed down.

Cash Flows:

The company has generated operating cash flows amounting to Rs 5,272 Crores between FY04 and FY17. This is against a cumulative PAT of Rs 5,549 Crores in this period.

Titan was a debt laden company back in 2002 (Debt was 2x the market capitalization) but the company grew at a fast pace and was able to generate cash from operations. The management kept reducing the debt in the balance sheet without diluting equity and selling assets.

Efficiency

Titan has consistently improved its Fixed Asset Turnover ratio and its inventory turnover ratio. In FY03, the company was able to sell its entire inventory 2.77 times a year and in FY17, the company was able to do it 6 times in a year. Also, the company was generating revenues of Rs 2.11 for every rupee of fixed asset in FY03 and it has increased to Rs 16.72 of revenue for every rupee of fixed asset. At Raghav Behani Equity Research we emphasize a lot on efficiency ratios as the key to judging the future performance of a company. Infact, investors put a lot of emphasis on PE ratio and other valuation metrics but often ignore efficiency ratios.
Titan Industries has maintained a current ratio between 1.1 to 1.7 throughout this period indicating a comfortable short term solvency position.

Valuations

Investors usually focus on past numbers and current valuations based on these numbers to take investment decisions. You cannot drive a car forward by looking at the rear view mirror. So, you need to gauge the growth prospects of the company and also the longevity of this growth before you invest. In our article titled: D’Mart: Still a Multibagger? we discuss this exact point of looking at current PE levels to term it as expensive. In D’Marts case we found many patterns similar to that of Titan in growth, profitability and efficiency.
At the end of FY03, the valuations of Titan Industries looked like this in comparison to FY17 numbers.
A PE Ratio of 107.66 is appears to be very expensive. To make it look worse, we are talking of a company that has debt in its book equal to nearly twice. Conventional wisdom would have advised to not invest in this company.

One of our top portfolio picks gave our investors close to 400% returns in just 16-18 months. We have written about the process that helped us identified this multibagger in this post.

Tailwinds

Tanishq Turnaround
Titan Industries was a consumer consumption story (It still is). Indians love to buy jewellery, watches and other accessories. Back in 2002, Titan was one of the most used watch brand in the country and India’s population was bound to go up and coupled with rising disposable incomes, we had a strong tailwind that presented before the company a huge opportunity to grow. Titan capitalized on this opportunity and went on to add further expand its portfolio by adding new brands such as Fastrack and Titan Eye+ but back in those days, the now famous Tanishq was a bleeding business. For five continuous years, Tanishq was making losses and Titan was running solely on its watch business profits.
So where exactly did Titan hit Bull’s Eye in the Tanishq story?
Titan correctly identified the opportunity for a national player in the gold jewellery business that was dominated by regional players. Tanishq sales were growing rapidly and the management was confident of the turnaround.

The above numbers are the revenue of Tanishq. The revenues grew at a CAGR of 51.6% p.a. and by FY03, Tanishq was contributing 40% of Titan’s total business (In FY97 this number was at 8%). Tanishq’s story dates back even longer when in 1992 the first plant was set up and in 1996 the first store was established.


Titan’s fairytale story would surely leave every investor in awe but there is a lot of learning in this story. You never know how many such Titans are out there in the making. These companies look like a strict “stay-away-from-this-stock” but you need to dig in deeper than just the historical numbers to dig out multibaggers.

A 10 Bagger Stock

In this article, we will discuss the case of a boring stock that hardly will be of any investors fancy. But his stock has delivered close to 10x returns over the last 8 years and it has achieved this feat without any significant growth in sales. Mind you, the sales have grown at a CAGR 13.1% over the last 10 years while profits have grown at a CAGR of 16.76% over this period. The company we are talking about is – Honda Siel Power Products Ltd.
What we can learn from this report is that to earn multibagger returns, you don’t always have to grow your revenues > 20% p.a. A company with an average growth in earnings and decent return ratios can be a multibagger too if bought at cheap valuations. HSPPL saw it’s PE expand from 15 to 24 in the last decade despite an average sales growth.
The Indian GDP has grown by ~6.5% p.a. over this period and inflation has averaged ~ 6% p.a. HSPPL has managed to grow at par with the nominal GDP growth rate and at the same time has improved its margins, thus generating wealth for shareholders.
Disclaimer:
Raghav Behani Equity Research is an equity research firm (SEBI Registered) that provides long term equity advisory services to its clients under the following Plans. The readers are advised to consult their own adviser or brokers before taking a financial decision on the company discussed here in.
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About:
Honda Siel Power Products is a subsidary of the Japanese company – Honda Motors. HSPPL was incorporated on 19th September, 1985. The company enjoys a leadership in the power products industry with a wide product range which is consumed in the domestic market and also exported. The company has its manufacturing facilities at Greater Noida.
Products:
  • Portable Generators
  • Water Pumps
  • Engines
  • Lawn Mowers
  • Brush Cutters
  • Rotary Tiller
  • Backpack Sprayer
The Honda engines are used in power sprayers, air compressors, rail drilling machines, pump sets and concrete saw cutting machines to name a few applications.
The Honda water pumps are used for irrigation in small land holdings (Upto ~ 5 Acres). The pumps come in three varieties – Kerosene, Diesel and Petrol. Honda enjoys a 40% market share in the water pumps industry.
The Honda portable generators are used during power cuts. Honda enjoys market leadership in the organized portable generators segment with a huge 80% market share. Honda generators are also acclaimed as the quietest generators in the market.
The company launched the rotary tillers in April, 2016 and expects significant revenues from the same going forward. The company claims to be getting good response for their tillers but what remains to be seen is if they can grow the tiller segment at 25%+ YoY and grab market share from existing players.
The revenue breakup of the major products is given below:
Geography:
North America is the major export destination for the company whose exports contribute roughly ~41% of the revenues as per FY17 figures. UAE is another important destination for the company.
Industry:
The power backup market in India is around ~ Rs 5,000 Crores. The global diesel genset market is expected to be worth $19 Billion by 2019. Inverter industry is highly fragmented and dominated by Luminous Power (28% market share), Microtek and Su-Kam.
Financials:
Despite having low growth rates over the last 10 years, Honda Siel Power Products turned out to be a multibagger for its investors largely due to PE expansion.
  • The company has retained earnings totaling ~ Rs 229.73 Crores over the last 10 years and added value of ~ Rs 1,182.78 Crores for its shareholders in terms of marketcap
  • The networth has gone up from Rs 151.13 Crores to Rs 366.57 Crores between FY06 to FY16 which is a CAGR of 9.27%
  • The book value per share has increased from Rs 149.04 per share to Rs 361.40 per share between FY06 to FY16 which is a CAGR of 9.25%
  • The company has been able to convert the profits to cash. The figures in the above table show difference due to some adjustments of extra-ordinary items.
The ROCE has fluctuated between ~ 11.5% and ~ 22% throughout the decade. The Return on Networth is however quite average with it peaking at ~15% at three different occasions. The company has room to borrow funds and boost the return on net worth (More on this later) but they choose to use only cash generated from business to fuel growth.
The company has largely been able to maintain its turnover ratios throughout the decade.
Profitability:
In 2009, the company had consolidated its operations in Noida by moving the Rudrapur operations to Noida. This move was done to optimize costs and improve margins. However, a general analysis of the margins show that the company was unable to meet its goal of cost optimization post shifting of operations.
Raw material expenses form a major chunk of the company’s cost and are roughly ~50% of their net sales. The major raw materials are steel, aluminium and copper. The company has been able to pass on the price rises over a period of time to the end consumer which is a positive sign.
Results for FY17 are given below:
Shareholding Pattern:
The major promoter shareholding is with the Honda group and 1% is with the USHA group (Shriram). Alchemy Capital and Lashith Sanghvi hold a chunk of this company in their portfolio.
Related Party Transactions:
There are a lot of related part transactions in the books of the company majorly due to it being a subsidiary of Honda. The company pays royalty at 6% of net ex-factory sales price to Honda Motor Co Japan apart from export comission, sales of finished products, purchase of raw materials and finished goods.
In FY16, the company had related party income of Rs 226.57 Crores, related party expenditure of Rs 173.69 Crores.
Valuations:
The stock currently trades at a PE of 24.35 and a price-to-book ratio of 3.49. When compared to its historical valuations, the PE has fairly priced in the positive factors.
The PE has been trading above 15 since mid 2012 and is quite high for a company that is growing at a 10% CAGR and doesn’t have many tailwinds for exponential growth going forward. The fluctuating margins and return ratios make it seem more like a commodity business and for the same reason a PE of 24 is fair. Now, interest rates are trending lower and in this scenario, we are definitely going to see higher PE ratios than previous years.
Even the P-BV ratio looks fairly valued at current prices. The company was available at throwaway valuations till 2009 and even in 2013. However, it was majorly on back of poor margins and profitability in FY13.
Should you invest? Can HSPPL give 1000% returns over the next 10 years again?
The company has cash of ~ Rs 142 Crores in its books which brings the Cash to Market Cap ratio at 10.24% which seems very good however, the cash in the books of the company brings down the return on capital of the company as it can earn only 6.5% to 7% post tax on this idle cash. The company is not opening up on dividends and the dividend yield is less than 0.5%. The management should consider a buyback of shares as it will increase the return on networth that the company is currently making.
The company has a low equity float. With Rs 10.17 Crores as the paid up capital and a face value of Rs 10 per share, the number of shares are ~ 1,01,43,071 of which close to ~ 27% is available with non-promoter non-institution shareholders. This means around 27.38 Lakh shares are available with retail shareholders.
HSPPL is fairly valued and has priced in all the positive factors and balance sheet strength in its current price. The stock at best can be a 12% compounder for your portfolio going forward. We don’t forsee a major PE expansion going forward due to fluctuating margins and ROCE. While < 12 PE is a great valuation level for “Multibagger” returns in this business, a PE of 24 doesn’t leave any room for valuations re-rating and PE expansion. Why are we not ready to pay a PE of 24 for such a financially strong company? Here are a few threats that could impact customer demand going forward:
The potential returns going forward are not in sync with the portfolio we are building for our clients. However, patient long term investors with a horizon of > 5 Years can take a deeper look at this stock for their portfolio.

Satyam Scam

Satyam Computers was an Indian IT services firm based out of Hyderabad. In June 2009, the company was taken over by Mahindra group’s IT arm and was merged with Tech Mahindra in June 2013. The name is synonymous with the major corporate fraud that it got into at the behest of it’s CEO – Ramalinga Raju. In Jan 2009 the scam came out in the open shortly after a bid to acquire Maytas Infra went dud. The Auditor of the company was PwC during this period and the signing partner was arrested post all investigations. This corporate fraud raised serious questions and red flags in the investing community with regards to the authenticity of financial statements and the accountability of auditors, especially the much revered Big 4’s. In this article we will try to understand what went wrong and what are the lessons we as investors should learn from this.

What Happened
Let’s first look at the numbers that Satyam Computers reported between FY02 and FY08. 
The CAGR given is between FY02 and FY08. Satyam Computers was growing at an extremely fast pace. In short, it was a growth company that most internet analysts today would be recommending to their “Paid” clients.
  • Revenue Growth – Check
  • Profit Growth – Check
  • Margin Sustainability – Check
So what went wrong? Everything. All the numbers were inflated and overstated. The cash balance at the time of Ramalinga Raju’s confession letter was overstated by ~ Rs 5,040 Crores. The margins were overstated at ~20% when in reality they were just ~3%. The revenues were inflated by raising fake invoices. A non-existent accrued interest of Rs 376 Crores on FDs, an understated liability of Rs 1,230 Crores and over stated debtors (Rs 490 Crores, shown as Rs 2651 Crores) came out in that letter. No analyst or investor saw that coming.
So what was the effect on the balance sheet? The below table gives you an idea using imaginary numbers.
Now, how can bank balance and FD’s be overstated? Simple – Forging documents. Fake FD receipts and bank statements were made and shown to Auditors. Since then, Auditors make it a point to directly go to the bank or write to them asking them for confirmation of the balances that the company holds with them.
Raju tried to acquire a real asset – Maytas, which was promoted and owned by his family members using the fake cash of Satyam computers. The independent directors and shareholders objected to this $1.6 Billion deal though the board approved it and even applauded it as a well-thought of move to de-risk the company’s business. They had three ways to spend the Rs 5,300 Crores of cash in their balance sheet – Dividend, buyback or acquisition. The institutional investors, analysts and other shareholders were angry because they felt that the cash could be utilized in a better way. The CFO of Satyam went on to say that 50% of the company’s revenues by FY12 will come from Maytas. The board didn’t bother taking approval of the shareholders which raised corporate governance issues. The ADR of Satyam tanked 55% on the NYSE that day. What Raju was trying to make the balance sheet look like is shown in the image below.
Since the promoters of Maytas were Raju and his family, the only actual payment he would have to make was to outside shareholders which he planned to do by raising cash outside and deferring the payment over a period of time.
What do we learn?
One cannot rely solely on the numbers stated by the management. The source of those numbers have to be questioned. Are all the companies in the industry growing at such pace? If no, then what advantage does the company enjoy over it’s peers? What is the moat and why are other companies not able to exploit it?
Growth is not easy and high rates of growth sustained over a prolonged period of time do raise red flags. As an investor, don’t take growth as a booster for your portfolio before you understand the authenticity of that growth. Also, big amounts of cash lying in company balance sheet needs to be taken seriously for two reasons.
i) Why is that cash not being returned to the shareholders?
ii) Till when will the management let the high cash remain in the books and lower the return on capital? Why is the management not distributing it?
The actions of Independent directors need to be observed. Are they quitting suddenly after a board meet? Are they giving vague explanations to the media? In Satyam’s case, an independent director resigned couple of weeks before the scam broke out! That should have raised some warning signals especially at a time when there was a tussle going on between the management and the shareholders. These are a few lessons we need to learn from the Satyam fiasco.