Wednesday, May 07, 2008

Few bets, Infrequent bets, Big bets!


Found an interesting study on portfolios of top value-managers at gurufocus.com..

LINK

Shows how concentrated a portfolio the top value managers run. Its a direct outcome of kelly formula - if you know something, and odds are in your favor and if you have conviction, bet big!

Its specially relevant for small sized funds, where a manager can cherry pick opportunities and make greater allocation towards his best ideas.

One may ask - Does too much concentration involves risk? Mr Buffett says - risk comes with not knowing what you are doing! A value-investor should not be in a business of "accumulating" hundreds of stocks, but cherry-picking just few value opportunities.

KRBL 2.0

This reminds me of Pabrai's Pinnacle 2.0. Oppurtunities in some sectors appear again and again and again..

The recent imbroglio over putting up export cess on basmati exports has resulted in the second oppurtunity arising in these businesses. Govt, seeing bumper windfall for the basmati exportors, decided to levy $200/Tonne of export cess. The companies were holding old inventories - nearly a year old. They had bought up these when the paddy prices in the market were not-supernormal. All of sudden, the spurt in rice prices happened, leading to a windfall for these export oriented companies.

For an exportor, the procurment price in 2006 Oct-Nov-Dec season or thereafter was between Rs 18-24/kg. A kg of paddy gives 0.6 kgs of rice.This makes their rice raw material cost at Rs 35/kg or $ 875/ tonne. This material was held in the inventories of the companies for 12+ months for ageing process, which brings out aroma/taste in the basmati. Market price of this held rice went upto 1600-1800 $/Tonne. So rice produced/procured at $875/Tonne in 2006-2007, is now salable in the market at $ 1500+/ Tonne.

Historically, raw material forms 80-90% of sales cost. Hence leading to normalised OPMs of 10-15%.

Basmati is not consumed within India fully, and more than 50% is exported. For middle-east countries, its a staple crop. So govt doesnt find any utility in stopping exports of the basmati, in order to control inflation or for crop security. Moreover quantum of Basmati as % of total produce is less than 2%. So Govt did a smart thing - seeing super normal profit for traders, decide to share the loot. Hence export tax of $ 200/Tonne or Rs 8/kg on exports.

In best case scenerio, the companies can ask the importors to pay for the cess. Hence they are able to sell rice at x+200 and enjoy the supernormal loot.

In the worst case, the Indian exportors bear the cost of cess - and hence their profits dip by 200$/T. In this case, their net revnue (after paying export cess) is 1300$/T (Rs 52/kg), when their cost of produce is Rs 35/kg ($875/T), they still have $425 / T as margin of safety (which historically had been around 100$/T).

In the worst case scenerio, think of it as a bank, which gets liquidated at the end of the period - sept/oct (before the next crop season begins) - It liquidates its inventory, pays of the creditors, and makes a little money for its equityholders (this time a little bit more than usual - leading to cash of around Rs 100/ share, which makes it a cash bargain!).

Markets, unable to understand simpler things, does exhibit semi-psychotic behaviour. And it creates mouth-watering oppurtunities. The stocks of basmati exportors are hitting lowers since past 3-4 days.... and gives me reason to smile..

.. So far so good.

Sunday, March 30, 2008

Punishment doesnt fit the crime

This company reminds me of the Aerosmith's song (Hole in my soul)..

..I'm down a one-way street
With a one-night stand, With a one track mind
Out in no-mans land
The punishment sometimes dont seem to fit the crime..

Market punishments are often too harsh. And this time its warth is on Patni - one of the infamous underdogs in the present markets.

Its well financed, sitting on around 1300c of cash. Over last three years, they have grown 24% on operating-cash-profits-after-workin-cap-changes. They havnt done well over past 6 or so quaters, and maybe therefore markets are not liking it. Price is fallen over 60% over past years - market is ignoring that the co did well till very recently and mr market is now dictating a life of only only 3 years to the company.

There are some clouds over muted growth, succession in the co, INR appriciaton , slowdowns & general negativity on sector, but I think we are paying too low for this decent sized company and downside looks protected. Let me explain..

Its being valued at 3700c - debt free, sitting on 1300c of liquid investments. Plus have their own land/buidling assets, which many IT companies dont have, as many operate on leased office spaces.

  • In worst case, if things start going down the drain, US recession hits them hard or mgmt is not able to manage the company well or family successsion problems arise, stock should crash to anywhere north of 180 rs/share (considering about Rs100/share of cash + Rs 30-35 internal generation for a year + land assets which I roughly conservatively value at rs 40-50/share) - and mgmt may throw in the towel and decide to exit at asset cost.
  • In best case, they can be a good acquisition target for anyone - they got 15000 employees! So may fetch decent premium if put on the table.
  • As going concern they are still doing anywhere between 400-500c of cash profits - which is like Rs 30/share.

On Relative basis, its one of the companies which have fallen the most in the entire sector. Infy has gone from peak to present of 29x to 15x multiples (mkt cap / operating profits multiples). Patni on the other hand has fallen from 20x to 4x (peak to present)

There is also a buyback offer from the management on the table. The company has offered to buyback its shares from the open market at max price of Rs 325, and has allocated nearly Rs 240c, which I think should give a temporary downside protection to the price. Anyways, if price does fall down, and company buys at lower cost, it will enhance the remaining shareholders' value; if it goes up, very well..

The best part is that with fall in earnings, the PE multiples also collapse - and vice versa happens on the rise. In this, we are getting free option on the upside. If things turn out to be well, we will make multi-bagger; if things turn sour, we are buying at the hard-asset cost.