H1 CY12 - Bright Spots

The business conditions haven't changed much in last few months. The signs of slowdown are now visible in some sectors, and now the Govt-bodies are also conceding to it. Biggies of the corporate sector have made multiple pleas to the Govt to push the reforms. Hopefully things will move.

Human minds works with a negative bias. The default mode of mind is to ignore the good things, and accentuate the bad things. This worked well in hunter-gather environment - but now, this trait is wired into our brains forever. Even without any external threat, mind makes its stories and produces unnecessary anxieties. Rick Hanson (Buddha's Brain) tells this as being in unnecessary flight/fight mode and unhealthy for our body.

Looking at the brighter side is equally important trait, which leads us towards development, growth, and entrepreneurship. Dr Martin Seligman – the positive psychology, and learned-optimism pioneer – says that we usually forget that nothing in this universe is permanent or prevailing condition. Things change for good. And its important to keep a tab on such changing and uplifting scenarios.

In past few months, few sectors have shown good movements.
• Power – Govt is trying to do its bit, and industry is not letting off Govt. Power prices in most of the states were increased last yr, and are again looking to be hiked this year. A recent Crisil report suggests that there is a big lag between rise in income levels and real power prices – i.e. consumers are willing to pay higher prices to get regular supply of power. Moreover, fall in coal prices internationally is good for Indian power producers.
• Cement production and prices are up in last few months, despite slowdown reports on infrastructure front.
• Consumables are doing well.
• NBFCs, catering to home-loans and auto finance are showing good growth.
• Overall, India, even within BRIC, isn't looking as bad as reported – Read this

(((Do you see any more? Send me the bright shoots which you can find around.)))

Markets are reasonably priced – in last several months, many things have gone from reasonably priced towards higher valuations. We are adding to our old positions, and are allocated comfortably.

Landmark

I attended this course recently - usually referred to as 'The Forum' globally – It was started in US in 90s. Its either loved or hated, due to its structuring and flow. The coaches rip apart the blind-spots and past foundations of the participants, and helps one see the past baggages, which aren't any good for creating the future which one desires. I recommend this, if it is available in your country – go and check it out.

H2 CY11 - Déjà vu

The fall in the market feels like 2008 - its ‘everyday low prices’ time again.

2011
The year went well - markets fell and “Sanborn” grew.

Our “Sanborn” - the fertilizer company, containing nearly quater of our assets, did very well. The thesis worked out quite fast - just over last 2 years. I expected it to add up cash profits of around 50-60 Rs/share on our cost of around Rs 200/share (which was nearly the investment/cash value of the company, thus protecting the downside risks).

The chemical compound which they make - shot up rapidly in 2010-2011 period and company reaped something like 100 bucks of cash profit per share per year!

Our cash position was large at the beginning of the year - Additional windfall came from liquidation of "sanborn", which further added to liqiuidity in the falling markets.


Agri Company
I invested into a company facing a rumoured loss and a liquidity crunch. It was a market-loved company with marquee PE funds as major investors + a reputed CA firm.

They are agri-traders and some agri-trades went haywire for them. The promotors had overleveraged their personal balance sheet, by pledging their personal stakes. With fall in stock, lenders became jittery, and in rush to get out of the stock at any price, further depressed the prices to a lucrative levels. I invested into it as price was quarter of book, company had liquidity problem which they were working on, the hard assets were good, and stock had sellers overhang. The upside expected was much higher than the downside risks.

However, with the fall in markets in Oct-nov period, good compounders had become more lucrative + company couldnt raise liquidity as mentioned by the management + business deteriorated as import of raw material became expensive & industry margins were squeezed + company started making delays in salary payment + there were reports of employees jumping off the ship.

Considering all this, I decided to exit the trade and switch over to somethings else.



Present condition

There is lot of uncertainty regarding future projects in the country - large capex is slow/stalled. But still the country is expected to grow at 6-7%, and within that some companies will do 20%+. Business conditions arnt as bad as perceptions - read Kamath interviews here and here and here(one of the better people to track).

We are comfortably positioned in the makets, holding back some 20-25% as cash. Our companies are facing general sectoral headwinds, with a few facing temporary-solvable-distress situations - hence low equity prices. Many have fallen close to all time low levels.

Our job is to find the right company and pay the RIGHT price. This time, unlike 2008, good companies, doing well, havnt fallen to good prices. There is no liquidity driven crises like 2008 - yet. The general disenchantment about the government’s pace of action may lead to a slow grind for the equity prices for year or two. I hope our cash holdings will give a good opportunity to buy more as markets fall down. Net net, i consider the present fall as once in a decade opportunity, coming up for the second time :) and we are happy to see "everyday low prices".


John Malone / Mohnish Pabrai / Chuck Feeney
Mohnish Pabrai visited Prof Bakshi’s classes at MDI Gurgaon recently. It was enlightening to talk to him and interesting to know how he is thinking about his allocation strategy over past few years.

I found another interesting person in “Cable Cowboy” - John Malone. Malone came up as a “disguised” fund manager, operating in media/cable industry. He used all the financial alchemy (dual voting stocks, stock swaps, zero tax structures, hiding earnings under high depreciation, leverage, etc) to create massive shareholders value over 3 decades. Recommended read.

The best find of the year was existence of a unknown guy named CHUCK FEENEY. He was the owner of Duty Free Shops and made business from zilch to multi billion dollar value. But thats just a small part. The best part - he kept his hedonism low and gave away his wealth - everything - for education and medicine. A real gem to emulate. Do read him in his bio.

One common thread which comes across most of such guys is - they are all extraordinarily long term thinkers, not paying attention to short term profits, running ulta-frugal operations, not wasting anything, concerned about building assets, and operating in taxfree structures. Conventional wisdom doesnt understand this - but as Buffett said, conventional wisdom is more on conventions than on wisdom.

H1 CY11 - Eat Well

That was KungFu Panda’s way of surviving the depression. And we also like to have the pleasure of gluttony whenever markets are in depression.

Look at the following charts. As you see, valuations have gone totally into depression – even below the 08-09 levels (and these are no small caps – the second one, infact, has a $25bn balance sheet!!)



Valuations have become attractive in many parts of the economy. Some sectors are genuinely facing headwinds – in form of delay in government approvals for projects, hike in interest rates, commodity inflation, etc – and markets are getting too pessimistic about them. Here, valuations have fallen a lot – even to as low as 08 panic-levels.

This is strange, especially when the companies are earning very healthy profits (much better than foggy periods of 08-09), AND they have strengthened the balance sheets, AND they have extra operational capacity with them…. Still markets are giving them a very depressed multiples.

There is surely some delays in projects involved. For example, govt clearances in UMPPs (ultra mega power projects) are facing some hurdles. But certainty of such projects is unquestionable. India needs Infra – things may move like a turtle, but cant be permanently stalled, else it would pull down the overall growth of economy. And this doesn't imply a life of 2 or 3 years (2x-3x cash flow multiple) to such companies, which markets are presently assigning to them.

On the other end of the spectrum, a part of markets has gone crazily expensive. Sectors like FMCG are IN-favour today and investors are over-betting for them. See the chart underneath (EV/ebdita)– no one was willing to buy this company in 2008 and even promoters backed off after announcing delisting offer then. Now, it’s a different story altogether!



Another interesting thing happening here in India, is exit of small retail investors from the market. Regulators disallowed the AMC (asset management companies) to pay incentives to middlemen/financial advisers to sell the mutual funds schemes some 2 yrs back –retail investors were given the power the do penny-pinching negotiations with the middlemen about his commission on sale of MFs (mutual funds). Hence middlemen have got disinterested in pushing MFs schemes to the investors. Combine it with Indians' fetish for gold. This apparently had resulted in lots of money from smaller investors going out of the markets. The fact is with the increase in economic prosperity of Indians, this money would be channelized into the markets sooner or latter.

Our positioning
We were able to convert a large part of our cash holdings into equities in last half – we have gone in from roughly a quarter in equities from last year to less than a quarter in cash position presently. We got into equities at very lucrative valuations - one company was bought from some distressed panicked seller - at a price earning us 7% dividend yield (tax-free) and good growth. We are holding some cash, for opportunistic reasons. Inflation, politics, Greece – anything will give us an opportunity to get things more cheap.

But with valuations getting lucrative, I guess, we would eat more soon.

H2 CY10 - The Turtle is in the shell

The picture describes our stand in the last half year. We sat on the pile of cash, waiting and waiting. There were no major mispricings in the securities, so we decided not to play the relative-fool game. As Buffett says, we dont get paid for activity - we get paid to be right!

Usually the securities are very efficiently priced, and no-brainers dont come very often. Munger says that good investing is all about extreme patience, combined with, extreme decisiveness . He advises to sit on the ass and wait for the things to turn to your level, combined with ability to take quick and big decisions. Most of Berkshire's growth is a product of this philosophy, whereby they were able to take few great decisions and bet heavily when odds were in their favour.

Waiting will have its own consequences, whereby I may commit the mistakes-of-omission, ie missing out at some times! But I think its OK to err on the side of conservatism as long as we dont lose any capital. Overall, i believe, this strategy will produce good results over long periods, although they may not as great as for past few years!

Considering that, I will leave this letter short. We are waiting for the right pitch to come at our prices and we are ready with ammunition.

H1 CY10 - Blooming Fat Man

Buffett said – when I see a fat man, I don’t know whether he is 300 pounds or 350 pounds, but surely, I can see, he is a very fat man. Our markets are like Buffett’s fat man presently – fat & blooming, but we don’t know how far it can bloom! We are concerned both about the valuations & the possible impact of problems in EU & China, though we don’t know exactly how long the music will continue.

Presently, the situation is very different from fy08 – during that period, all the engines were firing at full throttle – internal consumption was high, and exports were good. Presently, internally we are good, but exports have slowed or diverted back to India. Moreover, a reverse – imports inflows is becoming prominent. We already know the noises made by L&Ts & BHELs regarding Chinese invasion. As the world economy slows, China may be forced to divert goods to high-consuming economies like India, which may again effect the margins of our domestic industry.

India may attract more foreign flows – but only top few companies in market can accommodate greater-fool-capital. If money has to flow, it will flow more towards PE side, than the markets-side. Hence it could be beneficial for unlisted smaller companies, not for the markets!


Last few activities

In last few periods, the returns have been good, but it would be incorrect to focus on this blooming & benevolent period. What matters is how the portfolio was positioned in JFM09 – which decided how much will we earn. Buffett said that if things are bought very very cheaply, upside will take care of itself. I guess that’s had been the case.

Our activity in the first half was very limited due to the reasons stated above. As we move ahead, I would want to reduce it further to Buffett’s proverbial 20-punches-in-a-lifetime scenario, whereby we buy good managements selling at the rate of junk and ride on it for 3-4years. Thanks to another addition to my Guru list – Li Lu, who had been doing this well, and now has got Munger’s stamp!! See this link

We exited completely our rice company– the piggy-bank (described in the earlier posts). In our holding period, the value of the company rose, and the price-to-value gap was also filled up – its profits went up from around Rs 55cr to 125c in last 2 years!! This is the major theme on which we are focused. We want to buy 50 cents to dollar, and let the dollar grow, and wait for the next bull run.

When the earnings start rising, the perception (multiple) also rises, giving multifold results. For ex - a company growing by 25% will go like – 100 125 156 etc.
If it can be bought at 50% discount – at 50, and sold at 50% premium at end of 2 yrs, our capital goes to 234, making it 4x returns!

The only downside to this entire deal is that its painfully slow (one got to wait for few years or seemingly longer 365xNdays!!) and its very very very boring (not entertaining)!

As Munger puts it – real money isn’t in buying and selling pieces of paper – it’s in holding patiently!!!
If (1) biz grows in value (2) biz is bought at prices less than value- it will compound our money very very fast

Moreover, one saves on frictional costs like taxes and brokerages by holding for longer periods. With the change in Tax structure next yr with DTC (Direct Tax Code) coming, we will still do well, as holding long term gives us advantage of leverage.


New Buys

We bought only one new opportunity, which was very identical to Sanborn (made by Buffett during his partnership days). This is a Govt owned company, essential & must have product, with high demand, and tight supply (absence of its products in the markets have resulted in riots!!) and had been able to move from highly-leveraged-financial-restructuring-case to cash rich company over last one decade. It’s on its way to become cash bargain very soon, which is

(Value of cash on books – all liabilities) > Market Cap

In a way, you get operating businesses producing 500 odd crores per annum for free!! My thinking is that chances of goof-ups from corporate governance point of view are close to zilch (it’s a Govt co) & downside is highly protected (due to cash & free cash flows) – hence we loaded our trucks at good price – very similarly to Buffett’s proportion in Sanborn.

Why was market ignoring this? – Its like a 100$ bill lying on the street – till anybody picks up, all think it’s fake! Markets are anchored to its historical status of being highly indebted a decade ago. Also markets are anchored to its stock-price which remained around a level for past 4-5yrs. What markets ignored is that steam was building up in the pressure cooker, and it’s got to be released someday! With superb cash generation, they paid down all the debt, and build up cash rich balance sheet.


The TATA Gesture

So called professional investors and their clients are mostly worried about how the stock price is moving. That’s the reflection of their thinking process. They underestimate the value we should assign to longevity of businesses – a flavor of the season company, with bad economies and unfaithful management, will sooner than latter be more harmful to minority investors. A conservative, back footed, and righteous managers, even in mediocre business, will always serve us great.

THE ONLY THING WHICH MATTERS IS HOW ETHICAL IS THE MGMT/PROMOTORS - will they share the money made with you? Or are they just interested in their own Swiss-holiday homes and yatches? R they involved in doing somethings good socially? The big risk isn’t fall in mkt prices. Its when the promoter doesn’t tell u whats happening inside the co, when he treats the co as his dad's co, when he does under-the-table deals to fill his pockets, when he is more interested in building up wealth only for his great-grand-sons when he is more interested in preserving his wealth by diversifying thru subsidiaries in Netherlands, and Singapore, or riding tigers on Saturday morning or building up plush offices with fountains & palm tress on the mezzanine floors - that’s what is actually killing off the value inside the company!

Recently, I received a mail from a friend about how Ratan TATA behaved post attacks on the Taj, Mumbai – Here is the mail. … (No doubt you would want to partner with this man, for ever!)

A. The Tata Gesture

1. All category of employees including those who had completed even 1 day as casuals were treated on duty during the time the hotel was closed.
2. Relief and assistance to all those who were injured and killed
3. The relief and assistance was extended to all those who died at the railway station, surroundings including the “Pav- Bha ji” vendor and the pan shop owners.
4. During the time the hotel was closed, the salaries were sent by money order.
5. A psychiatric cell was established in collaboration with Tata Institute of Social Sciences to counsel those who needed such help.
6. The thoughts and anxieties going on people’s mind was constantly tracked and where needed psychological help provided.
7. Employee outreach centers were opened where all help, food, water, sanitation, first aid and counseling was provided. 1600 employees were covered by this facility.
8. Every employee was assigned to one mentor and it was that person’s responsibility to act as a “single window” clearance for any help that the person required.
9. Ratan Tata personally visited the families of all the 80 employees who in some manner – either through injury or getting killed – were affected.
10. The dependents of the employees were flown from outside Mumbai to Mumbai and taken care off in terms of ensuring mental assurance and peace. They were all accommodated in Hotel President for 3 weeks.
11. Ratan Tata himself asked the families and dependents – as to what they wanted him to do.
12. In a record time of 20 days, a new trust was created by the Tatas for the purpose of relief of employees.
13. Whatg is unique is that even the other people, the railway employees, the police staff, the pedestrians who had nothing to do with Tatas were covered by compensation. Each one of them was provided subsistence allowance of Rs. 10K per month for all these people for 6 months.
14. A 4 year old granddaughter of a vendor got 4 bullets in her and only one was removed in the Government hospital. She was taken to Bombay hospital and several lacs were spent by the Tatas on her to fully recover her.
15. New hand carts were provided to several vendors who lost their carts.
16. Tata will take responsibility of life education of 46 children of the victims of the terror.
17. This was the most trying period in the life of the organisation. Senior managers including Ratan Tata were visiting funeral to funeral over the 3 days that were most horrible.
18. The settlement for every deceased member ranged from Rs. 36 to 85 lacs [One lakh rupees tranlates to approx 2200 US $ ] in addition to the following benefits:
a. Full last salary for life for the family and dependents;
b. Complete responsibility of education of children and dependents – anywhere in the world.
c. Full Medical facility for the whole family and dependents for rest of their life.
d. All loans and advances were waived off – irrespective of the amount.
e. Counselor for life for each person

Clearly, one who takes care of the employees will always do good to the OPMI (other passive minority investors)

et al - few interesting books read
An exciting book which I recently finished was – THE BRAIN THAT CHANGES ITSELF. In the last few books read on brain*, this was a great addition. It shows that we can nurture our thoughts and give it a direction – learning even at latter stages is possible, if we concentrate and are focused to achieve it. I have read many such exemplary tales of people who re-constructed themselves

* I recommend reading
1. Your money and your brain - Jason Zweig
2. Stumbling on happiness - Daniel Gilbert
3. How the mind works - Steven Pinker (currently reading)
4. The secret life of brain (PBS Video)
5. The brain that changes itself

Second good book was – The Big Short – it’s the case of small group of value-hermits who made profits from CDS fiasco of 2003-2008. It’s remarkable to see that how myopic human nature is to make money in shorter and shorter intervals, and ignores ALL the evidences of eventual demise!!

H2 CY09 - Message from Master Oogway

Presently, I think that the opportunities in the market are very thin. Valuations have run ahead of the fundamentals of the companies - even bad businesses, with troublesome prospects are being richly valued. On the other hand, its good selling opportunity, as its sellers market now. Its quite evident from the number of IPOs and FPOs lined up (why else would promotor sell his equity, unless he gets very lucrative price?!). Overall, its good for the economy, as Indian Business owners, esp Govt companies, get good valuations and can expand the operations; courtesy, foreign liquidity. And good for investors like us, as we have more businesses to look into as buyers. We selectively take it as an opportunity to exchange our equity with the highest bidders. Thanks to buyers!

Over next few months, either the valuations will have to catch up over time, or asset prices will have to correct. With even an iota of bad news, there is a fair probability that asset prices will correct. And we are keeping our gun-powder dry!

Q: So what happens if Equity markets remain here? What do we do?
Well, Nothing for a while! We get into safest & best thing available - FDs. With that (1) we are still preventing inflation eating our money (2) we are safe (3) we have cash available to us when ever opportunities emerge!
The economics of this deal are wonderful. Consider the mathematical analysis of remaining patient. Observe first row - Assume that one lets the money remain in bank for 4 period earning 7%pa, and then gets (JFM09) kind of market in period5, making 100% return. Total return over 5 periods comes to be 21% - good! Consider second row. Money is in bank for 3 periods earning 7%, followed by a bumper year of 100% - net return - 25%! The economics of the deal gets better and better as possibility of absolute great returns over shorter period increases. Wonders of Patience!!








A friend shared this story about Charlie Munger's company lately - and how it generated great retuns lately. See Fool.com here
A company that Munger controls did just that. The Daily Journal saved its money over many years building up a cash reserve of over $20 Million. All of the money was invested in Treasuries and there was no hint that there was a desire to purchase stock. In the March quarter of this year, $15.5 Million was moved into a stock or several stocks. The value of that stock (or stocks) was $24 Million at the end of March, $41 Million at the end of June and $48 Million at the end of September.
Bottomline is BE SAFE!! PRESERVE YOUR CAPITAL!!

Pabrai mentioned the concept of "motta hisabb" (back of envelop mathematics)... similarly i think we should adopt only broader sense of markets and not do too much of mental jugglery about it. We waste our mental power/lives on issues which don't matter (where is economy heading in 6 months/where is interest heading in a quarter/how will commodities do next year, etc).

Master Oorgway says that a peach seed sown will grow out to be a peach tree - Buffett says the same when he mentions that you cant produce a baby in a month from nine women! Things will take their own time, but broader direction should be correct. A business, with good economics, with honest management, which is compounding capital at, let say 25%, will be double the size in three years. That's pure mathematics. In between, its all noise.

Looking at the requirements of the population in our country, we think that the direction for the Indian economy will remain upwards over long time - we got to grow a lot to reach to developed countries' level. And so, we always remember the wisdom from Master Oogway...

Message from the Master Oogway
(Taken from conversation between charterers of the movie - KungFu Panda)





Master Shifu: Master, master!
Master Oogway: En?
Master Shifu: I have...a...it's a...it's very bad news!
Master Oogway: A, Shi fu, there is just news, there is no good or bad.
Master Shifu: Master, your vague, your vague was right, Tai Lung is broken at the prison, he is on this way.
Master Oogway: But he is bad news, if you do not believe that the dragon warrior can stop him.
Master Shifu: The panda, Master? but the panda is not the dragon warrior, he wast even meant to be here, he was an accident.
Master Oogway: There are no accidents.
Master Shifu: Yes, I know. you said already, twice!
Master Oogway: Well, that was no accident.
Master Shifu: Thrice!
Master Oogway: My old friend, the panda will never fail his destiny, nor you yours, until you let go afraid to illusion of control.
Master Shifu: Illusion?
Master Oogway: Yes, look at this tree, Shifu, I can not make bloom someone and let's shows me, nor make bear fruit before it's time.
Master Shifu: But there is other thing we can control. I can control when the fruit fall, I can contorl where plant the seed, that is no illusion, Master!
Master Oogway: A, yes, but no matter what you do, that seed will grow a peach tree, you may whish for an apple or an orange, but you will get a peach.
Master Shifu: But peach can not defeat Tai Lung.
Master Oogway: Maybe it can, if you are willing to guide to it, to nurture in it, to believe in it.
Master Shifu: But how, how? I need you help, master?
Master Oogway: No, you just need to believe. promise me, Shi fu, promise me you will believe.
Master Shifu: I...I…I will try.
Master Oogway: En good. My time has come, you must continue your journey without me.
Master Shifu: What...what...what you wait... Master, you cann't leave me!
Master Oogway: You must believe.
Master Shifu: Master...

H1 CY09 - Surprise Party!!

Markets never deter to surprise us. JFM was the gloomiest and most beautiful quarter for Value Investors. This was a real market-panic never before seen in life, which amazed even veterans. The market was a buyer's market where one could have got anything at any asking-price. Cash was the real king. Then too many issues spooked the market - players felt that march quarter results would be worst than December quarter, credit lines had halted altogether, elections results were not supposed to be anything good and chances of hung Parliament were high. But markets have tendency to surprise us far more than we can assume.

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What did we do, when nothing was clear?
Once, a wise man asked a rich person - how did you get so rich? The person replied – I always keep a million here or there! And JFM was the time to use all the ammunition, while sticking to our system which said, be conservative, never over bet, don’t leverage too much.

In February, when things when really scary, we couldn’t have predicted how things were going to work out. But the message from the veteran value investors was – BUY. So investments were made in
(1) Cash rich companies, with no dependence on external credit, with zero debt status.
(2) Companies doing buybacks, with insiders buying and making use of the fire-sale market prices.
(3) Companies giving great dividend yield – in some cases as high as 10% assured, which was far superior to locking the money in the fixed deposit in the bank, post tax!
(4) Govt owned companies (In God, and Govt, we can trust in such times!).

We did not had any clue when growth would be back. But we were willing to wait for 1-2-3 yrs, when good companies, with good managements, paid us 8-12% tax free parking fees (dividends) for next 2-3 years.


Many investors, including Mutual fund houses, in the expectations of future downturn, were not willing to buy in JFM. The mistakes of 2008 were again repeated – “investors” who were unwilling to sell in Jan08, the same “investors” were unwilling to buy now!!

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Value Investing
Value investing offers a very conservative system of investing, as given by Ben Graham. It offers to invest in
• Very cheap securities – something selling at 50cents to a dollar
• Look for worst case – and try to get dividends for waiting.
• Buy companies which are not-too-big, where we have competitive ground-level-knowledge advantage, and less research is available from the street.
• Buying from punters, traders, not so knowledgeable investors,
• Buying from Financial Institutions (FIs) who cant hold smaller companies because of size,
• Buy from FIs, who have to forcibly get out of the market during falls, to beat the index daily – incentive caused bias.
• We are not required to be in the markets always. As Buffett says – wait for the fat pitch and strike when you want. We can sit comfortably on cash. Bernard Baruch, another great investor wrote in the book “My Own Story” that you must give rest to your soldiers!
• Our portfolios are non-indexed – and we are willing to unearth relatively unknown/ unloved/ under-owned names.

The overall result is a function of not only buying the right companies, but also managing the allocations. A good set of companies, with wrong allocation, will do no justice to the buying process. Allocation need to be managed within different companies, and between equity and cash.

PROTECTION OF CAPITAL to us means that our invested businesses shouldn’t go belly-up, or shouldn’t be under stress or dependent on the mercy of markets for capital. It shouldn’t happen that owners dilute the company at the cost of minority shareholder, because they went too aggressive when the markets were euphoric. For Ex - Unitech strained under debt, diluted the equity from 160c shares to 238c shares - at price between 38-85 bucks. This is good for company and promoters, but it dilutes the minority guys. Good for companies – as they got lifeline; Good for promoters – as they can still issue themselves warrants, or stock at lower price in a rising market and still enhance their stakes going forward. But minority shareholders lose their equity stake in the deal!!

For us protection means - good intelligent managements, which can add value without the mercy of external capital markets, and who are – most importantly fair to the minority shareholders. We want to grow the capital, but not at the risk of having “fun and excitement” from the markets and its corrupt deeds.

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Present Situation
Presently, Nifty is selling around 3.5x - not very cheap, but neither too expensive historically. The markets look expensive on PE basis selling at trailing 20-21x . However, so were they in 2002, when earnings collapsed and PE multiple remained high. When the earnings came back to the assets, the PE started looking cheap again!!

But the catch is the changing of constituents of Nifty. Exchanges move out the companies not doing well, with the companies which do well. Hence a inbuilt bias to see the eps-of-nifty high. For example – from 27 march 2009, Axis bank replaced Zee Entertainment. The idea is to keep healthier and flavor of the season in the index. Indeed, the exchanges are biased to see the growth in their own indices, which eventually overtime pushes up the EPS!!

The problems surrounding markets are not yet complete (but when are they?) Few companies - esp. real estate, has just been salvaged by new capital infusions. Few large companies are still sitting tight on debt and raising money. Interest rates have gone totally unpredictable, with the fear of inflation & increasing fiscal deficit– although the cheer leaders of the Govt dont accept that. The commodity prices can still shoot up again. The disinvestment program may face hurdles from employees of PSUs or other stakeholders. Threat of poor monsoon is also hanging on our head. World economy is still in woods. And more over, markets pendulum has swing too much to the other extreme, a bit too much too soon!!

On the positive side, presently, India is supposed to be a shinning star in dark global skies. World Bank recently showed bullishness by upgrading India's growth projections. (And smart people around say those World Bank projections are conservative!) Many industries are doing well, except for export units or those who have taken high debt in euphoric periods. With young and increasing population, the story of India's "demographic dividend" remains. The requirement for infrastructure (and capital) is huge in the country, and we haven’t even touched the tip of the iceberg yet. With world economy in doldrums, we think, India can be an oasis for return-thirsty investors!! But this has also started to reflect in the premiums of stock prices!!

The initiative of Govt to rope in people like Nandan Nilekani for Unique-ID project is commendable and shows the direction of change. This will give big boost to people living in rural areas and will help in sorting out complex problems like fertilizer subsidy or employment guarantee schemes.

The abolition of entry loads in mutual fund industry is another great feat achieved recently – good thing for the common investors of the country. Earlier the investors were “sold” the products which paid “advisors” or banks the highest commissions! Financial advisors used to churn and churn and churn, and bleed the investors – making them gain nothing out of their investments. Now at least, a common lay investor will know what he is buying and paying for!! Mahesh Vyas (of CMIE) recently wrote a wonderful article – Error of 2.25% commission - in Financial Express – which can be read from here

Re-election of the same political party for the second time in Parliament is definitely a positive for the country. They don’t have to waste time to rethink the old policies and can move forward quickly.

June quarter results have started flowing, and surprisingly they are looking good on face. A good reason for that is low commodity inventory accumulated by companies during JFM quarter. Also, another reason could be "re-stocking" the inventories, which were depleted in the last quarter. Banks are showing good credit growth, and loans off take has started picking up. Direct Taxes for the quarter look up and positive. However, I think next quarter would be a better guide of the industry conditions when low-cost inventories and restocking would be gone.

Soros’ Theory of Reflexivity has got a part to explain why companies showed good results and hence higher valuations. The new liquidity (QIBs) gave a lifeline to over-leveraged companies – especially real estate, which has helped them lower the pain of debt. The high stock prices of these companies - now fetching good value/share to the capital-raising-companies in turn, help improving the fundamentals - Only it needs to be seen is for how long will this party continue.

So far, so good for the businesses and real economy. However, valuations look a bit stretched, which is evident from crazy things happening in the market –
• Many companies are selling at or very close to all time high prices, historic high PEs and PBs.
• New companies are lining in the markets to raise capital
• Business houses have started talking about their grandiose plans to expand again. Acquisitions are back in action and animal spirits are high again.
• Fake trades are back on exchanges – read this article
• Small caps are seeing highlighted interest again
• Grey markets in Gujarat are active again

With such a bullish sentiment, it seems that words like "Fear", "Satyam", "Pyramid Saimira" are long forgotten again. Things are back to square-one - back to 2007 again!!

2008 and present state of business

2008 had been an interesting year. It was an year when excesses were eliminated, senses were restored and easy money went out of window. People realized that 50% returns were an exception, an aberrations, not a norm. Greed changed to fear, and fear to panic. Tulips (aka stocks) were no longer desired thing. And valuations fell from "super growth for next 10 year " models to under-book, under-working capital, and under-cash in many cases!

Many think that lowering of market prices was bad. I think asset prices have gone down, but the value isn't got destroyed as much, at least in "real" businesses. FALL IN THE ASSET PRICES IS NOT EQUAL TO DESTRUCTION OF VALUE. Value isnt destroyed by psychotic nature of Mr Market - its realization gets delayed, not destroyed. For a smart business owner, its a good time to buy businesses. As some say that a best time to start a business is the low years - similarly, the best time to own a business is also a year when the asset prices fall down. For an intelligent buyer, distress is the time for sowing!

Logically, destruction of value takes place when managers act stupidly. For example - one of the worst decision in Indian businesses in 2008 was implementation of CSR -TAX by the Gujarat government on several PSUs. The govt demanded around 30% of PBT to be contributed by PSUs (Gujarat Mineral Development Corporation (GMDC), Gujarat Narmada Valley Fertiliser and Chemical Limited (GNFC), Gujarat Industries Power Corporation Limited (GIPCL), Gujarat State Fertiliser and Chemical Limited (GSFC), Gujarat Alkalies and Chemicals Limited (GACL) and Gujarat State Petronet Limited (GSPL)) towards aiding social-purposes of the state. Link. The ideal way would had been fair distribution of money towards all equity owners - in form of dividends. The govt, by mandating 30% CSR, set a bad precedent for other states and tarnished its image as a investor friendly state.

Sometimes, such bad instances can create good value opportunities. For ex - Satyam (pre Raju's confession) had fallen down on the satyam-maytas merger attempt. When the management went back and aborted the deal, the price jumped back.

We see distress as an important source of opportunities. We like to classify problems at three levels -

1. Economy/country in distress - for example - US after subprime, or entire market crash
   
2. Industry in distress - for example - textiles in india presently.
3. Company in distress - for example - machinery breakdown, major commissioning delays, raw material paucity, etc
   

Taking call on type1 or type2 oppurtunities require too much of a macro view. For example - "when will US recover?" or "when will real estate sector make a come back in india" are the most difficult prediction to make. When the problem is localised to a company - type3 problem - its can be eliminated by the managerial efforts and we can assign a time line to it. Hence type3 is a fertile ground for seeking opportunities for us. For example - a machinery breakdown or fire in the plant, can be rectified easily by the management. We try to seek out reasons and figure out if the problem is temporary or permanent. If the problem is not of permanent long term errosion of earnings, then a carefully selected portfolio of such oppurtunities, with adequate margin of safety, can produce good results over time. Same has been demonstrated by value investors like Marty Whitman or more so by Mohnish Pabrai over years.

A well run company's market price may deviate from valueline as per short term trends, or due to market behaviour. But in type-3 kind of problems, we can see major deviation of price lines from the long term value line. Our endavour is to be part of such opportunities, and maximize our holdings in such companies.

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Present state of businesses.

Whats the ground reality?
As per our understanding from readings and talking to many people in the industry, the problem in the industry looks more of a credit non-availability, coupled with fear, leading to slowdown of business. Non-availability of credit is leading to slower import-exports, shipping lines are stalled, banks are afraid that smaller enterprises will become NPAs on their books, steel & cement demand - a subset of infra - and a further subset of capital - is slow, coupled with overcapaicty in pockets. Moreover, due to crash in commodity prices, many players of the industry are sitting on inventory losses.

Still, on positive note, India isnt that affected. India's exports form around 20% of its GDP - internal consumption is high. People are consuming goods, industry may not be growing at rapid pace, but its still producing cash!! We arnt at a stage where companies are over-leveraged and not finding takers of their goods, and hence defaulting large scale on the outstanding debt. Same is the case with most of indian population - who are very very conservatively financed.

All said, we feel that its time that we should - at personal and corporate levels - reduce levereage, and cut down unnecessary discretionary expenses, and save on to liquidity! Infact, our focus is now on goods and services which are most essential in nature, rather than for luxury!

State of markets
Not many value investors across the globe have done well - in terms of producing positive return in the last 12 months. Many famed value investors - Marty Whitman, Mohnish Pabrai, Bill Miller, etc, are down heavily. Assets across categories - value, growth, commodities, real estate - have crashed down. As Buffett says, it was an economic pearl harbor. All said, as someone says, these value guys arnt any more foolish than they were 10-20 years back. Infact, they are more wiser over years after been through many such crises. And at times like these, they are adding capital to their portfolios. Marty Whitman recently commented - "This is the opportunity of a lifetime, The most important securities are being given away.” See Video here.

See the following sample of arctiles-
David Dremen's "Its time to buy"
Warren Buffett's " Buy american, I american"
Marty Whitman's letter
Bill Millers' commentary

Infact, a research done by Michael Mauboussin of Legg Mason showed that Warren Buffett hardly gave any calls on markets, and when he did, its was a time to load the truck! See "Where from here?" by Mauboussin.
On similar note, this "Buffett4 market calls" was complied by Whitney Tilson.

The irony of the markets is that we tend to "feel" markets will go up, when they are going up., and we start "feeling" they will go down when they are doing bad - a natural investor behavioral psychology - hence we neither buy during panics, nor sell during euphorias. Emotions come in the way of our logical judgement and such decisions are bound to be biased/wrong. I feel that overall in life and in markets, one needs to be conservative, not take any esoteric risks, and keep walking(buying) bit-by-bit like sparrows, and one will do very well over years! If we are right in our analysis, markets will give due weights to the value overtime.

Presently, our focus is to be in few industries which are into "most essentials" goods. These goods are like very low cost options to the poor (and others), or food or shelter, etc. Growth is still healthy in such segments and hopefully do well. Moreover, we are trying to position our core-portfolio into companies which are either debt free, cash rich or reducing debt very fast. When the demand cycle turns, such companies which are unleveraged and with excess capacity, would be well positioned to take on the demand head-on.

Things are changing in India at a rapid pace - for good. Several long term changes are happening in the country, which will affect our lives very positively. For example - telecommunication is getting cheaper, teledensity is increasing, KG basin gas finds are good development for energy needs of the country. And we are not too much dependent on the world presently. If indian economy keeps doing well over time, as Rakesh Jhunjhunwala says - the money will come from Timbaktu"

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.