Whenever you bump into fellow investors, the conversations often steer into – “Aur Kya dekh rahe ho ? Kya aacha lag raha hai” (What new stocks are you looking into ? What is looking promising ?)

Our obsession to always chase the “Next Big” idea is often detrimental to our portfolios and wealth creation. In doing so we often miss out on the far most critical aspect of investments – that of portfolio construction and position sizing.

As we have seen from numerous investors through their investment journey – that it is often one/two large winners which are pivotal in their overall wealth creation and makes good a lot of mistakes – both of omission and commission alike.

Many veteran investors also list a common trait – of selling their winners too early and missing out on the huge runaway.

It was a great opportunity to connect to a highly revered investor of Indian equities, who have had huge multi-bagger returns not only at the stock level, but at the overall portfolio level in the past two decades.

The following is an attempt to capture key insights from the discussion and share this with the broader community of investors.

Portfolio Construction:

Your portfolio should ideally contain only three types of opportunities.

A) Compounders [Allocation: 50%] – Well discovered businesses, with steady operations and large size of opportunity growing at 20% available at decent valuations. The key to understand the importance of this bucket and the allocation. Here P/E discovery is matured and earnings fuel all the returns.

“Even if other parts of the portfolio – do not yield any results in a 5-year period, having 50% allocated to 2x+ bond yield will ensure your equity portfolio at least matches risk free returns”

B) Fast Growers [Allocation: 35%] – These are fast growers – rapid growth in sales with rising operating margins, here both legs of market cap growth – Earnings and P/E re-rating can come to your aid and create tangible wealth in a meaningfully short period of time.

"This part of the portfolio is also ideal for focussed cyclical baskets, opportunities that can yield high returns in short bursts to create future growth capital."

C) Seeds [Allocation: 15%] – Seeds are new emerging ideas, promising yet unproven ideas, which needs to be tested further before they can graduate to the buckets A) or B)

Portfolio Allocation & Position Sizing:

Initial Allocation:

For companies in bucket A) and B) start with an initial allocation of 5% (can be for a single stock or the commodity/cyclical basket of stocks) and exceptionally up to 10% only for bucket A). As we would see further down, we would end up upward averaging and increasing allocation to biggest winners.

For stocks in bucket C) start with a initial max allocation of 2%. As they graduate to Bucket A) or B) their allocations can be revisited thereupon.

Position Sizing:

It is of paramount importance to let your winners run freely but at the same time it is critical to prevent too much dependence of portfolio on few stocks.

· Allow position up to 15%: If the recent unexpected growth is led by a tailwind – China factor, Anti-Dumping Duties, sectoral rises etc.

· Allow position up to 25%: If the recent growth is led by something truly unique and organic to the company – strong brands, distribution moat etc.

Portfolio Maintenance

Weed Removal: During the wealth creation phase one needs to be really brutal in terms of allowing any non-performance. Typically examine the quarterly performance of the your investment candidates – against the hypothesis and key assumptions in your valuation framework and act decisively.

Based on the homework and management action in face of perceived risk and mitigations, be quick to act and get out completely if reality is deviating significantly from your hypothesis. Doing so will forcefully free up capital for allocation more to your top-performers

Quarterly Bonus: The impact of not upward averaging your key winners is perhaps one of the most underrated aspects. Whenever you see businesses and management performing extremely well – ahead of and surpassing your expected levels – always incrementally add to your winning positions. This completely breaks any price anchoring you might have had and when done together with weed removal – forcefully moves capital to better allocation within your portfolio.

Bucket Changes – It might often happen you like 2 or more opportunities from the same sector or just because you already had a large position in that sector, the new stock – despite all the positives – could only secure a seed position for itself.

The weed removal can often pave the path for removal of overvalued candidates faltering on expected growth in A) or B) to be replaced from a promising candidate from C).

Annual Portfolio Re-Balancing

Annual Portfolio Review and Re-Balancing

Typically, in a bull market, Bucket A) will underperform while in a bear market Bucket B) and C) would fall back on returns. Rebalancing portfolio once a year is extremely important to protect the irrational exuberance and lock some of the volatile gains into core compounders.

	Allocation	Bull Market CAGR	Bear Market CAGR
Compounders	50%	20%	30%
Fast Growers	35%	60%	20%
Seeds	15%	30%	15%
Overall Return	100%	36%	24%

The annual rebalancing is best done post the AGM session once the full year performance can be analysed in greater details and the next year can be planned accordingly.

Coming back to our discussion, the single biggest contributor of portfolio returns are by no means – stock selections. It is the ability to cut your losses early and upward average to ride your winners with meaningful allocation.

I will leave you with this beautiful presentation from Ian Cassel and this great quote from Bill O‘ Neil

Introduction

One critical aspect of infrastructure growth is Cement. As infrastructure activity, be it urban infrastructure, roads development or rural housing picks up, it creates an uptick in cement demand. So this is one of the leading sectors to track revival in economic activity.

Before going into investing, it is important to know the cement manufacturing process and familiarize yourself with the likes of “Kiln” and “Clinker” . A ready primer is available here.

Typically veteran investors would always advice to avoid to “invest” in a “cyclical” sector like cement, as this being a mere commodity is subject to the vagaries of supply – demand dynamics. Typically at the start of the infra growth cycle you would see stable capacities and increasing demand >> which would lead to demand outpacing supplies – leading to volume and value growth for some time >> new capacities come on stream and demand – supply gap normalizes >> till the point demand catches up and prices crash. And the cycle repeats all over again.

A look at Ultratech Cement’s price chart during the infra cycle of (2005-2009) helps one understand the typical story a bit better. So prices which rose from say Rs 350 in 2005 to Rs 1135 in 2007-08 and crashed back to Rs 350 all over again at the end of the cycle. So this is how most cement stocks behave in a typical cycle. Thus if one can get in early, there is potential of strong returns, provided one times the exit accordingly. Cement, or for that matter any other cyclical stocks are NOT BUY-and-HOLD candidates.

Ultratech Cement : Stock price during 2005-2009

Another interesting aspect of cyclical investing is reverse P/E. Contrary to regular stocks, where buying into lower P/E and selling into higher P/E is the norm, in case of cyclical stocks one takes just the opposite route. So buy when P/E is the highest and sale when P/E is the lowest.

This is because towards the beginning of the cycle, economic de-growth has bottomed out, earnings are most depressed, debt is at the highest levels hence P/E appears to be optically higher. While at the higher end of the boom cycle, earnings are at its peak which optically deflates the P/E to record low levels.

Again let’s study Ultra Tech cement, as in our current example.

	Mar-2005	Mar-2006	Mar-2007	Mar-2008	Mar-2009
Sales (Cr)	2,607	3,299	4,910	5,509	6,383
Profit(Cr)	3	230	782	1,008	977
EPS	0.12	18.22	62.28	80.09	77.63
Price (Mar end)	352	620	770	760	520
P/E (Mar end)	2933	34.02	12.36	9.48	6.69

Of course, the 2008-2009 period is a bit of exception due to the market meltdown from the US housing bubble led crisis, however the numbers serve just fine as an illustrative example of the point narrated just before.

With this very brief primer on cement industry let’s get started on to the stock we are here to discuss today – one of the prominent names from Midcap cement space — J K Lakshmi Cement.

About

JK Lakshmi Cement Ltd. (JKL hence forth) formerly known as JK Corp, is a flagship company of the Hari Shankar Singhania group. It commenced its cement operations in 1982, with an installed capacity of 0.5 million tonne (MT, a metric we would be using frequently to refer capacity henceforth) in Jaykaypuram (wherefrom it got its name!), Sirohi district, Rajasthan.

Today JKL caters to 13 states across North, West and Eastern India with a network of over 3800 dealers. Apart from cements, it has forayed into readymade concrete(RMC), plaster of paris(PoP), cement blocks. Interestingly all products are available to order on e-commerce sites. Link

Vital Stats

As on Date 27.05.2016.

Source: https://www.screener.in/company/JKLAKSHMI/

Market Cap. : ₹ 4,068.44 Cr.
Current Price : ₹ 345.75
Book Value : ₹ 113.62
Stock P/E : 239.17
Dividend Yield : 0.58%
Face Value : 5.00
52 Week High/Low : ₹ 387.80 / ₹ 253.95

Days Receivables Outstanding: 61.11
Debt to equity : 1.43
WCap to Sales : -0.09%

Price to Book ratio : 3.04

Sales growth 5Years : 9.13%
Profit growth 5Years : -12.17%

OPM last year : 9.8%
NPM last year : 0%
Return on equity : 9.45%
Return on capital employed: 9.49%

Promoter shareholding : 45.94%

The Story – JK Lakshmi over last few years

	Mar-06	Mar-07	Mar-08	Mar-09	Mar-10	Mar-11	Mar-12	Mar-13	Mar-14	Mar-15	Mar-16
Net Sales	582.50	843.80	1107.6	1224.5	1493.4	1319	1711	2054.9	2056.6	2315	2619.9
YOY Gr %		45%	31%	11%	22%	-12%	30%	20%	0%	13%	13%
Op Profit	120.9	256	351.3	317.15	424.60	183.34	326.80	428.70	302.00	352.60	270.10
Op Margin %	21%	30%	32%	26%	28%	14%	19%	21%	15%	15%	10%
PAT	55.4	178.1	223.7	178.5	241.1	59	109	192	93	167.4	6
PAT Margin %	10%	21%	20%	15%	16%	4%	6%	9%	5%	7%	0%
Equity	39.8	57.1	61.2	61.2	61.2	61.2	61.2	61.2	61.2	61.2	61.2

ROCE %	8%	18%	21%	16%	18%	5%	8%	12%	7%	6%	0%
RONW %	26%	38%	34%	20%	24%	4%	9%	14%	7%	12%	4%

JK Lakshmi - the last few years in numbers.

FY2010, was probably the best year in recent history with company realizing pick operating margins and profitability, another thing to note for cement companies is their balance sheets look pristine during these peak years (like FY10 for JKL with a D/E of 0.2 from as high as 1.32 in FY07) and they take up further expansions!

Like JKL emerged on major expansions i) 0.55 MT split grinding unit at Jhajjar, Haryana to be operational by Dec 2011 and ii) a major greenfield expansion of 2.7 MT in Durg, Chattisgarh at a cost overlay of 1200 Cr to be operational by FY12 end.

As seen with typical cyclical industry, the healthy growth of 10.2% for cement industry in India as a whole in FY2010 lifted all players – big and small – into big expansions only to face the oversupply and poor demand in the next few years.

Also cement is a very local industry, as in higher supplies in the western market cannot be transferred to eastern India, as transport costs become unviable. So once supply outpaces demand, prices crash. Then why is that prudent managements go on expansion spree knowing of these issues very well?

The answer lies perhaps in long term potential. AR 2011 cites a McKinsey survey mentioning the following

“…..Cement demand which traditionally has shown strong correlation with overall economic growth both in India as well as internationally by all account is expected to reach to in excess of 500 million tons in a year by the year 2020 and in excess of 1500 million tons a year by the year 2030.

Global trends studied for more than 20 years in developing world indicate that per capita cement consumption and cement demand grow in tandem with economic growth till per capita income reaches $ 15000. Average Annual Per capita income in India in terms of Purchasing Power Parity stood at approx. $ 3000 in the year 2009 and with expected average annual economic growth of 8 – 8.5% till the year 2030, it shall be little over $ 15000 in 2030.

Hence therefore it can reasonably be concluded that except for some minor aberrations and course corrections, cement as a commodity shall remain on strong growth trajectory for next 15 – 20 years….”

Thus the management clearly justifies (!!!) the supply gluts as something temporary in nature and embarks on the expansion plan.

Move to FY2012, company moved well on expansion plans as revenues improved slightly over FY10 and showed high jump over the lower base of FY11. The 0.55 MT unit in Haryana got completed by April 2012, raising production capacity to 5.3 MT.

The greenfield expansion in Durg got pushed both by cost and timelines. Company however added two additional split location grinding units mainly positioning for eastern India markets.

Also, post BIFR approval of the rehabilitation scheme for the Udaipur unit, earlier declared sick, JKL decided an overall revival plan adding the 1.2 MT capacity for effective use over next two years.

JKL continue to add the value added products with further expansion to ready made concrete (RMC) plants taking number to 14 and capacity to 7 lac cubic meter per annum.

During FY2013, the industry continue to reel under the supply glut with capacity additions being 17 MT and demand growth of only 13 MT over the last fiscal.

JKL again forays into value additive products in FY13, with the introduction of Aerated Autoclaved Concrete (AAC) Blocks with the brand name "JK SMART BLOX".

This is an interesting development on value addition and prevalent in developed markets, here is further insight on AAC

“….The AAC blocks, though relatively new in the country, are being extensively used in the developed countries and are a preferred alternative to the traditional red clay bricks (made by using top layer of precious agriculture land). These AAC blocks are light in weight and offer high thermal insulation. With these inherent characteristics, this product will offer recurring lifelong savings in the power consumption besides savings in construction time and labor cost…”

The dismal growth and supply glut continued well over in FY2014, the MD’s commentary lucidly captures the situation,

“…The capacities built by cement companies during the last 3-4 years, with the hope of continued double-digit growth, ended up only widening the demand and supply gap leading to fierce competition and unremunerative pricing in the market place. Consequently, the margins of cement companies fell and we were no exception….”

The much touted Greenfield project at Durg finally was completed during FY2015 at an overall cost of Rs 1700 Cr. It lead to 27% jump in capacity to 8.4 MT. The initial capacity commissioned is 1.7 MT which can later be expanded to the planned 2.7 MT and beyond.

Company had again ventured into value addition with the introduction of JK Lakshmi PRO+ - a premium cement brand majorly for the new eastern market and also for existing markets in West and North.

Company was able to reach stable utilization for the Durg plant in FY2016 on the 1.7 MT capacity. However, company had to face challenges on the realization front due to higher logistics and fuel cost. The volumes shown a jump of 23% in FY16.

	FY11	FY12	FY13	FY14	FY15	FY16
Sales volume (MT)	4.3	4.89	5.28	5.63	5.96	7.32
YOY Gr %		14%	8%	7%	6%	23%
Net Realization	3062	3498	3889	3653	3874	3579
YOY Gr %		14%	11%	-6%	6%	-8%
EBITDA/tonne	431	656	808	536	587	369
YOY Gr %		52%	23%	-34%	9%	-37%

Production metrcs for last few fiscal years

Outlook - The road ahead

One can listen to the Q4FY16 Concall commentary here :

Expansion in Odisha: Although land acquisition and approvals are in place. Company is facing resistance from local population for the grinding unit at Odisha and instead focusing on expansion at Durg.

Expansion in Durg:
JKL now plans to increase the Durg plant’s capacity to 2.4 MT from current 1.7 MT by Q4FY17 and further to 2.7 MT by Q2FY18. Capex estimated at 50 Cr.

Durg plant is operating at EBITDA break even for now and move to cash profit level from further savings in power and logistics cost.

Power Saving: currently on grid power. Waster heat recovery of 7 MW at cost of 90 Cr will replace 30% requirement. Expected to be commissioned by Q3FY17.
Logistics: Railway sliding completion planed by FY18 will help in better savings.
Expansion in Udaipur:The current capacity of 0.9 MT is of no use and it is depending on JKL’s other plants for Clinker. Once the 1.2 MT clinker comes online by Q3FY17, the capacity can be used effectively. Ongoing capacity ramp up on grinding unit expected to 1.6 MT.

Out of the total planned capex of 700 Cr, 450 Cr is spent and balance to be completed by Q3FY17. Funds from internal accrual and equity raised.
Grinding Unit at Surat: Grinding unit with capacity of 1 MT shall be completed by Q2FY17
Debt Scenario: Company is reaching peak gearing of 1.43x (Gross) and 1.25x (Net Debt). Hence management seeks consolidation of Balance sheet for some time before setting on further brownfield expansion. Company plans to repay 200 Cr debt every year.
Future Expansion: JKL has potential for brownfield expansion in all 3 places – Sirohi, Durg and Udaipur taking overall capacity from 13 MT by FY18 to 20 MT over the next few years as need arises.
RMC Capacity and sales: RMC volumes at 450 lac cubic meters and sales of 150 Cr has been stagnant YoY.

More about investing in Cement:

Read here for more info on Cement sector and right metrics to value cement stocks.

Prudent Investing : Towards smarter investments

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Sunday, October 21, 2018

Portfolio Construction & Position Sizing