Monday, June 16, 2014

Portfolio stocks: Annual stock performance against Earnings and Expectations.

Post the NDA win at the center the euphoria has touched upon almost all stocks, with most small and midcaps rallying 50-100%. Here's a quick look at the performance of portfolio & watchlist stocks over the past one year period.


Note: Adjusted EPS is arrived at by adjusting for one off expenses and revenue items. As obtained from screener.in

The stock price growth being a resultant product of earnings growth and expectations growth, some stocks have rallied on the basis of superior earnings growth supported by moderate PE expansion (Ajanta, PI Industries) while in case of others there is huge increase in expectations (Astral, Mayur) with moderate earnings growth. 

Perhaps the showcase example from this lot is that of Kitex Garments, which shows a strong earnings growth(95%) coupled with huge P/E expansion(98%) is the best recipe for success. The stock posted a 1 year trailing returns of 286% !!!

Also, stocks with muted earnings growth and high expectation look expensive but only on a trailing basis. Their low earnings base will help them post superior earnings growth, which at the existing P/E too will yield superior returns. Case in point being Hawkins Cookers.

One might argue that trailing P/E being meaningless as the market tend to discount forward earnings only. However, in cases like Astral Poly - where a lot of expectations are already priced in - significant upside in price terms can only be realized if the company is able to sustain and build upon the already expanded P/E backed by superior earnings.

Friday, February 14, 2014

The "business" of investing and the role of asset backed leverage

Our fellow investor and blogger Dhwanil in this excellent post has highlighted the merits of considering investments in good businesses as an overall better venture than setting up your own business. 

It is often repeated by seasoned investors to stay away from borrowed money of any sort and invest only the surplus you don't need into equities. This might be true if you consider equities as just another asset class of highest risk and return, however if this is your primary source of earnings and a business, will you shy away from use of leverage in a prudent manner ? Let's explore.

Most of the growing businesses, where we are invested employ leverage in some form of other, either for longer duration asset building or meeting short term working capital needs. Many large FMCG giants and brand plays thrive on the ultimate leverage of "float" or "OPM" (Other people's Money). Read this brilliant post by Prof. Bakshi to understand this.

In case of businesses, the optimum level of debt is often determined by the capacity of the company to service the debt in terms of principal and interest payments, in good and specially during bad times. Prudent level of financial leverage is necessary specially as interest payments are tax deductible. We as individuals do not have the luxury of such tax deductible interest payments in our business of investing, hence leverage should be weighted in the context of merits and increased risks alone.

Loan Against Securities (LAS): Asset backed leverage


LAS or Loan Against Securities is a commonly available form of financing where you pledge your securities and get an overdraft limit to a certain cutoff percentage which is usually 50% or lower. For e.g. if one owns HDFC bank shares worth 2 Lac, he can pledge those and get a limit of around 1 Lac, which can be used as fresh capital for the investment business. 

This is akin to pledging your plant and machinery as collateral in obtaining a working capital loan, here the core assets of the business are "part ownership in other businesses" which is pledged. 

Here is the product info and details from ICICI Bank and Axis Bank who offers this facility at decent rates of interest. Note that all stocks are not acceptable as pledge. Hence, make sure to go through the latest available list of approved securities ( which are periodically revised) to see if you have enough pledge worthy stocks in your portfolio. Here's the latest list from ICICI Bank.

Servicing the Debt: Serve the interest every month.


Now the key concern here is the debt servicing. Like in case of many businesses, you can make monthly interest payments and pay the principal at the end. Businesses need to make sure that the Interest Coverage ratio is high, meaning even during worst times their cash flows should meet the interest payments effectively.

The biggest advantage of regular cashflows (as in salary/ rent received etc. ) is that you are free from the volatility of business cycles and hence can deduce a monthly interest payment as a moderate percentage of your monthly cashflow. It will be safe to target a monthly Interest Coverage ratio of 16-20 times, so that interest outflow in 5-6% of your net monthly cash flow.

Serving the interest will make sure the loan do not compound on itself and you do not pay further interests on interest, a key differentiator over longer tenure.


Optimum debt with enough margin of safety


As we know Leverage is a double edged sword, hence protecting the downside is of critical importance. Assume that only 60-70% of your portfolio holding is pledge worthy only. Hence, max loan you can take, with a 50% haircut is only 30-35% of your net equity portfolio. 

So portfolio value : 10 Lac
Pledge worthy portfolio value: 7 Lac (70%)
Maximum loan limit: 3.5 Lac (50% haircut)
Assume loan availed as 2 Lac (20% of total portfolio, around 57% of the max loan limit)

Now assume the worst case, a look at last 20 years of annual Nifty returns shows a worst possible drop of 52%. Assume a 60% drop in stocks, 

So portfolio value now : 4 Lac
Pledge worthy portfolio value: 2.8 Lac (70%)
Maximum loan limit: 1.4 Lac (50% haircut)
Loan availed : 2 Lac. 

Hence,  the value of pledge worthy portfolio is still double the loan availed. Of course, the loan limit is now : 1.4 Lac, hence bank will ask for more collateral or sell off your stocks. Note however, that total portfolio value in general and un-pledged stocks in particular can be sold off  to meet the liabilities. 

Also we are considering a once in 20 years event. Note that the reduced portfolio value still meets the criteria to take up to 14% leverage. Thus 10-20% at max will be the prudent leverage or a max gearing ratio (D/E of 0.2) will be considered safe.


Is it worth the risk ?


The obvious question comes in mind, that does the returns justifies this risk and all the headache of all paperwork, maintaining collateral, serve monthly interests and all. 

Let us see. Here are the indicative returns on investment of Rs 1000, without leverage, with leverage at 10% and with leverage at 20%.


Capital : Rs 1000, No leverage

Capital
Return CAGR
1000
15%
18%
21%
24%
27%
30%
Tenure (Years)
3
1,521
1,643
1,772
1,907
2,048
2,197
5
2,011
2,288
2,594
2,932
3,304
3,713
7
2,660
3,185
3,797
4,508
5,329
6,275
10
4,046
5,234
6,727
8,594
10,915
13,786
12
5,350
7,288
9,850
13,215
17,605
23,298
15
8,137
11,974
17,449
25,196
36,062
51,186

Capital : Rs 1000, 10% leverage

Capital
Return CAGR
@ 13%
1100
15%
18%
21%
24%
27%
30%
Cost of Funds
Tenure (Years)
3
1,673
1,807
1,949
2,097
2,253
2,417
39
5
2,212
2,517
2,853
3,225
3,634
4,084
65
7
2,926
3,504
4,177
4,958
5,862
6,902
91
10
4,450
5,757
7,400
9,454
12,007
15,164
130
12
5,885
8,016
10,835
14,536
19,366
25,628
156
15
8,951
13,171
19,194
27,715
39,669
56,304
195


Capital : Rs 1000, 20% leverage

Capital
Return CAGR
@ 13%
1200
15%
18%
21%
24%
27%
30%
Cost of Funds
Tenure (Years)
3
1,825
1,972
2,126
2,288
2,458
2,636
78
5
2,414
2,745
3,112
3,518
3,965
4,456
130
7
3,192
3,823
4,557
5,409
6,395
7,530
182
10
4,855
6,281
8,073
10,313
13,098
16,543
260
12
6,420
8,745
11,820
15,858
21,126
27,958
312
15
9,764
14,368
20,939
30,235
43,275
61,423
390

Thus, one can see, a small leverage will add a significant boost to your overall returns over the longer term. 

Note: The minimum cost of this facility is around 13%. Hence one should only consider using this option when the potential returns are much higher than the cost of funds. 

Where it is readily useful


There are often scenarios, where there some sudden news driven sharp corrections. Being at the mercy of month end cash flows, it is often not possible to take a large position at one go. LAS often comes handy in such situation, where one can load up 10-15% of one's portfolio in a particular stock at one go.

One can later pay off the debt through monthly saving and contributions to equity. Since this is a debt with no payment commitments, foreclosure charges the overdraft facility is more helpful than other similar debt obligations. 

Another important case is while applying in IPOs/FPOs etc. Since you will most likely apply using ASBA, only a small part of the overall application money would be used in all practicality. Hence, you can avail LAS funds and return the excess back, without disturbing any of your long term debt or equity investments. 


The business of stocks


Coming back to where we started off, optimum leverage with adequate margin of safety and interest coverage will enable us to buy larger stakes in businesses we like to own. Further if we are not averse to the use of optimum leverage in our portfolio companies, why oppose to using that in our own business ?

Views invited.


Friday, January 10, 2014

Shilpa Medicare: Preferred vehicle to ride the Oncology bandwagon

Let's discuss today about the stock I am most bullish on at current levels for the year ahead - Shilpa Medicare. 

Shilpa has been one of the many brilliant discoveries of Ayush Mittal (of Dalal-Street fame) who have been tracking this since July '09 and already sitting pretty on a five bagger. Well done Ayush :)

Before we get started on this, would ask readers to go through the following links on the pharma sector at EquityMaster and ValuePickr (use the follow up reads too). 

Pharma as you know is a very complex sector and we have seen many debacles in the past one year. Sun Pharma's patent settlement with Pfizer, USFDA ban on Wockhardt and Ranbaxy are some of the major debacles which cost their shareholders heavily. Thus one must be aware of the risks before assuming this to be a "safe" or "defensive" sector.

Within the Pharma space, Oncology or Cancer drugs are showing the fastest growth.Sites one report

"...Oncology products have grown at more than double the rate of global pharmaceuticals, with a CAGR of 8.39% during 2004–’08.  Reasons for the robust growth of the oncology market are :

    • Increased use of targeted therapeutics, including more patients accessing modern
       targeted therapies in emerging markets 
    • Premium pricing for targeted brands as compared to cytotoxic therapies 
       and antihormonal therapies 
    • Longer treatment duration for patients due to longer survival and adjuvant treatment 
    • Earlier detection of disease with the availability of new screening procedures....."

Another ET report suggests similar potential for Indian Oncology market, 

"Chemotherapy, biologics, targeted therapy, hormonal therapy, and supportive care are the different types of available cancer treatment in India. Among this chemotherapy recorded the highest market value of approximately Rs 700 crore in 2012. Oncology market in India is forecasted to grow to Rs 3,831 crore by 2017," a study by Frost & Sullivan said."

Within the Oncology space, Shilpa offers one of the best bets in terms of seasoned capabilities and smaller market cap to ride this opportunity better as an investor. Starting from very humble beginnings in 1987 the company has shaped up well with strong R&D laden pipeline of 30+ products in the Oncology space. 


Oncology portfolio

Shilpa currently boasts of 25+ products strong present Oncology portfolio along with regulatory approvals across the world (and many pending). There are also 15+ oncology APIs under development. The key difference with other similar generic capabilities is the complexity involved in these. This space thus has much lower competition and hence higher margins. Also because of limited competition the post patent price erosion here is much lesser, hence provides opportunity of margins for both API manufacturers and generic marketers.


AntiRetroVirals

There is an alarming increase in patients of HIV/AIDs belonging to underdeveloped economies. In June 2013, Shilpa has signed an agreement with The United Nations-backed Medicines Patent Pool (MPP) and Gilead Sciences to increase access to medicines for HIV/AIDS treatment.

As part of this agreement, Shilpa will now be able to produce five key HIV medicines i.e. Tenofovir, Emtricitabine, Cobicistat, Elvitegravir and a combination of the four, known as "the Quad" for sale in over 100 countries, depending on the medicine. Post technology transfer Shilpa will be able to produce these at an even lower cost.


Formulation Foray

Backed by strong R&D capabilities from its centers at Raichur and Vizag the company is forward integrating to own formulations. The state of the art formulations unit at Pharma Park Jadcherla (SEZ) in AP will cater to Shilpa's own formulations also along with contract research and bulk API production for other partners. 

Company currently has API units at Raichur (Unit I and 100% Export oriented Unit II, while Unit III is coming up). It has formulation units at Jadcherla while one coming up besides the API units at Raichur

Key Subsidiaries

The subsidiaries form an important part of the Shilpa. Here's a brief snapshot of the subsidiaries.


Subsidiary
Details
1. Raichem Lifesciences (P) Limited (RLSPL) (Merged with parent in FY13)
Incorporated as the marketing unit for their formulation foray (in Oral, Injectibles and Lyophilised segments), it became a 100% subsidiary in FY13.  The SEZ at Jedcharla was conceived under Raichem Lifesciences.

The subsidiary was involved in marketing activity since FY10. It incurred overall losses (59.27 lacs in FY11, 59.14 lacs in FY12) which was spending on establishing the marketing network. Finally with the completion of Jedcharla SEZ, it was merged to parent in FY13 w.e.f. 01-04-2011.

The commercial operations after the initial stabilization period (trial runs, dossiers being sent for final regulatory approvals etc.) is expected to commence from Q3FY14 onwards.
2. Raichem Medicare Pvt limited
Raichem Medicare(P) Ltd. was incorporated in FY09 considering the good demand for Shilpa's Custom Synthesis products and capacity constraints in the existing production facilities. A 50:50 JV was formed with the "Industria Chimica Emiliana S.r.l, Italy" and "Prodotti Chini Alimetari S.p.A, Italy".

During FY11, with further investment of Rs.164.98 lacs in Raichem Medicare Private Limited (RMPL) it became a subsidiary of the company. The proposed Unit III at Raichur, Karnataka is coming up adjacent to Shilpa's main plant in Raichur with total outlay of 40 crores.

It earned a profit of Rs 23 lacs in FY13 from surplus funds. Civil construction has started and company also place orders for major equipment and machineries. It will be operational by FY 14 end-FY15.
3. Loba Feinchemie, Austria
Shipa acquired Loba Feinchemie, Austria through Zatortia holdings in 2007. Up to 2013 they invested total 23.29 crores as equity. The company turned cash positive in FY10 and profitable in FY12.
 
Year   
FY 09
FY 10
FY 11
FY 12
FY 13
Sales
31.16
29.72
31.24
36.53
40.25
PBT
-8.77
-2.29
-0.47
1.99
1.72

Loba Feinchemie, Austria has APIs, Laboratory Chemicals & Customs Synthesis manufacturing facilities and the strong marketing network in European countries. The marketing network (with their forthcoming formulations foray) and access to regulated markets was primary reason for this acquisition rather than immediate profitability.
3A. Zatortia holdings ( Holding company of Loba)
4. Nu Therapeutics Private Limited (NTPL)
Shilpa acquired 25.08% of equity stake in Nu Therapeutics Private Limited (FY09) a formulation developing company with an option to acquire up to 50.1% of equity shares as a strategic investment.It acquired further stake in FY11 to 67% ( Total equity outlay of 7.7 Cr as on FY 13 ).

Nu therapeutics possess novel oral fast dissolving thin strip technology. It commenced production in FY12 and earned cash profit. FY 13 Revenues and profits were 2.5 Cr and 3.06 lac respectively. While expansion plan has been chalked out with land acquired, machines installed, it is awaiting for the approval of Government for its new products. This technology might be future growth driver for Shilpa.
 


Financials

Here's a look at the last 5 years financials, as seen from below, profits has been almost stagnant over the past 5 years, while revenues have grown 45%. Company has maintained consistent dividend payout over the past. 

Figures in Rs Cr
FY 09
FY 10
FY 11
FY 12
FY13
Sales Turnover
169
270
296
324
378
Other Income
1
2
5
9
5
Stock Adjustments
0
13
-9
18
-3
Total Income
170
285
292
351
380
( - ) Raw Materials
94
150
154
202
212
( - ) Excise Duty
2
5
6
6
7
( - ) Power & Fuel Cost
5
6
7
9
11
( - ) Other Manufacturing Expenses
2
4
4
10
11
( - ) Employee Cost
24
28
33
34
43
( - ) Selling and Administration Expenses
7
11
9
13
19
( - ) Miscellaneous Expenses
12
-1
-1
7
4
Profit before Interest, Depreciation & Tax
23
82
80
70
75
( - ) Interest & Financial Charges
6
6
3
2
2
Profit before Depreciation & Tax
17
76
77
68
72
( - ) Depreciation
9
13
13
14
15
Profit Before Tax
8
64
64
53
57
( - ) Tax
9
21
15
12
10
Profit After Tax
-1
43
49
41
47
Equity Dividend (%)
25
35
40
45
65
Earning Per Share (Rs.)
0.0
19.3
20.4
16.7
19.1
Book Value
27
46
91
113
131

Looking at the common size metric, the company enjoys fairly handsome operating margins while the other costs would come down significantly with enhanced operations and further margin improvement from their formulations foray.
Common Size Metric
Figures in Rs Cr
FY 09
FY 10
FY 11
FY 12
FY13
Sales Turnover
99%
95%
101%
92%
100%
Other Income
1%
1%
2%
3%
1%
Stock Adjustments
0%
5%
-3%
5%
-1%
Total Income
100%
100%
100%
100%
100%
( - ) Raw Materials
55%
52%
53%
58%
56%
( - ) Excise Duty
1%
2%
2%
2%
2%
( - ) Power & Fuel Cost
3%
2%
2%
3%
3%
( - ) Other Manufacturing Expenses
1%
1%
2%
3%
3%
( - ) Employee Cost
14%
10%
11%
10%
11%
( - ) Selling and Administration Expenses
4%
4%
3%
4%
5%
( - ) Miscellaneous Expenses
7%
0%
0%
2%
1%
Profit before Interest, Depreciation & Tax
14%
29%
27%
20%
20%
( - ) Interest & Financial Charges
4%
2%
1%
1%
1%
Profit before Depreciation & Tax
10%
27%
26%
19%
19%
( - ) Depreciation
6%
4%
4%
4%
4%
Profit Before Tax
5%
22%
22%
15%
15%
( - ) Tax
5%
7%
5%
3%
3%
Profit After Tax
-1%
15%
17%
12%
12%

R&D Spends 

It is highly critical for the company to maintain quality R&D spend in terms of research as well as regulatory filings. The company has in fact improved R&D spend significantly over the last 5 years.


Figures in Rs Cr
FY 09
FY 10
FY 11
FY 12
FY 13
Sales(Net of Excise)
166
265
290
318
371
PAT
-1
43
50
42
47
R&D Spend
0.5
2.2
1.9
19.3
21.7
   R&D Capex
0.1
0.3
0.3
10.6
5.5
As %age of PAT
0.0%
5.2%
3.9%
46.4%
45.7%
As %age of Sales
0.3%
0.8%
0.7%
6.1%
5.8%


Forex Woes

Shilpa's quarterly numbers are often plagued by huge forex losses, but over a larger period there's hardly any significant dent to profits. Hence any short term aberrations from forex woes might provide additional entry points to long term investors here. As we see from below Forex adjusted NPM is hardly 1% above the reported average NPM.

Figures in Rs Cr
FY 09
FY 10
FY 11
FY 12
FY 13
Forex Loss/(Gain)
10
4
(4)
3
(1)
As %age of PAT
-988%
10%
-8%
7%
-2%
Forex Adjusted PAT
9
47
46
44
46
Reported NPM
-1%
16%
17%
13%
13%
Forex Adjusted NPM
6%
18%
16%
14%
13%


Robust Balance Sheet

Now comes the most interesting part. Since till now Shilpa was more of a API and CRAMs play there is high correlation between completed capex resulting into high sales over the immediate future. With Jadcherla SEZ gearing up for commercial production and foray into higher margin formulations investors might be in for exciting times.

Line Item
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Sep-13
Change in Net Block (Y/Y)
64%
2%
-1%
14%
8%
58%*
Change in Sales (Y/Y)
74%
59%
10%
10%
17%
34%*
* compared to FY13E on Mar-31

However, one major concern for a company of Shilpa's size undergoing this major capex (100Cr+ , over 50% of the then net block) is working capital management and debt servicing. 

But the Sep-30, 2013 balance sheet is a delight on both counts. The company has managed working capital beautifully, and D/E has in fact come down in the last 6 months. Also the operating cash flows over the past 6 years have always been robust. 



Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Sep-13
Sales
        95.81
     166.43
     264.91
     290.29
     318.18
     371.32
249.59
Working Capital
        39.04
        21.17
        24.95
     124.87
        34.69
        84.43
         67.00
Wcap as %Sales
41%
13%
9%
43%
11%
23%
27%
Op Cash Flow
          6.93
        29.74
        53.52
        42.61
        56.73
        43.50
as %age of PAT
61%
NA
126%
87%
138%
92%
Total debt
        88.28
     112.43
        77.27
        57.39
        46.32
     115.53
         83.78
Net Block
        87.85
     144.51
     147.55
     146.25
     166.61
     180.67
       286.01
Debt/Equity
1.00
0.78
0.52
0.39
0.28
0.64
0.29

Projections: Future growth ahead. 

Equipped with the above here's a take on the earnings ahead. Here are the key assumptions for the proposed model to project future earnings.


Assumptions:
Operating Margin
Move toward FY11 levels post full cap-ex to OPM of 25-27%
Depreciation
Considered over full Net Block as on Mar-13, Sep-13. Should reduce from FY15 onwards
Interest
Charged considering higher outgo and debt outstanding Mar-13, Sep-13
Tax
Considered at 25% for rest of FY14, 30% for FY15



Future Earnings

Period
FY13
FY14E
FY15E
Total Income
383.43
546.54
759.80
EBIT 
59.26
108.33
171.03
Net Profit
47.46
80.16
117.57
% Net margin
12.4%
14.7%
15.5%
Projected EPS
19.37
21.78
31.95
Reported EPS

20.10


As discussed above, the Forex losses can swing quarterly numbers but won't materially impact the overall PAT. The reported EPS here thus deviates from Projected EPS because of recent forex loss of 9.58 Cr (in Q2FY14). 

Based on a trailing P/E assumption of 18x-20x for Shilpa we arrive at the June -2015 price target of Rs 570 - 640 levels. On a 18 months time frame this is 62-73% CAGR opportunity based on current market price of Rs 280. 

Views invited. 

Disclosure: Invested.