June 3, 2009

Portfolio cleanup

I mentioned in my previous post, that I plan to use the current market rally to clean up my portfolio of some clunkers. In this post, i will also analyse why I plan to exit these stocks and what I have learnt from them (something good should come out of it :) )

VST industries
I wrote about
VST industries in 2007 and built up a small position over the course of a year. My key assumptions were

- The company had grown its net profit at around 20% in the past and would continue to grow it by 6-7% in the future.
- The company will continue to maintain its return on capital at current levels and a reasonable dividend payout (then Rs 20/ share)
- The catalyst for unlocking value could be higher dividend, better growth rates in the topline or continued good performance of the topline and bottom line.

So what has happened since then ?
- The growth has decelerated considerably. Initially the topline slowed down and in the current year the bottom line has been stagnant due to higher tobacco prices
- The company has increased its dividend to around 30 Rs/share and is thus returning majority of its free cash flow to the shareholder. This is good sign as the management is returning capital as it cannot re-invest it in the business and is also not blowing it away on needless diversification
- The catalyst for unlocking value was higher dividend (which has happened) and a reasonable growth rate (which has not happened).

The key reason for the price stagnation has been a slowdown in the growth rates, due to which the market continues to give (rightly so) a low PE to the stock. My mistake in the above idea was a failure to recognise that cigarettes are a low growth category and a no.3 player in this industry is not going to perform too well. The company has been doing fine and will plod along.

Although, One can look at the stock with a 10% dividend yield, there are risks to the business model and future profitability (government taxation and attitude towards smoking).

One final point – Although I have eked out a small gain, I got thrashed (figuratively speaking :) ) by my wife for investing in a tobbaco stock. According to her, I deserve to lose money on such a stock :).

India nippon electricals

I analysed this stock for the first time in 2007. This was a graham style deep discount idea.

My key assumptions were

- The net profit had grown by around 4% in the last few years. I expected the company to maintain the past growth rates.
- The company had a cash holding of 77 crs then, which has now increased to almost 100crs+. The company has a market cap which is less than the cash on books.

So what has happened since then?

- The core business of the company is on a downward slide now. The topline and bottom lines are both decreasing.
- The cash holding has increased since then, however the management is just sitting on the cash without any specific plans for the same.
- The market consider this company worth more dead than alive due to the fact that the core business is sliding and the management has not been able to turn it around and at the same time not returned the surplus cash to the shareholders

My key mistake in the above case was to ignore the management quality. I expected the business to have a very average performance due to the nature of the auto components business. However I ignored the management’s lack of interest in taking any value enhancing actions via dividends or buybacks. They have been sitting on the cash for quite some time and have not bothered to raise the dividend till date.

Holding the stocks at the current price is better than holding cash in my case. However I plan to exit once I can find an attractive idea. These stocks represent around 2% of my total portfolio and hence the impact on the overall portfolio is minimal. However keeping them around would be a waste of capital.

I may or may not declare the exact time of the sale too. If however I decide to provide an update, it would be via twitter as such an update is not suited for a post. If you are interested in it, then you can
follow me on twitter.

As always, please read the disclaimer !

12 comments:

Sachin Purohit said...

Wife is always right! I have never invested in any tobacco, cigarette or alcohol company's stock. Even before the key financial parameters, these businesses fall in my exclusion list. "Biwi ki suna karo. You will be successful in life" - was a comment made by no less than Chief Justice of India's Supreme Court a couple of weeks back while hearing a case!

As regards your portfolio clean-up, you have mentioned about India Nippon. There is another company in the same segment that I believe is in your list of Grahamian stocks, too - Denso. Like India Nippon, the management of Denso, too is sitting on a lot of cash. With no corporate website of its own and very low-profile maintained by its management, very little is known about what are its plans in utilizing its cash. Although it is heartening to see Maruti's sales breaking records month after every month and Denso's sales piggy-backing on Maruti. What is your take on Denso?

Vic said...

Thanks Rohit for the update.

Yes, your updated analysis/learnings definitely help.

I thought really hard about VST, eventually decided not to go for it..for the very same reason of your wife..:-)

Of course, we're never clean in this life. Some dirt is always there but thought this was a clear No.

Vikas

Rohit Chauhan said...

Hi sachin

india nippon and denso are in the same space. they are both cheap stocks and not really core ideas for me. the only difference is that the denso has maruti as its major customer and is growing compared to india nippon. however i would not expect much from denso too ..the saving grace is that denso is available at dirt cheap prices and hence it may give reasonable returns.

Rohit Chauhan said...

Hi vikas / sachin
we have our skeletons :) well better late than never

regards
rohit

income.portfolio said...

Rohit,

very interesting observation on VST Industries.
- should paying dividends be considered as "return of capital" or "share in profits". Aren't they two different things?
- Tobacco industry by it's characteristics is slow anemic growth sector (high single digits). In general, they are very resilent and continue to be profitable.
- they run on lower capital base, so long term ROI is usually very high.
- Altria and philip morris, have been paying high dividends for more than 25 years. they have provided more returns in dividends than stocks capital appreciation.
- I agree on no. 3 player argument.
- Whoever is against sin stocks, I consider that argument as hypocritical. We all do much more worst sins in our daily life (than investing in sin stocks). For me it is baseless. But then i don't argue with my wife. It is much easier to win by saying yes ma'am.

Best Wishes,
TIP Guy

Rohit Chauhan said...

Hi TIP guy
on dividend, a rational policy is to give it back to the shareholder if you cannot invest at high rates of return. unfortunately very few managements are rational about it. the good thing about VST is that they are returning the excess capital, maybe due to the majority shareholder being BAT.
i personally dont look at dividend the way you have mentioned it. for me, all capital is the same (profit or otherwise), so if the company can re-invest profitably, i am fine with a low dividend too.
i am not sure about resilience of the industry now. there is too much taxation , movement against smoking (which is a good thing) and litigation. so there are risks in the business. finally if there are better companies out there (in terms of returns), then it may be more profitable to pick those companies

Sam said...

Hi Rohit,

Can you please share your analysis on Repro India? You had mentioned that you had missed it in this rally... keen to know the fair value pricing on this.

Thanks
Sam

Rohit Chauhan said...

Hi sam

Ninad kunder (see under links) has a good analysis of repro. this is an idea stolen from him.
i was looking at it when the price was in 90s and felt that company was fairly undervalued then

regards
rohit

Anonymous said...

Hi Rohit,

One more book you might be interested in downloading -
http://www.ebookee.com/Financial-Shenanigans-How-to-Detect-Accounting-Gimmicks-amp-Fraud-in-Financial-Reports-2-Ed_252161.html

-Anon2(remember Security Analysis?)

Anonymous said...

Hi Rohit,
Superb Analysis.
I want to know your vuews about R Systems International. It is trading below its Book Value per share. Other things look good too.

Thanks
Avadhut

Anonymous said...

Hi Rohit,
I hold all my securities with more than 40-50% profit as of now. and i am in a dilemma whether to hold them or exit completely.

Currently I am reading Buffet Partnerships letters 1959-69, where i can see that what we know about Buffet & it's buy & Hold strategy is different. Buffet was seen timing the markets, putting upto 35% in one stock, short term trading, Investment upto 25% of NAV on borrowed money. That's why he could gather very big money to start BRK on his own. That time his approach was like book profits completely when there is an opportunity.

What do you say?

Ani

Rohit Chauhan said...

Hi avadhut
i have not analysed RS systems, and do not know much about the company. however for an IT company book value is not a very good indicator of value.

Hi ani
let try to answer your question via a post. a lot of other people have asked me the same question in a different way

regards
rohit