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 :) )
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 !