IPO - ERA Constructions

I'm definitely not going in for ERA Constructions. Looks like a major risk for at best moderate returns. Read on...

Litigation

I'm sure litigation is a way of life in the construction sector but even a brief look at the number and seriousness of the cases pending against ERA (check the prospectus) should make any would-be investor tread warily.

Most of the cases are such that an adverse ruling could lead to the arrest of the promoters / senior management.

A couple of biggies:

• Indian Oil has claimed damages to the extent of Rs 4.44 crores + 18% interest. The proceedings have been completed and a decision is awaited. As per the prospectus, the arbitrator "may award the entire amount along with interest and costs" in favour of Indian Oil. Yet it seems no provision has been made at all in the financial statements. This despite the fact that an award of this magnitude would almost wipe out the entire FY 05 profit of the company
• A counter-claim by the PWD (Public Works Department) in an arbitration case works out to Rs 1.54 crores, for which again no provision has been made

As per the prospectus, the company has not acknowledged claims amounting to Rs. 6.5 crores as debts as in the opinion of the management, these claims are frivolous.

Inadequate provisioning as indicated above has led to a healthy-looking balance sheet but it looks to me like an axe waiting to fall!

Poor Record on Regulatory Compliance

SEBI has served notice on the company for regulatory violations (probably poor financial reporting) in the period 1998 to 2002 and the company is paying a penalty of 1.75 lakhs to SEBI for the same. I fact, ERA Constructions has even waived its right to a hearing, thereby making it evident that it has no defence.

Or perhaps it was in such a hurry to push through the IPO that it wanted to get such matters out of the way, hmm...?

Inadequate Track Record of Promoters

Of the three promoters, only one (Mr. HS Bharana) has experience in the field. The others have little / no experience or knowledge of the business. Imagine what would happen if HS were to be booked even for a short while in connection with any one of the myriad cases against the company and its promoters!

Unusual Accounting Policies

Investments are stated at the cost of acquisition. Provisions for diminution in the value of investments are made only if such decline is other than temporary in management's opinion. Usually investments are stated at cost or market value, whichever is lower.

No Great Shakes Expected on Long-Term Returns

The issue is not significantly under-priced compared to its peer group, implying that any major gains would need to come from earnings growth. As evident from the discussions on litigation above, the earnings themselves are a little suspect.

In a nutshell, the investment is not worth the risk.

IPOs - Nectar Lifesciences

I know I was supposed to post my thoughts on IPO analysis but today’s the opening day for the Nectar Lifesciences IPO and the company looks like a good buy so thought I'd take a rain-check on preaching for today...

The Business

Nectar Lifesciences is a pharma company engaged primarily in API (Active Pharmaceutical Ingredient, the chemicals that actually have medicinal value in any tablet, syrup or powder we consume) manufacturing. It focuses on manufacturing Cephalosporin and Semi-Synthetic Penicillin (SSP), both of which are anti-bacterials and has manufacturing facilities in India as well as Sri Lanka.

It currently supplies to several Indian pharma firms including Ranbaxy, Aristo Pharma, Alkem, Ind Chemie and Biochem.

What Makes the Issue Interesting?

Reasonable Growth Prospects

• SSPs seem to be in a de-growth phase and demand seems to be slackening. However, the accelerating growth of Cephalosporins more than makes up for it. Bulk drugs (APIs) have shown a growth of almost 20% year on year for the past decade. One of the objects of the issue is to increase production capacity to take advantage of rapid growth in this segment and Nectar Lifesciences is well-placed to grow in line with this trend.
• Cephalosporins are the fastest-growing category in the Indian anti-infective segment, with a CAGR Of over 15%. Globally, too, they figure in the top 10 drug classes. Nectar Lifesciences manufactures 10 out of 15 types of Cephalosporins used in India
• There’s been limited impact of the new patent regime on the company’s business, primarily due to their focus on off-patent drugs

Sound Objectives for Deploying IPO Proceeds

The IPO proceeds are being routed to high-growth and business-critical areas, namely:

• Setting up a formulation plant, which will enable the company to forward-integrate into manufacture of capsules, tablets etc. and move up the value chain from being a supplier of bulk drugs
• Increasing production capacity of Cephalosporins to take advantage of high growth in this segment. Current capacity utilization is around 90%
• Improved R&D and quality control facilities. The quality control facilities will help the company obtain US FDA approval, which will significantly improve the company’s business prospects, especially in regulated markets like the US and Europe
• Movement into non-antibiotic segment for greater breadth in the company’s product portfolio

Sound Financials

• Sales and profits have increased at a compounded rate of 15% and 38% respectively from 2000 to 2005
• RONW has been steadily increasing from 21% in 2000 to 31% in 2005
• Profit margin has grown from 4 % in 2000 to about 10 % today
• Debt-equity ratio has fallen marginally from 1.54 in 2000 to 1.34 today, though total debt has increased (not very worrying for a growth business, especially since interest payments are still quite low compared to revenues and operating profits)
• EBITDA / EV (a good measure for capital intensive and growth businesses) is at about 9.6%, which implies that an investor in the operations of the business could expect an ROI of about 10%

Low Single-Client Exposure

The company exports to about 40 countries and its top 5 customers account for only about 17% of its revenues.

External Validation of Business Model

The company has a venture capital fund (Swisstec) among its shareholders.

High Promoter Holding

Post-issue, the promoter holding will stand at about 65%, which will ensure that the promoters have sufficient ‘skin in the game’ to ensure good governance and management.

Some Areas of Concern

Pricing Pressures

APIs are an ingredient in branded drugs and hence are susceptible to pricing pressures and price volatility. Further, the company’s main focus is on the Indian market, where leading pharma players have not been doing as well as in the past and drug prices are being brought under regulatory control. If big-name players find their margins being squeezed, they will almost certainly look at re-negotiating contracts with their suppliers

Size

Pharma, by and large, seems to be the kind of industry where scale is an important factor. Bigger companies can spend more on marketing, distribution and R&D than smaller ones, thereby making it that much more difficult for the smaller players to survive. Companies like Nectar Lifesciences need to find a niche or fall by the way-side.

Export Slow-Down

Exports as a percentage of sales has actually been falling (primarily due to lack of demand for SSPs) whereas it is rising for most Indian pharma companies

Tax Penalty

A tax –related penalty of Rs. 2 million looks likely to be imposed. It won’t have a major impact on profits, but will probably depress the share price for a while. Lawsuits and related payouts are always dampeners on stock prices

Few Big-Name Clients

The company does not seem to have any really large Indian clients except Ranbaxy, even though most of the drug majors market medicines that require Cephalosporin.

Competition

It is in direct competition with Aurobindo Pharma, Lupin and Orchid Chemicals, all of which are well-established players in the market.

Price Attractiveness

One thing I did not like in the prospectus was the use of pre-IPO numbers in calculating EPS and PE. This gives a pretty distorted picture of the price attractiveness. I’ve used post-issue share numbers below.

Post-issue, the number of shares outstanding will be approximately 14.9 million. This implies that the ’05 EPS post-issue will be about Rs. 15 per share. The book value (BV) will be about Rs 48.38.

The shares have been priced in the range of Rs 200 – 240, which yields a PE range of 13.3 - 16 and a P/BV range of 4.1 – 5.0. To give some perspective, its peers are valued in a PE range of 22-45 and P/BV range of 2.0-4.7.

For a company that’s been growing profits at about 38% compounded over the past 5 years this seems quite attractive, especially given the company’s growth plans and strategy. It would be worth buying even at the top end of the band.

IPOs - My Track Record

There’s plenty happening in the primary market nowadays. With the stock markets on a general up-trend (or is it a bull run, hmm?) plenty of companies are cashing in by way of IPOs, or Initial Public Offerings. And the public, by and large, are lapping them up! With every IPO over-subscribed by several times, the appetite of the average small investor for new issues seems to be insatiable. Wonder where the money’s coming from!

Being part of the herd of small investors, I’m often in a dilemma as to which issue to subscribe to. This is especially acute at times like now when there is more than one issue (Yes Bank, Provogue, Jindal Poly-Films) hitting the market at around the same time. How does one decide which one to give a miss?

In this, and the following couple of posts, I’d like to outline my decision-making process and invite comments on the same. To be honest, I’ve had a mixed bag of results on this count and would be happy to receive guidance that could help me spot the winners more often.

A Brief Note for Visitors From Outside India

IPOs in India are available to all investors, including financial institutions, high net-worth individuals as well as small investors. IPOs and fresh market issues normally follow the book-building process, which is kind of like an auction of the company’s shares.

My Track Record

The following are the IPOs / fresh issues I’ve considered and the approximate results to date. Since I’m a long-term investor, I do not look for listing gains. For an idea of how various IPOs fared on the first day of listing take a look here.

I’ve given the company name and industry followed by my call on the issue and the performance of the scrip till date.

• Biocon, Biotechnology (subscribed but did not get allotment) – up about 40% since issue in March 2004
• NDTV, Media (did not subscribe) – up about 200% since issue in April 2004
• Dredging Corporation, Dredging (subscribed) – up about 24% since issue in May 2004
• ONGC, Petroleum (subscribed) – up about 30% since issue in May 2004
• Bharti Shipyards, Shipbuilding (subscribed but did not get allotment) – up over 100% since issue in June 2004
• TCS, IT (subscribed but did not get allotment) – up about 50% since issue in August 2004
• Indiabulls Financial, Financial Services (did not subscribe) - up about 720% since issue in September 2004
• Deccan Chronicle, Media (did not subscribe) – up about 22% since issue in November 2004
• NTPC, Power (did not subscribe) – up about 34% since issue in November, 2004
• Indoco Remedies, Pharmaceuticals (did not subscribe) – up about 20% since issue in November, 2004
• Emami, Cosmetics (did not subscribe) – up about 7% since issue in February 2005
• Jet Airways, Airlines (did not subscribe) – up about 13% since issue in February 2005
• Punjab National Bank (did not subscribe) – up about 1% since issue in March 2005
• Gateway Distriparks, Shipping (subscribed) – up about 100% since issue in March 2005
• Shringar Cinema, Entertainment (did not subscribe) – up about 1% since issue in March 2005
• Jaiprakash Hydro, Power (did not subscribe) – down about 12.5% since issue in March 2005
• India Infoline, Financial Services (did not subscribe) – up about 12% since issue in April 2005
• Allsec Technologies, IT (did not subscribe) – up about 14% since issue in April 2005
• Gokaldas Exports, Export (did not subscribe) – up about 50% since issue in April 2005
• 3i Infotech, IT (did not subscribe) – down about 7% since issue in April 2005
• Cybermedia, Media (did not subscribe) – up about 150% since issue in May 2005
• Shoppers Stop, Retail (did not subscribe) – not listed yet
• Jindal Poly-Films, Packaging (did not subscribe) – not listed yet
• Provogue, Apparel (did not subscribe) – not listed yet
• YES Bank, Banking (offer open currently)

In order of annualized performance, the IPOs may be ranked as below (the ones in bold were my picks):

• Cybermedia : +1200%
• Indiabulls Financial : +960%
• Gateway Distriparks : +400%
• Gokaldas Exports : +300%
• NDTV : +170%
• Bharti Shipyards : +100%
• Indiainfoline : +72%
• Allsec Technologies : +67%
• TCS : +60%
• NTPC : +58%
• Jet Airways : +39%
• Deccan Chronicle : +38%
• Indoco Remedies : +34%
• Biocon : +32%
• ONGC : +28%
• Dredging Corporation : +22%
• Emami : +21%
• Punjab National Bank : +4%
• Shringar Cinema : +4%
• 3i Infotech : -42%
• Jaiprakash Hydro : -50%

There were some other issues as well but I cannot remember them right now. The above gives a good idea, though. As you can see, I’ve done reasonably well in avoiding the laggards but have not been able to consistently spot the real winners.

OK, got to go now. Will write in soon with Part 1 of my IPO Analysis ‘techniques’.

Na IPO porein… Heh, heh.

Little Tamil pun. Couldn’t resist. :-)

An Aside

I recently received a mail from Vibhu urging me to list my favourite books on the site.

Given the nature of this blog, it seemed to me that I should focus on investing related books rather than a general reading list. That's of course not to say that I have this single-minded focus on reading management tomes. I do read serious, high-brow classics like Asterix, Tintin, Dilbert, Red Riding Hood... but then there's probably a different and better forum for holding forth on those!

The following are (in order of preference) on my list of 'highly recommended' books for investors like me:

1. One Up on Wall Street by Peter Lynch - excellent teachings on finding small and mid-cap winners. You can read an excellent synopsis of the book and Lynch's teachings here
2. Buffetology and The New Buffetology by Mary Buffet - Buffet's modus operandi, mainly oriented towards finding large-cap stocks at a good price
3. Rich Dad, Poor Dad - the book that inspired me to think about my finances and set me firmly on the path to a comfortable and early retirement (hope springs eternal...)
4. The Intelligent Investor by Benjamin Graham - quite a tome, but this is by the guru of value investing and eminently worth a read

These four books are enough to help any small investor do well in stocks, provided he / she is willing to devote time and effort towards understanding and applying the lessons in these books to their hard-earned money.

Mutual Funds - Make Your Own Unit-Linked Insurance

Much is written and said nowadays about unit-linked insurance, which is touted as one of the best savings schemes for the retail investor, especially one with some appetite for risk.

Unit-linked insurance plans are essentially bundled savings offerings that combine the risk cover of insurance with stock market-linked returns of a mutual fund. These schemes are likely to generate superior long-term returns to the traditional endowment policy while allowing the individual to retain the tax benefits available on insurance – a win-win situation. As with any market-linked instrument there is a modicum of risk attached but over the long term that insurance policies are (or should be) held, the chances of loss are negligible.

There is a catch, however. Unit-linked insurance plans are always offered against funds managed by the insurance provider, which might not be among the better-performing options available in the market. Therefore, while you would be better off than if you invested in an endowment policy, the returns could have been higher. And the power of compounding is such that over the twenty-year period of the average insurance policy, a difference of even one percent could mark quite a significant increase in the size of your nest egg.

Do-It Yourself

Ideally, we’d like to have our insurance linked to the returns of the market-leading mutual fund and there is a way to achieve this. The solution lies in term assurance.

Term assurance is a no-frills insurance that covers risk, full stop. There are no returns – even your principal will not come back. However, the premium payments are really low, much lower than with the savings-oriented insurance schemes, and the same tax benefits are applicable. Such a pure-risk insurance plan offers us the ability to manufacture our own ‘unit-linked’ insurance, but this time with any fund of our choice.

A Step-by-Step Guide

• First decide on the amount of insurance you want to take on a unit-linked scheme and calculate the premium you’d need to pay
• Then figure out the term assurance premium of an equivalent amount. This would be significantly lower. Take out a term assurance policy for that amount.
• With the money you have left over – and this is where the beauty of the scheme lies - set up a Systematic Investment Plan (check out my previous post on SIPs here) in any fund of your choice. You’d generally prefer a market-leading diversified equity fund with a long and successful track record, like Franklin Bluechip.
• If your policy and SIP renewal period is the same (usually annually) then you need to take little extra effort over what you’d have done for a standard unit-linked insurance
• Sit back and relax – you’re almost certainly going to save more than with any unit-linked insurance scheme

Caveat Emptor!

Thanks to my wife for pointing this out:

Before you rush off to put this idea into action, remember that tax benefits would be available only on the insurance allocation, not on the mutual fund investment. Hence the plan might not hold as much charm for those who purchase insurance for tax benefits alone.