Realty Stocks Overvalued?

I've not really been tracking IPOs much of late. The main reason for ignoring these is the fact that there is almost nothing on the table for long-term investors in IPOs today.

The lack of sufficient historical information coupled with some really eye-popping valuations thanks to the bull market make me jittery, to be honest. Also, the mammoth oversubscriptions in most of these imply that the average investor gets a miniscule allocation that is simply not worth the effort. Even if you were to sell at a handsome profit on the first trading day, the absolute value of your returns doesn't make it really worthwhile.

Among IPOs, the ones I am most leery about are realty companies, which are blessed by being at the intersection of both a stock market boom as as well as a property boom and hence these companies are cashing in big time. This article illustrates the issue beautifully.

IPO - Suzlon Energy

Suzlon is by far the largest wind-energy provider in India, a lucrative and under-served market for renewable energy. It is also the sixth largest such company in the world.

What I Like

• The company holds a strong and sustainable position in a growing market where barriers to competition (need for an impeccable track record and significant capital to bid for projects) are high. Further, India is a potentially huge market for wind energy and there’s plenty of room to grow domestically. And petroleum prices are shooting through the roof, making renewable energy even more attractive
• Suzlon has captured 3.9% of the global market this year, which is much better than the 1.9% it has of the cumulative installations till date. This means it is actually increasing its share of the pie, a very encouraging sign
• Further, the company has demonstrated sales and profits growth of 54% and 47% respectively on a cumulative basis for the past 4 years, which compares quite well with the issue PE range of about 29-34

What I don't Like

• The EBITDA / EV margin is in the range of 11%-13% for the issue price band, which, unfortunately is a bit low for a relatively high-risk business. Wish the company had been able to bring it up to at least 15%
• The company has re-stated its numbers due to changes in its accounting policies. The cumulative effect of these changes has been to increase the profits for the last year by Rs. 204 mn leading to an EPS increase of about 66p, which is significant. While the accounting changes are probably all right, I’m sure the fact that they led to increases in profit was a big factor in approving these changes. Sneaky!
• The Price to Book ratio for Suzlon is around 12, whereas the same is in the range of 3-10 for its peer group companies. A P/B ratio of 12 is very high and would be an immediate disqualification for conservative investors
• Being sixth (with a tiny market share of about 1.6%) in a relatively small global market means Suzlon will have to really work at its strategy in order to grow faster than the market and move into the big league. The top player in this market has twenty-two times it market share and even the 5th largest has five times the market share of Suzlon.

In Summary

Apply if you like ‘growth’ stocks that with potentially significant upside (though at a high risk) – and even then go for the lower end of the band. Those willing to hold it for many years will definitely reap huge benefits - after all the market will really explode when the cost of wind energy comes close to that of fossil fuels.

Don’t touch it if you are risk-averse or if you have a short horizon.

IPO Analysis for Fun and Profit

Hi all! I’m back after a brief vacation and in keeping with my philosophy of writing for the thinking investor, here is my long-overdue note on IPO analysis.

[Note for people who think the title is nerdy: Make the profit and you’ll get my drift]

What follows is a list of things I look for when evaluating an IPO. These are, of course, generic and there are usually industry- and company-specific idiosyncrasies in each IPO that must be evaluated on a case-by-case basis.

The good news is that it doesn’t take too long to cover all the ground. On an average, it takes me no more than two or three hours to do the research (a fast internet connection is an asset) and make up my mind about an IPO.

Is that good enough? Possibly not, but then my track record is perhaps better than average and it’s tough to find more time than that anyway!

Part I: Screening (10 mins)

• Already Listed: Beware if a company is already listed. Chances are that it is trading at a huge premium to the offer price band at the time of the IPO and you’re tempted to make easy money. Going by recent history in many such offers (Punjab National Bank, Jindal Polyfilms) the prices are likely to come down close to IPO levels and you’ll make little or no listing gains. Invest only if you really like the business and even then it might be a good idea to wait till after the IPO and pick up shares straight from the market.
• Prior Experience: Experience of similar IPOs in the past should serve as a good guide to investing in any fresh issue
• Industry: Are you comfortable with the industry the company is in or do you feel it has bleak / unpredictable / cyclical prospects over the long term. Know what you’re getting into
• Market Cap Post Issue: Does the post-issue market cap ‘look’ reasonable or does it look like a grossly inflated figure e.g. Google has a market cap higher than McDonald’s, which, even given Google’s potential for stunning growth, seems a little out of whack
• Demand: Check out the NSE-BSE demand graph on the NSE website, especially on the last day. This will indicate the extent of oversubscription. Most investors seeking to make quick profits would apply for highly oversubscribed issues but I tend to favour the less popular ones as chances of getting a decent allotment there are better.

Part II: Googling! (1 hour)

• The Company Website: Look for their products and services, financials (if available), geographic spread, client list, history, management profiles, press releases, partnerships and client testimonials. If you’re really lucky, you’ll find downloadable documents / presentations related to the business and the industry on the company website. Read these carefully and no points for guessing that such transparency is a sign of good, professional management
• News Items: Check out news items (try Google News) on the company, preferably going back at least 2-3 years. These will give you a feel about the company, its management and its overall direction as well as its recent achievements and level of visibility. One often also finds out things (usually bad things like lawsuits and squabbles between promoters) that are under-stated in the prospectus but quite important from an investor’s perspective.
• Analyst Reports / Informed Opinions: Right from Sharekhan and Moneycontrol down to blogs like the celebrated one you're reading right now – there’s a wealth of opinion on the net. Get as many perspectives as you can.
• Industry and Peer Group: Which other companies are engaged in similar lines of business? How are they doing? What are the general trends (growth, innovation) in the industry?
• What People Are Saying: Check out the bulletin boards on Moneycontrol. They’re always buzzing with activity, though only about a tenth of the posts are of any use. You’ll might find a nugget or two there.

Part III: The Prospectus – Softer Aspects (30 mins)

You’ll find offer prospectuses (prospectii?) on the SEBI website. It could be filed as a draft, ‘red herring’ or final offer document. I have no clue as to the differences between these but I guess they are pretty much the same.

• Risk Factors: These are outlined right at the beginning and again in the middle of the document. Several of these are of the ‘filler’ type but tread carefully – there might be a couple lurking about that could really rock the boat if they were to come about. Examples of these are sizeable lawsuits (ERA Constructions), chances of a major industry downturn in the near future, over-dependence on a single or small group of clients / suppliers etc. There is often a discussion of management’s viewpoint on some of the ghastlier ones and they are worth taking note of
• Business Overview: There is usually a 2-3 page discussion of the industry structure and trends as well as key growth factors. This is worth reading to get an idea about the industry and to identify the company’s special niche (one hopes it has one!). As a bonus, knowledge gleaned from one prospectus can be used in IPO / stock analysis in the same or related industries
• Objects of the Issue: The proceeds of the issue should be used entirely in value-enhancing, business-related purposes. Anything else – like Emami using 17% of the proceeds to build a plush head-office – is a strict no-no. Use of proceeds for working capital is also not a very encouraging sign
• Track Record: The company must have a decent track record. Investing in brand-new companies (like YES Bank) is a huge risk in my book. If you must go for such issues thoroughly check out the management and the company’s strategy, because that is the sum total of what you’re paying for
• Promoter and Management Profiles: Ideally the senior management should have long years of experience in the industry and be professionals unrelated to the promoters. Companies where the leadership roster reads like a family tree are best avoided
• Promoter Holdings Post Issue: Should be high enough to keep them interested in the business but not so high as to smother professional management completely. Something like 40-60% sounds about right.

Part IV: The Prospectus – Financials and Hard Numbers (1 hour)

• Check on Diluted Financials: Remember to check that all per-share data has been calculated on a diluted basis i.e. on the increased number of shares outstanding following the issue
• Growth Rate: What is the cumulative growth rate of overall sales, net profit, and operating profit of the company over time (at least three years of data would be provided in the prospectus). What is the average year-on-year growth rate? Is it steady and increasing or showing signs of unpredictability, with wide deviations from the average growth rate?
• PE Ratio: Is it reasonable compared to its peers (a peer-wise comparison is often provided in the prospectus)? Ideally the PE Ratio should be lower than the average growth rate and also at a discount to peer values
• Return on Equity / Return on Net Worth: Is the ROE figure comparable or higher than its peers? Is it growing over time? I’d ideally like companies with ROE over 20% and growing
• Debt / Equity Ratio and Interest Cover: Is the debt / equity ratio low (for the industry) and consistently falling over time? Does it compare favourably with its peers? Is the interest cover high (preferably over 5) and consistently rising?
• Price to Book Value: To be a bargain, the price should be below the book value (price to book ratio of less than 1) but that is a utopian dream in a fresh issue. Anything that seems about right for the industry should be fine. Growth stocks (like IT, Pharma, Biotech) usually have prices waaaay beyond the book value.
• EBITDA / Enterprise Value: This ratio determines the return on investment for someone acquiring or buying into the company (like us!) and works well for growth companies like small IT players and capital-intensive enterprises like airlines and telecom. I’d ideally look for something greater than 10%
• Unusual Spurts and Dips in Financials: Look for suspiciously high profits in the last year or sudden increases in personnel / raw material costs. These may be genuine but one should know the reasons for the same.
• Large Bonus Issues / Stock Grants in Recent Years: These only benefit the promoters and leave less on the table for investors like you and me
• Notes to Accounts: Often neglected, this is the place to look for financial jugglery if you can make sense of it. If not, trust in God (and the management) not to hand you a mini Enron!

Part V: Informed Sources (10 mins)

• Friends in the Company: Company employees are usually a good source of down-to-earth information that cuts through the hype. The flipside of course is that most insiders usually paint an overly pessimistic or optimistic picture based on a relatively narrow view
• Industry Insiders: People in the industry usually have some idea of the main players and especially about their competitors. Such people are a good source of unbiased, though sketchy, information

Do write and let me know whether you found this useful.
Till next time, adios amigos!

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. :-)

IPO - Gateway Distriparks

The Gateway Distriparks offer hasn’t quite generated the frenzy that generally characterizes Indian IPOs. Oversubscribed by 6-7 times overall, the retail segment has seen remarkably little action, remaining undersubscribed up till the close of the offer. Perhaps the fact that Punjab National Bank and Emami were also available at the same time had something to do with the lack of enthusiasm…

What Makes Gateway Distriparks Interesting?

The following points indicate the company is a good buy:

It's a mid-cap company with significant presence in a growing industry

The company is in the logistics industry, dealing mainly with packaging of goods into containers and storage of incoming and outgoing goods in company-owned facilities. They have a significant presence in major shipping hubs like Mumbai and Vizag, with plans to acquire a facility in Chennai. They also have a presence in Gurgaon, thereby catering to road transport. The company plans to expand its presence geographically as well as in different transport sectors.

The offer proceeds are to be used for business expansion and other strategic purposes

GDL aims to use the proceeds to retire high-cost debt, acquire a facility in Chennai and improve its facilities in Mumbai and Gurgaon, all of whicih will lead to profit growth in the medium term.

GDL has displayed strong revenue and profit growth over the past five years

The company has shown a CAGR of 55% in revenues, with no year recording less than 20% growth. Costs have shown a more gradual increase, leading to excellent profit growth.

RONW and ROCE have been consistenly improving over the past few years

RONW has improved from about 8.3% to 23.5% over the past 3 years and ROCE from 4% to 19% over the same period.

Debt components have been steadily declining

Overall debt to equity and interest liabilities have been falling over the past 5 years and current interest coverage is at comfortable levels, suggesting that the company will at least not go under on account of debts!

There's evidence of improving business efficiency and movement up the value chain

The primary income streams are rental for goods storage and service charges for packaging and handling. While both have been on the rise, the share of rentals in the overall revenue has fallen, indicating the company has been able to command premium rates for services, indicating a move up the value chain. Further, reducing dependence on rentals also reduces the need to constantly acquire storage facilities involving high capital investments.

Price Attractiveness

At the offer price band of Rs 60 – Rs 72, the PE Ratio (using diluted EPS) is between 24 and 28, which is a tad high for a company that’s growing at an average of 30% year on year. However the overall business is attractive enough to buy at the price, especially at the lower end of the band.