Festive Stock Picks

On the occasion of Diwali, let the cheer & festivity spread all around.

I give following 5 muhurat stock picks from different sectors for next Diwali, that is one year horizon of Nov-2014.

1. Accelya Kale Solutions (CMP on Nov 01, 2013 : Rs 585)
2. Tata Coffee (CMP: Rs 1124)
3. JB Chemicals & Pharma (CMP: Rs 100)
4. MCX (CMP: Rs 497)
5. Divis Lab (CMP: Rs 977)

I am not finding time to make a detailed post on these stocks.

Out of these, MCX is only for high risk takers due to all the uncertainty surrounding,  and to be added only on declines.

May you & your family have a bright Diwali and healthy & wealthy year ahead!

Best Wishes.

On Buy-Back and Bite-Back

You might have seen following announcement from NHPC...

NHPC Ltd has informed BSE that the Board of Directors of the Company at its meeting held on October 24, 2013, has unanimously approved the buyback of upto 10% of fully paid up Equity Shares of Rs. 10 each at Rs. 19.25 per share payable in cash for an aggregate amount of Rs. 23,67,89,29,832/- (Rupees Two Thousand Three Hundred Sixty Seven Crore Eighty Nine Lacs Twenty Nine Thousand Eight Hundred Thirty Two Only) through tender offer.

I try to briefly give my thought process on this buy-back as follows:

To give you a small background, Government of India holds 86% equity in NHPC. They did an IPO at Rs 36 per share in Aug-2009 and the stock has been downhill ever since. CMP is at Rs 18.40. With investors having consistently lost money here and buy-back price fixed at Rs 19.25, it is highly unlikely that any ordinary shareholder would tender in this buy-back. Only Government of India would tender at this price.

In-principle, Buy back is usually resorted to owing to one or more of following reasons:

 (A) Increase the underlying share value

(B) Support share price during periods of temporary weakness

(C) Return surplus cash to the shareholders

Why is it unfair to ordinary shareholders of NHPC?

1)     In case of NHPC, it’s clear that (A) and (B) are not the underlying reasons. 

2) As regards (C), since the price is unattractive to ordinary post-IPO shareholders, cash return will happen only to “promoters” and not to “all shareholders” as is the underlying objective of buy-back.

3)     Point to note is that same “promoter” already pocketed the premium of Rs 26 per share at the time of IPO in Aug-2009, so now promoter does not mind a lower buy-back price since whatever the buy-back price it anyway stands to gain. But it is the ordinary shareholders that lose as they entered at the time of IPO or post that. The stock has never crossed its IPO price in the last 4 years.

4)     On the contrary, say the buy-back price had been fixed at Rs 30, it would have given a fair chance to all shareholders to tender. But then, it would not have served promoter’s objective of grabbing the cash and still not lowering it’s stake much in the company (assuming 14% of the public shareholders do not tender, promoter’s stake will go down only by 1.5% after all this). I don’t think even LIC that holds 1.84% will tender.

5)    Sometime in future say after 2 years, Government will still have to resort to an FPO or secondary placement if it intends to bring down its holding to 75% level. It is anybody’s guess that such an FPO, as and when that comes, will be at even worse pricing, else who would come forth to invest seeing the spectacular capital markets track record of the company. Oops, I forgot LIC and its charity work…

Why is it unfair to NHPC the company?

1)    Under obligations of buy-back, it cannot issue fresh equity for the next 1 year and lower equity+reserve would also make debt raising more arduous. Can a company in power projects sector be confident that it will not have to raise capital as per its business plan or is the decision just being forced upon them because Government wants to take the cash out to meet its fiscal deficit targets?

2)    Cash of Rs 2,367 crore that is being stripped of NHPC balance sheet could have been used by the company to expand its business or may be enter into some related projects/business. It is not a FMCG or IT type of company where we can say they do not have any real use for cash.

3)   Buy-back price is fundamentally an indicator of intrinsic value that the company gives to the markets and all stakeholders. As things stand, in case of NHPC, it appears the company itself does not consider that it’s worth is more than Rs 19.25 per share. So the question is why should the market give it a better price multiple anytime soon. At the most, market will adjust the price for marginally higher EPS that it will have post-buyback due to reduction in number of outstanding shares.

4)  In other words, company’s stock will be fundamentally de-rated after this buy back is completed. Look at so many of the PSU stocks that are quoting far below their IPO/FPO prices.

Why is it unfair to other PSUs?

Is anybody concerned as to what signal such actions give to other companies belonging to the same promoter and about the fate of ordinary shareholders in those PSUs. Oh, you said they are already quoting dirt cheap, as if they’re going to shut down. So nothing much can happen to those - they have already come a long way from “nav ratna” to “no ratna”. What I meant was some of these companies are cash rich, debt free, free cash flow generators like Coal India, Engineers India, NMDC etc, at least they can be a given a fair chance to command a premium that market would otherwise assign to any respectable owner group.

But that seems like asking for too much at present juncture.

Disclosure: I don’t hold any shares in NHPC, neither held anytime in the past nor holding at present. Reading this, you’d get an idea that I don’t plan to have it in future either.

Is There a Price Bubble Building in Consumer Stocks?

All the time, I get the question consumer stocks are trading at such rich valuations and is there a bubble building up there? I did a post on same topic in 2011 here.

“Stay away” from these is the advice from some of the analysts. Graham worshippers and “Value investors” say these stocks are absolute no-no, and cannot be justified anyway you look at them.

There can be no two opinions about ultra-expensive valuations of consumer plays. At the same time, it can be intriguing to see every other investor taking shelter in these names despite such pricey tags. 

I, however, think it is important to appreciate the overall landscape in which consumer facing stocks are being evaluated by the markets:

1. Infra companies pack has been a disaster in their capital allocations and many of their acquisition and other decisions haven’t been financially prudent. Government alone cannot be blamed for policy paralysis and their sorry state.
2. Cash flows in power and capital goods companies are unreliable, or missing in some cases. Well established names of yesteryear are languishing at lows. A recent article on BHEL gave insight into the real situation, so much for a Navratna enterprise.
3. PSU stocks have not come out of overhang of OFS and dilutions, the woes of fundamentally strong companies like Coal India, NMDC and MOIL etc in mining sector are well known. Oil & Gas sector has some minor positive with reduction in diesel subsidy but it will take long before that makes any real impression on the stock prices.
4. Auto majors like Maruti have to stop production for a couple of days every now and then to cool off the supply mismatch. Entry of one Honda has changed the 2-Wheeler market dynamics for our Bajaj auto and Hero.
5. Pharma is a mixed bag. For an ace like Sun Pharma, we also have to live with a Ranbaxy that acts as dampener. Still, market is giving high multiples to well performing Pharma guys so long as they are performing.
6. Banks are somewhat of a divided house where many PSU banks are saddled with asset quality issues and trading well below book. Private peers are already priced in overvaluation zone in excess of 2-3 times book.
7. IT with some exceptions (HCL Tech, TCS, Mindtree) have failed to live upto promise of  volume growth. The stock uptick seem to be on account of currency moves rather than real operating performance.
8. No point discussing about real estate and the likes.

All the above tentativeness in market leaves us with consumer facing businesses in FMCG and Consumer durables. Yes, we are talking about the likes of Nestle, HUL, ITC, Colgate, Britannia, Bata, Asian Paints, Berger Paints, Pidilite, Dabur, Emami, Bajaj Corp, GSK Consumer, Tata Global, Godrej Consumer, Marico, TTK Prestige, Hawkins, P&G, Gillette and so on.

Now, question is what is distinguishing these from the rest:

a.  Consistent cash flows, debt free (most of them), incremental capex is funded internally, no dilution,  high capital return ratios and decent pay-outs.

b.     Market very well knows that Nestle cannot grow at 30%+ anytime in near future but still gives it PE of 40. Such companies are like oasis in desert where “Predictability of Earnings” is the real PE decider not just the earnings growth.

c.   Domestic consumption stories are here to stay. A large middle class and growing number of consumers add to it. They can reduce some discretionary spend in inflationary times, ultimately that has to be realized in the market. After all, Chinese folks may not succeed selling hair oil and toothpaste in India.

d. Established consumer companies have strong brand power, distribution network and geographical penetration. Most of this is irreplaceable moat.

e.   Gestures from the parent shareholders to hike their stakes even at current levels like in GSK Consumer and HUL boosts market sentiment for investors (why will promoters not raise their positions when they have business growth compared to home turf, they take away high royalty payments of 1-3% and of course the dividends).

f.     In this kind of scenario, where do you think an emerging market fund looking to put money to work in India will invest, if not in these consumer stories?

In short, these consumer stories may have their ups and down and occasional performance blips. Broadly, this theme will continue to deliver earnings and premium multiples accorded by the market may not significantly shrink going forward. These are uncertain times and the way macro-economic scene is panning out, there may be bouts of sustained selling. That will again make participants look for defensives. 

No wonder, consumer facing businesses will keep the markets interested!

Which stocks should you pick in current fall?

We have witnessed midcap carnage in last one month or so, with concerns looming over some companies having pledged shareholding and margin calls getting triggered. A non-event making Union budget and FIIs having concerns over TRC issue did not help the sentiment, and we may lose further stream on the way down. Rather than dwelling over the macro direction, it’s better to focus on the actionable for an individual investor in any given situation. Most midcaps and small caps are beginning to look attractive. Decision point for an individual investor therefore is what to buy, if at all.

I would divide the stock universe at present juncture into three categories:

1.      Quality stuff– Most blue chip stocks with formidable market position have not seen much price action. Their financials and business dynamics are what they were. To give you a flavor I’m referring to strong companies across market caps like ITC, Nestle, HDFC twins, Pidilite, Colgate, Asian Paints, Titan Industries etc. which have remained relatively stable. Argument for buying these stocks as a portfolio choice at this stage can turn out to be a good decision, in case indices drop another 10% from here, these stocks are not likely to suffer as much. The counter-argument for these stocks being a bad decision is that they are already quoting at very high valuations and upside here will not be much when market rebounds.

2.      Beaten down – Here I’m referring to stocks that are damaged price-wise in the last few weeks. There may be concerns over pledged shareholding of these stocks and sometimes of margin calls over these holdings. In few of them there could be issues of corporate governance and suspicion over some of the actions or transactions. As an indicator of this category, we have names like Arshiya International, Opto Circuits, Core Education, Alok Industries, ABG Shipyard, Zylog Systems, Onmobile Global, PC Jewellers, IRB Infra, GMR Infra etc. Market does not give benefit of doubt in many cases and price action has been pretty severe.

3.      Down but not out – These are stocks where price decline in the last few weeks has been significant but the fundamental strength and standing of the businesses are intact. In other words, these companies stocks have also fallen but more in solidarity with the markets and their midcap peers, rather than any specific negatives on part of their business, promoters or management. One of the beneficiary themes could be exporters who are benefited by a weakening rupee. Domestic consumption themes with strong earnings visibility and robust cash flows are the others that look attractive.

If you have been following posts on this forum for sometime, you would be able to make out stocks in which one of the above three categories I’m going to recommend to buy at the moment.  Yes, it’s the third “Down but not out” since I believe the positive surprise would be the maximum in this category over the next 1-2 quarters. There is a good likelihood that Q4 results would be favourable for companies where business quality has not deteriorated and bounce-back could be swift. It is this category that can beat the consensus estimates in a decisive manner, if not in the next few months certainly over the next few quarters. This is a good time to invest in equities, let’s not miss out on the opportunity.