Paid For The Wait

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Today’s life is all about instant gratification.   Even though we all have heard about the saying ‘Patience is a virtue’ the world is moving towards instant gratification.  The product life cycles are getting shorter and shorter and all corporates wants to get to the D-Day in the shortest time possible to get the outcome they are waiting for.  For most of the folks in the current generation,  it is all about ‘what can I get and enjoy today’ which is very important.  No one is willing to wait for a long time to enjoy more benefits.  That is the reason we have all these FMCG companies exploiting this bias by introducing all instant XXX in their products ranging from instant Noodles to Coffee.  Life is moving fast and no one has time to even time to smell the roses, (forget about growing rose plants).

Does this kind of instant gratification work in investing?  Answer is a clear no.  Investing is all about patience and being a sloth.  Investing works best for people that are lazy and hate action.  

Image Courtesy Anekoho / FreeDigitalPhotos.net

 As Mr. Pascal said and I quote,  “All human evil comes from a single cause, man's inability to sit still in a room”.  We somehow associate action to being productive.  I do not want to get into the details but I can cite one example that I like the most.  There was a study which was conducted to analyze the penalty kicks by the shooter.  They found that it was equally disbursed by 1/3 towards middle, left and right.  So if you are a Goal Keeper, you have almost the same probability or chance of saving a goal just by standing in the middle and doing nothing.  But, you will be surprised to know that almost none of the goal keepers would stay in the middle but would either dive to the left or right despite knowing this probability.  Why would they do it?  Simple, they are influenced by action bias.  They are okay to have dived left or right and lose than to stand there and make other feel that they did nothing.  Most of the investment managers and investors feel the same.   They get fidgety when they are not actively engaged in stock market.

As I see it, the only profession that really pays you handsomely for doing nothing and being a sloth is investing.  You are almost paid for being lazy.  All you need to do is overcome the bias of doing something.  We go through lot of desperation in deploying cash or removing it in short times.   We may have a windfall or some profits we want to immediately invest in or we may want to quickly book profits on something that went up in a jiffy (even though we may do better holding it for long run). On the contrary, we want to exit from investments that have lagged or dragged your returns down in the short run of say past 1 year.

Investment is like gardening or parenting.  You cannot expect a seed to give you fruits or vegetable right from day one or you cannot expect your kids to be productive on day one.  They become productive over a period of time.   We need to approach investing like that.  All we need is to water or nurture them and understand them better and wait until they bloom.  In fact, we are paid to wait and we will be paid handsomely. 

If we find a golden goose and we have bought it, all we need to do is wait until it lays its next golden egg.  We should not try to cut open its belly to find all the gold (instant gratification) , neither should we try to sell the goose and try to buy a crow that is painted golden.  Be patient and always act only when there is a need to.

Stock Analysis - Torrent Pharmaceuticals

Business Overview:  

Torrent Pharmaceuticals is a Pharma company having presence in Indian and global markets.  It manufactures both branded and unbranded generics and has a small exposure to contract manufacturing.  It sells branded generics in India and sells both branded and unbranded generics in overseas markets.  As of 2013, domestic revenues contribute about 32% of total revenues and international revenue contribution is around 57%. Contract manufacturing and other form the rest of the revenue.

Their product key segments are Cardio Vascular (36%) followed by , CNS and Gastro Intestinal (18%) segments.  Other major areas include Anti Infective(9%) and Anti Diabetic (8%)

Torrent is now 17^th by turnover and has around 5 brands of top 300.  5 years back they were 16^th by turnover and had around 6 of top 300 brands.  They are present in Brazil, Germany and US.  Entry in US market was late but this market is growing to be a significant one for them.  They have presence in Europe and other emerging countries as well.

While the domestic operations are very profitable, the overseas operation performance has been lackluster and the profit always fluctuates.  They seem to always have good revenue growth overseas but the profitability is always inconsistent suggesting margin pressures.  They are expanding their footprint into global markets and are investing aggressively into many countries.

             Financials:

Company has employed debt at reasonable levels and has debt to equity ratio of 0.35 as of Mar 13.   On consolidated basis, company employs around 819 cr on Net Block and around 150 cr of net working capital to generate a revenue of 3211 cr which is pretty good.  It generates operating profit of 692 Cr from this capital deployed on core business and this looks impressive.  Company always has been generating good amount of free cash flow on regular basis except for last year when the free cash flow was negative because of high inventories and receivables.  Company has been investing aggressively into global businesses but they are not consistent in terms of profitability.  Consolidated profits has always been lower than stand alone profits showing that they are making losses in their overseas operations.  Despite all these, the return ratios and metrics are pretty impressive for the company.  It has an average ROE of around 30% and given the capital retention ratio one can expect a growth of around 16%.  Companies return on reinvested capital has been very impressive with a 5 year average of around 31%.

Investment Rationale:

Company has the potential to grow for some time at around 15%  due to various reasons ranging from expansion in global markets and domestic markets to the amount of products they have in pipeline given the numbers of products that are going off patent until 2016.   Company has been spending consistently on R&D to keep its product portfolio growing. 

Company is available at a reasonable valuation of around 15 time EV/EBIT(average)   basis.  Assuming a growth of 15% for 5 years and terminal growth of 4% afterwards and a discount of 12%, this stock has a fair value of Rs 562 and at current price of Rs 459, it provides a margin of safety of around 18%.  On PE basis it had valuation range between 7 times and 17 times and currently it is available at the high PE range of around 16.  

Any buy at a price with around 25% margin of safety would be great.  As of now I will wait for the price to decline to 425 or below for accumulation.

            Risks:

Currency risks due to exposure to global currencies may impact the profitability of the company as global revenues are almost nearing 60% of the total revenues.

Global operations may make big losses and may not turn out to be profitable as the company expects due to competition from other players.

Margins may contract in the global markets due to competition and changes in government policies.

Working capital requirements may increase in some countries due to long time for payment.

Product launches could be delayed due to longer approval cycles.

Drug price control revised by the government last year may bring in more products of the company under max price ceiling and that may affect margins in domestic market.

Quality issues could result in product return which could affect the profitability.

            Exit Criteria:

Company does not grow on average at 15% as per assumption and likelihood of future growth in this range is very bleak.

Balance sheet structure gets weaker with increased debt exposing the company to leverage risks

Prolonged decrease in the free cash making ability of the business

Company price grows more than the intrinsic value and priced over value by 25%

Return on reinvested capital falls below the bond rate.

Behavioral Biases - eBook

This is a good reference for all behavioral biases in one place.  Balaji Ganesan has done a great job of compiling his learning.  This has been posted in Safal Niveshak which is a site that I often visit.

Click here to open the eBook