Review And Outlook:
Third quarter has been mixed quarter of sorts as far as corporate earnings were concerned. While the economy continues to drag with high inflation and low growth, Mr. Market is in a very happy mood as he thinks that Mr. Modi will will the next elections and he would be able to bring in positive changes to the economy. His enthusiasm has started pushing many midcaps into limelight. Midcaps made handsome gains in price terms due to this general happiness of Mr. Market.
While the market is generally not over valued yet, the current valuation is high compared to the current inflation and the economic cycle. Most of the businesses continue to be overvalued with very low expected returns in the future. In some cases, the prices have increased substantially while the net profit of the company has shown degrowth.
When the market is in a cheerful mood, it becomes difficult for us to hunt for bargains. If the current mood persists, we will have lot of difficulty in finding any new ideas with adequate expected future return and margin of safety. Most of the businesses in our portfolio has grown handsomely since Mar13 qtr. On portfolio level, our business market value grew by around 34% while the sensex growth was at 8%. Most of this is attributed to valuation growth by the market. In pure intrinsic or networth growth terms, our business business grew by 20% which is great.
I have graded the business performance for the quarter as A, B, C and D. Profit growth at or above 20% are graded as A. Growth between 12% to 19% as B and those below 12% are C. If the profit was lower than last year it would be graded as D. Goal is to have more of A and Bs and less of Cs and no D.
Business Performance Of Our Major Holdings: ( > 3% of portfolio in value terms)
Mayur Uniquoters (Grade A):
Revenues grew by 30% and currently stands at 122 Cr. Operating profit was at 20Cr and grew at 39% year on year. Operating margins were at 16% which is great. Net profit growth was at 14 Cr and grew by about 38% due to lower other income. Overall, company has got back on growth track after an average last quarter which goes to show the robustness of revenue mix from multiple industries. This business has added so much of value since we acquired it and the market valuation has exceeded the intrinsic value growth.
Board has declared bonus issue of 1:1 which has led to too much of price action in my opinion. Now our exposure in this stands at 14% of portfolio and I may lighten it up a bit due to stretched valuation by the street. Street has pushed the market prices as usual with any bonus news but we understand that bonus does nothing in terms of business or shareholder value except improving the liquidity.
On long term basis I am very positive about this business. With an addressable market size of 4000 to 5000 Cr and with 50% being contributed by unorganized sector and the rest by organized sector there is a lot of growth that can be achieved by Mayur which is currently having around 10% of market share. They are the largest in terms of organized players and the only efficient one.
Axis Bank (Grade C):
Net Revenue increased by 13%. Net interest income growth was at 20% and non interest revenue was at 2% only. Net Interest margin grew from 3.57 to 3.71% which is good. Hope they can maintain it. Gross NPA continues to increase and currently at 1.25% of total assets. % of Net NPA also increased this quarter at 0.42%. This trend is expected to continue for some more time. Provision were lower this quarter even though the NPAs have increased. EPS growth is around 8.6% due to higher equity base. EPS growth will match profit growth only after the dilution effect is gone.
Corporate business has slowed down and the company is concentrating on the retail segment. Company continues to grow its deposits which is currently at 7.6% and the advances grew by 17% compared to last year. From the conference call, i got the sense that the company is being very cautious about corporate lending given the economic scenario.
There is no information on the restructured assets in the results. However, based on conference call 2.06% of net customer assets are restructured. They expect the total restructured assets to grow to 6000cr by the end of year. This is very high. We will continue to watch for better NPA situation before thinking about any further investment in this business. This is still the second best private bank available at a good valuation when compared to HDFC Bank which is gold standard in banking. All others either are smaller or have lower quality and higher valuations. I am very positive and hopeful on banking and specially Axis bank as it is worth the price paid and will grow in line with Indian economy. If you bet on Indian economy, you should bet on banking as without capital growth cannot come.
HDFC (Grade B):
On consolidated basis, revenue growth was at 13% whereas the profit from operations grew at 11%. Provision for contingencies has come down in this quarter compared to last year. EPS growth after taxes and considering other income was at 12.7%. While the banking and asset management business has shown growth, both life insurance and general insurance businesses profit had de-growth which has led to lower profit than revenue growth.
With most of the banks getting into the home finance business, competition has grown and currently they have around 15% growth in this bread and butter business. This could slow down a bit if the competition heats up in the future. This is a stalwart which will continue to grow around 12 to 15%. We will switch out from this when there is a better and faster grower with similar quality available at an attractive price. Until then we will continue to hold this.
BHEL (Grade D):
This business continues to have disappointing run as expected. Revenues were down about 16% but the operating income dropped by about 48% due to higher raw material cost. Net profits were down by 42% due to lower drop in other income.
Business has an open order book of around 100600 Cr as of this quarter end. This business will take a lot of time before it turns around and we may even have worse performance than what is currently being shown. Per past 4 qtr earnings this business is still yielding around 9% . This is where margin of safety has helped us. Hope the business bounces back and maintains flattish or growing yields from here on. As of now, things continue to remain uncertain and not looking good.
While I am still confident of BHEL as a long term out performer, I was very early on this one with regards to investment and the whole thing now boils down to opportunity cost. I would give myself a F on this investment choice. Given the goals that I have set for the year, I will soon be looking to exit this business at right opportunity. Hope I get lucky.
Atul Auto (Grade B):
Vehicle volumes increased by 17% and the revenue increased by around 19% due to slightly better realizations. It is heartening to note that the company is growing volumes when the entire auto industry is having de-growth. Operating margins were at 11% which is slightly better than last year. Due to this, the operating profit increased by 20%. Net profit growth was lower at 17% due to higher tax payout.
Overall, company continues to have impressive volume growth while maintaining its margins in a very tough market. Will continue to hold this business as long as it continues its forward march as it is currently doing. They are going to go for a greenfield expansion to manufacture CNG based autos for domestic and export market. Expected Capex is around 100 Cr and as of now company has around 40 Cr cash and expects this to be funded using internal accruals. We need to keep a close watch on how the business continues to perform and exit if the fundamentals seems to stagnate or deteriorate. I will hold this business only if my expectation of its growth is greater than 15%.
Sun TV: (Grade C)
Revenue grew around 5% but the operating profit went down by 3% due to higher cost of revenues which is probably due to high non fiction or reality shows. The ad revenues were down compared to last year because of the new rule of only 12 minutes of ad compared to 16 minutes before. The operating margins for the quarter were around 52%. The company is showing signs of a matured company with no more avenues for growth. We will continue to see an average growth of 10% or below. Company says that the drop in ad revenues are due to the change in number of minutes and they have managed to increase the ad revenues by 17% compared to September quarter and this would help them stabilize the ad revenues going forward. IPL losses will continue for another 2 or 3 years at least as per my understanding. With this kind of growth expectation, this business does not deserve the current valuation.
As I mentioned before, I am not comfortable with the corporate governance of this company with the aircraft buying episode. Also in the quarterly communicated, the company only selectively picked the growth and reported only good news. Subscription revenue is compared year on year whereas advertising revenue is compared quarter on quarter. We will exit this business as and when the prices go high as before.
Engineers India (Grade C):
Only standalone numbers have been made available. Top line continues to declined by 31% due to reduced contribution from the Turnkey Projects which fell by around 57% while the consulting and engineering segment was flattish. Now, Consulting and Engineering projects contribute to 67% of the revenue with the remaining coming from Turnkey projects.
Operating profit declined by 25% due to de-growth in turnkey projects. Operating margins were at 22.85% in this quarter compared to 21.2% last year due to higher contribution from consulting and engineering segment. Net profit however remained flattish due to higher contribution from other income which almost doubled from last year.
In summary, this business continues to have de-growth while the cash reserve is providing the cushion to maintain flat profits. This is likely to be the case until the capital investment cycle kicks again.
I will be looking for opportunities to exit this business. As of now we will continue to hold as the bad news is already priced in and there are no other exciting alternatives currently available.
Swaraj India (Grade B):
Revenues and operating income grew by around 20% and the operating margins remained steady at 13%. Net profit growth was lower at 13% due to higher tax outgo and one time expense item which was laying feeder line for sub station as charged by the state electricity board for better power. Even with this one time charge the growth has been impressive.
Tractor sales volumes are dependent on monsoons and interest rates. Right now the going is good but the future purely depends on the monsoons.
Ajanta Pharma (Grade A):
Business continues to do well with export contributing now 65% of the revenue. Revenue growth continued to be impressive at 31% and the profit growth was at 95% which is awesome. Growth has been achieved with margin expansion from 14% to 21% currently. Domestic market growth was at an impressive 38% and overseas growth was t 24%.
Company is currently ranked 40th in Indian Pharma Market. 8 new products were launched in the current quarter taking the total products launched in financial year to 19.
Emerging Markets growth continued at 26%. 4 ANDAs have been filed in US this quarter taking the total filed this year to 8. Company now has a total of 22 ANDAs out of which 2 are approved. R&D expenses were at 5% of sales which augurs well for future growth.
Company is in the process of setting up two more manufacturing facilities, one for regulated markets and the other for India and emerging markets.
While these growth rates are very high and may not be sustainable, this business continues to impress and I have high hopes on this business as a long time performer.
VST Tiller (Grade A):
Great run continues for this business. Revenues grew by 30% and earned around 160 Cr for the quarter. Operating profits grew around 60% due to better margins and was at 29.73 Cr. Operating margins were at 18.5% which is impressive. This suggests that there has been more contribution from tractor business in this quarter. They sold 2172 tractors against 1415 last year (> 50% growth in volumes). Tillers sales volumes were at 6427 against 5505 last year (about 16% growth). So, the volume growth has been impressive as expected. Net profits were at 21.5 Cr and grew by 67% compared to last year due to higher other income and lower tax payments.
Overall it is a very impressive performance with more contribution from tractor segment in my opinion. It is expected that when the monsoons are good agri equipment will do good. However there is no guarantee that this good performance will continue. We would like to keep this kind of industry exposure at a max of 3% of the portfolio. The valuations are not bad yet even after the price improvement. We may lighten up this a bit to keep the portfolio exposure under control.
HMVL (Grade A):
Total Revenues were up 18% supported by 16% increase in advertising revenues and 18% increase in subscription revenues. Total revenues was at 199Cr. Profit after tax grew by 38% and earned 28.8 Cr due to economies of scale and other income contribution. EBIT margins improved from 18% to 21% and the net margins 17% to 20% which is impressive.
As per the company presentation, based on the IRS readership survey results Hindustan is the second largest hindi newspaper. While on all India level their readership has increased smartly led by phenomenal growth in UP, their circulation came down in Bihar, Jharkand and Delhi. May be the entry of DB Corp into Bihar and Jharkand is having negative effect. However, the company has mentioned that Patna market they increased by around 45% in terms of readership. Overall they are still growing and have more growth left in them.
Company continue to maintain its cash hoard and have not given any dividend.
Company is pursuing both organic and inorganic opportunity and they want to maintain the cash hoard for the same. From what I gauged in the conference call, street is concerned about the cash on books and what the management will do with it. Hope some clarity emerges soon.
Indag Rubber (Grade C):
Revenues were flat compared to last year. Operating profit improved slightly due to lower raw material cost. Net profit was slightly higher due to higher other income. Profitability growth was at 6%. Given the state of economy, it seems to be okay.
Business growth is directly tied with the auto growth as their customer are commercial transport operators mostly. We continue to hold this business due to valuation and operational efficiency. The business continues to operate in a highly competitive industry with no moats. We may exit this business, if the valuation get too high or the business fundamentals deteriorate. As of now, it looks great from valuation perspective even though the growth has been muted.
Dhanuka Agritech (Grade A):
Business revenues grew by 19% and stood at 167Cr. Operating profit improved by 62% compared to last year and stood at 23.71 Cr. Profit after tax grew by 82% and stood at 21.27 Cr aided by higher other income and lower taxes. Last quarter there were higher taxes paid and hence the lower taxes this quarter.
Current Operating margins are at 14.19% compared to 10.42% last year which shows they had better realization this year. Net margins are at 12.7% compared to 8.4% last year due to lower tax payments and higher other income. Overall this business had a great quarter due to better monsoons which is good.
Suprajit Engineering (Grade A):
Business revenue grew by 25% and operating profit growth was higher at 35% due to higher operating margins. Net profit growth was at 25% due to higher tax payments. This growth is very impressive and seems to be too high given that auto industries continue to be slow. It may be due to inventory build up by the auto companies and get normalized the next quarter which remains to be seen.
On the long run performance of the business is tied to the performance of the auto industry in general.
HDFC Bank (Grade A):
Total income grew by 17.8%. Net interest income grew by 16.4% and net interest margin was at 4.3% which is very good given the economic status. Other income which is non interest income grew by 11.4% which is great. Net profit increased by around 25% due to lower provisions.
Total deposits grew by 22.9% including FCNR deposits due to the good FCNR growth as approved by RBI. Including this the CASA ratio was at 43%. With regards to lending retail lending grew at 13.6% and wholesale by 22% which is good.
Gross NPAs were at 1% and net NPAs were at 0.3% which is comfortable. Total restructured loans were at 0.2% of gross advances.
Going forward the growth could be in the range of 15 to 20% in my opinion depending on the competition and economic growth.
NMDC (Grade A):
Business had a decent recovery this quarter. Revenues and operating margins increased by 37% compared to last year. Operating margins remained stable. Net income grew by 21% due to lower other income and higher tax outgo. Company had increased the prices of fines by Rs. 100 per MT which is good. Exports have more than doubled in volume terms on 9 month basis and that has increased the selling expenses due to freight. However, the margins have been maintained well. Company has returned Rs5.50 as second interim dividend and the total interim dividend for the year now stands at Rs 8.5% which translates to around 6% on current valuation.
Overall given that the realization have been better than last year in a tight economic scenario, and company paying back its cash horde as dividend, we will hold this for some more time.
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