Ricoh India Ltd
The first on my list would be Ricoh India, not only its trading below net current asset value but it also exhibits high ROIC and in the past has shown signinifcant amount of growth in sales and earnings without deteriorating the incremental return on invested capital, though this growth has been achieved largely becoz of its merger with Gestetner India in 2004. I havent studied the competitive landscape in much detail but it seems that it has abt 30% market share after Xerox and Canon in India. It has held a strong presence in the Government and commerical segments.
Free Cash Flow = EBIT+depreciation-Capex = 298mn
Return On Invested Capital = FCF/(Net Working Capital +PPE) = 36%
Market Cap= 555 mn (zero Debt)
Net Current Assets = 696 Mn
The Stock is trading at a signinficant disocunt to the NCAV of abt 21% whereas the rest of the PPE and the earning power of the business is available for free. Now thats wat I call a pure graham type bargain.
Friday, February 13, 2009
Saturday, November 22, 2008
Credit default swaps in India
Credit default swaps, a financial intrument which insures creditors against default on loans owed by them is likely to be introduced next year. A credit default swap (CDS) is essentially a financial instrument that allows a bank or a financial institution to insure a loan or a debt investment it has made by paying periodic fees to another institution called a protection seller, which is willing to take the risk.The CDS seller, in turn, guarantees to pay the buyer a pre-determined amount if the company that has borrowed money defaults on repayment.
Worlds largest insurance company was in trouble bcoz of these instruments.it had sold CDS worth $440 billion on subprime and other securitised financial papers. Once the subprime borrowers started to default on their loans, investors who had invested in these securitised loans found their securities turn wothless and so they turned to CDS seller AIG to recoup their losses. AIG couldnt make good their losses, as every invstor turned up to demand their repayments at the same time.So it defaulted on $14 billion of CDS.
Worlds largest insurance company was in trouble bcoz of these instruments.it had sold CDS worth $440 billion on subprime and other securitised financial papers. Once the subprime borrowers started to default on their loans, investors who had invested in these securitised loans found their securities turn wothless and so they turned to CDS seller AIG to recoup their losses. AIG couldnt make good their losses, as every invstor turned up to demand their repayments at the same time.So it defaulted on $14 billion of CDS.
Wednesday, July 9, 2008
Myths about Branding
Often people misconstrue brands as a form of competitive advantage but this is not true. Firstly,What is competitive advantage? it means that it allows an incumbent firm to do what its competitors are not able to do or it deters them from emulating the incumbent firms strategy.it is an effective barrier to entry.So, basically barriers to entry and competitive advantage are the same thing. Only incumbent competitive advantage has value and not entrant competitive advantage bcoz entrant competitive advantage implies absence of barriers to entry for the incumbent firm. By definition, a successful entrant becomes an incumbent and then is vulnerable to the next entrant and the process continues with the every new entrant replacing the previous incumbent and this implies that are no competitive advantages neither for the incumbent nor for the entrants.
Now lets consider brands which are often mistaken to be a source of competitive advantage. Branding is like any other asset of a company which requires investment in form of marketing and advertising. By branding a firm can only make its presence felt in the market. It is an important asset of the company and cant be taken in a a loose manner but at the same time it doesnt deserve so much hype it gets compared to other assets. Its just an important asset of the company and by itself it will not drive excellent returns for the business. It wouldnt protect a lousy business. A competitive advantage is something which enables a business to earn high return on invested capital and keeps the rival at bay. It enables it to take away a disproportionate share of the market. A high return on invested capital and a disproportionate share of the market is a tell-tale sign of presence of competitive advantages or barriers to entry. Not many branded products show high returns and dominate their markets. they might show high returns in the short-run but not in the lon-run
It is not branding per se which drives the returns of the business but economies of scale with high customer captivity. Most of the branded products are in a market called monopolistic competitive market where in the long-run they dont tend to be highly profitable because there arent any effective barriers to entry. A monopolistic competitive market is defined as the one where there are large no of firms selling similar but differentiate products which means that the products sold by different firms are close but not perfect substitutes of each other
For example : soft-drink market,apparel market and various other brand oriented markets. Theoretically, in the long run in a monopolistic competitive market firms are not highly profitable and their profitablity tend towards zero.
For instance, consider the soft-drink market where there are a number of brands which differ slightly from each other in terms of taste and to some extent in color. In a study of demand for colas which used a simulated shopping experiment to determine how the market share of a Royal crown and Coca-cola changes in response to its price. In other words how elastic is the demand for a brand.
It was found that Royal crown is much less price elastic than coke i.e its demand is not much reponsive to price increases. The study seems to suggest that consumers are more loyal to royal crown and it has more brand loyaly than coke. But even because of higher brand loyalty it is not more profitable than coke. Profits depend on fixed costs and volume, as well as price. Coke will generate more profit beacause it has a much larger of market. Its the economies of scale which enables coke to spend heavily on advertising,marketing and distribution and this practice over a long period of brand reinforces the brand and keeps new brands at bay. Competitive advantages are supposed to protect profits and brand loyalty doesnt pass on that terms. Its the inherent characteristic or nature of the product which makes the customer more loyal to it than brands. people in america are habituated to coke and that is because of the first-mover advantage for the coke and the scale which enables it to sells at such a low price- the price difference between coke and any other brand is few cents and that prevents its consumer from switching to alternate brands just for price difference of a few cents.
Being a first mover in the market is more important thand brands.
At the end of the day brands are just necessary cost of doing business and making a presence in the market , nothing more and nothing less.
Now lets consider brands which are often mistaken to be a source of competitive advantage. Branding is like any other asset of a company which requires investment in form of marketing and advertising. By branding a firm can only make its presence felt in the market. It is an important asset of the company and cant be taken in a a loose manner but at the same time it doesnt deserve so much hype it gets compared to other assets. Its just an important asset of the company and by itself it will not drive excellent returns for the business. It wouldnt protect a lousy business. A competitive advantage is something which enables a business to earn high return on invested capital and keeps the rival at bay. It enables it to take away a disproportionate share of the market. A high return on invested capital and a disproportionate share of the market is a tell-tale sign of presence of competitive advantages or barriers to entry. Not many branded products show high returns and dominate their markets. they might show high returns in the short-run but not in the lon-run
It is not branding per se which drives the returns of the business but economies of scale with high customer captivity. Most of the branded products are in a market called monopolistic competitive market where in the long-run they dont tend to be highly profitable because there arent any effective barriers to entry. A monopolistic competitive market is defined as the one where there are large no of firms selling similar but differentiate products which means that the products sold by different firms are close but not perfect substitutes of each other
For example : soft-drink market,apparel market and various other brand oriented markets. Theoretically, in the long run in a monopolistic competitive market firms are not highly profitable and their profitablity tend towards zero.
For instance, consider the soft-drink market where there are a number of brands which differ slightly from each other in terms of taste and to some extent in color. In a study of demand for colas which used a simulated shopping experiment to determine how the market share of a Royal crown and Coca-cola changes in response to its price. In other words how elastic is the demand for a brand.
It was found that Royal crown is much less price elastic than coke i.e its demand is not much reponsive to price increases. The study seems to suggest that consumers are more loyal to royal crown and it has more brand loyaly than coke. But even because of higher brand loyalty it is not more profitable than coke. Profits depend on fixed costs and volume, as well as price. Coke will generate more profit beacause it has a much larger of market. Its the economies of scale which enables coke to spend heavily on advertising,marketing and distribution and this practice over a long period of brand reinforces the brand and keeps new brands at bay. Competitive advantages are supposed to protect profits and brand loyalty doesnt pass on that terms. Its the inherent characteristic or nature of the product which makes the customer more loyal to it than brands. people in america are habituated to coke and that is because of the first-mover advantage for the coke and the scale which enables it to sells at such a low price- the price difference between coke and any other brand is few cents and that prevents its consumer from switching to alternate brands just for price difference of a few cents.
Being a first mover in the market is more important thand brands.
At the end of the day brands are just necessary cost of doing business and making a presence in the market , nothing more and nothing less.
Thursday, May 8, 2008
Complexity of the CDOs Demystified
In early April the megabillionaire Warren Buffett hosted 150 students from the University of Pennsylvania's Wharton School and offered to have a Q&A session with him. One of the students asked the following question related to CDOs and the answer to it by Mr. Buffett really clarified the complexity and the blunder of the CDOs.
here is one of the excerpts from his question-and-answer session with the students.
Do you find it striking that banks keep looking into their investments and not knowing what they have?
I read a few prospectuses for residential-mortgage-backed securities - mortgages, thousands of mortgages backing them, and then those all tranched into maybe 30 slices. You create a CDO by taking one of the lower tranches of that one and 50 others like it. Now if you're going to understand that CDO, you've got 50-times-300 pages to read, it's 15,000. If you take one of the lower tranches of the CDO and take 50 of those and create a CDO squared, you're now up to 750,000 pages to read to understand one security. I mean, it can't be done. When you start buying tranches of other instruments, nobody knows what the hell they're doing. It's ridiculous. And of course, you took a lower tranche of a mortgage-backed security and did 100 of those and thought you were diversifying risk. Hell, they're all subject to the same thing. I mean, it may be a little different whether they're in California or Nebraska, but the idea that this is uncorrelated risk and therefore you can take the CDO and call the top 50% of it super-senior - it isn't super-senior or anything. It's a bunch of juniors all put together. And the juniors all correlate.
Direct Link to the Q&A session
here is one of the excerpts from his question-and-answer session with the students.
Do you find it striking that banks keep looking into their investments and not knowing what they have?
I read a few prospectuses for residential-mortgage-backed securities - mortgages, thousands of mortgages backing them, and then those all tranched into maybe 30 slices. You create a CDO by taking one of the lower tranches of that one and 50 others like it. Now if you're going to understand that CDO, you've got 50-times-300 pages to read, it's 15,000. If you take one of the lower tranches of the CDO and take 50 of those and create a CDO squared, you're now up to 750,000 pages to read to understand one security. I mean, it can't be done. When you start buying tranches of other instruments, nobody knows what the hell they're doing. It's ridiculous. And of course, you took a lower tranche of a mortgage-backed security and did 100 of those and thought you were diversifying risk. Hell, they're all subject to the same thing. I mean, it may be a little different whether they're in California or Nebraska, but the idea that this is uncorrelated risk and therefore you can take the CDO and call the top 50% of it super-senior - it isn't super-senior or anything. It's a bunch of juniors all put together. And the juniors all correlate.
Direct Link to the Q&A session
Charlie Munger's Wesco Financial Corp. (WSC) Annual Shareholders meeting on Wed, May 07, 2008 in Pasadena, California
Charles Munger, Vice Chairman of Berkshire Hathaway will host Wesco Financial Corp. (WSC) Annual Shareholders meeting on Wed, May 07, 2008 in Pasadena, California. Charlie is the Chairman, Chief Exec. Officer and President of Wesco, which is 80% owned by Berkshire Hathaway.
Charlie himself is very intelligent businessman and investor just as smart as Warren Buffett.
Link to some of the quotes by Charlie Munger
Charlie himself is very intelligent businessman and investor just as smart as Warren Buffett.
Link to some of the quotes by Charlie Munger
Notes from Berkshire Hathaway Annual Meeting 2008
Berkshire Hathaway Annual Meeting, Omaha NE 2008
May 3, 2008
Typewritten notes courtesy of Peter Boodell(As is standard, no recording equipment was used to reproduce these notes. As a result, these notes are recollections only – not quotes, and should not be relied upon. –PB)
Link to the Annual Meeting notes
May 3, 2008
Typewritten notes courtesy of Peter Boodell(As is standard, no recording equipment was used to reproduce these notes. As a result, these notes are recollections only – not quotes, and should not be relied upon. –PB)
Link to the Annual Meeting notes
Friday, May 2, 2008
ABC Bearings
Market Value: 11.5 million shares outstanding*86= 989 million
Industry: Bearings
Performance: Underperformed sensex by 18% for last one yr
Dividend yield: 4/86 = 4.6%
Institutional Ownership: Virtually No MF Holding
p/e ratio: 86/17=5 (seems cheap)
Price/Book value: 86/50=1.7 (moderate)
Enterprise Value=989 million+384 million= 1.373 billion
ABC Bearings is a 1.73 billion Rs Company and is one of the oldest bearing manufacturing companies in India. It is one of the leading players in tapered roller bearings.
ABC bearings was established in 1960 with Steyr Diamler Puch, Austria. It has three plants, two in Gujarat and one in maharashtra where it primarily manufactures taper and cylindrical roller bearings with an installed capacity of 6.5 mn pieces. The company has a focus on taper and cylindrical roller bearings which caters to most of the domestic HCV, LCV and tractors OEMs. Its major domestic clients include Tata Motors, Mahindra & Mahindra, Ashok Leyland, Escorts, Greaves, Bajaj Tempo and Swaraj Mazda, Toyota Kirloskar.
Industry Overview
Bearings are components used to reduce or eliminate friction between moving parts, which minimises wear and tear of machines and improves machine performance. There are two types of bearings, ball bearings and roller bearings. Roller bearings are of different types such as tapered roller bearing (TRB), spherical roller bearing (SRB), cylindrical roller bearing (CRB), and needle roller bearings (NRB), which have high end applications in commercial vehicles, tractors, railways, heavy engineering and industrial gears. Ball bearings, on the other hand, are used for simple purposes such as in fans and two wheelers.
SKF, NBC,FAG,ABC,NRB and Timken are the major domestic bearing manufacturers. In the organized segment, SKF is the leader with a market share of around 26 to 30% and ABC has a market share of only 8%. However it one of the top players in the TRB segment along with SKF
The Company might have a very small market share of the overall bearings industry but it is the largest tapered and cylindrical roller bearings manufacturer which are used in the automobile industry. It concentrates on its niche business of manufacturing tapered and cylindrical roller bearings for the automobile sector. The company focuses in a niche market where it is the largest and therefore can spread its fixed costs across a large number of output and enables it to be one of the lowest cost producer alongwith SKF India. I believe they might be forming a duopoly in this market without getting into a price war. However a matter of concern for both the players in the last five years has been a sharp rise in one of their main raw materials i.e. steel. But because of being the lowest cost producer and strong financials I believe that both the companies can withstand this cost pressure. During the past five yrs despite of the increasing raw material prices the company has continued to exhibit steady operating margins. The business doesn’t have any pricing power and it is evident from the fact during the last decade the business has not been able to increase their sales at the same pace as that of their raw material prices.
ABC has doubled its revenues from INR 954 mn in FY04 to INR 1.82 bn in FY07, solely on the basis of improving capacity utilization. In 2005, the company shut down its plant in Lonavala and consolidated operations at its Baruch plant andalso reduced its workforce from 1,200 to 350. The efficiencies arising out of these moves have helped it
improve EBITDA margin from 18.8% in FY04 to 23.6% in FY07. As a result despite of the increasing raw material prices they have been able to increase their EBITDA margin.
Valuation
At current market price the business trades at 5 times earnings which is a 16% earnings yield which is twice the expected earnings yield of the bse sensex. And also the company has been generating high return on incremental invested capital which is an indication of good capital allocation. The five yr average return on invested capital is 37% and five yr average return on incremental capital is 59%. In Mr. Buffet’s words it creates 5 rs of value for every 1 rupee invested.
Earnings Power
The value of a debt free company has to be substantially more than the amount of debt it can comfortably service. It's a principle which was first laid out by Ben Graham in Security Analysis. However the above company is not debt free and therefore to estimate its intrinsic value debt should be deducted from the earnings power value.
For this case I came up with an intrinsic value of rs 125.
I did not incorporate the growth factor in my estimate of the intrinsic value because I am not confident enough about the competitive scenario of the tapered and cylindrical roller bearings industry and will need to dig further to learn about it.
Industry: Bearings
Performance: Underperformed sensex by 18% for last one yr
Dividend yield: 4/86 = 4.6%
Institutional Ownership: Virtually No MF Holding
p/e ratio: 86/17=5 (seems cheap)
Price/Book value: 86/50=1.7 (moderate)
Enterprise Value=989 million+384 million= 1.373 billion
ABC Bearings is a 1.73 billion Rs Company and is one of the oldest bearing manufacturing companies in India. It is one of the leading players in tapered roller bearings.
ABC bearings was established in 1960 with Steyr Diamler Puch, Austria. It has three plants, two in Gujarat and one in maharashtra where it primarily manufactures taper and cylindrical roller bearings with an installed capacity of 6.5 mn pieces. The company has a focus on taper and cylindrical roller bearings which caters to most of the domestic HCV, LCV and tractors OEMs. Its major domestic clients include Tata Motors, Mahindra & Mahindra, Ashok Leyland, Escorts, Greaves, Bajaj Tempo and Swaraj Mazda, Toyota Kirloskar.
Industry Overview
Bearings are components used to reduce or eliminate friction between moving parts, which minimises wear and tear of machines and improves machine performance. There are two types of bearings, ball bearings and roller bearings. Roller bearings are of different types such as tapered roller bearing (TRB), spherical roller bearing (SRB), cylindrical roller bearing (CRB), and needle roller bearings (NRB), which have high end applications in commercial vehicles, tractors, railways, heavy engineering and industrial gears. Ball bearings, on the other hand, are used for simple purposes such as in fans and two wheelers.
SKF, NBC,FAG,ABC,NRB and Timken are the major domestic bearing manufacturers. In the organized segment, SKF is the leader with a market share of around 26 to 30% and ABC has a market share of only 8%. However it one of the top players in the TRB segment along with SKF
The Company might have a very small market share of the overall bearings industry but it is the largest tapered and cylindrical roller bearings manufacturer which are used in the automobile industry. It concentrates on its niche business of manufacturing tapered and cylindrical roller bearings for the automobile sector. The company focuses in a niche market where it is the largest and therefore can spread its fixed costs across a large number of output and enables it to be one of the lowest cost producer alongwith SKF India. I believe they might be forming a duopoly in this market without getting into a price war. However a matter of concern for both the players in the last five years has been a sharp rise in one of their main raw materials i.e. steel. But because of being the lowest cost producer and strong financials I believe that both the companies can withstand this cost pressure. During the past five yrs despite of the increasing raw material prices the company has continued to exhibit steady operating margins. The business doesn’t have any pricing power and it is evident from the fact during the last decade the business has not been able to increase their sales at the same pace as that of their raw material prices.
ABC has doubled its revenues from INR 954 mn in FY04 to INR 1.82 bn in FY07, solely on the basis of improving capacity utilization. In 2005, the company shut down its plant in Lonavala and consolidated operations at its Baruch plant andalso reduced its workforce from 1,200 to 350. The efficiencies arising out of these moves have helped it
improve EBITDA margin from 18.8% in FY04 to 23.6% in FY07. As a result despite of the increasing raw material prices they have been able to increase their EBITDA margin.
Valuation
At current market price the business trades at 5 times earnings which is a 16% earnings yield which is twice the expected earnings yield of the bse sensex. And also the company has been generating high return on incremental invested capital which is an indication of good capital allocation. The five yr average return on invested capital is 37% and five yr average return on incremental capital is 59%. In Mr. Buffet’s words it creates 5 rs of value for every 1 rupee invested.
Earnings Power
The value of a debt free company has to be substantially more than the amount of debt it can comfortably service. It's a principle which was first laid out by Ben Graham in Security Analysis. However the above company is not debt free and therefore to estimate its intrinsic value debt should be deducted from the earnings power value.
For this case I came up with an intrinsic value of rs 125.
I did not incorporate the growth factor in my estimate of the intrinsic value because I am not confident enough about the competitive scenario of the tapered and cylindrical roller bearings industry and will need to dig further to learn about it.
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