L&T Finance IPO: Why did I not invest?

L&T Finance IPO talks picked up steam lately. Everyone appear to be interested in the gold company primarily for its brand value. But should brand value be the only criterion while making an investment decision in such a jittery market? 

L&T Finance is a holding company. Their corporate structure as given in the offer document is thus.

I generally prefer not to venture into holding companies for it is N times difficult to assess what is going on in reality than a single company. Chances of false reporting (after aSatyam saga we all should give such things a serious thought) are very high in case of holding companies. 

Secondly, they are planning to use a portion of thus generated capital to pay off their debt. To me this is not a very good use of capital. In the offer document they have declared the proceeds will be used to pay off parent company's debt in the ratio as displayed in the left image. The debt is eating away only 9% and if L&T Finance is using the share capital to pay off debt, it is almost sure that they don't have a very good hope on profit generation.

Thirdly, as per my raw calculations, this IPO is little over-priced and retail investors may not get even the listing day gains. The Diluted EPS for 2011 was Rs. 2.83, and for 2010 it was Rs. 2.17. It was a negative of Rs. 0.05 in 2009. At the EPS of Rs. 2.83, and the higher range of Rs. 60, the P/E multiple comes out to be about 21.2, which I think is not too rich, but not cheap either. Especially so because their own prospectus lists down their competitors and their respective P/E ratios on the closing price of July 1 2011, and basic EPS of 2011. On the similar notes its P/B ratio too is not very encouraging to me at the given price band.

However, in the group of NBFCs, L&T Finance is still a better bet for longer term investment horizon. Currently my focus is little too short term, thus I have decided to vary of subscribing for this IPO for the time being. I will keep an eye on it on the listing day and buy up then on discount.

Investment buckets

I have been discussing my investment objectives in my various posts. Here in this post I am going to jot down a high level plan to meet my investment goals.

I have divided my total savings into four chunks majorly.

1> Bond Fund Chunk: This contains 30% of my total investment. I keep this fund in safe heaven such as AAA rating FDs, NSCs and PPF (yes I consider PPF a very good investment vehicle). In this bit of my investment planning, I am allocating money for my short term needs such as my education etc. I am happy with 8%-9% growth in this investment chunk.

2> Opportunity Fund: This is the most liquid part of my income portfolio and never exceeds 10% cap. I keep it in my savings account and use it to take advantage of news based sentiments. ICICI buying BOR, petrol prices etc. Since I am not a regular follower of complex news items, this part of the portfolio remains cash most of the time.

3> Medium to Long term Equity fund: This contains 30% of my investment capacity. I allocate this capital for various equity linked avenues. A part in Mutual Funds and a part in stocks. Here I choose companies which have good management and have wonderful business concept/moat and are to grow for sure. I consider Moser Baer, ABCIL in such category.

4> Dividend chunk fund: This consists my rest 30% investment chunk. Here in this part of the portfolio I would rather invest in a company that gives good dividends. My aim from this pocket of investment is to have capital appreciation and maintain a regular flow of income in terms of dividends.

Having said all this, I shall deliberate more on what to vehicle to choose for each investment chunk in further posts.

The Intelligent Investor: The Bible

Had reread the bible the first day of Diwali vacation. Cannot agree more with 'the Graham'; the basic principles he laid 50-60 years ago are so true even today.

I have extracted following main points from the book.

1. Beware of companies which are always interested in other people's money. They can be easily noticed by their acts of continuously diluting equity, issuing warrants, issuing convertible debentures (convertible bonds are double edged sword, Graham says. Companies management it betting on the fact that stock prices will always go up and people will eventually convert their bonds to stocks. This expectation gives them incentive to do financial alchemy to ensure that stock prices some how carry on going up. But we all know this is not sustainable).
2. Beware of companies' which have taken more loan than the cash they can generate. Take example of Rei Agro. They pay close to 340 crore as interest payment on the debt and generate net profit 150 crore. Are they sustainable? I don't think so.
3. Always look into the net profit and operating cash flow. Net profit should never be more than the operating cash flow. If a company continuously show such relation, beware!
4. A combination of high entry cost and good margin makes the company out smart the competition easily. TTK Prestige is an example from my kitty. No road side company can breach the brand Prestige easily.

Coal India: IPO analysis

Coal India has come up with the biggest ever IPO in the Indian Stock market history. Government, however, is being greedy these days and further offers of PowerGrid, Shipping Corp. of India, ONGC, IOC are coming. It is interesting to understand where is the money in the market for these issues. Anyway coming back to Coal India.

Summary:

As per research by CRISIL, CIL is world largest coal producer and largest reserve holder. India is world's third largest coal producer and consumer. CIL met close to 82% of coal demand in India; In India power generated from coal was 52% of total power (FY2009). Apart from power generation, coal is heavily used in cement and steel plants.


Negatives:

1. Coal India is a holding company and its results and profitability is dependent upon  its subsidiaries.
2. GOI is selling its stock. Gains from this offer will not be part of Coal India company.
3. The current state of transportation available will not help even if Coal India could increase its production. 
4. Coal India may (and probably will) face problems in land acquisitions. It also has mandate to share 26% of its profits with the affected people.
5. India is a power hungry country; still many NGOs have been working relentlessly against such power plants, and their efforts may result in Coal India's loss.Greenpeace is already on to this link.
6. Estimation of coal reserves is pretty much subjective process and could be incorrect.
7. Coal India sells its coal below international price (although coal has been deregulated since 2000)
8. Much of its assets are located in politically unstable areas.
9. Finding further coal fields has risks of not finding, not enough coal finding, and not finding a good grade coal.
10. Illegal mining.

Positives:

1. Largest coal producer and largest reserve holder. Apart from this, there is enough unmet demand in India.
2. Strong and stable financial track record.
3. Has started ERP implementation. For company of such a scale, ERP implementation will pay dividends in long term.
4. Focused on increasing resources by venturing into outside India.

Castrol India: A little analysis on dividend

To start with I have calculated Castrol India's dividend yield from last 10 years dividend data on the basis of current stock price. Now I will try to fit a regression line (using TREND function from MS Excel) and find out from which year I will start beating the risk free return of 7.5% of FDs.

My aim from this analysis is to understand if Castrol India will be a good investment choice for my dividend portfolio at current price.

So what is my conclusion?

I will wait for Castrol India a bit. I think I should achieve my dividend target of > 7.5% way before 2020.

Five good equity diversified funds for analysis

All the numbers have been picked up from valueresearchonline.com

So what is my conclusion today?
ICICI Prudential has historically performed better than the other three 5 star funds.
SBI Magnm contra was a good fund, but it is sliding down slightly
Reliance growth is a good fund but has high volatility

How to choose a good mutual fund

One line answer: select any 5 star or 4 star fund from www.valueresearchonline.com.

Long answer: look at the track record of various mutual funds, monitor how have they performed over the period of time and how the performance has been lately. Check out couple of ratios and bingo!

Let's take HDFC Top 200 (this is my personal favourite fund) : (All these screen shots are from valueresearchonline.com)

I have highlighted the important aspects:

1. It is 5 star fund
2. Its return grade is high and risk grade is below average
3. Trailing returns for 1 year is 32%, for 3 years (compounded annually) is 17.30 (due to 2008-09), for 5 years it is 26.67 (stupendous) and from launch it has been 26.71 (fantastically stupendous).

Now if we go to Performance tab the scene is as following:

This image has couple of important points. Fund returns with respect to category return, with respect to Nifty and with respect to Sensex.

There are other ratios:

1. R-Squared ratio: is the statistical measure of how well an approximation (regression) line matches with the real data points. It is an analysis of the deviation from the benchmark. For equity funds, the benchmark is Nifty or Sensex. This ratio varies from 0 to 1. 0 says there is no correlation while 1 says there is 100% correlation. This mutual fund's R Squared is .96, which means it is closely tied to the fluctuations/returns in the Sensex.
2. Alpha ratio: tells how better a security has been against the bench mark. Alpha of 9.41 says that this mutual fund has been outperforming the benchmark Sensex by 9.41%.
3. Beta ratio: talks about the volatility of a security as compared to the benchmark. If the beta value is more than 1, the NAV of that fund will fluctuate more than the benchmark. If the beta is 1, it will go along with Sensex. If the beta value is less than 1, it means the security is not much volatile and safe. This fund comes into this category.
4. Standard deviation: is another measure of volatility in the fund. It is calculated on the historical annual rate of return data. It is a measure of how the funds performance deviates from the average performance over a period. A low standard deviation is better. This fund apparantly has it little higher side, but this is due the recession (and jump back after that) effect.
5. Sharpe ratio: is one of the most important ratios for risk analysis of a fund. This ratio also throws light on the fact that the fund's performance was just a fluke or due to a smart fund manager. Sharpe ratio gives a sense of returns from a fund over the risk less return per unit of risk. Risk here is the standard deviation. The higher Sharpe ratio, the better it is. But it all alone doesn't guarantee any information. It is calculated as ((expected return - risk free return)/standard deviation). If the standard deviation is very low (for liquid funds) the Sharpe ratio could come very high but that doesn't guarantee higher returns.

Other tabs are self explanatory and can be easily understood.
In the next post I shall provide a list of 2010's good equity mutual funds and their ratio analysis.

So what is my conclusion here?
Always look at the risk side of your investments. Don't distribute your hard earned money to agents.

Disclaimer: I am not advocating anyone to buy HDFC Top 200. This is my personal faviourite mutual fund. I have selected it based on my risk profile and objectives from investing.