Friday, 29 January 2021

Nitta Gelatin India Ltd: Can be the next Wellness story

Nitta Gelatin India Ltd (NGIL): Just sharing a short note on this one. NGIL is a joint venture between Kerala State Industrial Development Corporation (31.5% shareholding) and Nitta Gelatin Group Japan (43%). It deals in Gelatin and Collagen products. Gelatin is an industrial product and is used for making capsules, food and cosmetic industry while collagen is a nutritional product. Animal bones, skin and tissues etc. are the raw materials for extracting Collagen. Gelatin is obtained from Collagen after undergoing industrial processes like heating. Collagen is the most important and abundant structural protein in our bodies comprising some 30% of the total protein mass of our bodies. Collagen is the most important protein found in connective tissues, skin, joints, bones, teeth and it is responsible for providing structure and strength to our bodies and healing wounds. It is the one which keeps our skin healthy and elastic and in its deficiency skin becomes dry and dull losing its elasticity and freshness. It is just like a glue which holds our bodies together.

Stock: Nitta Gelatin India

Financial Performance

(Fig. In  Cr)

 

 

(Amt)

Description

Half Yearly upto Sep-2020

Half Yearly upto Sep-2019

FY-2019-20

CMP

173

Turnover

189

179

342

Market Value

157 cr

Net Profit

9

8.5

12.34

PE Ratio (Annualized)

9

Interest Cost

2.9

3.9

7.77

Net worth (Sep-2020)

168 cr

Total Debt

70

 

76

Dividend Yield

1.45%

 

 

 

 

 NGIL is a dominant player in Indian gelatin industry and in the past it has faced pollution related issues for long time causing closure of its plants for long time hurting growth and finances. But that is now gone and it is focusing on growth and has shown great performance in last 2 years after the restart of its business. It exports some 40-50% of its turnover in quality conscious export market but this also means it is subjected to foreign exchange fluctuations but they are doing hedging etc. for the same. Demand for gelatin for industrial uses like pharma, food and cosmetics is going to be strong and grow much faster in India. After extracting gelatin from the animal bones etc. the remaining raw material is used for producing Di-Calcium Phosphate for poultry feed ingredient, NutriGold as agricultural growth promoter so nothing is gone waste and with growth in demand there is vast scope for margin improvement. But I think there is huge growth potential in collagen as nutritional product.

Across the globe, there is a huge demand for collagen as wellness product and is used widely in many health supplements related to skin and joint health. I am using collagen for long time as a supplement for joint health and advised this to many people suffering from joint pain or injuries and it has always worked wonders. Collagen is an excellent skin care product which keeps skin alive and elastic having strong anti-aging effects. As we age our bodies produce less collagen causing dryness and loss of elasticity but supplementing it in the form of collagen supplements has shown to provide anti-aging effects. Collagen/Gelatin are almost 100% proteins so these can also be used as a protein supplements (though i may not advise to use these as source of protein as these may be costlier than other cheaper sources of protein like eggs/Chicken).

These days awareness about nutritional and wellness products is growing across the world and India is not behind. The same has picked up further pace after the onslaught of covid as people are realizing the importance of strong immunity and health. Collagen is being hailed as next nutritional wonder and its use in health and wellness products is growing fast. There are even researches which have shown the benefit of collagen in fighting against covid.

NGIL is already operating in collagen wellness industry and is selling collagen supplements with brand name “Gelixer”. The same is available online (Amazon) and I am using it. One friend who was having joint pain due to old knee injury has used it and his pain has gone away. So I think this is a huge opportunity for Nitta and it has everything in it to benefit and extract a larger market share. It will be great if they can do some marketing for this as Indians are not aware of this. I think with better financial performance they will be having funds to deploy for the marketing etc. Nitta Inc. Japan is already selling Gelixer worldwide so their experience and approach will help in making Gelixer a success in India. Still, Collagen is different from Gelatin and do not have industrial uses so its demand dynamics are related to its acceptance as wellness product in Indian market. These days we can see many National/MNC advertising their nutritional and wellness products like protein supplements and Multi-vitamins on TV so i think Collagen will definitely find a place in Indian market. In any case, NGIL will be supplying collagen to other Indian brands which will provide another strong growth avenue till they make Gelixer brand a success in India.

There is quite a noise in the industry about people wanting to use vegan products and they also want their medicines/cosmetics to be vegan. So hunt is on for making Gelatin from veg sources and Agar agar is being used as vegetarian substitute for gelatin. Agar agar is a red algae (seaweed) that has natural gelling and thickening properties. But still I think veg gelatin may not be a good substitute as a nutritional product. Then cost is another factor as animal gelatin is way cheap. Further it is a good way to use dead animal bodies which otherwise may consume quite a bit of resources to dispose them off or else they will cause huge environmental damage. So I think there will be a case for animal based gelatin and vegan may take time to be a perfect substitute.

So I think at a market cap of 157 cr, PE of 9 and net worth of 168 cr, NGIL is worth taking risk. ROE is around 12% which is not bad keeping in view the plant closure troubles it has faced due to environment issues and this will rise further with future growth. It is getting the PE of a commodity player but if it can create a place for itself in the high growth nutritional and wellness sector then it will be a big re-rating candidate. I am reasonably satisfied with the management quality. Dividend yield is good at 1.5% and this may rise higher with good financial performance in the future. Still, treat this one as a risky stock (Tier 3) as most of the value accretion is dependent upon strategy and product placing in Indian market in the future. 

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your own Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. Reach me at oscillationss@yahoo.in).

  


Thursday, 28 January 2021

Business, growth and Value-The Holographic universe

Dear All, this study report is part of Monthly Newsletter of this Blog. I am sharing some samples from the report. One article I have already shared last month at this Blog. Anybody who is interested in reading the full report may please send an email at the ID of this blog: oscillationss@yahoo.in

CONTENTS

Description

Page no.

A Summary of Stock Valuation under traditional value investing

1-2

Valuation: Intrinsic or Subjective

3-6

Business, Growth and Value-The Holographic universe

7-16

Three levels in Business analysis

12-16

Stock Ideas:

 

Tata Coffee Ltd                         (CMP 110, TIER 1)

17-27

TTK Healthcare Ltd                  ( CMP 562 TIER 3)

28-33

D-Link India Ltd                        ( CMP 110 TIER 3)

34-35 

Redington India                          ( CMP 135 TIER 1)

36-39 

UTI AMC                                   (CMP 550 TIER 2)

 40-43

Mahindra EPC                            (CMP 150 TIER 3)

44-45

Sample:

A Summary of Stock Valuation under traditional value investing

Traditional value investing tries to calculate the intrinsic value of a stock/business. To calculate the same, it mainly undertake two approaches- first one is fundamental valuation where valuation is done purely on the basis of direct cash flows generated by the business and second approach is relative valuation where valuation is estimated with reference to valuation and fundamentals of peer companies. First approach mainly uses Discounted cash flows (DCF) and second one uses methods such as PE ratio or EBITDA times ratio etc.

Benjamin Graham who is regarded as father of Value investing used a formula in his famous book “Security Analysis”. This formula is widely used for calculating intrinsic value of a stock.

Let me first come to DCF- in DCF a security or a business is valued based on the present value of its expected future cash flows. Present value of future cash flows is calculated by using an appropriate discount rate. Appropriate discount rate is cost of financing or opportunity cost of any other alternative investment options available to the investor. I have seen DCF being adored by many as being superior to any other valuation methods. But I think this at the most is a good point of reference because I find this one a very confused attempt to find “intrinsic value”. First indicator of this confusion is – taking opportunity cost of the Investor (not business) as discount rate for calculating the present value of future cash flows.  DCF proposes to calculate the intrinsic value of the stock/business but then instead of taking the cost of capital of business it uses the cost of capital of the potential Investor which is not at all related to the expected future cash flows of the business. It fails to understand that just as future cash flows are related to business/stock similarly cost of capital is also directly related to the business/stock not to a third party investor. Cost of capital is a feature of business just like future cash flows.

Similar issues are with the estimation of future cash flows. Actually DCF concept is taken from the Bond valuation. Long time back, it was established that value of a bond is a function of its future cash flows discounted with a rate determined by the riskiness of the bond issuer (not the bond investor). But bonds are different from stocks/business and problems faced while valuing bonds are different from the problems related to business. Like, cash flows are CERTAIN in the case of bonds (we know the expected cash flows well in advance) but UNCERTAINTY is related to credit risk of the issuer. And this credit risk of the issuer impacts the discount rate (expected return keeping in view the credit riskiness of the issuer). So as we can see, in case of bonds the life span and expected cash flows are certain and known well in advance. The uncertainty related to credit worthiness is responsible for increase or decrease in the discount rate or expected returns.

However in the case of stocks/business UNCERTAINTY is related to future cash flows and to life span. Cash flows are highly uncertain but DCF method does not answer as to why they are uncertain. Whether their uncertainty is random? Without giving any answer, DCF just provides a solution (quite random) in the form of discount rate. But in case of bonds, the uncertainty of payment is not random but related to credit risk of the issuer and hence this risk of payment increases the expected interest rate. But uncertainty of business cash flows is more random and different hence the solution can’t be similar to bonds (Impact on discount rate). I think some other approaches like probabilistic distribution of cash flows (as the problem may be statistical) are required. (I will be taking this issue in the coming editions and will try to provide a solution).

Business, growth and Value-The Holographic universe

Once I was sitting with some of my friends. One fellow, who was a friend of one of my friend, was discussing something about aim of life. He was some sort of religious preacher and claimed to put people on right path. One friend asked him about the aim of life as my friend was really getting eager to understand something of this life process and he was greatly impressed by that fellow. The preacher fellow told them that the aim of life is to help and serve the poor needy people; people who are in grief, saddened by the troubles of life, no food no shelter. He told that this is the principle message of his religion and he made a strong emotional pitch about helping the poor people and many of my friends visualized themselves helping poor people and obviously they felt great.

But I asked him that his perceived purpose of life (to help the poor and sad) would make things very complex for the Almighty because in order to fulfill your (many more like him) purpose of life you would always need poor and miserable people so in a way you are praying for the people to be poor and saddened. For them to fulfill the purpose of their lives, they would always require poverty, pain and grief. But empathy and compassion are not the purpose but they are the manifestation of an enlightened person. Just like a Brave fellow saving the modesty of a girl; his bravery is not his purpose of life but it is the manifestation of fearlessness of his being which is one of the signs of an enlightened person. So a Brave/fearless person does not want girls to be molested in order to fulfill the purpose of his life…his bravery is just a manifestation of his being in time and space. I told the preacher fellow that he is just making a political statement but luckily enlightenment is very personal and individual and there is no such thing as collective enlightenment.

Inefficiencies of others can’t make me an efficient person…I can’t strive for the supreme by following the imperfection. Life principles are not made upon inefficient acts of others. Path to the supreme (value) is not directed by mistakes of others. Ignorant explorers can leave diamonds on road taking them as stones/glass but wise men do not follow these ignorant explorers in the hope that they will throw away more such diamonds because they know that by drawing a MAP to follow these ignorant fellows will only result in them losing the path/direction where vast quantum of valuable diamonds are trapped under earth. So they draw a MAP for places where there are Kimberlitic rocks (for diamonds)…their hunt for the VALUE is not dictated by the mistakes of foolish explorers but devising a plan for hunting the valuable gems.

Sometimes I feel, Value investing in essence tries to follow the ignorant explorers and in this quest of checking stones thrown by them it leaves some of the most valuable diamonds because it has not drawn a plan to hunt for these precious diamonds. It does need to understand that the value is not created by the mistakes of ignorant fellows but the wisdom, strategy and efficient decision making of the businessmen. So value investing is about finding the Kimberlite rocks- a business with vast scope of scale and a businessman with wisdom and vision for creating value. A true value investor looks for the kimberlite rock where diamond is not shining on the surface but it is hidden inside and rough. He knows that maximum value is created by finding these rough diamonds because a large crowd is following and looking for the final cut diamonds on the roadside which are far and few.

In its present avatar, Value investing finds stocks like ITC, ICICI bank, HCL, Dabur, Godrej Consumer or Titan in 2014-15 and these stocks have also given good returns after this period (Hindalco is a value buy for the last 15 years and ITC for the last 10 years). But this Value Investing misses stocks like Tata Elxsi (40 bagger), Avanti feeds (200 bagger), Borosil renewables (30 bagger), Biocon (15 bagger), KRBL (40 bagger), Cera (40 bagger), Garware technical (50 bagger), Info edge (15 bagger) and many more. I remember when I was buying Borosil Re (earlier Gujarat Borosil) in 2015 there was skepticism about its business plan- about the chinese import threats or no demand for solar power. But I was of the opinion that Indian solar story couldn’t happen on imports; it has to be local and solar glass is going to have regional markets (Full study of Borosil Re is at my blog). So I started buying from 10 (adjusted for Borosil consumer stocks after recent merger/demerger) and made last entry this June at 35. I sent another buy call for Borosil Re at 40 in the Blog post related to Value investing in July-2020. And it just blasted after that rising to 300 in no time.

In 2015, Borosil Re should have been discarded by Value investing because it had nothing to prove its worth against the stringent benchmarks of value investing formula. Same was the case with Tata Elxsi or Garware or Biocon. But maximum value is created by these stocks not by the generic value investing stocks. The reason is- these no metrics stocks are just like Kimberlite rock (raw diamond) which does not shine in the sunlight. Only a person with experience of ages and having an eye for details can recognize the hidden diamond in the giant rocks. So in its current Avatar value investing finds few discarded diamonds but fails to recognize the large number of rough diamonds. These rough diamonds stocks/businesses create value just like the real value is created- sheer hard work, wisdom, innovation, strategy, risk and tough decision making. Value investing thrives on the irrational choices/decisions made by the incompetent market but what if market is not irrational? What if market is not ignoring a great stock like TCS by making it trade at a PE of 10- I fear Value Investing will lost in darkened corners of the city.

Sample:

Value analysis tries to divide the whole business into various parts and by evaluating and comparing some of these parts it tries to find a figure which can be used as a representative of the “entire” business. So they grade certain parts- Price to book value, Debt-equity ratio, ROE etc. and assign a figure which they take as a “value of the business” which it is not. And in its attempt to focus on the body it misses the soul which in fact is the essence of existence and growth. Business consciousness is the essence of the existence and growth of a business; financial figures are just the physical manifestations. Physical manifestations happen in time and space but consciousness is the truth, the source which is un-manifested and unobservable by analysis. Some phenomenon can’t be comprehended by analysis or by breaking them into their finer particles. Our life and existence is one of them and comprehending business growth is another one.

Sample:

Value investing appears more like classical physics which tries to define the growth phenomenon by capturing the “molecular or Atom level motions”. But just like cosmos, business consciousness follows Holographic laws and so business growth can beat the barrier of speed of light (when Financial valuation (Value investing) tries to evaluate Growth motion by capturing the financial and other external parts). Growth is a sub-atomic phenomenon and the same can break all the physical boundaries. Business consciousness operates at sub-atomic level (through strategy, timing and risk) and is multi-dimensional. It is multi-dimensional because it is impacted/directed by Industry level, economy level and most importantly firm level (Business strategy) actions. Financial and mathematical tools are one dimensional so they are unable to capture the sub-atomic level growth motion of a business operating under a superior business consciousness. A superior business consciousness is able to outpacing competitors when Industry and economy is doing good and it withstands tough times better so it is able to capture much higher market share beating the industry level growth and that’s why growth is Multi-dimensional while financial data is one dimensional. Value investing tries to cut the business into various parts to evaluate the same but it fails to comprehend the source of all parts of business- Business consciousness.

Sample:

In my terminology there are three levels in the Value investing process.

Level 1 (Entry level/Evaluation of Financial Data and Relative valuation): This level is what our traditional value investing is all about- to capture, assess and evaluate the financial data to arrive at meaningful interpretations, inferences and relative valuation. Here, the analyst primarily is capable of finding the businesses available at relatively cheaper valuation, margin of safety where firms are trading at or below the market value of its assets (land and other assets), investments and cash. His perceived valuation gap is primarily due to these historical material aspects (not futuristic qualitative aspects). This as we can see involves simplest calculations and evaluations…level of insights and decision making involved is not very complex but very straight forward.

Level 2 ( Intermediate/Industry level Insights and forecasts):

Level 3 (Advanced/Company management decision assessment):

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your own Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. Reach me at oscillationss@yahoo.in).

Sunday, 27 December 2020

Value: Intrinsic or Subjective

 

(Click here for old post on value investing)

Recently, a young student was discussing business valuation with me. The young fellow was quite intrigued by the business valuation models particularly DCF. He asked me about my preferred model for valuation and I told him that in my view these valuation models are good for having a theoretical viewpoint and conceptual framework but these are very primitive methods and not practical most of the time in the real world. So we need much better valuation theory/methods which can stand on its feet during the evaluation process.

I know many hardcore Value investing followers and once during our discussions one fellow asked (challenged) me if I could suggest a better fundamental valuation method to value the intrinsic value of a business/stock. But I asked him- whether things really have intrinsic value? We value Roses and consider grass to be inferior to roses but just keep humans aside and nothing is more valuable than the others. Things are just IS. So Roses are Red only for us. The valuation we do is not linked with the individuality of that thing (standalone value) but to the relevancy of that thing to us. Without humanity, roses and grass have same value but it is different when they are “valued”. So value is different from valuation. Leave aside human beings and all and everything has same value…objectively everything is equal. But a three dimensional human being can trade all the grain of the world for a glass of water when he is dying of thirst in Sahara desert….a human can kill thousand others for something as abstract as religious sentiments. Can we value the embedded value of a handful of wheat or a glass of water objectively? So value is intrinsic but valuation is subjective. Objective valuation may not even exist (at least for businesses/stocks).

Value is intrinsic but valuation is subjective

Every asset that generates cash flows has an intrinsic value.

Value investing postulates that prices will oscillate towards intrinsic value (one and only one) and so this intrinsic value is an objective value. I have seen many commentaries on value investing and seen many value analysts (like Buffet) criticizing efficient market theory (CAMP model) but at the fundamental level if we can see even value investing believes that price and value should coincide. But first of all, why there is a difference in market price of an asset and its value because theoretically market price and value of an asset should be equal? Value investing assigns irrational behavior (by market) as the reason for this difference. Value investing accuses market to be guided by temporal forces of greed, fear and its changing mood where it completely ignores the economic considerations related to that asset. So if we can see this irrational behavior is the backbone of value investing where they try to unearth hidden gems ignored by wisdom-less market.

So Value investing declares itself to be far superior to the other irrational players of the market and it feels that it is superior just because they try to calculate intrinsic value (though with large numbers of highly subjective assumptions). But this “irrational behavior” is a very weak rationale for the most fundamental part of the value investing since presumed foolishness of others can’t create something very fundamental related to most valuable aspect of human life- Valuation of assets. It is possible that during Covid lockdown in India from Mar-2020 one investor might have sold Laurus labs at 70 due to the fear of covid related unknown or another investor might have sold it in order to arrange money to help poor migrant labors. Can we say that their behavior is irrational just because they sold Laurus labs at 70 which later on touched 350? Were they foolish for the choices they have opted? No, definitely not.

Fear and optimism are the fundamental forces responsible for the direction of the economy. These are as abstract as something can be but still they have the powers to drive and motivate something as material as an economy. When people and entrepreneurs are hopeful and optimist they spend and invest which drives the overall growth of an economy. Major function of the governments is not micro managing productive resources and their allocation but to create an environment where people have the faith and optimism in the government policies and administration. Like, GST was a great financial engineering having the capability to transform and revolutionize the business models and supply chains in India but a Government can always make a mess of this by making unnecessary rules and large number of compliances which will only create confusions, increase the compliance costs, restricts the flow of Input credit…and this will hit the confidence of investors and industrialists hard and they may choose to invest in some other country or cancel their planned investments in India forever. So fear and optimism are not irrational behavior but are the driving forces responsible for growth and preservation in adversity.

It is a misconception that man, material, money and technology are the most important forces driving the economies. Actually economies are just like a big truck. But which part of the truck bears the maximum weight of the cargo/truck? I ask this question all the time and many time I get answers like axle, wheel etc. But this is not correct as it is the humble AIR in the tyres which bears the maximum weight. So, the most insignificant, subtle and least-physical part holds together the most significant. Similarly, Confidence of the people in the economy and the Government is the most important factor driving the investments and thus growth.

Role of Market in “Value” and “Price”

So what explain the difference in price and value? Actually I have always felt that the fallacy may be related to the role of the market. Contrary to the general perception, the role of the market is not to “find the Value” of an asset/stock/commodity but the role of the market is to “price’ these things as an intermediary of the forces of supply and demand. Price of wheat in the market in the year of short production is high and it is low when there is bumper production of wheat in the following year. The price of wheat is not determined by the market keeping in view the relative value (which is same) but as an outcome of demand supply forces. So, the value is perceived individually while the price is determined collectively by demand-supply forces. It is not the role of market to find the true “value” of an asset/commodity but only to “price” it which is impacted and directed by large numbers of complex and diversified variables. Hence, even when value investing finds that value and price are same; market is not doing anything to Value but it is just doing in which it is most efficient- to price.

And all of a sudden, we can feel that this “price” is more objectively arrived at than the “value”. Value investing use highly subjective assumptions like discount rate, growth rate, terminal value, no growth PE ratio etc. and so this makes intrinsic value highly subjective. For example, expected cash flows of an asset are subject to the wisdom/strategy/decision making of an able manager who manages to extract much more value out of an asset due to his wisdom and decision making. And that’s why valuation is subjective- there is no standalone value which accrues to an asset on its own. Value is created by able managers with wisdom and price is paid (and accepted) for this value subject to prevailing market and general economic conditions. Price is what we know and value is what we perceive.

In Real Life Valuation is Subjective

In real life things are also like that. Valuation is subjective- just take the recent case of coffee retail chain Café coffee day (CCD) which is on the verge of sale. Can we say that CCD has one and only one intrinsic value? No, because its value will accrue differently to each buyer. Tata coffee/Tata-Starbucks can extract big synergy by consolidating CCD with them and thus creating more value as compared to other buyers with unrelated business like Dabur or even Coca cola. But the likes of ITC who are trying hard for long time to build a branded FMCG business can see this as a big opportunity and will be ready to pay much higher price because they will be hopeful of creating more “value” than by spending the same money for promoting their other in-house brands. So whenever this will happen there will be a fierce fight for the control of CCD.

Let’s take the case of ITC. ITC has not performed that well in last 10 years or so. So how value investing would have valued ITC 10 years ago could have been very interesting. ITC was churning massive volumes of cash and it had grand plans for doing big in FMCG business. Value investing would have arrived at a very lucrative value keeping in view the past record (in creating a great FMCG brand in Aashirwad) and low cost of capital of ITC. But the most significant part in any business valuation is qualitative part (and impact of intangibles) which is not captured that well by value investing. Just like our traditional accounting which has no tools to evaluate intangible assets. But we all know that net worth in fact is the minimum value as businesses get maximum value from the intangibles like brands, technology, Patents, customer loyalty, information and data which are not assigned any value in the balance sheets by traditional accounting (not much even by Value investing).

So the story moves forward and ITC couldn’t create the value. First, it was not vry wise in allocating capital. It wasted it in hotel business which is highly capital intensive but low return business. In FMCG- apart from Aashirwad it failed miserably. It invested and focused on second standard products in crowded segments like Yippee, Sunfeast, Bingo which are forced choices...nowhere near Maggi, Lays etc. I don't think it could ever be a leader in any of these products...when Maggi was hit badly due to bad press it could not do anything even at that time. Actually Aashirwad was a great venture and I was thinking at that time that ITC would make a killing in Pulses/Spices with its Aashirwad brand but instead they focused on other low margin businesses like stationary/Hotels and other crowded FMCG products with very strong brands. The main reason for me to buy Tata chemicals (Before demerger of branded product business) was their foray into branded Pulses and Spices business and Tata has created a great brand in the last 5 years or so. Tata chemicals has really leveraged its supply chain and brand recall in creating niche products (Tata Sampann Brand). That’s why Tata chemicals is already giving almost three times returns (Including value of Tata consumer post-demerger).

It is very tough to create strong brands in FMCG sector which is already having strong brands. Inorganic growth via acquisitions should have been a much better strategy than building brands from the scratch. In today’s world it is very costly. So I feel a better way for ITC was to acquire a good company in FMCG with good brands like last year Zydus wellness did by picking Complan/Glucon-D and Horlicks was acquired by HUL. These are master steps; CEOs are paid for this. Sometimes I felt ITC should have sensed the opportunity in premium whisky in India and instead of investing capital and efforts in creating new brands in highly competitive FMCG sector related to snacks etc. It should have attempted at acquisitions preferably in liquor sector like Radico Khaitan (who once was looking for a partner). United spirits and UB were picked by Diageo and Heineken but investing 20000-25000 cr for buying these giant Indian brands in high entry barrier Indian liquor industry would have been a much better strategy for ITC and cash was never a problem for ITC. Liquor business is a much better extension of its cigarette business and ITC understands the dynamics of this complex regulated business in India much better than others and that’s why I think ITC could have created more value for United spirits and UB businesses than by the likes of Diageo and Heineken.

So the value is not created in a linear mathematical formula but by human wisdom and strategy which are not confined to any formula or any boundaries. Value is created and perceived subjectively.

Here I remember something- the divine lovers Laila Majnu!! You know Laila wasn't very beautiful but Majnu was a handsome guy. The king of the city liked him and he was very concerned to see Majnu dying for Laila, an ordinary girl. So he invited Majnu to his palace and offered him to pick any girl from his harem having the most beautiful girls of that time. But Majnu declined; king was shocked and asked, “but how can you decline these pretty girls for that ordinary girl Laila…she is nothing against these women?".

"Well, my dear King, to see the divine beauty of Laila...you need my Eyes", was the reply from Majnu.

(Every asset that generates cash flows has an intrinsic value so can we say that Money has an intrinsic value? I have asked this question to the young fellow as his next assignment)

(Views are personal. This post is taken from monthly Newsletter of this Blog. Reach me at oscillationss@yahoo.in)

Tuesday, 1 December 2020

Insurance and Reinsurance sector- Truth is Beyond Time and Space

Stocks covered in this study: GIC RE and Cholamandalam financial holdings Ltd

Dear all, this study is mainly about the dynamics and factors affecting and governing the growth of insurance sector and not about any particular insurance stock. I have tried to list out the factors affecting the functioning and growth of this one of the most complex sector. But insurance sector (General insurance in particular) is going to see the huge growth for next 10-15 years in India and I feel this is going to be one of the sectors to produce future multibaggers. The growth and performance we have seen in Indian insurance sector up to now is nothing compared to the massive growth lies ahead. So I have tried to find out the most relevant factors which are going to shape this sector in the future and which stocks are going to be the major beneficiaries is just a matter of time and space and we will continue to find out more such stocks opportunities. As of now, I have selected GIC RE and Cholamandalam financial holdings Ltd (CFHL).

This study I have shared with the subscribers of this blog some 10 days back but due to some reason could not share the same here and in the meantime CFHL has witnessed good buying and has already touched 540 from 430 at that time. So not wasting any further time, I have decided to share the same here. The study is detailed spanning 42 pages so it will take some time in reading and understanding due to the complexity of the subject. I have also tried to cover issues related to valuation of businesses especially of financial firms. The second part of this study will be released soon covering the detailed study of stocks like GIC Re and CFHL. The full version of this study is available for the subscribers of this blog so I am sharing some samples from this study report here. Those who are interested in getting the full report please contact at oscillationss@yahoo.in

Sample study:

 

CONTENTS

Paragraph

Description

Page no.

(A)

Insurance- Role and impact on business and economy

4

1

Risk management in insurance and law of large numbers

2

Law of large numbers is everywhere

3

Concentration risk and Reinsurance

(B)

Insurance is complex but Reinsurance is even more complex

10

1

Law of large numbers and correlated or concentrated risk events

2

Reinsurance to manage concentrated/correlated risks

(C)

Time for Reinsurance is yet to arrive in India 

16

1

General Insurance has a long way to go in India

(D)

Reinsurance to play big role in India for the growth of specialty insurance

20

1

Cyber Insurance and Catastrophic Insurance- The big game for Reinsurance

(E)

Cyber Insurance-The next big thing in insurance and Reinsurance

23

1

Valuation of Intangibles- where traditional accounting is useless

2

Valuation of data, information, and intangibles- a must in today’s world

3

Valuing the data assets- The starting point of cyber insurance

(F)

Crop insurance and Aircraft insurance- other Reinsurance heavy sectors

31

(G)

Something about Float and Investment Income in Insurance business

32

1

How life insurance industry adds value

2

Solvency Ratio

 

(H)

Government role is crucial in catastrophe insurance and GIC Re will be a key player for India

36

1

Catastrophe Bonds

 

(I)

Individual valuation of GIC RE (CMP 127)

40

1

Valuation of financial sector business- Book Value multiple or Earnings Multiple

(J)

Cholamandalam Financial Holdings Ltd (CMP 430, Market Cap. 8100 cr)

43

One friend once told me that he was fortunate to be born into his present religion as his life could have been useless had he been born into some other religion. But I told him that he was not that fortunate because truth is beyond space and time. Truth is absolute, ever-existing and ever-lasting. It is not affected, directed and objectified/represented by variations in time and space. I told him that he would have felt the same had he been born into some other religion. However my friend argued that still he felt good about his religion. But I told him that I was not denying that (feel good) but that which can be affected so much by time and space can’t be the reality. It can be whatever it is but it is not the TRUTH. You aren’t/can’t be defined by these temporal and spatial phenomena. I have seen people having a feeling of greatness, ego and class because of money. But I always tell them (wherever I can) that this is not the reality because this reality is bound by time and space. They could have born into a poor family and they absolutely have no control over this.

This misconception engulfs every sphere of life and Stock market does the same mistake when it thinks that quarterly numbers (time) and issues (often temporary) affecting industry (space) are the truth. As it focuses on time and space so it misses the truth. It sees bad quarterly numbers and reshuffling of Industry as an end of the game. But restructuring, reallocation and consolidation in any industry are indispensible for long term growth and sustainability of the Industry. This restructuring takes care of the misallocation of the resources in the industry and so the same is corrected through reallocation and consolidation. It is not the sign of a disease but it is a much needed surgery to cut off the cancer. So, quarterly results are not the truth (may be bad due to industry or company specific issues)…Industry problems are not the truth.











Truth is something else. Consciousness is the truth as consciousness exits beyond time and space. Businesses/Firms have their own consciousness which has the ability to create a superior product with scale with high entry barriers. This consciousness can travel beyond time and space. Promoters/management is just one of the part of business consciousness which comprises technical capabilities, superior R&D abilities and focus, Networking effects, superior and vast supply chain etc. Businesses are not alive beings still we can feel they have their own consciousness…they have their own aura…employees feel it (different feeling with different employers), other stakeholders feel it. The legacy of a business, work culture, integrity and focus attract, nurture and develop like-minded people...just like the ones who have created the original legacy (Like Tata, I feel even when Ratan Tata is gone the legacy and style of Tatas will prevail and this shows that business consciousness is real and shape all and everything around it).

Brilliance is not the rarity but the opportunity and expression of it is. So Steve jobs, Gates and Ratan Tata are not the exceptions…they will keep coming. They will keep coming into Microsoft and Tata attracted by their business consciousness. Strong businesses are not one product wonders but they are because they create and develop a work culture (consciousness) which automates the generation of new ideas, innovation, expression and resilience. This is the real strength of a company…its soul…its most important asset. This is what makes companies to fight at the face of adversity and lead to their resurrection. A business becomes more resilient to outside threats (competition and existential) when it has technical expertise, high entry barriers due to business model and complex supply chain. A great warrior is not who can hit others hard with his power but he should have the will power to withstand the hard blows of opponents…only then he can win fights and be a great warrior. So, strong business model and technical expertise are not enough. A business has to be resilient…it should have the strength and will power to withstand tough periods…periods of droughts.

Future growth is extremely uncertain as it is impacted by thousands of variables…more so now because the world has become a big single market (and it may stay so). I don’t think it is possible to assess the impact of these vast numbers of variables into the distant future with a high degree of certainty and then assigning a value for this assessment (growth rate). This assessment or guesswork becomes increasingly difficult and complex for an emerging line of business or when there are structural shifts happening in an economy. But it is possible to assess the technical expertise, strength and resilience of a business. The chances of a traveller crossing a tough terrain are not determined by the risk of dangers which may come during the travel but more by his strength and resilience. He can defeat those dangers. So rather than focusing alone on assessing the future dangers (guesswork) the better approach is to assess the strength of the traveller. Same is also true for a business. Future growth is not determined by the external threats but by the capability of a business to fight of those threats.

But I have seen business analysts putting all efforts to declare a growth figure. I always wonder how they calculate the growth rates i.e. at CAGR of 15% or 20% because 90% of the times these estimates are wrong. But if I am a great analyst charging hefty fees then I have to give a figure otherwise I can’t claim to be a God…I need to demonstrate. I am not saying that all such efforts are futile and misdirected but that they should not be the sole basis for assessing the worthiness of a business. The value of a business should not be determined by these estimates. I always feel that the major portion of the value of a business is determined by the individual capability to fight and survive. Financial ratios are linear but consciousness (strategy) is multi-dimensional.

Last year I have written a detailed post on Homeschooling explaining the pain points of our education system. One school principal asked me that day what I think is the major limitation of our study books and teaching. I told him that our books lose the purpose when they declare, present and demonstrate that they know everything and what they know is unquestionable and absolute. I always feel that schools should not only teach what we know but also what we don’t know. Science books should also have strong focus on what we don’t know as of now. This will create more Einsteins…more children will feel interested and motivated. Similarly, I think we need to understand that we can’t assess thousands of variables projecting their future behavior in an excel sheet…rather than giving inconclusive and raw figures it is better to declare that this we can’t assess or can assess with lower degree of certainty.

GIC RE- Its recent business performance is not the TRUTH

 GIC RE has been hit badly in last one year and trading at extremely lower valuations. But the truth is completely different from its recent quarterly numbers. In the coming paragraphs we will try to capture the truth.

GIC Re is India’s biggest reinsurer with around 60% market share. Insurance business is one of the most complex businesses and reinsurance is even more complex. So no wonder people are trying to assess the fourth dimension with 3D tools.

Sample 1:

 Insurance- Role and impact on business and economy

Insurance is basically a process by which risk is spread among vast number of people across geographies. As I have shared earlier, future is extremely uncertain and there are existential threats for all whether for an individual or a business. So the focus was always on as to how to eliminate these existential risks. Insurance tried to fill this void with its innovative business model.

To understand the model, let’s assume a small town with some 1000 families. As there is a risk of untimely death due to accident or disease so every resident is worried about the safety and future of his family. The best way for him is to build an emergency fund for his family. As per his estimates, the fund he needs is Rs. 1 crore and so saves this much money. But this threat is for every family hence every family is focusing on saving around 50 lacs to 1 cr in order to ensure the safety of their families. This means that people will try to save 500-1000 cr in this small town and the same will be parked in safe instruments like FD. But the savings of this huge sum also means that people will spend less and take very less risk for staring new ventures. And this will certainly hit the growth of the town very badly and the question will come as to how they will save this much money in the presence of low economic growth. Interest rates will be low but still even at lower rates there won’t be much takers of credit as everybody has become risk averse.

But then, a smart guy comes into the town. He does his homework and finds that on an average every year some 10 people die of accidents. So he understands that there is no need for everyone to create emergency fund. In fact, he can create a fund sufficient to pay Rs. 50 lac to 1 crore to the family of each deceased fellow which will be around 5-10 cr and for that he can charge a small amount as premium from each family in the town. The premium he will decide based on his cost of capital, administration and other charges. So if everything goes according to his estimates (of 10 deaths) then he will make money from this business. Most importantly, people will be very happy to pay small annual insurance premium (say Rs. 20-30K) to safeguard the future of their families and avoiding the need to save huge money for emergency fund.

So we can see this arrangement is a win-win situation for everyone but most importantly this will ensure the good growth of the economy as a whole as people will feel comfortable to spend and to take risks for new ventures. So we can see the big role being played by Insurance for the growth of economy also not just ensuring the safety of the people alone.

But the major factor here is to cover large population under insurance because only then law of averages will come into play and this will further reduce the insurance premiums. Insurance is mainly about vast coverage because if in the small town in our example only 100 people opt for insurance then there are high chances that out of these hundred 7 people die of accident resulting in high claim payouts for insurance company which is not a viable model. So the expertise of Insurance firm here is to assess the mortality rate accurately and increase the insurance coverage to large number of population. Hence, Insurance is basically a risk management mechanism where the insured manage his risk by transferring the same to the Insurer while the Insurer manages his risk by accumulating/pooling the risks of similar large number of individuals.

Non-life insurance (General insurance) follows the similar model and just like the life insurance it has to assess the risk events accurately like motor accident rates, Fire and catastrophe risks. But the focus here also is to cover the large geographical area in order to spread the risks. Like in our small town case, effectively 1000 people are taking care of the families of 10 people expected to die of accidents in the current year because instead of each family taking care of themselves 1000 families are taking care by pooling money for an adequate fund. So the core competency of insurance business is to spread risk because the risks associated with different policies are not perfectly correlated so the total risk of a portfolio of policies is smaller than the sum of the policies’ risks- for example, 100 policies having insured value of 100 cr…now the risk of each policy is 1 cr but total risk of 100 policies is not 100 cr due to nonlinear correlation between all the policies.

Insurance is a unique business and a very complex one because unlike other businesses where they sell goods or services but in insurance they sell promises…a promise to indemnify the other in case risk/loss event happens in the future. So the indemnity event is also contingent upon the loss event happening in the future which may or may not happen. So, Insurance companies are required to keep adequate liquidity and capital to meet out their future obligations in the form of insurance claims. Insurance companies are required to maintain a solvency ratio of 150% in India (will touch this in the coming paragraphs).

 A strong and efficient insurance industry is vital for the growth of an economy because in the absence of insurance support businessmen won’t be able to take the risk of setting up new factories/projects. Take the case of a setting up of a power plant costing Rs. 5000 cr which is exposed to the natural catastrophic risks like earthquake, hurricanes or other risks like war and terrorist attacks. In the absence of strong and solvent Insurance industry it is not possible for any businessman to invest such a huge amount. Banks can’t provide credit to businesses in the absence of Insurance.....

Sample 2:

Concentration Risk and Reinsurance

This is what insurance business is all about and the most important strategic decision for any insurance company. The holy grail of Insurance business is to avoid concentration risk. This is the most important factor which affects the demand and profitability of insurance business however surprisingly there is not much information about this in any of the coverage reports on Insurance business. They only talk about regulatory and mass retail Motor insurance, health or fire which are required by law and are non-discretionary. But due to easy money there is high competition in these sectors.

The major risk for an insurance company is to have high number of claims as compared to expected claims upon which they have built and priced their insurance policies. Now this high claim risk can be due to two factors- first, their assessment was wrong and their data collection and analysis models were wrong or outdated; second they have accumulated/distributed insurance policies in such a way that it has concentrated the risk for them……..

Sample 3:

Insurance is complex but Reinsurance is even more complex

I have not seen a business as complex as Insurance where growth and demand dynamics are extremely difficult to assess. But I have seen people treating both insurance and Reinsurance on the similar lines…analysts predicts linear relationship between insurance and reinsurance business and growth in retail insurance will result in the same degree of growth in reinsurance. But this is not the case. Both have distinct demand and growth dynamics.

Once one analyst associated with large broker house was telling me that their analysis about reinsurance is that with the growth in Motor, health insurance in India more business will come to Reinsurers. But I told him that I did not feel the same and instead as far as I can see growth catalysts are very different for Reinsurers. Actually here things are very complex- risks associated with Motor and Health insurance are not co-related…means one car accident does not create the chances of another car accident. In other words, if one car insured by insurance company X gets into an accident in area A then it does not affect the possibility of another car accident in area B nor it creates a chain where another car accident may take place due to one car accident in area A…means each risk event is different and independent and does not even out the other risk event. Car accidents are not mutually occurring and each car accident is a mutually exclusive event and independent of other car accident unlike catastrophes like hurricane where one hurricane can do big damage in multiple and correlated risk events in a particular area and further you can’t pin point the area in advance……

Sample 4:

General Insurance has a long way to go in India

However, Indian general Insurance industry as of now is very backward and needs huge resources and innovation to start the new growth path. To have an assessment as to where India stands now, two ratios are used across the globe to measure the development of insurance industry. First is Insurance penetration which measure the development of insurance sector i.e. circulation rate of the insurance products in an economy and second one is Insurance density which is the ratio of total insurance premiums earned in a given year to the total population.

Insurance penetration rate is measured as the ratio of premium underwritten in a particular year to the GDP. India’s insurance penetration was 2.71% in 2001, when the world average was 7.83%. The same in 2016-17 was at 3.49% (2.72% Life and a mere .77% for non-life). The same now stands at 3.7% against global average of 6.8% which shows that we have too much to cover as of now.

But i don’t like this ratio much and don’t think that this ratio is expressing the status which is desired because:

(1) If we can see then this ratio attempts to show the relation between premiums and GDP. But I think the focus of Insurance is not on protecting GDP DIRECTLY.

(2) In fact, Insurance aims to protect the GDP generating assets not the GDP.  So I think the focus should be on to check how much of the income generating assets (Like factories/power plants) are insured.

(3) Also, insurance premiums are affected by competition and interest rate in an economy (because insurers can set low premiums to attract more business to invest the premiums in high interest generating assets like Bonds).

(4) So I feel instead of focusing on insurance premiums received in a year the better way is to focus on the value of income generating assets insured as a percentage of total income generating assets in an economy. I mean focus should be on sum insured not on premiums paid. For example, if an economy has Rs. 10 lac cr worth of assets then the penetration should be measured as how much of these assets have been insured not the premium paid for ensuring these…….

Sample 5:

Cyber Insurance-the next big thing in Insurance and Reinsurance

Data is God. As you all know I am a firm believer of this. And as things are changing in the structure, growth factors and catalysts of economies across the globe the same is going to be recognized by all the businesses and insurance providers. The world, economies and businesses as we know today are defined by one factor- DATA. Just see the top companies of the world- Google, Facebook, Alphabet, Apple, Amazon, Microsoft, UBER, Netflix, Linkedin. They are not our conventional companies selling physical goods but they are the ones selling information, digital goods and services. For these firms, Data is all and everything. Companies selling and dealing in physical goods are no longer the global giants. Goods are replaced by DATA.

This Data orientation of the businesses has fundamentally changed the risks associated with the businesses. Two-three decades ago, businesses were about investments in machines, plants, infrastructure and raw materials. Business meant physical assets but now is the time of intangible assets……

Sample 6:

Valuation of Intangibles- where traditional accounting is useless

Once I was sitting among the group of stock market enthusiastic and CAs when one passionate investor told me that my being a qualified CA helps me a lot in analyzing the stocks. But I disagreed with him. I have seen CAs considering themselves as depositories of accounting laws and fundamentals so they have a feeling that they can value stocks and businesses. But I usually tell them that this is not the case because stock analysis starts where traditional CA ends. In mergers and acquisitions, intangibles are accounted for some 70% of the business valuations with traditional assets in books accounting only for some 30%. The problem with the traditional accounting is that it has no tools to evaluate intangible assets. Our so called balance sheets comprise of just physical and financial assets and liabilities and accounting says that the difference of the assets and liabilities is the net worth which is the value of the business as per accounting. But we all know that net worth in fact is the minimum value as businesses get maximum value from the intangibles like brands, technology, Patents, customer loyalty, information and data which is not assigned any value in the balance sheets by traditional accounting. So we can feel the uselessness of our accounting systems. The uselessness of our accounting is more pronounced at present with the onslaught of digital economy as more and more resources are invested in the formation of digital and intangible assets…..

Sample 7:

But in the absence of capitalization of intangibles or valuation of Data assets in the balance sheets have rendered the books of accounts and return ratios meaningless in today’s world because as pointed out earlier it is very much possible (it happens always) that the revenue earned today is due to R&D expensed out 5 years ago so this revenue will distort the return ratios/metrics big time and investors/analysts will have a false interpretation of high return ratios when the fact is that the most of the related expenditure is charged off 5 years ago. Further, the timing of R&D expenditure may impact the results big time and people may arrive at wrong conclusions when the fact may be that in a particular year with lower profits the firm actually has invested much higher in R&D for a new breakthrough product. For instance, take the case of Pharma biggies like Gilead and Pfizer, aviation giants like Boeing planning a new aeroplane…all these new products require massive investments in R&D the benefit of which will be realized in the foreseeable future. So the books of accounts we are seeing and analyzing today (especially of a tech heavy and R&D heavy firms like Pharma) are just superficial. If you ask me, Indian analysts have very low expertise in recognizing and valuing intangibles (Biocon was never valued much in 2013-14 when it was spending big in R&D and I saw many analysts questioning its return ratios at that time. But I picked it at that time and it is now a 12 bagger). The main reason for this is that Indian companies are very backward in investing in R&D so in India these analysts have the liberty to ignore or deficient in valuing intangibles but still be regarded as great analysts…..

Sample 8:

How life insurance industry adds value

 If we can see, life insurance industry sells the true interest rate sensitive products or policies. Almost entire profits of a life insurance provider arise from the difference in the interest rates they are earning on their assets and the interest rates they have promised to their policyholders. So falling interest rates negatively affects the future value of its assets which it needs to payout its liabilities in the future which are at much higher interest rates. So this can result in the asset liability mismatch and even can threaten the insolvency of the insurance firms. That’s why prediction of long term interest rates is more relevant and imperative for life insurance firms than non-life firms.

So the most important thing for the life insurance firms is their ability to predict the behavior of interest rates over a period of 20-30 years…..

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your own Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. Reach me at oscillationss@yahoo.in).