TTK Healthcare Ltd: At the Crossroads

 

TTK Healthcare Ltd.

Grade: TIER 3

Value trigger: Level 3. Management is going to take certain decisions which will put the company on a strong growth path.

Stock: TTK Healthcare Ltd
Description	(Amt)
CMP	562
Market Value	794 cr
PE Ratio (Annualized)	35
Net worth (Sep-2020)	275 cr
Dividend Yield	0.50%

TTK is a very confusing company- Not for analysis point of view but as a company because somehow they don’t seem to be certain about their path. And in all this confusion they have created a mess of products and divisions which are going nowhere. Their portfolio of pharmaceuticals, medical devices and protective devices looks good but I don’t understand what they are doing in deodorant and home care business (Good home Brand-Drain Cleaner, Room Freshener, Scrubbers, Air Freshener Block and Odour Remover) where there already is very stiff competition with established multinational and national brands. I mean they could never spend on marketing and branding like other biggies and there is nothing great about their products. They are just routine products. And then they are also in foods business selling ready to fry snacks!!! It is surprising why management plans these half-hearted useless expansions where they stand nowhere against the competition-neither in terms of product innovation nor in terms of marketing spending. Their investments in these verticals have not shown good results and they are incurring losses or lower profits in these two. On the surface, their consumer business earning PBT of around 18 cr on topline of 181 cr looks good but this figure in mar-2017 was 240 cr and 25 cr respectively. So they are not being able to compete. Same is the fate of food business where turnover has grown at very slow pace from 72 cr in Mar-17 to 88 cr in Mar-20. So why to spend time, energy, efforts and money on such adventures when they have other business verticals with very strong growth potential and where they have done well.

And where they have done well?

Pharma and animal healthcare business: They have done well here. Topline has grown from 190 cr in 2017 to 231 cr and PBT at 21 cr from 13 cr. But they need to expand their product line and they need some path breaking products. They have herbal products like male/female fertility. In animal welfare division they offer products like medicines, tonics and productivity boosters and if you ask me this one is a great high growth opportunity. I feel they should have gone for some acquisitions in pharma and animal welfare segments if they can’t expand these businesses organically. Still, not a bad performance but they need to focus on complex products.

Protective Devices and Sexual wellness division: They have done well in placing Skore in the sexual wellness industry in India. They launched Skore condom in 2012-13 and with some path breaking aggressive marketing and branding they achieved 3^rd position in no time by 2016. In 2012, it had to break its long standing partnership with Reckitt Benckiser for selling Kohinoor and Durex condoms in India because both couldn’t be able to reconcile their dispute. Due to this, TTK lost the rights to Kohinoor (launched in 1979) and Durex (launched in India in 1997). But TTK launched Skore condom with big heart in 2012 and within a period of 4 years, it put behind both Kohinoor and Durex with wide margins. It even outpaced the giant Kamasutra brand. It is now at 3rd place in India behind Manforce and Moods with 10% market share (Manforce has 32%, Moods with 12%). Aggressive marketing and advertising, is the main reason for this success. Its advertising & Sales Promotion expenditure is at 88 cr in 2020 vs 68 cr in 2017 and bulk of it is going towards Skore. Recently it has started spending more on the advertisement of Woodward’s Gripewater (WGW) and it would be interesting to see the impact as WGW has not witnessed much revenue growth in last 4-5 years. At present it is selling around 15 cr condoms.

Actually, although TTK lost the brands of Kohinoor and durex but it never lost its technical prowess in manufacturing high quality condoms. TTK was the first to establish condom plant in India in 1963 and it was to first to install electric testing facility and first to introduce subsidy free condoms in India in 1974. So with its decade old marketing and distribution strengths, Skore was always going to make it big and fast in Indian market.

Recently, Skore has forayed into sexual wellness products and has introduced innovative products like lubes, sprays like pheromone-activated body sprays and gels, Vibrating rings with rechargeable and remote controlled variants (three variants, Skore Shiver, Skore Vybes and Skore Buzzz). These products are selling fast at online portals and these are going to see high growth in India. In fact sexual wellness category is growing at 25% across the globe so one can judge the scope of growth in India where people are opening up on sexual wellness and experiments looking beyond the taboo. Most importantly, online platform are playing a vital role in the search, information, availability and delivery of sexual wellness products not only in urban but rural India also. Online sale of sexual wellness product is going to be the major differentiator in the future high growth of this industry in India. In india condom penetration is still way lower at 6% and a country with vast population the value of condom industry is just around 1200-1300 cr. But this low value points towards a vast untapped market and this is the reason Skore is playing the game aggressively for the market share.

TTK management may look confused when it is about their Eva Deo, Home care and Foods business but in sexual wellness industry their approach and strategy is just top notch. I really like the aggressiveness, strategy, product innovation, disruptive marketing and branding activities of TTK management in establishing and growing Skore brand.

TTK has capacity to manufacture 2 billion condoms a year at its three factories in southern India. Some people compare the performance of Skore with another listed condom player “Cupid Ltd” (female condoms) which is having high margins and profits. But they are not comparable. Cupid is catering to wholesale market supplying to export market and orders from welfare agencies like WHO/UNFPA. But Skore is focusing on branded consumer segment where a lot of investments is required initially in establishing a brand especially in premium segment. Indian sexual wellness industry is still in the initial phase with a long way to go and that’s why one can see brands like Manforce, Durex, Kamsutra spending big on innovative products and marketing. Most of these players are incurring losses as of now but accounting losses are different from business losses. In many cases, accounting losses are business investments from business point of view for accounting does not recognize or value strategy and brand establishment. So big marketing and advertising spend is responsible for the losses of Skore whereas the likes of Cupid does not spend much on these. Hence, over a period of time with growth in volumes and lower requirement of marketing the profits of Skore will see massive growth. TTK is also focusing on getting bulk orders for export markets from agencies like WHO.

Medical device Business: The next big opportunity

Indian medical device market is quite large valued at some 40000-45000 cr but sad point is that we import around 70-90% across various product categories.  Local manufacturing is very poor and it is mainly catering to low tech class 1 (class A) devices. Class 1 devices are those which are having low to moderate risk to the safety and health of the patient like stethoscopes, bandages, dental floss etc. The level of manufacturing complexity is very low so these are low value devices. Class 2 and 3 are relatively much more critical to the health and safety of the patient. Class 3 (Class C) is the most complex with highest risk to the life of the patient. These are the devices which support or sustain the life of the patient like the implantable pacemakers, prosthetic heart valve, ventilators, HIV diagnostic tests etc.

It is shocking that with vast healthcare requirement for a large populous country like India we are importing 70-90% of our total requirements. This shows the neglect by the regulators and government in formulating policies to promote the local manufacturing and also a great opportunity missed by Indian manufacturers due to their own neglect. In fact, this neglect and poor manufacturing prowess appears shameful if we see the highly advanced world class pharma industry in India where India is the global powerhouse in medicine manufacturing. Most of the medical devices which india import from the global giants like GE, Siemens, Phillips are actually coming from China who realized the importance of medical device manufacturing much earlier than India and focused on local manufacturing some 20-30 years back. The current value of industry is Rs. 40000 cr but this is going to grow much bigger in the future with high growth in healthcare industry and demand. For information, the value of chinese medical device industry is somewhere around 4 lac cr to 5 lac cr!!! That’s why I always say that India needs businessmen everywhere not politicians (to make policies for poor people) and bureaucrats.

One of the major drawbacks hurting Indian medical device industry was that Indian medical devices industry was largely unregulated which hurt the investments and export opportunities. Now, Indian government has released The Medical Device (Amendment) Rules, 2020 (“MDR Amendment”) to regulate this market and they have approved stimulus package for promoting the manufacturing in India. (Will cover more on this topic in the next edition on medical device sector).

TTK Chitra heart Valve: For decades, India relied on imports of expensive artificial valve replacements to meet domestic need, but many families whose children developed Rheumatic Heart Disease (RHD) were also among the poorest in India, and could not afford even the heavily discounted price tags of imported valves, which hovered around $1,200 each. And so our children died, or lived drastically shortened and unhealthy lives.

Then TTK Chitra Heart Valve came to their rescue, it was developed painstakingly over 12 years at the Sree Chitra Tirunal Institute for Medical Sciences and Technology in Trivandrum, India, the device is now licensed for manufacture and marketing to TTK Healthcare. TTK valve uses the highest quality materials, features genuine design and material, blood flow resistance reduction, and durability. But in spite of high quality product with 12 year product development cycle with extensive clinical trials, TTK Healthcare still sells each valve for just $315-$400 (Rs. 20000-25000), a price range it has maintained since 1995, even when inflation is high in India. Due to TTK Chitra heart valve, all the MNCs had to lower their prices in order to stay in the Indian market.

TTK Chitra heart valve is the only Class 3 medical device produced in India which is a proof and a testimony to the technical capability in India for manufacturing complex medical devices. In numerous studies conducted, TTK valve has performed equal to other heart valves manufactured by renowned global producers like St. Jude. One recent study conducted in 2020 has established the efficiency of TTK Chitra heart valve equivalent of an imported St Jude Mechanical heart valve at almost half the cost making the prospect of cardiac surgery available to a large number of deserving poor patients. India is home to estimated 20-25 lacs patients with Rheumatic Heart Disease (RHD) which is the leading cause of structural heart valve damage in the country so there is a huge undiscovered and unmet market for heart valve surgery in India.

The Indian Government has designed and working on a massive Medical Insurance Scheme to cover poor families and this is going to create big demand for cost effective products like heart valve and orthopedic implants made by TTK.

TTK healthcare is also into the manufacture of orthopedic implants under the brand "Altius" which is low priced option against costly imports. The products are very good with US FDA cleared designs. As we can see, TTK has done well in medical devices but somehow the hard work is not reflected in the topline numbers and I think it may have been related to these products being looked down upon by Indian people who can afford costly products (doctors/surgeons also don’t take chance and opt for products with very slight medical benefits though at high costs)  and then there are poor people with no capacity to even buy these cost effective products in the absence of no support from government which as I have shared above is going to change and TTK may see high growth for its medical devices.

TTK’s R&D expenditure was around 4 cr (.6% of turnover) which is not bad keeping in view the fact that its NP is meager 20 cr.

So what is going to be the catalyst event for TTK in medical devices business?

They are having around 210 cr cash and I feel time is good for them to deploy this into high growth business of medical device. There is no better time to enter this sector than now. So I think TTK management is going to do something big in this segment this year- may be they will acquire a mid-size company or they are going to make investments for expanding their medical devices business. And if they can do this then we will see high growth happening in this company finally.

Why I feel they can do something big in medical device? Actually if we look at their performance in establishing Skore as a national brand in just 4 years then there is no doubt that they have the capabilities to execute something big taking over the entire industry; establishing a product where marketing and branding is the key and they did it skillfully so i think they can do something big in medical devices keeping in view their vast experience in dealing with this industry for last 20-25 years. The only thing is that they also feel like doing something in this industry. But I feel they don’t have any other choice and so soon we will be hearing something on this.

TTK healthcare has not performed at all in last 10 years and I think it has not given any returns at all but still good thing about them is that they have kept their business out of debt and amid all this surficial non-performance has created a significant consumer brand in Skore which is going to see high growth in the future and even the performance by Skore may be sufficient for a big re-rating. But as most of the value is coming from the future strategic actions taken by the management so treat this as a risky stock (Tier 3).

Summary of Analysis levels Involved in the study of TTK Healthcare:

1. Level 1 (Lower relative valuation) – Not cheap but not high also…just adequate for the current scale.

2. Level 2 ( Industry level growth and restructuring)- Sexual wellness and Medical device industry will see high growth but scale is small for TTK in these and it is not a leader in these segments so no automatic growth for TTK similar to industry growth.

3. Level 3 (Forecasting of management decisions which may result in massive future growth and value unlocking) – So the whole value is coming from the strategy and decision making of the management. Their strategy in growing sexual wellness and acquiring or expanding medical device business are the key growth and valuation catalyst events.

(This article is taken from the Monthly Newsletter of this Blog)

(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).

  

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).

  

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).

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)