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June 10, 2012

A company that can lay golden eggs


Let’s assume (hypothetical example) that somebody ( maybe XYZ bank) is going to offer me a loan of 50 Cr @ 15 %  ., With the condition I should pay interest per year and can repay partial amount any times and need to pay back the full amount after 5 years. First of all I do not like to take a loan but they offer me to think over the offer and  get back on offer within a month. I don’t like and suggest anybody to invest in the stock market with loan amounts that too with high interest rate. But , I have come to following option to make the most of this offer by investing in the stock market.

1.      Investing in Growth Stock : I should invest in high growing companies like Jubilant Foodworks Ltd , Page Industries . But it will be too much risky to invest in these high growing stocks , because these stocks are already trading at high valuations . Then , future growth of these stocks depends on many variables . I can’t predict future cash flow with these variables with my comfort level of variance .No certainty in cash flow , So this option is not suitable for offer.
2.       Holding Companies : I have another option to buy stock of holding companies which are trading 30% of their holding value . I should buy majority stake in this type of company and sell all the investment. I agree , I will not able to get majority stake at such discount rate , then there will be some tax impact. But if I assume that if I able to get at 50% discount and paid 30% tax then also I will able to make 66 % money on my investment with very minimal risk .

Holding Stock value
Acquisition Cost
Profit
PAT
100
50
50
33

               I can make a cool 33 car in a few months with few assumptions, but it will be one time profit. This is defiantly one of the better options.
3.      Golden Eggs Stock/Company : By buying & selling holding company I can make one time profit but what if I can get a company/stock which can lay golden eggs regularly.
Guess which company it is ? Is it MMTC  Ltd?  No .
               It is Indsil Hydro Power & Manganese Ltd . Let me explain how it can lay golden eggs. Last trading price of  Indsil Hydro Power & Manganese Ltd is 23.45 , which translates into market cap of only 37 Cr. Now assume that I am able to get whole company or majority stake at current price .
After getting a majority stake my  first steps will be to demerge Hydro Power Project unit in separate company from Indsil Hydro Power & Manganese Ltd. So there will be now two companies first Indsil Hydro Ltd and second Indsil Manganese Ltd. Indsil Hydro Ltd will have just power plant & all the cash , debt, investment etc. will be part of Indsil Manganese Ltd.
Indsil Hydro Power & Manganese Ltd is having following liabilities & asset on the book in last audited financial year. All values are in crore.

                Liability Side
SECURED LOANS
6.63
Buyer's Credit for raw materials
4.2

              
                                            Asset Side
Equity & Debt MF , Investments
5.26
Net Current Assets(including cash 8.02 Cr.)
26.74
Closing Stock of Raw Materials
19.65
Land accumulated in the last 22 years on the book value , current price may be 3-4 times
2.42
Building at cost (including Indsil House in posh locality R.S.Puram, Coimbatore)
29.8
Plant & Machinery
46.86(Deprecated 22.14)
Transmission Lines
2.67 (Deprecated  1.86)

Note :- I don’t know bifurcation of assets of hydro power project & smelter unit.

My second step will be to sell Indsil Manganese Ltd since it is in cyclic business and I do not want to take any risk since I have to pay loan @15 . By looking above figures of asset ,14000 M.T. INSTALLED CAPACITY of Silico Manganese , esteem fortune 500 client list and upcoming 75,000 tonne per annum ferro chrome smelter in Oman(25% stake). I can easily make PAT of 50 Cr  by selling alone Indsil Manganese Ltd , even considering, no power linkage will increase production cost. I am also not considering Sree Mahalakshmi Smelter acquisition since acquisition was done in the current year.
Let’s be conservative and assume I am able to sell Indsil Manganese Ltd with PAT of 30 crore . So , I will return 30 crore to my lender. So, now my loan amount will be just 7 crores  .

Now I would have only one company Indsil Hydro Ltd . But how will it lay golden eggs regularly ?
Bronze egg laid by Indsil Hydro Ltd will become golden by REC (Renewable Energy Certificates) .
REC get traded on INDIAN ENERGY EXCHANGE .
What is REC (Renewable Energy Certificates)?

               Hydro power plant of Indsil got Registered on 16-01-2012 REC . So, it is eligible to sell REC certificates on the exchange.


                              Refer https://www.recregistryindia.in/index.php/general/publics/registered_regens for complete registry .
              
What is REC rate ?
               Price band of REC for non-solar category is from 1500 to 3900 . First year Avg traded value was 1500 but last year it has improved to 2900 .
Last month Avg value was 2402. Most of the action is seen in near year closing period . So, price can be improved from here .





 


We can check last trading price at http://www.iexindia.com/RECData.aspx .


Get all the news about REC (Renewable Energy Certificates) in India at http://reconnectenergy.com/blog/category/rec-mechanism-india/renewable-portfolio-obligation-rpo/


How much it will benefit to Indsil Hydro ?
I don’t know exact PPA of company with KSEB for power . But I have observed Avg rate of 3.33/unit in the last few years as per annual reportApart from this power sell  revenue , now there will be additional revenue by selling REC units. This additional REC revenue will be without any expenses. 





                                   REC Revenue @
Power Unit in crore
Power Unit Sell rate
Revenue From Power Sell
1500
REC+ Power Sell Total Revenue @1500
2402
2900
3900
3
3.33
9.99
4.5
14.49
7.206
17.196
8.7
18.69
11.7
21.69
4.3
14.35
6.47
20.82
10.35
24.70
12.50
26.85
16.81
31.16
5
16.65
7.5
24.15
12.01
28.66
14.5
31.15
19.5
36.15
6
19.98
9
28.98
14.412
34.392
17.4
37.38
23.4
43.38
7
23.31
10.5
33.81
16.814
40.124
20.3
43.61
27.3
50.61


21 MW power plant can generate 18.4 crore units (21*1000*24*365) in a year at 100% load factor . It can generate 7.36 crores unit at 40 % load factor . If I am not mistaken , then the company’s highest record is around 7 crores unit .


As per annual reports, history of power units generated in last 6 years. You can access last 2 years annual report from BSE web site. http://www.bseindia.com/bseplus/StockReach/StockQuote/Equity/Indsil%20Hydro%20Power%20And%20Manganese%20Ltd/INDSILHYD/522165/IronSteelIntermProducts




                                   Year

2006
2007
2008
2009
2010
2011
Unit Generated in crores
5.2
3.97
5.89
2.7
3.78
4.3

Case1 :

The company had generated 4.3 crore units last year if company do the same then also it can generate revenue of 26.85 crore on last year’s Avg REC rate.
Whatever amount of capital company has actually employed in power planct, but for me I have employed only 7 Cr . So it becomes 300 % return my capital employed and it is not one single year that is a golden egg laid by Indsil Hydro. It is going to continue for many years . Only issue I will face is , I cannot re-invest that amount @ ROCE of 300% in the company again. I will have to deploy earned amount elsewhere, after paying the interest of around 1 crore to my lender .



The registration granted shall remain valid for a period of five years from the date of registration certificate i.e. 15/01/2017 for Indsil hydro. Company can apply for revalidation or extension of validity of existing Registration at least three months in advance prior to expiry of existing Registration. Please refer https://www.recregistryindia.in/index.php/general/publics/ProcedureRegistration for more details.

Now consider power plant produce 4.3 crores units every year in next 30 years and also assume REC units will be traded on avg price of 2900 for next 30 years . So our total revenue comes to 4.3*(3.33 + 2.90) = 26.79 . Now reduce 1 crores of operation expense (very low in case of Hydro Power project), 1 crores of interest on my personal loan and tax around 8 crores . My final profit will be 17 crores / year . Yes , with big assumption REC will be continue for that long period and realized rate is 2900/unit. We are at least sure about next 5 years .Now we will calculate my wealth for next few years by investing my profit 17 crores / year  . After seeing following figures , don’t be hesitate to call me biggest mad on the earth. It shows too much pretty picture which is unbelievable.


                                 Wealth in crores after following years

3
5
10
15
20
25
30
 9% p.a. RD
61.18
112.13
287.69
562.57
992.93
1666.74
2721.72
Got lucky , invested in MF /other investment with return of 15% pa.
69.22
135.91
422.29
1025.75
2297.35
4976.84
10623.02

Case2 :

Now I will come from sky to ground. Current market cap of company is 37 crores .  I make deal with promoter and followed by open offer , I managed to get this company 3 times current market cap i.e. around 110 crores . Now I will sell smelter division with 30 crores with all asset & liabilities. Now I will have only power plant with zero debt . My cost is 80 cores , I will have to pay interest @15 / year i.e. 12 crore / year . Lender was kind enough to extend loan amount.

Total Revenue

26.85
Interest Paid
12
14.85
Operational Expenses
1
13.85
Tax
4.155
9.695

PAT
9.695

My PAT / year will be 9.70 but consider it is 9 crores . I am not lucky so will invest in recurring deposit @ 8 . What will be my wealth now ?


Wealth in crores after following years

3
5
10
15
20
25
30
 8% p.a. RD
31.7
57.43
120
269.57
458
738
1154.05

 It can be more if I retire my high interest rate debt first instead of investing in RD@8. That will be another calculation , so avoided it.


Case3 :

            The promoter is holding more than 53 % and government is holding 6.64% in this counter . Promoter saw a dream . Not sure about promoter but the analyst (even rating agencies) are coming on business news channels and saying the Government  is sleeping . :)

God came into dream of the promoter and said leave all these moh maya ( illusory world ) of  metal and commodity business and create golden laddu (egg is Non Veg, so god avoided it)  for your shareholder and being yourself major shareholder you will also get majority of golden laddus( ball) . Promoter reacted immediately  and made plans similar to mine .
               Step1 :- Sold all business of smelter unit along with Stake in other company ,MF,raw materials , cash ,asset , liability in 30 cr PAT ( I am not a tax expert , but if company sells these business units then tax should be less , and tax should be on profit by selling these units) . Since, the company is going to adapt shareholder friendly policy , So decided to pass on these profit immediately as dividend and shareholder can reinvest that amount as per their own choices.  Current effective Dividend Distribution Tax is 16.23% which translates into 4.869 on 30 crores. So , per share dividend will be 30-4.869/1.59 = 15.80 . The shareholder will receive tax free cool dividend of 68 % on current price around 23. So the effective invested amount becomes 7.5 / share for shareholder invested around price of 23.

Last year power plant generated 4.3 units which is also coincidentally average of the last six years. Now consider it will be same average in the future .
Total revenue from power plant will be 4.3(3.33+2.9) = 26.85 .  There will be 1 crore operational expenses ( hydro power plant is known for low operational expenses) . So PBT will be 25.85. If you analyze last few years annual reports then you will figure out tax is always less than 30 % PBT . Let’s assume it's 30 % . Tax will be 7.75 . PAT will be 18.10 crores . Since the company is going to adapt shareholder friendly policy , will give this amount as dividend to shareholders . So , shareholder will receive tax free dividend of 9.53/share per year after paying DDT. It comes to around 41 % of current price but we had received dividend 15.80 after the sale of smelter division  . So , on our effective price of 7.5 we are receiving tax free dividend of 9.53 which translate into whopping 125 %  per year and shareholder has his/her own choice for reinvesting it.


Advantage of applying above mentioned strategies :
1.      Cost of raw material (water) is almost zero for golden eggs , Even, Hen which used to lay golden eggs might have been consuming high cost raw material.  :)
2.      Average age of hydro power plant is 40-50 year . It has operational from last 12 years . So still long life is remaining.
3.      I can go on long quarterly vacation , just need to take a weekly status report of unit generated.  Complete peace of mind.
4.      Most of the revenue is going to the bottom line , the government gives some tax benefits as well.
5.      Little or no competition.
6.      Average rainfall in Idukki district of Kerla is 3265  mm , which is 3 times the Pune district average rainfall .So very low chances of drought.
7.      21 MW power plant can generate 18.4 crore units in a year at 100% load factor. Some of the hydro power projects run with a load factor of 60 % . So there is scope to increase efficiency further .
8.      I don’t know the exact detail PPA of company with KSEB . Any increase of tariff rate as per PPA, in the next few years will be surprisingly positive.
9.      No exchange rate related worries.
10.   No direct risk of what is happing in USA , Europe elsewhere in the world . Since, I have already sold risky and cyclic business unit.
11.   It rarely matters who becomes the next PM . No issues if Narendra Modi or Rahool Gandhi or Digvijay Singh becomes PM.

Risk :
1.      Most of SEBs are already on the verge of bankruptcy , if anything happens to  KSEB and no other buyer is willing to buy .
2.      Any physical damage to power plant which is not insured .
3.      Any negative policy for REC.

I just want to elaborate how much cheaper this stock is trading now . Nobody , is going to offer me a loan in crores.
As we know , Warren Buffet has made a lot of wealth not only by buying stocks from the market but also majority controlling stake in the company .

I don’t know how great investor like Warren Buffet, Charlie Munger, Seth A. Klarman , Peter Lynch , Mohnish Pabrai ,Rakesh Jhunjhunwala or Professor Sanjay Bakshi would have reacted to similar type of opportunity but I, a normal value investor would have grabbed it with both hands if the fund is available with me. Not only on current market cap of 37 crore but till 3 times of current market cap i.e. 110 crores.  110 -30 = 80 Investment , 26.85 Avg revenue which translates into 33% return on my investment or capital employed every year.

Investing in Stock of Indsil Hydro Power & Manganese Ltd :
One think is sure buying a company and buying a stock is completely different thing , even though stock buying is considered to be buying a portion of the businessIf you are buying stock of Indsil Hydro Power & Manganese Ltd then there are a couple of extra risks emerges as compare to buying the company.

Stock Risk :
1.      Any corporate governance issue is risk , which is applicable to every stock.
2.      It is not possible for a company to demerge power plant . It will increase silica manganese plant production cost. So, stock can’t become risk free.
3.      Even though there will be predictable and stable revenue from power division but any global issue can impact smelter division.
4.      We are not aware Sree Mahalakshmi Smelter acquisition impact on the balance sheet.


Best time to invest in this stock would be when we see that smelter division is expected to show a profit. Smelter division has posted around 5 crores of loss for Last 9 months.

Now calculate expected price when good times return for smelter division . I don’t know when that time will come maybe 3 years , 5 years or next year. Nobody knows.
Due to the de - bottlenecking operation , Sree Mahalakshmi Smelter acquisition and upcoming 75,000 tonnes per annum ferro chrome smelter in Oman (25% stake) , I am sure in good days Smelter division will post PAT in excess of 15-25 crores .




                 Expected Market Cap @ 
Power Division PAT
Smelter  Division PAT
Total PAT
3PE
4PE
5PE
6PE
7PE
20
10
30
90
120
150
180
210
20
20
40
120
160
200
240
280
20
25
45
135
180
225
270
315

I don’t know how will be price movement of this stock in near future . There might be seller which will sell even below Rs 20 because they are not interested in fundamental of the company or have great knowledge of commodity pricing and expecting more & more losses for smelter division . Secondarily , this is a small cap with inconsistent growth , so very few analysts or nobody is going to analyze it in some depth. But one thing is sure whenever good days will return to smelter division , it will become multi bagger from current levels with minimum risk .The promoter also senses an opportunity to increase stake at low valuation and due to REC positive impact, last quarter promoter shareholding increased (first time in last 4-5 years) from 50 % to 53.63 % . I believe they are also having a shortage of funds like me , else should have brought more than 5 % and given open offer :) .

If you know any stock with golden eggs then please share with us , together we will make impact to reduce import of gold and contribute to reduce the current account deficit of India .

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4 comments:

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    Only Indian Businessman have made, value investing mockery. As an investor we need our investment grow - not in the fantacy world drinking water.

    I need not tell - you may review your own picks.

    ReplyDelete
  2. Thanks APPASAMY ,
    I completely agree with you , investor in Indian stock market are mercy of promoters. We have very low standards of corporate governance. This not only applicable to value stock but also with growth stocks. You have to pick out of favour stock in value investing which are having some catalyst.
    Anyhow , I see my portfolio of growth stocks is growing and values stocks is shrinking . I admit , I made few mistakes early in my picks by giving holding companies as value pick and not realized that gap is ever going to remain and stock performance will be related to underlines stocks .
    I have almost stops to discuss value picks from more than 1 years. Value investors are always on the lookout for catalysts. While buying assets at a discount from underlying value is the defining characteristic of value investing, the partial or total realization of underlying value through a catalyst is an important means of generating profits. I see REC (Renewable Energy Certificates) catalyst for Indsil Hydro . Registration is valid for 5 years and will be renew after that .
    So company is going to get PBT of 12-14 crore from REC without investing anything that is huge amount for 37 crore company. Total PBT from power division would be around 20-25 cores , if company deploy this amount in wealth creation of investor then it can grow tremendously. So ball is promoters half , they will decide fate of this counter. I do not expect immediate upside in this counter, counter performance depend on smelter division performance.

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