Tag: #DCF

My notes on Rajshree Polypack, a company that makes packaging for F&B industry

As I have understood, there are two packaging types – rigid and flexible. In rigid packaging, there are broadly two methods to make packaging – Thermoforming and Injection Molding. In thermoforming, plastic rigid sheets are subjected to heat for molding into a desired shape. IM on the other hand, converts plastic pellets into molten material, which is then injected into a mold. Thermoformed packaging is thinner than injection molded and as such both methods have different applications.

Rajshree Polypack (RPPL) is a microcap company that was started as a partnership firm in 2003 and then incorporated as a pvt ltd in 2011. The company makes plastic rigid sheets and thermoformed packaging for food and beverage industry. Plastic rigid sheets are both sold directly to end-customers and are used in captive production of packaging goods. The company has been steadily increasing capacity of both extrusion (for making rigid sheets) and thermoforming.

In FY23, they got into making IM packaging through a toll manufacturing agreement (i.e., Rajshree supplies the raw materials and pays a fee to access the contractorโ€™s manufacturing capabilities). As of now, the mfg capacity is 1,000 MT.

They have entered into a JV – Olive Pack – to make coated paper cups, glasses etc. The capacity will be 12,000 MT. This will get operational in FY25.

Moat

RPPL has a good list of marque F&B customers that have a stringent quality, timely delivery and turn-around-time criteria for packaging. It is not easy to become an approved supplier to such customers. In a very competitive and fragmented industry, this is perhaps RPPL’s biggest and only moat.

What is stopping me from developing 100% conviction just yet?

RPPL is trading at a market cap of INR 230 Cr (as of 20/12/24). 10 years ago in FY14, Mold-Tek Packaging – which makes Injection Molded packaging for paint, lube and F&B companies – had very similar sales (250 cr) and margin (12-13% EBITDA) as RPPL has today. But, Mold-Tek sweated their assets better and made Rs 3 for every Rs. of assets, whereas RPPL, which has a asset turnover of 2 currently. However, Mold-Tek had a higher D/E of 1.3-1.4 vs RPPL 0.7 currently.

During FY14, Mold-Tek saw its market cap become 5-6x from 50 cr to 250-300 Cr, which is at a shouting distance from what RPPL is trading at today. Mold-Tek then went onto post great results year after year. Although, initially they used a lot of debt to drive growth, but very quickly they pared it down to comfortable levels and used internal accruals to increases sales 3x (from FY14; 4x from FY13) to 730 Cr, expanded cumulative EBITDA margin to 17.5% with a weighted avg asset turnover of 2.3. The company now has a market cap of ~3,000 Cr i.e., 10x after its peak valuation of 300 cr in FY14.

The question is can RPPL replicate Mold-Tek’s growth? I do understand that comparison with Mold-Tek may be unfair since it draws 70% of its sales from paint, lube and oil customers; I am attempting to dig out what worked for Mold-Tek and how is RPPL placed currently.

So, now coming to why I don’t have full conviction just as yet?

  1. RPPL supplies to F&B industry only. Thermoformed packaging is thinner vs IM and hence is used in holding lighter content i.e., packaged food. IM packages, on the other hand, find application in a wide variety of industries – paints, lubricants, oils besides F&B. (Back in FY14, Mold-Tek drew 90%+ sales from paint and lube industry and how the split between paints, lubes: food, fmcg is 70:30. Being able to supply do multiple industries seem to have worked well for Mold-Tek). Moreover, thermoformed packaging cannot cater to heavier food content such as ice creams, shrikhand, spreads, dosa batter etc. Not saying thermoforming is inferior. It certainly is not. It finds its end use in different applications, which has limited RPPL to one industry. Make no mistake, F&B industry has great growth potential, but I would have been more confident about RPPL’s prospects if they didn’t stay confined to just F&B.
  2. No in-house Injection Molding yet. RPPL recently forayed into IM through a toll mfg agreement for food delivery containers. Since RPPL does not own the IM mfg tech, they likely wouldn’t be able to tech innovate (as Mold-Tek has been able to) and sign up existing and new marque customers for IM containers. Mold-Tek designs, maintains and manufactures their own molds (they also use robots for in-mold printing and decorating), which has given them an edge over competitors and has also helped them get exclusivity contracts with certain lube customers. Large customers are very picky when it comes to packaging since it is the face of their brand and hence they may not source from a company that does not own the mfg process. This may change in the future if and when RPPL begins investing in its own IM capability (and this may also help them foray into other industries).
  3. Capital allocation decisions! Value proposition in developing paper packaging? Will it lead to a moated business model? I am not so convinced. Although, this will likely give them good sales uptick serving HoReCa, but then how does it help in building a sustainable competitive advantage? Paper packaging is a non-differentiated / commodity item (but then one might argue that plastic rigid sheets are as well). What stops HoReCa customers from switching to (and keeping) other vendors? I believe the differentiation may not entirely be in the product per se (but because they have a good clientele, they may be to upsell them this new product category). Moreover, this new mfg capability demands an investment of 100 Cr, of which RPPL is putting half. To put it in context, this 50 cr is 1/3rd of RPPL’s gross fixed assets. Allocating an amount equivalent to 1/3rd of your gross fixed assets in a capability with low competitive advantages may not have been the best thing to do in my opinion. I hope I am proved wrong!
  4. Possibility of margin expansion? Over the last 5 years RPPL has witnessed its margin deteriorate (although, they have been able to more-or-less pass on RM price increases with a lag). This has been due to low operating leverage, high depreciation and interest cost. As op leverage plays out, they should see their margin expand. Mold-Tek expanded their cumulative EBITDA margin by 5% over the last 10 years because of widening gross margins, operating leverage and low levels of debt. Moreover, in-house IM mfg and automation has aided Mold-Tek keep in its margin expansion. Now, RPPL has in-house thermoforming, but since they don’t own the IM mfg, this may constrain RPPL’s ability to expand its margins to the extent Mold-Tek has been able to.
  5. Promoter giving aggressive guidance?. There have been instances (although I am leaning towards not reading much into them for now) where the promoter has not entirely walked the talk e.g., promoter was confident on margin expansion in FY23, but that didn’t happen. They were also expecting the olive pack mfg plant to commence from Oct, Nov 2023, but that didn’t happen. Re: barrier packaging sale, promoter gave a guidance of 30 cr+ in FY24, however only 10 cr in H1 has happened. I like conservative promoters better.
  6. Tube lamination business commenced, but was put on halt. The management seemed very ecstatic about this business at one point, but now they are saying it has been paused and will be looked into at a later point.
  7. Statutory audit fees increased from 8 L in FY21 to 16 L in FY22 to 22 L in FY23. Sales and scale of operations also did increase from 16K MT to 26K MT in this period. Scale can be equated to more work for auditors. So this is fine for now. However, if the disproportionate increase in audit fees continues then it will be a red flag.
  8. Strategic foreign investor gradually reducing their holding. Wifag Polytype Holding AG has been decreasing shareholding; 19.8% FY22 to 17.2% FY23 to 16.4% now. Moreover, Mr. Alain Edmond Berset (DIN: 07181896) resigned from the post as the nominee director of the Company (on behalf of Wifag Polytype Holding AG) w.e.f March 10, 2023.
  9. Aging receivables. 8% of the receivables were aged in FY23 i.e., beyond 1 year. This number was 4% in FY21 and 2% in FY22. RPPL has credit terms of 60 days. Since RPPL adds a good number of customers every year. I am assuming not all of these are very known brands. Many of these may be small mom-n-pop F&B businesses. If these small businesses don’t do well, they may shut shop and just not honor their payments to RPPL.
  10. Regulatory overhang. RPPL has stated that its products are of a much higher thickness than the ones which the government has sought to ban. Even if the regulations become aggressive, the end-companies wouldn’t stop selling their products. They will resort to alternatives such as bio-degradable packaging or thicker plastic. RPPL has also repeatedly stated that it has the capability to manufacture bio-degradable / sustainable products and they have the required certifications.

Despite having raised the above, one can’t overlook the fact that RPPL has a great set of F&B clients that can be sold more products in the future (but that will take some doing). Even with supplying the existing set of products to these existing clients, RPPL should continue growing. However, I’d like them cover a broader part of the value chain; they are doing it currently, but perhaps not in the way it has been done (by Mold-Tek).

Closing Thoughts and Valuation

It is interesting to note that as per my DCF (after projecting the three financial statements), for RPPL to almost justify its current valuation of Rs. 230 Cr, the company needs to demonstrate very similar growth, margin expansion and capital efficiency as Mold-Tek did over the last 10 years.

I am tempted to say that the market is pricing in the same high growth as Mold-Tek for RPPL, but that may not be entirely true. Right now, Indian micro and small cap scape seems to be in euphoria. People are playing the momentum game (I don’t know how to time the markets; I have a very long term investing horizon) so the market pricing currently does not seem rational. When the frenzy fades away and normalcy returns, and RPPL is available at sane valuations, then I may take a small stake subject to how some of the above points unfold in the future.

P.S: This is not a recommendation.

For any questions or comments, feel free to email me at gautamrastogi.investandrise@gmail.com or PM me on linkedin.

Oriental Carbon and Chemicals – Indian company operating in an Oligopoly

Image credits: tirehub.com

OCCL makes Insoluble Sulphur, which is used as a vulcanizer in the manufacturing of tires. There are 4 companies – Eastman / Flexsys (US), Shikoku (Japan), Chinese Sunsine and OCCL – that make a major chunk of the IS in the world. High capital intensity and long IS approval cycles by tire manufacturers has posed high barriers to entry making this industry an oligopoly.

Market: As of FY23, the global market size of IS is under 3,00,000 MT (or 300 million kgs). A bulk of the demand is driven by replacement (~70%) and the rest through new tires. The table below shows the global demand distribution.

India (non mentioned explicitly in the above table) has a market size of 20,000 MT i.e., ~7% of global. Only 50% of Chinese demand is quality IS. Since OCCL is into making various grades of quality IS, hence, the addressable market as of FY23 is closer to 2,50,000 MT.

The table below lists the global tire production and avg IS requirement per tire. You would see that the avg IS requirement per tire is 120 grams. Take these numbers with a pinch of salt, since I wasn’t able to reconcile tire production numbers from other sources, but they are in a distant ballpark.

Source: expertmarketresearch.com, IMARC group, OCCL Annual Report

Indian market is expected grow in double digits over the next 10 years driven by increasing radialization of tires and shift towards EV. EVs require lighter tires, which in turn demand more IS. Global market is expected to grow at 3% CAGR over the decade.

Market Share: Eastman has 60-70% global market share and is a price setter and other companies are price takers. OCCL has 55-60% market share in India, and a market share of under 10% globally. Tire makers like to work with more than one supplier and hence OCCL is either a preferred or secondary supplier to leading players like MRF, Brigdestone, CEAT, JK Tire etc. OCCL has sub 5% market share in the US. Over the past few earning calls, OCCL management has said that they are targeting to get to 10-12% market share in the US and it is a key focus area for them. They couldnโ€™t penetrate the Chinese market and are not focusing on that market anymore.

Business: Over the last 3 years, the industry has witnessed high raw material (sulfur) costs. Although, like other players OCCL is able to pass the increase in raw material costs to its customers with a lag, resulting in OCCL able to largely sustain the absolute gross profit per kg of sold IS, but this does not help sustain gross and operating margins. Due to high sulphur prices, the IS ASP / kg for OCCL increased from Rs 125 in FY22 to Rs 150-160 in FY23 per my estimates, but the gross and operating margin remained depressed at 60% and 15% respectively. On a good year, their gross and operating margins are 70% and 25%.

OCCL has a total IS capacity of 39,500 MT. Every 3-4 years, they do an IS capacity expansion of 11,000 MT in two phases if they have reached 85-90% of capacity utilization and if they see a healthy demand environment (They also manufacture Sulfuric Acid and use the steam produced in the process to make IS. Sulfuric Acid makes under 10% of their sales). Making IS is capital intensive and while ramping up capacity, it takes a while to reach optimal utilization.

Moat: the oligopolistic nature of the industry, high entry barriers, and tire radialization and EV tailwinds, coupled with regular expansions and low cost manufacturing (vis-ร -vis US and Japanese makers) are moats for OCCL.

Few things to note before considering an investment:

  1. High Freight Expenses: Other expenses were 102 cr and 135 cr in FY21 and FY22 respectively. Freight was 25% and 31% of other expenses in these years. Due to supply chain congestion around the world and since all the markets have presence of IS suppliers on their shores, OCCL incurred high expenses shipping to export markets. This dilutes OCCL’s moat of being a low cost player.
  2. High expansion spending? May be not!: Phase 1 of a brown field expansion costs OCCL Rs. 200-220 per kg, whereas China Sunshine incurs 50% less than OCCL to build phase 1 IS capacity. Reasons could be a.) OCCL is spending more than they should Or b.) As per my estimates, OCCL sold IS at Rs 125 per kg in FY21 and FY22, but China Sunshine sold IS at Rs 90 in the same time periods. This suggests that China Sunshine perhaps makes an inferior quality and hence it costs them less to set capacity for IS.
  3. Threat from Chinese competitors: While there is always a lingering threat from China, but as per ICRA credit report from Augโ€™22, Chinese companies lack the required Environmental, Health and Safety standards and because of their inconsistent quality, global tire manufactures are wary of sourcing from them.
  4. Sale of Eastmanโ€™s tire additive business to PE: This transaction happened in 2021. It remains to be seen what the new management does. If they expand aggressively then it will adversely impact IS prices.
  5. De merger into two listed entities: Oflate, OCCL has done a lot of AIF investments, which has not gone well with the shareholders. They are now splitting into two companies – one will be the chemical business and the other will be focused on such investments. Existing shareholders will get shares of both the companies.
  6. OCCL Promoters – Compensation: The promoters Arvind Goenka and his son Akshat Goenka have demonstrated good execution, resulting in increasing capacity from 3,400 MT in 1994 to 39,500 MT today and achieving a dominant market position. Overall compensation of the two promoters combined has been historically at 6.5% of PAT. Since, the PAT declined (from 83 cr in FY21 to 46 cr in FY22) by 44% in FY22, the commission portion โ€“ tied to profits โ€“ declined as well (from 2.2 cr to 1.7 cr i.e., 23% decline), but the salary component increased (from 3.1 cr to 3.3 cr) to offset the decline in commissions. As a result, due to sharp PAT decline, the sticky overall compensation jumped to 10.9% of PAT in FY22 (still within the statutory limit). For now, I think this is fine and am not making anything of it, but it needs to be tracked.
  7. Unexplained Payments of service charges, rent to related parties and miscellaneous expenses: There are unexplained services charges of 1.26 cr in FY22 (and 1.07 cr in FY21) to Duncan International (India) and New India Investment Corp, which are promoter entities. There is an additional annual service charge of 1.08 cr, which is embedded in the highlighted line item below. I am not sure what these charges are for. There is a rent payment of 0.83 cr in FY22 to a Cosmopolitan Investments Ltd, another promoter entity. While rent can be understandable, but these service charges make up 1.7% and 2.1% of other expenses (and 0.6% of sales) in FY22 and FY21. There are unexplained miscellaneous expenses of 8.16 cr in FY22 and 6.68 cr in FY21. These make up 6.0% and 6.5% of other expenses (and 1.8% and 2.0% of Sales) in FY22 and FY21, respectively. They could itemize this and provide some detail. Service charges and Miscellaneous expense combined form 8-9% of the Other Expenses and 2.5% of Sales. This is the main gripe I have – unexplained expenses! This is up to investors as to how they want to read this.

Valuation: OCCL is trading 16x earnings and 1.3x book at a market cap of ~780 Cr as of this writing (1/7/2023). My DCF valuation (after projecting the three financial statements) finds OCC to be fairly valued.

Valuations are subjective. I have taken many assumptions to project out cash flows for OCCL. Some of the key ones are as follows:

  1. Discount rate of 14% as my bare min return expectation
  2. Operating Margin of 20% which is their historical average.
  3. Implied 10 year CAGR growth of 6.5% after assuming a market share decline from 55-60% to 50% in India, a global market share of under 10% and only a slight increase in realization per kg of IS over 10 years. Any radialization and EV tailwind is my (unquantified) margin of safety.
  4. 2×11,000 MT capacity expansions in two phases resulting in an overall capacity of 61,500 MT over 10 years. This is consistent with history.

While I need to get clarity on the unexplained expense line items (particularly the service charges to promoter entities), I am leaning towards taking an educated bet given their business moats. But Iโ€™d sit on the fence for a while and will likely pull the trigger when it is available at a discount.

PS: This is not a recommendation.

Equity Research – Star Health Insurance

Section 1: Understanding Health Insurance Business in India

The number of lives covered has increased from 22% of the population in FY15 to 40% (~55 Cr) in FY22.
Government sponsored schemes (including RSBY Rashtriya Swasthya Bima Yojana) accounted for 68% of the total lives covered as of FY22; Group Business (i.e., employer provided coverage) 22% and Retail 10% (5.5 Cr lives).

Retail has over 40% MS by value i.e., 5.5 retail lives contribute over INR 30,000 Cr to the overall INR 73,000 Cr health insurance premium.

Health Insurance is provided by standalone health insurance (SAHI; Care, Niva Bupa, Star Health, etc.), multiline (ICICI Lombard, Bajaj Allianz, etc.) and public sector insurance companies (New India Assurance, National, etc.)

SAHI companies are retail focused; more than 50% of retail customer premium goes to them. SAHI companies derive 80% of their premium from Retail.

Retail Health insurance is an agent assisted product. Retail customers rely on agents, web aggregators and advisors like Ditto Insurance to guide them towards purchasing the right policy.

๐’๐จ ๐ฐ๐ก๐ฒ ๐ข๐ฌ ๐ซ๐ž๐ญ๐š๐ข๐ฅ ๐ฌ๐ž๐ ๐ฆ๐ž๐ง๐ญ ๐š๐ญ๐ญ๐ซ๐š๐œ๐ญ๐ข๐ฏ๐ž?

  1. ๐‹๐จ๐ฐ ๐ฉ๐ž๐ง๐ž๐ญ๐ซ๐š๐ญ๐ข๐จ๐ง: As of FY22, only ~17% (from 10% in FY17) of India’s population outside of govt plans is penetrated with health insurance. There is certainly scope for more penetration.
  2. ๐‡๐ข๐ ๐ก ๐จ๐ฎ๐ญ-๐จ๐Ÿ-๐ฉ๐จ๐œ๐ค๐ž๐ญ ๐ž๐ฑ๐ฉ๐ž๐ง๐ฌ๐ž๐ฌ: Over 60% of spends are out-of-pocket in India – highest in the developing countries.
  3. ๐€๐ ๐ž๐ง๐ญ ๐š๐ฌ๐ฌ๐ข๐ฌ๐ญ๐ž๐ ๐ฉ๐ซ๐จ๐๐ฎ๐œ๐ญ: Health insurance can be a complex product for customers to understand. As mentioned previously, agents guide customers to purchase policies suited to their needs. IRDAI norms allow individual agents to sell policies of three insurers โ€“ one life insurance company, one non life insurer and one standalone health insurer. 75% of the total premium of retail business came from individual agents in FY20. There is high co-relation between growth in number of agents and individual health insurance premium. Insurers with a growing and productive network of agents stand to benefit.
  4. ๐๐ซ๐จ๐Ÿ๐ข๐ญ๐š๐›๐ข๐ฅ๐ข๐ญ๐ฒ: Higher retail premiums (than public and group, which has corporate customers with high bargaining power) lead to higher profitability (pre-COVID Claims ratio: SAHI 59%; Multiline 67%; Public sector 92%). Lower the claims ratio the better.

All these are key reasons behind the enormous potential in this segment.

๐’๐จ ๐ฐ๐ก๐ข๐œ๐ก ๐œ๐จ๐ฆ๐ฉ๐š๐ง๐ฒ ๐ข๐ฌ ๐ฌ๐ž๐ญ๐ญ๐ข๐ง๐  ๐ฎ๐ฉ ๐ข๐ญ๐ฌ๐ž๐ฅ๐Ÿ ๐Ÿ๐จ๐ซ ๐ฌ๐ฎ๐œ๐œ๐ž๐ฌ๐ฌ ๐ข๐ง ๐ญ๐ก๐ข๐ฌ ๐ฌ๐ž๐ ๐ฆ๐ž๐ง๐ญ?

Section 2: Star Health is a health insurance leader in the retail business segment

Being a StandAlone Health Insurance (SAHI) company (others being Care, Niva Bupa, Aditya Birla HI etc), its singular focus on health insurance has led to new and innovative products (aided by IRDAIโ€™s use and file regulation) aligned to specific health conditions.

SH clocked gross premiums of ~INR 11,500 Cr in FY22 (from 3,000 Cr in FY17).
It has the ๐—น๐—ฎ๐—ฟ๐—ด๐—ฒ๐˜€๐˜ ๐—บ๐—ฎ๐—ฟ๐—ธ๐—ฒ๐˜ ๐˜€๐—ต๐—ฎ๐—ฟ๐—ฒ ๐—ผ๐—ณ ๐Ÿฏ๐Ÿฏ% ๐—ถ๐—ป ๐—ฟ๐—ฒ๐˜๐—ฎ๐—ถ๐—น (3x higher than HDFCERGO and NIA; 4x higher than Care and Niva Bupa) and draws 90% of its premiums come from this segment (higher than any other company)
The market share gains have come due to an enormous network of 13k+ hospitals, 5.5 lakh agents (3x higher than the closest SAHI) with the highest premium / agent of INR 180,000 in the industry.

But this growth has not come without some not-so-pleasant developments –

  1. Claims: For customers getting their accepted and settled on-time is paramount. SH has one of the highest claim repudiation rate of ~14% i.e., 14% of claims over the last 4 years were rejected. Aditya Birla and Niva Bupa are in a close ballpark.
    In FY21, CARE Health closed ~100% of claims in one month followed closely by ICICI Lombard that settled 99.7% of claims made during this period within a month
    Among the SAHI players, SH had the last spot with 94.4% claims settlement in one month. Public companies have lagged in claims payments
  2. Regulation: IRDAI has proposed to cap the tenure and age of MDs/CEOs of insurance firms at 15 and 70 years resp. SH CEO is past this cap.
  3. Management Compensation: If you are a value investor, you would like overall comp to not exceed 2-5% of PAT and expect comp to increase with PAT. But credit needs to be given where it is due. The management has built a good business from the ground up and they have very adequately compensated and rewarded themselves with ESOPs, which is typical for a growth company. 

SH is the only listed SAHI. It has a market cap of INR 43,000 Cr i.e., 9.5x book value and 3.7x FY22 premium. For some context, multiline insurer ICICI Lombard trades at 6.5x book value and 3.4x FY22 premium.

No matter how attractive a business is, one wants to get in at a reasonable price!
So would you invest? What price will you be willing to pay?

“Bhav Bhagwan hai”

Rakesh Jhunjhunwala

Section 3: Bhav Bhagwan hai!

No matter how attractive a business is, one wants to get in at a reasonable price.

Like other insurers, SH has two profitability streams – underwriting profit and income from investments.


Underwriting profit/(loss) is defined as gross premium less 1. re-insurance, 2. risk reserve, 3. net incurred claims (claim ratio) and 4. net commissions and other operating expenses (expense ratio)

SH has been able to increase investment assets more than 5x from 2,000 Cr in FY18 to 11,000 Cr in FY22, which is 2.4x book equity. This is a key metric they track; higher this metric, higher is their interest income
Going back five years pre-COVID, with a 7-8% yield, interest income from investments have been 2-6x UW profit pre-COVID”
Only in FY19, Cash Flow from Operations was enough to fund their investments. Other years, they have relied on raising equity, debt and existing cash to fund investments – necessary to generate an interest income (and in turn supplement the UW income/loss)

Moving forward, assuming less reliance on external capital and existing cash (~INR 550 Cr), there is more reliance on CFO i.e., profitable growth to fund investments. In the absence of that there is a danger to maintain solvency (since losses causes a double whammy – they erode equity value and increase regulatory required solvency margin) and generate interest income.
After two unprofitable years, FY23-Q1 seems to be on the way to recovery with a combined ratio (claims + expense ratio) of 98% from 118% in FY22

As of FY22, only 17% (~5.5 Cr retail and ~12 Cr group lives) of Indian population outside of govt plans is penetrated with health insurance policies
SH has covered ~1.6 Cr of the 5.5 Cr retail lives. With increasing awareness, rising incomes, retail segment may very well more than double in a decade to 13-14 Cr as per industry estimates.

My key assumptions in valuing SH:

  1. Growth: With growing hospital and agent network, SH covers 1/3rd retail lives (from ~30% today) in a decade. This translates to a premium CAGR of 15%
  2. Profitability: Combined ratio improves to 96% in FY24 and owing to operating leverage continues to gradually improve to 94% over the decade
  3. Hygiene: Profitable growth eliminates reliance on external cap and leads to a. maintenance of regulatory solvency margin and b. increase in investment assets (to 2x of networth; consistent with history), which in turn well supplements UW profit

With these assumptions, I valued SH at INR 27,000 Cr i.e., 5.7x book equity. As of 9/9, SH was trading at 9.5x book. As stated previously, for context, ICICIL is priced at 6.5x book (There is no listed SAHI player yet for a peer-to-peer comparison)

Clearly, at 9.5x book, the market is assuming a much higher growth – perhaps for both retail segment and SH market share – and/or profitability. This is my conclusion based upon my analysis and assumptions (stated above). If you are more optimistic than I am, then you may find SH to be reasonably (or even under) valued.

Does it mean, I will give SH a pass? For the moment, Yes!

Even if I get in at this the current price, in the long term I’d be okay, but I’d like to buy growth at a reasonable price (and I am not going to speculate on a target price). Remember, every normal year it is going to add earnings and may command a higher valuation.


What do you think?

PS: Not a Recommendation

EDIT: As of 14/03/2023, SH is trading at 6.9x book and ICICIL at 5.6x book. My fair valuations of SH and ICICL are largely the same at 5.5-5.7x and 5x book respectively. I will keep on waiting on the fence and take positions (if and) when they fall within my margin of safety

Equity Research – Aditya Birla Sun Life (ABSL) Asset Management Company (AMC)

** I will be creating an equity research report for ABSL AMC. For now, I am sharing the summary of my analysis and valuation (long-term return expectations) of ABSL AMC **

** Analysis and Valuation dated 29/7/2022 **

2 months ago, I had put out an equity research report on HDFC AMC, in which I had valued the firm at 28x earnings. In this post, I will present my valuation summary of another AMC, Aditya Birla Sun Life

ABSL is the 5th largest AMC in India by overall AUM. HDFC is 2nd. SBI leads, followed by ICICI
ABSL and HDFC AMC are the only two listed companies in the top 5

As of F23-Q1, ABSL has an overall and active equity AUM of ~โ‚น3000B and ~โ‚น1200B (i.e. 40% equity mix) with a market share of 8% and 6.5% resp, while HDFC has an overall and active equity AUM of ~โ‚น4000B and โ‚น2000B (i.e. 50% equity mix) with a market share of 11%

ABSL reported a PAT of 46% and EBTDA of 65%, well behind that of HDFC (PAT 57%, EBTDA 78%).

Why is ABSL less profitable than HDFC AMC?
1. Active equity is the most profitable asset class (do remember that pressure on equity yields continues owing to low priced NFOs and material gross flows), but HDFC’s higher mix of equity is a key but not the only reason for its higher profitability
2. Both ABSL and HDFC incurred ~200 Cr in other expenses โ€“ BD, new fund offering, marketing and tech expense. This is 14% of ABSL and 8% of HDFCโ€™s revenue
3. HDFC incurred 13% employee expense, ABSL 18%
This industry has economies of scale. HDFC seems to be getting the scale benefit. It certainly is maintaining a tight ship.

ABSL IPOed last year in Oct. From a high of โ‚น20,000 Cr, it has fallen to โ‚น12,000 Cr. HDFC has not done well either. Market seems to have priced in the low present and future yields and the continual debt outflows with these listed players trading near their lows

Now, I will use some rounded numbers to derive the return expectation of ABSL โ€“
1.    Ind active equity AUM is expected to grow to โ‚น 40,000 B from โ‚น 18,000 B today
2.    ABSL AMC derives ~70% revenue from active equity. They reported a quar. avg. active equity AUM of ~โ‚น1200 B. If they can slow the active equity market share decline to 5.5% by FY27 (from 6.5% today), they will reach an active equity AUM of โ‚น 2,300 B (i.e., ABSL active equity continues to grow slower than ind)
3.    ABSL derived an active equity yield of ~72 bp in FY22. With ongoing equity yield pressure, this may drop to mid-60s
4.    ABSL revenue in FY27 = โ‚น 2,300 B * 0.65% / 70% = ~โ‚น 2,100Cr
@ same 46% PAT in FY27 = 46% * ~2,100 = ~980 Cr
5.   Using 1-4, my base case DCF valuation of the company is ~โ‚น 13,500 Cr i.e., 20x FY22 earnings

** valuation with underlying excel models and assumptions will be present in the equity research report **

Considering ABSL trades at this PE 5 years out:
MCap by FY27 = 20 * 980 Cr = โ‚น 19,600 Cr (from 12,200 Cr as of 29/7/2022); Adding 2.5% div yield (based on hist. payout), the ann. return over the next 5 years is est. at 13% (after accounting other income and using actuals)
i.e., if ABSL AMC continues to grow below the industry amid a declining overall and equity yield environment coupled with higher interest rates, you could still expect 13% return over 5 years

Disclaimer: Invested. Please do your own analysis before investing.

Costco Equity Valuation

Costco Wholesale Corporation (Costco) has a solid business model with a predictable stream of subscription revenue, which constitutes 90% of the net profit.

In the video (embedded below), I have projected out Costco’s financial statements and valued its equity. Although, Costco trades at a P/E of ~36 (amongst the highest in the retail business it operates in), I have found it to be fairly valued.

I have embedded the base excel (without the projections). Please feel free to download and try to model the financial statements and value Costco’s equity if you’d like. Do write to me if you have any questions.