Friday, November 02, 2007

Competitive Project on a Deep Value Stock

Sent to my class just now:

There is a stock out there which, even in this so-called raging bull
market, is offering a dividend yield in excess of AAA bond yield (remember
Graham loved stocks that yielded more than 2/3rd of AAA bond yield).

The unique thing about this stock is that the company to which it belongs
is essentially debt-free. This combination of debt-free status and a high
dividend yield is very attractive, in my view.

Which stock is it?

The group which identifies it first and sends me a report on it, with not
just the name of the stock, but clear demonstration of its cheapness won't
have to submit a project for this term.

Rgds

==SB

27 comments:

Ranjit kumar said...

Hi SB,

Is it Clariant Chemicals which has given a 11 rupee dividend in 2005 and (Rs9 + Rs9 spl div) for 9 months ending 2006 Dec. So if the company maintains the same dividend level, the divdend this year should be Rs12 and next year should most probably be Rs12 or more which makes it Rs24 dividend for around 13-14 months.

With the current price of 267 the yield is around 9% and the AAA corporate bond yield is 8.68%

The company has little debt of around 6 crores and for a market cap of around 710 crores it is less than 1%

The september 2007 quarter loss is a one-off thing due to restructuring.

Regards,
Ranjit kumar

Ranjit kumar said...

Hi SB,

Sorry wrong calculation. The special dividend by Clariant chemicals for 2006 is 10/-. So the effective yield if they continue 11/- rupee dividend of 2005 in 2007 & 2008 Dec is 22/267 = 8.23%

Regards,
Ranjit kumar

VISHNU said...

Sir

I think it is DivyaShakti Granites

Dividend Yield is 7.9 , Zero Debt and the PE is around 4.5.

They are maintaining this dividend rate (10 - 15%) for the past 5 years.

Valuations:

Current Market Cap = 19 Cr
Current Networth = 22 Cr
(Past) 5 year average of Addition to Networth = 3 cr / Year
(Past) 5 year average of Dividend = 1 Cr / Year

Pessimistic Scenario:

(Future) 5 Year cumulative Addition to Networth = 5 cr (1 Cr /Year * 5 year)
(Future) 5 Year cumulative Dividend = 2.5 Cr
Future Networth = 30 Cr (22 + 5 + 2.5 cr)

Margin of Safety = 11 cr (Future Networth - current Market Cap)

I think huge margin of Safety exist even if we put pessimistic scenario. (I have not included Neutral & Optimistic Scenarios)

Possible flaws in my theory

1) Networth may not give a true intrinsic value (but I may be correct roughly)
2) Divyashakti is a micro cap stock
3) Granite is a commodity (No moat around the company)
4) Divyashakti units are EOU (Export Oriented Units) So they can hurt by currency fluctuations
4) I dont have any knowledge in Granite Industry
3) I know only layman accounting


Regards
Vishnu

Sanjay Bakshi said...

Ranjit, its not Clariant. A few observations on your post:

You have taken your estimate of Rs 22 per share as dividend likely to be paid over "13 or 14 months" and used that for computing dividend yield. This, in my view, is not appropriate because one has to take dividend on a continuing basis and not just next 13 or 14 months.

Can Clariant afford to pay a dividend of Rs 22 per share every 14 months, which is equivalent to Rs 19 per share per annum? I think not because the company does not earn that much every year.

Dividend yields should be computed on a sustainable basis. While its true that a company can pay more than its reported earnings as dividend - indeed Clariant did that in 2006 - it would be incorrect to assume that this can be done on a continuous basis.

Also notice that Clariant's depreciation for the last four years is less than total capex. While its true that some of this capex is for growth, and not for maintenance of its producitive capacity and competitive position, the fact remains that cash used up for capex is cash that is not available for payment of dividends. So, not only are the reported earnings insufficient, the company's cash flows also do not allow a continuous payment of Rs 19 per share per year as dividend...

Sanjay Bakshi said...

Vishnu, its not DivyaShakti Granites, although I have to say that from what I have seen about this stock in the last 20 mins, it could well have been one answer to the quiz!

I will post my answer soon - the quiz is open right now, so I have to wait...

Thanks

Mumbai Journo said...

Is this KRBL?

The stock has given 20 per cent dividend. trading for Rs 84 with a book value of Rs 112.91. The company has nearly zero debt though its working capital requirements are really high.

The stock is really cheap because of worries over the falling dollar impacting exports. However the management insists that they will get a higher price for Basmati Rice, the company's main exports.

The company's main client is in Saudi Arabia followed by the US. In Saudi the company needs to inform the authorities and seek permission to raise prices. Last year KRBL raised prices 20 per cent and more hikes are in the offing.

As an investor I hope that KRBL does not reduce prices next season when it can acquire raw materials cheaper.

sandy said...

Sir

is it zenith fibres or bharat seats?

VISHNU said...

Sir,

Is it Panasonic Carbon India Company Ltd ?

Dividend Yield is 5.2% (almost equal to 2/3 of AAA bond yield (is it 8% ?? ) , no Debt and the PE is around 11

Valuations:

I think this is no brainer stock.

Cash 40.99 Cr
Market Cap 53 Cr

Huge amount of Margin of safety exist given this company is paying 2.8 Cr as dividend to shareholders (past 5 years) and adding 2 Cr to shareholders fund for the past 5 years.

Regards
Vishnu
(Sir I will keep posting till I get the final answer :) , I hope you dont mind)

Anonymous said...

ultramarine and pigments?

VISHNU said...

Sir,

Yeah....I got it..I think this is your favourite stock VST Industries. (I am very ashamed of being a follower of your interviews, I should have guessed it earlier.)

As of today Dividend Yield is 6% , No Debt..Slow but Steady growth industry (Cigarette)

Regards
Vishnu

Sanjay Bakshi said...

It is Ultramarine & Pigments. A few things:

1. The yield is higher than AAA bond yield. This is true even if we ignore the fact that dividends are tax-free in the hands of investors. That is, I am not grossing up a tax-free dividend yield to compare it with AAA pre-tax bond yield.

2. Because of the above, we have a "positive cash carry" trade i.e. cost of borrowing is less than the income return.

3. Among other things, the company has an interest in an IT business, which has been seeing a drastic decline it its operating profit margins. This negative trend should not be ignored by the investor who is buying for the yield, becuase the future yield may be influenced because of it. Buying high yielding stocks, is tantamount to betting that the market is wrong about future dividend policy. If the investor is proved right, then he/she will do very well with such stocks. But, if the invetor is proved wrong and the dividend is cut, then there may be losses... One has to see how much dividend is sustainable considering the negative trend in the IT business.

4. The debt-free balance sheet should be given substantial weightage in determining the staying power of this company - although not for the continuance of its liberal dividend policy.

5. The company has been paying liberal dividends and has not cut them in the past several years.

6. There has been significant insider buying.

Suppose that you came to the conclusion that Rs 3.50 dividend is sustainable from earnings other than those of the IT division (i.e. you are assuming that the IT division will not make any money at all going forward - nor will lose any money for that matter), then using simple back-of-the-envelope calculation it can be seen that the dividend stream of Rs 3.50 per share alone is worth about Rs 60 per share. (Rs 3.50 /5.85% being post-tax AAA bond yield - pre-tax AAA bond yield is 9% p.a.)

Rohit Chauhan said...

Prof bakshi

Let me start by saying that I have a personal stake in ultramarine and hence more likely to have a favourable bias to the company. However the key reason for keeping the stake small is due to the IT services division.

The capex for the laundry and allied division and other divisions , is almost equal to depreciation. So we may be able to assume that EPS is roughly equal to the free cash flow. So with an EPS of around 6.5 and 50% coming from IT, the company’s ability to maintain dividend depends on the IT division. If the IT division starts losing money then the company may end up paying the entire FCF via dividend.

IT services is a fairly scale driven business. Ultramarine had 15 Cr of revenue last year with almost 50% PBIT margins and very low level of invested capital. I am not so sure if the company can maintain the margins at the current level in the long run. The IT division was actually loss making in 2002-2003 and has turned around since then. The company does not disclose much in the AR on the IT services division and hence it is difficult to judge the sustainability of the revenue and profit of the division

Due to the above reason I am not too sure if the company can maintain the dividend (just my personal opinion though)

I have a question for you and would appreciate if you could answer it – In your previous post on ESTL, I could see the reverse thinking one could use based on the hints provided, however can you share how you filter such opportunities – do you and your team check BSE/NSE announcement regularly or some other process ?

rgds
rohit

Sitansh said...

Dear Sir,
Suppose that you came to the conclusion that Rs 3.50 dividend is sustainable from earnings other than those of the IT division (i.e. you are assuming that the IT division will not make any money at all going forward - nor will lose any money for that matter), then using simple back-of-the-envelope calculation it can be seen that the dividend stream of Rs 3.50 per share alone is worth about Rs 60 per share. (Rs 3.50 /5.85% being post-tax AAA bond yield - pre-tax AAA bond yield is 9% p.a.)

In continuation to the above from your blog what about Wyeth?
Mkt Price 460
Dividend 30 p.s.
Yield 6.5%
Debt Free plus good cash reserve
Should fit the bill too. Your thoughts Sir,
Regards,
Sitansh

VISHNU said...

Sir,

I think Ultramarine have 5.6 Cr as Debt in Balance sheet.( I am looking at 2006 AR)

Thats why I have missed Ultramarine.

Regards
Vishnu

Anonymous said...

Hello sir,
Is this company Taparia Tools? Stock is trading at 31/- and dividend they announced is 2/-. So dividend yield is 2/31= 6.4% h,higher that AAA bond yield of 6%.
Debt is only 2 crore as per the Mar2006 balance sheet. total assets were worth 15 crore.

Thanks
Ashish

Sanjay Bakshi said...

It can't be KRBL as that company is highly leveraged.

It can't be Bharat Seats - the dividend yield is too low - less than 3%

It can't be Zenith Fibres - the yield is below the AAA bond yield which is taken at 8% p.a.

Same with Panasonic Carbon and Wyeth- yield is below AAA bond yield

Taparia Tools can't be counted - the stock is extremely illiquid - the last time it was traded was on 17 January 2007.

Merely because the yields of some the stocks mentioned above are less than AAA bond yields does not imply that they aren't cheap.

Sanjay Bakshi said...
This comment has been removed by the author.
Sanjay Bakshi said...

Rohit,

I had mentioned earlier that if a stock is yielding higher then AAA bond yield, then, in effect, the market is predicting a dividend cut. In case of Ultramarine, the possibility of a dividend cut cannot be ruled out. However, among other things, one should focus on the quantum of the cut if it happens. And that would require, as you mentioned, some judgment on the profitability of the IT business. One should also focus on two more things: balance sheet strength, and the consistency of management's dividend policy in the past....

In the end, all equity investment requires risk and some risks cannot be handled adequately except thru diversification. The key question, in relation to Ultramarine, in my view is this: Given the past performance of the company, its balance sheet strength, the track record of dividends, the high dividend yield, and after considering the possibility of a dividend cut, does this stock, at the current price of Rs 40 deserve a place in a diversified portfolio of many other stocks?

Deepak Shenoy said...

Prof. Bakshi,

I'm not a deep value investor but a few points from my side about U&P:

1) Since it split 5 ways (and had a 3:5 bonus) in 2005, the stock has fallen from about the 70 levels down to 40.

2) The dividends paid out since then - about Rs. 5.7 - make up for part of the loss, but leaves you negative to the extent of Rs. 24.

3) The major indices have gone up more than 100% since that date.

4) Dividend yield hasn't always been this good. In 2006, they provided Rs. 2.2 on a price of about 60, and in 2005 pre-split rs. 15 on 600, in 2004 Rs. 10 on 300. These are much lower than AAA returns. Typically I would sya this company offers about 3% dividend yield, this year being an aberration.

5) In the last five years though, the stock has returned about 6x if you consider dividends, but still, that's less that the Sensex itself in the same time, (not accounting for sensex stock dividends)

On a 2 year basis - I considered that timeframe as the split occured then, this would not have been a good deal. Getting a -25% return when the indices are up 100% and have provided for about 1/4th the dividend yield (about 2% for the Nifty) is a little tough on the digestive system.

In fact you wouldn't even have identified it with same strategy in 2005, because its yield was about 2.5%.

And then its forward dividend capability is further suspect. Recent earnings growth is negative and the insider buys are too small to show strength.

Maybe one could consider their own group company, Thirumalai chemicals.

Disclosure: no positions in any of the stocks.

Sanjay Bakshi said...

Deepak, I agree with you that the stock has underperformed relative to the market. Whether, this trend will continue or not, is the issue here. My own view is that like in ice hockey, you have to go where the puck is going, not where it is. So, the fact that the stock has underperformed in the past is not necessarily a reflction of what you can expect in the future.

That ice hockey quote, incidentally, was borrowed from Mr. Buffett.

You have to think about the consequences of mean reversion here - what will happen if the dividend yield went back to your own calculation of 3%? What would cause that reversion to happen (a dividend cut, a dividend maintenance combined with a rise in stock price, or a combination of the two?)

What could mean reversion to not happen?

And what would happen if the reversion was in the DIRECTION of a 3% dividend yield despite a dividend cut. For example, what if the dividend was CUT to Rs 2.50 AND the dividend yield went ended up at 4% (higher than past average)?

At the end of the day, you have to ask about the chances of permanent capital loss in a situation like this for an investor who is patient, and is investing his own money as opposed to managing, say, an open-ended mutual fund, or using leveraged funds...

About insider buying, in the two quarters ended on 30 Sept, insiders have bought 1.62%. Remember, in a single financial year, they can't buy more than 5% unless they want to trigger the takeover code which would require a mandatory tender offer...

Deepak Shenoy said...

Very interesting points there. I think the buffet analogy is well taken, though that works largely in a momentum stock - where the momentum is either in the price, industry or company earnings. In this case I see very little on all three. If it moves slow enough that you can move faster than the puck you can go to where it is now, and then chase it to where it's going. Probably better that way because then you don't need to predict, you need to react.

Also it is possible to predetermine where a tennis ball will NOT go depending on the position of the player just before he hits it. Remove that analysis from the tennis player's repertoire and you find the best players becoming mediocre.

What I mean to say is - past performance may not be an indicator but one has to question why a stock underperformed when there were no negative pressures, and why therefore would it outperform if negatives appear in the future.

Some additional points:

1) In the last two years, the company had no fundamental setbacks or one-timers (unless you are aware of some?). There have been triggers on the upside both market triggers and industry (the downstream product companies in the industry have done well both on earnings and price, in teh last two years).

2) Mean reversion may indeed occur from a reduction of dividend - which seems most likely as you have mentioned the pressures on maintaining the same level of dividend.

3) Interesting thought on where the mean would go. Unfortunately I don't have enough data to do a real monte carlo - but I'd assume that if the industry growth persists, we may not see much of a capital loss from here.

4) I didn't realise the percentages were so high - the market cap is very low because just a few lakhs f rupees can get you a significant percentage!

In fact I'd say this is a good takeover candidate - it's a fabulous buy to take private or merge into a larger (and if public, higher P/E) company.

Apurv said...

I got something which is not growth story but certainly sound track record of past 3 decades..

First Leasing Company of India Ltd.

I have been tracking this company for quite sometime and also hold some quantity of shares.

CMP: 49 (Devidend yield = 5%)

Revenue: 1304 Million INR (Sales/Mkt cap = 1.*)
Net Profit: 253 Million INR (RoE = 14%)
EPS: 11:30 Rs
Reserves: 1352 Million INR
Devidend: 22.5 % ( Least devidend paid in last 30 years is 18%... consistent devidend payee company)
Mkt Cap: 111 Cr
BV: 69

Note: Conservative management and hence, company is not able to show growth.

Thanks,
Apurv

Jayesh said...

Hello Sir,
I think that stock must be wyeth india ltd. available at Rs.460 with dividend of Rs.30, most probbly dividend will be maintained and sales and eps growth will be 6-7% in future

Jayesh said...

Hello Sir,
I think Wyeth India Ltd. Deep Value Stock . Current Price is Rs.460 and Dividend is Rs.30 per share
so yield is 6.5 (tax free yeild), these company is from defensive sector, In current year most likly to maintain dividnd In Fuure Sales and Eps growth minimun 6-7%,Only Negatives is Pharma Policy ,their is old case of DPCO pending aginst company but company has made sufficient provision for it

Sanjay Bakshi said...

It can't be First Leasing because that company is highly leveraged and not a debt-free company.

Sanjay Bakshi said...

Wyeth may be a deep value stock but it won't pass the test mentioned in my original post because the dividend yield is less than AAA bond yield.

Kamal said...

Sir,
Here's from an old student (NMP XVI, MDI).
Merck.
CMP = 385
Dividend = 30
No debt. Loads of cash.
Regards