What Rakesh Jhunjhunwala saw in DB Realty?

Rakesh Jhunjhunwala recently made an investment into DB Realty. This is the same company whose Chairman, Shahid Balwa, was made a party to 2G accusations list a few months ago. The Chairman and the company was shown to have provided Mr. Sharad Pawar, Agriculture Minister with certain favours.

In financial year ending March 2012, DB Realty did an annual sales of Rs. 590.86 crores, almost half of what it did in the previous year. Operating Profit is at Rs. 124 crores at a margin of around 20%. Debt/Equity ratio is at 0.06. Total Assets of the company is at  Rs. 5191.08 crores. Working Capital of the company is Rs. 1363 crores. Fixed Assets is Rs. 245 crores. RoCE is 7.11%. Share price is Rs. 98.75.

What we can see from here id that DB Realty is very under-leveraged as compared to other real-estate companies. Debt is at a very comfortable situation. If we talk about Total Assets, Total Assets per share of the company is coming out to be Rs. 213.44 crores. If we talk about Capital Employed, Capital Employed per Share is at Rs. 66.11. In June quarter this year, the company did Sales of only Rs. 85 crores made a net loss. If we see just at Project Expenses only as a percentage of Sales, its ranging between 60-90% over several quarters.

So, what could have made Rakesh Jhunjhunwala commit an investment into this company. First, Total Assets per share of the company is way beyond the current Share price. Second, certain projects of the company have been recently completed and others are due completion in near months. Will one invest into it based upon these parameters? Will this company provide a steady stream of revenues, profits and operating cash flows?

The fizzling Suzlon Energy

In the financial year March 2005, Suzlon Energy did an Annual Sales of Rs. 1942.48 crores. They did an Operating Profit of Rs. 473.40 crores, the Operating Margins being 24.37%. Capital employed was Rs. 1300 crores. RoCE came out to be around 35%. Debt/Equity ratio was about 0.50.

In the financial year March 2012, Suzlon Energy did an Annual Sales of Rs. 21,082.37 crores. They grew their Sales by 10 times from 2005. Operating Profit came out to be Rs. 1544.36 crores with the margin percentage being 7.33%. Capital Employed is around Rs. 15,500 crores. RoCE is at around 10%. Debt/Equity ratio is 2.

The maximum Sales was recorded in the year 2009 at Rs. 26,081 crore. Maximum debt was also acquired in the same financial year of 2009 as debt jumped 4 times from Rs. 390 crores in financial year 2005 to Rs. 14,700 crores. Most of the debt was meant for fixed assets for fixed assets walloped 3 times to Rs. 13,281 crores from Rs. 4568 crores. Capital Employed for that year is Rs. 24,500 crores. Operating Profit for the same year is Rs. 2849.71 crores at margin of 11%. RoCE came out to be around 10%.

Mismatch between Operating Cash Flows and Return on Capital Employed (RoCE)

Return on Capital Employed (RoCE) is the return on Fixed Assets as well as Working Capital. It indicates towards the efficient use of the two forms of capital. RoCE indicates towards the efficiency of the business. It indicates towards effective capital allocation. A company/business with higher RoCE is deemed good.

Operating Cash flows is the actual amount of money emerging from the business. It takes into stock money stuck in inventories, with customers and money given as advances or paid as loans. Thus, operating Cash Flow is pure cash coming out of the business within a period of time. Net Profits or Operating Profits is just profits or money on paper, while Operating Cash Flows is the crude cash coming out of the business. Operating Cash Flows as a proportion of Net Profits or Operating Profits is an effective indicator of the Cash Conversion Cycle of the business.

Thus, even though a business or company might have a higher RoCE, it doesn't necessarily mean that they're generating actual Cash. If a business isn't able to churn out actual cash, then it will have to take Working Capital Loans to maintain the running of business, thus incurring interest expenses and lowering of Net Profits. So, a lone look at RoCE doesn't actually work.

Working Capital and Return on Capital Employed (RoCE)

Working Capital or Net Current Assets is the difference between Current Assets and Current Liabilities. This is the money with which the business is run. Working Capital makes Sales happen. Working Capital is arranged in the form of Inventories, Sundry Debtors or Account Receivables and Sundry Creditors or Account Payables. The distribution of the capital between the three items becomes the face of any business. This distribution is characteristic of a particular business and  a business is seldom able to change this structure over its lifetime. This distribution of capital is indicative to investors to be worthy of investment. Everybody will like to be invested in business which lower distribution of capital in Inventories and Sundry Debtors. This indicates that inventory is readily consumed and sale money is not stuck with customers.

As I said earlier, Working Capital makes Sales happen. Working Capital is the money with which we buy Inventories, process it, then sell it, receive the cash from customers and pay the suppliers of the inventories. The ratio of Sales and Working Capital indicates the efficient use of Working Capital. Its an important indicator which an investor must pay attention to.

Return on Capital Employed (RoCE) is simply Operating Profits over Capital Employed. Capital Employed is the addition of Fixed Assets and Working Capital. RoCE is an effective indication of the returns being generated from the business. It indicates the effective use of Fixed Assets and Working Capital.

Thus, a better RoCE is mainly reliant upon the effective use of Working Capital. The arrangement of the capital across the components of Working Capital and RoCE indicates towards the quality of the business.

The sad story of Educomp Solutions

People hear about rags to riches story a lot. We're going to talk about Educomp Solutions. Educomp Solutions was the first mover in the digital educational content provider space. In short span of time, it grew tremedously providing a booster to shareholders' value. Something around the end of 2008 started going wrong for the company. Satyam fiasco happened at that time. Satyam was accused of inflating its revenues and its Chairman  Ramlinga Raju accepted the fraud committed by him. Around that time, CBI also started looking into Educomp. Though, nothing emerged concretely but it was rumoured that Educomp Solutions was cooking its books similarly to Satyam. It was inflating its revenues to drive the share prices. Educomp must had some political connections to get the CBI off its back. Then, after some time, SEBI summoned the Chairman Shantanu Prakash for some insider trading antics. SEBI and Shantanu Prakash reached a non-disclosure agreement by paying SEBI a certain amount of fine. It was rumoured that the Chairman and other high-end employees of the company were involved in insider trading. In 2009-2010, they raised Rs. 607 crores through private placements and diluted shareholders' equity. In 2011, an Income-Tax raid happened on Educomp Solution premises. Meanwhile, Chairman Shantanu Prakash started having bitter relations with his then CFO, Sangeeta Gulati, who resigned from Educomp Solutions very recently. It was rumoured in Educomp Solutions workplace that Sangeeta Gulati wielded more influence on Educomp Solutions than the Chairman himself. In the beginning of 2012, the company was able to raise money to pay off the burdensome FCCBs overseas. In 2011, they were able to securitise certain of their fixed assets with the help of the banks to improve their operating cash flows. But nothing much happened to that extent, as the company was laden with debts and with operating cash flows still struggling. Meanwhile, other big players entered this sector and have now almost commoditised this sector with the revenue per unit falling down.

From 2008 to 2012, Educomp Soplutions has trebled its debt. From 2010 onwards, profits have suffered a lot for this company. They have almost halved. For 2012, profits are already down. EPS has halfed from 2011 onwards. Despite securitisation programme, fixed assets are continuously growing up. Net Cash Flows have turned negative from 2010 onwards. Recently, the company announced that it needed to borrow money again. And, revenue per unit is falling down in wake of new entrants entering this sector. Stock prices are ever falling down. From highs of Rs. 600 in 2010 to dismal lows of Rs. 128 in 2012, this company is witnessing a gradual decline. In late 2011, Chairman Shantanu Prakash was talking about selling some of the fixed assets like schools to compensate for required money.

We can just hope that this company doesn't become a riches-to-rags story.

Behind the concept of Discounted Cash Flows

Discounted Cash Flow is all about valuing future cash flows from a business and then discounting it by a percentage value to the current value of those future cash flows. The percentage value can be your minimum expected returns or any current safe guaranteed returns from fixed deposits or bonds. If the current value of those future cash flows comes out to be higher than the amount you're going to invest  in the present, then its deemed a safe investment. Now there are three variables in this concept. 

1. First, it is the time frame for which you'll be calculating the future cash flows, 
2. then its the growth percentage which you'll factor in to guess out the future cash flows every year, and 
3. the discount percentage.

These variables are vulnerable to individual's perception about a business and as it is, future can't be correctly stated.

But the question is about the preeminence of  Discounted Cash Flow? Why investors all over the globe fall for this concept? Why value investors kneel before it and swear allegiance to it?

Discounted Cash Flows isn't simply about the guesswork of future cash flows from a business. Existing cash flows from any business go back into the company's Balance Sheet as Cash and Bank Balances, ready to be used for the company's purposes or growth or expansion. They're not meant there to be idle. Over a course of time, these incoming cash flows will be used to fuel growth. These cash flows will become assets for the company in future, Fixed Assets or Working Capital, and will aid in further expansion of business and will lead to increased future cash flows from the business.

So, if one is calculating future cash flows in present, he'll able to calculate cash flows only from the existing business or existing level of business. One'll not be able to gauge the growth in business from the utility of the future cash flows. Now, since future cash flows will get converted into assets for the company, the investor ultimately pays for the future total assets of the company or business which will in turn dole out further future cash flows. Thats why an investor valuing a business using Discounted Cash Flow model pays so much attention to the management antics as the perfect utility of the future cash flows depends upon the will and capacity of the management.

In a way, Discounted Cash Flow is a very strong, potent and conservative way of valuing any business. It really discounts the business for any growth resulting from the ensuing cash flows by sticking to the present condition of the business. If valued appropriately using Discounted Cash Flow model, an investor must reap rich dividends (in both forms).

The Curious Case of Mr. Robert Vadra "Gandhi"

The recent news reflecting upon supposed financial misdemeanor by DLF and Robert Vadra is coming to the point of "Loans and Advances" by DLF and Robert Vadra's companies. DLF gave Mr. Robert Vadra Rs. 60 crores interest-free to Robert Vadra through "Loans and Advances" items on Balance-Sheet. And as viewed from certain newspaper reports, Robert Vadra's companies gave supposed salaries to Robert Vadra through "Loans and Advances". The issue of Loans and Advances seems devious ones..

Often one can find huge sums of Loans and Advances on a company's Balance-Sheet and there's little or negligible information regarding that in the Schedules of the Balance-Sheet. It was always supposed that Loans and Advances can be mismanaged to one's benefits and the current case of Robert Vadra and DLF is pointing towards the same.

Its time the companies come forward in a more transparent way towards the same and the shareholders must take the habit of questioning them.

Why one should be wary of ESOPs?

ESOPs or Employee Stock Options are a modern instruments of incentivising employees by corporations or companies. But as we move forward, ESOPs are becoming controversial regarding their usage both from the point of shareholders as well as employees.

Firstly, ESOPs straightaway dilute the equity of the company, thus hampering shareholders' interests. Nobody likes to see his stake being diluted.

Secondly, as a motivational instrument too, ESOPs are becoming controversial. If an employee is issued ESOPs, then the benefit that employee will have from ESOPs will be reliant on the overall performance of the company and that'll come from the collective performances of all the employees or co-workers. Why should an employee's special efforts be put ransom to the efforts of other employees? In a way, ESOPs are unfair to employees too. Rather, they should be compensated straightaway in form of salary raises, bonuses, perks or incentives. So, ESOPs fail this purpose too.

Thirdly, the expense on ESOPs are not accounted in the expense sheet, thus inflating profits and artificial stock price increases.

Thus, budding investors must be wary of ESOPs and must ask the management regarding its true utility.

Is it worth buying Cash?

I was checking into Piramal Enterprises Limited. This company was in news after it sold to Abbott its formulation business for a huge sum of money. Kudos were levied upon Mr. Ajay Piramal for selling the business so high. He's now being regarded as India's biggest "value investor". He's considered a brilliant manager by almost all investors in India. His company Piramal Enterprises Limited has been considered as a "value" bet by a management guru from Gurgaon and he talks about adding Mr. Ajay Piramal as a manager  to this bet. Sounds convincing...

Bajaj Corp

A newspaper article..

http://timesofindia.indiatimes.com/business/india-business/Bajaj-Almond-Drops-volume-growth-to-sustain-at-18-20-levels-Analysts/articleshow/16641521.cms