It’s a matter
of Trust
The Webster
Dictionary describes ‘Trust’ as the assured reliance on the character,
ability, strength, or truth of someone or something.
It is an expectation that another party will not allow you
to be harmed at a time when you are vulnerable.
Most of us are willing to exhibit some level of trust for
others until given a good reason not to.
And I’d argue that the propensity to trust others is also a personality
trait, i.e., some of us tend to generally be more willing to trust others. So while some people may be too cynical and unwilling to trust others, some others
may be naïve or gullible. I’d like to
believe that I am neither of the 2 extremes.
In any event, as part of making investment decisions, we continuously
rely on information provided by management (besides of course, its ability) and
hence it is of utmost importance that we have the fullest trust on their
integrity.
For instance when Warren Buffett buys a new business for his Berkshire Hathaway
empire, he places his trust in the executives of the company he is taking over.
Rather than dismissing them immediately, or easing them out after a short
interval, as many other firms do after acquisitions, he only buys companies
with executives he would want to keep and then leaves them alone – trusting
them to make money for him. Mr. Buffett’s headquarters staff is only about 20
people, who oversee 77 operating companies and over 250,000 employees, a sign
of the trust in the leaders of those companies.
But Buffett’s trust is not blind trust. It is smart trust, which combines the
propensity to trust with analysis, experience and a bit of instincts to make
sure the trust doesn’t go awry. Ergo,
using the Russian proverb “Trust, but verify” to its fullest. Perfect.
Bajaj Electricals
Consider the following story line of the company:
1.
Part of one of India’s premier and reputed
family groups with a 100 year history and 27 companies under management with a
Group Turnover of USD 7 bn.
2.
Leader in small appliances – their largest
business stream (the group also has ~15% market share in fans, 8% in lighting
and17% in luminaires)
3.
Good return ratios – last 10 year ROCE ranging
between 20-40% and ROE ranging between 18-40% (most notably, the lower range in
ROE has been despite its recent problems); high growth company (has had a
revenue CAGR of 22% + over the last 10 years)
4.
Low debt (0.3:1) despite the issues related to
capital getting stuck in some of the projects
5.
Temporary problems on the Engineering and
Projects (E&P) division (possibly bad project management is one of the
likely reasons of the issues)
6.
Old projects being closed, costs being taken
upfront. By the end of the year (by
March 31st, 2013), only 6 of 24 projects will be pending
7.
Consistent message from the management:
a.
we are done with the bad projects,
b.
all new projects have good margins and there is
constant vigil on timely implementation,
c.
other businesses are doing well
8.
Core business ex-E&P is an excellent play on
the Indian consumer growth story
9.
Established reach with over 400,000 retailers in
Lighting, 40,000 retailers in Appliances and 50,000 retailers in Fans.
10. Reputable
management. One of the only groups that
I know of that size whose top person has publicly challenged the Government to
point out any incidence of tax avoidance or corruption. Company’s visiting card says: ‘Inspiring
Trust’.
BTW, I am already sold on the idea (I bought the stock almost
a year and 20% ago), but even at this point in time, I feel that the company’s
valuation is nowhere close to where it should be – mostly because they have
continued to clean up their act on the E&P business and the profits have
been depressed due to the resultant losses.
But I believe that the future potential of the company is excellent and
is foreseeable in the near future.
To elaborate:
High growth company
Temporary problems with the
E&P division
The following 2 tables show the declining fortunes of the E&P business. The division provided ballast early on but clearly
since then the business has become commoditized. Part of the problem seems to be the economy
and the growing bidders for a declining business pool but the other part seems
to be that there were delays in implementation and bad estimation of remaining
costs etc. In short, bad project
management.
Meanwhile, the rest of the divisions focused on direct consumer interface
are increasing their share of revenues and profits.
As per the management, sometime during this year the company will reach
its trough as far as delivering the bad news on the E&P is concerned.
And that’s where the trust element comes in. Can we trust that the management will be able
to clean up its act on all the old projects (the ‘bad boys’ as the management
called in one of the interviews) sometime in the next couple of quarters, do a
better job of project management in the future projects and bid for income
accretive projects henceforth? Do they
have shareholder interest in mind?
Given all the information and knowledge that I have about the business
and the group, I am willing to provide that trust on the management.
Accordingly, this is how I estimate the future to look like (I have to
state that I abhor working on future financials because of the obvious
uncertainties, but I am making an exception in this case – and as one can see,
giving a very high level view rather than getting into details).
Notes:
1. Growth estimates of the various businesses are as
follows:
a.
Consumer Durables: 20% (based on past)
b.
Lighting: 10% (based on past)
c.
EPC: None – based on expectation of normalization
of business
2. EBITDA estimates are as follows
a.
Consumer Durables: 10% (based on past)
b.
Lighting: 8% (based on past)
c.
EPC: 4%
3. I have mentioned the EPS estimates of some of
the brokerages that I could find. As one
can see, the issue is not so much on 2014.
The issue seems to be on the current year! So either the brokerages are over-estimating
the company’s earnings for the current year or I am being conservative. If it is the former, then a) its not because
of what the management has been saying as they have been quite clear on the
fact that there are issues left to be tackled in the E&P business in the
rest of the year and b) we can look forward to a nice price correction when the
current quarter results are announced.
4. Notwithstanding.
I want to be focused on the 2014 and 2015 figures. What’s the value of a
company’s stock price that has an EPS of ~ 18/- (there is near unanimity on the
later year EPS figures); is growing at 20% (+); has high ROCE and ROE (which
will jump further once the E&P is fixed); has the catchy Indian consumer
story with it and will be a turnaround story once the E&P is fixed?
You know what – I believe it is much more than
the 208/- price it was being quoted for as of Friday, December 28, 2012. How much more? Well, we don’t have to match Bajaj Electrical’s
PE to the consumer based companies of the likes of Hawkins and TTK to figure
out what it should be. Important thing
is: will the ‘E’ in the PE work out? Coz
if it does, then the ‘P’ will take care of itself.
Over to you Mr. Bajaj! You have inspired my trust. Now the tougher part of retaining it!
