Piramal Enterprise Analysis - 30-06-2019

      In order to understand Piramal Enterprise Limited (PEL) its important to understand what all has gone through it in the last 10 years since they sold their Indian Pharma business to Abbott for 3.8 billion dollar in 2010-11. Considering the exchange rate of that period in INR it was close to 17000cr. After the sale company reduced most of their debt and also returned 2500 cr to shareholder through buyback.
     Hence effectively from 2012 PEL almost started on a clean slate with close to 9000cr on its book as liquid investments. Its total equity was 11242cr in 2012.

Figure 1 - Equity movement from 2012 to 2019

Lets look at figure 1 which depicts how its equity has increase from 2012 to 2019. Over this period PEL has returned 3529cr as divided to shareholders gained 3036cr from its investment in Vodafone. Raised 7000cr from investors by issuing new shares in. Increased their book value by booking a deferred tax asset of 3500cr on merging all its financial services under one umbrella. This 3500cr is not a real asset. This is something which they will unlock in future by amortizing their intangible and goodwill on its book. They have not given much explanation with numbers on how it will really benefit them. They have just explained in words that their effective tax rate should come down from 2019 onward due to the merger. Frankly I have not seen any real change in their effective tax rate from 2018 to 2019. It would be great if any reader can explain here in comments section on how they can unlock the 3500cr DTA. 

                                           Figure 2 - Real money earned over last 7 years

With an understanding of figure 1 lets take a look at figure 2. Here I am trying to delve deeper into their equity movement to understand how much of that is real cash movement driven by business performance from 2012 to 2019.

The DTA is not a real cash sitting on their book and it has noting to do with their business performance hence I am deducting it. If we start with a equity of 27262cr in 2019 and deduct 3500cr we will get 23762cr. Similarly Rs7000 cr raised in 2018 from investors has nothing to do with its business performance and hence after deducting from 23762cr we get 16762cr. On the other hand the money they have returned to shareholders onver the 7 years should be added back because its a money generated from business performance. Hence after adding 3529cr to 16762cr we get 20291cr. 

Therefore the difference between 20291cr and 11242cr is 9049cr which is the real increase in equity from its business performance (retained earnings). For the period of 7 year it is a CAGR of 9%.

Now lets take a look at where PEL has deployed their equity in figure 3. 

                                           Figure 3 - Equity allocation 

In 2012 after the sale of their business to Abbott PEL had close to 8869cr of liquid asset. By 2019 we see that they invested close to 7197cr in Pharma (out of this close to 3000cr is intangible asset for buying many brands from Janssen and Mallinckordt). Rest is invested in plant and inventory.

5287cr is invested in Decision Research Group (DRG). Almost all of it is goodwill an very minimal is intangible asset.

In 2014 they spent 4440cr to buy Shriram finance (10% of listed company Shriram Transport finance for 1635cr, 20% of Shriram Capital Limited for 2014cr and 10% of Shriram City Union Finance for 790cr). In 2019 March quarter they have booked 6600cr for this investment in their books based on the market price at that time. Recently they have sold their Shriram Transport Finance 10% for 2000cr and are planning to  sell the rest of the stake. Shriram Capital is not a listed and 10% of Shriram City Union is around 1000cr (based on its current market price). Hence in case of liquidation they can at easily get more than 5000cr. The DTA that they booked in 2018 is 3500cr. That leaves us with 4678cr for financial services. 

The advances they have given by march 2019 was 56624cr and in summary this was backed by 4678cr (which is only 8.3% of total advances). This is the key reason why PEL had to sell Shriram's holding at lower valuation. Among all the assets they have this is the only asset which right now can give them liquidity and equity to back their advances.

Now lets look at how well they are using their assets allocated to their different business in Figure 4. 

                                          Figure 4 - Revenue analysis 

You would notice here that 50% of the revenue is from its financial services business. This we will get a better idea from its PBT analysis. Lets look at figure 5.

                                                  Figure 5 - Profit and ROA analysis

Few points to keep in mind. In 2019 they had a one off loss of -452cr for writing off a business they have acquired earlier. They have a 514cr cost on depreciation and amortization. Most of this is on account of their investment in pharma business. It would be little complicated to explain here but most of this is a real cost (depreciation is a real cost for the business and cannot be ignored). But to keep things in perspective I will not deduct this cost from their Pharma PBT for now. 

You would notice in figure 5 that most of their profit is coming from financial services business and in the earlier table we saw that not much of their equity was invested in this business. 

In other words if we now try to see the Return on asset (ROA) invested in different business we would notice that their DRG business is giving a very poor return on investment (and this business is not even growing in past 3-4 years). Pharma is giving an ROA of 9.5% (excluding the depreciation and amortization charge) which is not a good number, but the hope here is that it is at least growing by around 15% for last 4-5 years and is expected to grow at similar rate in future. Now coming to their Financial services business the ROA is 26.7% which is a very good number but at a very high leverage. 

Summary- 

Cons

* Very poor growth rate and return on their DRG business which is 20% of their total equity

* Pharma business is yet to give enough return on invested capital. It could give good return in future only if it would continue to have good growth rate without much requirement for additional capital

* Not much return on their investment in Shriram

* High leverage in their financial services business hence they are forced to sell their only liquid asset which is Shriram 

Pros   

* Small shareholder friendly (refer figure 6, whenever they had good year they have returned a substantial part to shareholders)

Figure 6 Amount returned to shareholders  

* Transparent disclosure - Last year when the NBFC crisis started they started disclosing more about their portfolio of advances and how they are managing the risk. Refer figure 7 and 8 below 

                                          Figure 7 - Discloses the details on concentration of advances

                          Figure 8 - Discloses the risk in their portfolio and how they are managing it

* Potential to grow their financial services business at a very fast rate.   

In summary its not really their financial services business which is a cause of concern for them. It is actually that most of their money is stuck in low return business like DRG and Pharma (at least in short term Pharma is not likely to give them good return on investment). 

Please provide your valuable comment if you think I have missed any important point here. 

ITC Analysis 2019-06-11

ITC is a company which is very well know to all of us. Here in this article I will try to see the impact of major changes that happened for ITC in the last 5 years and then look at its business from a long term perspective.

Figure 1 (Standalone financials) (Source: Screener.in)

Lets first look at figure 1. Here I have divided ITC history in 2 phases. One phase is upto 2014 when its profit was growing at the rate of around 20% per year. From 2015 it has entered into another phase when its rate of increase in profit dropped to around 9% (with a drop in profit in year 2016).

So what happen in 2015-16? 

- Increase in VAT and Excise duty 

- Increase in 85% Pictorial warning implemented (this change I have seen myself on the pack of cigarette)

  

Regarding VAT and Excise duty ITC management mentioned in page number 40 of 2016 annual report that the incidence of Excise duty and VAT on cigarette at per unit level has gone up cumulatively by 118% and 142% over the last 4 years. Which means that from 2012 to 2016 the Excise duty has gone up by 118% per cigarette. 

Now lets look at the trend of Excise duty (company don't declare any numbers on VAT)

Figure 2 (Source- Page 296 2017 annual report for Excise duty and March end financial results of each year for Cigarette Gross Revenue Breakup ) 

If we look at figure 2 then we would notice that the Excise duty as % of Cigarette revenue has remained around 47% from 2009 to 2017. It was little surprising for me. I was expecting the % to go up from 2012 to 2016 based on the increase in Excise duty of 118% in that period. I would be happy if any one of the reader can throw up more light on this.

Figure 3 (Source - March end financial results of each year)

In figure 3 you would notice that almost 80% of the total profit for ITC is still coming from Cigarette. 

Now lets again look at Figure 2. Lets go by the management comment of significant increase in VAT and Excise duty in the time period from 2012 to 2016. ITC is a market leader in branded Cigarette business. As long as everything is constant Cigarette has an inelastic demand. On the other hand the major risk for this business is the regulatory challenge of ever increasing tax rate and other forms of opposition (like increasing the Pictorial Warning). We have already seen that due to this ITC  profit growth has already came down from 20% to 10%. If in future government further increases the tax rate or impose any other challenge then ITC will definitely have a significant bottom-line impact.

In summary since 80% of the profit is still coming from Cigarette any changes in its tax rate will have a significant impact on ITC. 

Figure 4 (Source - March end financial results of each year)

Now lets try to understand how the management is managing the profit of ITC. Please refer figure 4. You would notice that almost 55% of the profit is distributed back to shareholders and 45% is kept back. 

Figure 5 (Source - March end financial results of each year)

In Figure 5. The row "Profit-Dividend" is the amount which ITC keeps back with themselves. 

Under "Capital employed" we have how much of the capital ITC has invested in Cigarettes and rest of the business. Under "Incremental Capital employed" we have how much incremental capital is employed by ITC. You would notice that incremental capital employed in Cigarette is very little compared to the annual profit of ITC (ignore the capital movement in 2017, all the movement you see there is mainly because of the change in accounting standard to IAS from GAAP).

You would notice that since Cigarette business does not require much capital ITC has the option to invest its profit in other business. Based on Figure 5 you would notice that almost 50% of the (Profit-Dividend) ITC invest in all the other business. I dont have the table to show but the balance 50% of (Profit-Dividend) ITC invest in mutual funds and bonds. 

Lets take another look at figure 1 where I explained the 2 phases of ITC. 

                                  Figure 6 (Source - March end financial results of each year)

Now lets take a look at figure 6 (please note that in Figure 1 the 2016 numbers as per screener is based on IAS accounting standard whereas in Figure 6 it is based on GAAP).

Please ignore the movement in year 2017 since most of the movement here is because of change in accounting standard. If we ignore 2017 you would notice that the Cigarette profit is slowly inching up from 5% in 2016 to 9% in 2019 because not major tax changes happened after 2016. 

Now lets look at the PBT movement of other business. You would notice that its little volatile but still more than 10% every year. In other words all the profit that ITC is investing in the business other than Cigarettes is helping it to grow by more than 10% every year. 

Now lets take a deep dive into ITC different businesses 

   Figure 7 (gross revenue) (Source - March end financial results of 2003 and 2019)

ITC started its FMCG business other than Cigarettes back in early 2000. Its other major business includes Hotels, Agri and Paper.

Now lets take a look at figure 7. Its shows the movement of ITC gross revenue by business from 2003 to 2019. Its mainstay business of Cigarettes revenue has actually grown by only 5.5% CAGR over the last 16 years which is even less than our GDP growth rate (Please note that ITC is the dominant player in organised cigarette market, in other words  it represents organised cigarette market). The low growth is mainly attributable to the significant increase in tax rates on cigarette. This increase is affecting only the organized market. The unorganized and smuggled cigarette is not affected by this tax rate hence over this period of time ITC is losing its market share to unorganized sector. 

Now lets look at its other business one by one. 

Lets start with FMCG - Others : From 2003 to 2019 it had an impressive CAGR of 34.5%. Now lets take a look at one more figure below.

   Figure 8 (gross revenue) (Source - March end financial results of 2003 and 2019)

You would notice that in figure 8 in last 5 years the FMCG- Others growth rate has come down to 6.8%. 

Hotels, Agri and Paperboard also had impressive CAGR of more than 10%. Lets take a further in-depth analysis of all these business with more data. 

 Figure 10 (Margins are based on PAT) (Source - March end financial results of 2003 and 2019)

Figure 11 (ROA are based on PAT) (Source - March end financial results of 2003 and 2019)

So far we saw the revenue analysis. Now lets take a look at Figure 10 and 11. 

FMCG - Cigarettes : In contrast to the rev the profit has grown at a CAGR of 13.5% mainly because of the significant improvement in its margin from 15% to 49%. The other interesting thing to note is that not much capital was required to be invested in this in the last 16 years since its ROA is significantly high. The ROA of 122.5% in 2019 is something which is very very difficult for any business to achieve. 

FMCG- Others: In contrast to the impressive revenue growth the profit has not grown much. Still from a loss in 2003 now there is a profit. But the margin is still very poor at 1% and ROA is also very low at 2.1%. ITC is still investing a lot in FMCG-Others and this is proving to be a very challenging market with competitors like  HUL, Marico, Britannia etc. Earlier we have seen that ITC FMCG section revenue growth rate has come down a lot in the last 5 year. ITC has entered in this market more than 16 years back and still their margin and ROA are quite poor. Despite these figure we cannot deny the fact that they have launched a lot of successful brands with good share of consumer mind. Now its just a matter of time to see how far ITC can further grow in this segment while improving margin.   

Hotels: The business revenue and profit both as grown impressively in the last 16 years. But still its a insignificant part of ITC total revenue and profit. On the other hand if you notice a good chunk of ITC total capital employed is in Hotels business. The reason is low ROA of hotel business. From 2003 to 2019 its ROA did improve from 0.7% to 2.1% but still its very low. Hotel business by its nature is a very low ROA business. So no matter how much you invest in it you wont get good return. Now is it a good or bad business depends on your perception and the idea that to what extent the assets itself will appreciate. Here in this case the assets are Hotels. If you ask me overall its not a good business. Over a long period of time if your asset value growth is lower than inflation and the ROA is very low then inflation will eat away the worth of this business.

Agri, Paperboard, Paper and Packaging business: All these business ITC created to support its Cigarette and FMCG business as backward integration. They have nicely expanded these business for other clients as well. Unlike any other commodity business they have grown this business at a healthy rate of more than 10% CAGR for last 16 years while maintaining a good ROA of 13-14%. 

Summary

If we take another look at Figure 11 we would notice that despite giving out almost 55% of profit as dividend ITC has close to 36000 cr of unallocated capital. Most of that is invested in mutual fund and bonds as liquid assets. ITC has entered FMCG- others almost around 20 years back but they are yet to generate good profit from it. Still almost 80% of their profit is from FMCG-cigarette business. Any impact in further tax rates would have a significant impact on its profit. The silver lining here is that ITC dont need much capital to increase its cigarette business and to a large extent they have been successful in creating lot of good brands in FMCG. Now time will tell to what extent they will be able to increase the share of FMCG-others profit in future. 

Valuation

Today's Market price of ITC is 280 and its standalone 2019 EPS is 10.1 which means its trading at a PE of 28. Lets take a look at figure 12. You would notice that historically its PE has been around 30 for last 10 years. The 2nd thing to notice is that in the last 5 years it has gone through a very tough phase of high tax rate and the probability is high that it will go even higher. But the silver lining here is that despite the high tax rate its profit is holding up well. ITC is one of the few Indian companies favorable to small shareholder. It has been consistently paying around 55% of its profit as dividend for a long time.

Since ITC profit is not very volatile we can actually look at its historical PE to compare its current valuation. At its current PE of 28 its not very far from its historical PE ratio. On the other hand when compared to any other FMCG company its valuation would look attractive. Primarily because its 80% profit is still from Cigarette and the risk of higher tax rate its PE has not expanded in the past similar to other major FMCG companies like HUL, Marico etc. 

Figure 12 (Source- Screener)

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I would like to thank you if you have read my analysis upto this point :). I would be very happy if you can give me your feedback and point out anything important which I have missed here. 

Regards

Team Arthavriksh

Video version of this analysis

Part 1 https://www.youtube.com/watch?v=1rljJq05vfk

Part 2 https://www.youtube.com/watch?v=f1egb2RnJpc&t=39s

   

  

Yes Bank Analysis 2019-06-07

Yes Bank is in top of the business news for last few days. Its stock price has dropped from around Rs 350 a year back to around Rs 150 now. Lets try to dissect what is going wrong with Yes Bank.

Figure 1 (Balance Sheet)

Lets first look at the balance sheet of Yes Bank declared in Mar Quarter of 2019 (Figure 1). You would notice that its Equity/Total Asset (standalone) = (463.01+26424.40)/380859.61 = 7%

Its Total Equity = 26887 cr 

Figure 2 (P&L)

Now lets look at its P&L for Mar-19 (Figure 2). 

Its gross NPA = 7882 cr (3.22% of total asset)

Its net NPA = 4485 cr (1.86% of total asset)

Figure 3

Now lets look at figure 3. You would notice here that 7.1% of their total asset has the rating of BB and Below which is a significant increase from 2.5% in Dec-18 quarter. What it really means is that a lot of their assets have been downgraded recently. The problem here is that they have not given out any more details of the asset quality like who are their major account and how those account's are doing neither they have given out more information  about who are those accounts which have been downgraded in last one quarter. 

For all the information about their downgraded account you will have to rely on new reports. Upon doing some google you will realize that bulk of that exposure is on Anil Ambani's ADAG, Essel Group, ILFS and DHFL and we all know what is their current situation. 

If I use the number from Figure 2 then if 3.22 % of NPA is = 7882 cr which means that 7.1% = 7.1/3.22*7882 = 17380 cr

Hence current gross NPA + BB and Below graded asset = 7882+17380 = 25262 cr 

25262/26887 (total equity)= 94% of total equity is equal to Gross NPA + BB and Below graded asset

So even if lets say (best case scenario) only 50% of the 7.1% BB and below graded asset gets defaulted then that means = 7882+17380/2 = 16572 cr which is 16572/26887 = 62% of total equity.

Hence in summary what we can conclude here? Even if 50% of Yes Bank BB and Below graded assets become NPA on top of its current gross NPA that is sufficient to wipe out 62% of their total equity. To make things worse assume what will happen if more of their assets will be downgraded in future?

So far we have talked about the issue with their asset which is where the devil lies in case of most of the financial institutions who tries to make money out of their highly leveraged balance sheet (just take Yes Bank as an example where the total equity is just 7% of total liability).

Now again to make things even worse lets again look at their income statement (figure 2). Look at its other income which has come down from 890 cr in Dec-18 to 531 cr in Mar-19. Lets see what is happening with their other income in the below chart

Figure 4

Here in the commentary section they have pointed out that out of the total drop 100 cr is because of one time reversal of banking fee. In addition to that you can see that from Q1FY19 the banking fee is consistently dropping down and they have not given any good reason for this consistent significant drop. To top all that an even bigger problem is with the aggressive accounting rule which they were following earlier which will be clear if we read the below comment from ICRA on their rating report they published on 3rd May

Figure 5

Here in figure 5 we can clearly see that Yes Bank was practicing upfront recognition of fee income. What does this really mean? If they were earlier practicing aggressive accounting practice for fee income that means there is a very high probability that they must be practicing it for many other account lines. We know based on history that whenever company has followed aggressive accounting policy they never did it with good intent and in most of the cases it was the investor of the company who has to pay for it. 

I would like to thank you if you have read my analysis upto this point :). I would be very happy if you can give me your feedback and point out anything important which I have missed here. 

Video version of the analysis https://www.youtube.com/watch?v=ODr3zMWCdw0&t=155s

Regards

Team Arthavriksh

2019-06-07 Portfolio

Rs 5000 invested as follows 

1 Share worth Rs 2670 in Piramal Enterprise bought on 20th Feb 2019

1 Share worth Rs 2210 in Piramal Enterprise bought on 4th June 2019

Balance Rs 120 is in cash 

2019-03-19 Portfolio

Rs 5000 invested as follows 

1 Share worth Rs 2670 in Piramal Enterprise bought on 20th Feb 2019

Balance Rs 2300 is in cash