Je Ne Comprends Pas Looking The Gift Horse In The Mouth



Regular readers know that I mostly write philosophically, trying to derive principles that drive action, rather than recommending specific actions for our readers. Rarely, do I speak about a specific company/ event/ trend, except to deal with a macro-trend. Today, here are some disconnected thoughts that slip through my mind as news/ events/ trends roll along; ng in fast forward…

Declaimer: This article was originally in August 2011 and some of the data points may be outdated.

  • So S & P downgraded the US, and everyone panicked. It wasn’t news, even from S & P; but I suppose once people start running, nobody knows why they are running. The same day,  S & P UPGRADED Tata Steel, which then proceeded to drop like a brick, till it reached a whopping 20% discount to Book Value. The debt has come down to 2 times consolidated EBIDTA, well under control. Corus has mostly turned around and cost synergies (estimated at $400 mn) have started to flow.

Closing illegal mining in Bellary will indirectly benefit Tata Steel to maintain its 20% topline growth in India and globally. At Rs.130 EPS (including one-time Capital Gains), you are buying the co at 3.7 times earnings and 4 times EBITDA. This is even better than Bharti, my last recommendation…F

  • The company has a Return on Net Worth of 13%, but the stock is available at a 10% discount to its CURRENT Net Worth of Rs.490 per share; since you would mostly be investing with a horizon of 1 year, that would be a 25% discount to its expected Net Worth (of Rs.550 per share) 1 year hence. In short, you get a 21% post-tax (and 31% pre-tax) return if you hold the stock forever. This is the kind of once-in-a-lifetime investment that Charlie Munger and Warren Buffet talk about. If you have bought the stock at the right price, and it is compounding steadily, the right time to sell it is …..never.
  • Let us take a look at how this has come about, and what the canards floating about in the market/ media/ analyst community have beaten down the stock to such deep value. In these chaotic times, the media is full of misleading stories, sometimes orchestrated by the analyst community, who will change their tune the moment the stock has reached the right hands. I think this is a bigger, and more systematic scam that 2G, CWG, and Bellary combined. It is just unfortunate that Anna and his Team don’t have the eyes to see it.
  • Don’t believe me?! For those of you who remember my columns while the Bharti story was unfolding, take a look at the sequence of events while the orchestrated beating down of the stock was taking place:
    • The first phase was when the tariff wars started and the stock was marked down on a huge selloff by Mutual Funds from 457 to 320 (circa 1st – 14th Oct 2009; look up the technical charts to follow my story). As a natural contrarian, this attracted my attention.
    • Tired bulls capitulated end-Nov, of 2009 (near the expiry) and there was a short-covering rally by mid-Dec to 342. This ended Phase I of my story.
    • Now starts the coordinated ‘story-spreading’. In Jan-Feb, 2010, the Zain story broke and an ‘analysts’ consensus’ was worked out, saying the acquisition was ‘value dilutive’ for Bharti because it was a premium (about 20% per subscriber) to Bharti’s beaten-down valuations. Look around now, and tell me where those concerns are. Bharti is up 60% from those days, even though the market is down 20%. Anyway, in the week of 10-16th Feb 2010, the stock was marked down from 315 to 271. Thereafter, it trundled along over March and April, recovering as more information about Zain trickled in. In Feb 2010, I wrote the first of my columns on Bharti, angry at the disinformation being spread about Bharti.
    • At just this time, I called up an analyst in a leading foreign brokerage who was covering Bharti. I challenged her downbeat view on the sector, finding that she agrees with all my counter-arguments about Bharti being a sector outperformer, and a relative value argument, etc. She agreed with everything, but maintained the ‘party line’. i.e. the stock is down from 271 with a target of 210. Recently, she has revised the price target to 504. I can’t believe that she did not know what she was doing; her ‘party line’ was to talk down the stock, and put out ‘public research reports’ which are duly headlined by the leading pink papers (more money is made by this process than Mr. Kalmadi could ever imagine; in respectable Indian society, this is even called a ‘business’ and gets you Market Cap in Dollars).
    • But back to my story. After the Zain fracas died down, the 2G scam broke out, circa late April 2010. It had a limited effect on the already beaten-down Bharti stock, except when a whopper of a story was headlined, obviously (surprise!!!) in the pink papers: the TRAI recommendations about the sector, especially one recommending a whopping Rs.14,000 cr license renewal fee. These ‘recommendations’ were duly headlined as fact and repeated ad nauseam. I wrote an angry column ‘TRAI-ing to Fail’, which should be read now in the archives, to see how right I was: tr=14788. The stock dropped below 260 and stayed there for 2 months, during which almost everyone I knew dropped out of Bharti. The stock they sold was picked up by some of the smartest investors in the country (including the promoters).
    • The point I am making: while the media (and analysts) were in a downgrade frenzy, why were smart, knowledgeable people, not reading those Research Reports (or pink newspapers)? Or were they writing them? In trading parlance, we call this, ‘maal nirvana’, and is in no way different from how you put a white bedsheet over yourself to make your sister shit in her pants…;). I survived all this, and exited Bharti at 360, happy at the predictable ‘behavioral map’ I had figured out. After 360, the analysts returned to telling the truth; actually (oh sorry! But Bharti was a good company, a sector outperformed, and would consolidate both India and Africa. So what if the profits are down, the stock is still up, despite a beaten-down market!!!)
    • Something similar happened recently in DLF, giving you a sense of déjà vu if you track the story with the technical charts. Thrice, there were prominent headlines in the pink papers on various issues with the company (bad accounting, hidden losses, high debt). Every time, it led to a selloff, the stock bottomed at 209 with huge volumes and backed up 10-15%…it was party time in a bear market.

The big story now is the ‘penalty’ on DLF by the Competition Commission of a whopping Rs.630 cr (see the TRAI ‘recommendation’ above). Suitably headlined in the pink papers, it led to a selloff on a day when the broad market bottomed and some very smart investors bought 140 lac shares from some very relieved idiots. Watch this issue one year hence….!!! DLF has since not broken new lows, despite being from a pariah (real estate) sector…!

  • But this story is about Tata Steel and I must return to it, first by making my main point: that there are serious, quiet, and invisible ‘cozy’ relationships between analysts (especially from foreign brokerages, who put out ‘research’ when the market is delicately poised) and the pink papers, who give it a loud, terrifying voice that will blow you away if you don’t know your facts thoroughly. Recently, the market bottom for this cycle was made on a day when the leading pink paper chose to ‘poll’ some unnamed ‘Fund Managers’ and told you that the market was dropping 13%……not 17%, not 9%, not 12.36%. Just 13%…..the stock sold by its foolish readers was dully lapped up. Now watch this space 6 months hence!!!
  • The lesson for you, my dear readers… will die rich if you just read these papers one week after they are delivered to your house, and then you watch what your foolish neighbors did when they listened to such false ‘advice’. In my case, I read these (pink papers) to find out what the fools are doing. And I don’t watch TV, which is seriously good for my financial health.
  • The canards floating around just now:
    • Tata Steel is a global company, and with Europe facing a double dip, its European operations will be badly affected.

Europe accounts for 56% of Tata Steel’s turnover and about 30% of its EBITDA. It has high Operating Leverage, i.e. unit drop in selling prices will lead to a high negative impact on its EBITDA. But at 5 times EBITDA, this belief will at best hold for the short term (even if it is true).

At these valuations, just the 20% EBITDA growth from the Indian operations, which are unaffected, will give you a decent return.

  • Steel prices are bearish, and Tata Steel will be affected.

They have been bearish for some time now (CMIE has projected a 7% increase in domestic prices around Oct 2011), and recent results showed that Indian turnover growth made up for the decline in prices. EBITDA was flat, despite lower prices. Going forward, India will still see 10% growth in steel demand, and maybe some price improvement if the ban on iron ore mining and the problems of JSW prove to be good for its competitors. But this is to tell you that even in the short term, Tata Steel’s EBITDA will be more or less flat. But its stock price is down 20% below its CURRENT Book Value. At these levels, its current profits give you a 21% post-tax return; all you have to believe is that EBIDTA will not fall significantly.

  • In a high-interest rate environment, this is an interest-rate-sensitive stock with high debt. It should be badly affected by a recessionary scenario.

Wrong! The Corus debt has been reduced steadily, and consolidated debt is at 2 times EBITDA now, a very stable ratio. Its spare debt capacity gives it the ability to make another aggressive acquisition; watch out. Even if it doesn’t invest, it is paying down Rs.10,000 cr debt this year, or its expansion at Jamshedpur will come up with lower leverage than at SAIL or JSW. The company is the most under-geared in its –

  • Other Positives.

Its  ‘global’ operations are genuinely global, with commercial operations in 53 countries. A shortfall in Sales in Europe will be made up by faster diversion to other growing economies, especially in Africa.

Corus is not the operation it used to be in 2008 when it brought down Tata Steel to 40% of its Book Value. Memories of that downfall have triggered the current selloff, and that is why it is an opportunity for you. Today’s Tata Steel is a different company: huge cost synergies have already been extracted, half the Corus debt is paid off and most importantly, Corus technology is now helping Tata Steel with its product development in India and other emerging markets; that will help it outperform its competition locally. And the local markets are both robust and growing.

The fears about a European slowdown, even if they are true, don’t justify a 65% discount to its average historic valuations (of 2.3 times Book Value). At a 20% discount to today’s Book Value, you are getting a strong, deleveraged Balance Sheet and a robust P & L with little downside risk. If there are risks, they are in the price. The positives have not been factored in, and some of them are already on the Balance Sheet. Like Benjamin Graham was fond of doing, he wanted to pay only for current reality, not for future potential. You are getting just such an opportunity at Tata Steel right now.

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