Background:
Gudovac first wrote about Jaiprakash in short piece last July. Their most recent quarterly results have been released. They are quite good.
Jaiprakash makes cement. Some 4o% of revenues are derived from the cement group. India needs a lot of cement.
Jaiprakash also builds infrastructure. Approximately, another 40% of revenues are derived from the construction group. India needs a lot of infrastructure.
The remaining revenues are derived from forays in glamour industries such as golf clubs and up market hotels, Formula One race tracks, and even cooking oil. Japiprakash has no particular expertise in real estate development. Neither does it have any particular expertise in cooking oil. Gudovac is willing to forgive Management for this potential waste of capital and talent. In family run Enterprises, these tangential forays are to be expected. They provide a venue for siblings and cousins to operate constructively but independently of the Patriarch. The amounts are small. The sector is wide open. Perhaps Jaiprakash will eventually generate excess returns in this sector.
Jaiprakash finally cleaned up its cumbersome share structure last May. A clean Ownership structure is always a good starting point.
Gudovac is familiar with Jaiprakash from a few years ago - when he became acquainted with the Patriarch's son who operates the business. The Chairman's son appears to be modest and hard working. Noteworthy is his total compensation of slightly more than $400,00o. This is an absolute pittance compared with the lavish pay of his less productive US counterparts. The next generation of Gaurs are likely to become playboys and fashion queens. But the current generation is exactly the sort of Owner-Manager who outside Owners wish to partner with.
Jaiprakash passes the first investment screen, Managers who are industrious and work for the Owner's interest. Next screen is to examine the numbers.
Financials:
What one notices at first with Jaiprakash is a double digit growth rate. Secondly, one notices margins are exceeded only by Madison Avenue Law Firms. The other number Owner's should notice is despite healthy margins, Jaiprakash consumes significant amounts of capital. This is to be expected. A growing industrial company will consume capital as fantastic rates. Constructing Power Plants and Cement plants requires staggering amount of up-front capital.
Breakneck revenue growth often results in working capital inefficiencies. Jaiprakash is no exception. The current ratio has slipped with revenue growth. Owner's would do well to monitor the current ratio closely. Gudovac would treat any slippage below 1.20 current ratio as cause for serious concern. A Current Ratio below 1.10 would be cause for alarm.
Debt at Jaiprakash has grown ahead of revenues growth. Revenue run rate has increased 250% over the past 5 years. At the same time book debt has increased 280%. This is exactly what one would expect. Debt taken on this year funds the next year's expansion.
However, the single financial ratios which does concern Gudovac is the interest rate coverage. Interest rate coverage at close to 3x PBTis low by conservative standard. Gudovac prefers to see coverage ratios of 4x PBT. However, the 4x threshold is a rule of thumb for mature companies in developed countries. Gudovac is not certain that applying a 4x ratio is appropriate for Jaiprakash. Owner's should note that the coverage ratio was a dreadful 1.01x PBT 5 years ago and has steadily improved. Therefore, as long as the coverage ratio holds steady or improves, Owners need not be too concerned about the debt burden.
However, even a slight decrease in the interest coverage ratio should be cause for concern. Decreases suggest the Enterprise is consuming Capital inefficiently. Inefficient use of Capital is often the first sign of grave misallocation within the Enterprise. Owners would be wise to examine this ratio every quarter.
The financials describe an Enterprise which one would expect given the Indian context. Insane growth, massive pricing power, and a not-so-great capital structure. At what price should an Owner buy Jaiprakash and partner with the Gaurs ?
What Price to Buy ?
Ascribing an appropriate price for Jaiprakash is an exercise fraught with unknowns.
How long can India GDP grow at 6-8% annually ? A Decade ? A Generation ? 3 Generations ? Where does India lie on the Solow Growth Model curve ? The answer to this question will determine at what point in time Jaiprakash will stabilize. 6-8% compounded over 10 years provides a very different result than 6-8% compounded over 100 years.
How long will it take India to create a national infrastructure equal to Germany's ? Gudovac has traveled extensively throughout India. Gudovac has toured dozens of factories, driven thousands of miles on Indian roads. Gudovac knows only that it will take more than a decade. He can conclusively state that anyone who tells you that he knows the answer with greater certainty does not have a clue.
So what is a prospective Owner left with to determine a sensible price ?
Perhaps using the efficient market ? In India ? The Efficient Market Hypothesis functions erratically on massive stable exchanges such as the LSE & NYSE. India's stock exchange(s) are buffeted by external Capital and animal spirits. A Owner would do well to ignore market signals while developing his own price. Further investigation is warranted, if there is a wide divergence between the market price and the Owner's price.
The sole benchmark one can use is comparables plus a liberal application of judgement. Jaiprakash might reasonably be expected to become the LaFarge or Holcim or Cemex of India. Therefore, an owner might reasonably use these 3 behemoths as a starting point.
All three have been hit hard by the developed world's downturn. Cemex is going through a painful debt restructuring. LaFarge and Holcim are generating small positive income. All three are laden with heavy debt burdens. The three have Enterprise Values of roughly 1.5 - 2.0 times TTM months revenues.
Jaiprakash currently sells for a significant premium over these 3. Jaiprakash sells for almost 7 times TTM revenues ! Is Jaiprakash worth nearly 4 times these comparable multi-nationals ?
Gudovac - believes No.
Jaiprakash is worth perhaps a healthy 3 times the industry titans of LaFarge, Holcim, and Cemex - in Gudovac's seasoned judgement.
This calculates out to a 160 RS. common share price. A 160 RS price calculates out to approximately 12 times TTM EBITDA. At 160 RS., Owners can feel confident they have bought Jaiprakash at a sensible price.
----------------------------
Don't Get Massacred !
Gudovac1941
No comments:
Post a Comment