Mad rush: Where does it lead us to?

Quite some time I last wrote. Well, I (and all of us) was going through the current topic itself!

This is about the world stock markets that crashed one after the other like a house of cards. Just stocks? Oh did I forget the bonds, real estate, credit cards, CDO multiples, jobs, confidence...Sounds like just yesterday.

Let us talk a little botany...life cycle of a tree?

Most trees grow out of a seed. That tiny seed that someone/something sometime sowed somewhere. And then ample sunshine, regular mineral enrichment of the soil, and adequate watering helped sprout the seed. It became a sapling. So it became easier for it to grow into a plant, and its journey from there to become a fully grown tree was quite a cake-walk. The whole process takes anywhere form 9 months to 2-3 years.

My point is not botany, but an empirical analysis of the series of crashes we've faced in the past two years.

We're facing currency risks now-a-days. The currency of the future and the royal currency - both have already been through rough times. The currency deemed to beat gold is now under pressure, and is bring in jeopardy currencies of the rest of the world. Middle east currencies are losing pegged value and are tensed. Eastern currencies are appreciating and are still tensed! Grass is greener on the other side, is it? Oh, we spoke about trees. Done! Well, this is a regime of currency shocks! Great, accepted!

Where did this regime come from? The abrupt GDP growth rate differences around the world. That came from the so-called "recession". Job-cuts emanating from losses suffered because of confidence crash, that happened due to the stock and bond market crashes, which it is believed was a direct overshoot of the COD multiples and families, which in fact was a result of housing market and credit card crisis. All this in just 2 years! Okay, must have been the growth stage of the plant to become a tree...the fast one...in the life cycle of a tree...botany lesson?

Damn what would have been the slow "sapling to plant" stage?

Oh and the most difficult sprouting stage?

Who harnessed this big tree?

What is the next stage? Fruits? Multiple seeds? Forests? OMG!!!

And now that we have a tree giving us oxygen, there's big penalty - ecological and financial - to cut it off!

What are we headed for?

The art of making an unfair coin fair

Almost every coin has a head and a tail. These are called two states of the coin.

We use these coins in many of our decisions. A boy in love makes his first move towards the woman of his dreams by tossing a coin over & asking for a head (or a tail). The batting order in cricket is decided on the basis of a toss done using a coin. But are these coins a fair means of evaluatng our decisions?

Well I feel, not really.

Take a look at these coins that are/were in circulation in India. On one side, there's a full emblem or map or an animal or any big figure in addition to the year and most of the times, a few more words here and there. This is what we call the head of the coin.

On the other side, we have a number, two small designs, and a word or two. This is called the tail of the coin.

Now let us take a look at these coins that are/were in circulation in Dubai. On one side, there's a big occasion or a map or an animal or any big figure in addition to words written all around the coin. This is what we call the head of the coin.

On the other side, we have a number, a word, and words allound the coin. This is the tail of the coin.

Now this is the Singapore Dollar coin.

A big figure on both sides! However, on close observation, it can be seen that on the tail side of the coin (where $1 is written), the figure captures a wider surface area as compared to that on the head side.

Now, why am I mentioning the structuring of all these coins?

Well, I'm sure you'd have drop an ink pen by mistake at some point of time in your life. What happens? If undistrubed, it always fall nib-headed. Why?
You'd have heard of or seen in movies, people falling freely from big heights e.g. in bungee jumping. They always fall with their head rushing for the ground. Why?
The reason is that these are the heaviest parts in the body of the falling object. Nib is the heaviest part of most fountain pens' body. Head is the heaviest part in human body.

Similarily, the heaviest part of a coin's body should head towards the ground in case of a free fall. The centre of mass of the matter on either side of the coin falls at the centre of the coin. However, its value on both the sides is different. Higher the mass on one side, higher is the probability of getting the other side of the coin as the outcome of the toss. So, coins having a larger picture on the head side, should show you the coin's tail as a more frequent outcome. And the coins having a larger picture on the tail side, should show you the coin's head as a more frequent outcome.

In a nut shell when we toss a coin next time, we should bear in mind that there does not exist an equal probability of getting a head or a tail.

"In statistics, a fair coin is an idealized randomizing device with the two states which are equally likely to occur."
For this purpose, there are three possible solutions that come to my mind:

1. Device a coin with exact proportion of masses on both sides, and take utmost care that it is kept away from the wear and tear
2. Assign probabilities to the two sides of the coin in inverse proportion to their weights, and multiply te outcome of the toss by its respective probability. The final decision in this case would be an aggregate probability of both the outcomes.
3. Toss the coin really hard, so that the centrigugal force does not let the unequal weights on the two sides come into play

The third option is widely used by all of us. However, most of us do not know that this is the art of making an unfair coin fair!!!

VALUE THE UNDERVALUED - BIOCON

SELL!!!

“Our ability to continuously scale new heights across the biopharmaceutical value chain enables us to realize the promise of future therapeutics.”

- Kiran Mazumdar-Shaw, Chairman & Managing Director

Some notable assets

1. Started divesting its enzymes division to Novozymes in 2007
2. Launched BIOMAb EGFR™- India's first anti-cancer, therapeutic Monoclonal Antibody-based drug for treating solid tumors of epithelial origin, such as head & neck cancers, in 2006
3. The first company globally to manufacture human insulin, INSUGEN®, using a Pichia expression system, in 2004
4. Biocon's proprietary bioreactor, the PlaFractor™, has a US patent
5. The first Indian company to be approved by US FDA for the manufacture of lovastatin, a cholesterol-lowering molecule
6. For the period between April 2006 and March 2007 Biocon has undergone 41 successful compliance audits by various national and international customers and regulatory authorities.Various other awards and recognitions.

Competitors' snapshot




Performance indicators

Valuation

A beta of 0.59 was calculated for the firm's stock. As the company was listed in 2003; so it might have performed quite differently from the index in earlier years. Now the stock is stabilizing; so present year values are bound to give a better beta for analysis.

For India, the market risk of 14.5% and 10-year treasury bond rate of 7.88% were taken from bloomberg.

Interest coverage ration being>12 yields cost of debt for the firm to be 8.22%. The cost of equity was calculated to be 11.17%. Average tax rate comes out to be 9.84%. This yields a WACC of 11.1%.

The low tax structure, the low beta, and fresh launch of equity gives a clear indication to use a three phased dividend model finding the intrinsic value of Biocon. Earnings are growing at high rate of 14.73% (Geometric mean of past five years growth) and are expected to continue the pace for an initial period of two years, and then start declining gradually over a period of five years maintaining an average growth rate of 12.86% (estimated from competitor growth) to reach a stable rate of 7.5% (economy growth rate) as the firm becomes larger and more firms enter the pharma space. The WACC for the subsequent years were calculated to be 12% for declining phas and 13.07% for the stable phase.

Looking at the highly fluctuating debt structure, we take the FCFF route to value the firm at Rs. 3378.86 crore yielding an intrinsic value of Rs. 337.89 per share.

Comment on Technical analysts’ view
Technical Analyst, Deepak Mohoni is of the view that one can hold Biocon for long term.
Mohoni told CNBC-TV18,

"Biocon is an interesting stock because it's not behaving like most of the other stocks in the market. It had been in a long-term decline till the middle of 2006 and since then it has been in a pretty persistent uptrend and now its actually started moving up quite quickly and is almost getting into the momentum category. So this looks like a good short-term trade whenever the opportunity comes and in the long-term it definitely looks like a hold. Other advantage with the stock is, it doesn’t usually go along with the index very much, it would go up or down against the direction of the index. So that makes good addition to a portfolio."

2007-11-16 14:52:39 Source: moneycontrol.com

The stock had been declining till mid 2006 because of its low net working capital followed by decline in PAT. It may no doubt move up in near future, given the supernormal growth calculated above continues for a longer period.
However, the observation that it does not go with the index seems hazy to us because it has a beta of 0.58 which is quite high. So with so high markets, if the risk associated with the index in 2 months time is 80%, that of this stock is 46.5%, which is a fairly high figure.
The stock may no doubt pick up in the near future; but the intrinsic value as given by the ‘g’ calculated above is quite low to make it fall. Well, it may be a good bet after a correction.

Looking at the strong India growth story, maybe, the analyst is looking at at short term gain of around 20%.

What does pharma sector say?

To further reaffirm our findings we looked at the major players in the pharma sector.

As per the PE figures, Biocon should be valued at Rs. 306.12 per share. P/BV ratio values the firm at Rs. 316.70 per share. PS prices the stock at Rs. 312.37 per share.

Hence, at current price level of Rs. 579.5, the stock seems too much overvalued.

Result

Biocon witnessed a 23.5% drop in PAT in 2006 due to increased pricing pressures, which impacted the net margins by 7.08%. This in turn affected its ROE. Biocon has a very high retention ratio, so it probably believes in reinvesting a major chunk of its earnings and allow capital benefits to its investors. It has however been reducing its retention over the years which in turn is reducing its growth rate. Well, this is a good sign for people who'd like to earn good dividends; but as far as capital appreciation is concerned, if conditions do not improve in the near future, the stock may fall badly.

We therefore recommend a Sell Rating for this stock.

In times to come, due to so many plus points that the firm has, maybe its PAT figures improve and then may be it becomes an investing opportunity. But with the present pricing policies of the GOI, that certainly is not an option.

VALUE THE UNDERVALUED - Andhra Petrochemicals

BUY!!!

Petro Chemical Industry

Over a period of last three decades, there has been a tremendous increase in the size of the petrochemical producers’ family in the country. In early seventies, the first integrated petrochemical complex i.e. IPCL was established at Baroda with the setting up of economic size naphtha cracker and downstream polymer plants of international size. In the decade of 1980-90, a gas based petrochemical complex with a cracker of international size namely MGCC was planned at Nagothane. However, by the end of 2000, more and more complexes were commissioned by the private players in the country. By this time other large and medium units also came in a big way by capacity additions or existing capacity expansions in synthetic fibres, polymers, elastomers, building blocks (aromatics and olefins) etc.

Andhra Petrochemicals - An overview

Andhra Petro Company’s main business is manufacture and sale of oxo-alcohols. The Plant at Visakhapatnam has the capacity to produce 42,000 MTPA of oxo-alcohols. The market demand for oxo-alcohols is currently estimated at 143,000 MTPA, out of which Andhra Petro Company is able to meet 30%. Balance 70% is met through imports. The estimated annual growth in demand is 8 to 10%. To secure a greater share of the market and meet the growing demand Andhra Petro Company has initiated an Expansion and Modernisation programme to increase its production capacity to 73,000 MTPA. The expansion initiatives have been undertaken with the twin objectives of gaining wider market share, and improving the profitability and returns to the stockholders while strengthening its competitiveness. The enhanced capacity of the plant is expected to be operational in the 2nd half of 2009-10. Andhra Petro Company will during the Financial Year 2010-11 operate at 73,000 MTPA when Andhra Petro Company’s market share would be around 36%.

Future outlook
With the strengthening of the Rupee value, imports are becoming cheaper and the Company’s products may be exposed to competition from imports. Further, as per the agreement with HPCL, the price of Propylene, the main raw-material, is due for revision. To meet the situation Andhra Petro Company is implementing cost reduction measures in power utilisation and in other possible areas of operation.

PBIT has been readjusted after amortization of R & D expense.
On checking the notes to accounts of the company, it was seen that the firm had Miscellaneous Receipts so that amount equal to 0.1455cr in year 2006 - 2007 was not included in the operating income as it was not part of company’s operations.
Tax is calculated on PBIT at the rate of 35% which was calculated on the basis of average of the last 4 years tax rate.
After calculation of the FCFF for the firm, the valuation of the firm has been done .As this firm is going for an expansion plans for worth Rs. 3.2 billion .So this firm will most likely follow a 3 phase growth model.
Growth story has been estimated on the basis of trailing 12 months values and is found to follow a three phase model,
1. Supernormal growth of 17.97% for 5 years

2. Declining growth of 12% for 3 years

3.Stable growth of 7.5% which will be in accordance with that of the Indian economy

The firm is valued at Rs. 62.03 per share provided it maintains the current growth story, which it is most likely to. Hence, the stock at Rs. 36.8 per share currently looks quite undervalued.


Industry Structure and Developments

The year 2006-07 witnessed all-round improvement in the performance of the Company. Production of Oxo-Alcohols was 42,408 MTs and sales achieved were 42,808 MTs. Gross Income for the year rose to Rs.312.41 crores from Rs.227.58 crores in the previous year. The company has posted an all time high Profit (Before Tax) of Rs.54.84 crores. The improved performance and profitability are mainly due to better sales realization and reduction in cost of power. To secure savings in power cost, the company has installed and commissioned 2400 KVA uninterrupted power supply system and discontinued the continuous operation of D.G. Sets. The system was in operation for the period from September, 2006 to March, 2007 which resulted in reduction in power cost to the tune of Rs.8 crores per annum on annualized basis.With the strengthening of the Rupee value, imports are becoming cheaper and the Company’s products may be exposed to competition from imports. Further, as per the agreement with HPCL, the price of Propylene, the main raw-material, is due for revision. To meet the situation your Company is implementing cost reduction measures in power utilization and in other possible areas of operation.

The numbers look quite good. It is evident that on the onset of further growth opportunities, the company is making good returns. The financials look pretty strong. A 1000% increase in ROE and 600% growth in ROCE figures is a good sign for the investors of this firm, and the market is responding to this with good appreciation in the stock figures.

Let us look at the petrochemical market as a whole, in order to estimate the value this stock should be at to be in tandem with the market figures.

Valuation through Multiples

Comparing with the industry average of petro-chemical business, the company should be valued at 16x multiple of its present earnings or at 8x multiple of its book value, which gives it a price target of Rs 68-71 per share. The share is currently available at Rs 36.8 per share on BSE making it undervalued. We recommend a strong buy for the share with a medium term target of Rs 56 per share, and a long term target of Rs. 71 per share.