We continue with Part 2 of our three-part series with focus on understanding how Rakesh Jhunjhunwala picks stocks which have served him well over many years. In this article, we look at the Rakesh in a Jhunjhunwala’s folklore. We look closely at Sesa Goa, Lupin, Titan Company and CRISIL
In part 1 of the series, we looked at Rakesh Jhunjhunwala & his investment philosophy, influences and inspirations. You can read all about it on how Rakesh Jhunjhunwala multibagger stocks identification strategy works.
Part 2 is about four of his early and most promising stock bets. We look at why he bought those and what learning investors can derive from these. We shall look at his investments in Sesa Goa, Lupin, Titan Company and CRISIL. Some of these stocks are present even today in Rakesh Jhunjhunwala stock portfolio.
What is covered in this article?
Sesa Goa
Sesa Goa Iron Ore (now Vedanta Limited) is a mining company based in India. The company has mining operations in iron ore, gold and aluminium mines in Karnataka, Goa, Rajasthan and Odisha.
Sesa Goa was one of Rakesh Jhunjhunwala’s early large bets. He invested in this company when the stock prices fell abruptly on account of a depression in the iron ore industry.
Rakesh Jhunjhunwala found the stock languishing at ₹25-26 with a good growth projection for the coming year. The bet was tactical as the prices of iron ore were at the lower end. The ace investor’s bet fructified into major gains as the prices rose by 20-25% the very next year.
Rakesh Jhunjhunwala bought 4,00,000 shares of Sesa Goa worth ₹1 crore. He sold 2-2.5 lakh shares at ₹60-65 and then some more at ₹150-175 and then some more at ₹2,200
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Lesson learnt from Rakesh Jhunjhunwala on his investment in Sesa Goa
Rakesh Jhunjhunwala’s investment in Sesa Goa was a pure cyclical value play. He recognised the mismatch between a company’s value and current price on account of depressed environments.
A more recent example of such movement is HEG Limited. HEG Limited is a leading manufacturer and exporter of graphite electrodes. Another player in the same league is Graphite India. Both these firms have seen super highs and super lows in their stock prices over the last three years. Their prices coincided with the price trends in graphite electrode prices.
There are many such anomalies that often present themselves as opportunities which can be utilized. Some other commodities which can be looked at are oil, coffee, rubber etc.
Infact, let’s look at rubber prices.
These are an excellent consideration to judge movement of the share price of tyre manufacturers like MRF or CEAT. For these businesses, raw materials account for 65-70% of the total cost. Just one raw material i.e. natural rubber accounts for 40% of the cost of manufacturing a tyre.
Here’s a line from the MRF Annual Report 2016-17. This was the period when the rubber prices spiked up 150% in six months. This happened due to diminished supply.
“The margins in the industry are under significant pressure due to the recent spikes in rubber and oil commodity prices. It is also likely that the headroom for passing on costs to consumers in such a competitive scenario will be increasingly limited putting a very high pressure on industry margins. Natural Rubber continues to be one of the core raw materials for the Indian tyre industry as against Synthetic Rubber which is the norm in the rest of the world.”
MRF Annual Report of 2016-17
Net net, the learnings here are –
- Understand the major components of costs will be of biog advantage to an investor. For example – the raw material cost to the companies you are tracking in your watchlist or portfolio
- Continue to track the prices of these components to identify buy and sell opportunities. Remember, the formula is – lower the cost of raw material, higher are the profits.
Lupin Limited
Lupin Limited is a multinational pharmaceutical company focusing on paediatrics, cardiovascular, anti-infectives, diabetology, asthma and anti-tuberculosis.
Per available data, Rakesh Jhunjhunwala invested in Lupin Limited as early as 2003. The share price then was in the ₹147-699 range.
Such a huge range!
Yes. 2003 was a breakout year for Lupin Limited when investors made a 400% profit on this stock.
Lupin Limited in 2003
To understand this better, we have to go back to 2003 and see what Rakesh Jhunjhunwala might have seen then.
Lupin Limited was an established company with a 35 year record of being in this business. As part of this exercise, I won’t get into the macro picture but it will be foolhardy to believe that Rakesh Jhunjhunwala would not have been impressed with Lupin’s stellar record.
Lupin’s market share with growing and it was #1 in the anti-TB category. The company had distribution prowess, high productivity, world-class manufacturing setup and good corporate governance.
From a financial perspective, here are some points that require due consideration –
- For this exercise, let’s assume Rakesh Jhunjhunwala started to buy shares of Lupin Limited in September 2003. The share price then was ₹400.
- Since the number of shares issued on that day was 4,01,41,134 shares. Each share had a face value of ₹10.
- The market capitalization of Lupin Limited in September 2003 was ₹1,605 crores
- The net profit or earnings of the company for the previous year i.e. FY 2002-03 was ₹76.6 crores. This results to an earnings per share of ₹19.1. Hence, the price earning ratio (PE Ratio) comes to 21.
- The company offered a 50% dividend in the previous year. If this were retained (likely should be the same or higher) comes to ₹5 per share.
- Lupin Limited also had an outstanding of ₹650 crores of loans. If assumed at 10% interest rate, the debt servicing ratio (assuming no principal is payable) was 2.85 i.e. EBITDA of ₹185.4 crores divided by Interest payable at ₹65 crores. 2.85 of debt servicing capacity is just borderline.
On the face of it, there might not have been too much of value for me to pick Lupin. I am speaking relatively from the thousands of options available in 2003. Afterall, the world had just come out of the 2000 dot com bubble and, India from the Ketan Parekh scam. There were truly many opportunities for Rakesh Jhunjhunwala to devour.
Why Rakesh Jhunjhunwala might have seen in Lupin Limited?
High Return on Equity
A positive area about Lupin Limited would be it’s High Return on Equity. Lupin Limited offered an earnings of ₹76.6 crores over a shareholder’s equity of ₹382.3 crores. This is an ROE of 20.1%. While I should not look at any current data, it should be noted that as it stands only 5 out of 59 pharma companies on my screener have an ROE of over 20%
High Revenue Growth
Lupin was exhibiting high growth rates which were faster than how the overall industry was growing. Revenue had grown from ₹750 crores in FY 2001 to ₹806 crores in FY 2002. And then again to ₹968 crores in FY 2003. Lupin had shown a strong Q1 and Q2 in FY 2004 which would have spruced up the confidence in Mr. Jhunjhunwala to consider this stock. The EBITDA and net profits were also growing at a similar pace on an year-on-year basis.
High Net Current Asset Value per share
From a value investing view point (Benjamin Graham style), I notice that the Net Current Assets were ₹617 crores in FY 2003. Net Current Assets = Current Assets minus Current Liabilities.
This comes to a Net Current Asset per share of ₹153 – which is quite massive. Benjamin Graham’s conservative value investing tenets allow a 75% value on these current assets. This means the per share price for all practical purposes is not ₹400 but ₹400 minus (₹153 * 75%) = ₹284 per share. Once we factor this, variables like the PE ratio start looking much in our favour.
Improving Free Cash Flow
Finally, Lupin Limited’s free cash flow is another positive which would have helped Rakesh Jhunjhunwala’s case.
Free cash flow is the cash generated by a company after accounting for cash outflows required to support business operations and expenditures towards adding capital assets. Free cash flows are different from net income or earnings as they exclude non-cash expenses like depreciation however include often big capital expenses like the commissioning of a plant which generally gets lodged in the balance sheet. I maintain that the free cash flow is a more important indicator of sustainable business than net profits or EBITDA or EBIT
In a previous article on Rakesh Jhunjhunwala, I had introduced the galle mein kitna paisa hai framework. The free cash flow metric is just that.
Lessons learnt from Rakesh Jhunjhunwala’s investment in Lupin Limited
- Historical PE Ratio is just half-a-bullet. A seasoned investor needs to factor growth in earnings to understand real value of the stock
- High Return of Equity companies are always going to be in demand. So unless the valuations is really over the board, do expect a lot of interest in those companies
- Value investing principles still work and help investors create a moat around their investment. In the case of Lupin, this was a high Net Current Asset value per share
- Free cash flow is perhaps the most important of all metrics. A company with the ability to generate high free cash flow will always have enough money to support its growth, expansion, slowdowns and disruption with better rigour and financial backing.
Titan Company
Rakesh Jhunjhunwala’s favourite stock is the Titan Company.
As it stands, he holds 6.69% of the company’s total stock which comes to just over ₹7,000 crores. His first investment was in the 2002-03 period. The stock was available for an average of ₹60 per share.
Financials of Titan
Let’s look at the numbers presented by Titan in the year 2003. Then the company was named Titan Industries
- The number of shares outstanding for the company were 4.22 crores of the face value of ₹10 each. The market capitalization of the Titan Company was ₹253.20 crores.
- The Titan Company share price was performing below average over it’s 8-year average share price. It was languishing around the ₹60 per share mark.
- Titan’s net profit was ₹6.21 crores on a revenue of ₹800 crores which signified a net margin of just 0.77%. This was a red flag.
- This was the time when Titan was doing organization-wide restructuring. There were cost reductions, voluntary retirement schemes (VRS) and downsizing of the company’s European operations. There was also a wage settlement with the Union which led to the management declaring a lock-out in the crucial fourth quarter. These problems kept the share price depressed. Something to worry about
- Titan’s dividend had been lowered to just ₹1 per share (10% dividend payout) on account of sharp decline in profits. The year was a very tough year. The Titan Company had to dip into it’s accumulated reserves to pay the dividend. Another red flag.
- Return on Capital Employed was on the lower side at just 7.8% in 2002-03. This is because of the retention of debt in the books and the low profits for the year
Picking Titan on a cursory view would have fooled anyone. Afterall, here was a company whose profits had come down twice in the last two years. Titan had also reduced its dividend for two years in a row. Infact, the 10% dividend payout offered in 2003 was the lowest for Titan since 1990. (The company first started to offer a dividend to its equity shareholders in 1990)
Why Rakesh Jhunjhunwala liked Titan as an investment?
My first guess that quipped Rakesh Jhunjhunwala’s interest in Titan was on the basis of value investing principles.
Titan had a market capitalization of ₹253 crores and the net current assets in the company were ₹396 crores. Even after accounting for a 25% discount on the net current assets, the discounted NCAV (net current asset value) per share was coming to ₹70.38 per share.
This means that if nothing else was worth liquidating in the company and the only thing we could liquidate were the net current assets at a 25% discount, still – an investor would have ended up with a profit of 17% on the acquisition price of ₹60 per share due to Titan’s High Net Current Asset Value per share
This is the classical Benjamin Graham way of looking at this business.
Titan’s revenue was always rising every year. Infact they had not have a single year in the last 15 years when the revenue had dipped. And generally the business operated at a net margin of 3-4%. The exception to this was 2001-02 and 2002-03 when the net margins dipped due to excesses and wasteful expenditure. This waste was being reigned in by the management
Titan also exhibited high return on equity (ROE) for years together. Barring 2002-03, Titan always had an ROE of over 30%. This which suggests that the company has the ability to generate profits without needing as much capital. A high return on equity shows that the company’s management is deploying the shareholder’s capital in a very efficient manner.
There were two divisions at Titan – 1. Time products and 2. Jewellery. While Time Products had a higher share of the revenue, it was getting clear that Jewellery is going to be the mainstay of this business. This augurs well in a country like India. Households here have an unquenching thirst for accumulating gold since the days of the Mahabharatas and Ramayans.
Titan had established Tanishq as India’s formidable organized market brand. The jewellery business had tripled its revenue over the last three years. It was getting clear that the jewellery business will overtake the watches business in a matter of two years.
Pros and Cons of investing in Titan
In summary, here were the pros and cons of Titan at the time Rakesh Jhunjhunwala would have evaluated at the time of deciding if & how much to invest –
- Why would I invest in Titan?
- Depressed share price which makes the valuations a really delightful buy
- Growing revenues
- Decades of profitability
- Established brand name
- High Net Current Asset Value per share (even higher than the share price)
- High return on equity
- Why would I not invest in Titan?
- Two years of depressed profits
- Lockout in their factory in Hosur which might jeopardize the 2003-04 profits further
- Low net profit margin
- Low return on capital employed
Lessons learnt from Rakesh Jhunjhunwala and his investment in Titan Company Limited
- Identify High ROE (Return on Equity) and Low PE (Price Earning Ratio) stocks to maximize gains. By 2003, Titan had a five-year ROE of 39% and a PE of 16. This qualifies for a High-ROE-Low-PE investment
- Stock prices will often get depressed due to external factors which don’t play out over the long run. For example – the lockout in that factory in Hosur happened in February 2003. Between Jan 2003 and Mar 2003, Titan’s stock price had gone down by 22%. The point is – the Unions and management are bound to negotiate the terms soon and the locks are coming down.
- Build a large margin of safety. In Titan’s case it came with the high NCAV per share. Even post discount was still 17% higher than the stock price of Titan Industries which served as an excellent valuation moat to the purchase
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CRISIL
CRISIL or the Credit Rating Information Services of India Limited is India’s leading ratings, risk, financial news and policy advisory company.
Recommended Book: Here is a good book about CRISIL that gives an inside view into how an independent, process oriented ratings business was built from the ground up.
The company is credited to pioneering the concept of credit rating in India. It is the leader in the ratings business for many decades now. Companies, governments, banks, multinationals, insurance companies, pension funds and other institutions rely on CRISIL’s ratings on corporate debt obligations for taking necessary strategic decisions.
Rakesh & Rekha Jhunjhunwala started investing in CRISIL in 2003 by picking up 10,000 shares of the company. This amounted to 0.16% of the total paid up capital. Their names were featured in CRISIL’s 2004-05 Annual Report. The investor couple held 550,000 shares as on May 26, 2005 representing 8.64% of the paid-up share capital.
If the shares were accumulated between 2003 and 2004, the share price of CRISIL ranged between ₹400 and ₹500. Let’s assume the share price was ₹500 when Rakesh Jhunjhunwala started picking up a stake in CRISIL.
Therefore, we shall look at the performance of CRISIL until mid-2005 to understand what prompted Rakesh Jhunjhunwala to invest in this company.
Financial Details of CRISIL
Let’s start with some macro here
- CRISIL had been growing its revenues every year. On a CAGR basis, the revenue has grown by 17.3% over a ten year period. And by 17.8% over the last 5 years.
- The company’s EPS too have grown in all years barring one. On a CAGR basis, the EPS has grown by 22.9% over ten years and 10.4% over five years.
The company has a unique business model which though seemingly easy, is quite difficult to replicate. What I find remarkable is the level of predictability that is there in this business.
The steady and predictable revenue and earnings allows us to run a discounted cash flow model. This will get us a better understanding of the worth of this stock. I have run a simplified version below because we are trying to do a back of the envelop evaluation of Rakesh Jhunjhunwala’s choices
Discounted Cash Flow of CRISIL
The Discounted Cash Flow (DCF) analysis is done to estimate the money an investment will produce after adjusting it for time value of money.
In order to do a DCF analysis, we need to make estimates about the future free cash flows of the business and the ending value (called terminal value).
I am going to assume terminal value as zero here for the sake of being conservative. I also believe the terminal value will not be high because CRISIL is in a service business and does not have assets like plant, machinery, patents etc.
Let’s estimate the free cash flow for CRISIL for the next 10 years
Free cash flow = Cash flow from Operating Activities minus Capital Expenditure
Per the 2004-05 annual report, the cash flow from operating activities for the year ending 31 March 2005 was ₹20.8 crores. Now based on the data we had seen earlier, it is fair to assume that CRISIL’s operating cash flow would increase by 15% every year.
The capital expenditure was about ₹5 crores which was hardly growing. We’ll put that increase to 5%.
And to calculate the present value, we will take a discount rate of 10%.
Hence the free cash flow calculation comes out to :
| Year | Cash flow from operations | Capital Expenditure | Free Cash Flow | Present Value |
| 1 | 20.8 | 5.0 | 15.8 | 14.36 |
| 2 | 23.9 | 5.5 | 18.4 | 15.22 |
| 3 | 27.5 | 6.1 | 21.5 | 16.12 |
| 4 | 31.6 | 6.7 | 25.0 | 17.06 |
| 5 | 36.4 | 7.3 | 29.1 | 18.04 |
| 6 | 41.8 | 8.1 | 33.8 | 19.07 |
| 7 | 48.1 | 8.9 | 39.3 | 20.14 |
| 8 | 55.3 | 9.7 | 45.6 | 21.27 |
| 9 | 63.6 | 10.7 | 52.9 | 22.44 |
| 10 | 73.2 | 11.8 | 61.4 | 23.67 |
The sum of present value comes to ₹187 crores based on my assumptions.
The number of shares outstanding were 63,65,500 shares. At ₹500 per share, the market capitalization of CRISIL came to ₹318 crores for the period under consideration.
Thus, the sum of present value as per the DCF model comes short of the market capitalization. In other words, the price asked for a stake in CRISIL is not commensurate with the future cash flows that the business is expected to generate.
Net net, I would not have bought CRISIL at the price at which it was offered.
Existing Assets of CRISIL
But this begs me to find if there were any assets worth looking at which I may be ignoring. The hardest and cleanest asset i.e. cash & related instruments did get me interested.
CRISIL’s balance sheet said that the company had ₹11.4 crores in cash and bank balance.
That’s not enough.
But a deeper look at the investment section shows that a large part of the ₹66.4 crores of investments is into liquid funds of mutual fund schemes. That is about ₹48 crores.
Cash and liquid investments = ₹11 + ₹48 crores = ₹59 crores.
₹59 crores represents almost 20% of the market capitalization of CRISIL.
Having a cash blanket like this is a good sign for looking at CRISIL as a dividend stock. CRISIL has been paying dividends every year and has been increasing the dividend payout % every year. The dividend payouts in the last five years are 55%, 65%, 100%, 100% and 125%.
At a face value of ₹10, that’s a dividend outlay of ₹12.5 per share. At 63,65,500 shares, this comes to ₹8 crores of dividend payout which can be easily managed with the existing cash reserves.
Now, it’s possible that Rakesh Jhunjhunwala might have seen CRISIL as a dividend stock. Because at the acquisition price of ₹500, the dividend yield comes to an mildly acceptable 2.5% (although I wish it were 5%)
Having said this, remember – there were a number of other opportunities available in the stock markets at that time which could be utilized to make big bucks. In my books, CRISIL does not really cut it per my investment criteria.
Conclusion
In this article we examined four of Rakesh Jhunjhunwala’s investee companies. And put ourselves back in time as to what prompted him to purchase a stake in these businesses.
In the next section, we shall look at some companies that Rakesh Jhunjhunwala invested in with rigour but did not shape up the way he assumed they would. Our analysis will include Praj Industries, Hindustan Oil Exploration, Karur Vysya Bank, Nagarjuna Construction and Punj Lloyd.
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