Banks suspending share buybacks

  1. CNBC just reported that the big 8 banks in the U.S are going to be suspending share buybacks.
  2. BAC, BNY, C, GS, JPM, MS, State Street & WFC are the banks that have suspended buybacks.
  3. CNBC link here

This begs a few questions:

  1. What happened to the capital cushion and Fort Knox balance sheet everyone was talking about? Probably, the move is to conserve cash.
  2. Were they asked to suspend buybacks from someone else?
  3. All the banks had record buybacks in 2019 when the stock prices were up and suspending when the stock prices are down. A classic strategy of buy high and sell low.
  4. Is the coordinated function to prevent weaker banks from being targetted during this time?
  5. If the banks are doing this at this point, coupled with the Fed’s decision to go down to zero, the underlying business must have cracked. They must seeing signs of distress everywhere.

Market behaviour and its implications

Investing is easy but not simple. Investing can be skinned in many different ways creating possibilities that are extremely far off from each other yet produce similar results over the long run. Emotional equanimity through the process is a completely different animal with varied outcomes depending on the part of the cycle one is in.

While markets are largely efficient, it is just as often extreme in its views of certain sectors of the market. Either investors are completely enamoured by the business and its quality that they want to own it at any price and project the future with a lot of certainty that the underlying business might or might not possess. On the other hand, they completely shun some businesses and refuse to touch it even when the value proposition gets compelling. Couple this phenomenon with the narration bias where glowing articles galore on businesses that do well and doomsday articles on businesses that rile on businesses that are out of favour. This creates an interesting pond of opportunity as the market analyses the information fairly well but there are times when the market also struggles to separate the wheat from the chaff. Other times, the narration changes very quickly.

Let us look at a business that is viewed very favourably today by the market. Apple Inc. The market cap of Apple is $1.395T today and the shares trade at $318.31 as we speak. The PE is north of 26 and the dividend yield is just shy of 1% (Yahoo Finance)  The market is pricing in what is expected to be a strong holiday season sales; the subscription growth of Apple+, the newly launched streaming service last year; the AirPods pro launch and the upgraded iPhones; the 5G compatible phones that are expected to be released later this year. All are valid reasons and you can find several articles that dissect any of the above mentioned reasons and you can get a fairly good sense of the narrative. All in all, it is priced like a technology leader who relevancy is solid with a strong moat that will protect the business (at least for the next decade).

Rewind a year ago, the market cap of Apple was close to 50% of what it was today. Jan 21, 2019, Apple closed at $157.9 a share; a tad less than half of today’s price. In less than a year, the company has added close to $700B of market cap. Around the same time last year, the company was coming of a bad holiday season, profit warnings, gloom and doom articles appeared around how companies could bypass the App Store and even though Apple was better than RIM and Nokia, it faced an uncertain future in a technology driven market and was much better priced at a lower valuation like a declining business.

What a difference a year makes. In context of Apple though, it needs to be kept in mind that the market does not owe a down year just because it had a stronger than expected 2019. Nor does it mean that the momentum will continue forever either. Remember, the market is supposed to be largely efficient. Yet, the narrative changes quickly. This is why investing is simple but not easy. 8.2% of the entire S&P growth in 2019 came from Apple alone. Apple and Microsoft, accounted for 15% of the S&P growth. If you owned the market, you benefited largely from the technology growth of 2019 or if you owned Berkshire, the value of your holdings benefited from Apple (as the single largest equity held by Berkshire). If you were a single name investor and did not have the index or Apple or Microsoft in the portfolio or were not big into FAANG or technology in general, you had an uphill battle in 2019 to beat the market.

However, that was an easy one. If you are investing in the markets, you probably were aware of the Apple example. If you had to benefit from Apple’s massive run, you had to buy / hold the stock through some scary headlines. Just being contrarian does not work either. Every bankruptcy has been preceded with scary headlines. Differentiating the wheat from the chaff is the key there.

Let us look at some examples at the other end of the spectrum. Pan out from the US and pan in into the Indian banking and shadow banking system. A poster child of things gone wrong. DHFL posted close to a $900M loss on a $14B loan book; financial irregularities are being investigated and the company is going through a bankruptcy process in India. Yes Bank is losing all credibility in the market for waffling around instead of raising capital. As of 30th Sep, the bank had a book value of INR 109, the market clearly does not believe that Yes bank is still marked properly. It has valued the stock the close to 40% of the reported book value. Very rarely have banks that have fallen more than 90% recovered quickly from debacles like this. Even if one were to assume that the bank was technically insolvent because liabilities exceeds assets, there is still a large piece of the balance sheet that is healthy that will earn positive cash flow and earnings. The only way in the medium term, the bank can come out of the mess is through a cap raise. Then the question becomes. at what margin of safety will investors be willing to invest capital in the bank? 50%? 60%? 90%? If the bank is not able to raise any capital even at a massive discount to the book value, they might as well go the same way as DHFL. In the case of no capital being raised, the market essentially signalling that it has no trust in the bank and with no trust, there is no banking. If not, they need to quickly raise capital and reverse the downward spiral they have been on for the last 24 months.

Examples like DHFL and Yes Bank coupled with a beleaguered real estate sector, growing NPA’s and slowing growth in India has resulted in separating the perceived very good banks and non-banking financial companies (NBFC’s) in India from the rest. Companies like HDFC, HDFC Bank, Bajaj Finance that are perceived to have less risk continue to enjoy a massive premium over the rest of the sector. They trade at huge multiples of book value, enjoy strong growth, low NPA’s and solid ROE’s and capital cushion.

But the interesting companies are neither of these two buckets but the ones stuck in the middle. The in-between bucket today neither enjoys the premium of a strong franchise nor the discount of a capitally starved financial institution. They are associated enough with the mess that the valuations are discounted due to association effects but decently high enough due to their earning power and robust business models. A decent example of both would be Shriram Transport Finance and Shriram City Union Finance, both of which we have been following (and owned) for years. The stocks have gone nowhere over the last few years even though the capital position is robust, earnings are increasing, the valuations are decreasing. Shriram Transport, which caters to financing of used trucks and new trucks, is largely dependent on the small owners of commercial vehicles. While at first glance, the NPA’s or the stage 3 ECL’s look high; they are more a function of the business model than they are of the underlying business. With a low LTV and a solid guarantor system, the realized losses are far lower than what the NPA’s or the ECL’s suggest. With a ROA close to 2.5%, ROE of close to 17%, Book Value of INR 751 and decent growth of AUM and decreased corporate tax rates, the stock is expected to earn around INR 125 this year and is trading at INR 1050 as of today. The market seems to be projecting the gloom and doom of today well into the future. Shriram City Union Finance, which caters to the SME sector and the MSME sector, is a similar story. With ROA north of 3.5%, ROE north of 17%, low leverage, a segment that is almost captive, high ECL’s but low real losses on loans, with a book value of 1031 INR at the end of Sep is trading at INR 1380 creating interesting possibilities. However, if you owned one of these in the last few years, the stocks and the portfolio went nowhere. Coupled with some big investors and PE looking to cash out, near term tailwinds are capped.

In this context, if one were to tether oneself to beating the market index while picking individual names, one would have to gravitate towards the momentum driven stocks or high quality stocks which are at sky high valuations. On the other hand, if one were to look at through the cycle growth and compare them, the risk-reward function might be changing. So far, the momentum and high quality stocks are miles ahead in the race.

As I am thinking through these examples, there are three broad lessons that I think of: 1. It is very tough to predict markets short term. But through the cycle, they will reflect the fundamentals of the business. 2. Markets are largely efficient but far from always efficient as seen by the Apple example above 3. One can have different investing approaches — the more I think, the more I am inclined towards being more conservative through businesses that have earnings on hand today, trade at low multiples to cash flow than predicting longer term cycles.

Disclaimers: Own several indexes, Banks, NBFC’s, Single Name stocks etc. See FAQ’s. Not recommendations. Please do your own research.

Piramal Watch: Another strong quarter from the numbers!

We had written about Piramal Enterprises before here recently. Last night, they announced their results. Strong revenue and profit growth at 21% YoY. As expected, the focus on was their financial services portion of the business. The book was flat quarter or quarter with about 5K crores of repayment and 4.8K crores of disbursements.

Screenshot from 2019-07-31 04-52-13.png

The real estate book is starting to show signs of diversification with a lower wholesale residential RE portion but it is still 47% of the book.

Screenshot from 2019-07-31 04-56-07.png

The ROA and ROE seems to be holding up well for the business. GNPA actually fell in the quarter based on 90 dpd. It does look like payments are coming in through for Piramal as of now.  I suspect there is a lot of advance payments that is going on here that is causing this to look very strong and probably some better risk management as well.

Screenshot from 2019-07-31 04-59-05.png

A detailed book sensitivity shows that there are probably around 10% of the deals that need attention which is not concerning given that Piramal has shown an ability to actually implement corrective action and fix them in the last few quarters.

Screenshot from 2019-07-31 05-03-42

The key news was on the liability and equity side. The company informed that they were planning to bring in 8K-10k crores of equity on what they called significant growth and consolidation opportunities that are opening up on the NBFC.

I will also link here the CNBC transcript that shows a more aggressive yet cautious contrarian waiting for the right opportunities to open up in the NBFC space. It was good to see that they are treading with caution and watching instead of jumping into the first deal they get. With a solid quarter behind them, will this be a case of yet another counter cyclical aggression from Piramal? Only time will tell.

Disclosure: Long Piramal.

NBFC Watch Continues! Shriram City Quarterly Results!

Last night Shriram City Union Finance announced its quarterly results. Assets under management is up from 29,582 crores in March 2019 to 30,352 crores at the end of June 2019. RoA is marginally down to 3.41% in June from 3.44% in the prior quarter. RoE is down to 15.44% from 16.48% at the end of March. Disbursements are marginally down 5% QoQ. EPS was INR 38.4, Book value at INR 1005, CRAR at 22.5%. Asset quality only very marginally declined with net stage 3 assets holding almost flat at 5.03% with provisions just marginally up. Looking at the ALM statement, looks like their short term liquidity is fine.

And this was supposed to be a bad quarter. Results have help up well and the business model seems more steady than what the news will lead you to believe. It does look like this blood bath will eventually open up interesting opportunities for the patient investor.

Disclosure: Long Shriram City. Also read disclosure here

 

 

 

Piramal Watch: Distressed Seller or a Predator on Hunt?

With all the bearishness around the NBFC and the liquidity situation surrounding the industry, we are closely monitoring the status of several NBFC’s. Amongst them is Piramal. Depending on which source you read at or talk to, you have Piramal, either an overexposed real estate NBFC lender in a liquidity crunch, selling investments to fund liquidity issues OR a savvy predator hungry for more deals in the market when there is blood on the streets. Either way, when the results come out tomorrow, it will be a good indicator of what the reality looks like.

With so many stories swirling around, it is really tough to separate out the truth from the rumor. All we can say is, given the sheer number of permutations and combinations of the stories out there, it is evident that Piramal is talking to investors. But for what and as what? A distressed seller or as a bloodhound on a trail. We will have to wait and see how this plays out.

Some of the links to articles around Piramal:

  1. Piramal capital eyes $600M of buyouts in NBFC space (here)
  2. Can Piramal enterprises weather the NBFC storm (here)
  3. Softbank set to infuse capital into Piramal capital (here)
  4. LIC, IFC come to the aid of Piramal’s financial services business (here)
  5. Piramal’s INR 2500 Crore debt up for redemption in next 18 months (here)
  6. Piramal sharply cuts short term debt as NBFC crisis lingers (here)
  7. Piramal raises 1500 Crores from Stanchart through NCD’s (here)
  8. Reliance Jio and Piramal might setup a joint venture for financial services lending (here)
  9. Consumer finance focus can bring softbank to Piramal (here)
  10. The pathetic performance of the IndiaReit V fund (here)
  11. Piramal sells entire stake in Shriram Transport (here)
  12. Piramal is in talks to sell stake in Shriram group of companies (here)

Update: Added a few more links to the Lodha issue

  1. Piramal capital offloads 2,000 crore linked to Lodha (here)
  2. Piramal to pare 1,000 crore of Lodha developers debt (here)

Disclosure: Long Piramal.

Berkshire Files with SEC on 10% ownership in BAC

We all know that Warren Buffett and Berkshire Hathaway have been bullish on banks in America. It looks like the fest is all set to continue. Berkshire Hathaway just filed a Form 3 with the SEC as a 10% owner of Bank of America (BAC). You can find the filing here

It looks like Berkshire has added over 54 Million shares in BAC since April 2019. What is even more interesting is that Warren Buffett and Berkshire have been actively selling down Wells Fargo every quarter for the last few years to keep its ownership interest below 10% (here) as it hampers their ability to do business with the bank (here)

It also looks like it is okay to own up to 25% of a bank as long the investor gets a permission from the federal reserve and assures them that they would remain a passive investor.

Whichever way you look at it, between WFC, BAC and the growing stake a JPM, Warren Buffett is owning a huge piece of the American banking system. And his actions are the strongest indicators on how Berkshire feels about the current valuation of American banks and areas where large amounts of capital can be deployed for Berkshire.

Shriram Transport Finance Q1 20! (STFC)

STFC announced their results last night. It has been a very tough quarter for the NBFC’s working through the liquidity crisis that has ravaged the sector. Considering the circumstances, I had braced myself for a blood bath from Shriram Transport this quarter. While the provisions and the NPA’s are sequentially up, they are only marginally so and could have been a lot more worse considering the circumstances.

Key metrics of ROA, ROE and provisioning continue to hold up pretty okay given the tough environment. Given the nature of the clientele that Shriram Transport caters go, which is the single owner trucking industry, it is not surprising to continue to see a large stage 3 asset book but very little seem to convert into actual write-offs.

What will be interesting to hear from the management will be the liability mismatches, liquidity and repayments during the conf call. Other than that, as an investor, I just have to sit and brace for another quarter of bad headlines and watch paint dry as the fundamentals continue to hold for STFC.

Wells Fargo (WFC)!

Wells Fargo has been a decisive name that has divided investors. While the fundamentals continue to hold steady, negative headlines and a rock bottom valuation continues to test the patience of investors. It has been interesting to look at what Charlie and Warren have been up to with Wells Fargo during this time.

Below is a look at the Daily Journal portfolio which is essentially managed by Charlie Munger. While the Daily Journal corporation is not the primary investment vehicle for Munger, it is hard to fathom Charlie not taking his fiduciary duty very seriously at Daily Journal on managing the portfolio.

Source: Dataroma (here)

The thing that caught my eye was just how big the Wells Fargo position is. It is over one half of the portfolio at this point. It is extremely interesting because Charlie has long preached assiduity and it looks like he is practicing it hard. Not a single trade on Wells Fargo since Q4 2013 (as far back as the database at Dataroma goes).

On the other hand at Berkshire, limited by an ownership limit of 10% that would force them to convert to a bank holding company, Warren Buffett has been selling just enough to keep it inside of the 10% ownership rule. While one can speculate on what would his actions if he was not loaded up to 10%, the act of keeping it just below 10% through this tough time for Wells Fargo is an indicator of the confidence that both Warren and Berkshire have on the bank.

Source: Dataroma (here)

Charlie Munger and Warren Buffett did weigh in on the Wells Fargo Issue a couple of months ago after the annual meeting at Omaha. It basically reinforces their faith in the bank while calling out the mistakes.

Some very interesting comments came from Saber Capital recently on Wells Fargo here

While it has been extremely interesting to watch the market react to the accounts scandal and politicians drum it up for headlines, what remains behind is a company that has $1.9 trillion in assets and $1.3 trillion in deposits that is buying back its shares and eating into itself. This year, an estimated 15% of the market cap of Wells Fargo will be distributed either in the form of a dividend or buybacks. Probably, it is not such a bad thing to be limited on growth but to allow the bank to buy itself back cheap on the back of negative headlines. While the headlines have been scary, the assets and the deposits are continuing to hold steady at Wells Fargo!

While time will tell how the next chapter unfolds but as an interested and a vested investor in Wells Fargo, it is tough to ignore the headlines and just watch the fundamentals. Probably time to practice some assiduity.

Short Post on Berkshire

While there are a lot of commentators out there commenting on Berkshire’s results, here is a short different take on it.

  • In 2018, Berkshire took a pre-tax mark to market losses of $22.4B on investments and derivatives and $17.8B on a post tax basis
  • Berkshire reinsurance group did not have a great year and lost $1.1B pre-tax driven by property casualty and retroactive reinsurance.
  • Berkshire’s portion of the Kraft Heinz goodwill impairment was $2.7B in 2018
  • $19.8B of Fixed Income securities compared to $172B of equities
  • $109B in Cash and treasury bills
  • Offset by strong earnings in the rest of the operating businesses and insurance companies resulting in a book value increase of 0.4% and net income of $4B for the year.

If on a year like this, Berkshire does not lose money, it talks a lot about the fortress balance sheet and the resiliency of the business model. I know that Buffett talks about not using BVPS any more. I look at it differently. It was an understated proxy for intrinsic value. Now, it is vastly understated for the intrinsic value.

It is often about return of capital before return on capital. There are a lot of commentary about Berkshire being an index fund. It might be but the risk profile is completely different.

Molycorp

About a week ago, Molycorp, the rare earth minerals manufacturer declared a chapter 11 bankruptcy.

From google finance,

Molycorp, Inc. is a rare earths producer. The Company operates in four business segments: Resources, Chemicals and Oxides, Magnetic Materials and Alloys and Rare Metals. The Resources segment includes its operations at the Mountain Pass facility. The Chemicals and Oxides segment includes the production of rare earths at Molycorp Silmet; production of separated heavy rare earth oxides and other engineered materials from its Molycorp Jiangyin facility, and production of rare earths, salts of rare earth elements (REEs), zirconium-based engineered materials and mixed rare earth/zirconium oxides from its Molycorp Zibo facility. The Magnetic Materials and Alloys segment includes the production of Neo Powders through its wholly owned manufacturing facilities. The Rare Metals segment produces, reclaims, refines and markets niche metals and their compounds.

Often companies get into bankruptcy as they are unable to absorb the burden of the debt that they have undertaken and go through the bankruptcy process and come out stronger with better negotiated debt on the other side. The market that Molycorp operates in is dominated by Chinese firms . When the economic behemoth tried to strong arm the world by controlling supplies, Molycorp and Lynas came up with supplies with some non-Chinese mines. These two companies at one point contributed to 10% of the global consumption. Since then the Chinese have backed down and the world has been more than willing to buy from them at rock bottom prices.

When one looks at the financials of Molycorp, attention needs to be paid to the income statement rather than the balance sheet as we usually do in distressed conditions.

$M 2012 2013 2014
Sales 527.7 554.4 475.6
GP 18.8 -67.2 -99.6
GP % 3.6% -12.1% -20.9%

The company has been reporting net negative gross margins. The company has been losing money just getting metal out of the ground. This is even before the sales force is paid, the corporate expenses are paid and even before the interest payments are serviced on the debt. The only time when the GP’s were positive was during the Chinese induced shortages which resulted in a huge price increased in the market. Just restructuring the debt with lower interests or better terms or financial engineering is not the solution to this problem.

The company has not outlined any measures that can make the investor comfortable that a margin of safety exists in the bond even under distress. Unless there is another attempt to strong arm the rare earth market from the Chinese or the US is determined to use only US made rare earth metals, or the Chinese crack down on the black market,  financial engineering will only go far to stem this tide. A cautious investor will do well to sit this out and watch from the sideline!