Piramal: Thoughts on current state.

Piramal closed on March 20th at a market price of INR 684 with a market cap of INR 15.4K crores. The shares outstanding as of Dec 31st was 20.45 crores with a dividend yield of 4%. Given the fall from grace the stock price has experienced, it will be worthwhile to examine both the liability side and the asset side and summarise what we know.

Networth:

  1. Company capitalisation and access to capital: A classic example of this was Yes Bank where they struggled to raise capital and the bad loans soured and the RBI stepped in. However, that is not the case with Piramal. With the recent cap raise and the sale of DRG, the net worth is estimated to be close to 34K crores or INR 1382 / share.
  2. DRG: Clarivate has confirmed that is has closed the DRG for $950M with a payment of $900M to Piramal Enterprises which amounts to close to INR 6K crores. You can see the link of Clarivate’s SEC filing here on March 2nd. We can safely assume that this INR 6K crores is available to Piramal for now. This is approximately 39% of the market cap of the company as of March 21st.
  3. The rights issue for INR 5,400 crores that the company executed in Jan was fully subscribed and the company has received the proceeds. It is important to note that the promoters of the company fully participated in the rights issue. This is another 35% of the market cap of the company.
  4. Less than 9 months ago, the company sold its stake in STFC for 2,300 crores.
  5. It is clear that the company has had access to liquidity from the stake sales very close to the market cap of the company today.
  6. In addition, the company has announced the monetisation of the Shriram stake, which is estimated to bring 7-8K crores into the coffers. However, it needs to be seen whether with the economy further deteriorating drastically and the Covid impact whether the Sep timeframe given by the management holds good.
  7. Furthermore, the company has announced that they are considering a stake sale of 20% in the Pharma business and the proceeds here will fund the further growth of Pharma and will ensure that any incremental capital is available for the financial services business.

Liabilities:

  1. The company needs to have the ability to roll over the debt or repay the debt over the next few months to a year while the economy suffers from both a prolonged real estate crisis and the impact of Covid.
  2. The company has moved from reliance on commercial paper and reduced the exposure from 18K crores 18 months ago to negligible amount as of Dec 2019.
  3. It has gone into longer term bank debt and bank funding has increased from 49% to 67% of the total borrowings. (See appendix A for points 2. and 3.)
  4. Recently, the company has accessed 1,900 crores at 9% per annum which provides further comfort that the cost of funding is coming down.
  5. What is even more important in my opinion is that the banks have had access to the books and have examined closely the assets of the book before lending to Piramal. This was confirmed by the management during one of the recent conference calls on March 12th. (Appendix B)
  6. The other thing that NBFC’s have to worry about is the ALM mis-match. Appendix 3 shows that close to 17K crores outflow is expected up to the next 12 months. Given the fact that they have close to 4.5K crores cash, Pharma generating proforma 1.5K crore operating cash flow over 12 months, capital raise and access to cash, high CAR of 32% before considering any payments coming from projects being refinanced or closed or the book run down, there should be a fair amount of comfort that the company will be fine in the next 12 months.

Asset Quality: The wholesale financing book is what seems to have scared the investors the most.

  1. The total finance loan book is INR ~51K crores. Housing finance is 6K crores, commercial real estate is 11K crores, CPG and ECL is 9K crores and the big chunk which is the residential real estate is 25K crores.
  2. So far, the company has reported only 1.8% GNPA and 1000 crores of provisioning so far. Again, given the recent experience with Yes Bank, the investors are being wary of companies that have exposure to stressed sectors but reporting very little GNPA and defaults.
  3. Firstly, it must be noted that, Piramal did not have any exposure to Yes Bank, Altico, IL&FS, DHFL, ADAG etc. which have gone bust. The fact that the company has dodged exposure to these stressed accounts indicate a certain level of quality of the book. Unlike Yes Bank, which had exposure to every stressed asset, Piramal seems to have dodged the bullet so far.
  4. In the housing finance segment, there is speculation that the government might provide some relief to MSME and non-salaried people towards EMI’s to help through the Covid situation. Hopefully, they will provide extended DPD guidelines to NBFC’s as well. Even if not, the GNPA’s might spike up. Unless Covid paralyses the economy over the next 6-12 months and things don’t get back to normal, the risk in the actual underlying defaults will be negligible. It must also be noted that the company has stressed multiple times that it is providing adequate LTV and security provisions in its loan book.
  5. The commercial real estate has not seen much stress in the last 2-3 years. Unless something new comes up as part of Covid and extended significant delays in construction, it would be fair to say that the commercial book will be fine.
  6. The corporate lending groups with its 9K crore book will see stress. We know that the Delhi Baroda truck financing with exposure of INR 75 crores is stressed. The Essel exposure from Piramal is close to INR 200 crores now. We should clearly expect to see more slippages from this and the GNPA shoot up over the next few months.
  7. The real estate wholesale financing segment is 25K crores. Piramal has run down close to 10K crores of the this segment over the last 18 months. The number of developers who were more than 15% of the net worth of the company has come down to 4 to 1. The one is Lodha.
  8. Lodha will have a INR 2500 crore exposure to Piramal by April.  A couple of positive developments. In the recent call, it was clarified that the capital under security for this loan is close to INR 6000 crores (Appendix D) Finished goods inventory is close to INR 2300 crores with another INR 1000 crores completing over the next 3 months. In addition, Lodha just tapped the capital markets to refinance and repay bonds. See link here. In addition, the last 12 months sales for Lodha was close to 7000 crores and continues to the largest real estate developer in India. While the current Covid shutdown and the resulting economic bumps might stagger payments, it is highly unlikely that Piramal will need to take a write down on  Lodha.
  9. In addition, it is worth noting that some of the accounts that Piramal has in stage 3 assets, they are moving to get the title of the lands and recover the loan. Easier said than done but the company has demonstrated that they can execute such moves well in the past.
  10. So far, the company has demonstrated that is can manage the risk and the recoveries from customers that it is lending to, have a low LTV ratio and a better than average risk monitoring system.
  11. It must be noted that no way does this mean that the loan book won’t sour in the near future or the stage 2/3 provisions will need to go up and more money needs to be set aside for provisioning, all we get comfort from is that the fact the management seems to have demonstrated reasonably well that it can manage the risk it is taking on.

Management: Understated in the market is what I call the Say-Do ratio of the management. Lots of companies make promises but it is execution that matters. Contrast the equity raising by both Yes Bank and Piramal around the same timeframe and the results each of them has had.

  1. Raising of capital through rights sale
  2. Completing the promise of bring in 8-10K crore equity into the business
  3. Reducing reliance on commercial paper. The management laid out the roadmap 12 months ago.
  4. Reducing reliance on exposure to single borrower names
  5. Piramal has put balance sheet strength over sheer growth reversing the earlier stance.
  6. The only con that I can direct to the management is the fact that they did not build a Fort Knox balance sheet from the start and had to go through several stake sales, cap raises (albeit at a premium to today’s stock price) to build a solid balance sheet. However, the management has shown that it will learn and correct mistakes quickly.

Unless it comes to light that the management is completely fraudulent, it is reasonable to assume that Piramal will weather the storm.

Valuation:

  1. The December end shares outstanding was: 20.5 crores. With INR 5,400 crores coming in at INR 1,300; approx. 4.2 more shares would be added. The total new shareholding will be at 24.6-24.7 crore shares.
  2. Total net worth at INR 34K crores or 1,382 per share and CMP is at 684 or 0.5 P/B.
  3. Total borrowings are at 50K crores.
  4. Enterprise value is at 64K crores: 50K borrowings + 14K  market cap.
  5. SOTP would be as follows (following Dec 2019):
    1. Shriram stake – INR 6-8K Crores
    2. DRG Cash – INR 6K Crores
    3. Rights issue – INR 5.4K Crores
    4. Commercial RE – INR 11 K Crores
    5. Housing Finance – INR 6K crores
    6. Pharma business – INR 15K Crores (@ 10X EV/EBITDA)
    7. Cash – INR 4.5K Crores.
  6. Sub-total of assets before residential RE and CPG/ECL assets is approx. INR 56K crores.
  7. The market is today valuing the INR 34K crores worth of assets at less than INR 10K Crores. It can also be reasonably shown that the INR 2.5K Crores to Lodha is reasonably safe. So, the market is valuing close to INR 31K crores of others at INR 7.5K crores.
  8. Depending on the risk appetite of the investor, it will open up interesting possibilities.

I am interested in your thoughts and comments. please mail me: contact@beowulfcap.com

Disclosure: Long several NBFC’s and Banks including Piramal.

Disclaimers: See FAQ here. Not a recommendation. Not a registered advisor. Just sharing my thoughts.

Appendix A:

Screenshot 2020-03-22 at 9.53.53 AM

Appendix B:

Screenshot 2020-03-22 at 9.57.00 AM

Appendix C:

Screenshot 2020-03-22 at 10.48.27 AM

Appendix D:

Screenshot 2020-03-22 at 10.22.57 AM

Yes Bank Bailout

  1. In a completely weird bailout, the RBI and the govt. bailed out Yes Bank with a consortium of banks pooling in equity similar to a LTCM type rescue
  2. The junior bond holders were wiped out (called the AT1 holders)
  3. But for some weird reason, the existing equity shareholders were diluted only 80% and not completely wiped out. The shareholders are however locked in for 3 years for 75% of their shareholdings above 100 shares
  4. The bank reported a completely horrendous quarter as expected with a 24k Crores INR loss before adjusting for taxes
  5. Net-net, Yes Bank for 11K Crore in equity and probably 8K Crore INR because they wrote off the AT1 bonds. This will be recorded as profits I guess as it is a bond they don’t have a repay. About 19K crore of new equity is infused in all.
  6. The moratorium will be lifted on Wednesday.

This week will be very crucial for Yes Bank.

  1. Unless the banks that have contributed equity also are lining up term deposits, the future still looks very uncertain.
  2. There is no reason why a depositor run will cease when the moratorium is lifted unless there are fresh announcements before the moratorium is lifted.
  3. While the pedigree of investors is good, it is not clear how the bank will stop a run on the bank.

All said, it will be an action filled, fast paced thriller Wednesday through Friday to watch this unfold.

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

What are we reading?

  1. The surreal weekend (here)
  2. Fliers coming in from abroad (to the U.S) face long, crowded lines at airports (here)
  3. Stock futures slide after Fed slashes rate to zero (here)
  4. The Yes Bank rescue: Banks chip in, shareholders locked (here)
  5. In the end, it took a whole village to rescue Yes Bank (here)
  6. Paddling through the storm: lessons in 2019 (here)
  7. For airlines, a week that went from bad to worse (here)

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.