NBI Industrial Finance Limited - Case Study

“It is not necessary to do extra ordinary things to get extraordinary results” – Warren Buffet. “I fear not the man who has practiced 10,000 kicks once, but I fear the man who has practiced one kick 10,000 times” – Bruce Lee. Both of the above mentioned quotes point towards one direction. To be successful one does not need to do something out of the world, and yes you will succeed only if you do that one thing time and again.

“It is a conscious effort, to be very honest. It is more like ‘Eat, sleep, train, repeat’. If you want to be consistent, you need to be boring with your training, your food and your batting habits”.

I have mentioned this a lot of times during my trade sheet. Lot of people find it boring, doing that same work month over month, but that’s the road towards success. Consistency is all that matters and plays a very important factor in determining you as successful. 

Let's understand it through mathematical equations.

Let's assume that today you have ₹10,00,000 (1 million) and as you are working, you earn 3% monthly and if you are able to do it successfully for 25 years, this investment of ₹1 million will turn to be ₹7.098 billion or ₹709,85,13,482.62. That’s the power of compounding and consistency.

In the previous article, we talked about Vardhman Holdings Limited, which we bought at ₹810-900 levels and it has recently made a lift time high of ₹4851, along with our other gems like Relaxo(₹35), Atul Auto(₹110), Dhunseri Investments(₹125), Naga Dhunseri(₹580), DHFL(₹230), Canfin(₹28) etc. One should know when he shall be on the front foot, stretch out and go for hitting a six and when one should stay back and defend, that’s the quality of the player which even determines whether team will win or not.

Today we will focus on another holding company i.e. NBI Industrial Finance Company Limited, which is looking great to me on certain parameters which I will discuss below. 

Stock has closed at ₹1336.75 as per Friday's close(22nd Dec, 2017). We accumulated this stock at ₹1180-1215/-

1.   Understanding Low Market Float.

Market Float refers to the number of shares that are available to the investing public. If we look at the number of shares for this company, its market float is 12,28,403 or .1228(Cr). Recently on 8th December 2017; tgw company has made a stock split, which reduced the face value of shares from ₹10 to ₹5. So now the total number of shares are 24,56,806. Out of this market float, the promoter owns 60% i.e. 14,74,084 shares are with the promoter. So let's assume that if the promoter has full faith on his business and in the future he is not ready to sell his business, the available free float to general public is 9,82,722. Now as we have seen in VHL, Dhunseri Investments & Naga Dhunseri, people who understand their worth are not ready to sell them, and the desperate buyers need to pay more to purchase them thus increasing the price of stock with great pace.

2.   Understanding the Cash Bargain

Suppose you have purchased a plot worth ₹10 Lakhs, for making your house. During laying of foundations, while digging you find gold reserves under that land, whose value is much more than ₹10 lakhs. That is a cash bargain. Now that was your luck, you just became lucky. But if before purchasing the land or before purchasing anything, you know that any such cash bargain would exist, what will be your reaction. I guess, you will rush and seal the deal as soon as possible.

Similar is the case with NBI Industrial Finance Company Limited. Let's check how. The below screenshot is of quoted investments that the company has held. It is quoted with the number of shares & it’s value at the time of buying it. 

Value of Portfolio Today :

The above screenshot shows the value of those investments as of now. Total Value of the holdings as per Friday’s close(22nd Dec, 2017) is ₹15,832,005,475 or ₹1583.20 (Cr). Now if you check another thing on this list is that, I have highlighted Shree Cements, which NBI holds huge number of shares i.e. 95.75% of the total investments. NBI has acquired or bought Shree Cements at ₹28.20, which is currently trading at ₹17847.10. The total Value of Shree cements as per today’s price is 15,160,219,095 or ₹1516.02 Cr.

Based on valuation of Shree Cements stock alone, NBI should have value of ₹6170.70/- per share.

Wow!! Right now stock is just trading at .2231 times of the fair value, magnificently stock has much more to gain in coming future.

One question that may arise in everyone’s mind is that major chunk of the investments is in one stock i.e. Shree Cements. We all know that Shree Cement is also a brilliant company with good fundamentals, but let’s be conservative & assume that stock value of Shree Cement falls to ₹10000 and then have a look at price valuation of NBI.

Stock still holds value of ₹3457 which is 2.58 times of CMP.

If we check the valuation of stock with entire value of portfolio it holds, it should be valued at ₹6444.14.

So other things remaining constant, stock should have been at least be valued at ₹6444.14 and it is just available for ₹1336.75 which is 4.82x cheaper. What a huge discount available.

I think the desire to acquire this stock would be increasing now. But hold on!!!

Imagine thinking intuitively(Backward thinking - Munger Mental Model) & if someone says that you can buy Shree Cement stock at ₹17847*(1336.75/6444.14) = ₹3702 whereas, the stock is trading at ₹17847.

3.   Understanding investing in Mutual Fund vs Holding Company.

We all know about mutual funds. In simple language, mutual fund is a combined investment where all the money received from different individuals is pooled and managed by a fund manager. He on behalf of people, buys stock from that money and instead of allocating stocks to everyone, gives them units of investment called as NAV or Net Asset value. The performance for that fund or manager is tracked with the increase in the value of NAV after certain time duration.

Now let’s have a look at what a holding company means. Holding company is similar to mutual fund, their major business is holding shares of other companies and earning through them. The increase in value of the investments held will be reflected in the stock price of their own share. We have recently acquired few of the holding companies like Vardhman Holdings Limited, Dhunseri investments, Naga Dhunseri etc. & all witnessed the same reaction.

People generally invest through SIP’s (Systematic investment Plans) in mutual fund. SIP means that one person gives a desired predetermined amount which is invested in the plan after a fixed interval on a fixed date.

Let’s assume if a person starts with SIP of ₹1000, he will be allotted units worth ₹1000 at that very point of price. But on the other hand if one invests ₹1000 in NBI Industrial Finance, at that very point he will avail benefits worth more than ₹1000 i.e. ₹4820.75 .

I leave it to the understanding of the reader, where they want to invest.

4.   Understanding the Graham Number/Value

“The Intelligent Investor” is considered to be the bible for investments, and the author is none other than Sir Benjamin Graham. He is considered as the father of value investing, the teacher of Warren Buffet.

“A great xompany is not a great investment if you pay too much for a stock.” An evergreen quote by Sir Graham.

Sir Graham excelled at making money in the stock market for himself and his clients without taking big risks. Graham created and taught many principles of investing safely and successfully that modern investors continue to use today. These ideas were built on Graham's diligent, almost surgical, financial evaluation of companies. His experience led to simple, effective logic, upon which Graham built a successful method for investing.

He always believed one can only control or mitigate his Risk and not Returns. He always focussed on having margin of safety in one’s investments. This means buying stock at a price that is well below a conservative value of business.

The Graham number is a figure that measures a stock's fundamental value by taking into account the company's earnings per share and book value per share. The Graham number is the upper bound of the price range that a defensive investor should pay for the stock. According to the theory, any stock price below the Graham number is considered undervalued, and thus worth investing in. The formula is as follows:

So, Graham Value for NBI Industrial Finance ltd comes out to be ₹2575.55 i.e., greater than CMP of ₹1336.75/-. Hence, even to reach graham number stock has to appreciate by 92.67%. Imagine the undervaluation at a price of ₹1336.75!!! Smart people notices this and knows very well what all to do, after noticing this interesting stock at interesting price with great future potential.

5.   Understanding Altman Z Score

This Ratio guides us about Financial condition of company, that whether it can pay back the debt it has or does it has any chances of filing bankruptcy.

Score below 1.1                     -         Company is near Bankruptcy

Score between 1.1 – 2.6        -          Grey area chances are there of improving or even downgrading

Score above 2.6                     -          Condition is good (Green Signal)

The Altman Z score of NBI Industrial Finance is 685.02. So there are no chances of bankruptcy; thus increasing the confidence of the investors.

6.   Understanding Tax Benefit

In the past few months, we came up with many holding companies, like Dhunseri Investments, Naga Dhunseri, Vardhman Holdings Limited, Kiran Vyapar, Nahar Capital etc. We have previously discussed what is a holding company, but one of another major advantage is that these companies enjoy Long Term Capital Gain Tax Benefits, also called LTCG benefits. In India, any stock which after the purchase date is held for more than 1 year is considered to be eligible to avail benefits under LTCG i.e., it is completely tax free. Any super normal gains made through it is completely tax free.

Warren Buffet once said while addressing his shareholders, that he is one of the richest persons not only in US but in whole world, but he pays a very small amount of taxes. Yes, he was talking about availing benefits under long term capital gains, as his company Berkshire Hathaway is also a holding company. Buffett has often emphasised the importance of long-term investing in his shareholder letters and annual meetings. Putting into practice what he preaches has made a big difference when it comes to him paying a far lower tax rate than many Americans.

In Buffett's own words:

"If you make money with money, as some of my super-rich friends do, your [tax] percentage may be a bit lower than mine. But if you earn money from a job, your percentage will surely exceed mine – most likely by a lot."

The good news is Buffett's tax secret really doesn't have to be a secret at all. Anyone can benefit from long-term capital gains as long as they remain disciplined. This means seeking out and investing in businesses not because of some great earnings report or new hot gadget, but because they have a long-term business model/plan that, after careful research, you believe can succeed over the long run. Finding companies with competitive advantages, and that pay regular dividends, is a formula Buffett's used for a long time. You, too, can use it to grow your investment portfolio while also possibly lowering your effective tax rate.

All these companies mentioned above also have the same benefit available, which increases the earnings of investor at greater pace.

This point is shown like this, but what people fails to understand is the logic behind this. Company is not paying out taxes on regular profits because all those profits are tax free. So instead of being a disadvantage, it is actually an advantage. So if tomorrow NBI sells their stake of Shree Cements, they don’t have to pay a single penny as taxes whereas, if normal corporate makes ₹1516 Cr. profit, they would be paying around 30-39% only for taxes. That means, only tax saved has more value than current stock price i.e., ₹1516*.30 = ₹454.8/-. If I divide the amount of tax saved by no. of o/s shares, I will get ₹454.8/.25 = ₹1819.20 per share which is greater than CMP of ₹1336/-

7.   Understanding Low PE supported by High Earnings

Today the current PE for this stock is 4.03. Let's have a look whether this PE is lower because of Low Earnings or Lower Market Price..

PE =        Price/EPS

                 1336.75/328.28       = 4.07

Now we see that a stock whose CMP is ₹1336.75 was just having a PE of 4.07x. Here we can conclude that the stock has Low PE not because of lower earnings but because of lower Market Price. Hence, market was not valuing NBI at its appropriate price. This stock will be classified as Value Stock, as it has a lot of potential, which can be unlocked in future once people realise the actual price of NBI.

Considering the future, it is still cheap. It all depends on how one sees it.

8.   Understanding the Time Machine Valuation

Let’s try to go into future using the Time Machine Valuation Approach, and try to evaluate the fair value of this company, while making few assumptions.

To apply this valuation technique, we must check the PBT (Profit before tax numbers) from income statement.

For keeping the valuation parameter simple & conservative, let me assume only 15% growth rate YOY. Ah, you will say why to do so? But lets be conservative and see what we get. I am assuming discounting factor for my model to be 12% by keeping in mind the inflation & interest factor on debt. And assuming only 2% growth rate after 2022. Right now, we are in 2017. Let's see what should be the price of NBI Industrial Finance Limited.

If I simply increase the earning by 15% yearly i.e., ₹99.79*1.15 = ₹114.7585 and so on & discount the earning for today, NBI is grossly under-priced. Stock must be valued at ₹3320.14 & I see that in long term this must be achieved. Moreover, keeping in mind the long term objective of the stock for 5 year - I would not be surprised if I happen to see this stock at ₹6837.97/-

Please note that these models are based on assumptions and can be 100% wrong, but that’s what analysing stock market is all about. No one can guarantee 100% success.

9.   Understanding CROIC (Cash Return on Invested Capital)

Cash return on invested capital greater than 100 is a good sign. This helps us to see how well management utilises the cash that isn’t part of the business. It is considered to be a great way to measure the skills of the managers. I find this to be the ultimate performance metric as it shows so clearly how effective management is and the strength of the business.

This shows us that management of NBI utilises the cash in effective manner & has been able to generate good return on invested capital.

10.   Understanding valuation through FCFE Approach

This model is a measure of dividend paying capacity. Free cash flow to equity (FCFE) is a measure of how much cash is available to the equity shareholders of a company after all expenses, reinvestment, and debt are paid. FCFE is a measure of equity capital usage.

FCFE  = Earning Per Share – (Capex-Dep)(1-Debt Ratio) – (Change in Working Capital)(1-Debt Ratio)

Under this model we take current year EPS, Capex, Depreciation, and change in working capital of a company. Like in TVM, we try to forecast price in future by growing all of them with assumed growth rate and then discounting them with assumed discount rate.

As this is a holding company, we have assumed the growth rate to be consistent with that of market. We assume that in 10 year period the growth rate will get reduced to 10% and then it will be stagnant. So for every additional year we are reducing the growth rate by .70% till it becomes 10% in 2027. For CAPM calculations we have taken Rf as 6.50% and Market return of 17%. One Year Beta of NBI is 0.74.

The Present value of share according to FCFE model should be ₹10,868.34, and if we compare the CMP which is ₹1336.75, stock is quite undervalued.

Note: This Model is based on Assumptions.

11.   Understanding the Hidden Dividend Value Approach

As per Modigliani and Miller, their MM approach state that if a company pays a dividend, then on Ex-Dividend date, the value of the stock falls by that amount. MM theory on dividend further states that investors should be indifferent between dividends and capital gains because what they get by way of dividends, they will lose by way a decline in the market value of their shares. And if a firm does not pay a dividend, they will have equivalent capital gains on the stock.

Let’s apply this theory to NBI and check if it still holds any value or not. Assuming that company declares a dividend of ₹1500 per share, they need to pay a total of (₹1500 x 24,56,806) ₹368,52,09,000 or approx. ₹368.5 Cr. Well, they can afford that much as dividend payments as they have investments worth ₹1583 Cr, in their Balance Sheet. So after declaration, stock shall fall to (1336.75-1500), - 163.25, but oops, stock cannot fall below Zero. What is attracting me more here is that still at Zero price of the stock, company is holding investments worth ₹1214.5 Cr. Accordingly, the value of the stock should be ₹4945.03 and you are getting that for Zero, without paying a single penny.

12. Understanding the importance of being Debt free

All the above points are very important but the whole idea would have failed if the company would be having high debt component which will eat or transfer most of the investors money to debt holders by the way of interest.

One very important factor to consider while buying holding company is considering that it should be zero debt. Debt can ruin the financials of a good holding company too. Unfortunately in a difficult economy, too much reliance on debt has become a way of life for many businesses versus a vehicle for growth. But during market crashes, being zero debt & having no leverage can be one thing which can save companies by not bearing the burden of interest. This is mostly common with traders too, they lose money most of the times not because their trade was wrong but because they could not hold it & margin call triggers. Similarly, a good holding company might buy a quality stock which might crash due to financial turmoil but if that holding company is debt free, it will hold on to that stock & it will eventually pay off. Even if it does not pay-off, losses will lower than companies which would have bought those stocks on debt.

In the case of NBI, it is Zero Debt business which available at attractive valuations. So risk is lower in comparison to the reward we can get.

To Conclude

When working as a Fundamental Analyst, one should look at wider picture and try to connect those dots which are not easily seen. There is this dialogue from one of my favourite movie (Now you see me) - “The Closer you see, the lesser you see.” That also holds true here. The more you focus on what you see, the lesser you see the hidden things which are equally important and plays a paramount role in making money.

The objective of accumulating this stock is to hold it for long term, and not selling it after making 50-60%. Patience is the key to make money in the stock market. Invest and forget and reap good benefits in the future.

Special thanks to Dev Veer Vikram Garg for helping me in compiling lecture notes.