Ponni Sugars (Erode) Ltd. - Case Study on Value Investing

Ponni Sugars (Erode) Ltd. - Case Study on Value Investing

Varun Aggarwal 11/02/2018 7

Avoiding where others go wrong is an important step in achieving investment success. In fact, it almost ensures it. Every once in a while, we tend to hear that either a friend or family member lost X amount of money. It pains us to hear such disastrous investment results, especially when it comes to unsophisticated and undisciplined investors. Thus, if we could convince more people to adopt proven successful investment strategies, it will definitely help to preserve and maintain their hard-earned capital.

Value Investing requires a great deal of hard work, usually strict discipline, and a long-term investment horizon. Few are willing and able to devote sufficient time and effort to become value investors, and only a fraction of those have the proper mindset to succeed. - Seth Klarman

A MOS (Margin of Safety) is achieved when securities are purchased at prices sufficiently below underlying value, to allow human error, bad luck or extreme volatility in a complex, unpredictable, and rapidly changing world. 

Value investing is the discipline of buying securities at a significant discount from their current underlying values and holding them until more of their value is realised. Value Investing is the process of determining the value underlying a security and then buying it at a considerable discount from that value.

The greatest challenge is :

  1. Maintaining the requisite patience and discipline to buy only when prices are attractive, and to sell when they are not
  2. Avoiding the short-term performance frenzy that engulfs most market participants.
  3. Avoid losing money

Value investors have a primary goal, the preservation of their capital. They seek MOS, allowing room for imprecision, bad luck, or analytical error to avoid sizeable losses over time. This requires solid discipline. 

Value investors usually stand apart from the crowd, challenging conventional wisdom and opposing the prevailing investment winds. It can be a very lonely undertaking. A value investor may experience poor, even horrendous, performance compared with that of other investors or the market as a whole during prolonged periods of market overvaluation. Yet over the long run, the value approach works so successfully that few, advocates of the philosophy ever abandon it.

Motivated only by their own results, infinite patience, willing to wait till an undervalued investment opportunity, for a value investor, a pitch must not only be in their strike price, it must be in their sweet spot. Results will be good when the value investor is not pressured to invest prematurely.

An investment must be purchased at discount from underlying worth. Value investor continually compares potential new investments with their current holdings in order to ensure that he owns only the most undervalued opportunity available. Investors should never be afraid to reexamine current holdings as a new opportunity appear, even if that means realising losses on the sale of current holdings.

No investment should be considered sacred when a better one comes along. Exhibit self-discipline, maintain the integrity of the valuation process and limit the price paid. It is critical to know why you have made an investment and to sell when the reason for owning it, no longer applies.

A market downturn is the true test of an investment philosophy. “You can’t tell who’s selling naked, till the tide goes out.”

This requires discipline (avoid unattractive pitches that are being thrown), patience (wait for the right pitch) and judgment (know when to swing). Sell when you want to, not when you have to.

If you hold cash, you are able to take advantage of opportunities. If you are fully invested when the market declines, your portfolio will likely drops in value, depriving you of the benefits arising from the opportunity to buy in at lower prices (forego opportunity cost that arise).

Understanding Bottom-up Strategy

Identification of specific undervalued investment opportunities (Fundamental Analysis)

  • Search for bargains security by security, analyzing each situation on it’s own merits.
  • Hold cash when you are unable to find attractive investment opportunities and put cash to work when such opportunities appear.
  • Do not time the market 

“Value Investing is not a concept that can be learned and applied gradually over time. It is either absorbed and adopted at once, or it is never truly learned.” (W. Buffet) 

“There are 2 times in a man’s life when he should not speculate, when he can’t afford and when he can. And understanding the difference between investment and speculation is the first step in achieving investment success.” (M. Twain)

We all have heard about Crypto currencies like Bitcoin etc. but I personally have not invested a single penny in it. The logic is simple, as I cannot call my investment into Bitcoin a value investment, as I am unable to find the explanation behind the surge and plunging of that asset class. If we have a look at its movement, it has shown volatility of 30-40% in a single day, and as the quote mentioned above, if that is entertaining that investment is not sustainable for long term. There are no shortcuts for making good amount of money.

In a previous article we talked about NBI Industrial Finance which we accumulated at 1180-1215 and which recently made a high of 2100, Vardhman Holdings Limited at ₹810-900 levels and it has recently made a lift time high of ₹6200, along with our other gems like Relaxo(₹35), Atul Auto(₹17), Dhunseri Investments(₹125), Naga Dhunseri(₹580), DHFL(₹230), Canfin Homes (₹28), Gufic Biosciences(₹65), Indag Rubber(₹19), Welpsun Enterprises(₹60), Thangamayil Jewellers(₹149), PEL(₹797), Thomas Cook(₹80), Titan(₹297), Tasty Bites(₹4058), Mind Tree(₹462), Tech Mahindra(₹390), Oriental Carbon(₹95), Nesco(₹112), Kovai Medical (₹162), 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.

The company i.e. Ponni Sugars (Erode) Limited, that I will be discussing in this article has hidden gems and like a treasure hunt, we will be decoding one by one clues and try to have a look whether it is really worth investing or not.

It’s been said that “Debt is like a double-edged sword”, it is great when things are good and horrible when thing turn bad and not anyone wants to be on the wrong side when things go bad. It can act as an obstacle around your neck, leaving long lasting consequences.

Companies with debt are not considered good but a company with good fundamentals despite having a debt can be a multi-bagger. Ponni Sugars is one of such company that we are going to analyse. So, I am going to discuss what made me pick this stock at ₹150-160, it was completely unexplored and what is making me so optimistic about this stock.

1.   Understanding Debt to Profit

Any company which is debt free, we can make this as a plus point of having zero debt in its balance sheet, but debt can be good also if that company is able to make money on that debt. For e.g. Mr. A borrows Rs.1,00,000 from a bank at 10% p.a. and he invests 1,00,000 from his pocket. He starts a business with this amount; the direct obligation of using this money for A is to pay 10,000 as interest cost.  

Case 1: A makes 20% return. So he has profit of Rs.40000 (20% of 2, 00,000). The interest obligation was of Rs.10,000 and still he is left with 30,000 which has increased his return to 30% (30,000 / 1,00,000).

Case 2: A makes 5% return. So he made profit of 10,000 (5% of 2, 00,000). All this money goes into the payment of interest and even after making money A has to be empty handed.

Case 3: If A earns less than 5%, he will not be able to even serve his debt and will end up eroding his own fund.

All above cases shows us the benefits and flaws of having Debt inside one’s business.

Let see what is happening is case of Ponni Sugars:

Debt: ₹ 49.05 Cr.

Debt to Profit: 25.82%

The company is earning 25.82% on its debt. Astonishing! Isn't it.

2.   Understanding Graham Value

Sir Benjamin Graham, author of “The Intelligent Investor” and mentor of Warren Buffet, also known as father of value investing claims that “a great company is not a great investment if you pay too much for a stock.”

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 focused 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 Ponni Sugar (Erode) ltd comes out to be ₹260.37 i.e., greater than CMP of ₹160/-. Hence, even to reach graham number stock has to appreciate by 62.5%. Imagine the undervaluation at a price of ₹160!!! Smart people notices this and knows very well what all to do, after noticing this interesting stock at interesting price with great future potential.

3.   Understanding Sales > MCAP

Sales is considered to be the top line of any business. This is the most important number from which all calculations originate. Sales or Revenue is simply the total amount of cash generated by the sale of products or services associated with the company's main operations.

If we look at the Market capitalization of Ponni Sugars, it comes out to be 137.57Cr. (160 x 85,98,418 = 137,57,46,880). Now if one have 137.57cr. he can buy the entire company as per today’s closing. Lets also have a look at the revenue figures of this company, it is 250.47 cr. That’s 1.82 times higher than the total value of the company. Yes, any company which can manage to make a turnover greater than the total value of self is definitely doing some great business.

For any company, whether it is having debt or debt free but if sales are increasing then it is really a good sign plus if a company is having sales which are greater than Total Capital Employed then it is a wonderful indication.

"Know what you own, and know why you own it." - Peter Lynch

4.   Understanding Real value of Quoted Investments

Although the primary business for Ponni Sugars is manufacturing of sugar but they do hold some stocks as investments in their portfolio. Let’s have a look at them :

Although Ponni Sugars hold stocks of just 2 companies but the total amount of that portfolio comes to be 176.01(Cr.) This is higher than Market Cap of 137.57Cr. Logically if we have a look, we are currently screening a company which is having portfolio that is greater than its total market value and even has a different primary business and is earning well through that also. According to the Market value of quoted investments the stock price of Ponni Sugars should be Rs 204.70 (176.13/.86) and stock is still undervalued as per this price.

5.   Understanding Asset Value > Value of Company

 We have seen that company is making sales of 250.47(cr.) over a market capitalization of 137.57(cr.). Let’s have a look at the Fixed Assets of the company.

The value of Non Current Investments is 17601.35570(lakhs), so that makes the total of Fixed Assets 30172.3557(lakhs) or 301.7235(Cr.). So a company which can be completely acquired by paying 137.57(Cr.) will give us direct ownership over assets worth 301.72(Cr.)

The stock still looks undervalued. Isn’t it!!

6.   Understanding Hidden Dividend Value Approach

We know if any company declares dividend, on the ex-dividend date the stock price gets to reduce down by the amount of the dividend declared. MM theory given by Modigilani and Miller approach 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 Ponni Sugars Erode. If ponni sugar’s price before declaration of dividend was 160 and if company announces dividend of 170, will the stock price come down to -10? Is that even possible!? Well company has enough investments which can be liquidated for giving this dividend but even after that company has its primary business of manufacturing sugar and is available at price of Rs.0.

If one is getting a good business with all machinery and fixed assets at price ZERO, it isn’t a bad deal.

“Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful”                                                 

- Warren Buffet during 2004 Berkshire Hathaway Investor Meet

7.   Understanding the Book Value per Share

Book value per share guides us, that if company is liquidated today; what all will be received by residual shareholders or Equity stockholders.

Book Value per share = (Shareholder’s Funds + Current Year PAT) / Number of Shares.

 BVPS = (13678 + 524) / 85.98 = Rs.165.16

The current price of the stock is less than its book value.

As quoted by Sir Ben Graham

A great company is not a great investment if you pay too much for the stock.”

We bought the stock when it was trading below it's book value. Idea is too keep accumulating it slowly over long term. It hardly matters even if the stock price plunges to rupees 100. All dips are good to add.

8.   Understanding Return on Equity

Return on Equity is a type of profitability ratio calculated as net income available to ordinary shareholders (i.e., after preferred dividends have been deducted) divided by the average total book value of equity. It is the primary measure that equity investors use to ascertain whether the management of a company is effectively and efficiently using the capital they have provided to generate profits. It measures the total amount of net income available to common shareholders generated by the total equity capital invested in the company.

ROE can be calculated as follows:

                 Net income/Average Stockholder’s Equity


The DuPont allows us to decompose ROE into components such as Net Profit Margin, Asset Turnover and Financial Leverage.

ROE = (Net profit margin: Net earnings/Net sales) × (Asset turnover: Net sales/Average total assets) × (Financial leverage: Average total assets/Average common equity)

I personally prefer stocks with Return on equity of greater than 12.

Return on equity: 15.98%

ROE for Ponni Sugars Erode is 15.98%. It gives good indication of efficiency.

Some securities are inefficiently priced, creating opportunities for investors to profit with low risks. Value investors are in position to take advantage of the market’s irrationality. And to those who do, have a good chance to enjoy long term success. 

When the price of a stock declines after it’s initial purchase, most investors become concerned. (Mr. Market knows more? Wrong judgment?)

It is easy to panic and sell at just the wrong time. Yet, if the security were truly a bargain when it was purchased, the rational course of action would to take advantage of this even better bargain and buy more.

Don’t confuse the real success of an investment with it’s mirror of success in the stock market. (Louis Lowenstein)

The fact that a stock price rises does not ensure that the underlying biz is doing well / underlying value of biz is increasing. Likewise, when a price fall, does not reflect adverse biz development or value deterioration.

Take advantage of the opportunities presented by Mr. Market.

If the markets were efficient, then how could so many investors identifiable by Buffett years ago as sharing a common philosophy, but having little overlap in their portfolio, all done so well? Buffett’s argument has never, to my knowledge been addressed by the efficient-market theorists, they evidently prefer to continue to prove in theory what is refuted in reality.

9.   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 sugar company, we have assumed the current year growth rate as 15%. We assume that in 10 year period the growth rate will get reduced to 5% and then it will be stagnant. So for every additional year we are reducing the growth rate by 1% till it becomes 5% in 2027. For CAPM calculations we have taken Rf as 6.50% and Market return of 17%. Beta of Ponni is 0.77.

The Present value of share according to FCFE model should be ₹323.10, and if we compare the CMP which is ₹160, stock is quite undervalued.

Note: This Model is based on Assumptions.

Remember : Investors must be willing to forego some near-term return, as an insurance premium against unexpected and unpredictable adversity.

The value of a stock is ultimately tied to the performance of the underlying business, the potential profit from owning a stock is much more ambiguous.

10.   Understanding the Time Value Machine Approach

Let’s sit in the time machine and have a look at future valuations of this company while making some assumptions. To apply this valuation technique, we must check the PBT (Profit before tax numbers) from income statement.

 for FY16-17 is ₹21.64 Cr. 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 10% by keeping in mind the inflation & interest factor on debt, and assuming only 2% growth rate after 2022. Right now, we are in 2018. Let's see what should be the price of Ponni Sugars (Erode) Limited.

If I simply increase the earning by 10% yearly i.e., 21.64*1.15 = 24.886 and so on & discount the earning for today, Ponni Sugars is grossly underpriced. Stock must be valued at ₹234 & I see that in long term this must be achieved. Moreover, keeping in mind the long term objective of the stock for 4-5 year - I would not be surprised if I happen to see this stock at ₹536/-

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

11.   Understanding Low PE

Let’s have a look whether this PE is lower because of Low Earnings or Lower Market Price.

           PE = CMP/EPS

                       160/17.66             = 9.06

Now we see that a stock whose CMP is ₹160 was just having a PE of 9.06x. The fact is PE is lower not because of lower EPS. Company is generating an EPS of 17 on 160 stock, which is 10.625% on it's price. Not bad at all. Here we can conclude that stock has Low PE not because of lower earnings but because of lower Market Price. Hence, market is not valuing Ponni Sugars 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 this stock.

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

12.   Understanding Management Quality & Cash Flows

Sometimes what we see is not important, what we don't see is more important. Most people might wonder by looking at ROIC of Ponni Sugars which is 4.29% only & say company is not looking good. Also, if they compare with peers they may not find anything interesting. Moreover, on cashflow front, you might find, it is not consistent. But here are some fact to note :

a) Management is indirectly controlled by SESHASAYEE PAPER AND BOARDS LTD.

What is more interesting is to check the notes to account of SESHASAYEE PAPER AND BOARDS LTD. Here is what I found :

I am sure, the above picture gives you a clear idea as to how Ponni Sugars is indirectly held and controlled by very good management quality board of Seshasayee Papers. They are pioneers in their business. It is the only company in India, which has monopoly in making Natural Color paper. Most other companies import the natural paper from other countries, but Seshasayee manufactures it. And as we know, Seshasayee is also held by Ponni Sugars. So most people might make a mistake of just analysing Ponni Sugars, ignoring the fact how it is held and how it holds the other company.

b) Seshasayee Papers has a great scope in the future. It is a great company doing wonderful business. One must see ROIC of Seshasayee Papers. It stands at 25.90%. Moreover, it has Graham of Rs. 1026, Piotroski Score of 6, ROE of 26.54% & consistent profit growth of 30.45% for last 5 years. Profit Growth is increasing & in last 3 years Profit Growth stands at 68.79%. The logic is very simple, if Seshasayee paper stock will rise, indirectly Ponni Sugars stock will rise. Also, Ponni Sugars is available at much cheaper discount than Seshasayee, so I personally decided to buy Ponni Sugars.

c) If you check the image of Seshasayee Papers holdings, you will find, it holds stake in TNPL, Times Sqaure & Atyant Capital. All are holding Ponni Sugars too. Moreover, TNPL on it's own, is excellent paper business. Seshasayee holds 14.27% stake in TNPL. Again, indirect benefit to Ponni Sugars in future.

d) Some people might express their concern on cashflows of Ponni Sugars. What they are ignoring is the important fact. They don't make more money from sugar business. They make money from Paper business. The by-product of Sugar waste is utilised to make natural color paper by Seshasayee papers. And check how it benefits Seshasayee to generate consistent cashflows.

Hence, sometimes what we don't see is more important than what we see.

To Conclude

Always see what others cannot see in a Balance Sheet and you will end up doing wonders. The objective should be clear before even picking up the stock and one should not be panicking if that stock plunges to 50% down. One should know and understand the fruits are not reaped as soon as after planting the seed. One should have that patience to buy and forget it to have the future benefits. We have seen this in the case of VHL, when I bought it the stock price was at 800 and now today in a single day stock gives movement greater than 800 points. This has been possible because I have kept that stock with a trust over my research and stock picking capability even when for few months it gave no return and was stuck in the same price range in which I have bought it.

Successful investors demonstrate caution in frothy markets and steadfast conviction in panicky ones.

The way an investor views the market and its price fluctuation is the key factor in his ultimate investment success or failure. Emotion lies dangerously close to the surface for most investors and can be particularly intense when market prices move dramatically in neither direction.

“Patience is the key to success and not speed.”

Please note : I could be wrong in my analysis. Do your own research and analysis. This is more for educational purposes only. Buying stocks can always be risky and you might lose your investment too.

I hope I could inspire you towards value investing. If you liked the analysis, do spare 2 minutes & post your honest feedback.

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

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  • Adrien Dorsey

    Another meticulous and educational financial analysis. This case is one my favourites also liked the quotes that you used in your analysis.

  • Matthew Lewis

    Warren Buffet is a legend, I am sure that he is also your mentor like all of us

  • Joshua V

    great introduction into value investing

  • Big Virgil

    Thanks for putting these notes for free to the public

  • Sunny Darko

    good analysis

  • Jimmy Young

    That was too long for me, I did my best to ready everything but I couldn't. On a positive note, that was good.

  • Siva Senthil Kumar Boominathan

    connecting the dots. great learning experience. your every analysis is brilliant.

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Varun Aggarwal

Finance Expert

Varun is the director of Profit Idea. He is a multi-skilled experienced professional in academics, corporate and administration fields. He has over 10 years of corporate training experience in the field of finance & provides training for CFA, MBA, Stock Market (Derivatives, Fundamental & Technical Analysis) & various other financial subjects. He is also associated with various institutes, boards & banks. Varun holds financial and investment qualifications from Delhi University, Yale University, London Business School, Indian School of Business, Columbia University and IESE Business School.


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