Vardhaman Holdings Limited (VHL) - Case Study

Vardhaman Holdings Limited (VHL) - Case Study

Varun Aggarwal 22/12/2017 12

"I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful." - Warren Buffett. We have seen that the above mentioned saying has proved to be correct every time we have acted according to it. A few months ago, when the whole Pharma sector was plunging, no one was ready to buy stocks like Divis laboratories (₹ 594), Gufic Bio Sciences (₹65), Lupin(₹916), Dr. Reddy(₹2010) although nothing was wrong with them it was just the overreaction of the markets.

We started acquiring Divis laboratories in January 2017 around 750 and bought it till 535, with few profit bookings in between with an average price of ₹594. Today, the stock touched ₹1118 on 2nd Nov, 2017 providing us a return of 88.21% in about 11 months, which is decent return. Same has happened with Gufic Biosciences; the stock is giving 100% return already in 6 months, Dr. Reddy (20% return). Lupin is nearly around our prices & I intend to buy them more on dips.

In my previous articles, we studied stocks like DHFL, Dhunseri Investments Ltd, etc. Dhunseri, which we have already seen them surging from ₹125 to ₹427 & DHFL ₹230 to ₹679. Today we will discuss another one of my picked gemstone that I chose last year, which is providing us with excellent return and has turned 4 times from the buy price. 

We all have a habit, people generally sell the stock which is making money for them and keeps the loss making stock in hope of recovering the money. That is what separates them from people who make money and people who don’t. One should never ever quit from the winning horse or make a mistake of placing bet on the losing stock. So if your stock is giving you return of 40%-50%, keep patience as the real wealth is waiting for you. Money is not made by market in isolation; it needs constant support from the patience inside you. That’s the secret ingredient most people do not use or know about. Without proper knowledge and adequate patience making consistent money in the market is not possible. I am not saying one cannot make money, look again, I mentioned consistent money, as that is what is required by anyone. If you are not consistent, you will not be successful.

“ 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”.

So it is undeterred practice and hard work, which makes one, a legend, not the comfort of mother’s womb. 

“There are hugely beneficial reinforcement effects for teachers like me by repeatedly teaching things that really work and also by teaching avoidance of stuff that just doesn’t work as in: All I want to know is where am going to die, so I never go there.” — Charlie Munger

(Compound Interest + Longevity) + Reasonable price = Wealth Creation

I have already shared with you about holding stocks like Eicher Motors, Relaxo Footwears, Atul Auto, Nesco, Oriental carbons, etc which have turned out to be multi bagger and earned a good amount of money for me. 

Today let’s discuss what made me pick this stock at that price when it was completely undiscovered and what is making me so bullish on this even now. Like our previous cases we will be analysing this on certain defined parameters, so that can help you to understand it on ground level and also provide you with insights to find any Multi-bagger in future.

I analysed and picked up the company in Feb, 2016 at ₹ 810-900 per share. Let's understand the valuations whether we paid an extra price or we picked up one of the Future Multi Bagger.

1.   Understanding Cash Bargain

Cash Bargain means when the company is available at cheaper prices vis-à-vis the amount of cash and other liquid assets in its possession.

As we can have a look, market value of Quoted investments that the company is having is worth ₹3,09,394.11 Lakhs or 3093.95 Crores. We will compare this amount with the Market Capitalisation of the company (no. of outstanding shares x CMP).

What if I tell you the MCAP of this stock was just for ₹287.28 Cr.( 900 x 3.192 cr). My god can you see the bargain. Practically saying, if anyone had 288 cr. Rupees at that time and if he had bought the whole company by buying the entire available shares in market, straight away he would have been owner of investments worth 3093.95 cr. On selling these investments in market he would have earned a return of 1074.28% on the very first day of the business purchased.

Even if I did not disclose the name of the company but still everyone now would be willing to buy this company, that’s the power of cash bargain. Even if we had to take a loan of ₹288 cr, one would be instantly ready to take it and buy this business.

Lets also have a look on the quality of the investments.

Wow, all these liquid investments are in good growing companies.

Lets have an idea of what price should have prevailed that time just considering current investments.

Market value of Investment per share = Market value of Investment/ No. of shares

                                                                       = 3093.95/.319 = ₹9695.92 Per share

So other things remaining constant, after just considering Investments the stock should have been valued at ₹9695 per share and we acquired it for just ₹810-900, i.e. buying it 10.77x cheaper. What a huge discount was there.

Now your urge to buy it would have grown further. I again presented the case in class & Even I posted this on facebook when stock was trading around ₹3000-3400/-

Since then also price has shot up nearly 20-30%, but the idea is not just the price. It is the hidden cash bargain I see. While compiling the article, stock is available at ₹3675-3700/-

What I still see is the value in the stock. It is still available at 72% discount to the expected price as per investments.

2.   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 outstanding shares for Vardhman Holdings, its market float is of 31,91,536 or .319(Cr.). Out of this market float, promoter owns 74.90% i.e. 23, 90,460 shares. So Free float left in this case is 8,01,076. Free float refers to the number of shares that are traded in the market. Now not all free float shares may be actively circulating on the market at any given time as many traders purchase shares as a long-term investment. For example – after looking at the stock’s valuation you buy 1000 shares and do not intend to sell in future, then the free float gets reduced by 1000 notionally. Like this, every time buyers are desperate to buy it from market as sellers would be diminishing with time. This desperation will help in boosting stock prices at faster pace, which we have seen in the recent time.

Having low float is considered good if stock is good. It gives good rise to the value of the stock. VHL has only 8 lacs shares as free float. It makes it a good candidate for rise in future as well.

3. Understanding the role of Financial Analyst

A financial analyst, securities analyst, research analyst, equity analyst, investment analyst, or rating analyst is a person who performs financial analysis for external or internal financial clients as a core part of the job. Let's try to understand some(at-least 4) of the task performed by them.

Task 1

Looking at Operating Profit and Net Profit, we can conclude that company has been maintaining a steady and good growth. Calculating CAGR returns for Operating profits, they have grown at 34.13% and CAGR growth for Net Profit stands at 33.56%. The growth seen is tremendous and no doubt we can see the effect in the stock price. Company is able to maintain steady Operating Profit Margins (OPM) year by year which is as high as 92% on average, means operating expenses are merely 8% of total sales in company, (that’s basically as this is not a manufacturing unit but a holding company). Less expenses means more share for Profits. 

Task 2

If we see for 2016 the net profit margin was 90.73%. For year 2017, net profits increased by 3.77 times.

Net profit margin for 2017 – 95.34%.

Isn’t this a Good company, who is managing to earn 95% as Net profit of total sales.

Let’s look at reason for such high NPM. This is because of high turnover ratio.

Capital Turnover =   

You can see the number. This tells us that they rotate their capital 59 times in a year into sales.

Task 3

Let’s also have a look at Book Value per share of this company. Book value guides us that if this company gets liquidated today, what value will be received by residual share holders (i.e. equity shareholders).

Book Value per share = Shareholder’s Funds / Number of Shares.

Total Shareholder’s Funds             = Share capital + Reserves and surplus

             for 2016                           = 3.19 + 278.31 = 458.03 (in cr.)

The price when we bought stock was Rs.810-850 and book value per share was Rs872.44 per share. Trading cheaper the book value per share.

As quoted by Sir Ben Graham

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

As we can see we bought the stock when it was near its book value.

Task 4

Return on capital employed (ROCE) is a financial ratio that measures a company's profitability and the efficiency with which its capital is employedROCE is calculated as: ROCE = Earnings Before Interest and Tax (EBIT) / Capital Employed.

An analyst always tries to look for consistency. Super investors prefer companies that are consistent. For me these super investors are the Sachins, Gangulys and Kumbles of Investing. They may have different approaches to investing, but one thing they have in common is a defined process and long-term track record.

Finding and following them is not an easy feast. Unlike cricket, their performance/investment approach is not accessible via television or newspaper. I look to find Sachin while investing.

Do you know? Virat Kohli followed Sachin Tendulkar for years to become "The King Kohli".

So if you want become like Rakesh Jhunjhunwala or Warren Buffett of stock market, you got to pick companies with consistent ROCE. Let's see what is the ROCE of VHL :

Track record for VHL says it's story. It is consistent & it keep getting reflected in share price performance.

4.   Understanding Low PE supported by High Earnings

When I bought the share, its PE was 5.98, which is quite low. But is it because of Low Earnings or Low Current Market Price. Let’s check.

PE =        Price/EPS

                 850/150.28       = 5.66

Now we see that a stock whose CMP was 850 was just having a PE of 5.98. Here we can conclude that stock has Low PE not because of lower earnings but because of lower Market Price. Hence, market was not valuing VHL at its appropriate price.

Even now stock trades with the PE of 3700/661.78 = 5.59.

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

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 have 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 VHL is 139.90. So no chances of Bankruptcy.    

6.   Promoter Holding

Promoter Holding above 60-70% is a good sign. It is necessary to study promoter holding as it tells us about the amount of faith promoter has in his business. Reducing Promoter stake tells us that promoter is disposing of his business and does not have faith on his business, and if owner doesn’t have that faith why shall we invest in that stock. The maximum amount of stock holding that any promoter can have with guidelines laid by SEBI is 75%.

In case of VHL, we can see that promoter holding is 74.90%, that suggests that owner has full faith over his business and he is not disposing off his shares to general public.

Owner is sitting at maximum Percentage of share holding, suggesting his full trust over the business the company is doing.

7.   Understanding as Old Fashioned Prudent Banker

When we have a look at balance sheet of VHL we see that VHL is a Debt- free venture. Still lets put ourselves into shoes of prudent banker and analyse this company. Let me remind you, a prudent banker is a typical old banker who is very strict while lending loans and follow a very conservative approach while distributing loans with Interest coverage ratio to be 1/3rd of EBITDA.

EBIT for VHL for FY16 was 181.64 cr. A conservative banker would not lend more than 1/3 against the EBIT. This means that the interest amount should not be more than 1/3rd of the EBIT of any company, now this is very safe practice and companies generally get the higher amount of loan, but let’s analyse playing very safe.  

Interest that can be easily served by VHL = 181.64/3 = 60.55 Cr.

Total loan amount (assuming loan to be lended at 8%)

= Rs. 60.55/.08

= Rs.756.83 Cr.

 So there would be a huge margin of safety on your loan because before your loan is in jeopardy, the earnings of VHL must collapse by 67%.   

8.   Understanding Hidden Loan Component Value per share

The conventional way of getting from equity value to per share value is to divide the equity value by the number of shares outstanding.

As we calculated that VHL is generating EBIT of 181.64 Cr a year, and even prudent banker has determined or agreed to provide a loan of ₹756.83 Cr to it. Now what if, instead of lending money to this business, I could buy the whole business, or parts of the business called shares, at less than debt capacity?” That will be a smart move and will benefit in longer run.

The biggest IRONY over here is that the banker who will lend VHL ₹756.83 Cr will get only 60.55 Cr as interest whereas, equity analyst who will buy the shares can get the full company at ₹271 Cr (₹850*.319). Let’s assume that we buy equity by paying full 271 Cr, we will earn 181.64 Cr net profit YOY. The equity ownership is available at just ₹271 Cr which will enable us to get ₹181.64 Cr of EBIT instead of just 60.55 Cr of Interest. No wonder why we at Profit Idea & I was personally interested to buy VHL at ₹850 per share.  

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.

For last 5 years EPS has grown with CAGR of 27%. 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 2.20% till it becomes 5% in 2027. For CAPM calculations we have taken Rf as 6.50% and Market return of 17%. Beta of VHL is 0.86.

The Present value of share according to FCFE model should be ₹11,692.76, and if we still compare the CMP which is between ₹3600-3800, stock is quite undervalued.

10.   Understanding Time Machine Valuation

If there was a time machine available today, one would have easily gone into future and have a look at the prices. Through this approach we can have a look at future prices while making few assumptions.

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

PBT for FY17-18 is ₹187.94 Cr. Also if you note, company is growing on an average of 68% for sales growth & Profit growth. 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 Vardhman Holdings Limited.

If I simply increase the earning by 15% yearly i.e., 187.9*1.15 = 216.085 and so on & discount the earning for today, VHL is grossly underpriced. Stock must be valued at ₹4494.80 & 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 ₹12567/-

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.

11.   Understanding Hidden Dividend Value Approach

If a company pays a dividend then on ex-dividend date its value will simply fall by the amount of the dividend paid. 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.

Well, let’s apply this “theory” to VHL. If VHL’s stock price before the dividend announcement was ₹ 900 per share, then after the payment of ₹ 1000 per share of dividend, its stock price should become negative ₹ 100! Is that possible? Can stock prices be negative? Of course not. Ok, let’s grant MM this. Let’s say since the price can’t be negative, but because MM on dividends is holy grail, we have to grant to MM that the stock price of VHL post dividend of ₹ 100 will go to zero! What?

How can this be? Let’s just do the math again.   

Logically, the value of any share cannot go below zero or cannot be negative, and if by giving that special dividend if the price of VHL reaches Rs 0, with quoted investments worth ₹ 3093.94 Cr in Balance sheet and a EBIT of ₹ 187.04 Cr, buying that stock for free isn’t a bad deal at all.

If VHL has to give ₹1000 as dividend, it would need ₹1000*.319 = 319 Cr. Let sell part of quoted investments worth ₹319 Cr. So we would be left with ₹3093.94 – 319 = ₹2774.94 Cr. Can a company having ₹ 2774.94 Cr of quoted investments and business generating EBITDA of 187.04 Cr be valued at zero. So even after paying ₹1000 dividend, the value of stock should be ₹903.94/.319 = ₹ 8698.87/-. So buying at a price of ₹850-900 was such a steal. Even at current price of ₹3700, it does not look bad. Isn't it :)

12.   Understanding Hidden Share Repurchase Value

As a Promoter you know your business and you are frustrated at the market and you really want people to know what your business holds. You know your company’s stock is worth a lot more than its current price of ₹850-900. You decide to teach market a lesson and that’s why you announce a buyback at ₹1800 per share!

That’s double the current price. People will get their investment double with this amount, but as a promoter you would also have thought something.

Lets find out by doing the math. How many shares of the company can be retired at ₹ 1800 per share by using quoted investments of ₹3093.94 Cr. Multiply ₹ 1800 per share with no. of shares outstanding i.e., (1800*.319) = 574.2 Cr. You would need ₹574.2 Cr to implement the buyback.

Let’s imagine that you go and implement this bold buyback plan and assume that it’s executed successfully. What will be the consequences?

The company would be left with no outstanding shares in market. We would still be having ₹3093.94 – 574.2 Cr = 2519.74 Cr of our investments. The company would still possess the operating business capable of delivering annual average EBITDA of 187.04 Cr. Now the promoter will be 100% owner of this business and will own everything completely.

13.   Understanding Henry R. Kravis, LBO Artist approach

Henry R. Kravis (born January 6, 1944) is an American businessman, investor, and philanthropist. He is the co-founder of Kohlberg Kravis Roberts & Co., a global investment firm with a market cap of approximately $16.5 billion as of October, 2017. He is the man who perfected the art of the leveraged buyout.

Similarly if putting ourselves in Henry’s shoes and if we wanted to acquire VHL in 2016 and paid 15% premium over the price ₹900 i.e. (Rs1035*31,91,536) = Rs. 3,303,239,760 or Rs. 3.3 Billion. We are saying that we will take 85% loan of Rs 3.3 billion worth (2.80 Billion) and rest 15% will be contributed by us.

As we can see from the above schedule, in 4 years we will pay the full amount of loan with interest with an assumption that we will be earning profits at constant rate.

So using this method of Henry R. Kravis, we will become owners of the business in 4 years after full payment of loan with interest. With this approach, we owned a company which is worth ₹ 330 Cr (1035 x 0.319) by paying peanut looking price i.e. 49.5/.319 = ₹155.20/-. (49.5 cr. is the total amount invested in form of 15%)

14.   Understanding Ben Graham Value/Number

Serious physicists read about Sir Isaac Newton to learn his teachings about gravity and motion. Serious investors read Benjamin Graham's work to learn about finance and investments.

Known as "the father of value investing" and the "dean of Wall Street," Graham (1894-1976) 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.

Graham also stressed the importance of always having a margin of safety in one's investments. This meant only buying into a stock at a price that is well below a conservative valuation of the business. This is important because it allows profit on the upside as the market eventually revalues the stock to its fair value, and it also gives some protection on the downside if things don't work out as planned and the business falters. This was the mathematical side of his work.

What is the 'Graham Number'?

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:

Let's see this calculation for VHL :

So, Graham Value for VHL comes out to be ₹4816.76 i.e., greater than CMP of ₹3700/-. Hence, even to reach graham number stock has to appreciate by 30.16%. Imagine the undervaluation at a price of ₹850!!! We bought this interesting stock at interesting price with great future potential.

To Conclude

For Fundamental analysis, one should not focus on things which are easily seen, but on things which are scattered in the financial statements, because those are the one which helps us in finding true value of any company.

Within a span of 1.5 year stock has moved from ₹850 to 3700 (CMP), giving us a return of 435% or 4.35 times. But as I always say patience is the key of making money in market. If I would have sold this stock at ₹1700-1800 thinking the return has been 100%, I would not have been enjoying 435% return today, and I still think this stock has lot of potential in coming future. The objective of buying the stock was not selling it after earning 2-3 times. The objective is to see this stock rising & become many bagger. If you see, the actual money is made there and that will be called as a multi bagger. One should compare buying a stock for long term as planting a seed and then waiting for it to produce fruits for you. Like no tree in this world will start giving you fruits the very next day after plantation, no stock will give you returns next day after buying, and when we do not cut a fruit giving tree, then why selling a good or brilliant company after some gain.

“If you are not willing to own a stock for 10 years, do not even think about owing it for 10 mins.” - Warren Buffett

Special thanks to Dev Veer Vikram Garg for helping me in compiling lecture notes. Do post your feedback on the case. Your feedback is important. Thanks for reading it.

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  • Kumar Mohit

    The math behind your reasoning is actually quite straightforward.

  • Rodolfo Chacon

    Thanks for the information

  • Dipak Ghose

    You are correct by saying that the valuation of a company is important, but it shouldn’t be the only metric you look at when researching a company

  • Sebastian Patten

    A bit too complicated for me, but thanks for the analysis

  • Stephanie Dittrich

    The analysis was too long, perhaps separating it into two pieces would have been better, but that's just my opinion

  • Daniel Cinquine

    I love the conclusion of your case

  • Rajesh KR sodhani

    Very easy way to explain all IMPORTANT factors


    Thanks varun sir for antoher valuable study like (vardhman holdings)

  • Vaibhav

    Analysis is good. But if i am not wrong the discount factor taken in the point 10. in your excel is 10% (both for Present value and terminal value).

  • S.V.N.G.S.S.Someswara Rao

    Excellent analysis. Thanks for giving so much data with valuable quotations.

  • subaganesh

    You have overestimated the fair value for this stock. The fair value may be around 1700 to 2000 Rs. Give 70 % discount to market value of quoted investments

  • Manu Jindal

    This leaves a lot of blank spaces. Please read about holdco discounts

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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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