Private sector bank gaining market share may not be desired beyond a point

Ever since RBI took constructive view on private banks and started giving license to new age private banks since 1990s, they are gaining market share. RBI gave licensee to ~10 banks since 1990, most of them are running successfully. During the same time, public sector banks "PSB" have also experienced significant increase in their loan book, however their market share is consistently reducing as private banks are slowly taking morsel away from PSB platter.

As the banking structure stands today, private banks own 30% of market share while the public sector banks own 70%. One will come across numerous reports that will say private sector will soon swap market share with public sector. Hence all market participants will bet on the HDFCs and Kotaks of the world, that they will continue to gain market share and it is fair to value well run private banks at 3-4x book value.

However, gaining market share beyond a point may not be desirable for private banks and gaining market share in the current borrowing habits of Indian corporate may backfire to them. 

I would put my argument in two parts, one where private banks should be happy not to take larger market share from PSB. Second changes in borrowing habits where private sector will want higher market share.

Obviously changing borrowing habits is like moving a mountain, so we will discuss the easier part first.

Let's look at why PSB enjoy larger loan books. It is not because they are very efficient in lending, where lending is done much quicker than private banks. Not even that private banks doesn't have reach beyond metros.... They may not have reached to the remote locations and villages but there are very much present in the tier 2/3 towns catering MSME borrowers. One reason might be that PSB offers slightly cheaper loan to different sets of risky borrower and that is because they are wrong is understanding the underlying risks and not able to price the risks properly.

PSB have larger loan book as it acts big daddy of Indian corporate, and keep giving loan to undeserving candidates. About 10% of the PSB loan books is recognised bad loan, actual number will be much higher than currently recognized. Every alternate quarter results PSB management rhetoric would be "worst is behind and now we should see improvement in assets quality".

Private banks own smaller but healthier loan book. Their market share is at 30% because they restrained themselves hitting bad pockets of Indian corporate. It's better to have 30% share with less than 2% NPA than to enjoy 70% market share with over 10% bad loan.

Another reason for low market share is active account management. If the business of borrowers deteriorate private banks are quick to ask for extra collateral to cover the risk. They may also get out of certain accounts before situation gets ugly. PSB in general, once given the loan is married to borrower. Borrower, might leave for London, but banks will cling to their properties in India as if they are the remains of their departed spouse.

So, this reading loan book market share is wrong. One should look at share of profit among Indian banks. Since last two years has been particularly bad for public banks, one can look at profit share of 10 years. Private banks must be already hitting 60-70% even in the longer time frame.

Now, let's look at difficult aspect, changing borrowing habits. Public banks should enforce borrowers to provide extra collateral when business starts turning south. Currently many thinks borrowing is gambling with downside protected. If the business does well, profit is privatized, otherwise losses are nationalized. PSB also give top up loans to defaulting borrowers just to keep the banks away from recognizing as NPA. However, it seems that certain Indian corporate, who are addicted to free loan from PSB, will be unwilling to bring extra equity/collateral to maintain their loan backed up by sufficient equity.

Private banks remains cognizant of the current situation and hence keeping smaller but healthy books. Investor are right that their market share will grow and but growing beyond a point where you start taking bad loan books from PSB will not be value accretive.

Just as RBI have been cautious in giving me licensee, there should be rationalising on number of PSB. But that can be a discussion material for another day.

Emerging economies excusing responsibility from carbon emission is self defeating

Ever since cognisance have risen in the global arena to be responsible towards environment and carbon emission, there is tug of war between developing and developed nations regarding how much hit each should take towards economic growth.

Developing markets like India argument have been broader economic shoulder should bear heavier burden. Rationale given towards that is during industrialization phase US, European countries have grown without giving any importance to environment. They have polluted their fair share of the environment. 21st century belongs to emerging markets, bringing environmental concern will slow down the dominance emerging market will get at world stage.

On the other side developed market, (Ok this is before Trump we will not get into what Trump says) is saying that world has reached a point of no return. This is a global crisis, it doesn't matter if the economy is not so strong or you didn't polluted earlier. Everyone is suppose to contribute when the crisis is global.

If you listen to media or hear citizen from both side of argument. Most of them believe is their side is righteous, which left someone like me to think where is the balance of economic growth and environmental sacrifice.

Let's divide the environmental degradation to two part. One is breaking of ozone layer, which most of us is not able to see beyond global warming and summer getting hotter and winter getting colder. Other is respiratory related death occurs in the country due to polluting industries or other form of terminal illness as the water bodies is contaminated when discharge is left to flow to main water bodies without treatment. This is done so that industry remain competitive. Apart from land, labour cheap in India, cost of life is also cheap right.

Severe pollution in Delhi leads to many deaths in winter or lack of clean water bring terminal illness there. I am not sure if that can impact my health in Mumbai, leave aside US, UK.

Everytime we come across that polluting industries find safe heaven in African countries. They are constantly ruining their environment especially the entire water bodies. My reaction has been their government is pushing its citizen to death for economic growth. How is it different for us.

Another point, we have very fragile medical supports beyond tier 2 cities. Disease is detected at an advanced stage and then also treatment is lousy. It is in our own interest that we take care of environment.

Developed nations might want to throttle down our growth, but we should give due consideration on quality of growth we want to bring in our country.

May be most polluting industries needs to move towards thinly populated area and then health parameter of that zone should be constantly monitored. My argument is not like developed nations or NGOs who wants slow down growth but to take more pragmatic approach to the problem which is as much our own as much it is a global problem.

Steel anti-dumping duties indirect mini bank recapitalisation

It will be funny to say two sets of words "anti dumping duties" and "bank recapitalisation" in the single sentence. But once anyone looks deeper into benefits of anti dumping duties, it might look like anti dumping duties is helping finance ministry within its capacity to reduce bank stress.

May be at the end of this article, I would be able to connect anti dumping to bank recap, atleast a symbiotic relationship should be established.

Pre-2016 all steel companies use to complain about the stress in the sector due to cheap Chinese imports. China has huge overcapacity and use to dump steel in India and around the world just to keep their factories running and GDP growing.

India along with other countries started complaining about unfair trade practice out of China. Countries realized that it is in the interest of indigenous steel companies to put a restriction on dumping of steel from China.

In India, Government responded to the request of the steel companies in 2016 and imposed provisional safeguard import duties on steel imported from China. Later on, ministry further improved the breath of protection and bring in anti dumping duty on China and other countries.

As a result of which India which has net import of 7.7 million tonnes of steel in FY2016 is now turned net exporter of steel and has clocked export of 0.844 million tonnes in 2017. This was further improved in FY2018, where India has net export of 1.8mt of steel till January.

http://www.thehindu.com/business/Industry/indias-steel-import-falls-36-to-74-mt-in-2016-17/article18133428.ece

https://economictimes.indiatimes.com/news/economy/foreign-trade/indias-finished-steel-export-slides-over-30-in-january/articleshow/62968377.cms

There is significant improvement in the health of steel sector with government intervention. All companies are reporting very strong EBITDA margin. Is it happening due to cost improvement? No, raw materials cost is high in India as well as overseas. Is it due to improvement of utilisation and fixed cost leverage? Mildly, steel consumption has improved only 3.0% in 2017, though production has improved by 8.5%, that's because of import substitution and this benefit is one time gain. From here, operation leverage will be equivalent to consumption growth.

http://www.financialexpress.com/market/commodities/steel-sectors-yearly-performance-good-but-yet-to-reach-potential/623312/

Now let's look at the banking side of the story. Steel companies is the largest contributor to the banks stress. Aggregate debt of top five stressed steel companies in India is close to 1.4 lakh crore.

Of the twelve stress accounts which are taken for resolution, major contribution is from steel sector (Bhushan Steel, Essar Steel, Bhushan Steel and Power, Electrosteel and Monnet Ispat) with amount of 1.4 lakh crore. Bid submitted for Bhushan steel is even higher than expected by the banks and now they are going for potential write back on the provisioning done earlier.

http://www.livemint.com/Industry/L3KX0hXzcSkUacALhNY6LN/Bad-loan-resolution-Banks-drag-Essar-Steel-Bhushan-Steel-t.html

Isn't it equivalent to bank recapitalisation. Few months ago, everyone was guessing for the quantum of hair cut banks have to take when these companies going for resolution and now we are saying taking about sector turnaround and write backs.

http://www.financialexpress.com/industry/banking-finance/resolution-will-happen-in-most-accounts-under-nclt-says-sbis-deputy-md-sunil-srivastava/1035521/

So far so good, banks have to be funded and industry has to be protected. But recent price hike by steel companies and raw material have gone far beyond. This might even kill the growth of the sector which it is trying to protect.

Current state of affairs is India is net exporter of steel. Price realised on exports is lesser than what they get from Indian consumer. Here is the link regarding milking of domestic consumer, what started as protectionism is moving towards profiteering. Article mention India has started exporting steel to China, this can happen only when exporting price is less than what they are selling to Indian consumer.

http://www.tribuneindia.com/mobi/news/business/steep-hike-in-steel-prices-hits-engg-industry/548085.html

May be some correction to steel prices will come once the process of resolution of steel companies is over, till then I would think anti dumping duty is a form of mini bank recapitalisation.

Wrong investment decision from incorrect reading of return ratios:

Return ratios are considered as one of the most important metrics in evaluating investment prospects. In our quest for finding ideal investment opportunities, everyone will enquire what is the return ratios of the prospect? Many globally renowned investment gurus have maintained, they look at their investment and ask if they can deliver higher return ratios for a long period of time. They connect this higher return capabilities as the moat of the business.

There should be no doubt in any one mind that the return ratios should always looked into before making investment decisions. However, there are some areas where return ratios are wrongly used to make the investment case and I would try to put my argument over cases where return ratios are blindly appreciated. Since, I am based out of India and most of the understanding  has been from Indian capital markets, I would restrict my argument for Indian markets.

Let’s understand in simple terms what return ratios mean for investment decision. Investopedia says "Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested." In simple terms suppose Rs 100 was invested as equity in a business (say a restaurant), may be some time ago, and today that restaurant is generating Rs 20 as profit after tax, one can simply say the business is making 20% RoE. Now investor would compare this restaurant with other restaurant/investment opportunities and see which business or owner is able to make maximum of the invested 100 buck.

This concept work well for western countries where the inflation is very low. US, UK and Japan central government are struggling to increase their inflation rate to mere 2%. while India has always witnessed high inflation, RBI will never dream of bringing down inflation to 2%. 

Indian companies follow conservative accounting policy which means showing assets in balance sheet at market value or original value whichever is lower, so assets will be shown at historical value. Plus, there will be depreciation for wear and tear, which brings down the value of assets further in balance sheet, even though the replacement value of the same assets in current condition might be 2x or 3x, it will be recorded in balance sheet as book value minus depreciation. This is one side of story where assets in countries with high inflation and conservative accounting policy will always recorded lower than fair as denominator for RoE.

Let’s look at the profit side, the numerator of the RoE ratio. Profit is driven by what prices are charged at the restaurant. A restaurant will not charge lower price just because that property was acquired few years ago and prices where low back then. It will not charge lower price even if the acquisition has done recently and owner got a cracker of a deal and bought the property at a bargain. Revenue is always marked to market, based on current economic conditions.

Now, Let’s compare two business, one/ which has assets recorded at lower than fair value and there is another restaurant which is newly opened and assets is current market price. Since India always had high inflation rate, replacement value will normally be much higher than recorded value in the books. Here, just comparing return ratios as reported by the company, doesn’t lead to proper investment decision. If company with lower reported assets is considered better investment decision, then decision is not relying on business ability to generate higher return ratios. Rationale for selecting the business is that promoter will keep on adding new restaurant at bargain value. If that is the reason this Promoter should be compared with DLFs of the world and not the CCDs. 

There are certain instances when it becomes completely wrong to consider return ratios for investment decision, mostly in capital intensive manufacturing units where assets have long history. Think that you are comparing SAIL return ratios based on assets built over life of the company and comparing it with Tata Steel Kalingnagar plant which is built recently.

Comparing return ratios for a bank is fine, as significant portion of assets in balance sheet will be loan and advances or investment which are regularly mark to market. Hence, no distortion there. Even for service companies, they generally don't own hard assets. Infosys might not own building and hard infrastructure to do business, they will be taking it on lease instead. So the rentals booked in P&L would be again as in banks, mark to market.

The level of distortion doesn't end there. I was comparing two companies return ratios and face difficulty is showcasing my investment case due to skewed return ratios. Distortion in my case was further aggravated as one company has done regular acquisition and when you do acquisition assets value will be bought to normal current price or you might have to pay goodwill if the assets is added to the balance sheet at historical value.

To address issue to distorted return ratios, when assets is recorded at low value. One should start looking at inverted PE ratios instead of only return ratios. It gives picture to investor what he is currently paying for the business and whether business is doing well enough to return the money is shortest possible time. However return ratios should continue to be critical factor for banks and financial sector.

Mastek is a low hanging fruit and a complete no brainer

Mastek Ltd. reported its first quarterly results post de-merging its insurance business ("Majesco Ltd.") on 16th July. Majesco Ltd. subsidiary is already listed on NASDAQ as "Majesco US" and currently has mcap of 1100cr. Company has reiterated that Majesco Ltd. will be listed in India by August. Mastek's investors are interested in knowing what is the fair value of Mastek and whether it is worth to commit their money in the company now.

I would try to answer this with the following points:
1. Mastek business model
2. Its revenue driver and expected future growth
3. Fair value of Mastek
4. Where most of the analyst covering Mastek got their valuations wrong
5. Can there be more value unlocking
6. What could retail investor do now

1. Mastek business model : Erstwhile Mastek ltd had two business segment, Insurance software products catering primarily to US markets and software services business catering to UK government. Post demerger, Mastek will have services business while insurance will be transferred to Majesco ltd, which is expected to list in India by Aug'15. I am not writing anything in detail about business segment and geographies of Mastek here as that is available on company's website and other analyst report links which I have mentioned below. Important information is "Mastek currently holds 13.8% of Majesco US".

2. Revenue driver and future growth: Mastek ltd gets 70% of its revenue from government contract in UK, remaining 30% comes from BFSI and retail/telecom segment. This is a very stable business where the revenue has grown at 24% in the FY15 with 11% EBITDA margin. Earlier, Mastek use to partner with BT and Captiva to earn government contract. But in 2012, UK government let small and mid-sized companies participate directly in bidding contract. Government wants 50% of their contract to come directly from smaller firms. This effort is yielding positive results on Mastek as corroborated here:
http://www.channelweb.co.uk/crn-uk/news/2415332/meet-the-new-public-sector-supplier-stars

Management is guiding the revenue will continue to grow at above industry average of 12-14%, but the street is anticipating it to clock mere 10% growth and EBITDA margin will remain stable at 12%. Which brings us to 67cr EBITDA in FY16. However, there were lots of noise in the announced results:

2.A Company has earlier said there shouldn't be any further de-merger related exceptional items. But in the concluded quarter, they had further restructuring expense of 1.8cr.
2.B They acquired IndigoBlue in May'15 and its two month financials were included in the current quarter. Full impact on the financial will be reflected in the coming quarters, when the operations are stabilized and management will be in better position to give guidance regarding benefits of cross selling of products through IndigoBlue and vice versa.
2.C Management has done soft launch of its Law Practice Technologies' platform. Full launch is expected by the end of Sept, and management said they will be able to give better picture of the platform by the next quarter results.

3. Valuation: Now this is the most juicy part and one should spend more time in understanding how this company should be valued. I am covering one critical point here:
Mastek has about 156cr of cash and equivalent, including 18.8cr as investment (book value) in Majesco. (Market value of 13.8% stake in Majesco US is c.150cr). This cash is after company has paid over c.22cr to IndigoBlue. Now since the Majesco US is in expansionary mode and still not making money, all analyst are valuing it at EV/Sales multiple. Analyst are assigning it the multiple of 2x EV/Sales, which is also confirmed by the market as its valuation on NASDAQ is also coming around 1100cr. Importance of this information will be clear once you go through entire article. So, Mastek's 13.8% stake in Majesco should be valued separately as Majesco true value cannot get reflected through its current EBITDA or Net Income.

EV/EBITDA: Market is anticipating EBITDA of 60-70cr of Mastek business, excluding Majesco. Even if we assign a EV/EBITDA multiple of 6x (which is very low for IT sector, 6x multiple is mostly used in manufacturing and capital intensive sector), we come to EV of 360-420cr. We add 137cr cash to it and then add valuation of Majesco (after 30% holding discount) as 105cr. Total valuations come to (360-390 + 137 + 105) 602 - 662cr. Now, post this conservative target we have decent upside risk to our target price for the reason mentioned in 2B and 2C, to be precise 2B upside will start trickling in from 1H16, while 2C upside will take shape from 1H17.

PE multiple: In the concluded quarter, company reported net profit of 4.4cr while the adjusted net profit was 10cr. Bridge to this adjustment comes under exceptional expense for restructuring (1.8cr) and 3.4cr loss related to Law Practice Technologies ("LPT") , the platform which was into development phase. Management has mentioned in the concall that platform has already crossed its peak capex and will be fully launched by Sep. If we remove loss due to LPT and restructuring exp, profit before tax would come to 16cr. It was very close to EBITDA as depreciation was offset by other income (Company holds about 137cr in cash and there should be considerable interest income from it). So we can assume company is going to have yearly adjusted net profit of 45-50cr. We can take a multiple of 10x for the current year to arrive at the valuation of 450-500cr. Now, here also we have left Majesco and that value should be brought in separately, another 100cr to come at final value of 550 - 600cr. This is bit lower as we have factored in higher tax rate, our effective tax rate is assumed near 25%-30%. Needless to say upside remains same as mentioned in EV/EBITDA multiple.

Average of both method gives us valuation of 576 - 631cr, which is 33-45% upside from yesterday closing price.

4. Where most of the analyst covering Mastek got their valuations wrong : Here I would simply highlight some of the point missed by the analyst covering the stock.
http://www.moneycontrol.com/mccode/news/article/article_pdf.php?autono=1402491&num=0
At page 21 of the valuation section, target price of 174 using PE method clearly missed that about 100cr valuation should be added from Majesco above it. In the same page, though they mention company has acquired IndigoBlue but they have not incorporated revenue and profit from Indigoblue. The 13.6% growth mentioned there is mere organic one, hence if we add IndigoBlue our net profit should increase to 50cr in FY17.
http://www.indianivesh.in/Downloads/635696086909375000_Mastek__Co_Update_09062015.pdf
Here, we don't even acknowledge that company owns 13.8% in Majesco.
http://content.icicidirect.com/mailimages/IDirect_Mastek_CoUpdate_Sept14.pdf
Services business is valued at EV/EBITDA level but they have missed both, cash and investment in Majesco. Valuation is done on 1st page, 2nd paragraph
http://www.rathi.com/ResearchCoverage/635572635632228750_Mastek%20_IC_%2030%20December%202014.pdf
In page 16, they have directly computed target price from EV, though here we have taken 13.8% stake in Majesco, but forget to add cash balance, which company just reported as 137cr, post payment of 22cr to IndigoBlue, hence valuation should be 661cr + 137cr

5. Can there be more value unlocking : It is forgone conclusion that de-merging Mastek was brilliant move to unlock value, which is clearly visible in share price performance. At times, when most of the CEO's wanted to build empire and merge business, de-merger was definitely a investor friendly move. Once the Majesco Ltd shared get listed on the Indian market, Mastek management can think of 2nd level of value creation. Transfer the 13.8% Majesco US stake from Mastek Ltd to Majesco Ltd. With that, Majesco Ltd stake in Majesco US will increase from c.70% to 84%. Issue fresh shares of Majesco Ltd to Mastek current shareholders. This way we will have complete de-merger of insurance and services business. Investor can make their free choice, which business they want to invest in, true value unlocking.
Mastek is a cash rich company. Idle cash always encourage management to go for shopping as a result they often destroy value through acquistion. Mastek CEO already mentioned that company will be generating 40-50cr of free cash flow:
http://www.moneycontrol.com/news/business/acquisitions-diversification-to-lead-fy16-growth-mastek_1624201.html
Share buy back is another option to create value, distributing dividend brings dividend distribution tax of 15% and hence not ideal way for value creation. Management also has history of buy back earlier as shown in the link below:
http://money.rediff.com/companies/Mastek-Ltd/13020010/capital-structures?src=comp_research

6. What could retail investor do now : There is very little option left for retail investor here. We always depend on expert advice and market will also follow what analyst/research house are saying about the stock and its future prospect. Until analyst pick up the points mentioned here, re-rating of the stock is bit difficult.

Rolta entire game plan

With the recent release of Glaucus research, Rolta shares nosedived with vigorous selling on the exchanges. Stock is down close to 20% in last three days. Even the astute investor are left wondering:

1. Should Glaucus report be taken on its face value

2. How long we will see downward price movement, and most importantly

3. What is the real value of Rolta

While thinking about these question, I came up with something equally interesting and sinister as mentioned by Glaucus research. 

First thing, Glaucus research should not be taken with its entire content at face value. We have come across similar report earlier by Canadian research firm Veritas. One major difference here is Glaucus doesn't even disclose analyst name and contact detail. Nothing is mentioned in their entire 32 page report or on their website. A research firm should always have their disclosure right, here we don't even know who prepared the report.

Lets move on to the content of the report. In the very first page of the report, they say two thing. One, credit rating firms are misled as Rolta window dressed their financial statement. Two, Rolta raised funds from overseas market as they will not be able to do it in India. Both things can't be true. If the credit rating firm are misled then it is fairly easy for the company to raise fund in India. 

So I think, there is another reason why Rolta raised money in US. I will come to that point at a later stage when I discuss what is the real value of Rolta shares.

It seems Glaucus has done detailed research on Rolta, but they missed on few things.

Why is Rolta promoter increasing their stake in company over the last few years. If the accounts are window dressed and profits overstated, promoter is the first person to know it. Then why K K Singh ("promoter") is deploying crores of money into a dead company. At this Juncture, let me take a step back and explain how promoter has increased its stake in Rolta.

K K Singh has increased stake in Rolta since last few years. The promoter buying in Rolta was very fast till share price was less than 80/sh or when the stake in company was less than 50%. Promoter buying in Rolta can be verified from the bse website link below:

http://www.bseindia.com/stock-share-price/stockreach_insidertrade.aspx?scripcode=500366&expandable=2

Besides, here is detail how K K Singh has increased his stake in Rolta (Again source is bse website)

Dec'14 - 51.09%

Dec'13 - 50.32%

Dec'12 - 44.22%

Dec'11 - 43.21%

It seems K K Singh love for the company has lowered once the stake reached over 50% or when the share price moved above Rs100. Both is partially true. Promoter has slowed buying shares because if they would have continued with the same pace, they would easily breach 55% limit of shareholding. SEBI rule says if promoter shareholding increase above 55% they have to launch an open offer. It seems Mr. Singh intent is not to launch any open offer, but just create that buzz and buying interest from retail investor in anticipation of open offer. One more reason can be he doesn't believe the value of Rolta shares above 100.

Here I bring my first point why Rolta raised money overseas.... connect all the dots .... and conclude my story.

Rolta raised the debt abroad because they wanted to have visibility in the overseas market. Their bond was subscribed in record time, a milestone you always like to show whenever you will go again and raise money overseas. K K Singh wanted to rope in an overseas investor/PE or an FII and wanted to get premium valuation for his company which doesn't make money as much it claims to be making. By increasing his stake gradually, he kept retail investor interest in his company intact. The FII or PE would have either purchased newly issued shares of Rolta or buyout from promoter, in both cases K K Singh stakes would have fetch much higher amount than he has invested.

This bring me to last question that I raised at the start of this article, What is true worth of Rolta. To be fair, I would say "I don't know". But I am very sure that the promoter of the company knows it very well. They will start buying again into Rolta, once it moves below that price. At this juncture, I would like to make one more point, promoter last investment in Rolta was close to Rs100. This might be the value of Rolta... or this incremental investment was made to lure more retail investor... to earn higher return on chunk of its investment that was made when the share price was close to Rs60. I would say let promoter increased their stake and take their holding above 55%, we can very well know real value of Rolta from the price they give for open offer.

Till then my guess is as good as yours .....