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Je Ne Comprends Pas

The author gives you disconnected thoughts that range for the US downgrade to the Bharti saga to Tata Steel’s fortunes

Regular readers know that I mostly write philosophically, trying to derive principles that drive action, rather than recommending specific actions for our readers. Rarely, I speak about a specific company/ event/ trend, except to deal with a macro-trend. Today, here are some disconnected thoughts that slip through my mind as news/ events/ trends roll along in fast forward…
# So S&P downgraded the US and everyone panicked. It wasn’t really news, even from S&P; but I suppose once people start running, nobody knows why they are running.
The same day, S&P upgraded Tata Steel, which then proceeded to drop like a brick, till it reached a whopping 20 per cent discount to Book Value. The debt has come down to 2x consolidated EBIDTA, well under control. Corus has mostly turned around and cost synergies (estimated at $400 million) have started to flow. The closure of illegal mining in Bellary will indirectly benefit Tata Steel to maintain its 20 per cent topline growth, both in India and globally. At `130 EPS (including one-time capital gains), you are buying the company at 3.7x earnings and 4x EBIDTA. This is even better than Bharti, my last recommendation…
# The company has a Return on Net Worth of 13 per cent, but the stock is available at a 10 per cent discount to its CURRENT Net Worth of `490 per share; since you would mostly be investing with a horizon of one year, that would be a 25 per cent discount to its expected Net Worth (of `550 per share) one year hence. In short, you get a 21 per cent post-tax (31% pre-tax) return if you hold the stock forever. This is the kind of once-in-a-lifetime investment that Charlie Munger and Warren Buffet talk about. If you have bought the stock at the right price, and it is compounding steadily, the right time to sell it is …..never.
# Let us take a look at how this has come about, and what are the canards floating about in the market/ media/ analyst community that have beaten down the stock to such deep value. In these chaotic times, the media is full of misleading stories, sometimes orchestrated by the analyst community, who will change their tune the moment the stock has reached the right hands. I think this is a bigger and more systematic scam than 2G, CWG and Bellary combined. It is just unfortunate that Anna and his team don’t have the eyes to see it.

The Bharti saga
Don’t believe me?! For those of you who remember my columns while the Bharti story was unfolding, take a look at the sequence of events while the orchestrated beating down of the stock was taking place:
# The first phase was when the tariff wars started and the stock was marked down on a huge selloff by mutual funds from 457 to 320 (October 1 - 14, 2009; look up the technical charts to follow my story). As a natural contrarian, this attracted my attention.
# Tired bulls capitulated end-November 2009 (near the expiry) and there was a short-covering rally by mid-December to 342. This ended Phase I of my story.
# Now starts the co-ordinated ‘story-spreading’. In January-February 2010, the Zain story broke and an ‘analysts’ consensus’ was worked out, saying the acquisition was ‘value dilutive’ for Bharti, because it was a premium (about 20% per subscriber) to Bharti’s own beaten-down valuations. Look around now, and tell me where those concerns are. Bharti is up 60 per cent from those days, even though the market is down 20 per cent. Anyway, in the week February 10-16, 2010, the stock was marked down from 315 to 271. Thereafter, it trundled along over March and April, recovering as more information about Zain trickled in. In February 2010, I wrote the first of my columns on Bharti, angry at the disinformation being spread about Bharti.
# At just this time, I called up an analyst in a leading foreign brokerage who was covering Bharti. I challenged her downbeat view on the sector, finding that she agrees with all my counter-arguments about Bharti being a sector outperformer and a relative value argument, etc. She agreed with everything, but maintained the ‘party line’. i.e. the stock is down from 271 with a target of 210. Recently, she has revised he price target to 504. I can’t believe that she did not know what she was doing; her ‘party line’ was to talk down the stock, put out ‘public research reports’ which are duly headlined by the leading papers (more money is made by this process than Kalmadi could ever imagine; in respectable Indian society, this is even called a ‘business’ and gets you market cap in dollars).
# But back to my story. After the Zain fracas died down, the 2G scam broke out, circa late April 2010. It had a limited effect on the already beaten-down Bharti stock, except when a bombshell of a story was headlined, obviously (surprise!!!) in the pink papers: the TRAI recommendations about the sector, especially one recommending a whopping `14,000 crore licence renewal fee. These ‘recommendations’ were duly headlined as fact and repeated ad nauseam. I wrote an angry column ‘TRAI-ing to Fail’, which should be read now in the archives, to see how right I was: https://www.valueresearchonline.com/story/h2_storyView.asp?str=14788 The stock dropped below 260 and stayed there for two months, during which almost everyone I knew dropped out of Bharti. The stock they sold was picked up by some of the smartest investors in the country (including the promoters).

# The point I am making: while the media (and analysts) were in a downgrade frenzy, why were smart, knowledgeable people, not reading those research reports (or pink newspapers). Or were they writing them? In trading parlance, we call this, ‘maal nikalvana’, and is in no way different from the manner in which you put a white bedsheet over yourself to make your sister shit in her pants…;). I survived all this, and exited Bharti at 360, happy at the predictable ‘behavioural map’ that I had figured out. After 360, the analysts returned to telling the truth; actually (oh sorry! But Bharti was really a good company, a sector outperformer and would consolidate both India and Africa. So what if the profits are down, the stock is still up, despite a beaten-down market!!!)
# Something similar happened recently in DLF, which will give you a sense of déjà vu if you track the story with the technical charts. Thrice, there were prominent headlines in the pink papers on various issues with the company (bad accounting, hidden losses, high debt). Every time, it led to a selloff, the stock bottomed at 209 with huge volumes and backed up 10-15 per cent…..it was party time in a bear market.
The big story now is the ‘penalty’ on DLF by the Competition Commission of a whopping `630 crore (see the TRAI ‘recommendation’ above). Suitably headlined in the ;pink papers, it led to a selloff on a day when the broad market bottomed and some very smart investors bought 140 lakh shares from some very relieved idiots. Watch this issue one year hence….!!! DLF is since not breaking new lows, despite being from a pariah (real estate) sector…!

Back to Tata Steel
But this story is about Tata Steel and I must return to it, first by making my main point: that there are serious, quiet and invisible ‘cosy’ relationships between analysts (especially from foreign brokerages, who put out ‘research’ when the market is delicately poised) and the media, who give it a loud, terrifying voice that will blow you away if you don’t know your facts thoroughly. Recently, the market bottom for this cycle was made on a day when the leading pink paper chose to ‘poll’ some unnamed ‘fund managers’, and told you that the market was dropping 13 per cent......not 17, 9 or 12.36 per cent. Just 13 per cent.....the stock sold by its foolish readers was dully lapped up. Now watch this space six months hence!!!
The lesson for you, my dear readers…..your only hope of dying rich is if you just read these papers one week after the day they are delivered to your house, and then you watch what your foolish neighbours did when they listened to such false ‘advice’. In my case, I read these (pink papers) to find out what the fools are doing. And I don’t watch TV, which is seriously good for my financial health.
The canards floating around just now:
Tata Steel is a global company, and with Europe facing a double dip, its European operations will be badly affected.
Europe accounts for 56 per cent of Tata Steel’s turnover, and about 30 per cent of its EBIDTA. It has high Operating Leverage, i.e. unit drop in selling prices will lead to high negative impact on its EBIDTA. But at 5x EBIDTA, this belief will at best hold for the short term (even if it is true).
At these valuations, just the 20% EBIDTA growth from the Indian operations, which are unaffected, will give you a decent return.
Steel prices are bearish, and Tata Steel will be affected.
They have been bearish for some time now (CMIE has projected a 7% increase in domestic prices around October 2011), and recent results showed that Indian turnover growth made up for the decline in prices. EBIDTA was flat, despite lower prices. Going forward, India will still see 10 per cent growth in steel demand and maybe some price improvement if the ban on iron ore mining and the problems of JSW prove to be good for its competitors. But this is to tell you that even in the short term, Tata Steel’s EBIDTA will be more or less flat. But its stock price is down 20 per cent below is current Book Value. At these levels, its current profits give you a 21 per cent post-tax return; all you have to believe is that EBIDTA will not fall significantly. In a high interest rate environment, this is an interest rate sensitive stock with high debt. It should be badly affected by a recessionary scenario.
Wrong! The Corus debt has been reduced steadily, and consolidated debt is at 2x EBIDTA now, a very stable ratio. Its spare debt capacity gives it the ability to make another aggressive acquisition; watch out. Even if it doesn’t invest, it is paying down `10,000 crore debt this year, or its expansion at Jamshedpur will come up with lower leverage than at SAIL or JSW. The company is the most under-geared in its sector, something it has in common with Bharti.

Looking at the positives
The ‘global’ operations of Tata Steel are genuinely global, with commercial operations in 53 countries. A shortfall in sales in Europe will be made up by faster diversion to other growing economies, especially in Africa.
Corus is not the operation it used to be in 2008, when it brought down Tata Steel to 40 per cent of its Book Value. Memories of that downfall have triggered the current selloff and that is why it is an opportunity for you. Today’s Tata Steel is a different company: huge cost synergies have already been extracted, half the Corus debt is paid off and most importantly, Corus technology is now helping Tata Steel with its product development in India and other emerging markets; that will help it outperform its competition locally. And the local markets are both robust and growing.
The fears about a European slowdown, even if they are true, don’t justify a 65 per cent discount to its average historic valuations (of 1.3x Book Value).At a 20 per cent discount to today’s Book Value, you are getting a strong, deleveraged Balance Sheet and a robust P&L with little downside risk. If there are risks, they are already factored into the price. The positives have not been factored in, and some of them are already on the Balance Sheet. Like Benjamin Graham was fond of doing, he wanted to pay only for current reality, not for future potential. You are getting just such an opportunity in Tata Steel right now.
Disclaimer: the author has put his money where his mouth is. He has put his shirt (and his reputation) behind Tata Steel.