When Titan went the Titanic way…
Many times in our investing careers, regulatory changes wipe out years of returns and make waste of all the time we have invested in studying and tracking businesses.
It happened some time back in Indrapastha Gas – one of our earlier core and loved holdings. We were plain lucky to have already sold out our shareholding near the peak price on pure valuation considerations (some benefits of having a value mindset!), without having any inkling of drastic regulatory changes around the corner.
A similar thing happened in Titan Industries sometime back, though for a short period of time.
But before that, a flashback….
Titan Industries was one of my first rookie investments way back in 2002, more so on coat tailing and simplistic analysis. Well, it turned out to be a good investment and I exited after making satisfactory returns (but only a fraction of what could have really been made). With hindsight, we see that everyone made money in that period in whatever they bought!!
With strong price anchoring and looking at high valuations, we never looked at investing in it ever again (plain stupidity – it’s much easier to analyze stocks that you have known for a long period of time).
We again missed investing in it in the golden period of early 2009, when it was available at rational valuations, with earnings having doubled over 2 years and stock remaining stagnant. We were quite focused on investing in cheap stocks, which gave very good and faster returns, but lacked the elusive mystique of “Fill it, Shut it, Watch it” stocks.
So, in early 2012, when the same situation arose (earnings having doubled over 2 years and stock remaining stagnant), we decided not to repeat the mistake (first sensible decision) and started analyzing the company in detail.
Here is a snapshot of the company, as we saw it:
Quite an incredible business achievement by the management of Titan Industries, we thought.
We figured that with even some of the following easily identifiable and high probability catalysts, the stock should be worth atleast Rs. 300/ share in sometime – a 40-50% upside in a large cap with years of potential compounding of around 25% and where you can make a good size bet (we love such bets).
1. The bull run in gold seemed to be correcting, and even some gold price correction should lead to increased business volumes (which were subdued due to record gold prices).
2. The management had nearly doubled the retail space over the past 2 years, which should lead to higher growth and increased operating margins.
3. The focus on studded jewellery should improve margins (studded jewellery has 3 times margins of plain gold jewellery).
4. The transformation of the balance sheet over the years should enable the management to meaningfully increase the dividend payout ratio from current 25%, without compromising on growth or balance sheet strength. We all know what happens to stocks of companies with increasing dividend payout ratio. Even RJ alluded to this in a recent con call.
5. The new incubated businesses were turning corners and should add to the profitability margins, instead of lowering margins.
So, we bought Titan Industries in a meaningful quantity.
Mr. Market obliged pretty quickly and the stock went to Rs. 300/ share within a year. We sold a part, looking at full near term valuations (blame the value mindset), but kept most of the holding for the long term compounding.
Now, comes the regulatory angle…
There were some regulatory headwinds that the jewellery companies were facing, though none of this was their own making but more to do with macro-economic issues, given the dismal situation of the economy.
These regulatory issues were supposed to have gone either way in March 2013, but nothing happened then. Then in May-Jun 2013, Mr. Integrity Management of Titan Industries themselves went to the RBI and asked to be wacked. Just kidding, they asked RBI for some clarifications.
With this, all hell broke loose. We were again in IGL, but this time with most of our shareholding intact. The stock fell from Rs. 280 to Rs. 200 within a week, and panic set in, with rumours of Rs. 150!! Now, when you are surrounded by panic, you need to think coolly. Read other people’s opinions, but finally frame your own opinion.
1. First question is, whether the stock can go the Arshiya way?
a. Management Integrity: Check
b. Balance Sheet strength: Check
Current is very strong, even with new business workings, it will be pretty ok.
c. Medium Term Product Demand: Check
Will likely continue – Indians going to stop buying gold jewellery? It’s part of “Roti, Kapda, Makaan, Sona, Padai” that every Indian spends on.
2. How will the new financials look like?
Capital Intensity of business will go up. From a cash surplus business, it will become a net debt business. ROCE will reduce from 60% to around 30%. (But how many businesses today are doing 30% ROCE?). Though catalyst no. 4 is gone.
3. What are the chances of further regulatory impacts?
4. What is the change in intrinsic value?
Based on the reduced growth rates, higher capital intensity, but still 30% ROCE, new intrinsic value seemed like Rs. 240. All other catalysts remain intact, though further expansion will moderate.
So, we just kept our cool, and finally exited near the new estimated intrinsic value, at a minor profit with >1 year of holding.
Selling at the new estimated intrinsic value was logical, given lack of visibility of any further regulatory impacts. We sometimes are willing to invest in low visibility stocks, provided the gap between the market price and intrinsic value is mouth watering.
1. Most people who lost large amount of money were people who had no idea of its intrinsic value – they had no idea when they were buying at Rs. 300 and they had no idea when they were selling at Rs. 200! Most people who did not think of its valuations at Rs. 300 were forced to think at Rs. 200!!
2. Though if an investor is not comfortable, it’s better to sell and invest elsewhere, rather than lose sleep over 20% probable gain in the short term.
3. Strong companies tend to help recover your money, unless you have bought the stock at very high valuations.
4. Contrary to popular opinion, investing in low P/E stocks does not help salvage such situation.
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