Value Operations

2013

A Value Operations Private Fund white paper

April 2013
A Value Operations Fund: A portfolio of extraordinary businesses of India This white paper provides information to the professionals, part time and first time investors to understand how the chief investment officer investigates investment opportunities for their clients. By Aziz Dodhiya

Disclaimer.

This report was prepared by Value Operations and services Pty Ltd. This document has been prepared for the purpose of providing general information, without taking account your particular objectives, financial circumstances or needs. You should obtain and consider a copy of information kit relating to the fund before making decision to invest. While the information in this document has been prepared with all reasonable care, neither Value Operations & Services or Aziz Dodhiya makes any representation or warranty as to the accuracy or completeness of any statement in this document including forecasts. Neither Value Operations & Services or Aziz Dodhiya guarantees the performance of the fund or the repayment of any investors capital. To the extent permitted by law, neither Value Operations & Services nor Aziz Dodhiya, including their employees, consultants, advisers are liable for any loss or damage arising as a result of reliance placed on the contents of this report. Past performance is not indicative of future performance.

Value Operations

2013

What future does Bajaj Auto and Hero Motocorp holds for its shareholders?
We have shared our view on the Bajaj Auto on our recent blog. This time we will try to add more bolts to our investigation and also look into the Hero Motocorp business. For investors who are looking for the exposure in the two wheeler businesses, where prices of many had come down from its 52 week high, Bajaj Auto and Hero Motocorp are worth to investigate further. The outcomes, however, are likely to be binary. Either a big win or a big loss and little middle ground will be the result of foray here, so be sure to seek personal or professional advice. When we talk about two wheelers market in India, suddenly it reminds us about the story of India shinning. The migration of the families to middle class and from middle to upper middle class in last one decade has changed the whole canvas of India in economic terms. Consensus report says that eleven years ago only 12% of the Indian families use to own two wheelers and that number has jumped up to 21% by the 2011. There are more than half a dozen businesses competing in this sector as many analysts think that there is still a room to grow. By average the industry is growing at 13% every year for the last one decade and is expected to grow by the same in coming decade. The major and the oldest players in this sector are the Bajaj Auto and Hero Motocorp (earlier it was Hero Honda). I still remember those old television advertisements and song, Yeh zameen Yeh asmaan, hamara kal hamara aaj and desh ki dhadkan Though there are so many players in this segment, Bajaj auto and Hero Motocorp together holds more than 75% of the Indian market. They do have big competitive edge on their rivals which is its presence in the market for a long time. Almost three generations of Indian households are their loyal customers. Now days it has become tough to maintain their share in the market as we find that many businesses are entering in this sector. There is a tough competition in the market. Today if anyone wants to buy a bike then he/she has almost 5 to 6 options to choose from in the market. Competition is good for consumers but not for the shareholders of those businesses. As competition grows you as a business owner loose the power of your product pricing. This results in less profits and lower return on the shareholders equity. To keep their returns steady these businesses have to invest in new technologies and in their research programs and keep inventing innovative products to keep that edge over their competitors. Eventual Bajaj Auto and Hero Motocorp will shed their market share due to increase in competition in the next decade. This is how businesses shape up. On this note by itself we can end this column. But lets keep going as these businesses have found other opportunities in this globe and are promising same returns to its shareholders.

Value Operations

2013

If we look through the global perspective then it is not just India which is a shining star. There is many other developing and even fourth world countries which are growing fast and are looking promising. Let me start with the Bajaj Auto, Value operations platform gives this business a grading of A1 in its Balance sheet quality and overall performance as a business. This grading gives us a green signal to do further investigation as it is an investment grade. Lets have a look at the capital history of Bajaj Auto and find out how the management of this business has managed shareholders capital.

Capital History of Bajaj Auto Bajaj Auto management had really managed well their shareholders fund. The very first good thing they did was getting rid of those debts on their balance sheet. The other most important thing to consider before investing is to check the cash flow of the business. It is important that managers of the business should be good allocators of shareholders and business funds. They should always keep the shareholders interest first before making any decision.

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Cash flow analysis of Bajaj Auto The management had really taken care of their cash flow. They have also managed not only to pay dividends but also had grown their dividends every year. Many analysts are expecting a robust growth in their profits for the forecast years. They are optimist of those numbers on the basis of their growth prospects in the exports. If we look at the sales for the year end 2012 then exports revenue accounted 35% of their gross sales. So far 2013 have been the worst year for the business. There are many factors to blame on. But the real question is, will it be crossing rupees four thousand Crore by the financial year 2015? It is impossible to predict the performance of any business. It is not also advisable to anchor those consensus estimates and take decisions based on it. As they change every month or even day. We are to witness 0 5% growth in its net profits and in its revenues for the 2013. If we do expect the same performance by this business for the year end 2014 then we value this business for Rs 1,604. If we anchor that consensus estimates are going to be almost exact figures then we value this business for Rs 1,840.

Value Operations
Also, Value operations value this business for 2013 to be Rs 1,390. With the expectations of falling interest rate, inflation and steady Indian rupee we are expecting its intrinsic value in range of Rs 1,604 Rs 1,840. Bajaj Autos market price is currently trading within those estimate range.

2013

On the other hand Value operations rate Hero Honda as a B1 grade in its quality and performance rating. It is an investment grade and we can further do investigation.

Capital history of Hero Motocorp The major difference between the Bajaj Auto and Hero Motocorp is in the estimates of future profits by consensus. They are not that optimistic about its future profits. We know that to the certain extent this business had damaged its competitive edge after leaving Honda. But you cannot ignore that one of the two bikes that sell in the market today is of Hero Motocorp. Hero Motocorp is under the process of building up its marketing strategy for exporting its products overseas where Bajaj Auto is already well recognised brand. The total number of units they exported overseas represents only 3% of its total units sold in the 2012 year. They have still long time to go and catch it up with the Bajaj Auto. It would be also not fair to mention that product mix of Bajaj auto (two and three wheel products) give them upper hand on Hero Motocorp.

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2013

Cash flow analysis of Hero Motocorp This is very interesting chart of how the cash flow was managed by the Hero Motocorp management. The good part about this business is that they generated surplus cash flow through their operations. In 2010 and 2011 they paid dividends more than what profits they generated to its shareholders. In other words they paid back some of the shareholders capital in a way of dividends to them. It is very hard to comment on this matter whether it was in shareholders interest or not. As it all depends on individuals goals and expectations through their investments. We at Value operations do not like businesses giving us dividends bigger than its Net profits or in other words return our capital back to us. It brings down business intrinsic value. We like to stay invested and look for businesses where its intrinsic value is growing. It tells us that management does not know or are not competent to allocate our funds to generate good returns within its business.

We value this business on its 2013 performance for Rs 1,427 and expect its intrinsic value to grow to Rs 1,527 for the year end 2014. The market price for this business is trading at almost its fair value today.

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Disciplined value investor obviously has to wait for justification and an alignment of its signal from both the companys valuation and performance before plunging any funds into it. Value operations private fund does not own any stock in any of those companies discussed in this paper.

Aziz Dodhiya (Chief Fund Manager)