Treasure in the Backyard

Several investment and holding companies continue to trade well below their net asset value. ETIG’s Ramkrishna Kashelkar suggests longterm investors to go value picking

While the stock markets are soaring and the investors are wondering at the pricey valuations of leading companies, one will be surprised to know that a bunch of companies are actually trading substantially below their fair value. Here, an ‘argumentative Indian’ may intervene saying “but valuation of a company is so subjective…” Well, not in case of these companies, we would say. And you don’t even need to indulge into deep valuation models, profitability analysis or scenario building for finding their real worth. The investment made by these companies in the shares of listed companies alone is many times more valuable than their current market capitalisation. ET Intelligence Group brings you a list of such companies that figuratively looks like a treasure buried in your backyard — a chunk of value, waiting to be unlocked.

The companies we are referring to are generally classified as ‘holding companies’, which are created to promote or control other operating group companies. One excellent example is Tata Sons, which is the controlling entity or the promoter for majority of the leading Tata Group companies such as Tata Steel, Tata Motors, Tata Power and TCS among others. Unfortunately, although a number of Tata Group entities are listed on stock exchanges, Tata Sons is unlisted. Apart from the Tatas, several other business houses, too, have their holding companies. The other type of companies that figure in our list are investment companies. Long term investing in other companies is their business — an example could be Tata Investment Corporation, while a few others carry on their own distinct businesses apart from the investment portfolios. For example, more than half the market capitalisation of Murugappa Group’s EID Parry is represented by the market value of its investment (i.e. shareholding) in Coromandel Fertilisers. In other words, the company’s core business is valued much cheaper compared to its peers.

NOT A MIRROR-IMAGE

The market capitalisation of these companies does reflect the ups and downs in the value of their investment, although they are not in perfect sync. This offers attractive arbitrage opportunities. For example, Vardhman Holdings gained only 35% during last one year, as against 64% jump in the share price of Vardhman Textiles, in which it holds 26.7% stake. Similarly, Uniphos Enterprises lost over a quarter of its value last year, substantially higher than United Phosphorous that lost just 3%. In the same period, Binani Industries lost nearly 10% of its market capitalisation, even as the share price of its 65% subsidiary Binani Cements is up 16%. Last six months have seen an excellent run-up in these companies, most of which have jumped two to four times since then, outperforming the 85% gain in Sensex.

VALUATION PROBLEMS

Despite being somewhat similar to close-ended mutual funds that also invest in listed equities, the holding companies’ always trade at a discount to the net asset value of their investments. The price movements in the investee companies rarely reflect in the share prices of the investor company. In Search Of Value THEreason being that the shareholders of the investor company, unlike in case of a mutual fund, can’t force the management to liquidate the investment and distribute the profits to shareholders. Their direct gain is restricted to the cash flows that the investor companies get from its investment in the form of dividends and other such nonoperating incomes.

At the same time, the holding company concept is still in its infancy in India and is not fully appreciated by the stock market, unlike in the developed world where a vast majority of large corporations are nothing but holding companies with business operations housed in scores of listed or unlisted subsidiaries. The most famous example, perhaps, is Warren Buffett’s Berkshire Hathaway, which holds stakes in a vast number of diverse corporates. In India, however, the holding companies have never gained market favour, probably due to the lack of comfort felt by Indian investors. As a rule of thumb, 50% discount to the asset value of their portfolios is considered fair. But their valuations do dip below this threshold from time to time, which creates opportunities for value pickers. For example, RPG Group’s CHI Investments, which was demerged from Ceat Limited in 2007 is currently valued at Rs 63 crore on the stock markets. This is just one-sixth of its investment portfolio worth nearly Rs 390 crore, which includes 8.4% stake in KEC International, 1.7% stake in CESC and 9.3% stake in Zensar Technologies. The company is currently seeking shareholder approval for amalgamating itself into RPG Itochu along with three other entities.

Maharashtra Scooters, a Bajaj group company, which was earlier manufacturing scooters, is now reduced to the production of dies, jigs and fixtures for the auto industry. The company’s investments in Bajaj group companies is valued over Rs 710 crore, which is four-times its current market capitalisation. Some companies do have their independent business, apart from the investments. Munjal Group’s Majestic Auto manufactures two-wheeler components and spare parts and holds a 0.81% stake in Hero Honda valued at over Rs 250 crore. Still its market value is just Rs 70 crore — 15 times its earnings for trailing 12 months.

Seed manufacturing company J K Agri Genetics underperformed the markets due to losses in FY09. However, its holdings in other group companies including JK Lakshmi Cement, JK Tyre and JK Paper is valued three times its current market capitalisation. It does not feature in our list due to the outstanding net debt of Rs 44 crore. After three quarters of losses, the company posted 44% growth in net profit for the June 2009 quarter to Rs 15 crore. The company has long been trying to separate its seed and investment businesses.

A few of these companies have decided to focus solely on their investment business and grow there. For example, Bajaj Holdings and KK Birla group’s SIL Investments have applied for licenses from the Reserve Bank of India to operate as non-banking finance companies (NBFCs). The promoter group of Bajaj Holdings recently subscribed to 1 million warrants pumping in additional cash and emphasizing their intent to grow in the finance industry.

CONCLUSION

This goes on to show that a lot of value remains locked in these holding or investment companies, which is not fully reflected in their share price right now. And, one cannot hope to unlock the entire value in such companies in a short while. A retail investor should, however, keep looking for chronically undervalued firms or arbitrage opportunities that can generate healthy returns in the long run.

NUMBER GAME

We have chosen only such companies, whose investments in Indian listed companies as on 1st September 2009 were valued more than twice their market capitalisation plus outstanding net debt. The substantially low valuations leave lot of headroom for capital appreciation in the long run.