Willow turned five this year. We thank you for your support through all these years. Many of you have been with us from day-one. Most of you have had to endure significant drawdowns, more than once. None of you left us. Several of you have asked to increase your allocations. We could not have possibly hoped for better.
Since the beginning we have asked that you evaluate us on a 3-5 year time frame. You now have a total of six periods (three 3-year rolling, two 4-year rolling, and one 5-year period) to use for your evaluation. We have outperformed the India index in all such periods, our 5-year cumulative outperformance being 74%.
Back when we started, we expected the Indian market to do better than the US market. We were utterly wrong about that. US investors were much better off staying home. Fortunately our own outperformance over the S&P 500 somewhat made up for our lack of our prediction skills. No more predictions. India will do very well over the next decade. Invest in India!
The broad Indian market rallied hard in 2017 posting its second-best year in the last decade. As stated several times before, we fully expect to underperform during such years. Our nitpickiness and caution made new highs in 2017. We kept significant amounts of cash. We even bought Index puts. Despite all this we managed to stay close to even with the broad market. Frankly, this surprised us.
When a market rallies this much it is natural for people to look for reasons. Punditry at large has converged upon India’s “structural reforms” as the primary reason. In our view that’s pure garbage.
For starters, here’s a list of reforms; the top five in our opinion.
Moreover, consider this ... a total of 42 out of the top 43 equity markets across the world were in the black in 2017 (sorry Pakistan!). Exactly HALF of those were up more than 30% for the year, in US dollar terms. Clearly, not every country in the world (OK, except Pakistan) could somehow be undergoing structural reforms in the same year.
So what’s causing this rally? Could be easy monetary policy, could be growth in corporate earnings, or could some worldwide joie de vivre. According to President Trump it’s all him. We don’t know and frankly, we don’t care much. Our plan remains the same; bottoms-up, fundamental stock picking.
Fortunately, we have a few things going for us. First, the absurdly high correlation between the markets does not exist within the markets. For every two high-flyer stocks there’s also a loser that has gone nowhere in several years. In other words, scratch the surface and it’s very much a stock-picker’s market.
In our 2015 letter we wrote:
We intend to stick to our plan and go wherever bargain hunting takes us. Lately, most of our energy is focused on companies in sectors undergoing turmoil. When analyzing such companies we ask ourselves three basic questions; 1) can the company make money even if the sector remains depressed? 2) if we buy the stock at current prices will we stand to make money in the long run, i.e., is the price right given the current depressed level of earnings and 3) is there a reasonable chance that conditions will get better soon? Three yesses usually mean outsized future returns.
This still works.
Secondly, while the markets everywhere celebrate new records, the volatility as implied by options dips to all-time lows. In other words, it costs next to nothing to insure against future bad outcomes. We plan to keep our insurance contracts alive and buy some new ones while they are still cheap. As usual, we are completely OK with these expiring worthless; that’s generally the intent with insurance. These contracts will help us invest more aggressively, especially when the inevitable market drawdowns do happen.
Lastly, while it’s true that current government’s zeal is causing considerable pain, it will almost certainly be a point of differentiation for India in the coming years. India is transitioning from being a mish-mash of small unorganized businesses to a collection of large corporates. This is bound to cause societal upheaval but is also bound to lead to higher system-wide efficiency. In sector after sector, year after year, small family owned businesses are ceding ground to larger players. This is as true for consumer products (jeans, paints, packaged food) as it is for B2B (trucking, tiles, PVC pipes). Notwithstanding the possible societal downside, the effect on well-run listed companies is obvious – they will do very well. The process will take time and picking winners at the right price will require patience. Buffett once quipped, “Lethargy, bordering on sloth remains the cornerstone of our investment style”. Ours too!
As usual, detailed write-ups and updates on our major positions follow this letter. Alert readers will notice that little has changed since last year. This is by design. We wish you a happy new year and thank you once again for investing with us. If you have questions regarding this letter or your portfolio, please do not hesitate to ask. Like always, you will receive your statements from NAV Consulting Inc.
Update on our significant positions
We closed the following positions in 2017:
1. Indian Metal and Ferro Alloys
2. CARE
3. Triveni Engineering
Our current significant positions are as follows: Bharti Infratel
(Reproduced from our Q3 2017 letter)
Indian telecom sector is going through some unprecedented times. In a previously eleven player market with rock bottom ARPUs, terrible service, and mostly 2G subscribers, Mukesh Ambani, India’s wealthiest man, rammed himself in by doling out (almost) free 4G connections. It took Ambani, six years and $25bn to get his venture, Reliance Jio, going but once he did there was no looking back. From a standing start less than a year ago, Jio has now gathered more than 100M subscribers. According to Ambani, this has never been done before, anywhere in the world. We believe him. He is committed and will spend more – anything to get a substantial piece of a billion-subscriber market.
Obviously, this has caused a bedlam of sorts. We looked closely at the entire telecom value chain and asked ourselves those same questions. Most businesses appear entirely hopeless to us. However, there are some that have a bright future yet remain grossly mispriced. One such business is Bharti Infratel.
Our simple analysis starts with the hypothesis that Indians will consume far more data in future than they do now. Aggregate data consumption, mostly thanks to Jio and its freebies, has gone up from 150m GB to 1.3bn GB within the last year. That’s about 9x+ increase in one year. There’s little reason it won’t increase another 10x over the next 5 years. Monthly cost of data in India at $1.25/GB is about the lowest in the world both on absolute and relative (to GDP per capita) basis. Yet only 27% of Indians have access to the internet.
Behaviorally, mobile data is an addiction that’s almost impossible to kick. The world uses more of it every passing day. There’s no public health outcry against the habit. Unlike other addictions, this one is encouraged by the governments. It’s available at ever lower prices. It’s rapidly eating away every attention minute we have available. This looks like a lasting trend to us. Many more Indians will consume ever larger amounts mobile data in the future.
In order to fill this need India will need better technology and more telecom infrastructure. There are as many competing versions of mobile tech/infra visions as the number of telecom analysts out there. We don’t know which “G” Indians will be using five years from now – currently about 70% are still on 2G, many of them skipping 3G altogether and moving to 4G! We don’t know how much spectrum will be required, what wavelengths will be used, or how the data will be backhauled from the towers to the data centers. But we do know that in every possible scenario we’ll either need lots of towers or more equipment on each existing tower.
The tower business at its core is a real estate plus legal business. You arrange land parcels, put up basic structure and uninterrupted power, let mobile operators install equipment, charge them rent, and write water-tight, escalating, long- term contracts. Historically, the Indian tower companies have begun operations as subsidiaries of mobile operators and later spun off into separate entities. As a consequence, tower assets are still partially or wholly owned by operators. (Bharti) Infratel is the largest such entity majority owned by Bharti Airtel, the #1 Indian mobile operator. Its towers are built on some of the most sought after real estate resulting in high tenancies-per-tower. The company generates almost a billion USD in EBITDA and $500M plus in free cash flow. It’s extremely conservatively financed with zero debt and some balance sheet cash. As a comparison, American tower companies typically operate with 5-7x Debt/EBITDA. It also has far better growth prospects then its global competitors. However, despite such operating characteristics, it sold off along with the rest of the sector after Jio’s entry. The stock was available close to 52 week lows and at about 40% discount to its global peers when we started buying it last quarter. The parent company, Bharti Airtel, is looking to sell its Infratel stake to pay off its own debts and fund future capex. The likely buyers (mostly private equity) are bound to lever the entity to appropriate levels hence increasing the returns on equity. Another interesting possibility may come about in a potential merger with Indus Towers, the other large tower operator in India. Infratel already owns 42% of Indus and eventual consolidation is looking increasingly likely. This will result in a massive combined market share, a wider moat, and far better leverage levels. None of this is currently priced into the stock.
Update: The complicated dog fight in the Indian telecom sector continues. We will wait for the drama to play out. We are flat on this position so far.
Godrej Properties Limited
(Reproduced from our Q1 2017 letter)
Much like Americans, Indians also love owning homes. Some of this love is simply cultural and some of it stems from the need to protect against persistent inflation that seeps into asset prices (“Property prices only go up”. Sounds familiar?). But a large part is borne out of the need to hoard undeclared income. Not surprisingly, landlords are happy keeping their “investment” properties empty or at best receiving a puny 2% rental yield. Also not surprisingly, most real estate transactions happen in cash. This pushes up home prices for both hoarders and real buyers who purchase a home for living in it. Moreover, the cities are bursting at the seams further exacerbating the housing situation. Builders have been all too quick to oblige by supplying a constant stream of new projects. The money collected upfront from these “launches” was often used to start other new projects. In a typical ponzi fashion, as long as people kept paying, the builders kept expanding.
In 2015 the party suddenly slowed down. This normal looking slump then turned into a debacle as credit tightened. Construction slowed down and the delivery time on these projects got stretched. Buyers complained and the government responded with a real estate bill fortifying consumer protections. This made matters worse for the builders. Next came the ban on large cash transactions, and Modi’s demonetization scheme, which suddenly sucked all cash out of the system. More bad news followed with a prominent builder getting jailed and another one getting barred from securities market. Builder stocks plummeted en-masse regardless of the quality or reputation of the company.
We bought Godrej Properties Limited (GPL) in this backdrop. In our opinion the new home market is now completely polarized where the strong will get stronger at the expense of the weak. Consumers are finally willing to pay appropriate premium for builders who have a long track record of quality and on time delivery. GPL has a 30 year history of doing just that. This builder is backed by the 120 year old Godrej group, one of the most well-known and highest regarded brands in India. GPL’s residential business is relatively asset light where it lends project management, sales, and brand expertise to large projects and charges a premium. In its commercial business it has developed and owns highly sought after office space in the heart of Mumbai’s business district. The company is currently monetizing these assets at significant premiums. A transaction in FY 2016 involved selling forty thousand sq. meters at a 30% premium to the market. Another one in the works will likely be done at similar terms. Funds received from these transactions are being poured into the residential business when other weaker players are getting decimated. The Godrej brand, being nationally recognized, travels really well so there is no dearth of opportunities. We expect great things from GPL and intend to hold it for a long time.
Update: In yet another terrible year for Indian real estate, Godrej Properties did spectacularly well. It is expanding aggressively and every project that the company undertakes is deservedly getting completely pre-booked. The stock was up 124% in 2017.
TD Power Systems Limited
(Reproduced from our Q1 2017 letter)
India being the third largest producer of power in the world (after the US and China) has a huge power sector, which is going through a multi-year slump. Retail consumers and farmers want power for free. Politicians are quick to oblige in order to get votes. State owned utilities bear the brunt amassing continuous losses and debts. Black outs (called load- shedding) still routinely happen in many states. Where power is available, around 30% of it is routinely stolen or lost in transit. The current government is working hard to fix this situation but it will take time.
Meanwhile, the industrial segment, requiring 24x7 access to large amounts of power relies on captive plants. In fact, India is unique amongst large power producers in its widespread use of small captive power plants. TD Power supplies the equipment and expertise for such captive plants.
In 2015-16 as Indian banks started struggling with their bad loans, credit tightened, and consumer demand waned, the manufacturing sector started postponing their plans to put up captive power plants. TD’s margins shrank to almost zero and its stock price shrank to half. In the wake of demonetization the stock further sold off and traded next to nothing when adjusted for cash and non-operating assets. For this zero debt, low working capital company the price made little sense. As the management started proactively shutting down loss making businesses, cutting fixed costs and setting up JVs to enter foreign markets we bought this stock, betting on an eventual turnaround. We paid close to 175 Rupees per share for a company that earned 60 Rupees per share in its heydays. When normalcy eventually returns for the banks and the manufacturers, we will see those days again. Meanwhile, our low purchase price affords us ample margin of safety.
Update: There’s still no sign of the normalcy in this sector. We are patiently waiting. The stock was up 12% in 2017.
PTC India Limited
(Reproduced from our Q3 2015 letter)
This position is a prime example of a good value in a terrible sector. The company is the largest power trading company in India. It has around 35-40% market share in power traded through bilateral contracts and power exchanges (IEX/PXIL). Like any trading operation, it collects a spread in the short term spot market, and earns annuity income through long term power purchase and sale agreements. The company was founded in 1999 by Power Grid Corporation of India, NTPC, NHPC and PFC - all government entities with clean managements. They together own 16% of PTC India. Apart from its regular business PTC owns investments in group /JV companies led by its two subsidiaries – PTC Financial Services, PFS (60% stake) and PTC Energy (100% subsidiary).
The current market cap of PFS is Rs24.5 bn and PTC India holds 60% stake in PFS, which results in Rs14.7 bn of value. We believe that PFS itself is fair to under-valued. PTC also has about Rs9 bn in cash and equivalents. Add everything and we get Rs23.7 bn in market value. It has substantial stakes in several power generation assets through JVs. There is no debt. The company currently trades at Rs18 bn. In other words, the core business of PTC is available for NEGATIVE Rs5.7bn. Perhaps even lower.
The company generated Rs2 bn in net income last year. It has not been in the red for the last 10 years. It should generate about Rs1 bn in free cash flow next year and likely higher thereafter. It’s a regular dividend paying company with 30% payout and 3.5% current yield.
So why is this business available for less than free?
The power situation is extremely grim in India and will require far more space to explain than we have in this letter. Currently, approximately one-fifth of the electricity produced in India is lost or stolen during distribution. Adjusted for per-capita income, India faces the biggest per-capita power deficit in the world. In other words, its power deficit is one of the biggest embarrassments for India. Modi and his power minister are laser focused on fixing this. Judging from their past record, there’s a fair chance of resolution to this problem. However, things move slowly in India and we cannot put too much faith in things getting better quickly. Apart from the sectorial issues, the company has had problems of its own in the past. It has recently faced competition from other independent players. It has also had problems collecting receivables from a few states.
We believe that the management as learnt from its past bad experience and is taking several steps in the right direction. It’s aggressively litigating and collecting from the problematic states. In fact, there’s an incoming Rs2 bn payment from the state of Tamil Nadu which is not factored in the current valuation. It’s also doing its business more selectively. Lastly, it’s getting into more annuity PPAs and PSAs where the receivable risk is lower and the competition is sparse. The company has consistently grown its units traded, revenues and profits since inception. Most importantly, the company’s reporting is conservative and its management is clean.
Update: PTC India was up 55% in 2017. We continue to remain optimistic about PTC India’s role in the expanding power trading base in India.
Piramal Enterprises
(Reproduced from our 2015 annual letter)
Over the last three years, post the sale of Piramal Healthcare (at a record 9x sales) to Abbott, Ajay Piramal has morphed this branded formulations company into a conglomerate dealing in financial services, real estate funds, contract manufacturing of drugs, information systems for clinical trials, and a few FMCG personal care brands. Obviously, the market dislikes this lack of focus and has penalized the stock accordingly. Moreover, a large part of cash received from the Abbott transaction has been deployed in an equity portfolio that yields little in the way of EPS. Finally, the nascent nature of its businesses makes the company unprofitable on paper. With this backdrop the stock has now sold off to levels where it’s trading at half its intrinsic value. The company is run by one of the most astute and shareholder friendly managers in India. The story of this man, Ajay Piramal, and his feats is an interesting one, but perhaps too long to be told in this space. In case of Piramal, our bet is as much on the man as it is on the business, at valuations that make the bet a no-brainer.
Update: The company keeps growing by entering into ancillary business. Recently they have become active in construction finance and mortgages. They are betting on an eventual consolidation and revival of the housing market in India. We agree. The stock was up 68%.
Hindustan Oil Exploration Company
(Reproduced from our Q1 2016 letter)
HOEC is an oil and (primarily) gas explorer with mostly non-performing assets. The promoter of this company is ENI S.p.A., the $120B Italian oil and gas major. ENI tried several times to offload its stake in this underperforming asset, finally selling a portion to a private investor a few weeks ago. ENI had also given a near-zero interest loan to HOEC, which it finally waived as the company was in no state to pay back. With no hope for a complete exit, ENI bought in new management and focused their energy on reviving two key gas fields, both of which are viable even at current depressed prices. This management team comes from Cairn India, country’s largest private oil producer. The turnaround is on track and if successful will result in reviving an asset base that’s at least three times it’s currently traded value. Finally, the company owns several currently non-producing assets that become viable at $50/bbl oil. This position is not without risk, but the commensurate reward, along with cheap optionality, make it a good fit for our portfolio.
Update: HOEC added to its existing asset base by acquiring dormant fields. It also was successful in re-starting key non-producing assets. The stock doubled in 2017.
Suzlon Energy Limited
(Reproduced from our Q2 2016 letter)
Suzlon is in the midst of a turnaround. At least we hope so. In general, our view of turnarounds is rather grim. Most end up languishing for very long and frustrate shareholders. Yet, if done right and extremely selectively, turnaround investing can work. We have done it a few times before with net positive results. This new position in Suzlon is currently small (sub 2%) but we intend to add to it as the story unfolds.
Suzlon is the largest wind-turbine producer in India, and one of the largest in the world. At its peak in 2008, Suzlon did more than 50% of all wind turbine installations in India, and was the fifth largest wind turbine manufacturer in the world.
Wind generation business in India before 2010 was mainly motivated by a tax policy, which allowed for corporate buyers to depreciate roughly 85% of the deployment costs in the first year. The government also gave some generation linked sops to encourage wind power. Businesses got to save on taxes and government got a quick ramp up in wind install base. Everyone was happy. These were great times for Suzlon and it expanded aggressively, locally and internationally. It acquired Hansen Transmissions and REPower (later rechristened Senvion), a German powerhouse in high wattage and offshore wind segments. As usual, large amount of debt, a lot of it USD denominated, was used to pay for these purchases and ever increasing working capital. Eventually, the party stopped.
The first crack came from the government pulling back the incentives due to cost parity between wind and conventional energy. A large part of Suzlon’s customer base vanished. The next to crack were the turbine blades, literally. Although a manageable issue, it led to awful press and loss of marketshare. Due to an onerous German law, Suzlon was not allowed to use REPower’s cash flows to pay down the debt, or use REPowers technology to address the faulty blade issue. To do so, it had to acquire 100% of the outstanding equity of REPower, and that required more money. Problems compounded as a lot of capacity built up in anticipation of continued growth became underutilized. In 2011, the company sold its stake in Hansen Transmissions. In 2012, it defaulted in its USD debt. In 2013, it undertook a debt restructuring with its Indian lenders. Between 2012 and 2014, the company tried to shore up liquidity by selling equity and tried to reduce the debt burden by restructuring the terms of its debt.
In 2014, once the Modi government took office, it reinstated the accelerated depreciation incentive and started re- emphasizing clean energy, largely solar and wind. In 2015, Suzlon got a fund infusion by Dilip Sanghvi, the founder of Sun Pharmaceuticals, the largest pharmaceuticals company in India. It was able to successful restructure its long-term USD and Rupee debt. It sold REPower/Senvion and used the proceeds to pay down debt. In 2015-16, it showed its first yearly profit in 5 years. In our opinion, things will get better for Suzlon.
Here’s why:
First, for Indian promoters, the most painful steps are to acknowledge the problem, reduce their span of influence by selling prized assets, use the proceeds to pay down debt, and move on. The difficulty and importance of these steps cannot be overemphasized. Suzlon is past this hurdle. Suzlon’s promoters seem sincere in their efforts and our checks suggest that they are basically honest. It is futile to hope for a turnaround unless at least this much it true (case in point: Kingfisher Airlines).
Second, we do not believe that the renewable bandwagon will stop anytime soon. Renewable use will grow for a long time and wind will remain a significant portion of renewable install base.
Third, Suzlon has enough spare capacity, meaning little capex for some time. It has about 3000 MW per year of wind turbine capacity, and it is presently making about 450 MW per year. It is growing around rapidly once again. In two years, it should do 1200 MW of turbine installations, which is about the size of its order book. The company is hoping to clear this up in 18 months. This can easily be a 1,000 Cr EBITDA operation with a market valuation that’s about 3x from here.
Finally, given the debt repayment schedule and the working capital needs we see little chance of further dilution. Suzlon is on a good track, but it still has a lot to prove. We will continue assessing Suzlon over the next 3-4 quarters and consequently increase our holding, or exit.
Update: Not much changed for Suzlon in 2017. The position remained flat.
Jain Irrigation
Agriculture accounts for about 14% of India’s GDP and employs more than half the workforce. In other words, it’s a huge sector. It’s also inefficient to the point of being comical, India being a top-ten country in terms of the total farm size and a bottom-ten country in terms of average farm size. Two hundred and fifty million farmers toil away on farms averaging less than 1.5 hectares each, perpetually struggling for resources, the biggest being water. Agriculture uses 86% of the fresh water in the country yet more than 60% of the farmland is dependent entirely on rains. Imagine rainfall determining the year over year health of one of the biggest economies in the world; this is literally true for India.
Jain Irrigation’ primary business, micro-irrigation, addresses this water issue. It’s India’s largest and world’s second largest micro-irrigation company. Apart from micro-irrigation it also engages in a few other ancillary agro-related activities such as food processing and tissue culture. It’s a 65 year old company run by a farmer-friendly, honest, and mostly socially motivated promoter. One of the problems that Jain has historically struggled with is the availability of financing for its micro-irrigation equipment. After unsuccessfully trying out a few different financing models it floated a financing subsidiary backed by International Financial Corporation and some agriculture focused PE funds in 2013- 14. This seemed to work but then for various reasons, primary one being shortfall in rains for two years, farm incomes suffered and Jain’s business accordingly slowed down. It also lost some money due to foreign exchange losses. We had followed Jain’s progress for quite a while and bought a small position in the midst of August 2015 market sell-off. Back then it was trading at about 8x its normalized earnings. As the firm made rapid strides building up its financial subsidiary and de-levering, we added to our position in late 2016. By then its food processing business was also doing well and the government, recognizing the water issue, started actively nudging the farmers to deploy the irrigation systems. Since our purchase the company has trebled its earnings on the back of small increases in revenue, increasing margins and a less expensive capital structure. The stock has accordingly risen, our position cumulatively up close to 100%. We believe that Jain solves a real and significant problem for the country, is well run, and has a long runway ahead.
Balkrishna Industries
Balkrishna Industries is a manufacturer and exporter of off-road tires; it makes tires for agricultural tractors, mining machinery, lawnmowers, etc. Its primary markets are Europe and the US and over the decades it has meticulously created an image for quality as is evident through market surveys. Yet its products are about 30% cheaper than off- road options supplied by others. Its cost advantage stems from using India as its low cost base. Although this sort of arbitrage is pretty common in knowledge industries such as IT and generic pharma, it is much rarer in manufacturing.
We started researching the company a couple of years ago. What caught our eye was how quickly the margins and returns were coming down from its long history of excellent performance. The reason was a half-billion Dollar expansion funded entirely with new debt. We looked into management’s past track record and their rationale. Its factories were running at near capacity and tire buyers were shifting en-masse to cheaper options. To cater to this demand, Balkrishna borrowed heavily to setup a manufacturing facility in Bhuj in India. The expansion would double its capacity, enable economies of scale and widen its moat. The plan made sense to us. Denominated in USD the debt was cheap and an effective natural hedge against its USD based revenue. Predictably, as the plant was being setup, the company bled money without earning much. Its margins looked exceptionally weak and ROE dropped to sub 10% levels. We bought the stock under these circumstances betting that eventually the management will deliver on their promise.
The Bhuj plant opened in late 2016 and achieved capacity production in late 2017. Demand for Balkrishna’s tires remains robust and as of Q3 2017, Balkrishna became debt free, again. Over the last 3 years, it has more than doubled its EBITDA. And after a few years of low return on equity, in Q3-2017 returned to its customary 30% return on equity mark. We have held the stock in varying sizes over the past 18 months for a cumulative 3x return.
Shreyas Shipping
The shipping industry is a textbook embodiment of of economic cyclicality. However, until recently, container shipping had largely escaped the wild gyrations so common amongst the dry-bulk, liquid, or break-bulk shipping. Over the years as global trade flourished, Asia became the world’s mega-factory, and standardization took hold, container shipping has gone from strength to strength. The financial crisis led to a brief kink in that uptrend but as trade started normalizing the shipping lines started ordering massive ships in the earnest. These ships took about 3-5 years each to build and were truly spectacular in size - super-carriers capable of carrying more than 18,000 twenty- foot equivalent (TEU) containers, a marked departure from the traditional sub-10,000 TEU carriers. “Shipping is an economies of scale business so why not order the biggest ships we can” the thinking went. As if right on the cue, just as these ships came on-board, China started slowing down and global trade became a bit less of a priority. The industry was (and still is) in tatters. Hanjin, the world’s fifth largest shipping line, filed for bankruptcy. Others, including the mighty Maersk Line, were bleeding losses.
Shreyas Shipping operates in this industry. Although puny compared to the global lines, Shreyas happens to be India’s largest container shipper. It transports containers along the Indian coastline and between India and Jebel Ali in the UAE. It also runs some last mile trucking services from the shipping end points. It’s a well-managed outfit with limited debt. The company tends to wait for distress to buy its ships and the recent turmoil gave it some great opportunities to do so. It recently almost doubled its capacity from 8,200 to 16,000 TEUs at super low prices. Our view is that globally the sector will eventually find its bearings, as a micro-market India will continue to do well, and all that added low-cost capacity will help Shreyas as things go back to normal. So far, the company has almost doubled its revenue since 2015 and our holding has cumulatively returned 140%. We plan to stay invested.
Since the beginning we have asked that you evaluate us on a 3-5 year time frame. You now have a total of six periods (three 3-year rolling, two 4-year rolling, and one 5-year period) to use for your evaluation. We have outperformed the India index in all such periods, our 5-year cumulative outperformance being 74%.
Back when we started, we expected the Indian market to do better than the US market. We were utterly wrong about that. US investors were much better off staying home. Fortunately our own outperformance over the S&P 500 somewhat made up for our lack of our prediction skills. No more predictions. India will do very well over the next decade. Invest in India!
The broad Indian market rallied hard in 2017 posting its second-best year in the last decade. As stated several times before, we fully expect to underperform during such years. Our nitpickiness and caution made new highs in 2017. We kept significant amounts of cash. We even bought Index puts. Despite all this we managed to stay close to even with the broad market. Frankly, this surprised us.
When a market rallies this much it is natural for people to look for reasons. Punditry at large has converged upon India’s “structural reforms” as the primary reason. In our view that’s pure garbage.
For starters, here’s a list of reforms; the top five in our opinion.
- A new tax code, which has everyone confused for now but promises to be wonderful in the long-run since the tax rates will go down and the base will widen.
- A note swap that made every Indian’s life miserable but promises to root out corruption in the long run.
- A real estate bill, which has led to the worst construction slowdown in nine years but promises to make the
industry far more customer friendly in the long run. - A central bank diktat to force defaults on some large borrowers, an action which has decimated bank earnings
but promises to be great for the long term health of the sector. - A bailout for India’s government owned banks, funded by the banks’ liquidity, in exchange for newfangled
bonds. Apparently, it might lead to some fiscal pressure in the near term but ... you guessed it...it’ll lead higher economic growth over the long-run.
Moreover, consider this ... a total of 42 out of the top 43 equity markets across the world were in the black in 2017 (sorry Pakistan!). Exactly HALF of those were up more than 30% for the year, in US dollar terms. Clearly, not every country in the world (OK, except Pakistan) could somehow be undergoing structural reforms in the same year.
So what’s causing this rally? Could be easy monetary policy, could be growth in corporate earnings, or could some worldwide joie de vivre. According to President Trump it’s all him. We don’t know and frankly, we don’t care much. Our plan remains the same; bottoms-up, fundamental stock picking.
Fortunately, we have a few things going for us. First, the absurdly high correlation between the markets does not exist within the markets. For every two high-flyer stocks there’s also a loser that has gone nowhere in several years. In other words, scratch the surface and it’s very much a stock-picker’s market.
In our 2015 letter we wrote:
We intend to stick to our plan and go wherever bargain hunting takes us. Lately, most of our energy is focused on companies in sectors undergoing turmoil. When analyzing such companies we ask ourselves three basic questions; 1) can the company make money even if the sector remains depressed? 2) if we buy the stock at current prices will we stand to make money in the long run, i.e., is the price right given the current depressed level of earnings and 3) is there a reasonable chance that conditions will get better soon? Three yesses usually mean outsized future returns.
This still works.
Secondly, while the markets everywhere celebrate new records, the volatility as implied by options dips to all-time lows. In other words, it costs next to nothing to insure against future bad outcomes. We plan to keep our insurance contracts alive and buy some new ones while they are still cheap. As usual, we are completely OK with these expiring worthless; that’s generally the intent with insurance. These contracts will help us invest more aggressively, especially when the inevitable market drawdowns do happen.
Lastly, while it’s true that current government’s zeal is causing considerable pain, it will almost certainly be a point of differentiation for India in the coming years. India is transitioning from being a mish-mash of small unorganized businesses to a collection of large corporates. This is bound to cause societal upheaval but is also bound to lead to higher system-wide efficiency. In sector after sector, year after year, small family owned businesses are ceding ground to larger players. This is as true for consumer products (jeans, paints, packaged food) as it is for B2B (trucking, tiles, PVC pipes). Notwithstanding the possible societal downside, the effect on well-run listed companies is obvious – they will do very well. The process will take time and picking winners at the right price will require patience. Buffett once quipped, “Lethargy, bordering on sloth remains the cornerstone of our investment style”. Ours too!
As usual, detailed write-ups and updates on our major positions follow this letter. Alert readers will notice that little has changed since last year. This is by design. We wish you a happy new year and thank you once again for investing with us. If you have questions regarding this letter or your portfolio, please do not hesitate to ask. Like always, you will receive your statements from NAV Consulting Inc.
Update on our significant positions
We closed the following positions in 2017:
1. Indian Metal and Ferro Alloys
2. CARE
3. Triveni Engineering
Our current significant positions are as follows: Bharti Infratel
(Reproduced from our Q3 2017 letter)
Indian telecom sector is going through some unprecedented times. In a previously eleven player market with rock bottom ARPUs, terrible service, and mostly 2G subscribers, Mukesh Ambani, India’s wealthiest man, rammed himself in by doling out (almost) free 4G connections. It took Ambani, six years and $25bn to get his venture, Reliance Jio, going but once he did there was no looking back. From a standing start less than a year ago, Jio has now gathered more than 100M subscribers. According to Ambani, this has never been done before, anywhere in the world. We believe him. He is committed and will spend more – anything to get a substantial piece of a billion-subscriber market.
Obviously, this has caused a bedlam of sorts. We looked closely at the entire telecom value chain and asked ourselves those same questions. Most businesses appear entirely hopeless to us. However, there are some that have a bright future yet remain grossly mispriced. One such business is Bharti Infratel.
Our simple analysis starts with the hypothesis that Indians will consume far more data in future than they do now. Aggregate data consumption, mostly thanks to Jio and its freebies, has gone up from 150m GB to 1.3bn GB within the last year. That’s about 9x+ increase in one year. There’s little reason it won’t increase another 10x over the next 5 years. Monthly cost of data in India at $1.25/GB is about the lowest in the world both on absolute and relative (to GDP per capita) basis. Yet only 27% of Indians have access to the internet.
Behaviorally, mobile data is an addiction that’s almost impossible to kick. The world uses more of it every passing day. There’s no public health outcry against the habit. Unlike other addictions, this one is encouraged by the governments. It’s available at ever lower prices. It’s rapidly eating away every attention minute we have available. This looks like a lasting trend to us. Many more Indians will consume ever larger amounts mobile data in the future.
In order to fill this need India will need better technology and more telecom infrastructure. There are as many competing versions of mobile tech/infra visions as the number of telecom analysts out there. We don’t know which “G” Indians will be using five years from now – currently about 70% are still on 2G, many of them skipping 3G altogether and moving to 4G! We don’t know how much spectrum will be required, what wavelengths will be used, or how the data will be backhauled from the towers to the data centers. But we do know that in every possible scenario we’ll either need lots of towers or more equipment on each existing tower.
The tower business at its core is a real estate plus legal business. You arrange land parcels, put up basic structure and uninterrupted power, let mobile operators install equipment, charge them rent, and write water-tight, escalating, long- term contracts. Historically, the Indian tower companies have begun operations as subsidiaries of mobile operators and later spun off into separate entities. As a consequence, tower assets are still partially or wholly owned by operators. (Bharti) Infratel is the largest such entity majority owned by Bharti Airtel, the #1 Indian mobile operator. Its towers are built on some of the most sought after real estate resulting in high tenancies-per-tower. The company generates almost a billion USD in EBITDA and $500M plus in free cash flow. It’s extremely conservatively financed with zero debt and some balance sheet cash. As a comparison, American tower companies typically operate with 5-7x Debt/EBITDA. It also has far better growth prospects then its global competitors. However, despite such operating characteristics, it sold off along with the rest of the sector after Jio’s entry. The stock was available close to 52 week lows and at about 40% discount to its global peers when we started buying it last quarter. The parent company, Bharti Airtel, is looking to sell its Infratel stake to pay off its own debts and fund future capex. The likely buyers (mostly private equity) are bound to lever the entity to appropriate levels hence increasing the returns on equity. Another interesting possibility may come about in a potential merger with Indus Towers, the other large tower operator in India. Infratel already owns 42% of Indus and eventual consolidation is looking increasingly likely. This will result in a massive combined market share, a wider moat, and far better leverage levels. None of this is currently priced into the stock.
Update: The complicated dog fight in the Indian telecom sector continues. We will wait for the drama to play out. We are flat on this position so far.
Godrej Properties Limited
(Reproduced from our Q1 2017 letter)
Much like Americans, Indians also love owning homes. Some of this love is simply cultural and some of it stems from the need to protect against persistent inflation that seeps into asset prices (“Property prices only go up”. Sounds familiar?). But a large part is borne out of the need to hoard undeclared income. Not surprisingly, landlords are happy keeping their “investment” properties empty or at best receiving a puny 2% rental yield. Also not surprisingly, most real estate transactions happen in cash. This pushes up home prices for both hoarders and real buyers who purchase a home for living in it. Moreover, the cities are bursting at the seams further exacerbating the housing situation. Builders have been all too quick to oblige by supplying a constant stream of new projects. The money collected upfront from these “launches” was often used to start other new projects. In a typical ponzi fashion, as long as people kept paying, the builders kept expanding.
In 2015 the party suddenly slowed down. This normal looking slump then turned into a debacle as credit tightened. Construction slowed down and the delivery time on these projects got stretched. Buyers complained and the government responded with a real estate bill fortifying consumer protections. This made matters worse for the builders. Next came the ban on large cash transactions, and Modi’s demonetization scheme, which suddenly sucked all cash out of the system. More bad news followed with a prominent builder getting jailed and another one getting barred from securities market. Builder stocks plummeted en-masse regardless of the quality or reputation of the company.
We bought Godrej Properties Limited (GPL) in this backdrop. In our opinion the new home market is now completely polarized where the strong will get stronger at the expense of the weak. Consumers are finally willing to pay appropriate premium for builders who have a long track record of quality and on time delivery. GPL has a 30 year history of doing just that. This builder is backed by the 120 year old Godrej group, one of the most well-known and highest regarded brands in India. GPL’s residential business is relatively asset light where it lends project management, sales, and brand expertise to large projects and charges a premium. In its commercial business it has developed and owns highly sought after office space in the heart of Mumbai’s business district. The company is currently monetizing these assets at significant premiums. A transaction in FY 2016 involved selling forty thousand sq. meters at a 30% premium to the market. Another one in the works will likely be done at similar terms. Funds received from these transactions are being poured into the residential business when other weaker players are getting decimated. The Godrej brand, being nationally recognized, travels really well so there is no dearth of opportunities. We expect great things from GPL and intend to hold it for a long time.
Update: In yet another terrible year for Indian real estate, Godrej Properties did spectacularly well. It is expanding aggressively and every project that the company undertakes is deservedly getting completely pre-booked. The stock was up 124% in 2017.
TD Power Systems Limited
(Reproduced from our Q1 2017 letter)
India being the third largest producer of power in the world (after the US and China) has a huge power sector, which is going through a multi-year slump. Retail consumers and farmers want power for free. Politicians are quick to oblige in order to get votes. State owned utilities bear the brunt amassing continuous losses and debts. Black outs (called load- shedding) still routinely happen in many states. Where power is available, around 30% of it is routinely stolen or lost in transit. The current government is working hard to fix this situation but it will take time.
Meanwhile, the industrial segment, requiring 24x7 access to large amounts of power relies on captive plants. In fact, India is unique amongst large power producers in its widespread use of small captive power plants. TD Power supplies the equipment and expertise for such captive plants.
In 2015-16 as Indian banks started struggling with their bad loans, credit tightened, and consumer demand waned, the manufacturing sector started postponing their plans to put up captive power plants. TD’s margins shrank to almost zero and its stock price shrank to half. In the wake of demonetization the stock further sold off and traded next to nothing when adjusted for cash and non-operating assets. For this zero debt, low working capital company the price made little sense. As the management started proactively shutting down loss making businesses, cutting fixed costs and setting up JVs to enter foreign markets we bought this stock, betting on an eventual turnaround. We paid close to 175 Rupees per share for a company that earned 60 Rupees per share in its heydays. When normalcy eventually returns for the banks and the manufacturers, we will see those days again. Meanwhile, our low purchase price affords us ample margin of safety.
Update: There’s still no sign of the normalcy in this sector. We are patiently waiting. The stock was up 12% in 2017.
PTC India Limited
(Reproduced from our Q3 2015 letter)
This position is a prime example of a good value in a terrible sector. The company is the largest power trading company in India. It has around 35-40% market share in power traded through bilateral contracts and power exchanges (IEX/PXIL). Like any trading operation, it collects a spread in the short term spot market, and earns annuity income through long term power purchase and sale agreements. The company was founded in 1999 by Power Grid Corporation of India, NTPC, NHPC and PFC - all government entities with clean managements. They together own 16% of PTC India. Apart from its regular business PTC owns investments in group /JV companies led by its two subsidiaries – PTC Financial Services, PFS (60% stake) and PTC Energy (100% subsidiary).
The current market cap of PFS is Rs24.5 bn and PTC India holds 60% stake in PFS, which results in Rs14.7 bn of value. We believe that PFS itself is fair to under-valued. PTC also has about Rs9 bn in cash and equivalents. Add everything and we get Rs23.7 bn in market value. It has substantial stakes in several power generation assets through JVs. There is no debt. The company currently trades at Rs18 bn. In other words, the core business of PTC is available for NEGATIVE Rs5.7bn. Perhaps even lower.
The company generated Rs2 bn in net income last year. It has not been in the red for the last 10 years. It should generate about Rs1 bn in free cash flow next year and likely higher thereafter. It’s a regular dividend paying company with 30% payout and 3.5% current yield.
So why is this business available for less than free?
The power situation is extremely grim in India and will require far more space to explain than we have in this letter. Currently, approximately one-fifth of the electricity produced in India is lost or stolen during distribution. Adjusted for per-capita income, India faces the biggest per-capita power deficit in the world. In other words, its power deficit is one of the biggest embarrassments for India. Modi and his power minister are laser focused on fixing this. Judging from their past record, there’s a fair chance of resolution to this problem. However, things move slowly in India and we cannot put too much faith in things getting better quickly. Apart from the sectorial issues, the company has had problems of its own in the past. It has recently faced competition from other independent players. It has also had problems collecting receivables from a few states.
We believe that the management as learnt from its past bad experience and is taking several steps in the right direction. It’s aggressively litigating and collecting from the problematic states. In fact, there’s an incoming Rs2 bn payment from the state of Tamil Nadu which is not factored in the current valuation. It’s also doing its business more selectively. Lastly, it’s getting into more annuity PPAs and PSAs where the receivable risk is lower and the competition is sparse. The company has consistently grown its units traded, revenues and profits since inception. Most importantly, the company’s reporting is conservative and its management is clean.
Update: PTC India was up 55% in 2017. We continue to remain optimistic about PTC India’s role in the expanding power trading base in India.
Piramal Enterprises
(Reproduced from our 2015 annual letter)
Over the last three years, post the sale of Piramal Healthcare (at a record 9x sales) to Abbott, Ajay Piramal has morphed this branded formulations company into a conglomerate dealing in financial services, real estate funds, contract manufacturing of drugs, information systems for clinical trials, and a few FMCG personal care brands. Obviously, the market dislikes this lack of focus and has penalized the stock accordingly. Moreover, a large part of cash received from the Abbott transaction has been deployed in an equity portfolio that yields little in the way of EPS. Finally, the nascent nature of its businesses makes the company unprofitable on paper. With this backdrop the stock has now sold off to levels where it’s trading at half its intrinsic value. The company is run by one of the most astute and shareholder friendly managers in India. The story of this man, Ajay Piramal, and his feats is an interesting one, but perhaps too long to be told in this space. In case of Piramal, our bet is as much on the man as it is on the business, at valuations that make the bet a no-brainer.
Update: The company keeps growing by entering into ancillary business. Recently they have become active in construction finance and mortgages. They are betting on an eventual consolidation and revival of the housing market in India. We agree. The stock was up 68%.
Hindustan Oil Exploration Company
(Reproduced from our Q1 2016 letter)
HOEC is an oil and (primarily) gas explorer with mostly non-performing assets. The promoter of this company is ENI S.p.A., the $120B Italian oil and gas major. ENI tried several times to offload its stake in this underperforming asset, finally selling a portion to a private investor a few weeks ago. ENI had also given a near-zero interest loan to HOEC, which it finally waived as the company was in no state to pay back. With no hope for a complete exit, ENI bought in new management and focused their energy on reviving two key gas fields, both of which are viable even at current depressed prices. This management team comes from Cairn India, country’s largest private oil producer. The turnaround is on track and if successful will result in reviving an asset base that’s at least three times it’s currently traded value. Finally, the company owns several currently non-producing assets that become viable at $50/bbl oil. This position is not without risk, but the commensurate reward, along with cheap optionality, make it a good fit for our portfolio.
Update: HOEC added to its existing asset base by acquiring dormant fields. It also was successful in re-starting key non-producing assets. The stock doubled in 2017.
Suzlon Energy Limited
(Reproduced from our Q2 2016 letter)
Suzlon is in the midst of a turnaround. At least we hope so. In general, our view of turnarounds is rather grim. Most end up languishing for very long and frustrate shareholders. Yet, if done right and extremely selectively, turnaround investing can work. We have done it a few times before with net positive results. This new position in Suzlon is currently small (sub 2%) but we intend to add to it as the story unfolds.
Suzlon is the largest wind-turbine producer in India, and one of the largest in the world. At its peak in 2008, Suzlon did more than 50% of all wind turbine installations in India, and was the fifth largest wind turbine manufacturer in the world.
Wind generation business in India before 2010 was mainly motivated by a tax policy, which allowed for corporate buyers to depreciate roughly 85% of the deployment costs in the first year. The government also gave some generation linked sops to encourage wind power. Businesses got to save on taxes and government got a quick ramp up in wind install base. Everyone was happy. These were great times for Suzlon and it expanded aggressively, locally and internationally. It acquired Hansen Transmissions and REPower (later rechristened Senvion), a German powerhouse in high wattage and offshore wind segments. As usual, large amount of debt, a lot of it USD denominated, was used to pay for these purchases and ever increasing working capital. Eventually, the party stopped.
The first crack came from the government pulling back the incentives due to cost parity between wind and conventional energy. A large part of Suzlon’s customer base vanished. The next to crack were the turbine blades, literally. Although a manageable issue, it led to awful press and loss of marketshare. Due to an onerous German law, Suzlon was not allowed to use REPower’s cash flows to pay down the debt, or use REPowers technology to address the faulty blade issue. To do so, it had to acquire 100% of the outstanding equity of REPower, and that required more money. Problems compounded as a lot of capacity built up in anticipation of continued growth became underutilized. In 2011, the company sold its stake in Hansen Transmissions. In 2012, it defaulted in its USD debt. In 2013, it undertook a debt restructuring with its Indian lenders. Between 2012 and 2014, the company tried to shore up liquidity by selling equity and tried to reduce the debt burden by restructuring the terms of its debt.
In 2014, once the Modi government took office, it reinstated the accelerated depreciation incentive and started re- emphasizing clean energy, largely solar and wind. In 2015, Suzlon got a fund infusion by Dilip Sanghvi, the founder of Sun Pharmaceuticals, the largest pharmaceuticals company in India. It was able to successful restructure its long-term USD and Rupee debt. It sold REPower/Senvion and used the proceeds to pay down debt. In 2015-16, it showed its first yearly profit in 5 years. In our opinion, things will get better for Suzlon.
Here’s why:
First, for Indian promoters, the most painful steps are to acknowledge the problem, reduce their span of influence by selling prized assets, use the proceeds to pay down debt, and move on. The difficulty and importance of these steps cannot be overemphasized. Suzlon is past this hurdle. Suzlon’s promoters seem sincere in their efforts and our checks suggest that they are basically honest. It is futile to hope for a turnaround unless at least this much it true (case in point: Kingfisher Airlines).
Second, we do not believe that the renewable bandwagon will stop anytime soon. Renewable use will grow for a long time and wind will remain a significant portion of renewable install base.
Third, Suzlon has enough spare capacity, meaning little capex for some time. It has about 3000 MW per year of wind turbine capacity, and it is presently making about 450 MW per year. It is growing around rapidly once again. In two years, it should do 1200 MW of turbine installations, which is about the size of its order book. The company is hoping to clear this up in 18 months. This can easily be a 1,000 Cr EBITDA operation with a market valuation that’s about 3x from here.
Finally, given the debt repayment schedule and the working capital needs we see little chance of further dilution. Suzlon is on a good track, but it still has a lot to prove. We will continue assessing Suzlon over the next 3-4 quarters and consequently increase our holding, or exit.
Update: Not much changed for Suzlon in 2017. The position remained flat.
Jain Irrigation
Agriculture accounts for about 14% of India’s GDP and employs more than half the workforce. In other words, it’s a huge sector. It’s also inefficient to the point of being comical, India being a top-ten country in terms of the total farm size and a bottom-ten country in terms of average farm size. Two hundred and fifty million farmers toil away on farms averaging less than 1.5 hectares each, perpetually struggling for resources, the biggest being water. Agriculture uses 86% of the fresh water in the country yet more than 60% of the farmland is dependent entirely on rains. Imagine rainfall determining the year over year health of one of the biggest economies in the world; this is literally true for India.
Jain Irrigation’ primary business, micro-irrigation, addresses this water issue. It’s India’s largest and world’s second largest micro-irrigation company. Apart from micro-irrigation it also engages in a few other ancillary agro-related activities such as food processing and tissue culture. It’s a 65 year old company run by a farmer-friendly, honest, and mostly socially motivated promoter. One of the problems that Jain has historically struggled with is the availability of financing for its micro-irrigation equipment. After unsuccessfully trying out a few different financing models it floated a financing subsidiary backed by International Financial Corporation and some agriculture focused PE funds in 2013- 14. This seemed to work but then for various reasons, primary one being shortfall in rains for two years, farm incomes suffered and Jain’s business accordingly slowed down. It also lost some money due to foreign exchange losses. We had followed Jain’s progress for quite a while and bought a small position in the midst of August 2015 market sell-off. Back then it was trading at about 8x its normalized earnings. As the firm made rapid strides building up its financial subsidiary and de-levering, we added to our position in late 2016. By then its food processing business was also doing well and the government, recognizing the water issue, started actively nudging the farmers to deploy the irrigation systems. Since our purchase the company has trebled its earnings on the back of small increases in revenue, increasing margins and a less expensive capital structure. The stock has accordingly risen, our position cumulatively up close to 100%. We believe that Jain solves a real and significant problem for the country, is well run, and has a long runway ahead.
Balkrishna Industries
Balkrishna Industries is a manufacturer and exporter of off-road tires; it makes tires for agricultural tractors, mining machinery, lawnmowers, etc. Its primary markets are Europe and the US and over the decades it has meticulously created an image for quality as is evident through market surveys. Yet its products are about 30% cheaper than off- road options supplied by others. Its cost advantage stems from using India as its low cost base. Although this sort of arbitrage is pretty common in knowledge industries such as IT and generic pharma, it is much rarer in manufacturing.
We started researching the company a couple of years ago. What caught our eye was how quickly the margins and returns were coming down from its long history of excellent performance. The reason was a half-billion Dollar expansion funded entirely with new debt. We looked into management’s past track record and their rationale. Its factories were running at near capacity and tire buyers were shifting en-masse to cheaper options. To cater to this demand, Balkrishna borrowed heavily to setup a manufacturing facility in Bhuj in India. The expansion would double its capacity, enable economies of scale and widen its moat. The plan made sense to us. Denominated in USD the debt was cheap and an effective natural hedge against its USD based revenue. Predictably, as the plant was being setup, the company bled money without earning much. Its margins looked exceptionally weak and ROE dropped to sub 10% levels. We bought the stock under these circumstances betting that eventually the management will deliver on their promise.
The Bhuj plant opened in late 2016 and achieved capacity production in late 2017. Demand for Balkrishna’s tires remains robust and as of Q3 2017, Balkrishna became debt free, again. Over the last 3 years, it has more than doubled its EBITDA. And after a few years of low return on equity, in Q3-2017 returned to its customary 30% return on equity mark. We have held the stock in varying sizes over the past 18 months for a cumulative 3x return.
Shreyas Shipping
The shipping industry is a textbook embodiment of of economic cyclicality. However, until recently, container shipping had largely escaped the wild gyrations so common amongst the dry-bulk, liquid, or break-bulk shipping. Over the years as global trade flourished, Asia became the world’s mega-factory, and standardization took hold, container shipping has gone from strength to strength. The financial crisis led to a brief kink in that uptrend but as trade started normalizing the shipping lines started ordering massive ships in the earnest. These ships took about 3-5 years each to build and were truly spectacular in size - super-carriers capable of carrying more than 18,000 twenty- foot equivalent (TEU) containers, a marked departure from the traditional sub-10,000 TEU carriers. “Shipping is an economies of scale business so why not order the biggest ships we can” the thinking went. As if right on the cue, just as these ships came on-board, China started slowing down and global trade became a bit less of a priority. The industry was (and still is) in tatters. Hanjin, the world’s fifth largest shipping line, filed for bankruptcy. Others, including the mighty Maersk Line, were bleeding losses.
Shreyas Shipping operates in this industry. Although puny compared to the global lines, Shreyas happens to be India’s largest container shipper. It transports containers along the Indian coastline and between India and Jebel Ali in the UAE. It also runs some last mile trucking services from the shipping end points. It’s a well-managed outfit with limited debt. The company tends to wait for distress to buy its ships and the recent turmoil gave it some great opportunities to do so. It recently almost doubled its capacity from 8,200 to 16,000 TEUs at super low prices. Our view is that globally the sector will eventually find its bearings, as a micro-market India will continue to do well, and all that added low-cost capacity will help Shreyas as things go back to normal. So far, the company has almost doubled its revenue since 2015 and our holding has cumulatively returned 140%. We plan to stay invested.
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