Many moons ago, Fundoo Professor wrote- I dont want to be a toll bridge, I want to be its meaning– and if there was ever a business which embodied the idea of an emerging moat then it should be this business.
This post is the culmination of tireless research put forward by Rohit Krishnan towards uncovering the potential behind the company. In the same vein, this post is also an attempt to ensure intellectual honesty on our end, encourage free and frank discussion on the company and to improve the efficiency of our Indian markets by disseminating information.
An Enquiry into National Fittings – Coupling with Free Growth.
Disclosure: The authors are long.
JB Chemicals [JBCPL] is a ₹11.76bn Indian pharmaceutical company with well known brand names like Metrogyl, Rantac, Nicardia in its portfolio. In 2011, JBCPL sold the Russian OTC business to Cilag GmBH, a Johnson and Johnson company, for a sum of ₹960cr.
This is the first part of a three part series on investing in banks. This is not a tip blog post, this is a discussion of different salient features which drive banking business. The method of analysis will be part inspiration and part plagiarism. In 1992 Bruce Berkowitz gave an interview to Outstanding Investors Digest (OID) regarding Wells Fargo. These are some of the ideas presented by him and an exposition by me.
Wells Fargo is an American banking company with head quarter in South California. Its the second largest bank in US in terms of assets and the largest in terms of market capitalisation. It extensively takes home financing. In February 2014 it was ranked as the most valuable bank in the world for the second time in a row. Wells Fargo is owned by Berkshire Hathaway. At different points of time it was owned by some of the most stellar value investors of present era.Munger went to the extent of calling Wells Fargo his investment filter. He implies that he constantly asks himself if he should put his money on a new investment when Wells Fargo is as a good and as cheap as it is.
But how do they think about a business as difficult as banking.
“Its a simple case of a bank with tremendous earning power”
Bruce very early in his interview makes it clear what is the Big Rock in his thought process. He underlines that Wells Fargo is a bank with a tremendous earning power. Wait a second! What does it even mean?
How do we identify the earning prowess of a bank?
Or rather what are the driving gears of a bank?
At the very core of its operations a bank is at the end of the day a commodity business. The commodity is not some agricultural produce but it is an economic produce- MONEY!
People go to banks to deposit their money and avail loan services. So when banks take deposits they incur expenses . Similarly when they disburse loans the interest income is their revenue.
No significant differentiator with respect to any other competitor. Of course a bank can raise the interest offered on deposits to attract more customers but it will be akin to making higher payments to your supplier. So higher interests offered to deposits imply lesser profits.
Compare this with a coal miner- another commodity business:
1. He has no pricing power- that is his price is dependent on the lowest price offered in the market.
2. The fruits of innovation is never going to create a unique production process for his own firm.
3. As a result, margins are going to be just enough for producers to survive.
So a bank can attract loan availing customers by lowering interest rate. However this is not going to make him any profits. It will be a value destructive growth.
However there are times when a bank can move away from a commodity business to a franchise model.
A related question here is- can we think about banking business in a different way?
And the answer is – Yes, we can think about banking business differently
So many people are dependent…
A Bank can also be thought of as a platform!. This is an incredible insight. Think of it, two persons walk in to a bank to avail loans. One of them is already a client in the bank having his own deposit. The other doesnt. Guess which one of them will walk out of the bank first with a loan in his hand?
Banks started loaning out to people they know to control their risks, but it has now spawned into a lock-in system. If you do business with this bank, your working capital loans of your business is given by this bank then you can’t shift away your deposit savings account to another competitor providing competitive rates!
And vice versa. If you do have a deposit account then selling the loan services to you is going to be easier from your as well as bank’s perspective. This is a way of thinking. In developed and matured economies the difference in convenience is not going to be huge, however my common sense says it should be present.
Now lets try to think a bit more through it- what if a bank has a branch at every corner of the road? The stupendous distribution system itself is going to lock away other competitors from even trying to enter this business. And that is one excellent reason why community banks thrive in US. And that is the reason why local moneylenders thrive in India.
So a bank with the biggest number of branches is going to win. However, branches imply growth and the margins of this business is low (why? because at its core its a commodity business). Hence it is imperative that the efficiency of the bank is as high as possible.
Thus for a bank to reinvent itself as a franchise- it has to have an excellent cost structure, low cost of funds, excellent footprint and the efficiency gains which come from scalability.
In as many words, when OID asks Bruce “Isnt that a contradiction in terms- a bank with a franchise?” He replies-” If I give you a billion bucks and let you pick your management team, how could you rationally hurt Wells?”
Indeed how could you rationally hurt Wells Fargo when it has a 9000 branches spread all over US?
Its scale leads it to earn a ROE of 20% and a NIM of 5.5% (at that time) and a 3.5% (today).
Additionally, Bruce points out that the banking structure at the upper reaches of the pyramid (that is where WF resides) is completely oligopolistic. WF forms the one of the banks in the quartet- Bank of America, Citigroup and JP Morgan Chase being the other three.
In the next post we will discuss on how Bruce talks about management quality, Warren Buffett’s views and some other accounting techniques and ideas
In the fall of 2011, somewhere in South Mumbai, a single line flashed on the computer.
“What do you think of DISHTV? Good buy?”
DISHTV, had already by then fallen quite a bit. From the highs of 140-150 it was trading at Rs 77-80. Once a darling, it was now hungrily eyed by investors and punters alike. Investors still believed in its “market opportunity” story and punters liked it for its volatility. On top of it, it was present on futures and options market as well. Optimists argued with an ever rising middle class and government’s push for digitization, DISHTV will have significant tailwinds. Coupled with the fact that DISHTV had access to easy programming content from Zee TV(its parent company), investors were merely biding for time.
In the mid week of August of 2011, I completed my thesis of DISHTV. The thesis
can be found here(some bug in dropbox preventing me from sharing a working link here). It didnt take a rocket scientist to conclude that not only the company was significantly overvalued even at those levels but also followed an inherently unsustainable business model. It could have been easily killed, if things went like this since they lost money on every connection.
Since then, the market consolidated, the pricing has increased, their revenues improved and yet their inherent profitability levels were lower than ever before.
“In retailing, to coast is to fail.”
V-Mart is trying out to win a game, where few have won before and those who have are always looking behind their shoulders. Retailing is a business meant for masochists. To win here, you just have to find a fanatic management.
A thesis on V-Mart (written by me) can be found here
I would request you to kindly acknowledge the source if you forward it to anyone else.
Last year in 2012, I invested about 10% of my personal portfolio in Atul Auto. This decision was backed by certain ideas which are outlined in the following investment theses. Additionally, an addendum is also given outlining the valuation and capital considerations.
I would be obliged if you acknowledge the source.