Stock Chart Pattern - 3i Infotech Ltd (An Update)

The following concluding comments were made in the previous technical update to the stock chart pattern of 3i Infotech: "Top line is sliding and bottom line is red. Over-leveraging in a bid to grow fast has ruined the balance sheet. Stay away. If you are stuck from higher levels, use any rally to exit."

That update had been posted more than 5 years back. The only thing of note the stock did since then was rise from a low of 6 (touched on May 7 '14) to a high of 13.60 (on Jun 13 '14) - a quick gain of 125% in 5 weeks that gave stuck investors an opportunity to exit.

In less than 2 months, the stock slid down below 10 and dropped all the way to a lifetime low of 2.20 on May 25 '15. Investors got a roller-coaster ride, as the stock rose to 6.80 on Jun 25 '15, and then dropped to 2.70 on Aug 20 '15.

The stock price closed in the range between 2.70 and 6.80 during the next 28 months before suddenly breaking out in Dec '17. What was the trigger? There were two. First, CRISIL upgraded the company's credit rating from 'D' to 'BB' (stable).

Then came news of the company pre-paying three instalments of its debt (worth Rs 195 Million) which were due in Oct '18, Nov '18 and Dec '18. How did a loss-making company pre-pay its debt? 

The reason may be found in the cash flow statement. 3i Infotech has generated positive cash flows from operations in 4 of the past 5 years. Bulls must have felt encouraged by the positive news. 

The stock has shot up to test its previous closing high of 9.10 touched three years back. Daily technical indicators are inside their overbought zones. The stock can consolidate or correct a bit before trying to move higher.

Q3 (Dec '17) results will be announced on Jan 30 '18. Consider entry if there are definite signs of a turnaround in business. (Turnaround stories can generate good profits. Note that the equity capital is bloated, so don't expect a rise from 10 to 100 in 6 months.)

Stock Chart Pattern - 3i Infotech Ltd (An Update)

The following comment was made in the previous technical update to the stock chart pattern of 3i Infotech: “There is every possibility of the stock price falling below 25 and turning into a penny stock.” Was it clairvoyance? Hardly. The extremely bearish technical indicators and a price chart that was falling like a stone gave ample indications.

The significance of the 25 level – which was the previous bear market low touched in Mar ‘09 - can be seen in the chart below. Shortly after the previous post in Aug ‘11 (date marked by grey vertical line in chart), the stock price dropped to 25 only to bounce up above the falling 20 day EMA on Sep 9 ‘11. The stock price managed to remain above the 25 level for the next 2 months before finally falling below on Nov 11 ‘11.

After falling to 12 in Dec ‘11, the stock started a 2 months long rally that coincided with the rally in the broader market. Consolidating within a bearish ‘flag’ pattern, the stock price reached an intra-day high of 22 on Feb 17 ‘12. But it turned out to be a high-volume ‘reversal day’, which ended the rally. That was the closest the stock price came to the 25 level.

The daily bar chart pattern of 3i Infotech is an example of the unfolding of a bear market with occasional counter-trend rallies that provide exit opportunities. The falling 200 day EMA has not been tested even once since the previous post.

In Jun ‘12, the stock price dropped below 10 and became a ‘penny stock’. A brief rally on fairly strong volumes took the stock price above its 20 day and 50 day EMAs as well as the 12 level for a few days. But the force of gravity towards ‘penny stock’ status proved too strong.

For nearly 4 months, the stock price has been trading within a rectangle pattern from which it is showing signs of emerging. Volumes have shot up and the stock price has been hitting the 5% upper circuit for 5 days. This is a stock held mostly by small investors, many of whom entered at higher levels.

Is the worst over? Is this a good opportunity to buy? Not really. Three of the four technical indicators (ROC, RSI, slow stochastic) are looking overbought. Even if the price breaks out above the rectangle, strong resistance is expected from the falling 200 day EMA and the 12 level.

Fundamentally, the company has managed to stave off bankruptcy by arranging a corporate debt restructuring (CDR) – by keeping the bankers at bay through an allotment of equity shares at a premium to current price. Outstanding FCCBs have also been converted into equity shares at a premium. While equity capital has become bloated, interest costs will be lower. That may be the reason for recent market euphoria.

Bottomline? The stock chart pattern of 3i Infotech is mired deep inside a bear market. Top line is sliding and bottom line is red. Over-leveraging in a bid to grow fast has ruined the balance sheet. Stay away. If you are stuck from higher levels, use any rally to exit.

Stock Chart Pattern - 3i Infotech Ltd (An Update)

The previous technical update of the stock chart pattern of 3i Infotech was posted exactly one year back. The stock had dropped from an intra-day peak of 103 in Oct ‘09 to close at 63 on Aug 17 ‘10, and was in a bear market. My concluding comments were:

‘If you are still holding the stock, get out at the earliest opportunity. The stock can fall much lower.’ 

And so it has – as a look at the one year closing chart pattern of 3i Infotech will confirm:

Shortly after I wrote the previous update, the stock price slid to a low of 58 on Aug 31 ‘10. Note the oversold conditions in the RSI and slow stochastic. A rally ensued, which found initial resistance from the 20 day and 50 day EMAs. Strong volumes enabled the stock price to reach the falling 200 day EMA, with a few isolated closes above the long-term moving average.

On Nov 11 ‘10, the stock touched an intra-day peak of 72 but it turned out to be a high volume ‘reversal day’ that extinguished the last flickering bullish hope. The stock dropped to an intra-day low of 38 on Feb 10 ‘11, and then started a ponderous rally that touched an intra-day high of 54 on Jun 6 ‘11 – just above the falling 200 day EMA, only to close much lower at 48.

It has been all downhill ever since. All four technical indicators are looking extremely bearish and oversold. But a stock can remain oversold for long periods. At today’s closing level of 28, it is just 10% above its bear market low of 25 – touched on Mar 12 ‘09. There is every possibility of the stock price falling below 25 and turning into a penny stock.

The company is still grappling with a huge debt burden, and had to sell off one of its US acquisitions to help clean up its balance sheet. But there is a long way to go. The slow growth of the US and Eurozone economies will continue to hamper its export business.

Bottomline? The stock chart pattern of 3i Infotech is an example of how a company with good pedigree and business model can come unstuck because of over-leveraging in an effort to become too big too fast. This is not a contrarian pick. Stay away.

Stock Chart Pattern - 3i Infotech Ltd (An Update)

If the stock chart pattern of 3i Infotech was a Bob Dylan fan, it may have been singing - “Can this really be the end, to be stuck inside of a channel with the down trend blues again”. But that song could not have lasted beyond the third week of May ‘10.

That is when the chart dropped below the down trend channel, and fell all the way down to the long-term support level of 60. But that is telling the story from Chapter 9. So let us start at the beginning, by taking a look at the one year closing chart pattern of 3i Infotech:

The bull rally in the stock from the bear market low of 25 (made in Mar ‘09), ended with two intra-day tops at 103 in Oct ‘09. Though the 312% rise may seem spectacular, it only retraced 56% of the bear market fall from the peak of 165 (touched in May ‘07).

By failing to go past the 61.8% Fibonacci retracement level of the 140 points fall (from 165 to 25), the stock technically remained in a long-term bear market – in spite of the fact that it was way above its 200 DMA when the correction began in Oct ‘09.

The stock moved within a down trend channel (bounded by the lines marked C and C’) from Oct ‘09 till the third week of May ‘10. From Jan ‘10 onwards, the stock’s decline became steeper – as marked by the down trend line D.

Note that the line C’, which had acted as a support, was touched 3 times. The first was in Nov ‘09, when the stock bounced all the way up to the line C in Jan ‘10. Thereafter, the line D became the resistance line. The second support on C’ occurred in Feb ‘10. This time, the upward bounce went only as far as the 200 DMA.

Further up move attempts were thwarted by the falling 20 and 50 DMAs and the down trend line D. The third support on C’ happened in early May ‘10. The short bounce stalled at the falling 20 DMA and the line D.

Now here comes an interesting part. As the stock fell below the line C’ and went lower, the MACD and RSI made higher lows and the slow stochastic made a flat bottom. Such positive divergences in all three technical indicators led to a brief up move after the stock found support at 60.

The first leg of the short up move went past the 20 DMA, the down trend line D and the 50 DMA before encountering resistance from the previous support line C’. As the stock corrected (in Jul ‘10), it twice received support from the down trend line D. Classic instances of how supports turn into resistances, and vice versa.

The second leg of the up move crossed the 50 and 20 DMAs as well as the line C’, but reversed after hitting the level of 68. Note that as the stock made a higher top, the RSI and slow stochastic made lower tops. The negative divergences pulled the stock chart down below both the 20 and 50 DMAs once more.

The fundamentals of the company has deteriorated – thanks to the huge debt burden, and the bottomline turned red in the year ending Mar ‘10. The business model can’t be faulted, as it is generating positive cash flows from operations. But the management’s growth strategy through leveraged acquisitions has badly affected the balance sheet.

Bottomline? The stock chart pattern of 3i Infotech is an example of what can happen if the growth ambitions of management exceed their execution capabilities. In my earlier post, I had recommended a stop-loss at 70. If you are still holding the stock, get out at the earliest opportunity. The stock can fall much lower.

[Note for readers: Several other companies have followed the ‘growth through leveraged acquisitions’ strategy. Do you know of any such companies? Can you share their names? Are you stuck with losses in such companies?]

What does the Interest Coverage Ratio signify?

The Interest Coverage ratio (also called Times Interest Earned) is another measure of a company's financial health. It signifies the ability of a company to meet its debt obligation.

In earlier posts, I have covered Current Ratio, Quick Ratio and Debt/Equity ratio. These financial ratios, together with cash flows from operations give a clear view of the financial soundness of a company.

The definition of the Interest Coverage Ratio is simple enough. It is the EBIT divided by interest expense:

EBIT is the earnings (or Profits) before interest and tax payments. It is calculated by adding the interest expense to the PBT (Profits Before Tax). The PBT and interest figures can be obtained from the Profit and Loss statement in any Annual Report of a company.

Let us look at Maharashtra Seamless' Mar '09 annual figures. PBT was 385 Cr; interest expense was 11.6 Cr. That gives an EBIT of (385+11.6=) 396.6 Cr. The interest coverage ratio is 34.

What does that mean? Maharashtra Seamless can pay its debt obligation 34 times with its earnings before interest and taxes. Let us look at another company - 3i Infotech, which is quite popular with small investors.

PBT was 288.5 Cr; interest expense was 95 Cr for year-ending Mar '09. EBIT = 383.5 Cr, not much lower than that of Maharashtra Seamless. But the difference in the interest coverage ratio is startling - an adequate 4, against a very comfortable 34!

An interest coverage ratio of less than 1.5 means that the company may have trouble meeting its debt obligations and may need to borrow more to pay its previous debts. A ratio less than 2.5 should be treated as a warning sign. Avoid companies with a ratio less than 1.

It is important to check a company's financial health over the past 5 years or more. A decreasing interest coverage ratio - even if it is above the threshold values mentioned - is a red flag. Look for companies with consistency of earnings. They can afford to have a lower interest coverage ratio - though the higher the ratio, the better their financial health.

Conservative investors can use a more stringent ratio, by using only EBI on the numerator. That is, they should deduct the tax amount from EBIT before calculating the Interest Coverage Ratio.

This concludes the series of posts on how to evaluate the financial health of a company. Readers may want to go through an exercise of calculating the financial soundness of stocks in their portfolios. The time spent will be well worth it.

Now, learn portfolio strategies from a game of stud poker

One of the best ideas for managing your portfolio on an ongoing basis is to treat each stock (or fund) in your portfolio as a hand in a game of stud poker. Not my idea. Peter Lynch mentioned it in his book: "One Up on Wall Street".

Stud poker is a 'man's game', pitting strong-willed men with nerves of steel and expressionless faces against each other across a card table. The game has been immortalised in several Hollywood films.

Two of them - my favourites - come to mind. The old pro, Edward G. Robinson playing against the new kid on the block, Steve McQueen, in "The Cincinnati Kid". And a sophisticated Robert Shaw being taken for a ride by a bumbling Paul Newman in "The Sting".

The game - for the uninitiated - is simple enough. A card is dealt face-down, which can only be seen by the player to whom it was dealt. This is immediately followed by a second card dealt face-up to each player. All players get to see the face-up cards. A round of betting follows. Each bet is for a specific amount.

A player has the option to 'fold' (i.e. take no further part, if the cards he has been dealt are not to his liking); 'call' (i.e. stay in the game by betting an equal amount) or 'raise' (i.e. increase the bet by a pre-determined amount). Every time a player raises the bet, another round of betting follows.

The process is repeated three more times, as a card is dealt face-up to each player remaining in the game. After all five cards for each hand have been dealt (one face-down and four face-up) and the betting is concluded, the players remaining in the game show their hands to the others. The player with the best five card combination wins.

I'm not a gambling man, nor do I advocate a gambling mentality in the stock market. But the analogy - that each stock (or fund) in your portfolio is akin to a hand at stud poker - seems very apt.

The face-down card is like some knowledge or information you may have about the company that may not be known to the general public. Each face-up card is some bit of financial news or company-specific information that becomes available in the market.

As each 'card' is dealt, you need to take some action as an investor. If it is pretty bad news - like the Satyam fraud, or Punj Lloyd's overseas subsidiary delaying a project and incurring a huge penalty - you should fold (i.e. sell) that particular hand.

If it is so-so or good information - like Larsen and Toubro bagging a new order, or Tata Investment declaring a marginal profit and matching last year's dividend - you may hold your stock (or fund).

If it is better news - like 3i Infotech declaring increased profits when most IT companies were struggling in the down turn - raise the bet (i.e. buy some more).

You'll need the mental and physical discipline of tracking each bit of information about each of the stocks (or funds) in your portfolio, analysing the consequences and filing it properly at a place from where it can be retrieved easily.

It is not rocket science, but it has to be followed diligently on a regular basis - at least once a week. That means not only tracking company results and announcements, but also the forex rates and macro-economic and political news to understand the implications and likely effects on your portfolio.

Many intelligent individuals never succeed in their market investments. A probable cause can be the lack of time and/or discipline in following a regular process of updating information about their portfolio holdings.

Life becomes a lot easier if you manage to limit your holdings to 10-12 stocks or 5-6 mutual funds. Keeping track of fewer companies improves your chances of being able to move quickly as the situation demands.

Weekly tracking of a smaller number of companies (or funds) means you will tend to remember the important bits of information necessary for taking buy-sell-hold decisions.