A Cautionary View on Future Group stocks

The erstwhile promoter of Pantaloon Retail - a debt-laden company subsequently sold to the Aditya Birla Group - used to be a market darling. 

Aggressive growth at the cost of profits led to his downfall. But you can't keep an ambitious entrepreneur down for long. He reappeared as the promoter of Future Group of companies.

Regular appearances at industry seminars and recent forward-looking statements to various TV channels about becoming one of the leading players in the retail segment had caught my attention.

Two recent articles in moneycontrol.com motivated me to look a little closer at Future Group stocks. The first, published on Dec 7, had a headline: Future Supply Chain IPO subscribed 72% on Day 2.

The second, published on Dec 8, had a headline: Future Consumer Spikes 15%; Morgan Stanley initiates Overweight; sees 61% upside. My mental 'alarm bells' started ringing. Was this article 'planted' to ensure full subscription of Future Supply Chain?

There are already several listed Group companies - Future Enterprises, Future Lifestyle Fashions, Future Consumer, Future Retail, Future Market Networks. Now, Future Supply Chain. What is going on? 

Ambition to succeed is fine - but should it be at the cost of gullible small investors? Future Group can hardly be compared to Tata Group, Birla Group,  Ambani Group or Mahindra Group. So many listed companies seem like a ploy to raise (and siphon off?) money.

Here is a quick look at the fundamentals of Future Group companies (based on Mar '17 annual figures from money.rediff.com):-

1. Future Enterprises: Sales - Rs 3782 Cr; Net Profit Margin - 1.09%; P/E - 59.4
2. Future Lifestyle: Sales - Rs 3877 Cr; Net Profit Margin - 1.18%; P/E - 146.2
3. Future Consumer: Sales - Rs 1645 Cr; Net Profit Margin - 0.46%; P/E - 1359
4. Future Retail: Sales - Rs 17075 Cr; Net Profit Margin - 2.15%; P/E - 67.6
5. Future Market: Sales - Rs 82.5 Cr; Net Profit Margin - (20.8)%; P/E - (36.2)

The five listed companies have a total debt of almost Rs 7000 Cr, and are barely making any profits. How will they service their debt? By raising more equity or, even more debt? The same operating pattern of top line growth at the cost of non-existent bottom line is getting repeated.

Can a leopard change its spots? Caveat emptor.

Stock Chart Pattern - Balrampur Chini (An Update)

Sugar stocks are not really my cup of tea - though I do add a spoonful of sugar to my evening cuppa. 

The sugar business is cyclical and weather dependent. To make matters worse, policies and prices are subject to frequent interference by the government.

That makes the business unpredictable, and I stay far away from it. But a young, risk-taking trader interested in making quick gains may find sugar stocks attractive.

The 2 years closing chart pattern of Balarampur Chini clearly reflects the cyclical nature of the sugar business. How cyclical? A look at the net profit figures of the past 5 years should suffice.

For year ending Mar '11 and Mar '13, net profit crossed Rs 160 Crores. For year ending Mar '12 and Mar '14, net profit was Rs 6.6 Crores and Rs 3.6 Crores respectively. For year ending Mar '15, there was a net loss of Rs 58 Crores.

Debt/Equity ratio is 1.43. High interest expenses continue to affect the bottom line. In other words, fundamentals do not warrant long-term investment.

But have a look at the returns that a trader could have made. From a low of 36.80 touched on Jan 31 '14 to a high of 85.15 touched on Jun 23 '14, the stock gave 130% return in less than 6 months.

A 15 months long bear phase followed (marked by the blue down trend line). The stock dropped to a closing low of 38.90 on Jun 16 '15 - giving up almost all its gain in one year, but providing good trading opportunities.

After forming a 'double bottom' reversal pattern (marked B1 and B2), the stock price embarked on another bull rally, touching a 2 years high of 87.85 on Jan 13 '16 - giving 120% return in less than 5 months from the low of 39.60 (B2) touched on Aug 31 '15.

The stock is trading well above its rising 200 day EMA in a bull market, but such a sharp rally is unsustainable. 

All four daily technical indicators are looking overbought and a couple of them are showing negative divergences by failing to touch new highs with the stock price.

Get ready for another stomach-churning roller coaster ride. Like I said, not really my cup of tea.

Technical updates – Container Corp and Indraprastha Gas

Stocks of PSU companies have never been my favourite because too often, management decisions have been dictated by government prerogatives and their bulging cash balances have been used to fix problems arising from faulty fiscal policies.

But if some one pointed a gun at my head and forced me to pick two PSU stocks – these two would be at the very top of my list. Why? Their near-monopoly status, and consequent strong fundamentals.

Container Corp is debt free, with RoE of 14%, and net profit margin of 18.4%. Indraprastha Gas has a debt/equity ratio of 0.18, RoE of 20.4%, and net profit margin of 9.1%. Therefore, it is no great surprise that the former has a P/E of 26.6, while the latter has a P/E of 17.6.

The charts below show that both stocks are trading in strong bull markets. But the general public holds just 1.3% of Container Corp’s equity and 6.5% of Indraprastha Gas’ equity. Two excellent investment-worthy stocks – and the public doesn’t seem to care about them!

Container Corp

The stock price of Container Corp. consolidated sideways within a ‘rectangle’ pattern for a year before finally breaking out upwards on a volume surge. As often happens, a pullback towards the breakout point gave investors an opportunity to enter.

The stock closed at a new high of 1483 in Nov ‘14, but negative divergences in all four technical indicators - which failed to touch new highs with the stock (marked by blue arrows) - led to a correction. The stock dropped below its 20 day and 50 day EMAs, but has recovered since then.

Technical indicators are looking bullish. Some consolidation can be expected before the up move resumes. 

Indraprastha Gas

The stock price of Indraprastha Gas consolidated sideways within a bullish ‘falling wedge’ pattern before breaking out upwards with a volume surge. It has been a strong up move since then, with intermittent corrections that ensured that the stock didn’t become too overbought.

The stock touched a new closing high of 465.40 in Dec ‘14, but negative divergences in all four technical indicators, which failed to touch new highs with the stock (marked by blue arrows), have led to a correction that is continuing.

Any drop below its 50 day EMA will be an adding opportunity.

Technical updates – Gayatri Projects and IRB Infrastructure

Stocks from the construction sector have emerged from long bear phases in anticipation of growth in the economy that may lead to revival of stalled projects and awarding of new contracts. The ground reality hasn’t quite lived up to the expectations – though there are some signs of increasing construction activity.

Gayatri Projects and IRB Infrastructure are two companies from the construction sector that have similar looking chart patterns (below), but looks can deceive. While the former has gained a considerable 270% from its bear market low to its 2 years high, the latter has gained an even more impressive 365%.

On the valuations front, Gayatri has a debt/equity ratio of almost 2, and its financial expenses are three times more than its net profit. IRB’s debt/equity ratio is a more manageable 1.06 and its financial expenses are marginally less than its net profit. No wonder Gayatri is trading at a P/E of 9.4 while IRB is trading at a three times higher P/E of 29.3.

Does that make one a better buy than the other? Or, should both stocks be avoided? You tell me!

Gayatri Projects

The stock price of Gayatri Project went through a long ‘double bottom’ bear market reversal pattern formation that took 7 months to complete. The subsequent rally was sharp, and was supported by strong volumes that launched the stock into a bull market.

Such sharp rallies are difficult to sustain. All four technical indicators reached extremely overbought conditions that led to a correction and then a small ‘double top’ pattern with a higher second top. But none of the technical indicators touched a higher top. The combined negative divergences was followed by a sharp correction that bounced back before testing support from the rising 200 day EMA.

For the past 4 months, the stock price has been consolidation sideways within a triangle pattern from which the break out can occur in either direction. Technical indicators are in bearish zones, but the 200 day EMA is still rising and the stock is trading above it in a bull market.

IRB Infrastructure

The stock price of IRB Infra dropped to a bear market low of 54 on a sharp volume surge, which was a sign of selling exhaustion. A ‘V’ shaped recovery was followed by a drop to a higher bottom – forming a small ‘double bottom’ pattern that preceded a gradually rally.

The rally faced resistance from the 200 day EMA and dropped to a higher bottom that indicated the start of a bull phase. The next leg of the rally was sharp and accompanied by strong volumes. But overbought conditions and negative divergences (marked by blue arrows) in three of the four technical indicators led to a sideways consolidation within a ‘rectangle’ pattern.

The consolidation within the ‘rectangle’ has consumed more than 5 months. Since rectangles are usually continuation patterns, the eventual break out is likely to be upwards. But rectangles are unreliable patterns, so one needs to wait for the break out to initiate any buy/sell action. Technical indicators are in bearish zones. The consolidation is likely to continue for a while longer.

Is the Sensex valuation signalling a ‘buy’?

Given below is a chart that appeared in the Economic Times a couple of days ago. For those who are not familiar with, or feel shy about, graphs and charts – a brief explanation may be necessary.

What is PE (Price to Earnings ratio)? It is a common valuation metric that is calculated by dividing a stock’s current market price by its TTM (trailing 12 months) EPS:

In other words, PE of a company = CMP (Current market price) / TTM EPS

EPS (or, earnings per share) is calculated by dividing the net profit by the total number of shares outstanding (i.e. shares authorised, issued and owned by investors, including company promoters).

Net profit is declared along with quarterly results of a company. Quarterly EPS can be calculated by dividing the quarterly net profit by the number of shares outstanding. To calculate the full year’s EPS, the quarterly EPS of three previous quarters is added to the EPS of the current quarter (i.e. TTM EPS).

The Sensex is an index of 30 stocks. The ‘price behaviour’ of the index is supposed to represent the ‘price behaviour’ of the entire stock market. Does the Sensex have a PE, and can it be calculated. The answer is ‘Yes’. How?

By performing a simple arithmetic trick to make the calculation easier. For each of the Sensex constituent companies, CMP and TTM EPS are respectively multiplied by number of shares outstanding:

• CMP x number of shares outstanding = Market Capitalisation;
• TTM EPS x number of shares outstanding = TTM Net profit.

So,  PE of a company = Market Capitalisation / TTM Net Profit.

Now, calculate the market capitalisation of the 30 Sensex stocks; then add the 30 market capitalisation numbers (in Crores) to get the total Sensex market capitalisation. Next, add the TTM net profits of the 30 Sensex stocks (in Crores) to get the total Sensex TTM net profit. Dividing the total Sensex market capitalisation by the total Sensex TTM net profit gives us the Sensex PE. Voila!

Why is the PE ratio important? Because it is a commonly used valuation ratio. A PE of 15 means the market is ready to pay Rs 15 for each Re 1 in earnings of a company. A lower PE means the stock is a more attractive purchase. A higher PE means the stock is on the expensive side. Note that PE ratio should not be the only criteria to value a stock. Other metrics like Price to Book Value, Return on Capital Employed, cash flows from operations, etc. should also be looked at.

The chart above plots the Sensex PE from end 1998 to Jul 12 ‘13 (in red), with the average PE during the entire period of 18.34 (in blue). How to use the chart? Below the blue line is the ‘buy’ zone and above the blue line is the ‘sell’ zone. On Jul 12 ‘13, Sensex PE was at 17.65 – below the average level of 18.34. In fact, Sensex PE has been below the average level for the past several months. Now you know why investors were being implored to buy in various posts on this blog over the past few months.

Don’t worry too much about the gloomy economic scenario. The government is taking belated steps to allay the situation. The stock market cycle is usually a few steps ahead of the economic cycle. By the time the economy improves, it will be time to sell.

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How to read the Cash Flow Statement – Part 2

In last Tuesday’s post, I had covered the first part of the Cash Flow Statement – Cash Flow from Operating Activities. The next two parts will be discussed in this post.

Part 2: Cash Flow from Investing Activities 

To remain in business over the long haul, a company needs to grow. Without growth, a business will stagnate and eventually die or get acquired. But growth has a price. Cash has to be spent to buy land, machinery and related equipment, build factories and offices, acquire other companies, start subsidiaries or joint ventures, and make appropriate investments.

All of the above comes under Cash Flow from Investing Activities. You don’t have to be a genius to guess that this figure will be a (negative) one for most companies. Many mature companies, particularly those in the FMCG sector, don’t have much need for Capital Expenditure (i.e. spending cash on factories and equipment) because their rate of growth has slowed down.

Ideally, the depreciation amount in the Profit and Loss statement should be less than or equal to the amount of cash being spent in investing activities – because depreciation is meant to cover the notional loss due to wear and tear of the existing plant and machinery. If a company does not continuously spend on upgrading and modernising its facilities, it will not be able to compete with newer entrants who may have the latest technology and equipment.

The definition of Free Cash Flow is:

Cash Flow from Operating Activities – Capital Expenditure

This is a (negative) number for companies in their early growth stage, when cash generated from core operations may be insufficient to cover the cost of capital expenditure. But for well-established companies, positive Free Cash Flow is an indication of financial health. The more positive Free Cash Flow a company can generate, the easier it is for them to expand, acquire, pay dividend or buy back shares, and pay off loans.

Part 3: Cash Flow from Financing Activities 

What if a company has (negative) Free Cash Flow, or still worse, has (negative) Cash Flow from Operating Activities? Where will they get the cash to pay their suppliers, interest to banks for any loans taken, and for growing the business?

They can either resort to more borrowings, and/or issue more shares. If such companies are showing a net profit, then they are also expected to pay dividends to their shareholders. All inflows and outflows of cash due to loans, share issues, share buybacks, dividend payments come within Cash Flow from Financing Activities.

Financial prudence should dictate a company’s growth plans. As a thumb rule for selecting good stocks, about 60-70% of the Cash Flow from Investing Activities (Part 2) should be funded by positive Cash Flow from Operating Activities (Part 1); the balance 30-40% should come from Cash Flow from Financing Activities (Part 3).

Many companies forget the simple adage that one should cut one’s coat according to the cloth. They may even have positive Cash Flow from Operating Activities, but their ambitious growth plans require far more cash than they can afford. They resort to frequent borrowings and share issues in the hope of reaching the top quickly. One or two bad years can bring such companies down to their knees. Pantaloon and Suzlon come to mind.

(Note: The financial health of banks and financial institutions can’t be judged by analysing the Cash Flow Statement alone – because they need to borrow cash to give loans, and invariably have negative Cash Flow from Operating Activities. Price to Book Value and Return on Assets are better measures for such companies.)

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How to read the Cash Flow Statement – Part 1

Have you heard the statement: Cash is king? A business needs cash like a car needs fuel. If there is no regular generation of cash from the day-to-day operations, the business will need to resort to debt and share issues to survive. Seems logical that investors would first look at the Cash Flow Statement in an Annual Report – right?

Unfortunately, most investors in the stock market – even those who have been investing for many years - do not understand or know how to interpret the Cash Flow Statement. Just looking at the Balance Sheet, Profit and Loss statement and the Management Discussion and Analysis is not enough. The real state of a company’s finances is hidden in the Cash Flow Statement and the Notes on Accounts.

With another accounting year coming to a close on Mar 31, 2011, this is as good a time as any to learn the basics of the Cash Flow Statement:-

The Cash Flow Statement allows you to check the different sources of cash inflows into a company during a particular year vis-a-vis the prior year, how much cash was spent, and what it was spent on. Cash inflows are positive, cash outflows are (negative). The three parts of a Cash Flow Statement enable you to understand what a company’s management is doing with the cash at its disposal, by comparing the figures with those appearing in the Balance Sheet and Profit and Loss statement.

Part 1: Cash Flow from Operating Activities

The Net Profit before tax and exceptional items from the Profit and Loss statement is adjusted with depreciation, interest, provisions, profit/loss on investments, debtors, inventories, creditors to arrive at the cash generated from operations. Tax and exceptional items are then adjusted to arrive at the Net Cash from Operating Activities.

Though it may seem counter-intuitive to non-accountants (like me), depreciation is considered an inflow (it is an expenditure in the Profit and Loss statement, but the cash is not paid to any one and remains within the company); creditors/accounts payable is an inflow (because they haven’t been paid yet); debtors/accounts receivable is an outflow (because a ‘sale’ has been accounted in the Profit and Loss statement but the money hasn’t been received yet).

Net Cash Flow from Operating Activities should preferably be positive, and greater than the previous year’s if the net profit has gone up. Newly set-up companies, particularly those in high growth fields like Information Technology or Bio-technology, often have negative cash flows from operations in their initial years. They need to ramp up operations quickly to meet demand but may not be able to negotiate good payment terms from their clients.

Negative cash flows from operations of established companies, if over prolonged periods, indicate that there is something amiss with the business model, or the management has questionable integrity and is diverting cash to unlisted subsidiaries or to related parties.

Investors need to be particularly wary of companies that show good top-line and bottom-line growth year after year, and pay taxes and dividends but show negative cash flows from operations. Where is the cash to pay the taxes and dividends? It comes from regular borrowings and share issues. If such a situation continues for a few years, the debt burden will eventually sink the company. Many realty and high-flying infrastructure companies, and investor favourites like Bartronics, Cranes Software fall within this category.

(Note: The next two parts of the Cash Flow Statement will be covered in Thursday’s post – so please stay tuned.)

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