The 'Ten Blunders' to avoid when markets are touching all-time highs

The euphoria is unpalpable, The anchors at the top TV channels have already printed T-Shirts of “Nifty - 21000”. The Nasdaq is about to finally breach (or atleast it was just a few days ago) its life high in a few days and there has never been a better time to believe that “This time it’s different”

I have been in markets since 1993 and like most 50 yr olds have seen a few booms, busts, scams and a few financial crisis. As a fund manager – when sometimes my clients ask me - markets are at all-time highs and making new highs everyday why are you not investing our money and simply holding on to cash.

I give all my clients 2 choices – Take Your money Back – Or be patient. But I ain’t changing my philosophy because of the pressure of capital deployment.

Even though I am always fully invested (personally), in markets (Levered to 120%) I am still almost always fearful, as Socrates keeps knocking within me subconsciously with his words – “Fools are always confident and the wise are always in doubt”

Perhaps I am a mad raging bull in a bear clothing. The bull in me keeps me hopeful and the bear allows me to be patient, cognizant of risks and to be non-greedy when everyone around me is convinced that this time its different. Perhaps that’s why our portfolios have been least volatile and have beaten markets with least amount of palpitations for our clients over a long term.

But the 10 lessons that I have learnt over the years and tried to imbibe in my investing style are as follows.

1. Be bullish not foolish

If the world is progressing and must keep moving ahead (with inventions, technology, opportunities, AI et al) markets will always go up over a long period of time. That allows us and encourages us to be a perma-bull ala Rakesh Jhunjhunwala. Sensex at 60,000 seemed like an impossibility some 10 years ago. Today its 66000. So being a bull almost always helps in the long run.

But in the short run becoming a muppet in the hands of commentators is the worst punishment one can allow oneself to be inflicted with. The narratives that emerge at the seeming peak of the markets are always almost misleading and suicidal.

Lesson

When a stock, an idea or a sector is being pushed feverishly – AVOID.

2. Breakout Stocks

Finfluencers are running paid courses on breakout stock strategy and thousands of gullible retail investors fall for this trap.

In the long run everything is driven by fundamentals without an exception (or else Yes Bank wouldn’t have become a No Bank and Suzlon would still be a blue chip) but in the short run, everything is driven by operators and insiders. How else do most shares start to perform or go down just before a major corporate announcement. Examples are galore not only in Indian markets but US as well.

Stocks break out not because the companies have become fundamentally adroit. They break out because too much money and fear is chasing too little items available. And that can make any s*** break out. Sub 1000 Crore companies that suddenly get new narratives built around them, coupled with incessant peddling of ‘the new promise in the lala land’ on social media and sometimes on business channels always prove to be  a trap and wealth destroyers. Its surprising that almost all breakouts happen only when markets are peaking.

If Infy or ICICI or the likes of it break out, its great and merits attention but when stocks break out because of positive news (in most cases planted) while promoters are happily offloading their stake, not only should you be fearful, but you should also contemplate sitting out of the markets for a while. As Buffet famously quotes “Only when the tide goes out do you discover who is swimming naked”.

Lesson

If you are a superman and can get on a bullet train (thats running towards an abyss) and get off it - just in time, breakout investment strategy is ok. Else you will almost always get scorched.

3. Beating the estimates

When rivers start flowing above the danger mark, the powers that be, worry little about the river or the impending danger. They just raise the danger sign by a few feet so that the river remains below the danger mark. Such is the story of the estimates by analysts. All estimates are always beaten because estimates are not based on the FCF or Earnings Yield. But based on a collective intelligence of sub optimal and mostly clueless analysts who are experts in guesswork.

And sometimes estimates get beaten because of a low base effect, one off income etc etc. For this one needs to delve deep into the financial statements. But beating the estimates is one of the most specious narratives to misguide the DIY and the gullible investor.

Imagine Nykaa listed at a peak valuation of some 1,16,000 Cr (Nearly 15 Billion USD) and analysts hailed it as a profitable company going into IPO while the Nayars privatized their profits and socialized the losses. Its present EPS is some 7 ‘paise’ while its trading at 70% below its listing price and still discounted more than 2200 times.

Over the long term there are just 3 things that matter for a strong stock performance that has any likelihood of creating wealth for shareholders. Valuation, Free Cash and Management intent.

Lesson

Stick to the basic principles of investment that have been in existence for decades. Analysts and their estimates can be great entertainment not the bedrock of sound investment strategies.

4. Feeling good about bad data

Bad data is bad and good is good. However markets have started interpreting this inversely. Can you imagine that if the US jobs and inflation data is good, markets react negatively and vice versa. Eventually the reality will catch up and markets will realize that job losses aren’t good in the long run as data leads the reality by a few months and yet in the short run bad data almost always pleases the market till it doesn’t.

Lesson

If data is correct then trust the data and not the convenient interpretation of it. (eg. Bad data will lead to interest rate cuts and party of excesses will continue). Eventually something that’s good for the economy will manifest itself into goodness and something that’s bad will manifest itself accordingly in not so distant future.

5. Discounting the distant future in the present valuations

Decision of a Capital Expenditure by a company, or establishment of a new factory or a newly acquired business contract spread over multiple years almost always takes the stock price to tizzy heights. And human mind is wired to feel bullish on news that has not produced a single cent yet and no one really knows when it will – These traps are best avoided as euphoria almost always fizzles out. Does anyone remember the infra theme of 2006-2008? Most of those companies aren’t even listed anymore. The present defense theme is no different. Be cautious when buying into future stories.

Lesson

If a company is good it will keep creating consistent shareholder wealth. And any prudent investor will make money in that company’s lifecycle. (Buffet invested so late in Apple’s lifecycle – And How - he didn’t miss any bus or opportunity). Don’t invest just on the promise of a rosy future. Wait for your time.  

6. The FOMO factor

History is replete with examples – and I have experienced it personally. If one really is in love with a stock and wants to create a position, the irresistibility upon hearing TV commentators and news flow is intense. But almost always every single stock that you want to buy today will almost always be available a bit cheaper few weeks or months down the line - Even if it’s the HDFC’s or the Bajaj’s of the world. All one needs is a bit of patience to wait and build a stronger conviction while the target or lower price is achieved. If FOMO could be quantified, its directly proportional to the level of indices. Most bitcoin retail aficionados invested between 50000 – 68000 USD. If Bitcoin is really a store of value why aren’t they doubling down at 20000 USD?

Lesson

Investments made in a state of FOMO are never sound investments. Date your stock, understand it better, observe it for a few Qtrs and then say Yes. You will never go wrong.

7. Recency Bias

Anyone who has vivid memories of 2000 and 2009 and remembers Pentafour Software, DSQ, HFCL, Global Tele and JP Associates, would resonate well with the perils of recency bias. When most of these shares fell from (approx.) Rs. 3000 levels by 20%, people rushed to sell their family silver and real estate to capture the opportunity of owning these blue chips of those times. Well eventually all of these companies got delisted and JP is now at an unfathomable level of Rs 8.

The point to remember is that a stock at Rs 1000 can well become a penny stock and the adage “how much more can it fall” is stupidity.

Lesson

Not only should you never catch a falling knife, don’t invest in story stocks. Companies that peddle stories and not profits will always destroy their shareholders’ wealth.

8. Herd Mentality

Speciality chemicals was as crowded a trade, 18 months ago as Banking is now. Finfluencers were allowed to blatantly push narratives on TV Channels and the entire sector has destroyed a considerable wealth over the last 2 years. Indian Banks are trading at reasonably rich valuations while the CEO s of the same banks are subtly raising red flags on growth and margins yet the BAAP (Buy at any price) brigade is relentless – and while banking sector is the bedrock of economic growth of any country – valuations do matter.

Lesson

When everyone is chasing the same theme – it almost always spells trouble. DotCom in 2000’s, Housing in 2008’s had the same fate. AI is the new darling theme. Lets see what happens to AI and chip companies a few qtrs down the line.

9. Cutting the flowers and watering the weeds

Peter Lynch famously quipped the above adage. I know more than a dozen people who are in love with Yes Bank and Vodafone rather than ICICI Bank and Bharti. A large number of DIY investors feel that the chances of a penny stock doubling are far higher than a respectable and a fairly priced stock. The ‘averaging on the way down’ brigade of Yes Bank, Unitech and JP Associates will continue to sell their winners while collecting mountains of trash.

Eventually such investors get ejected out of the markets forever.

Lesson

The performance of a company gets reflected in numbers and numbers get reflected in the Balance Sheet and the BS gets reflected in the stock price. Stocks are where they are for a reason. A red black on a roulette table offers a better probability of winning than holding onto The Yes’s and Vodafone’s of the world in the hope of they springing a magic.

10. Falling in love with stocks, promoters or commentary

I recently heard a well known fund manager mention in a podcast how he was in awe of Mr. Gosh and Bandhan bank. This adulation towards a particular management clouded his ability to see the turning fortunes for the worse at the bank and eventually he had to exit the investment at a big loss to his investors.

It is easy to fall in love with stocks/sectors which have given good returns in the past. But this should not blind one’s rational thinking towards changing times. One key TV commentator keeps peddling the idea that the next HDFC bank is the HDFC bank itself, while the stock underperformed Nifty by a huge margin in the last 2.5 years and ICICI snatched the mantle of growth and consistency in the Indian Banking space.

Positive Management Commentary is another trap that most investors love to fall into. Bias clouds their judgements and the performance as well. And most investors get sated by just commentary. Which promoter will ever say that his future is bleak or give a negative commentary?

Lesson

Don’t cling onto stocks where data or price isn’t supporting or where the business model could itself face a headwind. If at all - cling onto relationships, great friendships and emotions – not stocks and commentary.

11. Checking the price and not value

We all aspire to upgrade our standard of living (Car, House, Holiday destinations, etc) and happily pay a premium for superior quality and size. But some of the most prudent investors and sometimes fund-managers as well, take refuge of substandard – low priced stocks (penny stocks) in the hope of dramatic turnaround or a story that’s likely to unfold in some distant future. The propensity to indulge in this investment strategy is directly proportional to the index levels.

Lesson

If there is 1% chance that your investment behavior is vaguely similar to gambling, you are most likely to get into trouble. The probability of landing a multibagger amidst an ocean of crappy stocks is like finding a unicorn in a herd of donkeys.

If one could just avoid stupidities in ones investment journey over decades, there is no force that can stop you from compounding your wealth at an appreciable rate. And compounding – the eighth wonder – is everything isn’t it?

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5 lessons from life and times of Rakesh Jhunjhunwala – The legendary Bull

Anyone who is even distantly involved with stock markets knows Shri Rakesh Radheshyam Jhunjhunwala (RJ) as “The Big Bull”

What a nomer to have and outlier of a recognition in a nation of 1.6 billion people where one of the most remarkable catalysts of vision and growth amidst all adversities is the bullishness of each and everyone among us. Floods, Droughts, Terrorism, Catastrophes – nothing perturbs the spirit of Indian’ness’ because everyone here is a Bull, everyone has a shameless and unapologetic audacity of hope and where the spirit and belief of an Indian investor created a FOMO amongst the ilk of all FII/FPIs and didn’t allow the Indian markets to crash the way others did across the globe.

If not all – a large part of this credit must be reserved forever for ‘The Big Bull’.

I had the good fortune to spend an entire day with RJ some 12 years ago when he invested in Delta Corp and I was heading its Operations in Goa. (Enough and more has been and will continue to be written about his investing skills so I will avoid the slack and just stick to the basics). His sense of humor stood out for me. He was humble, polite, airless and carefree.

Markets are engines of creating enormous wealth but are meant only for the brave. If you cannot tolerate an upto 50% drawdown you should get out and stick to Bank FDs etc. Yet inspite of knowing this theory, we would all look for words of reassurance from RJ whenever markets tanked in the last 2 decades. His belief and conviction was indomitable and while he would himself be reeling under losses (during drawdowns – as markets are impartial and truly secular), yet his presence on TV would always have a calming effect and millions of investors would always look upto RJ during the tempests of the market. It almost always seemed that our fraternity was safe with him as a leader and in control of the ship.

My learnings from RJ’s life and times have been immense.

1. Audacity of imagination and dreams 

RJ has been an outlier in his imagination and calculation. Even if it was mathematically impossible to achieve a 5Tr $ GDP by 2025 or 125000 on Nifty by 2030 (28% CAGR), his optimism has been so damn infectious that one would start believing him and having faith in the markets. One would always imagine that India will suddenly be blessed with miracles of incessant growth (with all the bells and whistles that come along) and would perhaps be much larger than the largest economy on the planet in no time. If there is anyone who truly believed and professed that India is shining and will continue to do so - It was RJ and he is right.

Positivity and indomitable belief in a brighter future is the single most potent catalyst of progression and evolution. Hopeful leaders, citizens and societies are happy, self reliant, progressive and above all evolutionary. Targets of growth and progress should be dramatically out of the whack. Cloud nine seems terribly near when one is only aiming for the stars. RJ always believed that markets and India would always go for the fences in every single shot.

 

2. Accept Losses

RJs loss in AtoZ was approx. 150 Cr in a single investment. And yet I remember seeing a video where he spoke kindly of the promoters, accepted his mistake/wrong judgement and moved on. Even while nursing a large loss he was hopeful, well diversified and positive. He wished well for the promoters. That requires a golden heart.

Everything that happenes in your life is because of your own karma and judgements. Never ever blame anyone for any adverse consequences. Accept fate/losses and move on. More time is lost in analysis of history rather than action for the future. Let go of negativity and embrace positivity. Rear view mirror of decisions are for the regressive. Keep moving against the currents, there’s never a failure  – only feedback.

 

3. Harvest the Crops

RJ would always harvest his crops in time and was quick in removing weeds from the garden of his investments. He was always quick in accepting mistakes and taking large losses. He has committed a large part of his wealth to philanthropy and also led a good life. I hear that he built one of the most palatial houses recently for his family. May God bless his family with all the amazing traits he had.

Every crop must be harvested and every fruit of labor and effort must be enjoyed. Crops that remain unharvested tend to rot away and are rendered useless. Enjoy your wealth, spend it for gratification and seek the power and courage to give away for the greater good of humanity to find the true purpose of life and probably leave a legacy. There is no fun in being the richest man in grave.

 

4. Friends / Hanumans

Very few people have heard of Mr. Utpal Sheth the man behind RJ s success and investment decisions. Sharp, Astute, Soft Spoken and Loyal. Mr. Sheth has spent a large part of his professional life at RARE Enterprises, and has been the real tailwind behind RARE. While RJ has been the real Big Bull of all times Utpal Ji has been the force, energy and strategist behind all these iconic decisions.

Stick to Friends and colleagues who assist you in winning all the battles and wars of professional and personal life. Lord Rama without Lord Hanuman couldn’t have achieved much. But allow your Hanumans to become Lords in their own right. If you find your Lord Hanuman you are the real winner.

On that note I would like to express my most profound gratitude to my friends, Punith, Nezvilla and Chef Tiger who have stood by me like a rock in all the ups and downs and sacrificed a lot more for me than me for them and who would take a proverbial bullet for me and so would I.

A leader without an army of true and genuine Friends / Hanumans is a like a Golden Chariot without wheels. Where would you go on the Pushpak without a pilot.

Friends for a season or friends for a reason are just waste of time.

 

5. 7 pounds at birth to 7 pounds at death

Every child is born roughly 7 pounds and the weight of the final urn full of mortal remains at the end is roughly 7 pounds as well.

A new born baby is born after fighting all the adversities of ‘survival of the fittest’ principle of evolution. Every child is born equal and similar. What we make of our life is entirely in our hand. We are a sum of choices that we make during the course of our lives. RJ loved to eat and drink and he probably went overboard to a point of no return. Obesity leads to diabetes (mostly) which leads to all the malfunctions in ones body. For a man who could buy the best beach or the best aircraft, struggled, in his own confession, to really walk on the beach or travel the world in his own aircraft.

Obesity is the root cause of all evils. Our genetic makeup is still about 40,000 Yrs old (evolution takes time) where we had to hunt and fend for ourselves. Last 200 Yrs of development (or destruction) has made us dormant, lazy and susceptible. Economic progression has laid the foundation of eventual destruction of this planet. We have stopped giving rest to our pancreas because we have started believing in the concept of 5 meals a day. We just never stop eating. The concept of intermittent fasting is nothing more than eating between sunrise and sunset and giving the rest to ones metabolism for 14-16 hrs a day. That’s what our body needs. Not the American peddled concept of heavy breakfast of cereals because Mr. Kellogg wanted to sell his (high fructose) corn flakes.

Human body is the best and most efficient bank. If calories consumed are more than calories expended, it puts on weight. If calories expended are more than the calories consumed, it loses weight. Rest are all excuses that we find to justify our indulgences and lifestyles. No matter what – don’t put on weight.

We all vie for freedom and yet we spend our lives enslaved in the bondages of jobs, responsibilities, aspirations. On the eve of the anniversary of India's 75th year of freedom, RJ tricked us all and unshackled himself from all bondages and became free and has left his admirers and well-wishers teary eyed  and proud that that there was one helluva visionary who instilled hope and positivity in an entire generation.

 

RIP Big Bull – Kickass in heaven and keep an eye on us.

_______

With inputs from Abhishek Murarka

Magic, Illusion or just Trickery – The story of ITC

Quarterly Magic of ITC Numbers

The greatest trick the devil ever pulled was convincing the world he didn’t exist. And looking at the way ITC is managed, it can be said with reasonable certainty -

The greatest trick the ITC is pulling is to convince its shareholders that its board exists and is indeed responsible for the company.

The alarming regularity with which the stock price is manipulated weeks before every quarterly result, the rumours about the demerger, stellar results round the corner, special dividend in the offing and buyback, only to be disappointed quarter after quarter - is nothing short of a movie plot. The retail investors also known as the hopeful romantics within the ITC fraternity, keep buying the stock, while Wealth Managers across the country have created an entirely new and risk-free business model of selling ATM call options month after month and making a killing, as they exactly know where the stock is going - NOWHERE  

Here’s the secret Y’e stupid shareholders of the ITC

ITC will never ever demerge its businesses as the present comfort of the high tide that hides all the executives that are swimming without pants will get exposed. The cash machine that ITC is, through its cigarette business is good enough to keep the party going for a very long time.

And no one likes the party to end isn’t it?

When I wrote this piece some 8 months ago asking some pertinent questions to the board, the least they could have done was to gather some data, do some math and respond with a sound and logical rebuttal or future strategy, especially when thousands of shareholders resonated with my thoughts all over the world, but obviously rebuttals require courage, facts, demonstration of intent and a clear conscience – all of which seem to be missing in ITC.

Can we even begin to imagine if ITC was managed / owned by Mr. Ambani or Mr. Adani how happy we minority shareholders would have been? Or if the representatives of SUUTI, LIC and a few Mutual Funds along-with BAT could discover their spines jointly, and make the management answerable – ITC has the potential to be one of the best companies in India. But alas….

So while the latest investor presentation used the word robust 31 times and growth 41 (the same is missing from actual performance), it has no mention of shareholders, reduction in executive compensation during the pandemic year but they did try and take credit of reducing “controllable” fixed costs. Fixed costs are uncontrollable and that’s why it requires serious executive courage to control them. Controllable Fixed costs? – Are you kidding me?.

At a time when the entire listed corporate world has left shareholders spellbound in the last 15 months, with appreciable reduction in costs, stellar EBITDA margins, efficiency not seen in the last decade, ITC has at best established itself as a mediocre company with a mediocre P&L, poor decision making and afraid of taking any meaningful steps that are value accretive for its shareholders. – 

details later here…..

The talk of a robust dividend yield is akin to shifting money from one pocket to the other because the board doesn’t have the courage to declare a buyback for the fear of losing control and were gleefully diluting the value of minority shareholders till recently, when BAT put an end to equity dilution through issuing stock options in year 2018. Since then, the company has changed its policy and it gives Stock Appreciation Rights (SARs) which entails more cash-outflow for the company. We aren’t sure that the principle of 'High Water Mark' is being followed to ensure that SAR isn’t brought lower to adjust to the stock’s abysmal performance.

Isn’t it surprising that the top management of ITC, despite generous grants of stock over the years, owns less stock than perhaps me and my family and are selling their stock with alarming regularity. So much for the confidence in their own executive abilities. The issue of ESOPs and quick-sale data is available here.

Fun fact : Just top 282 employees of ITC sold shares worth 1024 Cr in the last 3 years. And the top 10 sold shares worth 190 Cr. The real KBC is being played here at the cost of minority shareholders.

SEBI came out with a bold skin in the game reform for the mutual fund managers by   mandating that a minimum of 20% of the compensation of mutual fund managers and other key personnel in an asset management company (AMC) should be in the form of units of the mutual fund schemes they manage.. 

I wrote a recommendation piece about the same some 3 years ago and when I heard of this reform, I was pleasantly chuffed about it. I am proposing 2 more reforms and will write to SEBI soon that : 

a. Companies that don’t have a promoter shouldn’t allow its executives to draw a compensation beyond a pre-defined threshold and all other compensation should only be in form of dividends generated through restricted stock options monetizable only upon end of employment.

b.  The other skin in the game reform for promotor-less companies where the promoter or the KMP has less than 20% stake should definitely have a representation of minority shareholders on the board and that too in the proportion of their stake.

 

That would indeed be another set of ‘skin in the game reforms’ for promoter-less corporations.

If this would’ve been the norm and discipline, one celebrated CEO of an American corporation wouldn’t have been allowed to fly fresh salmon from Norway for lunch in the company’s private jet. The folklore has it that he was terribly fond of Salmon.

But lets get back to the recent stellar quarter of ITC and study the ‘FMCG giant in the making’ narrative:

1.  Companies that make significant growth, report their numbers in absolute numbers and        the ones that enjoy growth on the base effect of extreme underperformance only talk in         percentages.

2.  While Marico (Sales up – 10% y/y, PAT up – 15% y/y), Britannia (Sales up - 13% y/y, PAT up – 33% y/y), and Dabur (Sales up – 10% y/y, PAT up – 17% y/y ) grew at a remarkable pace, ITC sales de-grew by (2%) and PAT de-grew by (15%). ITC has almost become like a few other PSU Banks where “the worst is behind us” and “the future is bright” narrative is being peddled for years, quarter after quarter while the balance sheet at the cost of tax payers needs to be recapitalised ever so frequently and here in the case of ITC, the minority shareholders are underwriting the underperformance.

3.   Further its pertinent to note that a large part of the FMCG growth came from a very very expensive acquisition of Sunrise which means that for every Rs 1 of growth in revenues, the shareholders paid Rs 4.

4. Remove the Sunrise acquisition, and the revenues from Aashirwaad atta (where the EBIDTA margins are negligible) the real growth would be much lower.

5.  “Value Accretive M&A” is a meaningless metric until ITC acquires another company that’s trading at cheaper valuations than itself. And thereby creating some shareholder value. M&A at the cost of free-cash that generates lower ROE than treasury yields is nothing short of financial hara-kiri.

6.  Recently a new kid on the block – Rossari Biotech trading at 80 PE acquired Unitop Chemicals trading at 10 PE (just an example). But ITC is the only generous and philanthropic organisation that itself barely manages to trade at 19 PE but acquired Sunrise at 38 PE. So much for its negotiation ability and size leverage.

7.  ROCE of ITC has been dramatically falling. In just last 5-6 years alone the ROCE has declined from 50% to just 29%.

8.   With a consistently falling EPS and ROCE the cash generation will likely not keep up with the abysmally low shareholder expectation of atleast earning dividends that match treasury yields and ITC will be forced to dip into their cash reserves thereby weakening the only reasonable moat around their balance sheet.

 

Hotels

This division can single handedly bring the entire ITC down. Someone from the industry recently informed me that ITC keeps building hotels because one (deceased now) earlier Chairman liked hotels. Wow that’s some real compelling investment argument to destroy shareholder wealth. ITC hotels hasn’t been able to develop its own distribution network in so many years and relies on Marriott and Preferred for its booking engine and loyalty program. And it talks of creating a world class brand.

Allow the powers that be in the hotel division to raise funds, deal with financial institutions, consider capital an expensive and rare resource and then make investment decisions and only then gloat in the glory of making green hotels and winning global awards. Every investment and every new hotel would then seem like a wasteful expenditure. But then the past Chairman liked hotels……..

If managers don’t have the ability to raise and manage capital and understand the concept of ROCE, then either the managers need to be replaced or the businesses sold off.

Rather than trying to acquire Oberoi hotels (through the present 14% ownership) for the purpose of empire building, ITC should sell their hotels to some global hospitality chain that has the edge of a superior global brand recall and a distribution network. That indeed would be value accretive for shareholders.

All the We-assure and the marketing campaigns that the hotel division indulged in couldn’t prevent an outbreak in the Chennai hotel when the entire hotel had to be shut down. Marketing is good, but gimmicks are misleading especially in the face of the ferocity of Covid-19.

If hospitality was a separate division, the mettle of the managers would have come to fore and perhaps the expression “house of cards” would be exemplified if they would have had to raise working capital through ECLGS, deal with financial institutions, institute meaningful salary cuts and worry about cash to sustain rather than dip in papa’s pocket whenever money runs out.

Can we – the minority shareholders know the equity invested and ROE (return on Equity) only in the Hotel division alone please?

The segment assets of 6,525 Crores (post an approx. 30 yr opportunity cost) tantamounts to approx. equity worth more than approx. Rs. 50,000 crore destroyed in hotel division alone. And we aren’t even talking of Capital Work in Progress that will further erode the shareholder wealth. This money over 30 years with any half-wise capital allocation would have added atleast Rs. 2-3 lac crores (26 – 39 billion USD) in market cap alone

 

FMCG

Agri business grew at 23% for the year but the EBIT that should have grown better or more only grew at 11% resulting in EBIT margin going down from 8% to 7% (Poor operating leverage). Does that mean that there is a possibility that Agri margin is being sacrificed to prop up the margins of FMCG business through transfer pricing tricks thereby misleading shareholders?

Or does this mean that the company has no clue or understanding or internal controls to increase operating leverage??

 

FMCG - Peer Group Comparison

Now if there was a my-baap in ITC these numbers would have been treated like murder – but we have no doubt that the powers that be in the FMCG division would not only have got ample pats on their backs but also huge increments and ESOPS (needless to say – value destructive for minority shareholders) 

 

All Hope isn’t lost

 

While much has been debated about ITC’s strategic decisions on business ventures, capital allocation and performance of the businesses, all hope is not lost as company can alter its approach and enhance shareholder’s value through a few short term and long term initiatives which are presented below –

 

1)  Hotels – While company has created admirable properties across India, The present management neither runs these with any sense of ownership (would have been reflected in the numbers else) nor do they take decisions that are prudent in the interest of shareholders.

 

Due to the evolving dynamics of the industry, hotels are not value accretive as these have very long gestation periods. Further, the pandemic has grounded even the most ardent believers of face-to-face meetings and have compelled them to adopt the ‘new normal’ of Zoom and WFH, and this trend will permanently impair business travel as demand side will dramatically drop.

 

The pandemic provides a great opportunity to sell the hotel division ‘NOW and HERE’ rather than continuously bleed the consolidated B/S and putting good money after bad.

 

If the wishes of the past chairman are so dear, then reimagine the division to make it profitable and figure out WHY (do we exist), HOW (will we prosper) and WHAT (needs to be done).

 

Value Unlocking:

 

a) Demerge the business which will bring financial discipline and bring more accountability as mentioned earlier

Or

 

b) REIT - Develop a REIT structure, divest stake in the business to a global alternate asset manager who is looking to lock capital for a longer period to time. All the owned assets can be transferred to a separate trust and properties could be leased back at an attractive yield. Not only would this make the managers accountable, as they would have to earn to pay the lease, but also this would unlock the shareholder equity to the tune of approx. Rs. 25,000 crores and thereby become an efficient Operating Company (OpCo)

Or

 

c) Sell all the owned assets to strategic players i.e., global hotel chains to focus on Cigarette and FMCG business.  

Or

 

d) Become a Property Company (PropCo) and get some of the best global operators to manage hotels

 

2)  FMCG – Building FMCG companies from scratch can take years. The company has done a commendable job in building some widely recognized brands by channelizing its strong distribution network. However, ITC has high volume and low margin businesses, and products are largely ‘Me too’. If the company were to achieve Rs. 100,000 crores target by 2030 (Vision statement) the top-line of FMCG should grow by ~23% in the face of cigarette sales degrowing by 5% YOY over the decade which is much higher than the present 13% growth rate. But I am sure ITC is managed by magicians and this growth wont be hard to achieve. We have faith in the magical powers of the executives but pls don’t behave like a minister who recently, famously said – “don’t go into numbers and don’t do math” have faith.

 

Tatas, Ambani and Damani are all getting into D2C and private labels to create an edge. Use the power of your network to take advantage of the large fortune at the bottom of the pyramid rather than wasting time selling some expensive chocolate that will remain unprofitable. If ITC doesn’t evolve or acquire (not at Sunrise valuations) some new-age businesses, it faces an existential crisis in the modern well connected e-world.

 

Strategy:

 

a)  Product Innovation/Creation of category: Stop being a me-too company through Yipee and Sunfeast biscuit. Create a new game-changing category.

 

Tell me the second man on the Moon and the Everest – no one knows them. And ITC should stop being a distant No.2. Unless ITC gets its mojo to create and sustain a category, it has no future.

 

b)  Spotting trends early: While market share gradually shifts from unorganized to organized, it is a multi-year process and this seldom results in high margins. Few of the interesting areas that look promising are Frozen food market, Adult Health & Nutraceuticals, Cosmeceuticals etc.

 

c)   Geographical Diversification: ITC is ITC – don’t allow regional players such as  Adani Wilmar to weed you out. Get your act together or you wont exist.

 

d)  Contract Manufacturing:  Demonstrate the power of the ITC brand to outsource a large %age of products to contract manufacturers and free up capital. ITCs incessant desire to do all-by-myself is hurting its shareholders.

 

3)  IT Services -  Demonstrate the ability to become the Larsen and Toubro Infotech or stop pretending to be an IT company and allow the super-efficient Board to be distracted. There is no way that ITC Infotech can ever become anything meaningful or it would have already become.

 

4) Cigarettes and general – As the capex requirements are complete, the company should return the money to the shareholders in form of buybacks. Rs. 60,000 crores buyback can be planned for next 6 years, utilizing existing bank balances and the rest through borrowing. Theoretically, if the earnings yield is more than the post-tax borrowing of the company, the company should do a buyback until such time that palatable debt is reached. Debt magnifies RoEs and buyback reduces the equity base, both done today maximizes returns for shareholders.

 

But that would mean sacrificing a bit of control to BAT – but Boards that mean well for the company and its shareholders think beyond the virtues of selfishness and control freakery.

 

Overall -

 

1) Selling Non-core assets – Small business should be sold or shut down. Stakes held in other hotel chains should be sold at optimal valuation as of yesterday.

 

2) Shareholder Communication – Company of this size should have analyst concalls, provide definitive guidance on the numbers. (the way Infosys does)

 

3) CAPEX Guidance – Company of this size should declare its capex plans so that it can be built in pricing of financial models.

 

And above all -

 

4) Appoint Minority Shareholder Directors – The company should onboard an eminent small shareholder director with a relevant experience so as to amplify the importance of retail shareholders as well.

A family can never be fatherless. And if it is – the minority shareholder should become the deemed one.

When someone posts an opinion or an article on ITC, the emotion and response that it generates is overwhelming. If the true meaning of Stockholm Syndrome needs to be understood, delve deep into the mind of an ITC shareholder – That’s the Enigma of ITC. 

During my hospital visit to look upon someone some years ago, I learnt that the ECG monitor of a dead person is just a straight line. ITC stock price graph reminds me of that line I saw years ago because the price is more stable and straighter than that line.

Long live ITC…..

Twitter https://twitter.com/manurishiguptha

10 Blunders - 1 Arrogant Company - Millions of Shareholders Suffering (The story of ITC)

 

Dear Board Members,

As a minority shareholder while I sift thru the 368 page Annual Report (AR) of my company, it seems and appears to be a manifesto of a large political party that is proud of what its done in the past and what it hopes to do even if nothing sounds or appears to be value accretive for the shareholders. 

Markets are wise and perceptions are strong and the 1.5 million investors who have reposed their faith and trust in you, seem to be losing the confidence in Your leadership. Else ITC that was once the most respected company wouldn’t have performed so miserably on the bourses inspite of the 368 page chest thumping manifesto.

I must say you are failing miserably while sitting in the comfort of your mahogany and leather lined offices, a mutual appreciation club of 14 people presiding over an annual revenue of over 50,000 Crores each one building large personal empires thru generous grant of stock options and over the top compansation while I am seeing my wealth erode by the hour.

ARE YOU ANSWERABLE?

The unbridled power that you wield without being questioned by a real promoter / entrepreneur has spelt a real disaster as I fear that my company is being taken on the same self destruct path that General Electric, Nokia, Blackberry and Exxon Mobil have been taken in the last 2 decades and the less said the better as to how value destructive this journey has been for them because there was no one to shake up Jack Welch at the right time (he became the greater God without being one). For way too long these companies and their respective managements suffered from Hubris not able to see a fast approaching train while being frozen on tracks, not able to course correct - eventually leading to their demise. 

While I will ask some specific questions, the crux of this note is that if you cannot protect my wealth thru the alleged magic of your strategy and leadership – You don’t have the moral right to hold these positions and lead my company.

ARE YOU ANSWERABLE?

The First Blunder 

The biggest blunder of diversifying into hospitality and continue to burn cash and capital in this black hole using cash generated by the cigarette business (which is the only meaningful cash flow division) is nothing short of financial hara-kiri on minority shareholders. You have acted no differently than most of real estate developers who want to own a hotel / hotel chain from their free cash flows because its sexy to own one when it’s the most unprofitable industry and most susceptible to economic mood swings. 'Dala Bhukara' is fine – I appreciate it and love it too, You should have stopped at that, but then it was simply stupid to burn thousands of crores of my money by assuming that every hotel will be as successful as dal bhukara. I would like You to share with the public – Who is advising you to spend thousands of crores of shareholder wealth to build these large hotels (and overspending on most of these).

Who (employee or consultants) is regurgitating on excel sheets - the potential of new hotels and how are these people made accountable? The AR must include a detailed P&L and BS of each of my subsidiaries hereafter clearly mentioning the ROCE on a quarterly basis.

At Rs.17.9 lacs revenue per room per annum of revenue you have missed the bus of being any formidable hospitality brand even while you can't stop gloating on all the award and accolades that the hotel division has got. Mind You - most of these are all subscription based awards (awards and accolades is a paid international scam at the cost of the hospitality industry) the sooner we realize this the sooner we will stop burning cash. I would like to know how much money has been burnt in annual subscription of these awards.

ITC Grand Bharat with 104 keys is generating a mere revenue of 28 Cr p.a, that’s is lesser than some successful Lemon Tree Hotels on a revenue per key per annum basis.

It is pertinent to ask what’s the spend per key of all the hotels that have been built grounds-up in the last 10 years. If it is anything more than 2 Cr per key (all in) there is something dramatically wrong with our projects team and financial forecasters. How many hotels have performed in line with approved financials from the time of board sanction of these projects within the next 5 years. This is an important analysis that You should seek and make the same public.

ARE YOU ANSWERABLE?

The entire rigmarole of Fortune Hotels with 4000 rooms is generating a mere profit of 2.76 Cr – who is responsible for this and why is this abysmal performance being tolerated at my cost?

Welcome Heritage does a NP of  a mere 40 lacs with 36 hotels , 900 rooms and the management bandwidth at my cost.

Which international brand / concept are we benchmarking ourselves against to justify our investment in the business and which of my employees has his/her skin in the game in this business and how is the executive compensation tied to the performance of the Hotel Division.

ARE YOU ANSWERABLE?

The Second Blunder

Small irrelevant businesses that we have ventured into must be taking immense bandwidth and time (board meetings, audits, finalization of accounts, consolidation) why are we in the businesses such as Antrang Finance that generates a mere 6 lacs a year. I would like to know the details of every business / subsidiary that generates less than 50 Cr of NP after taxes. In the scheme of things and larger objectives there should be a board resolution passed that defines / disallows continuity, if certain thresholds aren’t met by any subsidiary.

The Third and Series of Blunders

Our acquisition history and parameters are abysmal. That eeks of internal misjudgements. I might not need to tell you that a series of these judgemental calls, gone wrong with alarming regularity, might be perceived to be fraud. Nimyle, B Natural, Savlon – have you ever calculated the price paid for acquiring these businesses and the value accretion/destruction that these businesses are doing for me. Your endeavor to build on these brands might be noble but the subsequent performance is abysmal.

Enron wasn’t a fraud at the beginning , But they lost their way alongside because they didn’t know when and where to diversify and how to wisely allocate capital and burnt cash and rapidly eroded shareholder wealth. Don’t take my company down that path or history will find it difficult to forgive You.

When I read about the ITC Sangeet Research Academy I couldn’t stop laughing for 5 minutes. The cacophony of the music of frustration is still ringing in my brain. While I would like to know the total cumulative annual spend in this musical initiative since 1977, I kept wondering that the music for all the gurus and the budding musicians is playing fine while the music for the shareholders is dimming with an alarming speed or might already have stopped a few years ago. What a paradox..

BECAUSE YOU ARE ANSWERABLE

The Fourth Blunder

The FMCG division launched in 2000 generates just 3-5% PBT, thats a meagre 6% segment ROE (vs >35% of other FMCG players) – put Your hand on your heart is this justified. The QOQ and YOY narrative, propagated by You that 'we are becoming a global FMCG brand' is fine – how is it value accretive for me – because our operational performance is miles short of our competitors.

Are our employees lackadaisical and suffering from sloth because they don’t have a real BOSS or there is something drastically wrong with our strategy and execution. How have we benchmarked ourselves against the top 5 competing FMCG companies?

I would like to know if the salary growth of all the people earning over 35 lacs per annum is directly correlated to Revenues and EBIDTA of those divisions and if NO – it tantamounts to the very premise where we begun – My cash business is being used to fund the inefficiencies of the entire company without a credible benchmarking against other brands / businesses that are doing well. How are we different today from an inefficient PSU. 

The so called Dividend Yield is a paradox - How would You justify the same to investors who entered the stock on ~14th July 2017. Yes agreed i am getting some 7-10 Rs a year in dividend while losing a major part of my capital. 

The Fifth Blunder

For a Balance Sheet of my company’s size you have failed repeatedly to disclose Your CAPEX plans and capital allocation plans in advance – isn’t that taking the executive power to a level of unsanctioned discretion? While I am suffering with my capital erosion you guys are building personal empires of reputation and brand building.

ITC Infotech @ 2300 Cr per annum of revenue and single digit PAT must be the most underperforming IT company in the country. Do we take pride in investing businesses that underperform and continue to make the shareholders believe that the future is bright (why has the board not thought of divesting this and all such small divisions) and if NO – what’s the boards commitment on revenues and PAT in the next 5 years for this company.

The Sixth Blunder

You recently acquired Sunrise at approx. 3.7 X the FY 1920 revenues of 591 Cr at a PE of 37.

How does this deal add to my geographical diversification? How is this value accretive to me? And why would you pay this valuation when you aren’t able to sustain a 15 PE for my company? How did the board approve an acquisition at 37 PE while struggling to keep my valuation even at 15 times.

Why could we not expand our own spices division to strategically expand our geographical reach with internal talent and resources and had to go thru the path of an expensive acquisition.

Norway’s food major Orkla acquired Eastern Condiments (almost double the size of Sunrise) at 2.1X Sales and at 18.5X earnings. Which team was responsible for the due diligence of Sunrise and it would be in the interest of the shareholders if the negotiation documents and files are brought out in public domain.

For a minority shareholder watching from a distance, this is nothing short of an internal fraud. If my company is receiving Outstanding Performance Award by CII for its spices, does our management not have the wherewithal and talent to setup and expand our products’ geographical reach rather than paying a hefty premium just to capture a market share.

ARE YOU ANSWERABLE?

The Seventh Blunder

The executive compensation keeps going up and shareholder wealth keeps coming down. It’s a shame that in the last approx. 12 years the revenue has gone up from 16000 Cr to 50000 Cr and the employee cost is almost stagnant at 9% or has marginally inched up. Where is the operational leverage? Where is the demonstration by the management to incrementally and geometrically increase revenue and thereby profitability for every additional crore spend in Executive Compensation?

Some of the most progressive companies on the planet (such has Amazon) have a cap on executive compensation at less than 160000 USD per annum and all additional comp is through stock awards.

Our compensation system acts as a disincentive for executive outperformance and in the absence of a real my-baap of my company, I – THE MINORITY SHAREHOLDER am suffering.

In 12 years the revenues are up approx. 3.12 times and employee cost is up 3.26 times. And most likely the perks, hidden benefits, Pension Plans, Travel Plans, Drivers, Cars, Leave Encashments are not even a part of this metric. I would like a declaration / system – where every penny spent on every employee is a function of CTC that’s declared and filed without any benefit being accrued under any other account head.

Do you – dear Board Members understand the concept of operational leverage?

ARE YOU ANSWERABLE?

The Eighth Blunder

Our stakes in EIH and Leela have a MTM loss of approx. 1250 Cr in just one last FY. What's the rationale in holding onto these investments when we don’t really know how to manage our own hotels in the first place or make them world class by any stretch of financial performance. Not a single rupee should be allowed to be invested in the hospitality business to fund losses or any further CAPEX. And every business balance sheet should fend for itself for its OPEX and CAPEX without dipping into our cash generated from the primary business – Cigarettes.

The Sri Lanka investment of 1800 Crores (~236 M USD) so far, baffles me as a shareholder. And I understand that the project is far from complete. Who are we building this empire for and how will we get our investment back? Do You have a plan besides just an excel sheet to justify this black hole.

ARE YOU ANSWERABLE?

The Ninth Blunder

Our abysmal ability to engage with capital markets / investors / analysts is nothing short of abject neglect (no mybaap syndrome). If you had succeeded in creating any mentionable shareholder value – this attitude is pardonable. But while You are all doing exceptionally well, with your compensation and hefty sitting fees and perks, the lack of investor and market engagement is taking me and my shareholding for a ride. Why cant we have a mature set of professionals who have the knowledge and the art of engaging with investors and the media.

ARE YOU ANSWERABLE?

The Biggest Blunder

You are conducting an average of 41 committee meetings a year. Take out the weekly offs and holidays, You are meeting approx. every 5^th day. FOR WHAT? And what are you achieving for me? Except strategically destroying my wealth and value of my shareholding at my cost and charging exorbitant sitting fees? Gentlemen the average age of my board is approx. 65.6 Yrs. God give You all a happy healthy life but don’t treat my company like a retirement resort.

You talk of Triple Bottom Line repeatedly trying to be the 'pallbearer' of goodness – While every section of society gets a mention – the shareholder is left out of that focus - high and dry. If I was on Your mind – You wouldn’t waste a single rupee in reputation management through charity and social activities and alleged multiple bottom-line spiel till the interest of minority shareholder is protected and demonstrably served.

While every corporate house has declared salary cuts in view of the pandemic – there is no evidence of any salary cuts in my company. on the contrary you have recently chosen to reward yourself for destroying shareholder wealth. Is that morally and ethically correct even while the latest Tax filings reveal that our advance tax returns are lower by almost 50%. That portends that the Net Profit is likely to fall dramatically - At whose cost?? – MINE!

Another large conglomerate / business house indulged in empire building, international acquisitions at obnoxious valuations, over leveraging, failed product/car launches all at the cost of minority shareholder and to sate the ego of a few top guys in position of authority and they have reached a precipice of existential crisis.

Its becoming increasingly irritating to be repeatedly reminded through media, about the deep value and future potential of my company under Your leadership – Lets stop behaving like the state that talks of glorious vision in year 2050 (safe distance away) – because by that time none of us will likely be alive. Its not to take the credit away for many good things that are happening in my company but pls remember Good is not Good enough because we need to be Great. I must confess we are far from Great and not even looking in that direction.

Pls get Your act together and don’t allow my company to get to a point of no return. A few more mistakes and a little more neglect – And you would have succeeded in destroying one of the finest companies in the country to a mere HAD BEENS…… Remember markets are unforgiving and it would take no more than a few quarters to get our share-price to double digits.

God Bless You and God bless ITC

A distraught shareholder…………

Co authored with 
Ravi Sharma @caraviusharma ; https://www.linkedin.com/in/ca-ravi-u-sharma-65901b97/
Uday Bhaskar https://www.linkedin.com/in/uday2210/