Burnt! Investors Who Ate This Pizza When it was Too Hot

Sep 28, 2016

In this issue:
» Qualified Institutional Investments in vogue
» India finally getting in the competitive groove
» ...and more!
Madhu Gupta, Research analyst

The gravity-defying stunts of a trapeze act are a visual treat.

As the acrobats swing from one bar to the next in perfect synchronisation, we are spellbound by their fearless agility.

However, crucially, a safety net shields them from the grave risk.

Just as a safety net saves the acrobat from sure death, margin of safety protects the equity investor from sure ruin.

Investors in Jubilant FoodWorks Ltd (JFL) surely appreciate this. They recently burnt their fingers when the stock eroded half of its value from last year's peak.

JFL has been grappling with a slowdown in consumption in the past three years. But falling profitability and high profile management exits in quick succession have proved to be the proverbial last straw.

JFL pioneered time-bound pizza delivery in India and is the leader in the organised pizza market. Armed with the largest global pizza brand, Domino's, and a business model that does not require big investments in retail outlets, JFW has been able to swiftly scale up its operations and expand its presence in the quick service restaurant space.

This, along with a robust supply chain, led to optimal resource utilisation with minimal reliance on external debt. As a result, the company was able to deliver good shareholder returns and commanded hefty valuations.

And that's when the company lost the plot...

As a matter of fact, the company's aggressive expansion is now proving to be its Achilles' heel. The relentless pace of growth is being blamed for pulling down profits, same store sales growth, and business returns.

Moreover, the attraction of the company's robust delivery model is waning with the entry of several delivery-based applications that offer a wide range of eating options.

Fingers are also being raised at JFL's other acquired franchise brand, Dunkin' Donuts. This franchise has not been able to add much to the company's growth as the brand remains niche with limited consumer appeal.

With existing brands already struggling, JFL's plans to launch a homegrown restaurant brand have fallen flat. And the mounting stress has recently led to many high profile exits. In July 2016, the company' chief financial officer left followed by the more recent resignation of its chief executive officer. A cloud of doubt has been cast over the company's governance.

Needless to say that in a rapidly emerging technological landscape, no business is invincible. Investors need to be extra careful investing on the basis of the future growth prospects of a business. A seemingly rock solid moat can melt away, draining the company's strength as business dynamics change.

No one can accurately predict the future all the time. As investors enter stocks trading at hefty valuations in the hope of gaining from a further rally, they risk flying too high. And to protect their fall, investors should never ever lose track of the margin safety net.

Only margin of safety can absorb a fall from unforeseen slip and help investors retain at least some of their initial investment.

Warren Buffett owes his spectacular success to margin of safety. Here's how you could make this approach work for you too...

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02:45 Chart of the day

The last three years have seen quite a surge in qualified institutional placements (QIPs). While 2016 started off on a poor note, the month of September alone has seen Rs 32 billion raised through 6 issues. Infact, an article in the Economic Times highlights that Indian companies are expected to raise Rs 100-120 billion through QIPs in the next few weeks. Liquidity in the market is one big reason for the increasing appetite for QIPs. Most promoters believe the valuations also to be fair and are capitalising on the opportunity to raise funds through this route for immediate spending needs and also to clean up their balance sheets. Also, QIPs tend to be a faster way to raise capital as the dealing happens with a few investors - only institutions in this case. And this is why companies prefer this route - because of its convenience and less resource requirements when compared to other methods of raising equity.

Banks in particular have been keen on raising funds to shore up their capital in an environment where the asset quality risks in the banking sector have risen. Even for the other sectors, as investment activity picks up, capex will see a revival too. Thereby, supporting the case for a rise in QIP activity in the coming quarters.

QIPs Are Making a Comeback


When it comes to competitiveness, India seems to be making rapid strides. Indeed, as per an article in Business Standard, India jumped 16 places to the 39th rank on World Economic Forum's (WEF) Global Competitiveness Index in FY17. This is for the second year in a row. The performance has been judged on three parameters - basic requirements, efficiency enhancers, and innovation and sophistication.

As far as basic requirements go, improvements were seen in institutions, infrastructure and the macroeconomic environment. On infrastructure specifically, India's ranking improved to 68 (81 last year).

The improvement in institutions has largely come out on efforts taken to curb corruption, and also those by SEBI to enhance corporate governance standards and protect the interest of minority shareholders.

Other areas where improvement was seen was relaxation of FDI norms, and labour market efficiency. Of course, India cannot rest on these laurels and there is a lot in all these areas that still need to be done. But the jump in the competitiveness ranking is, nevertheless, a big boost.


In the meanwhile, after opening the day in the red, buying activity picked up in the subsequent hours and pushed the Indian stock markets into the positive territory. Sectoral indices were trading firm with stocks from the metals and auto sectors leading the gains. At the time of writing, the BSE Sensex was trading up 84 points and the NSE Nifty was trading up 37 points. The BSE Mid Cap and the BSE Small Cap indices were trading up 1% each.


"What we learn from history is that people don't learn from history." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Madhu Gupta (Research Analyst) and Radhika Pandit (Research Analyst).

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