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This Company Beat the Business World's 'Three Killer Cs'

Aug 16, 2017

In this issue:
» Telecom Sector: A Decade of Underperformance
» Luxury Cars Feeling the GST Heat
» Market roundup
» And more!
00:00
Taha Merchant, Research Analyst

Not one but three 'killer Cs' lurk around the darkest corners of the business world.

If any one of them grips a business, it makes life hell for the managers and profits elusive for the owners. What are they?

The first is 'cyclical'. When a business is cyclical, it sees large and unpredictable swings in its revenues, margins, and profits. Everything that matters is all over the place.

The second is 'capital-intensive'. Businesses afflicted by high capital-intensity require a lot to produce little. They suck investors dry as they need large amounts of capital to make profits.

The third is 'commoditised'. Companies here can do very little to prove to customers that their product or service is better than their competitor's.

The presence of even one of these killer Cs is bad news for a business.

So imagine a business that has all three killer Cs. A sure recipe for disaster!

What if I told you this company exists? Not just that - but this company has been able to do something incredible: It has not had one year of losses in in the last quarter of a century.

You read that right. Twenty-five long years of clean profits year in and year out.

Most companies in much better businesses will never come close to such a record.

The company is The Great Eastern Shipping Company and operates of course in the infamous shipping business.

And trust me, this is one choppy industry. It's a space filled with bankruptcies - both in companies that make as well as operate ships.

So how has GE Shipping managed to pull-off its impressive success story?

If you think about it, the shipping business has many similarities to the stock market. And GE Shipping's success mantra is very close to what we call value investing.

Here's the company's Chairman in a recent letter to shareholders:

  • Shipping is a highly capital-intensive business... As you may have noticed, interest and depreciation, which are directly affected by the capital cost of the asset, constitute almost half of our operating cost base. This shows the key role that the acquisition price of ships plays in our profitability. This leads to critical decisions that the management needs to take on when is the 'right' time to buy (ships)...

    We have done a lot of work trying to identify the right price for different types of assets. In most cases, this coincides with very weak freight markets, which means that charter rates are unremunerative if not lossmaking, i.e., earning a very low or negative current yield. As a result, the purchase decision which is good for the long term is often detrimental to the short term profitability of the company.

    The one possible downside with the value investing method is that there may be significant periods of time when we are unable to invest due to prices not being right. In such times, and with a focus on longer term returns, we will resist the temptation to move from 'low yielding' cash to 'higher yielding' assets.

The same value investing mindset that's helped us deliver rich returns to our subscribers for more than two decades has also helped GE Shipping thrive in the extremely difficult shipping business.

If you're not part of the value investing clan yet, I suggest you join us right away!

Editor's Note: Speaking of value, Ankit has just written about the fundamentals of a contrarian bet he's recently cherry-picked for his readers. If you're not already on his Insider list, click here now to subscribe.

02:15 Chart of the Day

Telecom Sector: A Decade of Underperformance

Speaking of difficult businesses, the whole telecom business has been an underwhelming story so far. While the telecom subscriber base has increased from 300 million in 2008 to 1.2 billion in 2017, investors have little to cheer. The BSE Sensex has gone up 3.25 times in nine years, but the BSE Telecom Index has not moved an inch from its levels of 2008.

Telecom companies are straddled with high debt, intense competition, and lack of pricing power. High spectrum costs and regulatory issues have hampered the sector. While consumers have benefited from low costs and new players fighting for their share, investors have suffered.

With the entry of Reliance Jio, the competition has intensified further. Reliance Jio's low cost offerings and strategy of capturing market share will further dent the sector. The sector has been a classic 'valuet trap'. While it always looks cheap compared to other sectors, it has failed to provide any reasonable returns. We also believe the situation is unlikely to change in the near future. For an investor, it's important to differentiate between 'value' and 'value traps'.

03:30

After cigarette companies, it's time for luxury car companies to suffer. Constant policy revisions related to tax rates post GST have left car makers in a fix. The GST council has proposed to increase cess on premium vehicles from 15% to 25%. This is over and above the 28% GST tax rate. With the increased cess, prices of top luxury cars are expected to go up to Rs 2.58 lakh.

It's been a rough ride for the automobile industry since the second half of 2016. Notebandi affected vehicle sales in Q3 of FY17. Once the sector recovered from the shock, BS-IV compliance presented another roadblock. Once they managed to maneuver these obstacles, a third hurdle came when the Goods and Services Tax (GST) hit in Q1FY18 and has been a problem since.

While GST is likely to benefit these automobile manufacturers in the long run, these constant tax rate changes will hurt the companies in the near future. Some car makers also hinted they will need to review their expansion plans in India. This is likely to affect job creation at the company and dealership level.

With valuations of most companies close to all-time highs, it's important to consider this when valuing an automobile manufacturer.

It is always important to look at the long-term picture. Identify stocks that are a part of the Megatrend, a trend that ignores short-term fluctuations and looks at the bigger picture.

04:45

The Indian stock markets were trading lower at the time of writing. The BSE Sensex is down 20 points and the NSE Nifty is down 12 points. The S&P BSE Mid-Cap and S&P BSE Small-Cap Indices are up 0.8% and 0.7%, respectively. Barring capital goods stocks and bank stocks, all sectoral indices are in the green with FMCG stocks and automobile stocks leading the pack of gainers.

04:56 Investment Mantra of the Day

'When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.' - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Taha Merchant (Research Analyst) and Girish Shetty (Research Analyst).

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