PVR INOX: Has the Correction Created a Big Opportunity? 

Hello everyone, Rahul Shah here, trying to make investing accessible and profitable for the average investor.

Well, before I start today's session, let me take a few seconds to pat myself on the back.

Now, this pat on the back is because I had made a prediction a few months back in a piece that I wrote on the Equitymaster website.

The link to the piece is given in the description box below.

Anyways, the key takeaway from the piece was that from a risk-reward perspective, the share price of PVR-INOX doesn't appear to be too favourable. Put differently, I had predicted that the share price of PVR Inox had a strong chance of going down than going up in the current calendar year i.e. 2023.

The piece went live on November 28, 2022. The stock was trading at a price of close to Rs 1,900 per share.

As I record this video, the stock is trading at a price of Rs 1,400 per share. This means that the stock is down more than 25% in six months which I believe is a considerable fall.

So, this pat was essentially for getting the prediction right at least till now.

Anyways, investing is a field where it is almost impossible to be right 10 times out of 10.

Which means I also have predictions which have not worked out well.

But I try to be right at least 6 times out of 10 and am happy to get this one right.

Moving on to PVR Inox, what makes this fall even more noteworthy is that the broader stock market has been flat or has gone marginally higher during the same period.

So, it is not as if the entire market is down and hence PVR Inox is also down.

The entire market has been holding up quite well. Therefore, the fall has to do with challenges facing the company or the company's own fundamentals than the broader market sentiment.

So, what are these challenges? And more importantly, has the risk-return equation turned favourable after the 25% fall from the top?

Let's find out.

Let us talk about the challenges or the business fundamentals first.

What are the different ways in which you think a stock can underperform?

Well, if you ask me, there are 3 ways this can happen.

A stock can underperform either because of exorbitant valuations or consistent losses or even high leverage for that matter.

Think of it as a student who has to clear three subjects in order to be called a smart or an intelligent student.

If he fails in any of these subjects, he will not be termed as smart.

Likewise, a stock with poor marks or poor grades in any of these 3 parameters, is a dangerous stock to own.

It can underperform, perhaps in a big way, and put your overall returns at risk.

Now, what about a student who fails in all the three subjects? He will certainly not have a good reputation, isn't it?

Likewise, what about a stock that is trading at expensive valuations, is frequently loss making and also has a high amount of debt on the balance sheet?

Shouldn't one stay away from such stock at all costs? I certainly think so.

You see, some time back, I ran a test to identify such stocks. One of the names that popped up was the multiplex major, PVR Ltd.

Yes, you heard that right. Back in November 2022 when I wrote the piece, PVR Ltd had a valuation problem, a debt problem and also, a profit problem.

In other words, it was a student with poor marks in all the three subjects.

Let us understand in more detail by starting with valuations.

I believe that it is difficult to make money on a consistent basis if you buy stocks with a PE multiple of 40x or more.

You may get lucky with a few stocks. But to consistently pay high PE multiples is a recipe for below par returns in my view.

Is PVR currently trading at a PE of more than 40x? No.

The stock is currently loss making and has a negative PE ratio which is not good either. It means that the company is struggling and has run into rough weather.

Thus, PVR can certainly be called a dangerous stock based on its negative PE ratio.

In case you find this unfair, please note that the highest EPS the company has recorded was in FY19.

Even on this high EPS, the PE ratio back in Nov 2022 stood at close to 50x. Thus, the stock was expensive based on its all-time high EPS as well.

A high debt to equity ratio is another big red flag for me.

Companies that load their balance sheets with more debt than they can handle, are constantly flirting with danger. They find it difficult to tide through tough times.

Based on FY22 numbers, PVR had more than Rs 5,000 crores of debt on its balance sheet against an equity of close to Rs 1,400 crores.

This is certainly on the higher side and well above what I consider to be the danger mark of 1x.

Upon closer inspection, Rs 3,700 crores out of the total debt of approximately Rs 5,300 crores consists of lease liabilities. This cannot be termed as debt in the true sense of the term.

But even if you exclude this, the debt is still higher than equity, albeit only marginally.

Thus, PVR still can't escape the tag of being dangerous based on the debt-to-equity ratio.

The last parameter is about whether the stock under consideration is running a profitable operation in the present.

I am not interested in future promises of profitability. If the stock is loss making currently or has recorded losses in a minimum of 2 years over the last five years, then it is a big red flag for me.

PVR has recorded losses in both FY21 as well as FY22, thus once again finding itself in the list of dangerous stocks, this time based on profitability.

Of course, one can be lenient towards the stock as FY21 was a terrible year for the industry due to the Coronavirus pandemic. However, a loss in FY22 as well as over the last 12 months, does not augur well for the long-term fundamentals.

Which is why it doesn't make sense to give the company a clean chit on this parameter.

So, there we are. Three parameters of valuation, debt and profitability and PVR Ltd finding itself at the receiving end of all three.

If the stock would have had one cross or even two crosses against its name, I wouldn't have labelled it dangerous.

However, having three crosses i.e. failing on three important parameters, is not a good sign.

Such stocks should be stayed away from for at least a couple of years if not more.

By the way, did you notice that all my analysis is backward looking? I haven't mentioned a single word about the stock's outlook and future earnings.

Shouldn't this also be considered while deciding whether the stock is dangerous or not? Won't these factors count for something if the stock has a bright future ahead of itself?

Well, the odds are stacked against the company to be honest.

I am of the view that it is difficult to get all the three parameters back on track over a short-term period of 2-3 years.

Let's do some quick back-of-the-envelope calculation to drive home the point.

PVR has now merged with another listed multiplex chain, INOX Ltd.

The two together will now lord over 50% market share in multiplexes and the stock may become one of the rare monopoly stocks in India.

However, size does not necessarily translate into higher profitability. Besides, the starting valuations also need to be considered no matter how good the underlying stock quality.

Our analysis suggests that PVR will dilute a little over 50% of its equity in order to take INOX into its fold.

Considering PVR's and INOX's best profits which they achieved in FY19 and PVR's current share price, the combined entity trades at more than 40x even after the 25% fall in share price.

This is still expensive in my view. The maximum PE that one should pay for a stock like PVR Ltd should not be more than 25x-30x to be honest.

Therefore, the stock is 30%-40% more expensive based on my estimate of its fair value and that too, based on the best earnings of both the firms.

Of course, it is a different matter if the growth over the next few years turns out to be stellar and the combined entity is able to extract synergies way beyond our expectations.

However, investing in the stock based on such aggressive assumptions would be speculative in my opinion.

Therefore, once the two entities merge, the stock may cease to be dangerous based on its debt-to-equity ratio and even profitability.

But the current expensive valuations could ensure that significant wealth creation in the medium term looks like a distinct possibility.

To cut a long story short, any strong upside doesn't look likely even at the current share price, given how a lot of expectations seem to be already built into the share price. Therefore, caution needs to be exercised to that extent.

Let me know what you think of my viewpoint. Also, please do not forget to like, share and subscriber in case you found the video useful.