PPFAS Bharti Airtel Buy - Genius or Gamble? 

As a dedicated value investor, I closely follow the strategies of other prominent investors in the field. In India, PPFAS is a name that immediately comes to mind when discussing value investing.

Recently, while researching PPFAS's latest stock acquisitions, I discovered several reports indicating their significant purchase of Bharti Airtel Ltd. shares.

The fund has acquired nearly 2 crore shares, valuing their current holding at approximately ?4,000 crores.

While this position isn't exceptionally large for the fund's size, it's certainly not insignificant. Also, it doesn't matter anyway. Because the true essence of value investing lies not in a stock's portfolio weight but in the company's fundamentals.

Bharti Airtel's historical performance has been notably volatile.

Between FY16 and FY25, its net profits fluctuated wildly, from as low as ?1,700 crores to as high as ?37,481 crores. This dramatic swing, coupled with substantial losses of ?30,000 crores in FY20 and ?12,000 crores in FY21, makes it challenging to ascertain the company's sustainable earnings potential.

Beyond the volatile earnings, another significant concern is Bharti Airtel's highly leveraged balance sheet. The company's debt-to-equity ratio has consistently exceeded 2x, meaning it carries ?2 in debt for every ?1 in equity. This is considerably higher than the "safe zone" of below 1x.

Furthermore, the stock's valuation doesn't suggest a compelling buy. Bharti Airtel trades at a Price-to-Earnings (P/E) ratio of almost 34x-35x, which is far from cheap. On an EV/EBITDA basis, its current multiple of nearly 13x is also higher than its long-term median of 9.5x.

Considering these factors - volatile earnings, high leverage, and elevated valuations - it initially seemed unlikely that a value investor, particularly at the current stock price, would invest in Bharti Airtel. This led me to ponder: What did PPFAS see that I might have overlooked?

I believe two key factors might have driven PPFAS's investment despite Bharti Airtel's seemingly below-average fundamentals:

1. The strength of the company's cash flows.
2. The prospect of a significantly improved future for Bharti Airtel.

Let's delve into the first reason: strong cash flows.

Consider these impressive figures: ?50,000 crores, ?55,000 crores, ?65,000 crores, ?80,000 crores, and ?1,00,000 crores. These represent the cash flow from operations that Bharti Airtel has generated over the last few years. While the company has struggled with consistent profit growth, its cash flow generation has been remarkably steady. These strong cash flows have enabled Bharti Airtel to reinvest in its business, cover interest expenses, and even pay generous dividends.

As long as these robust cash flows persist, Bharti Airtel should comfortably meet both its capital expenditure needs and the interest payments on its substantial debt.

This brings me to an important metric: free cash flow yield.

To calculate free cash flow, you subtract the total capital expenditure for the year from the company's cash flow from operations. Then, divide this free cash flow by the company's market capitalization to arrive at the free cash flow yield.

For example, if a company has a cash flow from operations of ?100 crores and capital expenditure of ?50 crores, its free cash flow is ?50 crores. If its market capitalization is ?1,000 crores, the free cash flow yield is 5% (?50 crores / ?1,000 crores).

Think of free cash flow as the cash available to the company for either dividend payouts or debt repayment. Many investors prefer using free cash flow yield over the P/E ratio because it offers a clearer picture of how much cash a company generates after covering its capital expenditure and working capital needs.

Consistently negative free cash flow, even with positive earnings, is a red flag. Conversely, consistently positive free cash flow indicates a profitable company generating surplus cash that can be used for dividends or debt reduction.

Here's an interesting observation: I created a model portfolio of 20 stocks from the top 100 companies by market capitalization, selecting those with the highest free cash flow yield.

This portfolio delivered a Compounded Annual Growth Rate (CAGR) of 24% over five years, significantly outperforming the BSE 100 index's 15% CAGR. Between 2020 and 2024, this simple, annually rebalanced portfolio effectively tripled investor money compared to the benchmark's twofold return. That's the undeniable power of free cash flow.

Let's reiterate the formula:

Free Cash Flow Yield = Cash Flow from Operations - Investments in Fixed Assets upon market capitalisation

As a rule of thumb, avoid companies with a free cash flow yield of less than 3%. Investing in stocks with a yield of 2% or 2.5% often means you're paying too much, increasing the likelihood of underperformance.

So, what about Bharti Airtel's free cash flow yield? It currently stands at around 3.5%.

Since this is higher than our 3% threshold, the risk-reward profile appears favorable for Bharti Airtel investors. A portfolio of 20 large-cap stocks with free cash flow yields of 3.5% or higher has a good chance of outperforming the benchmark index long-term.

While my backtested portfolio included exceptions with yields as high as 10-12%, Bharti Airtel has a strong chance of being a component of a high free cash flow yield portfolio today.

Therefore, Bharti Airtel's attractive free cash flow yield likely compelled PPFAS to consider it for their portfolio.

The second major reason supporting Bharti Airtel is the potential for a significant improvement in its future fundamentals.

• Average Revenue Per User (ARPU), a crucial metric for Bharti, has steadily risen over recent quarters.
• There's further room for tariff hikes as 5G adoption grows and market competition stabilizes.
• Capital intensity is expected to decrease, with capital expenditure projected to fall from approximately ?40,000 crores to ?30,000 crores.
• The Indian telecom industry has largely consolidated into a near-duopoly, dominated by Bharti Airtel and Reliance Jio.

Thus, Bharti Airtel's appealing valuations from a free cash flow yield perspective, combined with improving fundamentals, likely pushed PPFAS to invest in the stock.

It's quite possible their assessment proves correct, as I've outlined here.

What are your thoughts? Do you believe PPFAS made a safe bet with Bharti Airtel, or have they taken on more risk than usual? Share your opinions in the comments section.

This will be all from me today. I will see you again in the next session. Good bye and happy investing.