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Can PVR Do a PayTm or Nykaa in 2023?

Nov 28, 2022

Can PVR Do a PayTm or Nykaa in 2023?

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.

A stock with a cross against its name on any of these 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 stock with a cross against its name on all these three parameters? In other words, a stock that is trading at exorbitant valuations, is loss making and also has high leverage.

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

Recently, I ran a test to identify such stocks and one of the names that popped up was the multiplex major, PVR Ltd.

Yes, you heard that right. PVR Ltd seems to be having a valuation problem, a debt problem and also a business quality problem. Thus, it satisfies all the three conditions of an underperforming stock.

Let us understand in more detail by starting with valuations.

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.

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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 at current price stands at close to 50x. Thus, the stock is 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.

Last I checked, 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.

My last filter 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. 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.

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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 is about to be 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 a PE of almost 54x.

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

Therefore, the stock is almost twice as expensive 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, the stock may not go the PayTm or the Nykaa way and crash big time from its highs.

However, any strong upside doesn't look likely either given how a lot of expectations seem to be already built into the share price. Therefore, caution needs to be exercised to that extent.

Happy Investing.

Warm regards,

Rahul Shah
Editor and Research Analyst, Profit Hunter

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