Cloud computing – hugely disruptive

Clouds are fascinating. They come and they go. They acquire a whole new experience if you’ve had shrooms. They appear dancing, fighting, playing, singing all at one like a drama that no real world theatre can replicate.

“Clouds that wander through the sky,
Sometimes low and sometimes high;
In the darkness of the night,
In the sunshine warm and bright.
Ah! I wonder much if you
Have any useful work to do.”

– Anonymous!

Clouds are serious business in India with 40% of population have direct/indirect dependance on agriculture and allied activities and contributes about 16% to total GDP. Rice, milk and wheat are the biggest terms of value (US$90bn, 2013) and its uncertain ways are a cause of massive heartburn across rural India. So much so that agriculture is exempt from Income tax!

My reference here is however to the more invisible type of cloud- Cloud computing. The definition of the term on Wikipedia states “Cloud computing is an information technology (IT) paradigm that enables ubiquitous access to shared pools of configurable system resources and higher-level services that can be rapidly provisioned with minimal management effort, often over the Internet. Cloud computing relies on sharing of resources to achieve coherence and economies of scale, similar to a public utility.”

My experience with cloud is through the iCloud interface of iPhone which enables shared files on the iMac, iPad and MacBook. In a way its the sole reason apart from the cool designs which has kind of left almost no scope for switchover to any other platform. In many ways it makes you a slave. For almost every other utility you have a choice, which have petered away profits from most industries. As Peter Thiel quotes in his book ‘Zero to One’ –

“Americans mythologize competition and credit it with saving us from socialist bread lines. Actually, capitalism and competition are opposites. Capitalism is premised on the accumulation of capital, but under perfect competition all profits get competed away. The lesson for entrepreneurs is clear: if you want to create and capture lasting value, don’t build an undifferentiated commodity business.”

Now coming back to cloud computing and opportunities in the Indian markets, 8K Miles is an interesting company in the space. For person with a non-IT background, there is limited ability to understand the intricacies of the business where there is limited scope for channel checks etc., we can only go by what management says. They are present in the Pharma and healthcare space in the US enabling large corporates to move to the cloud -both public and private. They have made series of acquisitions in the past in US to gain market access and technical capabilities. The key benefit they offer is savings in the hardware budget and ensuring IT security and meeting compliance requirements of agencies such as USFDA etc. Honestly, unless you are an expert in such fields, you can only try to use your understanding from elsewhere and guess things from your lenses of past experience. You can try to simplify things, but only so much as is possible.

All said and done, valuations, financials etc., vis-a-vis the price of the stock has to make sense before you attempt to decide if its worth your time to dive in. They have been growing 40-50%yoy on the back of a low base. However, there were several red flags such as low cash conversion, market perception, change of auditors etc which have to weighed in the backdrop of size of opportunity. If one goes through its historic stock performance – it went up by a massive 120x in 5-6x yrs (rather phenomenal) and was trading 10x sales and 150x cash flows in early 2016.  And goes to show the humongous wealth creation for the early investors. However, a reject in every metric for much of 2016 and did not warrant any further enquiry.

At around end of 2017 with a combination of gradual de-rating and improving business performance, valuations fell to around 1.5x sales and 12-15x cash and did warrant digging further and an exposure if other things fell in place. And in hindsight it did prove right with the stock surging 150% in about 2 months!

This is what makes investing a very hard and complex business. Perception of time varies significantly from person to person and tradeoffs are essential. Management bias is a given as incentives are pinned in the that direction as ‘never ask a barber if you need a haircut’! I guess a simpler heuristic to follow here could be, if it fits your metric for valuations and if growth is coming through, debt levels are comfortable and time is not an issue, you stay put.

Rather writing on this piece has made me more appreciative of the real clouds. A gift of nature which, we do remember when we get stuck in traffic on a rainy day.

Spas – is it an investible idea?

Urban life has its fair share of stress. Traffic, deadlines, pollution, chaos, crazy working hours, noise you name it, its all there. At times one would really wonder, if these are really ideal living conditions for humans. But as the long-term trends go, we are urbanising at a fast clip. As this particular report indicates, “The expected increase in urban land cover during the first three decades of the 21st century will be greater than the cumulative urban expansion in all of human history”This is phenomenal by any standards.

Among the many factors driving urbanisation is certainly the creative aspect as several studies indicate, the bigger the city, the more creative they become. It allows for more social connections, more interaction and mixing of ideas and thus improved potential for human development.

That said, organised Spas is a relatively new industry in India and largely dominated by the unorganised players.

Business dynamics –

  1. Location- Several formats exist in this space from fast service at airports to more relaxed spaces at hotels. Control over rentals could be crucial.
  2. People- In many ways, it seems more like a staffing business as access to skilled personnel who may have to be fungible across locations is essential.
  3. Capital intensity- On the face of it, capital intensity appears to be very substantial. Location, decor etc are likely capital guzzlers and deterrent for return ratios. We are always looking for businesses which are low on capital and high on scale effects.
  4. Brands – Even on this front, there are several formats. Most spas operate as standalone entities within large hotel properties or at high footfall locations such as malls and airports. Standalone entities don’t offer scale benefits. Even the ones that do have multiple locations, rental costs can be very substantial.

Investible ideas-

In the listed space, SBP is interesting. They have tied up with several global brands (L’Occitane, Elle etc.) and are at present operating at more than 20 locations and plan to scale up to 50 locations both domestic and international in the next few years. Business model is asset light as they enter into revenue sharing business model with the owner of the premises and share a part of their revenues with the brand owners.

Moat – as with most industries, established brands are few and fewer are quality locations. SBP does have long-term agreements with brands owners and also has several marque developers and property owners with whom it has tied up for setting up of spas. Also, competition in the catchment location would likely be limited. Also, they seem to have a high threshold for risks by willingness to target several new segments such as male grooming personalised gyms etc. Most of these new ventures are at a very nascent stage.

Valuations- Leap of faith needed.

For such companies valuations isn’t very straight forward as current earnings aren’t really much to talk about. However, top line has been growing at a fast clip though from a low base. O2 Spa has got funding of US$15 from Banyan Tree is a much larger business and with a different business model where they own the brand and also incur rental for the locations they operate from. Now, if we assume that they paid $15mn for a 25% stake, it would value O2 at $60mn and their top line would be in the range of Rs100-120cr (as per news reports), it would imply almost 4x sales multiple. Another company in a different consumer space -Westlife which is a regional franchisee of McDonalds appears to be trading at a sales multiple of 4x 2yr forward multiples. Now, if we assume SBP manages to scale up over the next 2 years and visibility of achieving a top line of Rs80-100cr sinks in, there could be significant equity upside.

Promoter has demonstrated ability to scale from a low base and also has an online sales business which is in an unlisted entity presumably due to high cash burn nature of the business. Also, Tano Mauritius a private equity investor has a sizeable chunk in the SBP as well as the unlisted entity.

 

Snacking – the sign of our times

If you travel around you can hardly miss the shining multi-coloured packets hanging outside retail shops. They are everywhere. Now, would I personally get into consuming these things is a different matter. But they do tend to solve problems for a lot of people. Low on price points, the children and youth are a big consumer of these products. Also, as an investor, they are quite appealing as the whole space has a lot the right combinations:

  1. Massive and large consuming base
  2. Changing habits- people are surely more busier and lazier
  3. Other alternative such as as fruits etc., are so much more expensive
  4. Brand attributes
  5. Lakhs of outlets

Network effects – FMCG as a space allows for strong network effects especially if you have a reasonably large addressable population. However, the name FMCG is an oxymoron as though items get off the shelf fast, it takes considerable time to introduce new variants and is a very slow process. And in that sense, is very low on the disruption scale. You will very easily find local sweetshops, low cost restaurants etc., that have been around for decades at the same location selling pretty much the same stuff that they started with. But, for the rest, especially if somebody is trying to cash into a new trend, longevity isn’t very common.

The snacks space is largely dominated by unlisted players such as Haldirams, Balaji, Pepsi (Kurkure). For a long time there was only one listed retail play – DFM Foods. Starting from a low base, DFM has pioneered the corn based snacks space in India with innovative marketing strategy such as place a toy in every packet and expanding its offering through new flavours and new toys. However, their presence is largely in North and Central India presently and almost all the sales are through its initial offering “Crax”. All this is likely to gradually change with two new recent product launches “Curls” and “Cheese Balls”. Also, they are setting up a new plant Pune. Unlike some of their competitors, their entire production is through in-house manufacturing.

What we like is the fact that the entire top line growth from Rs48cr in 2008 to Rs350cr in 2017 has been funded through internal accruals. This is by no means an easy task. Management has demonstrated strong brand building capability and growth in a highly competitive market.

Prataap Snacks is a recent listing largely catering in the chips category. They are pan-India and also engages in third party manufacturing. The claim to sell a humongous 8.6mn (DFM at 3-3.5mn) packets per day. These are surely very massive numbers.

Competitive edge and moat: These companies are known to adjust the packet content depending upon prevailing raw material pricing pressures. Also, the price point for most of the sales is at Rs5pu. Now, if you take a decade view, gradually either the size of the packet can get smaller or the industry would gradually move to higher price points depending upon competitive intensity. Taste is the critical factor which requires steady innovation and localisation.

Valuations –

  1. DFM Foods (3x sales)
  2. Prataap Snacks (2.9x sales)

On PE, Cashflow multiples, these stocks are not cheap on near term earnings.  If one were to take a 5-10 year view, they are likely to grow at 15-20% pa, gradual transition from unorganised to organised sector and also almost negligible requirement for external capital, they have all the ingredients to grow 5-10x over the next 5-10 years. There is a catch though, as we did see in DFM Foods, if earnings/growth falters for a quarter or two, stock performance does take a back seat and there can be long periods of correction/stagnation. Then thats problem that we have to contend with most growth oriented stocks. These stocks certainly do not fall in the ‘value’ category per se but score high on capital efficiency, market opportunity, low on disruptions. Net margins are also in low single digits, implying at once scale kicks-in, earnings can expand driven by efficiencies of scale etc. Over-time as these companies gain experience, we could see several new product launches and formats to reach a larger consumer segment. Certainly, a very interesting space for long-term wealth oriented investors.

 

 

Paper – surviving disruptions

Cai Lun a eunuch who served at the court of Emperor He of Han (modern day China) is credited to have invented paper in 105 AD. Thats a really long time ago and has survived almost 2000 years of disruptions. Probably, nothing has been more severe than the recent onslaught through smart phones etc. But its also true that read somewhere – as the internet taketh, it also gives back. Ecom packaging, has surged leaps and bounds renewing demand for paper substantially in recent years.

Although, a deeply cyclical sector and almost never looked at by a very large section of investors, i did get interested a few months back. It had something to do with a shift in  perception. Cash. Somehow along the way, i wanted to be very close to cash as market were seemingly raging and cash would give good downside support. We’ll do the post mortem later. Now lets understand the arguments for investing.

  1. China is apparently shutting down polluting industries
  2. Paper demand picking up due to resurgence in e-com
  3. Despite all sorts of innovation, paper has been around for a thousand years and has stood the test of time
  4. The cyclical recovery was actually underway a few year back with strong cash generation
  5. Also, like most western bad habits, Indians haven’t really caught on using toilet paper which would likely change in the years to come
  6. Valuations – super cheap – but again thats relative

However, it lacked- a determinate outlook. Pricing power is also a question mark.

Honestly, the industry like any other large industry which has been around for many decades is very complex.

Now, if one does a deep drill down into the companies available in the space, all of them are mid and small cap names. JK Paper, West Coast, TNPL, IP, Star, Emami, Kuantum, Shreyans, Ruchira, NR Agarwal, Genus… the list is very long.

Valuations – I’d say they are cheap, because if you see on cash flow multiples and PE they are all in lower single digit and very low debt or net cash. All the right catalyst for a gradual rerating with good down-side protection.

My experience so far with paper stocks: West Coast – The moment I looked at the stock it was trading at about 3x cash flows, low debt etc. which seemed extremely cheap and immediately took a position which, helped by general market buoyancy rose sharply in a few months. However, later positions in Kuantum and Star haven’t done much and are lower from our entry points, which led me to delve deeper into my approach towards cyclicals.

And then, I read an interesting post by Rod Maciver- https://microcapclub.com/2015/05/i-passed-on-berkshire-hathaway-at-97-per-share/

Now, if you this very long and very interesting article, among other things, delves upon the ways to approach commodity stocks and cautions-

“The approach that almost always results in disaster – investing in cyclical stocks based on P/E ratios. Cyclical stocks are cheapest when, industry-wide, companies are losing money or have very low earnings, and most risky when they have low P/E and high price-to-book ratios.”

Now again, if we look at the Paper stocks, the whole basket is up by 3-30x over the last 3-5 years. They were mostly into losses or meagre profits. But, if you come to think of it, it would never have met your investing criteria at that time. If you further drill down individual names, there are a lot of variations in terms of their future plans, process of making paper, capital structure, pledging of shareholding etc.

Conclusion – Investing is always a hard game. Constant learning and reassessing your beliefs is the core. For the moment, we continue to like the space. My belief is that a cyclical upturn that has happened after more than a decade wouldn’t likely fizzle out in a hurry. Besides, most of these names trade at 2-3x of 2 year forward cash flows. Wonder then, in this market where so much junk is so atrociously priced -can things get cheaper than this. But as always, we are always open to looking at things differently.

Summer time

Summer is really upon us.

Its just beginning of April and its touching 40+ (104 F) in most parts of the country. As investors, we wanna look out for ways to make money.

Air cooling companies are the first that come to mind.

If we make a list of companies in the listed space

  1. Symphony (15x sales)
  2. Whirlpool (4.x sales)
  3. Johnson Controls- Hitachi (3.5x sales)
  4. Voltas (3x Sales)

Valuations are quite stretched though. And baring Symphony, these companies are largely in the appliances category. So paying 15x sales isn’t really mouth watering. Rather we would always want to pursue buying companies which trade below 1x with potential to trade above 3x over time. But yes, considering that just 5% of Indian homes have AC, does leave scope for steady top line growth for years to come.

Another space one can look at food-

  1. Manpasand Beverages (4.5x)
  2. Varun Beverages (4x)
  3. Vadilal Inds. (1.2x)
  4. SCPL (0.5x)

Now lets look at each one of these in more detail:

Manpasand has done a great job in penetrating the market largely dominated by MNCs. This is one space where domestic cos can make huge gains, just by avoiding the kind of salaries and royalties that MNCs have to dole out. Just that the priorities for capital allocation among entrepreneurs in an emerging economy has been largely towards industries the advantages of which have been massively diluted with the emergence of China.

Now coming back to the moot point, Manpasand has off late diluted significant equity to pursue organic expansions. The beverage space requires significant capital investments as availability of third party bottlers appears limited. RoE’s have come off, cash from ops which is our key metric hasn’t been all that robust. We will relook at some later stage.

Varun Beverages (VBL) is an interesting play as it’s the only large soda play in the listed space. Coca Cola isn’t listed on Indian exchanges and Manpasand’s focus is largely on fruit based drinks. However, there some complexity with its relationship with Pepsi. There isn’t a proper royalty sharing agreement rather Pepsi appears to collect its royalty in the form of prices for its formula based syrup. So, in a sense Pepsi has outsourced its capex to VBL. Given the strong underlying market dynamics, VBL has a long way to go. However, given the high capex intensity, leverage and high dependance on Pepsi, it would need more in-depth understanding to get grip on appropriate valuations.

Vadilal is dominant player in ice creams with 5% market share. But last 3yrs sales growth of 9% isn’t really exciting. Also, high inventory levels imply suboptimal working capital management. Valuations of 1x sales aren’t too demanding considering that Havmor was sold for Rs1,000cr almost 3x of sales and at 80x PE to Lotte of South Korea speaks volumes about future prospects of the sector.

Now coming for the stock worth considering SCPL. Though, coming from a very low base, it is growing at 50% pa for the last few years and is a super low cost producer. Promoters take salaries of just Rs50k pm. Very good channel check feedback. Has a good diversified portfolio of milk products, ice creams, snacks, bakery items etc. ensuring lower seasonality impact. However, rerating would be slow process as the operations are largely focused only in Gujarat. As they venture into more states and maintain the strong top line traction. We’ll keep watching this one for some time to come.

Happy investing.

After a really really long break, I look forward to updating more regularly!

Road trip

Takeaways from a recent 3 day visit to Deolali, Nasik – Maharashtra

Roads are impeccable. Rode 180kms in about 2-21/2hrs flat. Its a completely stress free ride

However, the instance of opposite driving has gone up dramatically. People seem to have got a lot more lazier to do roundabouts. So, one has to be a lot more careful now if wish to overtake from the left side.

Things that just hit you as you move from a 20mn+ people city to a city with 50k people.

  1. Everything is at a slow motion mode. It works magic on your system
  2. Noise level drops 80%
  3. You sleep more
  4. You completely loose track of time. Anyway in today’s life can you be far away from a clock!

Business observations

  1. Construction has gone up many fold in the last 10 years
  2. It seemed hotter in the afternoon
  3. Restaurants are in a time warp. A lot of the full service restaurants give you a feel of coming to the 80s/90s. The menu’s serve everything.
  4. Price levels a 50% lower for a lot of things
  5. Cafe Coffee Day is the only cool spot to escape from the heat.
  6. Healthcare Juice Centre on Lam Road is still cutting edge. The best juice centre in all of Maharashtra.

Conclusion

  1. Must go every few months
  2. Take loads of books. See and make sure there is no internet wherever you are.
  3. And don’t forget to shout “I love you mountain” on the way!

Public space evolution

There has been a massive explosion of creation of public spaces over the last 10 years. Growing up in the 80s and 90s I hardly remember instances of going out for coffee (fewer people were hooked on to caffeine) or ever visiting a mall. The fact is that there were none.

On second thoughts, after my recent visit to South India about which I will write later, I completely missed the role of temples. Yes, about 25 years ago, no house was complete unless there was a temple nearby. And yes, you were supposed to go there everyday. A lot of people go to temple everyday, but in more urban centres, they are soon becoming a minority.

But back then, we had a lot of fun playing cricket. Now cricket is a luxury. All the spaces are covered with cars and bikes.

Nowadays, hardly a few weeks go by when one hasn’t visited a mall. The near complete lack of parks coupled with rising temperatures, there are only few options left. Club memberships cost a fortune and traffic is a put off too.

That leaves movies, coffee shops and malls as the only real family hangout places. But these too have a lot off limitations.

Movies are very selectively targeted to particular audience tastes and require a time commitment. Coffee shops tend to get boring for children and there aren’t any apart from Starbucks and Cafe Coffee day.

With malls the only real place where the masses can hangout are their food courts the rest of the spaces require you to commit cash. Nonetheless, the large spaces that some of these malls such as Phoenix and InOrbit occupy allow people to do their evening walks in an air-conditioned, safe and secure environment which very few public spaces offer.

Starbucks would have serious limitations on expansions in India. I do not see the queues in the mornings as you see in London or New York. Rather, for a significant part the staff is busy chatting.

Cafe Coffee day has a phenomenal reach. You would find it around at every major urbanised space in India. I find the menu to be more of a food experience rather than coffee. But again, due to pricing and lack of focus on creation of a coffee habit, I really wonder if would be a money spinning business.

All this leaves me to one definite conclusion. Demand for air conditioned public space would continue at a scorching space. The space occupied by temples only a generation ago would gradually give way to merchandise and engagement.

So how do we play this story?
Direct – 1. Keep a watch on new format open spaces which blend all the above constraints.
2. Air conditioners – come what may, no public space would not work without aircon.
3. Hydraters – There is a serious lack of water based brands in India. In fact in upmarket retail outlets its amusing to find shelves full of imported non-alcoholic brands! Crazy, i thought only oil and alcohol were imported…

Conclusion:

  1. Explosion of cafe’s – but profitability of cafes is a question mark. High rents, operating costs, value for money proposition are key hurdles.

Last mile connectivity

Ola and Uber are changing India in more ways that the Government could never do by adding roads! The concept of last mile connectivity is almost unknown in India. As one lands at Mumbai airport, you realise, there is no public transport at the airport. The nearest train station is hardly a few kilometres away but to get there is bothersome. Compare this with Singapore and Hong Kong -you feel so relaxed coming out of these airports.

A recent ET news report stated that Ola is doing about 750,000 trips in a day and Uber about 200,000 trips in a day!

Those are massive numbers and I won’t be surprise if they grow 100% annually for the next few years. To think of something like this even 2 years ago would be unimaginable. Smartphones coupled with data plans have revolutionised way urban India moves around.

All this, has major implications and among others clearly the big beneficiaries are:

  1. Airlines
  2. Movies
  3. Restaurants
  4. Hospitals
  5. Trains

However, the impact is way beyond what I can fathom currently.

But this is one space which will continue its explosive growth year after year. The benefits are clear –

  1. No haggling
  2. Guaranteed cleanliness
  3. Safety
  4. State of the art mapping
  5. Drop off to the last point

Can’t think of a direct play on this change in habit (lifestyle). But I do think airline traffic surge of 30% in July, 2015 would have something to do with this. But airline companies have many other issues to grapple. Makes me wonder why the airline companies never thought of solving this simple problem of making their customers go where they have to. Just like, how they seem to have got it right on feeding their customers en-route.

The moral of the story is that a revolution in one space rarely ever goes without touching others.