One of the viewers from our Youtube channel Mr Subhajit Biswas requested for comments on GTPL Hathway Ltd.
There are 5 data points mentioned by Mr. Biswas :
- 10 yr ROCE > 20%
- 7 Yr Sales growth > 15%
- Debt to Equity < 0.25
- Market capitalization > 1000 cr
- Stock Price fallen 60% from Peak
Let’s look into these data points
Firstly, ROCE is a super important ratio because it tells us how much operating profit (EBIT) a company can generate on the capital (Debt + Equity) it uses to run the business.
ROCE is comparable to an FD Return.
You put Rs. 100 in an FD and you get Rs. back (assume 6% rate, and ignore taxes), this means on a capital deployed of Rs. 100, your Return on Capital Employed is 6%
Naturally, you have higher hopes from a company than the bank FD, that is the whole reason you are willing to invest in a “Riskier” asset class – Equity !
An ROCE of 20% is respectable by any standard and it is definitely a sign of a company with some sort of competitive advantage but that 20% should ideally be consistent, year on year with minor fluctuations allowed.
An AVERAGE of 20% over the last 10 years is not as great because a company could’ve gone through an upcycle where for 3-5 years it earned ROCE of way higher than 20%, which may skew the average number in the higher direction.
This may be the case with GTPL Hathway
Infact, the ROCE was higher than 20% only in the last 3 years !
Whether this Avg. ROCE performance of more than 20% is a thing of the past ? or will it likely sustain? is a question that really worth asking
And the question requires deeper understanding of the company’s Products/services, the industry dynamics, whether it is a cyclical industry or not, what are the competitive dynamics etc
I would suggest Mr. Biswas look into this aspects of the company
Secondly, Sales Growth of 15%+ over last 7 years is great and we would certainly prefer that but last 7 years is of no use if the outlook of the future is not great
You will notice that sales growth in FY21 was 3.5%, and in FY 22 was -2.1%
No wonder the stock has taken a beating since Sales growth is one of the most important drivers of value
I recommend you find out more about the growth drivers of the company going forward
Thirdly, debt to equity of < 0.25 is preferable to higher debt companies, the lower the D/E the better since one of the most common causes of company’s failure is excessive Debt
Fourth, Mr. Biswas mentions Market Capitalization of > 1000 Cr
Maybe what he is suggesting is that because it’s a small cap it is likely to grow faster?
That might be true given other factors required for growth are in place.
We can get a perspective on growth by understanding the NFAT – Net Fixed Asset Turnover
Basically, Sales/Net Fixed Assets required to support that growth
The NFAT of GTPL is around 1.7-1.8 over the last 3 years
This means that for Every Rs. 100 worth of Net Fixed Asset , the company can generate ~ 170 – 180 Rs of sales
This means that to 2X its sales from ~ Rs. 2500 Cr to Rs. 5000 Cr, it will require around ~ Rs. 2950 Cr worth of Investment into Fixed Assets
Assuming it is possible to grow to that number in the company’s respective industry, at the current Investment rate of ~ Rs. 350 Cr per year, It will take ~ 8 years to make that kind of investment in Fixed Assets !
Or, the company will take on Debt to make that process faster, which will in turn increase Debt to Equity, which will likely lower Net profit margin since a higher percentage of operating profit will get eaten up by Interest Costs.
It might not necessarily take 8 years to actually double sales, since there may be existing capacity/assets that are not fully utilized but you get the point – This business will require large amounts of capital to grow !
Large amounts of capital that it does NOT generate internally, at least not enough to 2X sales in 3-5 years !
Lastly, Mr. Biswas mentioned Stock Price has fallen by more than 60% from the peak !
I believe that this might be real reason for Mr. Biswas’s interest in the stock
This is a psychological bias. We get anchored on the higher stock price, at the peak and we unconsciously assume that this is the true value and somehow that 60% fall in price is somewhat equivalent to a discount of 60%
Nothing could be further from the truth !
I know this because I have seen practically every new/untrained investor fall for this trap !
I fell for it myself when I invested in Vakrangee in 2017-18 or when I invested in Newspaper Stocks
Often, with such cases we don’t realize that the peak share price at Rs. 296/share might have been overvalued to begin with !
In closing, I would suggest some homework to Mr. Biswas and share his findings with other viewers/readers of First principles Investing
- What are the Growth prospects ?
- Is the Industry Cyclical or non-cyclical in nature ?
- How & Why is it able to maintain Operating margins ~ 20% + levels, and is this likely to continue in the future?
- Does it have questionable related party transactions with the promoter group? You use our youtube video on RPT to answer this question.
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