Sunday, December 25, 2016

Future Retail

The present incarnation of Future Retail came about through a merger with Bharti Retail and demerger of non-retail and back-end businesses.  Now, all the company does is operate the retail business.  It has a clean balance sheet with most of the debt being for the working capital.  Here are a few reasons why I think it a very good business already and has high probability of being a great business.

Small Stores
Organized retailing of food and general merchandise in India started with relatively big stores.  These stores were mostly away from the population centers as they needed to control costs.  This model has worked well in many countries around the world.  However, in India the challenge came in terms of poor transport infrastructure.  Because of poor quality of roads and inadequate public transport, these stores did not get the expected footfalls.  As a result, the business suffered and the growth plans were shelved or greatly reduced.

The recent trend towards small stores has changed that.  These stores are typically 1000-2000 sq.ft. and are located in busy population centers.  They compete with small mom and pop shops and with larger independent players.  They are in locations where people already go to shop.  Many people prefer them to local stores because they are cleaner, are better stocked and allow you to browse the aisles and pick out what you want.  They also take electronic payments, which helped greatly during early days of demonetization drive.

Merger with Bharti Retail brought the Easy Day brand of small stores to the company.  These stores were set-up with the guidance of Wal-Mart and (I am guessing here) must be operationally very sound.  The company aims to aggressively expand this small stores business.  Number of stores are expected to increase to ~3000 from about 338 now in a few years.  They plan to expand by building central warehouses and opening many stores around that.  They have also been very active in inorganic growth.  Most recently they bought out the retail stores of Heritage Foods which gives them a strong network in Hyderabad and footholds in Chennai and Bangalore.  They are also re-branding their other small stores as Easy Day.

The small stores business is still EBDITA negative, but is expected to turn the corner in next 2-3 quarters.  I believe that a well-run small-store business could be a huge opportunity.  There is almost an endless need here (in move from unorganized sector to organized sector).  Company can keep plowing their cash back into the business for the foreseeable future.  This can lead to a very nice compounding effect.

In-house Brands
The company sources a lot of products from Future Consumer, a group firm.  Future Consumer is developing many brand in different FMCG areas.  Future Retail gets to keep higher margin on these products than on established brand products.  While this is only a nice to have in large-format Big Bazaar stores, I think in the small-format Easy Day stores it can be a big advantage by helping them offer lower prices and compete more aggressively with the local stores.

Retail demand scale.  Future Retail is one of the largest organized retail player and is growing rapidly through both organic and inorganic routes.

First generation entrepreneur with proven success record.  Mr. Biyani has his detractors, but he seems to be committed to the business and to learn from his mistakes.  The company also seems to be encouraging leadership among the younger employees by giving them more responsibility and demanding results.  It will help if the company and the management commit themselves to even more openness with minority shareholders and higher corporate governance standards.

Growth Rate
The company reported about 13% same-store growth and about 10% growth in number of stores in last quarter.  So, the top-line is growing by about 25%.  Margins are also improving - they went up from 3.1% to 3.2% in last quarter.  The company expects small stores to break even in next 2-3 quarters, so there is reason to believe that margins can go up further.  Further, the D&A expenses don't go up proportionally with same-store revenue growth.  So, the bottom line can go up by 30% or more.

I have little doubt that the top-line will grow at a fairly robust pace for the next few year.  There might be short-term hits to the bottom-line due to acquisitions and rapid growth in small stores, but I believe chances of a significant hit are rather low.

There are 2 categories of competition.  There are companies with different business model than Future Retail such as D-Mart, Amazon and Big Basket.  And then there are other more or less similar players such as Reliance Retail, More and Spencer's.

I believe there is room for many players in many different formats in this space.  Retail is highly unorganized and will rapidly organize.  I think the major catalyst is changing customer preferences. Young people want to go to browse-able stores and organized players are much better suited to do that.

There is a place for Aldi's of the world (read D-Mart).  But there is a very big market for large stores (Big Bazaar, Spar etc.) and convenience stores. D-Mart runs an excellent operation, but it is a different business than Big Bazaar and Easy Day.

Online and mobile players, such as Amazon Grocery and Big Basket are growing at a brisk pace.  However, they are being run in customer-acquisition mode where they make a loss on most of their orders on per-order level, not to speak of the enterprise-level.  It remains to be seem how they will fare when their higher costs are passed on to customers.

Future Trends
I believe real (inflation-adjusted) rents for locations where a Easy Day store or Big Bazaar store can open will go down in future.  Since rent is a significant cost item, this should aid in increasing profits not only at Future Retail but also at other organized offline retail stores.

Modern retail, whether online or offline, will be won with analytics.  Future Retail seems to realize this.  They have identified “Top Consumption Micro-Markets” and are opening more stores in these.  The have a large loyalty program with 28 million members.  This data can be sieved to understand customer preferences.  I believe the company is already doing this.

Going by the past 2 quarterly earnings, the PE ratio at current market price (~Rs 125) is around 20.  I believe that undervalues the business significantly and ignores the growth prospects.  Not enough historic data exists for this new avatar of Future Retail and that might be part of the reason why the stock is so cheap.

The stock holding pattern is very favorable with 49% with promoters, 22% with institutions and about 9% each with Times Group and Bharti Group.  Free float is only about 4% with retail individuals and an estimated 1-2% with companies.

This is not a stock recommendation.  I, my family and my friends might have positions in the stock.  I reserve the right to close or change them at any time without any notice.

Monday, December 5, 2016

Orient Green Power - Update 1

I recently came across some excellent blog posts on the quality of earnings.  See and .  I had been thinking about sustainability of earnings for a while, and these posts provided a nice framework for that.

Quality of Earnings

How steady are the earning?
In geographic areas, where Orient Green Power operates, wind season is during Q1 and Q2 of financial year.  Earnings are substantially more in these 2 quarters.  However, on an annual basis earnings are expected to be comparable YoY.

The variation could come from a) quantum of wind in a season, (b) grid availability (though this factor is becoming less significant), (c) potential changes to government policies towards the sector (such as requiring minimum percentage of renewable power in energy mix), (d) PPAs, and (e) cost of capital (through changes in interest rate).

Quantum of wind is the main variable here.  Other factors are either becoming less uncertain or are expected to lead to positive surprises.

Growth of earnings?
Other than the factors mentioned above (signing of PPAs, decrease in cost of capital and favorable government policies), earnings growth would come through expansion i.e., by installing and operating more wind mills.  There seems to be sufficient demand for the end product (power) and sufficient supply of raw material (capital) to believe that expansion could continue for a while (though the company has been in a consolidation mode of late).

Other wind power companies operating in India are growing at a significantly higher rate than Orient Green Power.  Most of these are either PE backed or have raised funds outside India and therefore have much lower cost of capital.  This group includes ReNew Power, Mytrah Energy, Greenko and Continuum Wind Energy.  The differential in cost of local capital and external capital is getting smaller with the recent strength of $, and should continue on that path with expected interest rate increase from Federal Reserve and decrease from RBI.

Update on Stock Price

With recent M&A activity in the renewable energy sector (e.g. Tata Power and Welspun, Brookfield and Continuum (still in works)) and proposed Indian IPOs of other wind and solar power companies, Orient Green Power would get a fresh look from investors.  That should correct at least some of the mispricing in the stock price.

Wednesday, November 23, 2016

Orient Green Power

About the Company

Orient Green Power is a Shriram Group company based in Chennai.  They own and operate wind farms and biomass power plants.  Total wind capacity is around 450 MW and biomass capacity is about 100 MW.

Most of their wind assets are in Tamil Nadu.  Rest are in Andhra Pradesh, Kerala and Gujarat.  There is also a 11 MW wind farm in joint venture in Croatia.  The biomass plants are 2- 20 MW units concentrated in Tamil Nadu and Rajasthan, with some units in Maharashtra, Madhya Pradesh and Telangana.

The company is in a process of transitioning to a pure wind power company.  The company has divested its interest in a few biomass plants in the past year and is in process of doing it for a few more.  The rest of the plants would be listed as a separate entity called Biobijlee Green Power.  They are also looking to get out of the Croatia joint venture.  In the past, they had plans to invest in small hydro projects and expand in other countries including Sri Lanka.  They have either shelved those plans or have exited existing businesses.

About the Business

Owning and operating wind farms can be an excellent business.  Wind energy is a proven technology with long-term reliability and performance data.  The basic premise is that the return on capital is greater than the cost of capital (even in India).  Hence, in principal, with same equity one can raise progressively higher debts, use them to own and operate wind farms and pocket the difference between the returns from the wind farms and the interest outgo on the debts.  Since there is plenty of demand of end product (clean electricity) and supply of raw material (wind energy sites and capital), this arbitrage can be had for a while.

However, there can be many operational issues in wind farms.  The operational issues in initial set-up can arise in locating good wind sites, getting land at reasonable prices, transportation and logistics cost of installing wind mills (since good wind sites are typically at remote locations) and getting transmission capacity.

Transmission capacity can be an ongoing issue as well.  This issue is more pertinent to Tamil Nadu because majority of good wind sites are in the south of the state and most of the consumption sites are in the north.  Other issues which have come up in India in the past are non take-up of wind power by the utilities.  This is either due to higher cost of wind power than the fossil fuel based power or the intermittent nature.

Biomass power plants have some operational issues as well, which mostly arise from seasonality of raw material and the need for working capital to accumulate it.

About the Promoters and the Managers

Shriram group is a well-respected group with primary focus on NBFCs.  Group companies, Shriram City Union Finance and Shriram Transport Finance, have done very well over the years and their stock prices have reflected that.  However, their foray in non-financial businesses has not been that successful thus far.  Both Orient Green Power and Shiram EPC have been languishing much below their IPO prices.  However, the group seems to be committed to these businesses and, as far as I can tell, they have good management teams.

One sign of promoters' commitment is a low(er) interest loan from a promoter group company to Orient Green.  This is the company's lowest interest loan.

What's New

I believe the company was facing teething issues related to wind energy business.  These issues such as transmission capacity, uptake of wind power and financing issues are not there any more.  Tamil Nadu has mandated that the wind power has a must-run status.  They have also scheduled annual maintenance of state-owned thermal power plants during maximum wind months. There is a also a new north-south transmission line for evacuating wind power.

I believe with these issues behind them, the management is now focusing on judicious growth with geographic diversification.  Listing biomass business as a separate entity is a great idea since it is an unrelated business (at least in practice).

The company has raised significant capital in the past year from promoters and private placement.  This should bring down the interest cost.  Also, the expected rate cuts and lower interest rates for green bonds enable further cuts in cost of capital.  Capital being one of the primary raw materials, this should help company increase margins in the future.

This year has been great for wind energy with strong winds in Tamil Nadu.  The company has posted excellent results for the first quarter and the second quarter is expected to be even better.

About the Stock

The stock price has taken quite a hit over the years.  The IPO price was Rs 47 in 2010 and the current market price is less than Rs 9 in November 2016.  In fact, the stock has never closed at IPO price or higher.  The stock trades below book value at under 0.9 time book value.  The company has been posting losses lately, so PE ratio is not available.

I believe it is a great opportunity to own a great business and (potentially) a great company at a cheap price.


This is not a stock recommendation.  I and my family have long positions in the stock.  I reserve the right to close or change them at any time without any notice.

p.s.  As expected, the company has posted excellent Q2 results.

Saturday, October 15, 2016

First Post - Motivation

The idea behind the blog is to help me understand and document my investment thesis for stock selection.  I will document the initial thesis and then develop it over time.  The idea is to look for stocks where I can invest large amount of capital for the long-term, the longer the better.  I am not completely averse to the idea of investing for the short-term.  However, the capital deployed to short-term investment will necessarily be small and hence the potential gain per unit effort will be limited.  Hence, the preference for long-term ideas where one can invest over time.

Here is a basic check list for stock selection.

  • High corporate governance standards: This is rather obvious.  This is a stringent criteria which limits the investable universe to companies and promoters who have a history of good corporate governance or are in businesses where corporate governance cannot be too lax.
  • India focus: India is growing faster then most other countries where Indian companies do business.  This excludes most IT, pharma and export-oriented companies, as well as India based MNCs such as Tata Motors, Hindalco etc.
  • No PSUs: Management motivation and promoter priorities are major concerns.  Examples include public-sector banks and oil marketing companies.

My intention is to develop all posts, including this one, over time.  However, I will keep all originals intact.  The latest version of each post will be marked by label 'latest version'.