Dear Readers,
Many of you who regularly follow my column would know that I generally don’t consider IPOs to be attractive investments. Then why this sudden volte-face you may ask? Well…usually IPOs come with baggage: either a high price, or low quality or both. Recently, I was listening to a speech (on YouTube) by Charlie Munger (the not so popular side kick of the billionaire investor Warren Buffett) to students at the University of Southern California (USC). In the course of his speech he mentioned about a particular aspect of human nature that he felt was a big danger in life: intense ideology and the resulting lack of open mindedness to examine disconfirming evidence. So, while I may still be skeptical about IPOs, what I have uncovered is disconfirming evidence - a rare worthy IPO (issue opening Sep 7th, 2009)
OIL is a company that’s been around for 50 years. It is the second largest public sector oil and gas producer after ONGC (but only 10% the size of ONGC). Over the last nine years the company has generated an average return on capital in excess of 20%. The company has almost no debt (loans). It has steadily paid increasing dividends year on year to its investor – the Government of India (till date). Going by the long-term track record, the company has demonstrated that it is doing very well financially.
Of course there is a huge macro risk – which is the price of oil. If oil price crashes and stays below $30, it may adversely impact profitability of oil production companies. Currently oil price is around $70. There are numerous highly intelligent people making a living out of predicting the price of oil. But even those who get it right the first time, trip when they try their luck again (remember the famous Indian research analyst who first correctly predicted oil will touch $100, but later upgraded the price target to $200, only to see it fall even below his first prediction). Although there are many alternative fuels under development, many of these are prohibitively expensive or inaccessible. They are unlikely to impact the demand for oil – atleast not over the next decade. Infact, oil consumption will continue to increase, as it has done over the last many decades – but may be slower. That’s on the demand side. On the supply side, everyone believes the world is running out of oil– so as long as this fundamental belief is not disproved, the price of oil can be reasonably expected to stay at current levels or move up over the next decade. The same argument can be extended for gas.
The second macro risk is the subsidy regime of our Government, which currently mandates PSU oil-producing companies in India to share the burden of selling fuel at below market price. Despite this, PSU oil and gas production companies in India, including OIL, have managed to maintain their high profitability in the past. So I think we can assume that as long as the Communists don’t come to power, oil-manufacturing companies can maintain their profitability.
Now, let’s get to the pricing of fresh shares in OIL that are being offered in the IPO. Firstly, only a small portion of fresh stock is going to be issued in the IPO - 11% of post issue total shares to be precise (I am not counting the portion of existing shares (10%) that would be sold by Government of India to the Oil marketing companies – namely IOC, HPCL, BPCL). At the higher end of the price band (Rs 1050 per share) at which fresh shares in the company are being offered, the post issue Enterprise Value of the company (approx. 25,000 crores) will be around 2.1 times the total capital in the company’s balance sheet i.e 2.1 times the ‘book value’ of total assets (post issue).
Book value of assets refers to what you would get, if you were to strip the company into parts and sell them chunk-by-chunk. In other words, ‘1 time book-value of assets’, is the bare minimum that the company would be worth, if it were to shut down tomorrow. We all know this is not going to happen. I think this company is going to continue to exist for many years to come and most likely continue to earn a return of 20% + on the capital that it uses. FYI this is more than twice the passive return generated by money in a bank FD. For this superior return generating potential, the IPO price is valuing the company at 110% premium to the value of assets in the company. This, according to me, is at a discount to the true fair value of the company. In my opinion, this IPO provides an opportune time to get into a strong company and compound your wealth for many years to come. May be that’s a reason why the Government is diluting only a small portion of its stake at this point.
Does this mean post listing the stock price of OIL will never come down below its issue price? No.
Would there be an opportunity, in the near future, to buy this stock cheaper? May be.
Is there risk of ‘permanent’ loss of capital if you invest at current price being offered in IPO? No.
What is the long-term average return that you can expect if you invest at the IPO price? 15%-20% p.a.
Please note: the standard disclaimer applicable to any investment advice applies here too. And…please don’t go bonkers and invest 100% of your net-worth in this. For the overzealous types, here’s my adaptation of Mr. Narayana Murthy’s famous saying: In God we trust…in stocks we better diversify.
Regards,
Shyam Pattabi www.shyamscolumn.com
OIL is a company that’s been around for 50 years. It is the second largest public sector oil and gas producer after ONGC (but only 10% the size of ONGC). Over the last nine years the company has generated an average return on capital in excess of 20%. The company has almost no debt (loans). It has steadily paid increasing dividends year on year to its investor – the Government of India (till date). Going by the long-term track record, the company has demonstrated that it is doing very well financially.
Of course there is a huge macro risk – which is the price of oil. If oil price crashes and stays below $30, it may adversely impact profitability of oil production companies. Currently oil price is around $70. There are numerous highly intelligent people making a living out of predicting the price of oil. But even those who get it right the first time, trip when they try their luck again (remember the famous Indian research analyst who first correctly predicted oil will touch $100, but later upgraded the price target to $200, only to see it fall even below his first prediction). Although there are many alternative fuels under development, many of these are prohibitively expensive or inaccessible. They are unlikely to impact the demand for oil – atleast not over the next decade. Infact, oil consumption will continue to increase, as it has done over the last many decades – but may be slower. That’s on the demand side. On the supply side, everyone believes the world is running out of oil– so as long as this fundamental belief is not disproved, the price of oil can be reasonably expected to stay at current levels or move up over the next decade. The same argument can be extended for gas.
The second macro risk is the subsidy regime of our Government, which currently mandates PSU oil-producing companies in India to share the burden of selling fuel at below market price. Despite this, PSU oil and gas production companies in India, including OIL, have managed to maintain their high profitability in the past. So I think we can assume that as long as the Communists don’t come to power, oil-manufacturing companies can maintain their profitability.
Now, let’s get to the pricing of fresh shares in OIL that are being offered in the IPO. Firstly, only a small portion of fresh stock is going to be issued in the IPO - 11% of post issue total shares to be precise (I am not counting the portion of existing shares (10%) that would be sold by Government of India to the Oil marketing companies – namely IOC, HPCL, BPCL). At the higher end of the price band (Rs 1050 per share) at which fresh shares in the company are being offered, the post issue Enterprise Value of the company (approx. 25,000 crores) will be around 2.1 times the total capital in the company’s balance sheet i.e 2.1 times the ‘book value’ of total assets (post issue).
Book value of assets refers to what you would get, if you were to strip the company into parts and sell them chunk-by-chunk. In other words, ‘1 time book-value of assets’, is the bare minimum that the company would be worth, if it were to shut down tomorrow. We all know this is not going to happen. I think this company is going to continue to exist for many years to come and most likely continue to earn a return of 20% + on the capital that it uses. FYI this is more than twice the passive return generated by money in a bank FD. For this superior return generating potential, the IPO price is valuing the company at 110% premium to the value of assets in the company. This, according to me, is at a discount to the true fair value of the company. In my opinion, this IPO provides an opportune time to get into a strong company and compound your wealth for many years to come. May be that’s a reason why the Government is diluting only a small portion of its stake at this point.
Does this mean post listing the stock price of OIL will never come down below its issue price? No.
Would there be an opportunity, in the near future, to buy this stock cheaper? May be.
Is there risk of ‘permanent’ loss of capital if you invest at current price being offered in IPO? No.
What is the long-term average return that you can expect if you invest at the IPO price? 15%-20% p.a.
Please note: the standard disclaimer applicable to any investment advice applies here too. And…please don’t go bonkers and invest 100% of your net-worth in this. For the overzealous types, here’s my adaptation of Mr. Narayana Murthy’s famous saying: In God we trust…in stocks we better diversify.
Regards,
Shyam Pattabi www.shyamscolumn.com
11 comments:
Hi Shyam,
Good Post.. there is one more aspect to OIL.. Like PGCIL, OIL is currently running fiber along its oil pipelines..They lease out the excess bandwidth. This will be prove to be steady additonal revenue stream with high bottom line as they are the only ones to have fiber running in the Northeast.
Good description. OIL will climb like OIL. it is very rare to get PSU's in good value.
growth stock in value price.
Do you thinks after looking at the fate of Adani Power and NHPC (both good companies) IPO performed poorly, not upto the mark as per expectations, Oil India will also perform in the same range. Max listing price will be +/- 5% ?
So instead of blocking 1 lacs for one month to get the shares worth 20 K, isnt it good idea to wait till listing and purchase OIL India shares from secondary market ?
Pls respond .
Sachin
Karthik - interesting piece of info (icing on cake)
Mitran :)
Sachin - personally...i feel power companies have such low ROE that they need to be available at or below 'book value' to be considered attractive investments. secondly, our objective in the case of OIL is stable above-average long term returns and not immediate listing gains. the philosophy of this blog esp. when it comes to stock investing is that over the short-term the share price (and so the index) is a voting machine (and hence unpredictable) but over the long term it's a weighing machine that favours fundamentally good companies. The idea is to use the short term aberrations in price to lock in long term returns. 2.1 times book value is cheap valuation of OIL...so any price that is lower can only make the stock cheaper and therefore a better buy...the question is will it get cheaper. i dont know! if you think it'll - may be it helps to set aside some cash for additional purchases.
p.s. btw why are you so concerned about locking money for merely 1 month? hope you are not borrowing money to apply.
Hi shyam sir i am satheesh.Below content is taken from premiuminvestments.in.
First dont mistake me.Just i want to know what is wrong in the below content or argument (for academic purpose).Waiting for ur reply
Oil India is entering the Capital market on 7th September 09 with a public issue of 2.65 crore equity shares of Rs. 10 each, in the band of Rs. 950 to Rs.1,050 per share.
The company can very well be compared with ONGC, as, it is about 10% of ONGC, in terms of level of operations and activity, while, almost at par on financial parameters. Let us have a look to the financials of both the companies as at 31-03-09: -
Rupees / Crores
ONGC
Oil India
Sales
1,05,257
8,138
PAT
19,795
2,162
EPS (Rs.)
93
101
Book Value (Rs.)
428
436
Equity
2,139
214
Net Worth
91,573
9,331
Dividend (Rs.)
32.00
30.50
Subsidy Share
28,225
3,023
Debt Equity
Debt Free
Debt Free
So, if someone is deciding to buy share of Oil India, infact, it is mini ONGC being bought. Post IPO, equity will rise to Rs. 240 crores, with Government of India stake falling at 78.50% against 74%in ONGC. So even on this count, it remains, almost at the same levels.
It is an accepted fact of the market, while valuing companies in the same sector, with same pedigree, smaller companies have atleast 15% discount to the bigger ones. Also, in the case of IPO, atleast 10% discount needs to be given, over the expected listing price, to prospective investors.
Since ONGC is now ruling at Rs. 1,185, a discount of 15% over this, gives a secondary market valuation of Rs. 1,000 per share. A further discount of 10% on this, justifies a price of Rs. 900 per share in IPO. Since the band of the share has been fixed at Rs. 950 to Rs. 1,050 per share, even accepting lower band of Rs. 950, based on these presumptions, would be difficult to accept.
NHPC, another PSU IPO, has also recently disappointed giving not much profit to retail investors and losses to HNIs. At that time also, we have said that the government has become greedy by having stiff pricing and the same trend looks to continue for this IPO as well. NHPC having issued shares at 36 is now ruling at 37. It may be worst for Oil India.
Really speaking, though we are not convinced even at the lower band of Rs. 950 per share, but those who are to keen to go for it, should contemplate applying at the lower band. It is infact worth and advisable to buy ONGC from the secondary market, instead of going in for this IPO. To justify the pricing of this IPO, share price of ONGC has to move up from its present level of Rs. 1,185. So why not bank on the leader and giant instead of this tiny and regional player.
Satheesh - Mr. Tulsian who supposedly runs the website obviously does not know that when you are comparing an IPO company with listed one, you have to take the post money ratios for the former. Which means book value per share of OIL India will be around Rs 500 post IPO and not Rs. 436 as listed.
I have a slightly different argument with my limited financial knowledge.
ONGC is trading at a PE of 15.15
OIL is available at a PE of 10.4 at the cut-off price
Let's take the same arguments as presented in premiuminvestments.
IPO of a smaller company = Listed company * 0.85 * 0.9
This will put OIL's fair PE = 11.6
Given OIL's offered PE of 10.4, it is available at a discount.
Any thoughts or issues in this reasoning?
Anand
Hi Shyam,
As you said rightly; I was stunned to see an article from you vouching for an IPO- rare worthy! ;-)Also just to add to your points- i felt the management also sincere and committed for the growth of the company (saw an interview of Mr Borah with Udayan in CNBC TV18); which I thought is a key ingredient besides Business & valuation.
On a different note; could you write an article on 'Insurance'(life)- just to simplify the subject. Why I am saying so is because many of us (including me) use the premium paid for rebate under sec 80C and as an investment tool(money back kinds) which actually helps the agent- as they get more commission on them rather than the term insurance.
Thanks once again for the splendid article on OIL...reminds me to read the book - A thousand barrels a second (by Peter Tertzakian)
Srikant
Hi Shyam Sir,
This is Jatin Jain from IFMR. Firstly it was nice attending your session. You showed me a new thought process to investing.
Talking about OIL IPO, accepted the fact the OIL is a good bet at current levels. In driving the share prices sentiments also play an important role and seeing the current sentiment for the IPO market, one can expect a lack luster listing for OIL.
Hence one can expect to make an entry at lower levels.
The response to the IPO has also been a lack luster from the retail category.
Seeing the current sentiment for the IPO market would you still advocate to invest in IPO and block your money till listing or wait for the listing to invest.
This reply is just to understand your strategy after the opening of IPO, nothing against your article.
Once again it was really nice attending your lecture. I have already started looking out for companies with high ROC (where can I get the consolidated list of companies with high ROC???).
We hope to see you soon at IFMR.
Regards,
Jatin Jain
IFMR
jatin - hi! glad that you are implementing the message from the lecture already. does that mean I was so convincing? anyways, I will take the credit for it. abt OIL India - the question is will the stock become cheaper? this is a fundamental question that every value investor needs to address whenever he buys a stock. I guess one never knows and the best way to handle it is to buy in lots on the way down. no one wants to entirely miss the opportunity to buy a cheap stock, by waiting for it to get cheaper. but before one declares a stock cheap in the first place, we need to be convinced that it's cheap by atleast 25% compared to a CONSERVATIVE estimate of fair market value.
Post a Comment