Thursday, 24 November 2011

JB Chemicals: A Classical Ben Greham Style Stock

Benjamin Graham, a legendary investor and pioneer of value investing, had designed a framework for selecting stocks where inherent value of the business is much higher than the value assigned to the stock by the market. Even though there are very many variations that have been developed and adopted since this framework was designed by the Ben Graham, the framework suggested by him is still considered one of the most conservative way of picking stock. 

Before I try to put JB chemicals into the framework provided by Greham, let me give a small introduction of JB chemicals. JB chemicals is one of the oldest pharmaceutical companies in India founded by Mr. J.B.Mody. It was earlier known as Unique pharmaceuticals and has 11 manufacturing facilities spread across four locations Panoli, Ankleshwar, Daman and Belapur. Over the years, it has devloped some very formidable brands like Doktor Mom (given Superbrand status in Russia and CIS countries), Metrogyl, Rantac  and Nicardia. They have recently sold their Russian and CIS countries OTC business to J&J for approximately 1200 Crores. They have received proceeds from the sale and distributed around 320 Crores as special dividend to shareholders. This indeed is commendable and speaks a volume about the management's integrity and its focus towards shareholders. 

Let me carry out a step by step analysis as suggested by Graham Framework.

1) Size of the company: Greham has suggested that defensive investor should stay away from small/obscure company. JB Chemicals had turnover of 800 crores in year 2010-11. Company has history of more than 50 years. Thus it qualifies on this account as it has a long history of professional management combined with increasing revenue.

2) Sufficiently Strong Financial conditions: Current ratio of a company (Current Assets/Current liabilities) should be above 2 and long term debt shall not exceed net working capital of the company. Based on September 2011 balance sheet (more relevant considering the cash received from Russian sale) JB has current ratio 5.2 (including 561 crores in long term/short term investment) and long term debt is only 25% of net working capital.

3) Earning Stability: Greham suggested to look for positive earnings in each of the last 10 years. JB definitely meets this criteria.

4) Dividend Record: Greham suggested to look for dividend payment for each of last 10 years. JB has uninterrupted dividend payment history for more than 10 years. Moreover company was prompt to declare special dividend on sale of Russian subsidiary, a windfall profit, rewarding shareholders handsomely.

5) Earnings Growth: Greham suggested that investor should look for earning growth of CAGR of atleast 3% for last 10 years. However, I feel that, benchmark is set too low hence one should at least look for CAGR of 7-8%. In case of JB, it has achieved earnings growth of 11.5% CAGR. Though it is not spectacular, it is decent enough.

6) Price to Earning Ratio: Greham suggests that one should look for P/E ratio of 15 or less. In case of JB chemicals, considering 2010-11 EPS of 14, and reducing it by 30-35% (considering sale of Russian business and hence reduced earnings), at current market price, P/E will be around 7-7.5.

7) Price to Book value: Greham suggests that defensive investor shall not pay more than 1.5 times book. Considering cash from Russian operations, JB is trading much below its book value.

Market Cap Less than Net Working Capital: In addition to this, Greham suggests that one can simply buy a stock if the market value of enterprise is less than net working capital. He suggests that such opportunities are very rare. Greham suggests that one should be extra cautious and should reduce total debt from NWC and compare it with Market cap and if market cap is still less than NWC - Debt, one can buy stock, just considering this parameter.

In case of JB, NWC - Debt is 729 Crores while its market cap is merely 594 Crores. In other words, Investor is getting Cash/cash equivalents/inventory/investments of 100 Rs. for 80 Rs. In addition to this, he is getting fixed assets of the company and operating business for FREE. In words of value investing, there is substantial Margin of Safety for investor and as Graham puts it, even if a dumb fellow is running this  company, you are not likely to lose money!

In all, I think it is a great buy considering decent business run by good management available at very attractive valuation! 

19 comments:

  1. Good Stuff! There is a report that Rakesh Zun... bought 12.50 Lacs shares of JB at around Rs. 68 in March 10. I read it somewhere
    SPD

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  2. Thanks. I have also read that RZ has created some position in JB in 2010. However, I am not sure about current holding.

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  3. Looks good. Will falling rupee generate more export income for JB?

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  4. Chirag, post sale of Russian and CIS business, JB's export revenue will go down considerably as Russian and CIS market had major contribution to exports. Moreover, JB has reported M2M losses of 19 crores in last quarter on FE fluctuations. Hence it is safe to assume the there will not be any gain for JB due to falling rupee. My personal take on FE is that in the longer term Rupee is going to strengthen.

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  5. Hi Dhwanil,

    I like JB Chem as a net bargain and included it in my virtual portfolio. While researching the company, I came across your blog, you've made nice posts.

    On JB Chem, do you have any idea what was the real reason that DRL called off the Russian deal.

    Keep up the good work thru your posts.

    Regds

    Shikhar

    Visit me at http://www.investor-link.blogspot.com/

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  6. Hi Shikhar,

    Thanks for your words of appreciation and encouragement. I am not privy to the details of why JB Chem deal with DRL fell off. However, Rx business for JB in Russian and CIS countries is very small compared to their OTC business and hence not much of an impact is expected.

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  7. Dhwanil,

    Nice post. I am also tracking Piramal Healthcare (PHL) and JB Chemicals (cash bargains) for quite some time. If I were to choose one of them, what would you suggest? My preference is more towards JB Chemicals. Here is my reasoning:

    1. With PHL, I am a bit worried about too much diworsification, whereas with JB they are very clear that they want to focus only in Pharma
    2. Also with PHL, we will have to apply holding company discount (I am not sure if you applied the same in your valuation exercise in the other post). This does not apply to JB
    3. However, PHL is a much bigger brand, Mr. Piramal and the management has capability to make it big. Also, the UU factor in drug discovery can lead into positive black swans

    Would love to hear from perspective on this.

    Regards,
    Vijay

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    Replies
    1. Hi Vijay,

      I feel that JB and Piramal fall in different categories in the sense that JB is purely a value play only. To me primary reason for holding JB is the cash bargain/NWC bargain and not the quality of business and hence moment price approaches intrinsic value, I would exit out of JB as i do not see long term sustainable moat for JB.

      In case of PHL, I feel one is getting a value play in very high quality business, a rare opportunity indeed. In case of PHL we are talking about businesses that are in the top of the league world over (CMO and Critical Care). Moreover, as you rightly pointed out, one is exposed to positive black swans on NCE business which can potentially transform PHL into big league of pharma giants like pfizer and cipla in next 10-15 years. Another positive in favor of PHL is Mr.Piramal's unmatched managerial/capital allocation skills which has very high intangible value.

      I understand that PHL is diversifying in many areas and some of it may not work out, however, the prime focus for PHL is going to remain mainstay of the company according to their own projections. Hence, even if these business remain mediocre, it will still not be value destroyer.

      I have not applied holding company discount as PHL is not purely holding company as it has its own operations and most of the subsidiaries are 100% owned by PHL (which may not be the case for many holding companies).

      In all, if I have to choose between piramal and JB, I will be inclined towards PHL due to potential reward size can be substantially more than that of JB. One word of caution here is warranted though. PHL is a long term play as story is going to develop over next 3-5 years and in the short term, market may still remain pessimistic about PHL while in case of JB, one can expect that gap between intrinsic value and price will be bridged in next 1-2 years.

      Best Regards
      Dhwanil Desai

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  8. Thanks Dhwanil for the clarification. Appreciate it.

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  9. Dhwanil,

    I learnt few things about JB Chemicals and would like to share here. I am sure you would have gone thorugh the transcript fo this con-call post the sale. Anyways posting here for the benefit of all
    http://www.aceanalyser.com/Conference%20Call/106943_20110603.pdf:

    1. Post the sale of CIS OTC business, there will be roughly 2-3% impact on margins. On the other hand, the debtor turnover days will reduce drastically from 180 to 40-50 days, thereby reducing the working capital requirements
    2. JB has signed an agreement with J&J, whose subsidiary buys the CIS OTC business, to supply the products for the next 5 years. This will generate around 100 Crores per annum. Since these brands (Doktor Mom etc.) are huge in CIS regions and considering J&Js strength, I am sure they will grow this business in the years to come. This will eventually benefit JB

    I also agree with you that this stock can unlock its value in 1-2 years time frame.

    Disclosure : Invested at levels of 64

    Regards,
    Vijay

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  10. Hi Vijay,

    Thanks for sharing the link to the concall transcript. I think, JB management has taken a very judicious and conscious call on selling off its OTC business and if you read their 2011-12 AR, it again reaffirms its focus on slowly but surely growing within its area of competence. One statement from Chairman "We do not plan to
    invest this money in haste and will invest it
    when the right opportunity emerges in our
    pharmaceutical business." does strengthen my confidence that company will not spend on making pricey acquisition just because it is flush with cash. I think management has done a very decent job in terms of rewarding shareholders (450 crores with dividend tax) and keeping money for business expansion. I see re-rating on the cards which will mean significant return in next 1 year while there is limited downside.

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  11. Dhwanil,

    Also check out the way Ashish Dhawan is buying into this stock for the last 3 quarters. He is an insider for so many years and he seem to be bullish on this. Somehow, these kind of activities make me more confident than anything else

    Regards,
    Vijay

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    Replies
    1. Hi Vijay, good observation. Yes, Mr.Dhawan has increased shareholding from 6.92% to 9.16% which definitely helps in conviction building.

      Moreover in 2010-11. quarterly results were shadowed by the forex losses on forex loan count/ JB apparently had short term loan facility in foreign currency of 104 crore which has been reduced to 26 crores. This will reduce forex losses considerably.

      In all, I am fairly convinced on this as typical net-net buy.

      Best Regards
      Dhwanil Desai

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    2. Hi Dhwanil,

      Seems to be a good value pick! Just curious, Where did you find that Mr. Dhawan's stack has increased from 6.92% to 9.16%? I can't verify the same on bseindia.com...Thanks.

      Regards,
      Aksh

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    3. Aksh,

      I think its mentioned in the latest annual report.

      - HG

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  12. So Dhwanil your pick being recommended by Hitesh Bhai as well.Good .any risk in the story???

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  13. Hi Dhwanil,

    What do you think of Eon Electric (previously Indo-Asian Fuse Gear)? I came across this at the value picks blog -
    http://value-picks.blogspot.in/2012/11/eon-electric-worth-bet.html

    It seems to have some similarities with the JB Chem story -
    - Sold off a division and used to the money to give out a special dividend, pay down debt and buy back stock.
    - Lots of cash balance (and hopefully they will put it to good use)
    - Ashish Dhawan is invested in it

    Would love to hear your views on this.

    - HG

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  14. Hi Dhwanil,

    Is JB still a buy at current levels of 110?

    ~Sunil

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    Replies
    1. Hi Sunil,

      When I first wrote about JB, it was a Graham style stock and "net working capital" bargain in strictest of sense! So,extremely low risk indeed.

      At current price, it is no longer a working capital bargain but still seems to be undervalued considering the traction in earning growth that it is showing. JB is a decent pharma company (though not a blockbuster one like Lupin/Glenmark) which, in the past, has grown at average 15% with ROCE of around 20%. When we consider this with large amount of cash sitting on books, creates high margin of safety. Though, in the long term, I am more optimistic on their US and rest of market business than Indian business mainly because Indian business operates in highly competitive environment with very average margins. However, in the short term, latest pricing policy creates some tailwind for Indian business which may help company increase its price in line with inflation, giving it some pricing leeway, which was hitherto not there. Overall, at this price, risk reward seem to be in favour.
      From a purist perspective, large cash sitting on books for more than a year without any firm plans (except for the reiteration that it will be deployed in pharma business) and earning sub par return does create discomfort. But my solace is that management is ethical and honest hence capital allocation may not be most efficient, it is not likely to be tucked away into personal accounts through some shady means!

      Disclosure: I currently do not have position in JB.

      Best Regards,
      Dhwanil Desai

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