Value-Stock-Plus

• Companies with Jhunjhunwala’s stake - Source: ET dated 15th January, 2007
• Wall Street Journal on Rakesh Jhunjhunwala - Indian Mogul Rises to Status Of Money Icon Hunt for Undervalued Now Goes to the Mall; Like Warren Buffett
• Jhunjhunwala’s new game is Private Equity - Dalal street was never like this — anonymous, faceless fund managers who sit in front of lifeless grey screens and move millions of dollars in and out of the market with the click of a mouse.
• Let’s not take stock - Mr. Jhunjhunwala at Intaglio 2007 at IIM-Calcutta - (Notes by Harish Bihani)

December 2006

• `2007 will be year of consolidation and rise for the Indian markets’ : Rakesh Jhunjhunwala - Equities delivered superior returns over the long term. “Market is always right. Markets cannot be taught, they have to be learnt.
  
• Rakesh Jhunjhunwala - The Man who saw tomorrow - Best Quote: If you find an idea that you are convinced of, take a position which if proved correct makes a meaningful difference to your Balance Sheet

November 2006

• Trading is against human nature: Rakesh Jhunjhunwala - ‘Trading is against human nature,’ says Rakesh Jhunjhunwala, while talking about his investment approach in the stock markets
• Rakesh Jhunjhunwala’s portfolio valued at Rs 1,341 cr - More than 33% of the stocks in portfolio have underperformed Sensex in last six months
• Rakesh Jhunjhunwala’s Portfolio as on 31st October, 2006 (Update 1) – Thanks Market Analyst!!

October 2006

• Video Download link of CNBC-TV18’s Samvat 2063 programme - Click here (70.91 mb .flv file)
• Good stocks and good markets always remain expensive: Rakesh Jhunjhunwala
• Market trajectory pointing upwards: Rakesh Jhunjhunwala

• ‘What we buy is important; at what price is most important’: Rakesh Jhunjhunwala
• What turns on Rakesh Jhunjhunwala?
• Rakesh Jhunjhunwala on markets & P-Notes

• Rakesh Jhunjhunwala: The Punter’s Favourite
• Rakesh Jhunjhunwala’s latest portfolio at theequitydesk.com

• Equity still best vehicle for returns: Rakesh Jhunjhunwala
• Lunch with Rakesh Jhunjhunwala
• Presentation by Rakesh Jhunjhunwala (July 2006)

• Wealth Creation & Wealth Management - A presentation by Rakesh Jhunjhunwala RE-UPLOADED
• India: The Structural & Secular Bull Story by Rakesh Jhunjhunwala RE-UPLOADED
• Secular & Structural Bull Market is alive: Rakesh Jhunjhunwala

• Being Rakesh Jhunjhunwala: Bull of Bourses RE-UPLOADED

• Bull Markets & Scam: A view by Rakesh Jhunjhunwala
• No Viagra, none was needed. Good Show: Rakesh Jhunjhunwala

• No bubble in market: Rakesh Jhunjhunwala

• What Rakesh Jhunjhunwala & other Money Monarchs expect this year?
• Investing strategies for 2006 from market experts

• Challenges & opportunities for New India Inc by Rakesh Jhunjhunwala
• Investing tips for 2006 from 4 market experts

• Assessing value: My education as an investor by Rakesh Jhunjhunwala
• Interview of Rakesh Jhunjhunwala
• Is the market rally different this time? by Rakesh Jhunjhunwala
• 50:50 chance of going past 8800 levels: Jhunjhunwala
• Samavat 2062: Jhunjhunwala gives his list of hit sectors

June 2005

• Rakesh Jhunjhunwala - The sage of Mumbai

May 2005

• Indian investors follow ‘beacon’
• Don’t fall in love with stocks: Jhunjhunwala

March 2005

• The market maestro

November 2003

• Rakesh Jhunjhunwala, Investor & Trader: A Chat

October 2003

• Big Bull: Jhunjunwala rules Dalal Street

Needs and wants are different: This is the first rule to be followed. Needs is defined as goods or services that are required. This would include the needs for food, clothing, shelter, and health care. Wants are goods or services that are not necessary but that we desire or wish for. For example, one needs clothes, but one may not needs designer clothes. One needs food, but does not have to have dessert. Just about everything else is a want and wants are endless. Just because resources are limited we have to make a choice about which want to fulfill. Also the way we fulfill our wants involves choices for example, travelling in Maruti 800 or Mercedes Benz. Taking responsibility for the choices is difficult, but in the end you are not the victim of the circumstances.

Scarcity: It would be a dream to see the world of endless abundance. But in reality, at any point of time, we have limited resources. The land, oil, and even the cash we have are limited and this scarcity makes us the need to choose. Markets and scarcity are closely related. The former would be rendered irrelevant and unnecessary in the absence of the latter. Assets increase in value in line with their scarcity. When scarcity decreases i.e., when demand drops or supply surges - asset prices collapse. The dotcom bubble was the result of this scarcity. Stock prices were driven by projected ever-growing demand and not by projected ever-growing supply of dotcom providers.

Opportunity cost: Opportunity cost is defined as the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. For example you invest in a risk free bond yielding 5%, you gave up the opportunity of another investment – like equities yielding, say 10%. In this situation, your opportunity costs are 5% (10%-5%). Opportunity cost show variation among individuals, and between expectations. One person may perceive that an investment in a company will produce four times his investment in two years. Another person may expect only a doubling in two years. In fact, the stock may drop by half in two years. Retrospectively, both parties see the opportunity cost of not putting the money into a savings account as very large. Thus one has to invest according to one’s need and risk appetite.

Risks: the concept of opportunity cost comes along with risks. Every human endeavor carries some risk, and investments are no exception. Also not only does risk mean different things to different people, your own definition will probably change during your lifetime. What differs is the amount and type of risk and how you are compensated for taking it. In the above example, for a 5% higher return, the investor is taking the high risk of investing in equities. Here are three risk considerations you should review when planning your investments.

• Time frame: Whether you are a long term or short term investor. Stocks and bonds can be volatile, especially in the short run. That is why, over the long run, your time frame is perhaps the most critical component in planning your investments. For example, if you are investing for a retirement that is 25 or 30 years away, you have time to ride out the ups and downs of the market

• Inflation: One big risk most investors face is that their purchasing power will be eroded by rising prices in the future. “Playing it safe” and accepting no market volatility also means accepting the potential for lower returns - a risky strategy if you are trying to keep up with or even beat inflation.

• Goal: This is the most important thing. The basis of investment depends on this. Once you know your goal, match your investments to it. If your goal is ambitious, you may have to accept higher volatility and a greater chance of loss in return for the potential to reap higher rewards. But if your goal is modest, you may be willing to accept the trade-off of less gain for lower volatility and less chance of losing your capital.

Time value of money: this is defined as: the rupee I get today is worth more than a rupee I’m promised sometime in the future. The reason for this is that the rupee I get today is real, but the rupee I’m promised in the future will be worth less (because of inflation), Also, the money I get today can be invested to create more rupees in the future. On this ground, one can distinguish between the worth of investments that offer you returns at different times.

Compounding: Albert Einstein rightly said, “The magic of compounding interest is truly the eighth wonder of the world!” Compounding is a simple concept that offers astounding returns: if you park your money in an investment with a given return, and then reinvest those earnings as you receive them, your investment grows exponentially over time. With simple interest, you earn interest only on the principal (that is, the amount you initially invested); with compounding, you earn interest on the principal and additionally earn interest on the interest. In other words, it’s a way of making your money work harder for you, and is perhaps the most powerful tool that an average investor can use to plan for many of life’s financial goals, including retirement.

• ‘Do not take fresh positions now’
• Brokers bullish on LIC Housing Finance, Madhucon Projects
• Marginal impact on Re seen due to carry trade: UBS
• Are hedge funds moving out of crude oil?
• FIIs are back; bring back 77% of May outflows
• 11,900 to be a crucial level for market: Choksey
• Mkts’ current levels not sustainable: Commerz Bnk
• Easing oil prices to lead a change in valuations: Dalal
• Good buying support in engg, tech & auto: IL&FS Investmart

• Construction Sector - SSKI
• Construction Sector - EC
• Telecom Sector - Mac

• The amazing story of Harley-Davidson
• Lalu to teach management at IIM-A - !@#%^
• Garbage too can make you RICH

• The market, like the Lord, helps those who help themselves. But, unlike the Lord, the market does not forgive those who know not what they do. lass="984410012-30082006"> - Warren Buffett

Growth in user industries like power, construction, refining, textiles, automobiles, and other manufacturing, has led to strong performance by the Indian capital goods and heavy industries companies in the past 2-3 years. Apart from creating sufficient domestic supplies, the growth in capacity expansion and improvement in productivity levels has also led to these companies charting a more confident global route than ever before. In fact, as per the Engineering Exports Promotion Council of India, India’s heavy industrial and capital goods exports, which have grown at a compounded rate of 32% during the period FY01 to FY05, are estimated to grow at a rate of 25% per annum during the period FY04 to FY09.

However, do these statistics and growth prospects definitely mean that investors should be blindfolded in their approach to investing in stocks from the sector? Not really!

While we have a positive view on the sector in terms of improving revenue visibility on the back of burgeoning order books of players across the sector, which is a consequence of the huge investment plans from public and private sector enterprises, there are a host of risks that surround these companies’ prospects.

Over the past few years, considering the huge opportunity that the sector brings along, there has been a multi-layer increase in the number of participants in the capital goods and heavy engineering sector - multi-layer because the increase has been seen across the spectrum pf projects and heavy equipment segments. This has led to an increase in ‘commoditisation’ of the industry, whereby companies are fighting for volumes by sacrificing profitability. Even the best and most diverse of the companies have not been able to perk up their margins significantly in the past two years. While higher input prices are definitely a reason for lacklustre margin profile of many of these companies, there is no denying the fact that commoditisation has taken a serious toll across sub-segments, be it infrastructure creation, or power.

Another negative offshoot of the business opportunity has been increasing challenges for companies on the employee acquisition and retention front. Some of the companies have even indicated of attrition levels of 10% to 15%, which, unless clarified, might seem like employee churn in the IT services and BPO industry. Some critical divisions of these companies, like design and project execution, are in fact facing the biggest crunch in terms of talent acquisition and retention. And, apart from rise in employee costs, this has led to a big part of the crucial management time getting diverted to human resource issues.

Finally, as a flip side to the ‘high visibility’ factor in terms of burgeoning order books, there emerge equally high levels of high execution risks. This is because companies from the sector are increasingly adding contracts that have long gestation periods, or long execution cycles. Among many, this leads to risks from changes in business climate and uncertain movement of commodity prices.

And, what about valuations?
Well, this is one of the foremost concerns that we have with the capital goods/heavy engineering stocks. With some of the leading companies trading at price to earnings multiple of as high as 40 times trailing twelve months’ earnings, despite factoring in all kinds of positives like visibility and improved execution capabilities, we are uncomfortable with respect to the overall sector valuations.

As indicated above, apart from the ‘visibility’ part (as seen from big order bookings), investors need to clearly understand the risks associated with the same. While the need to sustain high levels of growth through creation of world-class infrastructure facilities shall continue to provide companies from the sector with multiple growth options, you, as an investor, need to identify whether the price that needs to be paid for the ensuing growth is justifiable or not.

• Brokers bullish on PNB, UTV Software, Marico, Cipla
• Brokers bullish on Zee, M&M, Sterlite Optical
• Let mkts decide a reasonable price for gas: Raha
• Merrill Lynch puts a buy on BHEL
• Follow the market,don’t take contrarian calls: Anand Tandon
• Mkts poised to move upwards: Dilip Bhat
• India story still good but valuations stretched: JP Morgan
• Mkts to correct over next 2 mths: DSP Merrill Lynch
• Mutual funds or bank deposits?
• Equities seem on course for a rough ride
• <!–
  What do brokers expect from Big Daddy, Infy? Infy to determine market’s next move: HDFC Securities Infy should report 25-30% growth in bottomline: Dilip Bhat

  –>Investments: Thinkbig

• FIIs: Follow the leaders
• Operators are the real people who are moving the markets.
• Show Stoppers: 201 cos Shine post May meltdown
• Paper power: Good times ahead for paper sector

• Trading on Greed & Fear
• Matrix Labs. - Citi SB
• Ashapura Minechem - MO
• BHEL vs L&T - Enam
• Oil Sector - Mac
• Global Consumer - MS

• Why wasting time is a good thing
• What’d Bill Gates study at Harvard?
• How to allocate assets & be RICH

• When you combine ignorance with leverage you get some pretty interesting results. - Warren Buffet

• Rakesh Jhunjhunwala’s latest portfolio at theequitydesk.com

Now, a number of investors were crying hoarse about how much money they lost after buying stocks at the highs and selling at the lows (which, of course, is the opposite of what an investor must do to make money in stocks). We heard horror stories about how people lost fortunes by leveraging too much - clearly a case of biting off more than one can chew. However, we were always uncomfortable with the way the Sensex was moving non-stop in the upward direction, a clear sign of overvaluation, and had been advocating utmost caution much before the Sensex came even close to these high levels.

The markets have again moved up from their lows, as buying has resumed at ‘more reasonable’ levels following the crash. What can investors now expect from the Sensex? Any number of views abound on the street, with some quarters giving 7,000 as a possible target, while others give another extreme target of 15,000! We refrain from giving any such number, as we do not predict index levels. We believe that it is better to adopt a bottom-up approach and select the best stocks that have the potential to give superior returns over the long-term. We examine here, a few macro factors taking place that could impact the stock markets and specific sectors.

A higher interest rate environment
For too long, there was a global party, with all-time low interest rates prevailing in major economies globally, including the US, Australia and Japan. This caused money to flow out from those economies into the ‘emerging market economies’, such as India. Global risk appetite increased significantly, with funds from developed economies scouting the globe for investment opportunities, since their markets hardly offered any meaningful returns. Thus, we had a strange scenario, where fund managers from the US invested in crude oil, gold, commodities, real estate and other such investment avenues, as well as emerging market indices. This caused the bull runs across these asset classes, a unique, unusual and highly risky situation indeed.

However, with the US Fed resorting to a hike in interest rates, this risk appetite has reduced. Now, with higher-yielding US treasuries, some amount of outflows could be seen from emerging markets over a period of time. Given the Indian markets’ dependence on FII money, this might have an impact. However, we believe that, despite rising interest rates, given Indian companies’ strong fundamentals and growth prospects, these will continue to do well, and consequently, their stocks should also do well on a macro basis.

Higher crude prices
This is certainly one variable that could slow down Indian and global growth to an extent. There have been no major new finds of crude over the past three decades, and given ever-increasing demand from countries like China and India, crude oil prices may not soften in a hurry. Higher crude prices act as a ‘tax on growth’, since countries need this valuable commodity to run their economies, despite the fact that prices may increase. Sectors that could get impacted are energy (specially oil marketing companies), sectors like paints that use crude-based raw materials, auto, petrochemicals and shipping.

Commodity prices
We are of the view that over a longer period of time, steel prices will trend downward, and are now at a stage where they are going into a downturn, as opposed to the strong upturn seen, peaking in FY05. This will have the beneficial impact of reducing the cost of raw materials for sectors like auto, construction and engineering, which use steel as a major raw material. On the other hand, steel companies will be negatively impacted, due to lower realisations.

Other factors
Geopolitical factors like the recent Israel-Lebanon conflict and North Korea’s nuclear programme have the ability to impact sentiment, although they might not necessarily have an actual impact on the country. Given that India is becoming increasingly integrated with the global economy, this factor cannot be discounted. The ‘political factor’ could also play its part.

A stable government is always a positive factor, and an unstable Centre is certainly not in India’s interests. Nonetheless, it also needs mention here that despite the political turmoil that India has seen in the past, the economy has still grown at an average of around 6% per annum over a long-term period.

Conclusion
We believe that it does not make too much of a difference as to what level the BSE Sensex is trading at. What is more pertinent for an investor is the level at which the stocks that he or she wants to buy are trading at. We firmly believe that, in such times, a bottom-up approach would serve investors the best. Always consider the risks in your investment, such as the ones mentioned in this write-up, and go for strong companies that are likely to stand the test of time.

• Rakesh Jhunjhunwala’s latest portfolio at theequitydesk.com
• Fingers of Instability
• Brokers are bullish on PVR, HBL Nife, Sterlite Optical
• Take a bottom up approach on midcaps: Motilal Oswal Sec
• Expect some selling to come in September: Investshoppe
• Cement, property stocks rule the roost among midcaps
• Can invest in riskier assets for now: JP Morgan
• Internal Indian mkt scenario is quite robust: Choksey
• Prefer SpiceJet in aviation sector: Edelweiss Capital
• KRBL looks attractive at this price level: Religare Sec
• Why Stock Prices Move
• Beware booming asset markets! by Dr. Marc Faber

• Global Outlook - Citi SB
• India Strategy - AB
• Power Sector - JPM
• Sugar Sector - SBICaps
• Airlines Sector - Brics
• Asia Rally to continue - MS
• India Strategy - MS
• SSKI Technical Analysis

• Global brokerages want retail action
• The birth of India’s global giants
• Palm CEO on mobile manners

• With enough inside information and a million dollars you can go broke in a year. - Warren Buffett

So far…
The turnaround in corporate investment, which began in FY03, peaked in FY06 and if the RBI projections are to be believed, will sustain in the current fiscal. The total project cost as well as the average cost of projects was significantly higher in FY06 as compared to the previous fiscal - reflecting increased investment opportunities. The sharp increase in production of capital goods, import of capital goods and other non-oil imports, improved corporate profitability and robust GDP growth in manufacturing over the quarters of FY06 continued the momentum in fixed capital investment.

Not to be left behind, the aggregate capital expenditure of services industry also multiplied by nearly 3 times due to the initiation of large projects pertaining to airlines, shipping and entertainment industries. Improved capacity utilisation and conducive investment climate (backed by adequate liquidity) accelerated capital spending, particularly in industries such as infrastructure, construction, textiles and iron & steel. It may also be noteworthy to point out that while investments in greenfield projects grew by 102% YoY in FY06, growth in brownfield projects was a mere 7% YoY. It thus reveals the mindset of companies to explore opportunities in new areas and capitalise on the prospects lying therein.

Where to spot it?
For investors, the easiest way to reckon how much a company had incurred on capital spending during the fiscal is to scan a component of its cash flow statement. ‘Cash flow from investing activities’ lists all the cash used by the company for purchase of assets or investment in subsidiaries and that garnered through the sale of assets. A comparison of the same with the ‘cash flow from financing activities’ will also enlighten the investor as to whether the capex was funded by additional debt or equity or neither (internal accruals).

How to evaluate it?
Since cash returns on capital spending often do not make an appearance in the company’s financials until many years after they are executed, investors often do not get a justification for these outlays - beyond the guidance offered by management. One method that attempts to estimate the ‘required level’ of capital expenditures over a period - thus asserting by way of hindsight as to what was the ‘discretionary’ portion of the spending - is the comparison between the growth rate in cost of goods sold (COGS) and the growth rate of capital expenditure. The logic is clear. Absence of any physical measure of output can be matched with a growth in cost of inputs. Also, cost of sales can serve as a proxy because it constitutes all the necessary components needed to capture fluctuating product costs.

It is also pertinent to evaluate the impact of the capex funding on the company’s balance sheet and bottomline going forward. While infusion of additional equity will lead to capital dilution, the debt funding must be necessarily accessed at feasible rates. While most textile companies embarked on capex plans over the last couple of years, it was only those, which availed of the benefit of TUF (Technology Upgradation Fund - offering 6% interest subsidy) that have accessed the funds at attractive rates.

What lies ahead?
Going forward, we expect the momentum of capacity expansion (in terms of growth) to get moderated on account of the uncertainties about oil prices and primary commodities prices, which have risen significantly in recent years. Global interest rates have also firmed up along with the rise in domestic interest rates, thus chocking the liquidity flow. Nevertheless, the prevailing interest rates levels being relatively lower than the historical highs - are yet to have an impact on corporate borrowing. While the higher capacities may give Indian corporates the scale required to compete with global peers, investors must keep in mind that the capex must be ‘well timed’. Else, overcapacity may adversely impact realisations. Not to mention the execution risks involved!

Source: EM

Export optimism

For those worried about the sustainability of the current bull run, a quick check on fundamentals should help. Especially export fundamentals, since that’s where firm-level competitiveness is most tested. The rearview window is extremely reassuring, with India’s exports surging 34% in April-July, 2006, over the same four-month period in 2005.

Details from the first quarter (April-June), which contain more disaggregated figures, show that engineering goods have been among the best performing sectors. The share of engineering goods in the total export basket has risen to 20.9% in 2005-06 from 15.8% in 2000-01. Within this group, project goods logged 79% growth during the first quarter and transport equipment 61%. Other star performers include petroleum products, basic chemicals, pharmaceuticals and cosmetics, coffee, oil meals, processed food, carpets, raw cotton, textiles and spices.

The vibrant export performance is testimony to the growing competitiveness of Indian industry, thanks to serious firm-level restructuring initiatives. This is remarkable given the fact that most of the recent export growth - barring the last one year - has happened with an appreciating rupee.

The question is: can this sustain? There are worries about the slowing of the world economy, especially the United States, India’s biggest export market, which accounts for a 16.7% share of the total. The US takes in 15% (the biggest chunk) of engineering goods exports.

A lot will then depend on how quickly India diversifies the direction of its exports. The proposed free trade agreement with Asean will offer one pointer. Textiles, gems and jewellery and electronics goods form the bulk of Indian exports to the region. Depending on how the negotiations progress, the prospects might brighten for these sectors.

Additional Readings:

• Top 20 stocks that mutual funds hold
• Market’s near term rally is over: HDFC Securities
• Mkts to trade between 11,330-11,900 this month: Choksey
• Risk appetite in EMs has improved: Allianz Dresdner
• How the promoters’ shareholding changed in Q1FY07
• FIIs show their affection on India inc in June qtr
• How much does your portfolio weigh?
• Let not IPO gradings lead you
• Brokers bullish on HBL Nife, GE Shipping, Rohit Ferro

• Sugar Sector - Brics
• Ferrous Metals - EC
• Oil R&M - MF

• How to invest internationally
• Tax Chat with Shanbhag!
• Premji among 10 richest tech titans

• Occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics is equally unpredictable, both as to duration and degree. Therefore we never try to anticipate the arrival or departure of either. We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful. - Warren Buffett

In our view, retailing is not just about how many square foot stores does one has managed to set up. More important, and this is something that we wish to re-iterate, is the fact that majority of the retail stores are not owned by the retail companies! So, do not buy a retailing story based on ‘the real estate story’, which is very hot in the stock market. Most of the properties are based on lease agreements (ranging from 10 year to 20 years).

“The secret of successful retailing is to give your customers what they want” is what Sam Walton wrote in his autobiography - Made in America. Wal-Mart started in 1969 with 15 stores in 5 states and currently has a network of more than 5,000 stores across the world. The company’s topline growth, over the last 32 years, stands at a healthy CAGR of 4%. During this period, Wal-Mart has faced competition in form of local retailers, departmental stores, speciality retailers and the larger-format retailers like Kmart.

The following is the excerpt from the Annual Report of Wal-Mart in 1972. The company’s strategy was:

1. Putting in dominant new full-line stores in the medium size and smaller communities in the five state areas within 300 miles of our distribution center.

2. Continuing our policy of maintaining true discount prices and one of the lowest gross margins of any chain in the United States.

3. Being extremely control and expense conscious, starting with our construction program all the way through our entire operating structure.

4. Continuing to develop loyalty, morale and enthusiasm among all the personnel for the total Wal-Mart program. Of all our assets, I must count this last ingredient the most important.

These principles still hold true! While every company has a vision, not many have the ability to translate it into actual financial performance. The table below highlights the performance of Wal-Mart since 1972! Consistent with its objective, the company’s gross margins are in single-digits. More importantly, despite the rapid expansion in the number of stores (not just in the US but also in the international markets, which have been scaled down consequently), the average return on equity is commendable.

While we are not disbelievers in what Indian retailing companies are aiming for in the long-term, we challenge the investor’s blind assumption that ‘these companies will grow’. We have heard this argument time and again. In the early years of post liberalization, cement stocks were bought as if there is no tomorrow. This was based on the premise that per-capita consumption of cement in India is among the lowest in the world, India’s infrastructure is poor and the replacement cost of a cement plant is much higher than their current stock price. After almost sixteen years, all these factors still hold true. Take the case of software stocks in 2000. Time and again, ‘these companies will grow’ assumption has been tested big time and investors have lost money.

Here is our fundamental take on the retailing sector and their valuations.

1. Perhaps the most misunderstood side of the retailing story is the fact that merchandise for sales at the retail outlet is not easily available. Even if they are available, for a Pantaloon or a Hypercity, the suppliers lack the scale. Discount stores are viable in the long-term provided they have scale, which is not a factor of how many square foot one has in a mall, but whether suppliers can meet the long-term requirement of retailing companies (i.e., supply-chain). Here is where the likes of Wal-Mart have mastered their skills on the sourcing front. Wal-Mart has acquired the scale over the years to source products from across the world in bulk (say, China and India) for selling in its US stores. For an India-based retailing company to achieve some kind of scale, it will take at least three years, if not more. And that too, if the expansion plans are as per the schedule.

2. It is important for investors to focus in the long-term on not just the sales per square foot but also profit per square foot. Profit per square foot is influenced by a retailer’s ability to manage supply-chain efficiently. Typically, especially on apparel sales, a retailer derives revenues from both private-labels as well as other branded products. As far as the private labels are concerned, the onus of selling the stock lies with the retailer (because he owns the stock), which is not the case in the case of other branded apparels (which are returned if not sold). Margins in private labels are higher and due to the lack of any advertisement or brand-related expenses, private labels are sold in the retail outlet at a cheaper price. The risk on the supply chain therefore, it to make sure that stocks are cleared faster, so that working capital is efficiently utilized. While Indian retailers have been fairly successful on this front till now, given the rapid expansion plans, challenges are huge.

3. Availability of prime locales for new stores and more importantly, ability to attract and retain people is perhaps the other major challenge. Revisiting Wal-Mart’s 1972 annual report, there is a specific mention about the human capital. “Continuing to develop loyalty, morale and enthusiasm among all the personnel for the total Wal-Mart program. Of all our assets, I must count this last ingredient the most important.” The race for human capital has started and every company under coverage feels that this is one of the major challenges for executing their business plan over the next three to five years.

Coming to the valuations side of retail stocks, hoping that retailing companies will grow earnings by over 50% to 100% over the next two years and paying price to multiples of more than 40 times trailing twelve months earnings is not justified. As per Pantaloon, as against the total square foot under management of approximately 3.5 m, by FY10, it is expected to touch 10 m! With all due credit to the management, there are huge execution risks involved. Many domestic and foreign retailing majors will expand in India. Remember, the once-feared K-Mart actually went bankrupt!

Despite the fact that organized retailing is just 3% to 5% of total retail sales in India combined with robust GDP growth prospects of the Indian economy over the next ten years, we believe that investors should exercise caution. Fancy valuation metrics like ‘enterprise value upon sales’ are great for investment bankers, but not for retail investors!

If one wishes to buy the retailing story, it will be a wise investment decision to buy into those stocks, whose products these retailers will be selling at their outlets (from soap to apparel manufacturers). While we do like some stocks in the retail sector, we suggest investors not to pay extravagant valuation multiples and justify the same by quoting their price to earnings growth m