VALUE BUY - HITACHI

Hitachi Home and Life Solutions (India), previously known as Amtrex Appliances is a leading manufacturer of window and split air conditioners.

The demand for its products is extremely strong considering the growing Indian middle class with its disposable income and the recent tendency to buy premium brands. In this context Hitachi's wide range of energy efficient products would place it at a considerable advantage in relation to its competitors. Its parentage and technological advancement should make it a product of choice among discerning consumers.

Hitachi also makes commercial and industrial air conditioners ranging from floor standing AC's, microprocessor controlled AC's, AC's for factory use and AC's for intelligent building cooling. With malls and modern residential complexes coming up at a rapid pace, this segment should witness high growth in the coming years. Hitachi also manufactures refrigerators and washing machines.

Financials:

For the year ended March 08, Hitachi clocked a turnover of Rs.446 cr and a PAT of Rs. 42 cr, giving an EPS of 18.40. PAT for the March 08 quarter was Rs.11.6 cr, a 100% growth over the March 07 quarter. The market price of the stock is Rs.145 as on date, giving it a PE ratio of 7.8. This appears undervalued considering the brand equity the company enjoys and the premium pricing its products command in the market.

The market capitalisation of the company is Rs.332 cr and the M Cap to sales ratio is 0.75. As against this Blue Star, operating in a similar segment has a PE ratio of 19 and a M Cap of Rs.3304 cr, with sales at Rs.2221 cr. The M Cap to Sales ratio for Blue Star is 1.5. Although Blue Star is more active in the commercial and industrial segment, Hitachi has taken steps to enter this market aggressively. The valuation gap between the two is wide, and Hitachi holds the potential to narrow down this gap.

Major risks are that Copper is a major input for air conditioner manufacturers and rising Copper prices could impact margins. Hitachi's products are priced higher than its competitors and in a recession consumers could downgrade to lower priced offerings.

 

THEORY OF REFLEXIVITY

The theory of Reflexivity propounded by George Soros, seeks to demonstrate that financial markets cannot discount the future correctly because, in certain cases, the behaviour of financial markets affect the so called fundamentals which they are supposed to reflect. It implies that financial markets do not merely discount the future; they help to shape it.

Therefore reflexivity is a self fulfilling prophecy which occurs when markets react to the expectations of its participants. A feedback loop occurs, wherein prices are driven by perceptions and the movement of prices help to reinforce expectations.

Consider the example of the Indian stock markets after its all time high in January, 2008. Once the markets started falling from its highs, investors, particularly FII' withdrew from the markets in large numbers. This caused stock prices to fall further. The fall in prices led to a perception among investors that markets were overheated. This in turn led to further selling in the markets, thus creating a feedback loop, where the prices were affected by investors' negative perceptions, which were in turn reinforced by falling market prices.

This selling and absence of fresh inflows by FII' led to the Rupee weakening against the Dollar, which resulted in inflation rising and interest rates going up. As a consequence, profitability of companies, which was projected to grow at 20 % on an average, started slowing down. Though not the only reason for slowing growth numbers, this example serves to illustrate how markets can influence fundamentals.

Soros contends that, "such boom/bust sequences do not arise very often, but when they do, they can be very disruptive, exactly because they affect the fundamentals of the economy." Conventional market theory acknowledges that all the available information is built into prices and current markets correctly discount the future. Soros thinks that this interpretation of the way markets operate is severely distorted . He works on the principle that whenever he takes a position, he does not automatically presume that the markets are wrong, but allows for the fact that he himself could be wrong on his call.

This article relies heavily on a speech made by George Soros on April 26, 1994 to the MIT Department of Economics World Economy Laboratory Conference Washington, D.C.

WHERE DO WE GO FROM HERE

With crude showing signs of cooling off, stock markets look poised for a rebound. It also depends on the vote of confidence scheduled for the 22nd and the inflation figures. In my opinion it’s a good time for long term investors with a time horizon of 2 years and above to go on a shopping spree.

Oil, which has been a major drag on the markets is projected to react to $100 to $110/bbl in the next six months. The reasons are slowing demand for gasoline in the US, the relatively lower growth in GDP projected by India and China and the comments of the King of Saudi Arabia seeking lower oil prices. If oil prices fall as expected, this would provide a huge boost to economies like India and consequently their stock markets. Since higher oil prices are already factored into current market levels, any positive news could act as a trigger.

On the political front, the exit of the left parties should act as a pleasant surprise for stock markets, only if the government survives the vote of confidence. In such a scenario, the Government would be free to aggressively push reforms in insurance and banking sectors. Moreover the disinvestment process of PSU’s would get a huge boost, bringing quality new issues to primary markets and increasing the depth and liquidity of our markets in addition to improving sentiment among battered investors. Also opening of the insurance sector would bring a flood of FDI into the economy, thereby strengthening the Rupee.

Inflation poses a huge risk to the markets, but again most of the bad news is built into prices. Though inflation is not expected to fall off any time soon, it is after six months that the higher base effect will kick in. Since, in India inflation is measured on a YOY basis, we are getting inflation figures compared with last year’s figures. Inflation was quite low at this time last year hence we are seeing disproportionately higher inflation growth figures. Also by this time we will see some of the measures taken by RBI to curb inflation take effect. Another positive would be the normal monsoon, at least till now, which would bring down the prices of food articles.

A caveat here is that any of the above scenarios not happening could act as a dampener. But in my view, current prices hold value for investors willing to wait it out and having the capacity to bear some potential pain in return for longer term capital growth.

A CASE FOR SIMPLICITY IN INVESTING

In a book, I recently read, the author gives the example of a person who turned this life savings of $ 2,000 into $ 1 Million by following a simple strategy. When the dividend yield of the Dow Jones Industrial average went up to 6 %, he put all this money into stocks. When it went below 3 %, he got out of stocks and put the realised amount into a savings bank account. It took him 30 years to achieve the above result, but still it is no mean feat. Though I am in no way advocating that investors follow this method, the fact remains that the techniques that make you the most money are often the most simple to execute.

 

If making money is the ultimate objective, why do we then follow exotic strategies in our hope of beating the markets in the short term? Could it be that the more we try to outwit the markets, the more we fail? I have tried to examine the reasons behind why people (including myself) go for complicated strategies in trying to outperform. One of the reasons is that we like to have our profits on a regular basis, rather like the coupon payout on a bond. We seek the regularity of bonds with the high returns of stocks. We hate the lumpiness of stock market returns as a result of which the maximum profits occur in short intervals with the markets either going down or sideways in the intervening periods. The fact that the profits made in the good years more than make up for the losses or opportunity cost of down years, tends to be neglected by us.

Another reason could be that we seek a sense of control. We feel the need for activity in the markets, thinking that if we do nothing, we are simply watching while opportunities pass us by and this creates a pressure on us to act. Comparisons with profits made by neighbours and acquaintances make us feel that we are being left behind, while others are raking it in. This psychology was at work in the bull ramp up till January, where most investors got carried away by stupendous returns made by active market players and were attracted to invest in stocks. To compound matters, most investment analysts were predicting still higher levels.

For some investors, outperforming markets is a matter of intellectual satisfaction. Everyone gets an ego boost when their trades turn out right. When we get things right a few times, we tend to feel that we have found Alladin's lamp. Only in retrospect do we realise that in the short term, markets are far smarter than us. I have seen a few experts claim that they can manage to outperform markets on a consistent basis, whatever the time horizon. I do not have the data to judge their claims, but I feel that for the average investor, the simpler the investment strategy, the higher will be the returns.