where's ntpc headed

NTPC is all over these days for wrong reasons, though. Too many news leading to negative reactions about the power-generating business. 

I have noted about its poor state of affairs in the past, and argued how it has been lagging the market over the past years.

Although the market had discounted the upcoming news regarding tariff norms in the stock prices, when the final tariff regulations actually came out yesterday it did react again resulting in the stock dipping by over 11%, and over 1% today. 

This is how the stock looked from 21 Feb to 25 Feb: over 12% drop in market value. 

Just to magnify the situation - the market value of equity was Rs.1,092 b on 21 Feb which has come down to Rs.955 b now - this is a loss of Rs.137 b in just two days. 

To make matters look worse the market value had reached Rs.2,391 b in 2008. 

This is about 60% erosion of market equity in less than 6 years. The market is saying that it does not like the business anymore. May be long term is yet to come for this business to reward its (long-term) stockholders.

It is for us to judge how good that rationale is, and act based on facts rather than on market's views. An opportunity to buy at these low prices, or continue to believe that the business is facing headwinds is something to think about. Some raw data should help us.

On a firm basis - Operating profit:

• Last 3-year average - Rs.123 b;
• Last 5-year average - Rs.110 b;
• Last 10-year average - Rs.90 b. 

For those who like equity analysis - Net earnings:

• Last 3-year average - Rs.105 b;
• Last 5-year average - Rs.97 b;
• Last 10-year average - Rs.80 b. 

For those who like dividends:

• Last year dividend per share - Rs.5.75;
• Last 3-year average - Rs.4.52;
• Last 5-year average - Rs.4.19;
• Last 10-year average - Rs.3.42. 

The current dividend yield is 4.96%, and based on 5-year average it is 3.61%. 

However, the company's return on capital is not very good, and when analyzed with a higher cost of capital (long-term government bond rate itself is over 8%) it looks like any reinvestment is a value-destroying proposition. 

The only way NTPC can add value is by being efficient in both current and future projects, and increasing return on capital. If that is not possible, it may be a good idea not to reinvest at all. On average the company has been reinvesting about Rs.150 b each year. If these investments do not yield better than its cost of capital, growth is unwarranted.

Being a government-owned company in a power-hungry country, it is startling to see such an important utility business being managed so badly. 

Who is to be blamed - the government or the managers, or both?

amazon: how long is long term

Last year I said that not many would  have thought in 1998 that this loss-making business would one day sell at about $120 billion. Now Amazon is selling at $160 b; up 33%.

As we can see analysts have estimated it to sell at about $200 b in a year's time. That's a cool 25% upside when the T-bill rate is a fraction and T-bond rate is about 2.68%.  

The stock had reached $408 in Jan-2014 and $245 in May-2013. For those who get excited about the timing game, it is a return of 66%.

Amazon has 459.26 m shares outstanding of which about 19.20% are held by the insiders and about 68.10% are held by the institutions.

The insiders:

The outsiders:

The price setters:

It is unlikely that Jeff Bezos and his team would trade frequently; and it is not possible for the holders of the balance 13% (collective ownership) of the stock to set prices in the market due to their small individual ownership. These shareholders are weak and scattered. Therefore, it is clear that the mischief-makers are the institutions who own the big chunk, have the ability to trade them, and frequently do trade them. They want to play both the timing and the expectations game. 

Is Amazon worth $160 b? 

To answer this we have to leave aside the games played by the market, and concentrate on the fundamentals of the business that the company is in.

While revenues have grown considerably over the last 5 years, there has been a notable deterioration in operating margins. This is definitely not a good news.

The company has $9.75 b of equity and about $4.50 b of debt including capital leases of $1.3 b, all at book values. It also has non-cancellable operating leases. Furthermore, Amazon has about $12.50 b of cash and marketable securities. Effectively, this translates into book operating capital of $1.75 b before capitalizing operating leases. Due to the low capital base, the return on capital appears to be more than adequate. Amazon is still doing good at least based on the current numbers.

Into the future for Amazon:
The key is how far can Amazon translate these current numbers into better numbers in the future. To justify the current market price for the stock this appears to be a daunting question.

Based on reasonable expectations we should get a far lower value for Amazon than what it is priced now.

At a price of $347 per share and market value of $160 b, the implied variables the market is currently assuming over the next 10 years are: an operating margin of 3%, a growth rate of 19.25% and a return on capital of 48%. After 10 years, the company is presumed to be in a stable growth mode.

Just to give an idea, at 19.25% growth rate the company would have revenues of $445 b in year 11, which is pretty close to Wal-Mart's revenues.

That has not stopped analysts from doing their job:

We should follow them at our own risk is an understatement, though.

What is long term?
The question to the managers, analysts and investors then is, what is long term when we look at Amazon as a business?

use of multiples in valuation

I have argued in a previous post that the only way one can value a cash flow generating asset, such as a business, is based on the discounted cash flows method. This is on the premise that value of the business is the present value of its cash flows discounted at an appropriate rate. I have then argued that use of multiples is actually not a valuation; it is rather pricing.

Having said that, multiples can actually play some role in an analyst's affairs. Here's how: If cash flows, growth and risk could be estimated with comfort there is no need for any other analysis; we can just value the stock (i.e. business behind that stock), and then take a decision after checking the price. However, this is not the case usually since valuation is precisely a process of estimation with a lot of discomfort. In such situations the analyst can look for other clues. One such clue is the use of multiples. We can also use implied variables in the market's pricing, such as the growth rate for clues. Another is the dividend yield on the stock.

A stock might appear to be high or low based on equity-based multiples such as price-earnings ratio, price-to-book ratio, or even firm-based multiples such as price-operating-profit, price-to-book, price-to-sales ratio. Obviously, the clue is how the market is pricing the stock or the firm. There are key differences between the equity-based and firm-based multiples which is for another post.

While stocks do trade at high multiples or low multiples for good reasons, frequently stocks trade at wrong multiples too. Naturally then, these multiples help us in checking out the extent of irrationality in the stock price. A good way to use these multiples is to screen the stocks for cash flows based valuation, or to check out the multiples after a valuation has been done. This is to provide some sort of comfort to the valuation process and estimated value of the stock. We can say that the more irrational the prices are, the higher the comfort level in valuation process; any chances of error in valuation is cushioned by the stupidity in market prices.

For instance, Pepsi is currently trading at a PE multiple of 18.05 and has market value of $119 b; and Pfizer is trading at 18.87 with market value of $207 b. The two companies are completely different businesses probably having different cash flows patterns, growth and risks; they also operate in different markets. Then their similar multiples appear to be just a coincidence. Amazon is trading at an astronomical PE multiple and has market value of $161 b. A good way to interpret this would be to first check if they appear to be trading at too-high or too-low multiples for screening purposes only, and then carry out their business valuation, and compare the fundamental multiples, i.e. value-to-earnings with price-to-earnings.

The only way the multiples help us is by telling us that a stock is trading at too-high or too-low multiples. Put another way, if a stock does not appear to be trading too-high or too-low, the multiples do not help us.

Needless to say, though, multiples-based-pricing does not and cannot replace cash flows-based valuation process.

Nevertheless, there is some use of multiples for value analysts. It gives clues to make money out of market's follies.

politics and bad economics destroy value

The growth story
There have been a number of issues affecting economic growth in India in recent times. For the last several years there has been a decline in all aspects generally. However, instead of trying to resolve critical matters the game of politics coupled with lack of economic sense has resulted in a situation which is laughable. 

The recent news on power tariffs and recovery puts us on the spot - laugh, or sit back and ponder. Power companies generate power and sell it to the distribution companies who sell it back to the consumers. Due to the (subsidized) lower power tariffs, it is argued by the distribution companies, payments to the power companies have not been possible. The overdue payments have become significant. 

Profit or not as a goal
If the goal of a firm is to provide social benefits and not make profits it is understandable by everyone. Here irrespective of economic profits operations are carried on. The funding comes from the sponsors whether state or private. The investors, at least, will be cautious enough when supplying capital. 

Instead, if a firm's goal is to maximize its value as it is generally argued and accepted in corporate finance, the decisions taken by the shareholders, managers and other stakeholders should reflect that goal. If not, it is only going to destroy value in which case the whole point of incorporating a profit-making enterprise becomes futile. 

The power sector
In the case of power as a utility, the regulators usually guarantee a certain rate of return on equity to the generating companies. There is also a cap on this return so that super-normal profits are not achieved. This is fine because these utilities also enjoy certain benefits. 

If the power tariff goes down to such a level that the distribution companies are not able to recover their costs, and thus turn defaulters, and consequently, the generating companies are denied their dues, there is heavy cost on both working capital requirements in the short term, and on capex program in the long term. If reinvestment is not adequate it is a matter of concern for the shareholders. 

It is not fair for the minority shareholders who suffer because of the majority shareholder's irrational decisions. For instance, NTPC is already suffering due to poor policy making. 

The culprits - lower tariffs, poor managers or the regulator
It is common sense that the distribution companies should be allowed to recover their costs first, and then some profits, however capped they might be.

If it is not the case because of lower tariffs it is the regulator's responsibility to set the tariffs right. On the other hand, if it is due to poor management decisions it is again the regulator's responsibility to ensure that the licence to generate or distribute is taken away from poor operators.

Correct corporate finance decisions not votes create value
It is also common knowledge that utilities, if managed and regulated properly, provide adequate, if not super-normal, returns to the shareholders. The business itself is good enough to ensure that. 

In the final analysis, whether a firm is in the business of providing a key utility or selling tulips the value to the shareholders accrues only when economic decisions relating to investing, financing and dividends are taken in a business-like manner.

It might appear unfortunate to some, nevertheless, politics and votes have no role here.