karnataka bank, holders

Karnataka Bank is a private sector bank, which surprisingly does not have a promoter. The stock has been trading in the range of Rs.108 (March 2018) and Rs.181 (June 2017). Of late, though, the stock has been wavering, what with talks of bad loans in the banking sector in general and public sector banks in particular. In fact, the stock is available at its lower levels as of now. Who's the taker?

The bank has had four major individual public shareholders. As of September 2017, we have got these:

Kedia has been more vocal on the prospects of the bank and consequently, its stock. Of course, he walked the talk. In May 2016, he bought 1 m shares at Rs.121.95 per share. In Feb 2017, he bought 1.5 m shares at Rs.122.18. That means 3.16 m  shares were held by him prior to becoming a major (greater than 1%) shareholder. He had a total of 5.66 m shares as of Sept 2017.

I think we should ignore Nomura; it is either crazy to do what it did in Oct 2016, or we do not have the full story.

Kedia said, in Oct 2016, he was expecting Karnataka bank to be a multibagger. 

He backed up his faith with a column in Outlook business in Jan 2017; and why not? In fact, he was bullish in Nov 2017 too. Then something happened. By Dec 2017, Kedia's shareholding in Karnataka bank dropped to 3.3 m shares.

That is down 2.33 m shares. Surprisingly, we don't find any bulk or block deals in either NSE or BSE on the stock by Kedia. That's a piece of the puzzle. 

So what do we do with the stock? First, you do not follow anyone without doing your own research. To each his or her own; circumstances of one will be different from another. Caveat emptor is my favorite quote. Be responsible for your own actions. 

For Karnataka bank, it comes to estimating how much of Rs.12.6 b net NPAs and Rs.8.9 b restructured assets is going to actually turn bad. My guess is that the stock is trading at about 1 x its book value after adjusting for the bad stuff. 

investing isn't hard

Recently, I came across a post that wrote about why investing is hard. The author is a microcap-stocks investor; and that's fine. I have no problems with him except that the team, it appears, makes a living out of other people's money as well. For instance, 

Well, it is their life and their problem. It's just not them; there are so many more both in the US and India. Nevertheless, I don't like it when investors tend to look for other people's cash. Never mind.

By the way, I care two hoots to such workshops, seminars, and so forth. If I am good at investing, I better stick to my own philosophies and strategies, which are, again by the way, simple, not path-breaking. If there are facts, I take them; if it is opinions, I would rather keep mine. Sounds good.

The author in the post looks at a few historical anecdotes, and concludes that investing is hard. Well, I say, it isn't. Let's look at the stories.

Amazon:

Well, Bezos himself at one point wanted to be an astronaut, later changed his mind to aspire to be a theoretical physicist, whatever that means. But then, he majored in computers and electrical engineering. Yet, he ventured into an employment in finance, which had nothing to do with this educational majors. Amazon started as an online books seller. It only so happened that Amazon started selling other things and every thing much later. The point is that without taking away the extraordinary vision and execution from Bezos, there was, and is, this luck factor that helped Amazon's stock prices thrive. Amazon wasn't a great business in June 1997, or at least no one knew it would be one. In my opinion, the stock prices have always been way higher than the intrinsic worth of this amazing, great business. And, I wouldn't invest in Amazon in 1997; and by investing, I mean, a significant portion of my capital. I am not wired to take chances on matters that are not entirely in my control. Heck, I am not even buying the stock now. There are plenty to pick on value and price terms; Amazon isn't one of them.

Valeant:

Well, the stock closed at $15.98 yesterday.

That's correct; the market price is heavily down from $262, the all time high. Now, its market cap is only $5.6 b. True, there were many buying the stock in 2015 for long. But then it is also true that the stock was trading at single digits before 1999. And an investor who bought the stock anytime before 2011 could have made a lot of money by 2015. 

It is another matter that by end of 2015, the stock came crashing to $90. By that time, there were two stories floating about. One, it was a great business, and therefore a great stock for keeps. Two, the business was built upon unethical terms, heavy on inorganic growth tempered with unsustainable economics. Not taking away anything from the investors long on the stock in 2015, I suppose the second story was resonating much with the numbers from the financials. These things happen both in business and investing. That is why it is better to keep investing simple. If you invested in Valeant type stocks, you are a bit less certain of matters to come. Of course investing is a game of probabilities; and may be because of that, what we want instead is businesses whose future looks more certain than those of others.

Apple:

Well, Wayne made an error of judgment; not in terms of Apple's future, rather in terms of the chance he could take. $800 of 1976 is probably worth $3,750 adjusted to inflation now. Wayne could have easily played the gamble and stayed on, what with $3,750 today. The stake was negligible, and there were opportunities. But not to the size of what they eventually turned out. Here's why.

Apple became a publicly listed company in 1980 with $22 per share IPO. I don't think Apple gave outsized returns by that date to its founders. Those visionaries of Apple surely did not envision iPhone during the IPO time either.

Steve Jobs left Apple in 1985 because of the fight for power. And we could rephrase that and say, Apple had lost focus and vision by that time.

Apple's fortunes turned only after the success of iPhone launched in 2007. From 2010, Apple started selling iPad. Even today, a much larger part of its business value is dependent upon the continued success of iPhones. While Wayne could have, and probably should have, retained his $800 stake, no one was sure of Apple's phenomenal dominance as we see it today. This was a huge factor of luck for its founders. There wasn't anything hard in the 1976 decision; just tough luck for Wayne.

Altria:
I don't want to comment anything on cigarettes as a business except that tobacco is addictive and there are way too many stupids around the world to consume it. The business that makes tobacco obviously is going to make money, and the government who regulates it wants a fair share of profits through duties and taxes. Altria has been a great stock.

Alibaba and Softbank:

Well, again, Softbank made a portfolio of investments; some clicked, many did not; and Alibaba made its returns outsized. That is how the portfolio of stocks are supposed to turn out. There is nothing hard or easy about it. The extent of excess returns is more of a luck than anything else though. Softbank is sort of a private equity, venture capitalist firm; it liked to take chances; and it did. In fact, the story is similar to Yahoo's investment in Alibaba giving the business supersized returns.

Patrick Industries:
The story is similar. There is nothing hard about it. The investors averaged their cost when the prices were coming down. They took chances when there were a lot of unknowns. Anything could have happened. There wasn't any foresight involved; it was pure luck that the investment turned out to be a great one. The fact that Tontine Capital was bold enough to buy more when chips were down played in their favor when things started looking better. If they had not, there would be outsized losses, instead of profits. There was luck again playing the dominant role.

Investing isn't hard
There are two reasons for that.

If you want equity market returns, which would probably be better than alternative investment opportunities, investing is very simple and easy. Just dollar cost average in the index for a long time. Rest assured you will be financially independent sooner than you think you can provided you stick to the game rules. It is possible whether you are a US investor or an Indian investor. Just throw the cash periodically into a low cost index fund, and more importantly, never stop it whether the market is excessively optimistic or pessimistic. Boom or recession, your investments should continue. After a decade or two, the risk in your investments significantly reduces and returns increase. Less than a decade, you could probably win; however, less than five years, anything is possible. So the game is long, quite long.

If you want to be better than the market, be willing to spend time to learn how to understand and value a business. Exhibit behavior to restrain greed, fear, and envy. Grasp the difference between value and price. Buy only when prices are much lower than the intrinsic value of the business. For that to happen you have to believe in market inefficiencies. And then wait for such opportunities; they are not available on an everyday basis; so obviously there is no action for the sake of it. Then you have to wait for the market inefficiencies to correct to make money. You also buy stocks of businesses which have long term competitive advantages, and hold them for a long time in order to reap excess returns. Patience is key to this game. Investing isn't hard for those who are willing to learn, analyze, act, and wait to fructify. Some investments will fail, some will not have an impact, but there will be a few that will reward you very well on an overall portfolio level.

pnb equity

Punjab National Bank stock is trading at Rs.97 per share. In January 2018, it had a high of Rs.194.  Oh yeah, it was priced Rs.231.45 on 26 October 2017. What happened? Well, this happened, and was explained here. $1,771.69 m is about Rs.115 b; that's the amount the bank is likely to be liable to the counter parties in case of full default. And later an additional Rs.13 b fraud was detected. 

So how much PNB's liability in this fraud is depends upon how much is the default going to be. SBI is already confident that PNB will make good all of its dues. PNB is in a slippery lane as of now. Until how much can be recovered from borrowers is known, all numbers are estimated in speculation. And the market says, so be it, if the price has to fall in speculation.

PNB equity was priced by the market at Rs.560 b in October 2017. It was Rs.392 b on 13 February 2018 just before the fraud detection, and has fallen 40% (Rs.156 b) since then. That raises question to the rational investors as to whether the stock is a buy now. After all, 40% fall is unprecedented, or is it?

Before the analysis, we have to begin with an understanding of the banking business. Core banking is after all raising equity and debt, the operating capital, at a lower rate in order to lend it to the borrowers at a higher rate. The difference in interest rates is the margin, and the difference in the amount of interest earned on lending and that incurred on borrowing is the operating profit earned by the equity shareholders. Ignoring the nuances of the banking regulation, it is a simple business at its core. 

A bank's borrowings include customer deposits and its bond raising. Debt for banks is actually the main feed for their lending business. Because banks are heavily leveraged, it is imperative that they exercise extreme caution on their operations. Otherwise, its shareholders will have to pick up the tin cups. Here's is how enormous its impact can be.

Suppose that a bank's equity is $10 and its debt is $90, and suppose that $100 is fully lent to the borrowers. Now, if only 1% of total loans turn non-performing, $1 of bad debt erodes 10% the bank's equity. Bad debts of 5% clears 50% of equity. Now we get the point how leverage plays on the bank's balance sheet. Nevertheless, banking is a business where debt is like oxygen; you need it to function. That said, extreme caution is imperative for banks.

Lending business is actually an investment operation. Investment in pure debt instruments requires both skill and caution. What is the point in lending for the sake of increasing the size of advances when its recoverability is in question? Be it businesses or individuals, there have to be sufficient free cash flows, both in size and consistency, available to service their debt; if not, they do not deserve debt. Banks will have to grasp this before lending.

Our definition of non-performing asset is one that bank is unable to recover. Let's see what the RBI guidelines say about NPA. 

Generally, the guidelines say that banks will have to classify assets as non-performing if principal or interest remains overdue for more than 90 days. That means, if a bank takes a view on a loan and before it becomes 90 days overdue concludes that it is not recoverable, it need not classify it as non-performing. That's the leeway banks take anyway which is legit, though not correct. However, after it becomes 90 days past overdue, the bank will have to classify it as an NPA. Do banks do that all the time? That's the question which remains a question. When a loan becomes NPA, bank's assets and income reduce due to provisioning and loss of income. That's bad for the banks, and they don't want to look bad. And that's why they take recourses to not to classify as NPA; and this ain't legit. 

Have a look at the RBI guidelines for provisioning.

The guidelines say that banks will have to provide 100% if the loan remains overdue for more than 3 years. While the call has to be taken by the individual banks as to whether a loan has become bad or remained doubtful, what is clear is that not providing for an unrecoverable debt does not make it recoverable over the period. One day the true picture will emerge. The credibility of a bank is built upon how it deals with its bad assets. The quality of a bank is built upon the levels of its non-performing assets; the lower the levels, the higher the quality, and of course, the safer its equity.

Coming back to PNB, as of December 2017, it had total equity (standalone, as we don't have consolidated numbers) of Rs.489,970 m; and shares outstanding of 2,425.587 m. That gives us a book value of Rs.202 per share. At the current market price of Rs.97, it appears to be a steal for an investor. But not so soon. As we have learned before, we need to know how good is this book value of Rs.202. 

As of December 2017, PNB had gross NPA of Rs.575,190 m (12.11%), and net NPA of Rs.340,760 m (7.55%). Its reported provision coverage ratio was 60.78%; whereas, our calculation suggests that just over 40% of gross NPA were provided for. The bank had stressed assets of Rs.671,290 m. There is an overlap between the gross NPA and stressed assets, and the stressed assets outside of NPA are estimated to be Rs.96,100 m. These are only estimates, still. 

The math then comes to this: Net NPA of Rs.340 b, fresh NPA of Rs.128 b, both of which call for higher provisioning if not 100%. Then the stressed assets of Rs.96 b. PNB is planning to go ahead with its Rs.55 b equity raising through issue of 334.9 m shares to the government at Rs.163.38 per share. After this, the total number of shares outstanding will be 2,760.487 m, and the new book value will be Rs.197 per share. 

Against its total equity of Rs.545 b, PNB is staring at NPA of Rs.468 b, and stressed assets of Rs.96 b. How much of PNB's equity is good depends upon how much of its loan assets will turn 100% bad. 

If all of its NPA turn bad, the bank will have to frantically look for fresh equity; or else...well, there won't be any equity left. That will not be good for a going concern operation.

If we estimate a loss 50% on NPA and none on stressed assets, the book value per share reduces to Rs.112. 

Loss of 50% on the existing NPA and 75% loss on the fraud assets will lower the book value to Rs.101 per share. 

A 75% loss of its NPA and none of stressed assets, and the book value will be Rs.70 per share.

We will have to take a pick based on our judgment. 

In fact, 75% loss on NPA and 25% on stressed will bring the book value to Rs.62 per share. What it means is, if the market wants it, it can bring the stock price to any level it wishes.

As of December 2017, PNB had return on assets of 0.12%, and return on equity of 2.03%. Its reported Tier 1 capital ratio stands at 9.15%; but the moment further provisioning is made, it will fall, and the bank will be much starved of equity capital.

It will be interesting to see if the government will buy the stock at Rs.163.38 per share as scheduled. The movie is unfolding for the public sector banks, surely.