Case study of a 33 bagger whose sales grew at just 6% CAGR over 5 years

I love biographies. Particularly, those of investors who have experienced Mr. Market’s mood swings, over the years.

In this pursuit, I am currently reading the mind blowing book – Masterclass with Super Investors. There’s an investment case study of a co. between 2003 to 2008, by Mr. Raamdeo Agrawal of Motilal Oswal.

I started the book with the assumption that sales growth is important for a multibagger to happen. This assumption was based on sales growth of multibagger businesses, that I had analyzed in the past, which had some tailwind going for them, in a particular phase of their long journey.

CompanyPeriodSales CAGRStock Price CAGRStock Price went up by
Avanti Feeds2011 to 201753%106%83 times
Page Industries2008 to 201735%74%35 times
Bharti Airtel2003 to 200855%97%29 times

Based on the above table, it looks like, there is some correlation indeed, between the top-line of a company and the stock price, which is what we all are interested in.

Or so, I had assumed.

Until, I ran into the story of CESC Ltd. in the book.

Just 6% CAGR in sales. That sucks, some investors might have thought!

But surprise surprise. Here’s what happened to the company’s stock price.

Here’s the investment thesis given by the legendary investor himself.

“Another investment was in CESC. They had a monopoly in power generation and distribution in Kolkata and had done a wonderful job in terms of operations. Yet the whole company was available at a market cap of Rs.90 crore. The reason was that they had very high debt and were paying an interest of Rs.400 crore. Still, they weren’t generating loss but were making meagre profits of Rs.7 crore. I saw that the interest rates were falling. I had read Security Analysis by Benjamin Graham, and knew that equity is always some kind of option value. With the crash in interest rates, the interest cost fell from Rs.400 crore to Rs.200 crore, so the profits jumped 30x. You get these kinds of opportunities only when markets are very depressed.”

Despite a stagnant top line, the co. was able to turnaround it’s business and deliver a profit growth of more than 300x, thanks to an improving balance sheet.

Here’s how things turned around for this business.

Interest rate reduction coupled with lower debt levels, resulted in money flowing directly to the co’s bottom line.

Total interest paid reduced by 281 Crs
Profits increased by 470 Crs

In other words, a big chunk of earnings per share in 2008 was funded by interest that would have otherwise been paid out to banks.

2002 & 2003 not included because the co. was not making profits

Sometimes, it’s not about ROE, but about growth

At most times, both ROE and Growth are equally important to achieve high returns. Yet, there are times when ROE doesn’t matter as much as growth. Despite having single digit ROEs in a high interest rate environment, this co. turned out to be a multibagger for investors who were smart enough to recognise this anomaly. Had one focused on ROE, he’d have lost out on an 80% compounder.

Conclusions:

  • Sales growth is almost always important, but not always important and a good investor recognises the difference between almost always and always. A golden rule to follow in the market is never say never.
  • When interest rates are going south, they are disproportionately beneficial to highly leveraged businesses.
  • Do not assume that a power generation and distribution business cannot deliver a multibagger stock.
  • Do not assume a low ROE business can never deliver a high CAGR stock. An 8% ROE business whose profits are growing fast could still deliver better returns than a 20% ROE business with no growth.

Barath Mukhi
2nd-March-2021

Author: Barath Mukhi

Concentrated investor in Indian markets

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