Kotak India Focus- Series 1

The main objective of the Investment approach is to generate capital appreciation through investments in equities with a medium to long-
term perspective.

The portfolio shall essentially target to invest in Value Opportunities and Special Situations in individual stocks and related instruments. Value Opportunities are ones, wherein in the opinion of the fund manager, the company’s Intrinsic Value is ‘X’, while the stock is trading at a discount to X. Special Situations are dependant on the probability of occurrence of one or more corporate events, rather than market events. These situations can largely be classified as follows:

a. Price arbitrage: In such situations securities are bought at a discount to the price, which is/ may be guaranteed by any institution. These situations can arise in the form of buybacks, delistings, etc.

b. Merger arbitrage: In such arbitrage, shares of a company can be created at a discount to the current market price.

c. Corporate restructuring: Such arbitrage is a consequence of specific corporate action in the form of spin offs, asset sales, management change, etc. leading to either value unlocking or cash payouts to investors

The Universe – Value Opportunities

• 1000 – Total universe of top 1000 market capitalization companies
• 804 – Companies having greater than 30% promoter shareholding
• 536 – Rank companies based on ROE and 1/PER (Earnings Yield). Add the two parameters to arrive at a combined rank. Identify the top 2/3rd of this combination to arrive at stocks likely to perform best
• 421 – Capital Efficiency i.e. ROE of at least 15% trending toward and higher than 20%
• 227 – Compounded PAT Growth of at least 10% in the last three years
• 50 – Assess companies based on Management quality, Integrity, Balance Sheet strength, Capital Allocation, Execution Capabilities, Vision for the business, fairness to stakeholders, etc
• 12-18 – Valuation not more expensive than peer set and Price to Value Gap of at least 30%

Fundamental Analysis Process

Management

• Is management trustworthy and rational
• Is it candid with its shareholders

Return ratios

• Is ROCE/ROE stable over the last few years? Why?
• Expectation of ROCE/ ROE going forward
• Expansion or contraction because of – a) Asset turns, b) Margin changes or, c) Leverage

Capital Allocation

• Asset turn
• Assets tied up in non-core businesses
• Revenues from core activities

Earning Power

• Revenue growth expectation
• Expense trend (as % of sales)
• Margin trend
• What are the company’s owner earnings i.e. the FCF

Valuation

• EV/EBITDA, PER, FCF Yield, P/B, Replacement Cost
• Comparison with other players within sector and benchmark indices
• Can the business be bought in the market at a discount to current market value

What are Special Situations?

Investment operations whose results are dependent on happening or not happening of one or more corporate events rather than market events

Key Advantages – Investment results of Special Situations opportunities are largely independent of market moves

Key variants

• Price related – Securities bought at a discount to (expected) price guarantees by buyer in the form of de-listings, buy-backs, open offers, etc.

• Merger related – Shares can be created at a discount to current market price

• Corporate restructurings – Value unlocking due to corporate restructuring, assets sales, demergers, business triggers, etc.