STOCK ANALYSIS

VST INDUSTRIES

Prepared By:
Vansh Khanuja
Vanshkhanuja78@gmail.com
8 JUNE, 2021
PREFACE
This analysis report covers various aspects of stock selection.
Although my report is not something you should solely base
your investments on, but I'm sure it can serve as a guide. Stock
selection is a process of elimination, with an approach like this,
one should constantly find reasons not to buy the stock. This
will help you make better investment decisions as eliminating
stocks can be much easier. You should only focus on the
companies you can understand well.

The reasons for eliminating a stock can be different and does

not necessary give a negative opinion about the company.
Everyone has different investment horizons and different risk
appetite; this makes it tough to make an analysis that will serve
everyone equally because of the bias towards different
companies we all have. Thus, it would be better for me to
explain my perspective so you can better understand the
reasons I select/reject a stock.

I’m looking for undervalued growth stocks. My time horizon

varies with kind of stocks but generally you expect it to be at
least 5 years. The company should have excellent management
and display consistent growth over a long term. While the latter
can be easily known just by analyzing the financials, The major
concern is regarding how to check if the management is
competent enough.

The only thing one could do is again try to gain some insights by
looking at the financials. A healthy growth rate added with
better than average margins displays managerial competency.
Along with this, careful scrutinization of management’s
discussion section in the annual reports over the last few years
can surely yield some insights.

Valuation is the last step in stock analysis. The basic role is to

use all the facts obtained to find a price that is justified. This is
probably the most controversial part because there is no
perfect way to value a company. I will be using a DCF
(Discounted Cash Flow) model and use the risk-free-rate as the
discount rate. I understand the conventional method of DCF
includes calculation of weighted average cost of capital that is
used to discount the cash flows but I'm not using it because I
will deduct 25% of the calculated value to get a margin of
safety. Furthermore, I will be conservative in my projections so
using risk-free-rate is appropriate.

Given the fact that the intrinsic value of any given company
cannot be calculated with exact precision, it is important to
consider that I can be wrong in my projections. This is the
reason I will be deducting 25% of the calculated value. If then
the stock is selling at around the price I calculated, then only I
will be bullish on that particular investment.

The strategy I just mentioned is a rough explanation of what I

will follow. There can be certain adjustments that will vary
according to the company. Note that the valuation is based on
forecasts of Future Cash Flows (FCFs) and thus carry an inherent
flaw I.e., predictions. Given that there are many variables that
can disrupt cash flows, you are advised to invest only after
you’ve understood all the points I've mentioned and if you can
hold the stock patiently for years until the discrepancy between
the price and value is fixed. This process can be frustrating and
you’ll be tempted to sell in bear markets, but if you truly
understand the principles of investing, I expect you to buy more
during such conditions. If there are any questions concerning
any phase of the report, I would welcome hearing from you.
TABLE OF CONTENTS:
(1) Overview
(2) Risk Factors
(3) Financial Statements Overview
(4) Valuation
(5) Conclusion
(6) Appendix
(7) References
 (1) Overview
VST Industries Ltd. is a public conglomerate company
headquartered in Hyderabad, India. The company
manufactures and distributes cigarettes and related
products.

The reason I chose a cigarette company is because of the

challenge it presents. Companies like these are usually
considered evil because they engage in production and
distribution of harmful products. This is invariably reflected
in the stock chart. This also means that there can be many
opportunities in companies like these but there is an
inherent problem with this logic. If the stock is going to
stay undervalued forever then what’s the point of investing
in its stock? The reason is that sometimes the price could
be too low and make it an attractive buy.

The market cap of the company is 5416.41 Cr. Rs. (LTP

:3507.60) as of 8 June, 2021. The stock has returned only
14.61% in 3 years (cumulative) which equates to CAGR
return of 4.6% per year which is less than risk-free-rate
(6.02%) in India. The company’s registered office is in
Hyderabad. The company’s managing director Mr. Devraj
Lahiri’s remuneration for FY19-20 totaled 3.73. Cr. Rs,
The company’s non-executive director and chairman Mr.
Naresh Sethi’s remuneration totaled 1.67 Cr. Rs.

Key Performance Indicators:

Return on Equity 35.98%

Return on assets 20.88%
Return on Capital 35.12%
Net Margin (5Y average) * 15.37%
Sales Growth (5Y average) 10.77%
Net Income growth (5Y 15.21%
average)
Current P/E ratio 17.50
P/E 5Y High/Low 29.23/14.08
*Against 6.53% for industry

As evident from the above chart, this company earns

35.98% on equity with the total debt being zero! The return
on assets figure in incredible with 20.88%. The net margin
is 15.37% and this is a 5Y average as against industry
average for the same being 6.53%, this confirms efficiency
in operations.

The net income has grown at 15.21% in the last 5 years,

this means that the bottom-line has doubled in the same
period the share price returned 15% cumulative return.
It might look as if the market has been unfair to this
company but in reality, there are many risk factors
associated with this company, but I can confidently say
that the returns being negative if compared with the risk-
free-rate is an extreme reaction from the public.

Anyone considering investing in this stock must be

prepared for irrational movements. I can calculate the
intrinsic value, but I cannot predict with certainty the price
of this stock. Most of the readers will think that because
the stock hasn’t moved significantly in years, it will not
move in the future as well. This kind of extrapolation is
only natural but nothing can be said for sure just on the
basis of past history. Infact, I’m happy that this stock is still
trading around the same price, this can turn out to be the
value stock everyone desires.

In the next section, I will list out several risk factors which
can affect the price considerably.
 (2) Risk Factors

The most important risk factor is obviously government

regulations and taxes. There is huge uncertainty regarding
taxation on tobacco products and extra ‘cess’ duties
imposed. These charges can affect the profitability.

The company has many lawsuits against it related to

wrapping materials (4.5 Cr. Pending charge in supreme
court), tobacco refuse, Service tax disputes, real estate
disputes in Telangana high court.

An NGO has filed a petition in Supreme Court against

manufacturing of tobacco and related products within the
territory of India (91% of the revenues is generated from
India).

Petitions have also been filed in other courts such as High

Court of Madhya Pradesh - Jabalpur, National Green
Tribunal, Delhi seeking ban on sale of cigarettes and
before High Court of Madhya Pradesh-Indore Bench,
seeking directions to mention tar and nicotine content on
cigarette packs by the manufacturers.
The Government of Andhra Pradesh had filed a land
grabbing case against the Company in 1991 in relation to
a piece and parcel of vacant land which has been under
possession and occupation by the Company for over four
decades. The Company filed a writ petition before the then
Hon’ble High Court of Andhra Pradesh to expunge that
part of the Order giving such liberty to the Department
despite the fact that the Company has already been
declared not to be a land grabber. The writ petition is still
pending.

In view of the provisions of COTPA, various restrictions

such as ban on advertising in print, visual media and
outdoors, regulation of instore advertising, prohibition of
sale of cigarettes to persons below the age of 18 years,
etc. have been in force. Printing of pictorial warnings on
cigarette packets, came into effect from 31st May, 2009
were further revised and the pictorial warning covering
85% of the front and back side of the packets was
implemented w.e.f. 1st April, 2016.

One more case of land grabbing was filed by the then

Government of Andhra Pradesh against the Company in
the year 1989 on a piece of land along with building called
‘Lal-e-Zar’, before the Special Court.
It is clearly evident that the company is constantly in some
sort of legal trouble and that has been reflected in the
stock price.

Other risk factors include basic business risks. The

company does not have any major credit risk. The Credit
Rating Information Services India Limited (CRISIL) has re-
affirmed the rating of the Company to “FAAA/Stable” for
Fixed Deposit Schemes, “AA+/Stable” for Long Term Non-
Convertible Debentures and “A1+” for non-fund-based
liabilities (Letter of Credit and Bank Guarantee). The
Company has stopped accepting fresh deposits for the
past several years.

The Company generates positive cash flows which are

predominantly invested with financial institutions and
mutual funds. Delay and/or default in settlement on
maturity of such investments could result in liquidity and
financial loss to Company.

Hence, the main risks can be summarized in the form of

taxation changes, regional disruptions and government
regulations.
 (3) FINANCIAL STATEMENTS OVERVIEW

I have provided the important financial data below. I have

thoroughly read all the statements but I'm providing only
the relevant information.

For the fiscal Year ending March 31, 2021, the revenues
from operations were 1471.70 Cr. Rs. as against 1369.12
Cr Rs for the previous year. The net profits were 312.41
Cr Rs and 299.91 Cr. Rs. for FY20-21 and FY19-20
respectively. The company has a total 1485.79 Cr of
assets with 940 Cr. Of equity. The company has 523.27 Cr
Rs of current liabilities against 1250.73 Cr Rs of current
assets.

The company generated 239.8 Cr of Free Cash Flow for

FY20-21 and 309.5 Cr for FY19-20 (22.5% decline but still
not a red flag considering it was the pandemic year) and
264.28Cr of Free Cash Flow for FY18-19.

The major reason for the cyclical nature of the FCFs is the
trade cycle. The company has no debt but working capital
changes affect the cash flows in the short term. However,
the numbers for this current year could be misleading as
due to the pandemic, The general business was disrupted.
If we look still at the profits, The company has grown at a
healthy rate of 15% per year as mentioned earlier.

In the next part, we start with Valuation of this company.

 (4) Valuation

While valuing a company, there are several different ways

and countless variables added with mental bias towards a
company. You and I might come up with drastically
different values for the same company with the same
information.

Eg) The current market cap is 5.3k Crores, Current

earnings at 312 Crores. This implies a price-earnings ratio
of 17.2.

If we extrapolate the past earnings trend with conservative

estimates for the next 10 years then at 12% growth, we
will get earnings of 969 Crores. If we apply a P/E of 15,
then the market cap would be 14,535 Crores.

If we forecast at 15% for the next 10 years and take P/E

as 20 at the end of the 10th year then the earnings would
be 1,262 Crores and the market cap would be 25,240
Crores. A difference of more than 10k crores.
This example was to illustrate how different valuations can
be if some estimates are changed.

DCF:
Taking growth rate at 8% for all the cash flows and
discounting back at 6%, I have calculated the intrinsic
value. However, for the year FY21-22, I took the FCF as
the average between FY19-20 & FY20-21 to balance out
covid effect. After that, I have forecasted FCFs at 8%.

For terminal value calculation, I have taken perpetual

growth rate at 1%. This numbers resulted in an intrinsic
value at 9,027 Crores as against market cap at 5.3K
Crores.

After deducting 40%, we get the value at 5.4k Crores,

which is roughly the current price. Note that I deducted
40% instead of 25% as previously mentioned, the reason
for this was the risk factors. The cash flows are highly
unpredictable because of government regulations. Even
though the management has proved itself for years now,
we cannot eliminate the possibility of a lawsuit that can
cause permanent damage to the company.
 (5) Conclusion

People believe volatility is a measure of risk, but according

to our calculation, if the stock goes down another 20-30%
then it becomes even more attractive. Risk in any stock is
the probability of permanent damage. This company has a
really high probability of facing such things.

Is this stock a ten bagger?

To answer this question, Let's check the numbers. If the
stock proves to be a ten bagger, then the resultant market
cap would be 53k crores. The historical P-E ranges from
15-30 but to be conservative, we will consider it at 15.

This means the earnings should jump to 3,533 crores. 11

times increase in earnings. At 15% per year compounded
growth, earnings double every 5 years. To get to 11 times,
you will need to double 3.3/8 times. That means at least
17-18 years. If this stock jumps 10 times in price in the
next 18 years, Your CAGR return would be 13.6%. But
you have to review yourself that how certain you are
regarding a growth like this for 18 years.

A more realistic return over the long term would be around

8-10% compounded. This can be 3-4 percentage points
more but then it will classify more as a speculative bet
instead of an investment.

Should you buy the stock?

I don’t see this stock deserving more than 5% weightage
in any portfolio. If you have a well-managed diversified
portfolio, you can surely add it if you have understood the
factors affecting it. This stock is undervalued as per our
intrinsic value calculations but that valuation is to some
extent justified. It’s not appropriate to give a direct buy
rating to this stock because it will not fit in everyone’s
portfolio.

I have mentioned all the facts that I considered were

important in your decision-making process. I am willing to
make myself available to discuss my points of view with
anyone having any questions regarding the same.
 (6) Appendix
Is DCF the correct way?

The intrinsic value is arguably the most important part of

investing. Without it, you don’t know if an investment idea
is worth it or not. How to find intrinsic value has been a
controversial topic because many disagree on a lot of
things. I will not provide a case study of why DCF is the
one I used, instead, I will explain my idea of intrinsic value
and components I used in DCF valuation. (This is
necessary because you need to understand how I
calculated the value)

DCF is short for Discounted Cash Flows. This is the most

logical form of intrinsic value calculation because investing
is related to cash flows. If you invest in a company, you
expect it to generate cash. If you invest with an objective
to sell it at a higher price, then it’s called speculation.

I calculated the free cash flows I.e., the cash that is free to
use for the company at the end of each year. This is
calculated by deducting capital expenditures from cash
flow from operations. Companies that needs to constantly
deploy a lot of capital to stay in business are the ones you
should avoid. Once you’ve forecasted the Future Free
Cash Flows, you will need to discount them back to
current year. I used risk-free-rate as the discount rate
because 1) I’m conservative with my forecasts 2) I am
using a margin of safety by deducting a certain percentage
at the end.

The usual method is to calculated the cost of capital by

taking into account cost of debt (if any) and averaging it
with cost of equity (calculated using equity risk premiums
and beta co-efficient). I am not against this method and
both the methods works. It’s up to you to put in the right
numbers.

With this, I end my report on VST industries. I have not

provided the product names because I didn’t want to
promote the products due to obvious reasons. In the next
section, I have provided all the references.
 (7)References

• VST_Industries :Annual report. [Online] 2020.

Available from https://www.vsthyd.com/Annual-
Reports.html
• VST_Industries : Financial results. [Online] 2021.
Available from https://www.vsthyd.com/Quarterly-
Results.html
• Money. VST Industries. Summary. [Online] 2021.
Available from https://www.msn.com/en-
in/money/stockdetails/nse-vstind/fi-ahkmr7
• Wikipedia. VST Industries. [Online] 2021. Available
from https://en.wikipedia.org/wiki/VST_Industries

(Accessed 8th June, 2021)