Mohnish Pabrai has made two things very clear about his investment philosophy. First, he is not interested in a stock which does not offer potential 2x or 3x returns in a couple of years. Second, he is not interested in risking his capital. He expects his stocks to have a high margin of safety.
Mohnish’s earlier three stock picks, South Indian Bank, J&K Bank and GIC Housing, live up to these expectations. They are presently quoting at reasonable valuations and offer the potential of hefty gains when the economy improves and interest rates are slashed.
Mohnish’s latest stock pick, Rain Industries, is in the same mould. Today, his fund, The Pabrai Investment Fund II LLP, bought 26,64,000 shares of Rain Industries at Rs. 34.52 each, laying out an investment of Rs. 9.20 crore.
Rain Industries is a Hyderabad-based small cap with a market capitalisation of Rs. 1,155 crore. It is engaged in the manufacture of calcined petroleum coke (CPC) and cement. It is the world’s largest manufacturer of CPC with ~14% share of the global market (excl. China). CPC is consumed primarily by the Aluminium and Titanium Dioxide Industries. It also has a cement division.
Rain Industries has not been doing well in the recent past. Its sales and profit growth have been sluggish. It reported a loss in the December 2014 quarter. It also has high debt on the books.
The stock has grossly under-performed by returning a loss of 10% on a YOY basis. It, however, offers a dividend yield of nearly 3%.
To understand what attracted Mohnish Pabrai to Rain Industries, we have to turn to the brilliant analysis by Parry Pasricha at Beyond Proxy.
Parry Pasricha’s research report is a textbook example of how to research a company. It delves into meticulous detail into all aspects of the company’s working and lays bare all the positive and negative factors. The report is also written with utmost clarity of expression.
Parry Pasricha has listed out several factors which he claims “combine for an inordinately cheap valuation and attractive risk/reward opportunity”. He further emphasizes that “Rain is a potential “triple play” – essentially you’re buying a quality business, trading at a depressed valuation, and one that is operated by a competent and well-aligned management team – providing several avenues for capital appreciation.”
What has appealed to Parry is the fact that Rain Industries is operating in an oligopolistic business with high entry barriers, and that it is quoting at trough earnings (P/E of 2.7x and EV/EBITDA multiple of 5.1x). He adds that Rain Industries has a well-aligned management team with a track record of prudent capital allocation.
At the end of the comprehensive analysis, Parry concludes that Rain Industries real worth is about ₨. 177 per share which translates to 4.9x the current market price of about ₨. 34 per share. He emphasizes that this valuation does not include any future capacity growth, upside for margin expansion, increases in sales price, or value for the tax shield provided by the company’s current debt levels and adds that “It is rare to find this level of mispricing in a business without assuming exponential growth rates or indefinite periods of peak profitability”.
Parry Pasricha further states that even assuming that all his assumptions go haywire and one has to adopt the “Tight Margin” scenario across all business segments, Rain Industries is still worth about ₨. 72 per share which is an upside of about 80% from the current price.
The result is that in buying Rain Industries, there is little downside and huge upside, Parry concludes.
Well, if Mohnish Pabrai does get a 4-Bagger out of Rain Industries, he will have to give Parry Pasricha a pat on the back for the brilliant analysis.