25 October 2018

Whose Wealth Are Banks Managing Anyway?

By Vivek Kaul

HDFC Bank is one of India’s best managed banks. But that

doesn’t mean that everything that the bank does is for the
good of its customers. (I am using HDFC Bank here to just
illustrate what is basically a broader point valid across banks
and financial institutions. If they chose to do the right thing
all the time, the world would be a much better place than it
is. But then that is another topic for another day).

In its annual report of 2017-2018, the bank states: “The Bank also distributes Life Insurance,
General Insurance and Mutual Funds, often referred to as Third-Party Products. Income from this
business grew by 51 percent from Rs 1,381 crore to Rs 2,091 crore and accounted for 18 per cent
of total fee income in the year ended March 31, 2018, compared with 16 per cent in the
preceding year. This was primarily on account of distribution of mutual funds of the top asset
management companies in the country. Mutual Fund industry saw an unprecedented flow of
household savings into the mutual funds. In the system the assets under management of the
individual investors grew by 36.8 per cent to about Rs 11.7 lakh crore as of March 31, 2018.”

In simple English what this means is that the wealth management division of the company
did very well, during the course of 2017-2018, by selling mutual funds to a large number of
people.

It also tells us that retail investors get the timing of investing in stocks (through the indirect
route of mutual funds in this case) all wrong.

Take a look at Figure 1, which plots the yearly price to earnings ratio of the Sensex stocks,
over the last two decades.
 Figure 1: Price to earnings ratio of Sensex stocks

26
24
22
20
18
16
14
12
10

2018-2019*
1998-1999
1999-2000
2000-2001
2001-2002
2002-2003
2003-2004
2004-2005
2005-2006
2006-2007
2007-2008
2008-2009
2009-2010
2010-2011
2011-2012
2012-2013
2013-2014
2014-2015
2015-2016
2016-2017
2017-2018
Source: www.bseindia.com

The price to earnings ratio of Sensex stocks in 2017-2018 was at 23.79. This basically meant
that investors were ready to pay Rs 23.79 for everyone rupee of earnings of Sensex stocks.
The only other time when the price to earnings ratio was so high was in 2000-2001, which
was the time of the dotcom bubble and the Ketan Parekh scam. The price to earnings ratio
of 2007-2008 came in close at 22.61. This was before the financial crisis of September 2008
broke out and stock markets and the real estate markets all around the world, had been
rallying.

Now let’s take a look at Figure 2, which basically plots the price to earnings ratio of the
stocks that comprise the BSE 200 index. The BSE 200 index is a much better representation
of the overall stock market. (I haven’t taken the BSE 500 index, which would have been an
even better representation for the overall stock market, simply because the data for that is
available only from 2004-2005).

2
 Figure 2: Price to earnings ratio of BSE 200 stocks

26
24
22
20
18
16
14
12
10
1998-1999
1999-2000
2000-2001
2001-2002
2002-2003
2003-2004
2004-2005
2005-2006
2006-2007
2007-2008
2008-2009
2009-2010
2010-2011
2011-2012
2012-2013
2013-2014
2014-2015
2015-2016
2016-2017
2017-2018
2018-2019
Source: www.bseindia.com

Figure 2 makes for a more interesting reading than Figure 1. The price to earnings ratio in
2017-2018 was at 24.98. This is the highest it has ever been. Despite, this high ratio, the
Indian investor bought stocks in 2017-2018, like never before. This shall become clear
through the next two charts.
Now take a look at Figure 3, which basically plots the net investment in equity mutual funds
over the years. Net investment is what remains after subtracting mutual fund redemptions
from the fresh investments being made into the mutual funds.

Figure 3: Net investment in equity mutual funds

180,000
160,000
140,000
120,000
(in Rs crore)

100,000
80,000
60,000
40,000
20,000
-
-20,000
-40,000
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
2014-15
2015-16
2016-17
2017-18
2018-19*

Source: Centre for Monitoring Indian Economy

3
When an investor invests in an equity mutual fund, he is basically giving a mandate to the
mutual fund to indirectly buying stocks, for him. In 2017-2018, when the price to earnings
ratio of the BSE 200 stocks was at its peak, investors bought the maximum amount of equity
mutual funds that they ever have during the course of any year, till date. The net investment
in these funds stood at Rs 1,56,753 crore.

Take a look at Figure 4, which basically plots the number of retail folios in equity mutual
funds.

Figure 4: Number of retail folios in equity mutual funds

60,000,000

50,000,000

40,000,000

30,000,000

20,000,000

10,000,000

0
2009-10

2010-11

2011-12

2012-13

2013-14

2014-15

2015-16

2016-17

2017-18
Source: Centre for Monitoring Indian Economy

Figure 4 makes for an interesting reading. The number of retail folios in 2017-2018 finally
crossed the peak achieved in 2009-2010. This is another good indicator of the fact that the
retail investors who had gradually left the stock market after the crash in 2008, came back
to it with a bang, during the last financial year.

What Figure 1, 2, 3 and 4, together tell us is that the retail investors invested a lot of money
in equity mutual funds in 2017-2018. This is the highest amount of money that was ever
invested in equity mutual funds, and it was all invested during a year, when the stock
valuations (measured through price to earnings ratio) were very high.

In fact, nothing even comes close to it. In 2014-2015, the next biggest investment of Rs
68,121 crore had happened. In 2007-2008, the year where everything was going up, the
investors had invested just Rs 40,782 crore in total.

4
Of course, this was also a function of the fact that mutual funds are much more popular
now than they were a decade back. Among other reasons, the brilliant mutual fund sahi hai
advertisements of the Association of Mutual Funds of India, is responsible for it. (I would
rather have people buying equity mutual funds than the Ulips sold by the insurance
companies).

Let’s get back to what we were discussing. The larger point here is that the retail investors
broke a very basic rule of investing, which is to buy low. In fact, let’s take a look at Figure 5.

Figure 5: When retail investors invest

29 25,000
28 20,000
27
15,000
26
10,000
25
24 5,000

23 0
Apr-17

Jan-18
Sep-17

Dec-17

Feb-18
May-17

Jun-17

Jul-17

Mar-18
Oct-17

Nov-17
Aug-17

Net investment in equity mutual funds (in Rs crore)

PE ratio of BSE 200 stocks
Source: www.bseindia.com and the Centre for Monitoring Indian Economy

What does Figure 5 tell us? First, it is important to understand how to read Figure 5. The
price to earnings ratio of the BSE 200 stocks is on the left y-axis. The net investment in
equity mutual funds is on the right y-axis. On the x-axis is time, or basically the period
between April 2017 to March 2018.

From Figure 5, it is clear as the price to earnings ratio went higher, money kept coming into
equity mutual funds. In November 2017, the price to earnings ratio was at a very high 27.56.
During the month Rs 19,508 crore crore was the net investment in equity mutual funds. The
net investments remained high during the next two months. In January 2018, the price to
earnings ratio reached a high of 28.7. Even during this month equity mutual funds saw a net
investment of Rs 13,404 crore. It is worth remembering that in January 2018, Sensex had
touched its then high of 36,050 points. Hence, the higher the stock market went, more was
the money that came into equity mutual funds. This is a mistake that retail investors tend to

5
make over and over again. They burn their fingers in the process and then equate investing
in the stock market to gambling.

All this takes us back to the first paragraph of this Letter. HDFC Bank sold a lot of mutual
funds in 2017-2018. While other private sector banks do not say so clearly in their annual
reports, there is no reason to believe that they didn’t do equally well at selling mutual funds.
The question here is, when banks talk about wealth management, whose wealth are they talking
about anyway. The wealth of their clients? Or is it more a case of using the wealth of their
clients to generate income for the banks?

If wealth management was wealth management, during the last one year, the wealth
managers would have been discouraging people to make big one-time investments in
mutual funds. But the fact that the net investment in equity mutual funds was at an all-time
high, tells us that nothing like that has happened.

The wealth of the customers of the bank was used to generate other income for the bank, in
terms of higher commissions received on mutual fund sales.

In fact, if we take a look at one-year mutual fund returns, the clients of banks have lost out.
Large cap equity funds have faced an average loss of 0.7% over the last one year. When it
comes to large and midcap funds, the average loss stands at 8% over the last one year. For
multicap funds the loss is at 5.7%. For midcap and small cap funds, the average losses are at
11.4% and 14.1%, over a one-year period, respectively. (data source:
www.valueresearchonline.com).

These investors would have simply been better investing their money in bank fixed deposits
or for that matter let their money sit around idle in a savings accounts.

Clearly, the wealth of customers of banks has not been managed well. The question is why?
The bank makes a commission by selling mutual funds. It does not lose money when the
mutual fund that the customer has invested in does not do well. Basically, the bank and its
wealth manager, have no skin the game.

Hence, the incentive of the wealth manager of the bank is to sell mutual funds at all points
of time, irrespective of the state of the stock market and how expensively priced the stocks
are.

6
A point can be made here that once a customer has made a loss, he won’t return to the
same bank and the same wealth manager. Now that might be true, but by the time
something like that happens, the wealth manager would have moved on to another job.

One comes across such cases all the time.

Also, if the wealth manager does not missell during the boom, he loses out on his bonus,
which can be a substantial amount these days. It can also impact his promotion. Further, he
is not going to get any credit for ensuring that the bank’s customer does not lose money.
Maybe it might just help him have a clear conscience that helps him sleep peacefully at night. But
a clear conscience does not help pay EMIs. Does it?

The point being the incentives that a wealth manager has, are totally skewed against
anyone investing in a mutual fund through a bank. (Now that does not mean that other
mutual fund agents are better. But that is again, another topic for another day).

Postscript: One problem with this kind of analysis is that stocks that make up any index,
keep changing. Some companies shutdown. Some others don’t do as well as they used to.
Also, stock exchanges like to drop stocks that are not doing well from the index, and
include, stocks that are doing well.

Hence, it is not the same index that we are looking at, at different points of time.
Nevertheless, as we shall see in the next section, this is a quick and dirty method, which
helps.

********

7
Is there some way to figure out that the stock market is in expensive territory and it might be a
good time to get out? This is a question I get asked often. While, there is no ready made
answer for it, there is something which is quick and dirty.

Let’s take a look at Figure 6. Here we plot the price to earnings ratio of BSE Sensex stocks,
month wise, between April 1998 and September 2018.

Figure 6: Price to earnings ratio of Sensex stocks

30

25

20

15

10

5
Mar-02

Mar-13
Dec-04

Dec-15
Nov-05
Oct-06

Nov-16
Oct-17
Jun-99
May-00
Apr-01

Jan-04

May-11
Apr-12

Jan-15
Feb-03

Sep-07

Jun-10

Feb-14

Sep-18
Aug-08
Jul-98

Jul-09

Source: www.bseindia.com

Figure 6 basically plots the monthly price to earnings ratio of BSE Sensex stocks. It is clear
from the figure that the price to earnings ratio of the Sensex rarely crosses 25. Only in 2000,
when the dotcom bubble was on, did it cross a price to earnings ratio of 25.

The point being that when the price to earnings ratio of the Sensex stock crosses 25 or is
around that number, you know that the stock market is in expensive territory. In fact, in
January 2018, the price to earnings ratio was at 25.69. At this point of time, I had written two
pieces saying so. (You can read them here and here).

The Sensex in January crossed 36,000 points. By the beginning of April 2018, it had fallen to
33,000 points. After that, the Sensex rallied again and by August it had almost touched
39,000 points. Then it fell again, and is currently quoting at less than 34,000 points.

The point being that the price to earnings ratio can only be a quick and dirty indicator and
not a specific one. Nonetheless, it gives a good indication of when the stock market is in
expensive territory, if one remembers the basic tenet that it’s impossible to time the market
correctly, all the time.

8
Of course, it does not tell you anything about individual stocks. For that you have to rely on
good research around that stock.

Also, Figure 6 tells us very clearly that price to earnings ratio can go very low. In October
1998, the price to earnings ratio of Sensex stocks was 10.27. In November 2008, it was at
11.88. After these lows, the stock market rallied.

Again, the low price to earnings ratio of the overall market, just tells you that it is a good
time to buy stocks. The average price to earnings ratio of the Sensex stocks between April
1998 and September 2018, has been at 18.3.

This does not help in choosing the right stock which is at a low price to earnings ratio but
has the potential to give good returns.

For that you need to listen to what Radhika Pandit has to say.

Over to you Radhika.

9
 25 October 2018

This Company Has Become Quite a Bargain

After the Correction in the Markets…
By Radhika Pandit

We are almost towards the end of 2018 and it is fair to say that
it hasn’t been a particularly memorable year. For the stock
markets at least.

Compared to the buoyancy that was seen in 2017, what

happened this year was a completely different story
altogether.

Right from the start of 2018, Indian markets were on the edge, and the midcap and smallcap
indices particularly witnessed a spate of sell-offs.

The last couple of months especially have been quite challenging, as a plethora of sharp
corrections were seen in stocks across market caps including the Sensex.

Indeed, since the start of 2018, the Sensex has been flat, and in the last couple of months
(September and October), the benchmark index has slipped 9%.

There are many factors that have brought this about…

• Steep decline in the Indian rupee

• Rising oil prices, widening trade deficits, in turn putting pressure on the rupee
• Trump’s trade wars particularly with China
• Rising yields in the US leading to FIIs pulling out money from the markets
• A not-so-surprising fall in valuations given how expensive stocks were in 2017

It is hardly surprising that the fear in the stock markets is feeding on itself and this is leading
to the spate of sell-offs we have been seeing recently. Everyone is clearly in a panic mode.

But I think otherwise.

I have a portfolio of stocks at hand and whenever there is a big correction, I closely scan them
to see whether there are some good quality stocks I can recommend. Because you see, it is
in a falling market where the prospect of finding stocks at a bargain is considerably higher.

And I have zeroed in on one such stock. This is a company with robust fundamentals, and the
recent correction in the markets means that its stock is trading at a price to earnings multiple
of around 12 times, which I believe is cheap. Quite a bargain, in fact.

The company I am focusing on in this edition is none other than Jagran Prakashan Ltd.

Jagran Prakashan is a leading player with a well-established print and radio business in India.
In the print segment, its flagship daily Dainik Jagran is the most read Hindi paper in the
country and it has a strong presence in the primarily Hindi speaking states. In other words, it
has a good stronghold over the regional markets.

Interestingly, Warren Buffett had a preference for newspapers with a regional flavour. His
rationale? Newspapers in small towns and communities are near-indispensable to readers
because they cover local news that no one else will. Buffett reasoned that as long as such
papers were smart about their digital strategy and didn't compromise on content, they would
make enough advertising and circulation dollars to survive.

Jagran Prakashan enjoys the benefits of precisely this kind of regional flavour. And it is also
looking to stay ahead of the curve by having chalked out a well thought out digital strategy as
well.

Let’s look at more such factors that make Jagran Prakashan such a compelling case…

What Makes Jagran Prakashan a Worthy Investment?

Healthy brands in the print business: Given the massive disruptions in technology over the
last couple of decades, there was this risk that the printed newspaper business will gradually
die out. Indeed, we live in an internet age where information is available at the click of a
mouse. Thus, internet has more or less become a substitute for newspapers as far as getting
information is concerned. This is particularly true in advanced countries where internet
penetration is high.

11
And yet, Jagran Prakashan's print business has weathered many storms and done well over
the years. The reasons for these are many.

For starters, its flagship daily Dainik Jagran is the most widely read Hindi newspaper in the
country and Jagran has a total readership base of 77 million plus. More importantly, its
publications cover 13 states, which are largely Hindi speaking and in the vernacular belt. This
gives the newspaper a strong regional flavor. Thus, despite various challenges that the print
media has been facing in recent times, Jagran Prakashan has retained its edge because it has
content that is superior, relevant and local.

Dainik Jagran has an established market position across the Hindi belt in Uttar Pradesh (No 1
Position), Uttarakhand (No 2 Position), Bihar (No 2 Position), Jharkhand (No 3 Position),
Punjab, Haryana (No 2 Position), and the National Capital Region. Jagran Prakashan has
maintained its leadership position in the market through Dainik Jagran, despite competition
from other Hindi dailies. Competition in the Hindi belt is intense as all leading players are
expanding their operations to new markets to increase their readership.

Besides Dainik Jagran, two other publications are also doing well viz., Naidunia and Midday.
Naidunia has largely given Jagran presence in the states of Madhya Pradesh and Chattisgarh.
Since posting losses in FY14, Midday turned around in FY15 and profits started inching up
since then. Jagran Prakashan considerably revamped the Midday newspaper, which led to
increased circulation and better overall performance.

Advertising to bring in the money: Jagran Prakashan largely derives its revenues from
advertising and circulation. Advertising accounts for the largest chunk of revenues at around
74%.

Now, in print media, the top two players also garner the largest share of the advertisement
revenues as they boast of the largest circulation and readership. Moreover, large print media
players like Jagran Prakashan earn majority of their revenues from a couple of their flagship
markets. For instance, Jagran derives more than 50-60% of its revenues from the key flagship
markets like Uttar Pradesh and Bihar.

We believe Jagran will continue to gain readership in its present markets as established
newspaper publishers have strong franchise. While the possibility of more competition
cannot be entirely ruled out, a new player will not be able to penetrate deep into the

12
markets Jagran is strong in, without undertaking cuts in cover prices and compromising on
margins.

A strong established presence in the print business, will essentially keep the advertisement
revenue coming in.

But print is not the only avenue that will bring in the ad moolah. There’s Jagran’s radio
business. Firstly, in the overall advertising pie, the contribution of radio is low at a mere 4%,
which means that there is ample headroom for growth. Also, Jagran has completed most of
the capex for its radio business, which means that once the advertisement revenue starts
coming in it will directly flow to the bottomline.

Jagran is looking to attract advertisements through its digital platform too. Here, it is looking
to attracting advertisers either on its own or through networks such as Google and Facebook.
Producing videos is also another option that Jagran is keen on developing. Currently, the
digital business is loss making (it is expected to start contributing to profits FY20 onwards).

Advertisement Revenues Steadily Growing

20.0

15.0
Rs Billion

10.0

5.0

-
FY14 FY15 FY16 FY17 FY18
Source: Company FY18 Annual Report

Non-print businesses, especially radio, to grow faster: Besides print, the company derives
revenues from radio and digital. Although currently they contribute lesser to overall revenues
as compared to print, they have been growing faster than the latter and are expected to do
so in the future as well.

13
The company acquired 70.58% stake in Music Broadcast Ltd (which owns the brand
'RadioCity') in 2015. Currently, the company has a network of 40 radio stations across 12
states, and this medium is also expected to grow overall advertising revenues. Firstly, in the
overall advertising pie, the contribution of radio is low at a mere 4%, which means that there
is ample headroom for growth.

Further, the completion of the first batch of Phase III auctions provided strong tail winds to
the overall radio industry. Though expensive, it was considered successful with 96 channels
out of 135 channels getting allocated. Jagran Prakashan was awarded licenses in 11 cities.

Jagran has already completed capex for the radio business, which involved migration fees for
Phase I and Phase II stations, new licenses for Phase III stations, and set up cost for new
stations.

There is no more capex on the anvil for the radio business, which means that once the
advertising revenue from this business picks up pace, it will directly flow to the bottomline.
Further, the radio business has been reporting healthy operating margins of more than 30%,
which is expected to continue in the coming years as well.

The radio business has grown at a CAGR of 14% in the last five years, and we expect sales
from this business to grow 15% plus in the next few years as well.

The digital business is an extension of the company's print business and highlights the
company's willingness to adapt to change. The business has been growing at a scorching pace
of more than 40% and this has largely been because of the company's efforts to ensure that
it is not just an e-version of its printed newspaper, but a product that offers value to readers
in its own right.

14
 Source: Company June 2018 Quarter Presentation

Healthy financial performance: Over the last five years, Jagran Prakashan’s return on net
worth (RONW) has averaged at a healthy 18%. This is decent given that the company has gone
in for acquisitions during this period, which pulled down the RONW. Jagran’s debt is negligible.
And it has sufficient cash on its books. In fact, recently the company completed buyback of
its shares, as a strategy to reward shareholders.

The last couple of years have been quite challenging for newspaper businesses (due to
various issues including GST transition), but the management strongly believes that the
scenario is expected to considerably improve going forward. Although growth in sales and
net profits have not exactly set the pulse racing, the company nevertheless boasts of healthy
operating margins (at 25% plus in the last four years). Also, Dainik Jagran has consistently
enjoyed margins of more than 30%.

Key Challenges for Jagran Prakashan

Newsprint price fluctuation: Newsprint, as the primary raw material, represents a

significant portion of overall expenses. Newsprint cost is the largest operating cost for JPL
and typically accounts for 45-48% of total operating costs. Earlier in FY09, high domestic
newsprint prices resulted in significant erosion in EBITDA margins across the print media

15
industry. Any significant movement in newsprint prices will adversely impact the profitability.
In fact in the last couple of quarters, newsprint prices have been moving upwards and have
put some pressure on the company’s profits.

Over dependence on advertisement revenue: JPL derives more than 70% of total revenue
from advertisement. Advertising revenue depends on overall economic conditions. Low
economic growth, high inflation, high interest rate and certain policy decisions of the
government may hurt the overall consumer sentiment, which will negatively impact the
consumption and thus media industry. Similarly, shortfall in the expected growth in revenue
for any reason will disproportionately reduce the growth in profits or result in lower profits
because advertisement revenue has high operating leverage.

Intense competition and threat from Internet: Newspaper market is highly competitive
and is dominated by two or three players. Competition in the Hindi belt is intense as all
leading players are expanding their operations to new markets to increase their readership.
The company's prospects may get adversely impacted in case some existing or new players
with deep pockets enter or increase presence in the company's markets.

Key Management Personnel

Mr Mahendra Mohan Gupta is the Chairman and Managing Director of Jagran Prakashan.
He holds a bachelor's degree in commerce and has a rich experience of more than 60 years
in the print media industry. Throughout his career he has held many prestigious positions in
the industry including being the Chairman of United News of India, President of The Indian
Newspaper Society, President of Indian Languages Newspaper Association, Council Member
of Audit Bureau of Circulations among others. Mr Gupta is the Editorial Director of the
flagship newspaper Dainik Jagran too. For his contribution to the Hindi newspaper sector, he
has been honoured with 'Indira Gandhi Priyadarshni Award' by All India National Unity
Conference, New Delhi.

Mr Sanjay Gupta, Chief Executive Officer of Jagran Prakashan is a whole-time Director and
the Chief Editor of Dainik Jagran. He holds a bachelor's degree in science and is mainly
responsible for the implementation of business plan, regular monitoring of operations and
participating in strategy formulation. He has been a director of Jagran since 1993 and has
been in the print media space for more than 35 years.

16
Risk Analysis

In order to further improve our risk analysis of companies we have come out with a revised
Equitymaster Risk Matrix (ERM®). The ERM® is broken down in to 4 sub heads namely industry
risk, performance risk, management risk and balance sheet risk. (For details please refer to
the ERM® at the end of the report).

• Regulatory Risk

Some businesses are subject to regulations by external government agencies. These

businesses are subject to regulatory risk since they do not have the liberty to operate
in a free environment. Excessive regulations can create bureaucratic hassles and
impede growth. Thus, higher the regulation, higher is the risk of volatility in profit
and growth for any business. Being a democratic country, the regulatory framework
in India is not very restrictive for print media companies. Therefore, companies such
as Jagran Prakashan do not face high regulatory risk. As a result, we have assigned
a rating of 9 to the company.

• Cyclicality Risk

An industry cycle is characterized by an upturn as well as downturn. Businesses

whose fortunes typically swing with industry cycles are known as cyclical businesses.
Cyclical businesses do well during an industry upturn and vice versa. On the other
hand, there are some businesses that are not very cyclical. These businesses are
more immune to changes in industry cycles in the sector and have less risk. In short,
if the business is cyclical higher is the risk. Although print media is not a cyclical
business on its own, its advertising revenues which forms a major part of the
revenues is related to economic cyclicality. In economic slowdown, advertising
expenses of corporates are curtailed, which affects the revenues of print media
companies. Therefore, print media business is sensitive to the economic progress of
a country. As a result, we assign a score of 5 to the company on this parameter.

• Competition Risk

Every industry is characterized by competition. However, some industries where

entry and exit barriers are typically low have higher competition risk. Low barriers
mean more players can enter into the industry there by intensifying competition.
17
 Low capital requirement and no entry barriers in print media have led to increasing
competition in the recent past. Although Jagran Prakashan has a strong hold in the
two biggest Hindi markets such as Uttar Pradesh and Bihar, the competition has
nevertheless increased considerably. Therefore, we assign a rating of 4 to the
company.

• Sales Growth

Over the nine-year period (actual history of past 5 years and explicit forecast for the
next 4 years), Jagran’s sales growth is estimated at a CAGR of 8%. We thus assign a
score of 4 to the stock on this parameter.

• Net Profit Growth

Over the nine-year period (actual history of past 5 years and explicit forecast for the
next 4 years), we expect a net profit CAGR of around 6%. We thus assign a score of
4 to the stock on this parameter.

• Operating Margins

Operating margin is a measurement of what proportion of a company's revenue is

left over after paying for variable costs of production such as raw materials, wages,
and sales and marketing costs. A healthy operating margin is required for a company
to be able to pay for its fixed costs, such as interest on debt. The higher the margin,
the better it is for the company as it indicates its operating efficiency.

Jagran’s average operating margin over the nine-year period (actual history of past
5 years and explicit forecast for the next 4 years) stands at 25%, which is very
good. We therefore assign a score of 7 to the company on this parameter.

• Net margin

Net margin is a measurement of what proportion of a company's revenue is left over

after paying for all the variable and fixed costs inclusive of interest and depreciation
charges. Net margin is the final measure of profitability. It reflects the total profits
the company takes home. Higher the margin, better it is for the company as it
indicates better pricing power and effective cost management.

18
 For Jagran, the average net margin over the nine-year period (actual history of past
5 years and explicit forecast for the next 4 years) stands at 14%. We assign a score
of 6 to the company on this parameter.

• Return on Invested Capital (RoIC)

RoIC is an important tool to assess a company's potential to be a quality investment

by determining how well the management is able to allocate capital into its
operations for future growth. A RoIC of above 15% is considered decent for
companies that are in an expansionary phase.

The average RoNW for Jagran over the nine-year period (actual history of past 5
years and explicit forecast for the next 4 years) for the company stands at 18%. We
assign a score of 5 to the company on this parameter.

• Earnings Quality

This measure helps us assess the quality of earnings reported by the company. For
instance, some companies may follow aggressive accounting practices and
recognize revenues earlier than warranted. Earlier recognition of revenues boosts
profits. However, at the same time they do not generate sufficient operating cash
flow (OCF). This signifies debtors are not liquidated on time as sales were booked in
advance. Such companies face working capital issues and their quality of earnings is
poor. We assess earnings quality by dividing operating cash flow to net profits.
Higher the ratio better is the quality of earnings.

For Jagran, the average OCF/net profit ratio over the nine-year period (actual history
of past 5 years and explicit forecast for the next 4 years) stands at 1.3 which is
healthy. We thus assign a score of 10 to the company on this parameter.

• Transparency

Transparency is the key to any business. Transparency can be gauged by assessing

the past dealings of the company with various stakeholders, the way it displays its
financial information and the frequency of management's desire to communicate
with external shareholders whenever some unfortunate incident happens. The
easiest way to gauge the same is checking the level of disclosures in the company's

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 quarterly financial updates and annual reports. Transparent managements would
get a higher rating.

There is fair amount of transparency from the management of Jagran Prakashan in

terms of disclosures and frequent communication to investors. As a result, we
believe the company deserves a score of 7 on this parameter.

• Capital allocation

Apart from honesty, capital allocation skills are equally important in assessing
management quality. By capital allocation we mean how the management chooses
to deploy capital in the business. There are many instances where growth is given
priority over returns on the investment. This results in a company with larger size
but with poor returns. Managements are enticed to increase the size since their
compensation is tied to the size of organization they manage. Also, they sometimes
destroy shareholder wealth by making expensive acquisitions or by diversifying into
unrelated areas. Hence, capital allocation skills assume great importance in gauging
management quality. Capital allocation skills are good when return ratios depict
resilience. In short, more stable/higher the return ratios better the capital allocation
skills.

Over the years, Jagran has adopted both the organic and inorganic route for growth.
It bought the publications Mid-Day and Naidunia and also invested in Music
Broadcast Ltd in order to foray into radio. Although these acquisitions dampened
return ratios to a certain extent, the overall ratios are still pretty good. We assign a
score of 7 to the company on this parameter.

• Promoter Pledging

Promoters typically pledge their shares to take a loan which is generally infused in
the company. This exercise is generally resorted to when all other sources of
external liquidity dry out. The risk with this strategy arises when share price falls.
This triggers margin calls. If management is unable to provide some sort of a
collateral to the lending party from whom the money is borrowed that party may
sell the shares to recover its money. This accentuates the share price fall. Hence,
higher the promoter pledging higher is the risk. Currently, there are no promoter
shares pledged for Jagran, we assign a rating of 10 on this parameter.
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 • Debt to Equity Ratio

A highly-leveraged business is the first to get hit during times of economic downturn,
as companies have to consistently pay interest costs, despite lower profitability. We
believe that a debt to equity ratio of greater than 1 is a high-risk proposition. The
company's debt equity ratio historically has remained low.

Jagran’s average D/E ratio over the nine-year period (actual history of past 5 years
and explicit forecast for the next 4 years) stands at 0.2 times which is quite
low. Therefore, we assign a score of 9 to the company on this parameter.

• Interest Coverage Ratio

It is used to determine how comfortably a company is placed in terms of payment

of interest on outstanding debt. It is calculated by dividing a company's earnings
before interest and taxes (EBIT) by its interest expense for a given period. The lower
the ratio, the greater are the risks. With negligible debt, Jagran is safely covered in
terms of interest re-payments for its debt. We assign a score of 10 to the company
on this parameter.

It may be noted that leverage, return generating capability, earnings quality and management
risk get the highest weight in our matrix. Hence, scores assigned to these factors influence
the overall score.

Considering the above analysis, the total ranking assigned to the company is 97. On a
weighted basis, it stands at 7.3. This makes the stock a low-risk investment from a long-
term perspective.

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ERM®

Riskiness (A)
Company specific Weightage Weighted
Points High – Medium – Low
parameters (B) (A*B)
1 2 3 4 5 6 7 8 9 10
Industry risk
Regulatory risk $ 9 5.0% 0.5
Cyclicality risk $ 5 5.0% 0.3
Competition risk $ 4 5.0% 0.2
Performance risk
Sales growth 4 5.0% 0.2
Net profit growth 4 5.0% 0.2
Operating margins 7 5.0% 0.4
Net margins 6 5.0% 0.3
RoIC/RoNW 5 10.0% 0.5
Earnings Quality (OCF/PAT) 10 10.0% 1.0
Management risk
Transparency $ 7 10.0% 0.7
Capital allocation $ 7 10.0% 0.7
Promoter pledging $ 10 10.0% 1.0
Balance Sheet risk
Debt to equity ratio 9 10.0% 0.9
Interest coverage ratio 10 5.0% 0.5
Final Rating# 97 7.3
*Excluding extraordinary gains
For qualitative factors, denoted by $ sign, lower the risk, higher the rating.
For any risk parameter if the score is below or equal to 4 it indicates high risk.
The risk score of these parameters is highlighted in red color. For risk parameters where the score is above 4 riskiness is low.
The risk score of such parameters is highlighted in grey.

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Market Data Rationale for Valuations

Price On Reco. Date (Rs) 107 Jagran Prakashan has a

Consider buying the
52-week High/Low (Rs) 192 / 102 total readership base of
stock of Jagran
NSE Symbol JAGRAN
77 million plus and its Prakashan at the
flagship daily Dainik current price of Rs
BSE Code 532705
Jagran is the most widely 107 or lower.
No. Of Shares (million) 296.4
read Hindi newspaper in
Free Float (%) 38.7
the country. More importantly, its publications cover
Face value 2.0
13 states, which are largely Hindi speaking and in the
FY18 DPS 3.0 vernacular belt. This gives the newspaper a strong
Dividend Yld (FY18 at regional flavor.
2.8%
current prices)
Market Cap (Rs m) 31,568 Thus, despite various challenges that that print
media has been facing in recent times, Jagran
Rs 100 Invested Is Now Worth Prakashan has retained its edge because it has
content that is superior, relevant and local. Besides
250 Dainik Jagran, two other publications are also doing
200 well viz., Naidunia and Mid-Day.

150
Besides the print business, the company now has
100
Jagran Prakashan: Rs 124
two more faster growing business segments under
50
BSE Sensex: Rs 164 its belt - radio and digital.
Oct-13 Jan-15 Apr-16 Jul-17 Oct-18
The digital business is an extension of the company's
Shareholding (%, Sep-2018) print business and highlights the company's
willingness to adapt to change. The business has
Category (%)
been growing at a scorching pace of more than 40%
Promoters 61.3
and this has largely been because of the company's
Banks, MFs and FIs 17.2
Foreign portfolio investors efforts to ensure that it is not just an e-version of its
5.4
Others 16.1 printed newspaper, but a product that offers value to
Total 100.0 readers in its own right.

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The third important growth driver for Jagran is radio. The company acquired 70.58% stake
in Music Broadcast Ltd (which owns the brand 'RadioCity') in 2015. Currently, the company
has a network of 40 radio stations across 12 states, and this medium is also expected to
grow overall advertising revenues.

Besides healthy return ratios, Jagran Prakashan also has a very strong balance sheet with
negligible debt on its books. Plus, the company does not plan to undertake major capex in
the coming few years as most of it (especially the radio business) has already been done.

Now, at current price of Rs 107, the stock is trading at a trailing price to earnings ratio of 12
times, which we believe is attractive. Infact, the stock currently is trading close to its 52-week
low of Rs 102.

We are valuing the company by assigning a price to earnings multiple of 16 times on its
consolidated business from FY22 perspective.

As such, we have arrived at a target price of Rs 237 for the company (from FY22
perspective). This implies a CAGR of around 26% (excluding dividend yield of ~2.8%).
Thus, we recommend that subscribers could consider Buying the stock of Jagran
Prakashan Ltd at the current price of Rs 107 or lower.

According to us, in a scenario of ideal allocation of funds, mid and small cap stocks could be
considered to comprise of not more than 30-40% of one's total equity portfolio. Further, we
believe that a single small cap stock should ideally not form more than 2-3% of the total
portfolio. However, please note that this allocation will vary from person to person. For
something that works best for you, we recommend you talk to your investment advisor.

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Financials At A Glance

Income Statement FY17 FY18 FY19E FY20E FY21E FY22E

Sales 22,830 23,040 25,031 25,738 28,473 31,534

Sales growth (%) 9.8% 0.9% 8.6% 2.8% 10.6% 10.8%

Operating Profit 6,395 5,825 6,003 6,173 6,971 7,721

Operating profit margin
28.0% 25.3% 24.0% 24.0% 24.5% 24.5%
(%)
Net profit 3,493 3,109 3,234 3,325 3,869 4,384

Net profit margin (%) 15.3% 13.5% 12.9% 12.9% 13.6% 13.9%

Balance Sheet
Current assets 10,843 10,520 13,643 16,597 20,468 24,946

Fixed assets 15,678 13,977 13,188 12,253 11,279 10,266

Other assets 5,595 6,507 6,542 6,563 6,645 6,737

Total Assets 32,116 31,004 33,374 35,413 38,392 41,949

Current liabilities 5,831 5,459 5,870 6,008 6,540 7,136

Net worth 21,549 20,397 22,355 24,258 26,703 29,665

Other liabilities 4,736 5,148 5,148 5,148 5,148 5,148

Total Liabilities 32,116 31,004 33,374 35,413 38,392 41,949

Valuations

(Rs million) FY17 FY18 FY19E FY20E FY21E FY22E

Revenue (Rs m) 22,830 23,040 25,031 25,738 28,473 31,534

PAT (Rs m) 3,493 3,109 3,234 3,325 3,869 4,384

Diluted EPS (Rs) 11.8 10.5 10.9 11.2 13.1 14.8

Price to earnings (x) 9.0 10.2 9.8 9.5 8.2 7.2

Price to sales (x) 1.4 1.4 1.3 1.2 1.1 1.0

Price to book value (x) 1.5 1.5 1.4 1.3 1.2 1.1

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Performance review of stocks recommended in The India Letter

To view the Performance Review for The India Letter stocks for the month of October 2018
and the result updates, we request you to visit The India Letter homepage, or click here.

Regards.

Radhika Pandit (Research Analyst)

Editor, The India Letter

Radhika Pandit (Research Analyst), is the Editor of The India Letter and is one of our senior
analysts with more than a decade-long stint in the field of equity research. She has helped
build our pharmaceutical sector research from scratch and has a firm grasp of the Indian
automobile industry. Being an ardent follower of Warren Buffett's value investing
philosophy, she believes in investing in solid businesses for the long haul.

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Frequently Asked Questions

These are some of the Most Frequently Asked Questions on The India Letter. Please view the
others here.

If the stock price runs up post the recommendation and trades at levels higher than
the buy price, should one still buy the stock?

Please note that small and midcap stocks, in general, have low market capitalisation and
liquidity. There is always the possibility that these stocks may shoot up in price in no time,
even at the time of our recommendation.

Therefore, we would like to recommend to our subscribers not to chase prices and not to
consider buying a stock once it goes beyond our recommended maximum buy price. There
will be enough recommendations in a year so that the pain of missing out on a few
recommendations is eased considerably.

Do note that we give best buy price for every stock we recommend in The India Letter.

Can there be an overlap or contrary views on the stocks recommended under this
service and that of the other Equitymaster services?

Each of our product teams, be it StockSelect, Hidden Treasure, Smart Money Secrets or The
India Letter, has its own unique screen and checklist for selecting and recommending stocks.
In rare cases, where there is a compelling proposition to recommend a stock in more than
one service simultaneously, there could be an overlap in stocks. There could be contrary
views on the same stock in different services, only in rare cases, where the investing tenure
or the investing philosophy of the two products are very different. In The India Letter for
example, all recommendations are based on a megatrend theme based on a time frame of
three to five years.

27
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