Value Investors Club / Tata Investment Corporation (501301)

Description

Summary thesis:

We are bullish on India due to (i) the leadership of Prime Minister Modi and Governor Rajan;

and (ii) lower oil price, which produces a double benefit of increasing domestic consumption and

investment and lowering inflation. The recent controversy over the retroactive AMT tax, which is not

applicable to foreign investors who invest in India after April 2015, has led to a 10% decline in India’s

stock market year to date. This provides a good entry opportunity as we believe this is a minor hiccup in

a long term secular bull market.

Tata Investment Corporation Limited (TICL) represents a diversified and discounted way to

invest in India and benefit from its bullish macro set up. TICL is an Indian investment holding company

that’s trading at a ~52% discount to its portfolio. Public Indian securities represent 87% of TICL’s

portfolio value. The discount to TICL’s portfolio has widened over the past year as the public portfolio

appreciated 39% while TICL’s stock increased only 28% over the same time period. Besides its

significant undervaluation, investors get to invest alongside a well-reputed family owner-operator

whose public equity portfolio has outperformed the general BSE Sensex index over the past 8 years by

6% annually; in addition TICL has a dividend yield of 2.9% vs 1.2% for the BSE Sensex. With reasonable

assumptions, we feel a better than 65% return on investment is possible over a 2 year period. We

believe TICL is similar to ideas like Softbank, Cheung Kong Holdings, and Naspers; these are holding

companies managed by good capital allocators and trade at a discount (~28% for Softbank, ~16% for

Cheung Kong, ~25% for Naspers). We like these companies as well and feel that over time these

discounts would disappear like it did for Berkshire Hathaway, which now trades at a premium of ~1.5x

book. Please note the average daily trading volume is ~35,000 shares ($350,000 daily turnover) so the

idea may not be suitable for large funds.

Macro backdrop on India

Below are some of the reasons we are bullish on India and its stock market:

GDP growth: GDP is expected to grow 7.8% in 2015 and 2016 due to the combination of greater

infrastructure investments, increased consumer spending, and increased corporation investment. This

is up from 4.5%-6.0% growth experienced from 2012-2014.

Mandate by Prime Minister Modi to drive economic growth in India:

Modi’s party won India’s 2013 election by the widest margin in over 30 years. His previous initiatives as previous governor in the

Gujurat state include providing electricity to every village and improving the water grid infrastructure.

During his term in the 2000’s, Gujurat’s per capita income grew 7% while the national average was 5.6%.

Currently, Modi is removing excessive bureaucracy that have stalled numerous infrastructure projects;

these infrastructure investments will boost India’s GDP in the near term because these infrastructure

projects represents ~8% of GDP and over the long term as completed electricity, roads, water, railroad

projects make it easier to conduct business and invest within the country.

Budget deficit is expected to drop to 4% of GDP, down from 6% in 2012 and 7% in 2010. As an

importer of oil, India is benefiting from lower oil prices. Oil prices at $60 per bbl has reduced India’s

budget deficit by 1% of GDP. A lower budget deficit provides room for Modi’s government to be more

aggressive on fiscal investments.

Trade deficit: India’s trade deficit has improved YoY to 11 billion USD. India’s largest trade deficits

are with China, Saudi Arabia, Iraq, Kuwait, and Switzerland. India’s trade deficit will narrow with lower

priced crude oil imports, offset slightly by lower prices of its petroleum exports. India’s largest exports

are refined petroleum products, engineering goods, pharma products, and services (software and travel).

India is currently addressing domestic production shortages in certain sectors (i.e. iron ore with

China for India’s steel industry) to gradually reduce dependence on the associated imports.

Foreign exchange reserves: India’s foreign exchange reserves increased to an all-time high of 344

billion USD in April 2015. These increased reserves will provide a buffer against potential capital

outflows when monetary policy normalization in advanced economics (US, Europe, Japan) commences.

Lower inflation: Under Raghuram Rajan’s leadership, the Reserve Bank of India has gained

credibility and curbed India’s inflation issues. Raghuram Rajan was previously the Chief Economist at

the IMF and was well known for his prescient paper at the 2005 annual economic summit in Wyoming

warning of large systemic shocks in the financial system. From 2008-2013, inflation in India skyrocketed

to 8-11%, dramatically higher than the 3-6% range experienced during the 2000-2007 period. After

Rajan became Governor in late 2013, inflation decreased to 6.4% for 2014. Now, the RBI is targeting CPI

inflation of ~6% for 2015-2016 and ~4% by the end of 2017-2018. Lower inflation provides consumers

and businesses with (i) greater confidence to make long-range plans and (ii) lower borrowing costs

which facilitates consumption of durable goods and improves the ability of corporations to invest.

Debt: India’s debt to GDP ratio has fallen to ~67% due to strong economic growth as opposed to

other countries like the US and Eurozone countries like France where their debt to GDP ratios has

increased over the past years. Currently, India’s credit rating is BBB-/Baa3; Moody’s has raised India’s

outlook to positive, citing “structural advantages, relatively benign commodity prices and potential

improvement in infrastructure bottlenecks.”

Stabilized currency: We believe the narrowing budget & trade deficits, strengthened foreign

reserves, low debt to GDP ratios, lowering inflation, and accelerating GDP growth will lead to a stable

and potentially strengthening rupee. During the inflationary period from 2007-2013, India’s real interest

rates fell into negative territory and caused the rupee to depreciate against the USD by ~32%. Lower inflation

allows the RBI to decrease its benchmark repo rates without hurting the rupee. Based on

current rates and inflation, India’s real interest rates are positive which should strengthen the rupee.

Finally, the RBI is implementing reforms that will lead to a fully convertible rupee. For example, earlier

this year the RBI allowed international institutions to borrow using rupee bonds. A fully convertible

rupee should improve the confidence of foreign investors and multi-national corporations in India.

Improved consumer confidence: After Modi’s appointment as Prime Minister, the Nielsen consumer

confidence score in India increased from 112 to 129, near its all-time high. Indian consumers’

purchasing power has also increased due to lower oil prices

Consumer demographics: By inspiring optimism among India’s young population, Modi has

unlocked India’s structural “demographic dividend”. The young population is the engine of greater

consumer spending, a key component of GDP. To give a sense of the magnitude of India’s youth, India’s

dependency ratio is expected to be ~20% while all other major countries will have dependency ratios

above 40%. Second, its literacy rate has improved dramatically to 74% as of 2011 (world average is 84%)

from 50% in 1990 and is forecasted to improve in the future. The combination of optimistic and better

educated young Indians entering the work force will lead to significantly greater consumer spending.

Improved international relations: One example of India’s improved international relationships is the

collaboration of Modi’s government and Obama’s US administration. Most recently, Obama supported

India’s membership in a reformed UN Security Council and both countries have re-launched a Trade

Policy forum in which India has indicated its commitment to intellectual property rights in India. We

believe a favorable relationship between the two nations will lead to more foreign direct investments

India, another contributing factor to GDP growth. Additionally, relations between India and Pakistan are

stabilizing.

Tata Investment Corporation

We believe Tata Investment Corporation Limited (TICL) is a cheap investment opportunity with a

large margin of safety. TICL trades at a 45% discount to its public equity portfolio and a 52% discount to

its total portfolio value. While TICL’s public portfolio has increased 39% over the past year; TICL’s stock

price has only increased by 28%, thereby widening the discount. The portfolio is diversified across

various industries and is representative of India’s economy, which benefits from a weak commodity

pricing environment. Additionally, TICL’s public equity portfolio has outperformed the BSE Sensex over

the past 8 years by 6% annually. Historical G&A expenses have been ~0.2-0.4% of TICL’s portfolio value,

which is good value for its capital allocation outperformance.

Company Background: Tata Investment Corporation Limited is a non-banking financial company; it

was promoted by Tata Sons Ltd., in 1937, under the name The Investment Corporation of India Limited.

It IPO'ed in 1959 on the Mumbai Stock Exchange. In 2008, TICL became a subsidiary of Tata Sons Ltd.

Tata Sons owns ~73.02% of TICL. Tata Sons is the founder and significant shareholder of the major

operating Tata companies (Tata Motors, Tata Chemicals, Tata Steel, Tata Global Beverages, Tata Power,

Indian Hotels, etc.) and 66% of Tata Sons is owned by philanthropic trusts endowed by members of the

Tata family.

Investment Philosophy: TICL’s investment philosophy is to “seek a combination of value and growth.

A company that exhibits growth characteristics, is well managed, has a sound position in its industry,

available at fair value according to conservative accounting norms is an ideal investment opportunity

for” TICL.

Situation Overview and Historical Track Record: Currently, Tata has an investment portfolio value of

67 billion rupees ($1.1 billion); 58 billion rupees ($950 mm) are in public Indian companies and bonds

and the remainder are in private companies. TICL’s current equity value is 31 billion rupees and its

enterprise value is 32 billion rupees ($520 mm). The discount to its portfolio value has ranged from a

52% discount to 33% discount over the past 8 years (average discount has been ~44% to its total

portfolio.) The current discount is near its widest range; as mentioned above, TICL’s stock has not

increased proportionally to its underlying public investments’ increase.

Comparing TICL’s historical track record versus the BSE Sensex index, we note that TICL has

outperformed the BSE Sensex over the past 8 years. The 8 year CAGR for the BSE Sensex from 2007-

2015 is ~10% while the public portfolio of TICL generated an 8 year CAGR of 16%. Cumulatively, TICL’s

public portfolio has returned 230% while the BSE Sensex has returned 114%. Hence, we believe our

investment in TICL is in good hands as we wait (i) for the discount to shrink; (ii) for TICL to continue to

outperform the BSE Sensex; and (iii) collect a 2.9% dividend yield, which compares favorably to BSE

Sensex’s 1.2% dividend yield.

Unlike other holding companies in India which are concentrated in 1-2 companies, TICL is more

diversified; its investments span the entire spectrum of India’s economy; hence investors are not overly

exposed to a specific sector. Its largest company specific investments include Tata Chemicals; Titan

Company (jewelry and watch chain); Tata Motors; Tata Global Beverages; Voltas (engineering solutions

and AC unit manufacturer); and Trent (textile and bookstore). A short profile and summary financials of

the mentioned companies are provided below. The largest portfolio weighting by value is Tata

Chemicals at 12% of its public portfolio value; in aggregate, the 7 aforementioned companies represent

~52% of TICL’s publicly quoted portfolio. In terms of sector weighting, the largest sector in TICL’s

portfolio is consumer goods. Titan, Voltas and Trent trade at 16-20x 2016 EBITDA due to the positive

market sentiment on companies that would benefit from the rise of Indian consumers; all three trade in-

line with the consumer and retail industry. The other mentioned companies trade at reasonable

valuations (4-12x ‘16E EBITDA). Among TICL’s private equity investments, the most notable are Tata Teleservices (formerly known as

Tata DoCoMo and the 7th wireless carrier in India with 64 mm subscribers) and Tata Capital, a bank that

serves commercial and consumer customers.

Lastly, investing in India requires strong local relationships and in-depth local knowledge. By

investing in TICL, investors are partnering with the Tata family, one of India’s best known business

families, and benefiting from their accumulated local knowledge of Indian businesses. This advantage

shows up in TICL’s historical outperformance against the BSE Sensex.

Taxes: The long-term capital gains taxes in India is 20% (cost basis is adjusted for inflation) while

taxes on dividends is 15%. The current book value of TICL’s investments is 390/share while the market

value of its investments is 1,220/share. Hence, the deferred tax liability on the capital gains is 166/share

and the after-tax value of its portfolio is 1,054/share.

Conclusion: We believe investors will generate an attractive return over a 2 year time horizon

through the following catalysts. First, the discount to TICL’s portfolio value narrows to its historical

average (from 52% to 44%), which generates a potential return of ~17%. With the discount at its

historical widest, the probability of it widening further is low. The discount also provides a margin of

safety if the Indian stock market drops. In 2009, when the Indian stock market declined sharply, TICL’s

discount to its public portfolio turned into a premium. Second, the NAV grows as the Indian stock

market appreciates alongside the improving Indian economy. Over the past 8 years, the Indian stock

market has appreciated 10% annually and its GDP has grown 6% annually. If India grows its GDP by 7+%

over the next two years, it’s reasonable to expect India’s stock market to grow at least ~10% annually or

better over the next two years. Third, TICL investors can benefit from a strengthening rupee as a result

of lower inflation which produces higher real interest rates. From 2005-2012, INR/USD traded between

45-50, reaching a low of 40 in 2008. With India’s strong expected growth and low inflation, a reversion

to 50 INR/USD would return ~24%. We would hold TICL in euro terms where we feel the prospects of

currency appreciation are even higher. Fourth, two years of dividends would yield ~6%. In sum, an

investor in TICL can reasonably expect to obtain a potential return of over 65% over a 2 year horizon.

Risks

Infrastructure investments are delayed
Corruption among Modi’s government is found, which reduces their credibility and lowers consumer confidence
Oil price rises back to $90+ / barrel which causes inflation to rise
Lack of rain that ruin’s India crop season, leading to higher food prices
Harsher capital gains tax for foreign investors are imposed which hurts market sentiment around India.
Tensions between India & China and India & Pakistan

Summary of TICL’s Largest Public Holdings

Tata Chemicals is one of the largest chemical companies in India with a focus on chemicals and fertilizers (i.e. soda ash and ammonia fertilizer) Comps for Tata Chemical trade at a median of ~7.4x ‘16E EBITDA

Titan Company is an Indian designer and manufacturer of watches, jeweler, precision engineering components (i.e. gear boxes) and other accessories including sunglasses, wallets, bags, belts, fragrances and helmets. Consumer comps for Titan trade at 25x 16E’ EBITDA

Tata Motors Limited is an Indian automotive company that produces passenger cars, trucks, vans, coaches, buses, construction equipment and military vehicles. It’s the world's 17th largest motor vehicle manufacturing company, fourth-largest truck manufacturer, and second-largest bus manufacturer by volume. Tata Motors is planning to raise 75 billion rupees in a rights offering expand its domestic business and Jaguar development. Comps for Tata Motors trade at a median of ~10x ‘16E EBITDA

Tata Global Beverages Limited is an Indian multinational non-alcoholic beverages company; it is the world's second-largest manufacturer and distributor of tea and a major producer of coffee. Recently, Tata Global Beverages announced a JV with Starbucks to own and operate Starbucks cafes in India. Comps for Tata Global Beverages trade at a median of ~20x ‘16E EBITDA

Voltas Limited is an Indian engineering, air conditioning and refrigeration company; Voltas is India’s largest AC company. Comps for Voltas trade at a median of ~19x ‘16E EBITDA

Trent operates Westside, one of India’s largest and fastest growing retail chains; Star Bazaar,a hypermarket chain and Landmark, a family entertainment and book store. Trent alsooperates a JV with Tesco, Zara and Lakeland respectively. In 2013, Trent merged with Landmark Ltd. Comps for Trent trade at 13x ‘16E EBITDA

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Narrowing of discount
Strengthening Indian rupee
Strong Indian economy and stock market

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			2015	2016
Price:	567.00	EPS	0	0
Shares Out. (in M):	55	P/E	0	0
Market Cap (in $M):	503	P/FCF	0	0
Net Debt (in $M):	17	EBIT	0	0
TEV (in $M):	520	TEV/EBIT	0	0