A Fast Moving Stock Gets Into the Multicap Portfolio

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This is an interesting opportunity, but one that’s fairly risky simply because it’s moved up fast. The problem with adding stocks at new all time highs is that you just don’t feel great taking them as fundamental opportunities, even if the future seems good. This is one of them.

We’ve not added stocks to the portfolio for a while, and that will also change in the next few weeks. Remember that in the multi-cap portfolio we have 25 positions, with 4% each. We will still have 10 positions empty even after this addition. Therefore, we are only 60% invested. You will find the full portfolio here.

We’ll be adding this to the Long Term Multicap portfolio, and the stock is IRCTC. This is a government owned railways catering and ticket booking company.

First, why do we like it?

This is a government company. Therefore it is (usually) unlikely to provide great long term growth. However, there’s a story here which we believe gives us a 50% return in a year or so, if things go well. So we’ll take a position based on this, even if we find the stock a little expensive right now.

IRCTC does four things:

• Catering: Food provided on trains (55%)
• Ticketing: the monopoly online booking agent for the railways
• Rail neer: the near-monopoly water supply (packaged) for the railways
• Tourism: manages tourist trains and offers packages to travellers

Here’s a quick summary of what they do.

Catering

IRCTC provides food on trains, and on stations. It also allows for online booking of food through partner restaurants (that pay it 12% commissions, and deliver food straight to your seat) They are, effectively, the Swiggy of the rail network.

A new catering policy 2017 put the catering monopoly back to IRCTC (it was taken away in 2010 and given to the railways itself). This business should still grow at 8% a year for the next 5 years.

Tourism

IRCTC operates the tour trains (like Maharaja’s express and Bharat Darshan) that bring in about 300 cr. roughly. Focussed mostly on foreign tourists, this and the tour plan (revenue of about 40 cr.) are expected to grow by about 8% annually.

Packaged Water

IRCTC has a monopoly on providing drinking water on platforms and trains. Rail neer, their water brand, is what will be provided to passengers, and only if they can’t supply it will other vendors of water be used. Currently, IRCTC is constrained by capacity, and only provides water that caters to 45% of demand. To increase capacity, they will add 6 more plants in FY20 (from 10 to 16 plants) and another four by 2021.

Ticket booking

This is the biggie. For much of the last decade, this was India’s largest e-commerce site. They book tickets for the railways – again, a monopoly. From 2014, when IRCTC saw ticket bookings of 15.8 cr. tickets, the e-booking system has grown to about 28 cr. tickets  in FY2019. IRCTC’s site sees more than 70 lakh people login every day, and sees more than 2.5 cr. transactions a month. In 2016, the government had disallowed them from charging a service fee, so they saw these revenues dip – but the service fee was reintroduced (Rs. 15 for non-a/c and Rs. 30 for A/C) in September 2019.

Why do we like it?

Simple points.

• They have 16 cr. shares outstanding, so the current market cap is Rs. 14,500 cr. of whereabouts. at Rs. 900 per share.
• Out of this around 1,100 cr. is cash. (And there’s no debt)
• Tax cut: The company had a profit of about Rs. 272 cr. in the last year (FY19). This was at the 35% tax rate. Since the tax rate has fallen to 25% the tax impact of this change itself will be 50 cr. more profit after tax each year.
• Service charge: IRCTC will now charge Rs. 15 to Rs. 30 per ticket as service charge. They will book about 2.5 cr. tickets a month, so that’s a decent 260 cr. increase in revenue. Subtract from this the Rs. 90 cr. the Railways used to pay them for the lack of service charge, and a bit of tax, and the net impact in this year (FY20) will be about 150 cr. and the next year (FY21) will be 400 cr. with the increases.
• Ticketing market share: About 70% of all railway tickets are booked through IRCTC today – the rest are at the counters physically. In five years they expect this to become 82%, which means about 43 cr. tickets sold. That’s a growth of about 7% a year.
• Lower sharing with Railways: IRCTC says it’s been asked to redesign the pantry cars in trains to be more hygienic, and instead of paying 40% of catering revenue to Railways, they’ll have to pay just 15% on such redesigned cars.
• Doubling Rail Neer Capacity: They can only cater to 45% of demand due to lack of capacity, and in packaged drinking water, they have the first right to provide their products. They are adding 10 more plants in the next two years, and margins in this segment are very high.
• Passenger rail expansion: There’s a Dedicated Freight Corridor (DFC) coming along where goods trains will have separate lines, initially in DEL-BOM and BOM-KOL. This will allow for more passenger trains in this sector. That should increase the total available seats, and as we know, most trains in these sectors are heavily booked and in demand so utilization will be a major problem. The railways is spending Rs. 150,000 cr. in each of the next two years on modernization and changes, so that should help IRCTC with expanded capacities after 2022.
• Optionality: There are some fringe areas we haven’t seen yet. They have bid to operate entire trains (they pay a certain fee, but all the revenue from ticketing etc. is theirs). They have a wallet and a payment gateway that could reduce costs of the ticketing operation. There’s a lot more they could do with dynamic pricing and linking to other booking apps as well. This provides a certain optionality but we don’t know how much of that will come about.

But the basic thing is: the lower tax, the service charge addition and the increasing of capacity should nearly double their profits this next year, and the capacity expansions in catering and water will help with better margins and revenue.

The financials

We’ve built an optimistic projection but the FY20 and FY21 numbers seem achievable:

By next year, as capacity comes online, news will drive up expectations in the stock.

Liquidity: There will be scarcity premium

One big move here is that the Government stake is locked in for a year. This can change, because the government makes the rules, but it’s unlikely. After a year, we are sure to see a big stake sale again.

The government owns 87%. They can’t sell for a year. And after that, they have to bring stake down to 75% by 2022.

So we believe there will be a lot of buyers but hardly any sellers for this stock in the near term, which gives us a cushion for the valuation at least for the next year.

Valuation and Why We Are Buying

This is a government company. You should never expect too much from a government company.

So, the deal is this:

• At a Rs. 44 EPS in FY21, they will be making around 30% ROE with no debt. And for a business that needs no more money (it hasn’t raised any money in the recent past either).
• This is likely to get a 30 to 35 P/E if the company and the government play it right.
• If this happens, you are likely to see a price of Rs. 1400 or so, in about one year as FY21 visibility increases.
• That’s a 50% increase over the current price.
• The scarcity premium – because the government can’t sell for a year, and there’s a buying frenzy – is likely to protect the downside.
• So the idea is to hold for a year, around when the government will want to sell another tranche of shares, and if we get to a decent return, we should exit.

This is not really how you should play a long-term portfolio, but it takes all kinds. Since we are willing to take deep draw-downs on the remaining stocks, we can have a few that we don’t really intend to hold very long – but even one year is long enough in our view. We have added it at a price of 894, and will exit if the price goes to the 1400-1500 range.

Chart

(Note: it’s listed only a few days back, so this is an hourly chart)

Disclosure: Capitalmind and its authors may have positions in the stocks above, and as a portfolio manager, may have added positions in the stock for their customers. None of this should be considered investment advice.

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