Valuation model explanation:

Our valuation model takes into account the fluctuations in business cycle and hence uses averages over the business cycles where appropriate while calculating ratios. For example: Operating profit margins and net profit margins are averages of the last 3 years (or 4 years) data.
A Dupont analysis is used to identify the sources of return.

Explanation of a dupont analysis:

A Dupont analysis breaks down the return on equity into component ratios. A Dupont analysis can be a 2 step, 3 step or a 5 step analysis depending on specific circumstances. A deeper analysis is warranted for when a 2 step or a 3 step analysis fails to provide us with the information we are looking for.
2 step analysis:

            ROE = (ROA x Financial Leverage)
            Return on Equity = Return on Assets multiplied by the Financial Leverage
            Where Return on Assets = (Net Profit/Total Assets) and Financial Leverage = (Total Assets/Shareholders Equity).

Breaking down the ROE helps us understand if an increase in ROE is achieved by a more efficient utilization of assets as calculated by the return on asset ratio or by using greater debt as calculated by the financial leverage multiplier [(average total debt + average total equity)/average total equity)].

3 step analysis:

ROE = (NPM x TAT) x Financial Leverage
Return on Equity = Net Profit Margin multiplied by Total Asset Turnover multiplied by the Financial Leverage
ROE = (Net profit/Revenues) x (Revenues/Total Assets) x (Total Assets/Shareholders Equity)

The 3 step analysis breaks the ROA into NPM and TAT components thereby leading to an ROE which is a product of 3 distinct ratios. For example, if from the 2 step analysis you notice that the financial leverage is the same but ROA has increased; you would then be interested to see what resulted in the greater ROA. In this case, a 3 step Dupont analysis helps us to understand if the increase in ROA is a result of an increase in net profit or an increase in revenue or both.

A 5 step analysis breaks down the NPM further into the following components, Operating Profit Margin, Interest Burden and Tax Burden thereby helping us to understand further how the change in ROE comes about

Explanation of Ratio Analysis:

The main ratios we look at in ratio analysis include

NPM = Net Profit/Revenues. This ratio is a measure of profitability. A higher Net Profit Nargin is preferred because it allows the company to stay profitable even if costs rise and Operating Profit Margin drops. Ideally, profit margins over 10% indicate that the company has pricing power and does not have too much interest and tax outgo that cuts into profitability. Capital intensive companies typically have NPM less than 10%, if investing in these companies care should be taken to ensure that the company can remain profitable even if the economy turns bad. Else investment in the company should be avoided.  

            OPM = EBITDA/Revenues, This ratio measures the Operating Profit Margin. Though a higher ratio indicates a better company, this ratio must be looked at in conjunction with the NPM ratio.
            Return on Equity = Net Profit/Shareholders equity. This ratio is a measure of profitability. It measures how much revenue the company is generating on its equity. Equity is the sum of retained earnings and paid up equity capital. Ideally, a company consistently generating 15% or more is preferred for medium to long term investments.

            Long Term Debt to Equity Ratio = Long Term Debt/Shareholders Equity. This ratio checks to see how solvent the company is and how much the debt is as a percentage of shareholders equity. Ideally, a ratio less than one is preferred, however some capital intensive companies and companies growing fast may have ratios significantly higher than one. Due diligence is required to understand the reasons when the ratio exceeds one.

            Current Ratio = Current Assets/Current Liabilities. This ratio indicates whether the company has enough assets to cover its short term liabilities (less than one year). This translates into a positive working capital. A ratio over 1 is preferred. A ratio less than 1 indicates that the company has negative working capital and needs to borrow money to pay off short term liabilities.


Selan Exploration:

Selan Exploration Technology Ltd.. is a fairly new company in the oil drilling and exploration business. For a new company, it has had good results from its business. Its success can be seen by the increase in the proven reserves in the oilfields of the company. Driven by this, the company gave a maiden dividend of Rs.1.5 per common share to its shareholders. Selan is expected to ramp up production from 120,000 barrels in FY08 to 400,000 barrels in FY10. In its annual report for yearend 2008, the company says it has reserves of 73.3 Million barrels in the Bakrol oilfield. Its Indrora field is 3 times as big as the Bakrol field and may have significant reserves. The company should be able to increase production further from these oilfields. The company keeps finding oil in its exploratory ventures and recently obtained a mining lease for the Ognaj oil field from the Government of Gujarat. Its board of directors has a majority of independent directors, each of whom has a strong reputation as noticed by their years of experience in the oil industry and strong educational backgrounds. For example: its chairman, Mr. Rohit Kapur has an MBA from Columbia Business School, one of the top 5 business schools in the world. He has also worked in senior management positions in fortune 100 companies before.   Another independent director, Mr. Corbishley has nearly 37 years of experience with Shell, an oil industry giant, including being managing director of Shell, India for the last 6 years.  The company’s president Mr. M.N.Prasad has a Ph.D in petroleum geology. The company is in good hands ! Moreover, the board of directors in their meeting held on November 20, 2008, have considered and approved the proposal for Buyback of the equity shares of the company upto 25% of the paid - up share capital and free reserves. The buyback shall be carried out from the open market through the Bombay Stock Exchange / National Stock Exchange upto a maximum price of Rs.230/ - per share".


Operating Profit Margin (average of last 3 years) - 75%. Operating profit margins have been more or less constant over the last 3 years. The operating profit margin is very high because the company has very little expenses and oil prices have been very high compared to the production cost over the last few years. It employs a total of only around 30 people.

Net Profit Margin, NPMavg – 37%. NPM has been around 37-41% over the last 2 years. Such a high profit margin has been possible because of higher oil prices over the last few years. We should be aware that as oil price falls and stays unstable, the profit margins might vary and may fall to 10% or less. From a medium to long term perspective of 3 years or more, oil should surely rise. Anyways, revenue volumes and the share buyback program should compensate for any drop in margins to keep EPS for the next couple years at least at a level similar to FY2008 end.

Return on equity: 29.06%.
Liquidity: Current Ratio: 1.15
Solvency: Long term D/E: 0.302

Business model durability in tough times (can it withstand a recession, if yes, why?):  Though the company is dependent on oil prices, I am bullish on oil prices rising back to $60-70 per barrel from the current $30-45 range. Oil is a scarce commodity in low supply. When the economies of the world come out of recession, demand is going to be enough to push oil prices high again. Meanwhile, the company has low production costs and very high operating margins and can stay profitable even if oil prices stay at 30 levels. It does not have too much debt and is run by a good reputed management team that has declared a maiden dividend of 15% last year and declared an interim dividend this year of 15% when oil prices were high. The company is happy to enhance shareholder value by sharing in the profits it makes through dividends. This is a good sign for investors .  The share buyback program will also enhance shareholder value by increasing treasury stock and reducing total number of common shares outstanding. Its success so far in drilling in its oilfields and its strong management team in addition to the other factors listed above make me give the company a rating of 7/10. It deserves 8/10 but because it’s in a high risk industry, I have to deduct points for that. A definite 4-5% portfolio candidate.

Valuation ratios: FY08 P/E – 4                               FY09 P/E – 3.2

Possible Targets: As explained above, Selan is in a high risk high return field. Nevertheless, the good prospects of oil price rising in the future, Selan identifying greater reserves in its bigger oil fields combined with the confidence shown by the company in going for a share buy back at a much higher price than the current market price and a low P/E ratio indicates that the company is a value buy at current prices. The downside is pretty much non-existent at current valuations whereas the upside could be 300 or 400% over the next 3 years.

Venus Remedies:

Venus Remedies is an exciting fast growing small cap company in the pharmaceutical sector. It operates in only one segment, formulations. Its vision is to become one of the largest injectable manufacturing companies in Asia Pacific.

It has 2 manufacturing facilities in India and one in Germany. It has almost fully automated facilities and employs very few people, thereby cutting down on employee costs.

The company has the following achievements in the last one year:

The company has achieved European GMP certification for its oncology facilities and Kenyan GMP certification for its Baddi plant. As per a recent survey, the Middle Eastern Market is likely to be worth USD 12.00 bn by 2010 and is largely import oriented.  The Company's manufacturing facilities have been approved by the G.F.T.O of Syria for manufacturing and exporting its products to Syria: The company has filed 20 dossiers in Cephalosporin, Oncology and Carbapenem range of its products in Syria. Germany being a leading trade partner for Syria, the company will be exporting to Syria through its German subsidiary, Venus Pharma GmbH. The company's IPR Department has filed its 7th patent application with the Indian patent office for a novel, safe, non - irritating, highly efficacious and physiologically compatible antibiotic for the treatment of bacterial / multi-bacterial infections in children.

The company follows a Six Sigma approach to quality and their manufacturing locations have earned the following certifications:

Venus Germany : EU-GMP
Venus Baddi : EU-GMP, WHO- GMP, ISO 9001, ISO, 14001, OHSAS 18001, Latin American GMP(INVIMA), Ukrainian GMP, Zimbabwe GMP, Uganda GMP, Syrian GMP, Kenya GMP
Venus Panchkula : WHO GMP

They have a very strong R&D division and regularly file patents. VENUS has 7 Patents, 5 have already been published on WIPO site. WIPO is the world intellectual property rights organization.
VENUS has entered into an in licensing agreement for India & 10 Asia Pacific countries with university of Illinois,Chicago,United States of America for its patent technology for detection of tumors by imaging .


Operating Profit Margin (average of last 3 years) – 25.2%. Operating profit margins have increased from 20.63% to 25.61% over the last 4 years.
Net Profit Margin (lowest of last 4 years) -  12.03%. Though the company has only little debt and good solvency ratios, we will be conservative in our forecasts and choose the lowest net profit margins from the last 4 years as interest costs maybe higher in the future.
Return on equity: 65.79%. The company’s ROE is high because its net profit margins are high. The financial leverage component is moderate. Even at 10% net profit margins, ROE may come down to reasonable 30% levels, which is a still a very good ROE. I expect the company to maintain ROEs in excess of 30% for the foreseeable future.

Liquidity: Current Ratio: 2.79
Solvency: Long term D/E: 1.023

Business model durability in tough times (can it withstand a recession, if yes, why?):  The company is fast growing and has good liquidity and solvency ratios and does not have too much debt. It also has good profit margins and its interest costs will stay manageable in the future. I give the company a durability of 8/10.

Valuation ratios: FY08 P/E – 4.7                         FY09 P/E – 3.8

Possible Targets: Venus Remedies is another bear market anomaly. Given its growth and fantastic ratios and general growth prospects in India and overseas and that it has such a strong R&D division, it deserves atleast 10 P/E. A return of 150% is certainly possible. Another close your eyes and choose 4% candidate.

Website: http://www.venusremedies.comGerman website:

ICSA industries:

ICSA is headquartered in Hyderabad, India, with its operating locations spread across the World. The company derives almost 65% of its revenues from selling products with embedded technology that help bring down transmission and distribution (T&D) losses. By 2013, India plans to bring down its T&D losses to 15% from the current 35 to 40% and while that happens, ICSA should be a major growth company.

The problem:

Of the total investment of Rs.810,000 crore in the power sector during 11th Plan, over Rs.270,000 crore may well evaporate into an unknown space if no war-footing steps are taken to control mammoth T & D losses as a pan-India study conducted by the ASSOCHAM reveals. India can more than make up its severe power shortages if only 50% of the T&D losses are reduced by stoppage of theft and up-gradation of the T&D  system. The study warned that given the high T&D losses to the order of 30 to 40%, India would not be able to come out of the power crisis as the financial health of the utilities would go on deteriorating. Countries such as China, Pakistan and even African nations such as Cameroon have more respectable T&D losses as compared to India's average loss levels of about 33%. In broad terms, the power sector is expected to achieve break-even at T&D loss levels of around 20% or so.  While T&D losses of anything below 20% means the power utilities in the country would start making operational profits, any higher loss levels would push the country's power sector into the red.

The solution:

ICSA undertakes intensive in-house R&D to come up with viable, cost-effective solutions for the power sector. The company has developed innovative products suitable for Power utilities in the field of Energy Management, Energy Audit, and Control applications and provides versatile Data Acquisition system using several Communication media such as GSM, CDMA, Satellite, Optical fiber and RF. The focus area for ICSA has been the technology solutions to Power Sector to identify Transmission and Distribution (T&D) losses and monitor power consumption using GSM Network. The company also introduced the Remote Switching facility that is in sync with the on going Power Sector reforms. The company provides solutions to identify distribution losses, which has been a major area of concern for power utilities. ICSA helps the power utilities reduce their costs and streamline their operations. The remote sensing applications developed by the company can transfer data from power points to the control room through telephone lines and wireless, including GSM technology.

 The company has made significant headways in the embedded technology segment of the power sector and successfully developed Substation Controllers, Distribution Transformer Controllers, and Automatic Meter Reading Systems etc.

The company has a strong clientele and gets repeat orders. Given the T&D loss scenario, the growth prospects for ICSA are excellent. Its clientele includes many of the southern state electricity boards and the private transmission and distribution power utility companies. Examples include:  Maharashtra State Electricity Distribution Company Ltd, Madhya Pradesh Paschim Kshetra Vidyut Vitran Company Ltd, Transmission Corporation of Andhra Pradesh Ltd (TCAPL), Kerala State Electricity Board(KSEB), Reliance Energy Ltd. etc.


Operating Profit Margin (average of last 4 years) – 25.5 %. Operating profit margins have been more or less stable around the 25% mark over the last 4 years with minor non-significant fluctuations.
Net Profit Margin (average of last 4 years) -  17.35%. The net profit margins have fluctuated between 16.74% and 18.59% over the last 4 years.
Liquidity: Current Ratio: 4.39
Solvency: Long term D/E: 0.54
Business model durability in tough times (can it withstand a recession, if yes, why?):  The company has a strong future, is in a niche field with limited competition. Its strong D/E and Current ratios indicate the company has no liquidity or solvency problems. As long as India grows, the power sector will grow and as long as the power sector grows, the company will grow. It gets a 7/10 for durability and not 8/10 only because it has high debtor days and the state governments electricity boards have a prolonged payment cycle. Nevertheless, payment is assured, though delayed.

Valuation ratios: FY08 P/E – 2.7                         FY09 P/E – 2.2
Possible Targets: Possible 10 P/E given its prospects. I will not be surprised if the stock triples or quadruples from current levels. A sweet 4.6% dividend yield makes the investment even more worthy. A definite 4% candidate.


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