Myth buster for Mr. Market – A Rail Infra Development company

Let’s begin with an old thought experiment. 

An economist spots a $100 bill lying on the ground but decides to ignore it and walk past it, telling himself – “if it was a $100 bill, someone would have picked it up already”.

There exists a belief system that the collective knowledge is right, and if there were a stock worth investing in to generate supernormal returns, then someone (read smart investors) would have already identified and invested in it, taking away any excess returns. This behavioural bias allows Scientific Investors to identify and invest in hidden opportunities with supernormal return potential. We call these – market anomalies, and in this article, we are discussing two market anomalies, viz., Mispriced Fundamentals and Mispriced Growth.

TLDR;

Omni Bullet Train smallcase portfolio is a collection of interesting market anomalies and investment opportunities. One such company in the portfolio has

• Completed 15,000 km of rail projects
• Revenue Growth of 27% per year in the last 6 years
• Order Book of 50,000 Cr predicting future growth
• Profit After Tax (PAT) growth of 23.6%
• Improved its Return on Equity (RoE) to 19.2%
• current P/E just above 10

Want to buy such mispriced stocks? 

The company is a structurally important railway infrastructure firm. This firm is a good example to understand the above anomalies. It was established to develop the rail infra in India in 2002. Since then, it has commissioned nearly 15,000 km of rail projects which include new railway lines, doubling of lines, electrification, metro lines and gauge conversion. It has also built 13 railway workshops. Building on its technical know-how, the company has entered the Road & Highway projects and undertaken international projects.

The standard perception or the perception propagated by experts about Public Sector Companies (CPSEs) is that they lack high quality, visionary management, and are poor at capital allocation and hence fail to grow the business even if they have large growth opportunities given to their monopolistic advantages. In a stark contradiction to this belief, this rail infra firm has grown its revenues at a staggering 27% CAGR over the last 6 years in spite of pandemic or GDP slow down. The company has an orderbook of around 50,000 Cr which gives further growth visibility. 

Revenue FY2016 to FY2022 (Company filings, Omniscience Research)

Profit After Tax (PAT) FY2016 to FY2022 (Company filings, Omniscience Research)

The second widely held belief about CPSEs is regarding their operational inefficiency. There is a misbelief that the CPSEs do not have a profit motive and their operations are lax resulting in poor profitability. Consequently, they are considered as value eroders. Again, contradicting this belief, this rail infra company has maintained a steady profit margin (PAT margin) since 2016, including the covid year and has grown its Profit After Tax (PAT) at 23.6% over the same period reflecting a profitable growth. The current Return on Equity (RoE) is at 19.2% which reflects efficient use of capital. The company has improved RoE from around 15% to 19% over the last 5 years indicating a persistent competitive advantage. 

“Perceived as non-growers and value destroyers, most of the Public Sector Companies are given very low valuation multiples and if one looks closely, one can find great investment opportunities from this pool.”

We discussed the fundamentals of one such opportunity above. Now, let us look at the valuation matrix of this firm. Despite delivering strong growth with consistent fundamental performance, the company has traded at a P/E in the range of 5 to 7 all through since its listing in 2019. Clearly, it has remained significantly undervalued for a very long time. With Mr. Market taking note the share price has doubled since the beginning of Oct 2022 taking the current P/E to just above 10. 

For a company growing at a rate of 20%+ with a RoE of ~20%, a P/E of 10-11 is surely a market anomaly of mispriced fundamentals and mispriced growth. Interestingly, this anomaly is in the process of getting resolved otherwise the price-is-always-right or bhav-bhagwan-che group would have claimed that it is a ‘fake’ $100 bill!

Omni Bullet Train smallcase portfolio is a collection of such interesting market anomalies and investment opportunities as discussed above. While the unlocking has begun in this stock and the smallcase portfolio collectively (8-10 stocks), there is a long runway before it realises its fair value. The median last 5-year growth of this pack is above 12% with good visibility of future growth given the large infrastructure push under 

• Vision 2024
• National Rail Plan
• National Logistics Policy and 
• National Infrastructure Pipeline. 

The current portfolio P/E is 14 leaving much room for rerating with improving fundamentals.

Want to buy such mispriced stocks? 

Disclaimer: Please note that any mention of company names is not a recommendation to buy, sell or hold. Equity investments are subject to market risks. Past performance is no guarantee of future performance. One should invest based on the advice of their financial advisor based on their investment objectives, financial situation and risk profile. OmniScience Capital, its management and employees and its clients might be buying, selling or holding the mentioned companies. Please read the detailed disclaimers and disclosure at http://omnisciencecapital.com/disclaimer.