Friday, January 2, 2015

Accelya Kale: Review from May 29 2014

My review of Accelya Kale Solutions on May 29,2014. The stock has run up over 45% since then. It was on the edge of the margin of safety - now of course is overpriced for a decent return. 


Accelya Kale: Decent moat and excellent business

The airlines industry famously has destroyed a lot of capital over the years due to the high leverage and primarily being a commodity where players find it hard to differentiate their product offerings. Airline IT however seems to be a different ball game. Here is a company with no debt, cash flow from operations greater than net income, very high dividend payouts, low debtor to sales % and very high returns on capital. Seems too good to be true? Yes, it trades around 10.9 times earnings too! Now it definitely sounds too good to be true - so lets study whats up with this one.

1. How good is the moat?
Grade B+
  • Brand replication cost and timeline - Airlines typically are large companies where building trust will take long periods of time. I recon that replicating the brand of Accelya Kale will take more than a decade 
  • Product and technology replication - Reliability factors will be required to be very high. Also gaining domain knowledge will also take capital and time. But overall this factor gets a 0 on the -1,0,1 scale.
  • Sales and distribution - Even Accelya Kale itself in the form of Kale Consultants did not have the distribution network it built after being acquired. This is going to be a tough one for competition.
  • Vendor relationships - not real vendors to speak of and nothing special here.
  • Employee relationships - seem to be strong but nothing super special. Average compensation per head is low for the IT services industry at 5.6L/head/year.
  • Performance during recessions - should not be very badly affected unless clients go into bankruptcy. Overall due to their low cost base they could have a situation where people switch to them in a recession but no real evidence of this yet.
  • Pricing power - several airlines have in-house units doing this work. Too much of a pricing change will drive customers away so I don't believe this is a source of competitive advantage. The low cost base definitely puts them at a slight advantage.

2. Risks

  • Customer creditworthiness - This is likely to be a huge issue. The airline industry as a customer scares me much but the debtors % of sales is only 11% so not much to worry about given the margins are at 27%.
  • Parent company risk - the parent could start taking contracts directly short changing the minority shareholders in India. Given that its an overseas company it might be hard for Indian shareholders to battle that.
  • Growth sources risk - Its unlikely that industry growth is going to be a big driver of growth for this company but:
    • Market share growth - Currently Accelya Kale has only 3 of the top 20 airlines in its customer set so there is room to grow. Their cost basis has got to be among the lowest and the airline industry survives on the lowest cost carrier. 
  • Obsolesce risk - Airlines, their reservation systems and accounting standards are complex and slow to evolve due to the complexity. Given that this is an IT company obsolesce risk is real but not as rapid as some of the other IT businesses.
  • Debt/financial risk - minimal
  • Transparency risk - Nothing much to talk about yet.
  • Customer concentration - the concentration aspect is low well and the company is fairly diversified across geographies.

3. Financials

  • The company is a net foreign exchange earner of 69% of annual revenue which is very good for shareholders given India's trade deficit.
  • Stock options - not much to talk about here.
  • Somehow the cash from operations is greater than net income consistently. This is also corroborated with the fact that the dividend payouts have been greater than 100% of net income.
  • Exceptional items on P&L have been low
  • Debt is zero
  • No real inventories to talk about
  • ROE is 80%+ which is spectacular and has recently gone up. Margins started picking up in late 2011 and have been fairly high since.

4. Soft factors

  • 74.66% owned by foreign shareholder Accelya
  • No interesting insider transactions to report
  • Very large dividend % indicates that the foreign shareholder might want to buy the whole thing out at some point. This might be a low probability but high return outcome.
  • Directors don't seem to hold shares in the company - I say seem because the data is only disclosed for directors who are up for re-appointment
  • High conviction position for large investors - not that I can tell. An investor called VLS finance owns about 2% of the company.
  • Corporate governance - Seems to be done well with the one of the old founders - Vipul Jain is the CEO. He is paid about 2.2 Crores for the year which seems to be reasonable but on the higher side for a pre tax P&L of 123 crores and an average pay per employee of 5.6L. The difference between the lowest and highest paid executive seems to be very high.
    • Auditor B S R & Co seems to be reputed

5. Pricing

  • This is the tough one. At 11 times TTM earnings or so with a high dividend payout and a gain in market share the growth source this becomes a conundrum.
  • This valuation would be justified if the company were to be able to growth its earnings by 20% a year CAGR for 5 years. Now given the high payout ratio that seems to be tough but with the massive returns on capital this could be on the brink of growth if they are able to close some deals.
  • If growth does not happen and the company holds its margins it should remain a high dividend yield stock at a 10% or so div yield.
  • FX interest rate parity should drive up earnings due to the depreciating rupee in the long run as well - unless ofcourse the new government is able to stem the inflation and interest rates in India.
  • Price to book at the current prices stands at around 9.35 times which is blasphemy in the world of value investing!
  • Another issue with the pricing is that the graham number here works out to be 103 which should be no more than 22.5 as per Ben Graham. So is this really a value investment?
  • I think it is worth considering at 635. I am still working on the conviction on this one as the downside is massive if the earnings fall off. The question is what is the probability of the earnings falling off the edge?

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