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There are 62 different industries trade in stock market of India. Not all of them will do well in the future. What is your flavour to invest with in India today?

Looking at our own portfolio, we are more attracted towards the IT, Bank and Mining industries that operate in India. Well, we are more attracted to these industries because we are seeing plenty of value investing opportunities available today within them.

But it could turn out to be a value trap! We are attracted to those businesses because they are good quality businesses with strong Balance sheet, both their historical and current returns on equity are of high quality and they are well run businesses in their space.

In my previous post that I have shared with you tells us that even high quality businesses can surprise us on the downside. There is a thin line that differentiates between value and value trap. This is by looking at the bright prospects for the future and make sure that businesses are adding more value to it.

If you lose 50% of your capital then you need a return of 100% on your remaining outlay to square off. We believe in preservation of capital and this is the reason we are sitting on 70% cash for our own portfolio. With that equation in mind, we are still outperforming the market and many other professionally managed funds that are merely sitting on 0 – 10% cash and might lose the opportunity to invest more when this high tide will fall.

Let me go through with you our rationale behind investments in the mining industry in this blog. If we look at the NSE500 companies then there are 7 businesses trading as a miners. These businesses are:

Coal India

GMDC

Gujarat NRE Coke Ltd

Mercator

NMDC

Orissa Mineral Dev. Co.

Sesa Goa

Gujarat NRE Coke had not yet released its consolidated results so we will ignore it to consider for investments.

We want to buy businesses that are giving high returns on their equity. Three businesses out of them have reported return on equity greater than 20% for the year end March 2013 and also qualify as an investment grade business.

Coal India

A1

GMDC

A1

NMDC

A2

My next job was to look at how the intrinsic values are behaving for these businesses. Are management adding any values or destroying them. This is very important for us and it should be to all the investors if they believe that price of underlying asset follows its intrinsic values in the long run.

Companies

IV for March 2012

IV for March 2013

Coal India

Rs 260

Rs 316

GMDC

Rs 152

Rs 171

NMDC

Rs 234

Rs 149

Business economics for NMDC is not looking that attractive just by looking at the trend of its intrinsic values. They have reported drop of 13% in profits compare to their 2012 profits. On the other hand Coal India had added 22% and GMDC have added 13% more value to their 2012 intrinsic values.

We have identified two great businesses to invest with. One is the producer of 80% of coal in India and another one owns more than 90% of mines in Gujarat and looking to stretch its business horizon in other parts of India. Before investing in any of these businesses it is important that you understand its business economics and its products future prospects.

Both the businesses are investment grade. Coal India is today trading at premium of 3% to its 2013 intrinsic values and GMDC is trading at discount of 16% to its 2013 values.

Market prices in the stock market trade at looking at the future earnings and its prospects. So what does the future holds for both these companies. Our platform calculates its future earnings trend looking at the historical performance.

It won’t be appropriate if I don’t add disclaimer that we don’t believe in predictions. We do not trust on their accuracy. But we believe on the available evidences of this businesses performance (quarterly results & Managements guidance) where we can estimate its earnings range. Also we do not want you to buy businesses on its intrinsic values, we advocate buying them at discount. This way any fluctuations in the intrinsic values estimates will give you a buffer.

Below are the following earnings estimates by Value operations platform and the Consensus reports of future earnings for both the companies.

Companies

VO Earnings 2014

VO earning % 2014

Consensus Earnings 2014

Consensus Earnings % 2014

Coal India

Rs 30.95/ share

12%

Rs 28.97/share

5%

GMDC

Rs 21.44/share

13%

Rs 22.51/share

19%

Now, because these are all estimates, my personal advice is to take into account the lowest forecast to calculate its estimate intrinsic values. In my last month’s white paper we did shared the basic formula to calculate intrinsic values.

The formula is ROE/RRR*Book value, where ROE is returns on equity, RRR is your required rate of return. Now, this formula is good for businesses that share all or most of their profits with their shareholders.  Give a shot to calculate your intrinsic values for both these businesses and if you get stuck anywhere we can discuss about it on this blog.

Here are the estimates of intrinsic values based on Value Operations Platform and Consensus earnings estimates as of today for both the businesses.

Companies

IV estimates by VO for 2014

IV estimates by Consensus 2014

Coal India

Rs 381/share

Rs 346/share

GMDC

Rs 207/share

Rs 223/share

If I believe in those estimates to be true then Coal India is trading at discount of 6% and GMDC at 31% to its expected 2014 intrinsic values.

A note of caution b2ap3_thumbnail_red-warning-sign: Thse estimates can change almost every day. Value Operations private fund owns both the businesses in its portfolio. You still need to do your own due-diligence before committing any of your funds within those businesses. Seek professional advice from your financial planner before investing in the above discussed businesses.