If you lost your 50% fund, you have to make 100% on your remaining one to just breakeven. This is the simple reasoning behind the Buffett’s two rules of investing. Rule number 1 don’t lose your money (A reference to permanent capital impairment) and rule number 2) don’t forget rule number 1!

Going further to this invaluable insight by legendary investor and I really appreciate him for sharing his wisdom so generously with everyone. I personally think that the best way to avoid capital impairment permanently is a) stick to high quality companies, b) avoid low quality companies and c) getting out when facts change. These three simple ways will help you to protect your investment wealth.

Do not get caught in all the different mantras like ‘ high yielding’ business, F&O expiry, ‘sell in May and Go away’, ‘Mood of the market is downbeat but good time to buy good value stocks’ and all other marketing gimmicks used by various analysts in their analysis and interviews on business channels.

Think about it; how many business owners would speak about their business in those terms? “ Hi, my name is Raju and I own retail business – it is a high yielding business and that pays all its earnings to shareholders every year” or “ please, do not buy my business shares in May!” You will NEVER hear any such comments by business owners. That only comes from stock market or people who have never run a business!

The key is not to focus on stock market or talk about any market jargon. Just focus on business. That’s what we are doing today through this article on Essar Oil.

Essar oil is a part of Essar group of companies and is involved in refinery and oil exploration business. India as a nation is the biggest importer of Oil & Gas and that makes any refinery business very lucrative business. But due to big fluctuations in the oil market in last 5 years, many refinery businesses have turned into loss or low earning companies and their operating margins have turned very thin.

This business is a very high capital intensified business and that is one of the reason that it cannot be copied easily but for Indian market it is not unique. This business profitability also relies a lot on government regulations and makes investment little risky.

Because it is capital intensified business, to maintain its profitability they have to keep investing in plant and equipment heavily. This business has managed to grow its sales revenue but it is all thanks to the inflation and fluctuations in international oil prices, that leaves the company with no real growth.

Looking at its profits on year to year basis for past 5 years they managed to show profits only in the 2011 year, which reflects the business condition.

Personally speaking, I don’t like capital intensified businesses which are producing low returns and especially if they are in habit of making losses. I like only the business which has net cash on their balance sheet and are giving consistent at least 15% return on your shareholders equity.

 

Value Operations Verdict

Quality Rating

Performance Score

Value Prospects

Safety of Margin

C

3

?

-40%

We cannot value loss making companies. As per their financial standing at 2011, we valued this business for Rs 31.25. Essar oil has booked losses for the year end 2012 and we do not have clear earning guidance from the company and that is the reason we cannot forecast growth in its business value. But today it is trading at premium of 40% to its 2011 values and we do not expect its value for the 2013 to grow above 2011 levels.

 

Key Facts:

Essar Oil losses have grown from Rs 41.18 Crore to Rs 4,199 Crore from 2008, a jump of 10096%.

The company’s net debt has also gone up from Rs 10,000 Crore to Rs 11,814 Crore, a jump of 18.14% in last 5 years. Net debt/Equity stands at 520%.

 

Key Facts:

Since 2008 this company never had surplus cash year. They always required cash from their borrowers to keep running their business from last 4 years.

If you own this business then we would like to know your rationale behind your investment into this business. I know that management has tipped that last year (March 2012) was the final year for their all Capex expenses and it will be interesting to see how they manage companies investment. Looking at above charts and figures I do not need any special IQ to come to any conclusion.