FACT: Good Times to Keep Rolling? 

Hello everyone, Rahul Shah here, trying to make investing accessible and profitable for the average investor.

What do you feel about buying a stock that's trading at a PE multiple of 85x?

Well, for value conscious investors like me who believe in following rules and having strict upper limits for valuations, I will simply give the stock a pass.

A PE of 85x is quite high and does not offer margin of safety of any kind.

Having said that, one needs to check whether the denominator of the PE ratio i.e. the earnings, are not abnormally low. If they are then the PE ratio may not be a true reflection of the current valuations of the stock.

A quick glance at the company's P&L statement reveals that the earnings being considered for the current PE ratio of 85x, are not low at all.

In fact, they are one of the highest that the stock has managed to achieve in recent years. Therefore, the stock certainly looks overvalued from a historical earnings perspective if one considers the PE ratio.

It isn't cheap on a price to book value basis either, as the ratio currently stands at a huge 35x.

To be honest, the only stocks that are commanding valuations of this kind are extremely high-quality companies like Titan, Pidilite, Asian Paints etc. These are stocks with amazing long term track records, solid franchises and great returns on capital.

However, FACT Ltd, the stock under consideration today, possesses none of these qualities.

It has posted losses in 5 of the last 10 years, turning profitable only in FY19, had negative net worth for all the 10 years barring FY22 and FY23 and had debt significantly higher than what its operations could handle.

If the historical track record of the company paints such a sorry picture, why is the stock going all gangbusters?

To put things in perspective, FACT was trading around the Rs 25 mark back in March 2020. From there, the price has jumped to close to Rs 750 per share, translating into a whopping 30-bagger or gains of 2,900% in under 4 years.

Truth be told, the stock did deserve to be re-rated.

After all, it has managed to turn its operations around and become a profitable entity from a non-profitable one. Besides, the company's future also looks promising.

FACT is the leading fertilizer supplier of Kerala and also supplies fertiliser to all the South Indian states.

Its operations are also marked by high level of vertical integration as its ammonia requirement for fertiliser manufacturing is met through captive production.

The company also has robust expansion plans lined up as it targets increasing the fertiliser production from 10 lakh MT to 15 lakh MT.

Having said that, it is not completely out of the woods yet.

The biggest challenge it faces is an outstanding loan of almost Rs 18 bn that it has taken from the Government of India. Additionally, the interest accrued on the same stood at Rs 12 bn.

As per the company's credit report dated March 2023, it has requested the GOI to write off the loan interest, convert a portion of the loan into equity and change the balance loan amount to interest-free loan repayable in 10 annual instalments starting from FY23.

Then there are other long-term challenges like regulatory risks and the dependence of the fertiliser sector on the vagaries of the monsoon.

Therefore, if I were to summarise, there has been a marked improvement in the long-term fundamentals of the company. However, are the improvements so good that investors start treating the stock like the way they treat world class franchises like Asian Paints, Titan and Page Industries?

Well, I don't think so.

FACT still belongs to the fertiliser sector whose long-term history of wealth creation is middling at best. We haven't seen too many investors earn multi-bagger returns from fertilizer stocks over a 3-5 year horizon. Therefore, giving a PE multiple of more than 80x to a stock like FACT is taking it too far I believe.

Another way of analysing this is considering the valuations its peers trade at. The long-term average PE across most of its peers like GSFC, GNFC, Chambal and National are in the range of 10x-15x.

This makes FACT's PE ratio close to 7x as expensive as peers. Put differently, FACT will have to grow its earnings by a huge 600% in the near future to bring its valuations in line with its peers. And this sounds almost impossible to achieve.

You see, the future is always uncertain and there's no telling how a company will perform in the future. However, the past performance of not only the stock but the overall sector as well, can certainly act as a guide for the future.

Therefore, if you want to practice sensible investing, you shouldn't be too adventurous and assume that the future will show a marked deviation from the past. In fact, you should buy at a price where even if the future is slightly worse than the past, there isn't too much damage to your invested capital.

When you look at FACT's share price from this vantage point, it has an extremely rosy future built into it at the moment.

And I don't like such situations.

For if the rosy future does materialise, the stock price doesn't move up too much as it is already built into the price. However, if the future turns out to be thorny instead of rosy, the share price can take a huge knock and cause substantial damage to your capital.

Hence, I will definitely proceed with caution as far as the current share price of FACT is concerned. That does seem like the safe thing to do for now.

Well, that brings me to the end of this short video. I will see you again next time. Good bye and happy investing.