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Strategy begins to pay off

The recent sell-off has given a boost to Wealth Zoom. Our fund manager is convinced that as the global economy worsens, the shorts will rake in more profits.

Dipen Sheth | Print Edition: August 6, 2009

The good news: Wealth Zoom is up 3% for the fortnight ending 15 July, courtesy our aggressive short positions on a number of stocks. As the June quarter season revs up, I expect the market to reverse after its sharp pull-back of 14 and 15 July. If it had not been for this technical bounce, Wealth Zoom would actually have been over 7.5% in the 12 days till 13 July. If this convinces you that shorting is a viable investment option, consider that market volatility wiped out over half these gains in just two days. While shorting is indeed an innovation for Wealth Zoom, we will not succumb to the temptation of trading in and out every fortnight. Instead, a feasible strategy for now is to wait quietly on the sidelines, and short aggressively in case the markets pull up even more.

Last fortnight, we introduced a fresh long—Dishman Pharma— that I had failed to explain. This is a lesser known, but highly respected, contract manufacturer which has finally crossed Rs 1,000 crore in revenues in 2008-9. For a long time, Dishman has been the preferred supplier of key patented drugs for global pharma majors, Solvay and Astra Zeneca, and it is building on this strength. The company has built a strong pipeline of new products, which, on fructification, will lead to a sustainable growth in business volumes.

For some years now, Dishman has been constrained by being in the ‘investment mode’, wherein it was acquiring companies abroad (UK, Switzerland) or building on its manufacturing capacity in India. This is now on the verge of a multiyear pay-off. The existing product mix is expected to ride volume growth with both Solvay (three products) as well as Astra Zeneca (15 products). Meanwhile, Dishman’s development pipeline includes three onpatent products for Solvay, which hold the potential for boosting the 2010-11 post-tax profit by 14-28%. This does not include another 14 projects for contract manufacturing with Astra Zeneca.

Why are global pharma majors willing to outsource patented products to Indian firms? It’s because the latter are very good at reverse engineering and synthetic chemistry. This is evident from the product proliferation in the domestic pipeline on the back of a ‘process patent’ regime for many years. Manufacturing costs in India (particularly manpower, which is a significant component in pharma) are among the lowest in the world, and so is the case with compliance and regulatory costs. If the overseas manufacturer is convinced about the technical capability and trusts the Indian manufacturer, it makes eminent sense to farm out production of patented drugs to India as sales volumes rise and end-user prices level off in the developed world.

Dishman has a traditional presence in the low-margin quaternary drugs (quats) business, which is now gradually taking a backseat in the overall revenue mix as CRAMS revenue increases. Our research efforts indicate that revenue could jump 15-20% in both 2009-10 and 2010-11 as Dishman posts a much awaited ramp-up in CRAMS volumes. If the projects under development bear fruit, the profitability could jump even higher. On a conservative basis, the 2008-9 reported earnings of Rs 18 per share (profit after tax was Rs 146 crore) in 2008-9 could shoot up by over 50% to cross Rs 220 crore in 2010-11. Here is where the bargain kicks in: Dishman’s market cap is approximately Rs 1,500 crore. Expect significant additions to this position in Wealth Zoom as the market, hopefully, tanks again.

Our other portfolio, Safe Wealth, is currently under-performing due to its extended cash position of over 76%. I am not unduly perturbed about this as it is aptly clear (after the post-budget sell-off and the not-too-encouraging global news flow) that we will get a chance to acquire most of our portfolio items for much lower than the current prices. A number of readers are fretting over the relative underperformance vis-à-vis the lead indices such as the BSE Sensex or Nifty. While our intention is to beat the indices, keep in mind that we aim to do this via active investing, which carries every possibility of significantly under- or overperforming the benchmark indices in the short term. Let’s not get swayed by such noise and stick to what we believe in.

Readers’ Response
I am disappointed by your articles these days. I believe asking the readers to short-sell is not a healthy investment strategy. If a prediction for holding long fails, the reader can, at least, earn dividends on the shares until they get the right sale value. What will they have if the short call doesn’t meet its target? When they are forced to cover their short positions they will lose money.

We are not traders but investors who are trying to build a good portfolio to take advantage of multi-baggers and safe front-liners that will earn us steady returns.
- Phanindra Palepu

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