Finding Hidden Value

Holding company stocks trading at a sharp discount to their SOTP can be attractive investments

Many stocks are trading at a steep discount to their sum-of-the-parts (SOTP) valuations currently, which appears unreasonable. Out of the Nifty 50 companies, Sesa Goa, Jaiprakash Associates, Grasim Industries, ICICI Bank, ITC, Gail are some of the companies that are  trading at a steep discount to their SOTP valuations. Notably, these SOTP values are after providing for the customary holding company discount (which ranges between 20-25 per cent) and thus, these discounts appear to be streched.

This strategy of stock picking tries to identify stocks trading below their intrinsic value. This means the growth and/or monetization opportunities underlying in the subsidiaries/non-core businesses of such holding companies is not adequately captured by the markets. Usually, these companies have subsidiaries across sectors/sub-sectors.

One such example is of Grasim. At the current market capital, the company is trading at a 31 per cent discount to its investment in group companies, in addition to the 20 per cent holding company discount. Gautam Trivedi,   MD & Head of Equities, Religare Capital Markets India, says, "Right now Grasim is trading at a 47 per cent discount to Ultratech. Even though Ultratech accounts for 76 per cent of the SOTP of Grasim. The discount should be around 20 per cent or so. The market prefers to play an Ultratech than a Grasim. My personal view is it’s a wrong way to look at it. Another such company is Network 18 which owns 55-60 per cent of TV18."

Another case in point is that of Reliance Capital. The company's market capital is 39 per cent lower than its combined stake in three of its subsidiaries in the asset management, life and general insurance businesses.  However, most of Reliance capital's businesses are poised for strong growth going forward - thanks to the company's focus on improving growth and profitability. Further, the company would benefit from clearance of insurance sector reforms.

While investing in such stocks one should look at the equity investments already made as well as the future commitments planned.  One should also look at the key challenges facing the company and the management's future strategy to reduce the investment risks in  such stocks.

"High investment commitment in the subsidiary, any stake sale in subsidiary at low valuation, unrelated diversification through subsidiary impacting parent's cash flows are some of the key risks involved in this strategy of stock picking. One such stock that we like is L&T due to its limited equity commitment to subsidiary businesses, high quality management and strong track record", says Vinay Khattar, Head Research (Individual Clients), Edelweiss Financial Services.