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In our Portfolio edition dated May 30, 2021, we had written on the value some of the holding company(holdco) stocks of different business groups offered.
Holding company discount impregnable even in bull run
In this context, one company that has potential for value creation for long-term investors is Sundaram Finance Holdings (SFH). The company is part of a business group (TVS) that has a good reputation for corporate governance and shareholder value creation. Investors can accumulate the stock on dips provided one has the patience to wait for value unlocking catalysts to play out.
Company
SFH was spun off from Sundaram Finance as part of a demerger scheme in 2018. Till then it was a wholly-owned subsidiary of Sundaram Finance with the main objective of engaging in the business of investments, including investments in financial services enablers, fin-tech investments. As part of the demerger, the investments of Sundaram Finance in companies engaged in non-financial services were vested with SFH.
These non-controlling investments consist of a portfolio of auto component companies mainly from within the TVS group, like Wheels India, Brakes India, Sundaram Clayton, Lucas-TVS, etc. While the company’s investments in financial services/fintech have not picked up, and its standalone business which consists of BPO business is miniscule, it has, in the last one year, focussed on consolidating its portfolio of investments in auto component companies. In the first quarter of current fiscal it launched a ₹350-crore rights issue to buy out a JV partner in Brakes India and increased its stake in the company by 7.71 per cent to 14.38 per cent. While Brakes India is controlled by the same family within TVS Group that controls SFH, broadly its investments are spread out across the businesses of the extended family.
Value of underlying companies
Within the investee/associate companies, the value is split between listed and unlisted companies. Amongst listed companies, significant value is derived from Sundaram Clayton (holding company of TVS Motors) in which SFH has a 11.24 per cent stake and is worth around ₹832 crore at current market prices. Its 23.28 per cent stake in Wheels India is worth around ₹445 crore. Overall, the value of its listed investments based on current prices is around ₹1,500 crore.
With regard to unquoted investments, as per it FY21 annual report, the value of these is approximately ₹1,202 crore. Out of these ₹760 crore of investments are recorded at carrying amount (at book value). Subsequent to FY21, the company has utilised the rights issue proceeds of ₹350 crore to increase stake in Brakes India. This brings the value of its unquoted investments to around ₹1,550 crore.
Together, the value of the company’s quoted and unquoted investments adds up ₹3,050 crore (combination of current market price for some, revalued for some, and carrying amount for rest). SFH has a strong balance sheet with insignificant third party liabilities. Against this, its current market cap is ₹1,740 crore. This implies a holdco discount of 42 per cent.
What works
The holdco discount of 42 per cent, while significant at an absolute level, is not so high, when compared with many other holdcos in the markets, which trade at discounts of more than 50 per cent. However, there are a few factors which, when analysed, indicate that the underlying value of investee companies is higher and thereby the discount is also higher than 42 per cent. One, the likely understatement of actual value of ₹760 crore of investments recorded at carrying value. Carrying value is conservative accounting and hence may not reflect the true value. Two, some of its significant investments that are recorded at fair value, like Brakes India (stake worth approx. 37 per cent of SFH market cap), are unlisted and hence may be getting better public market valuation multiples. And three, its single largest investment — Sundaram Clayton (stake worth approximately 48 per cent of its SFH market cap at current prices) is itself trading at a holdco discount of little more than 50 per cent when considering the market value of its subsidiary – TVS Motors.
Another data point to note is that, including company’s share in profits of associate companies for FY21, its PE multiple is 23.5 times. This is not expensive considering FY21 was a tough year for the auto sector, and given prospects for turnaround in the sector. For example, the company’s Q1 FY 22 net profit including share of profit in associate companies was already at 42 per cent of entire FY21 number. These, combined with track record of the Sundaram Finance group over decades in terms of business performance as well as corporate governance, are factors that work in favour of the stock.
However, there are some risks also. One, unlocking of holdco discounts may be long-drawn processes and investment horizon beyond 5-7 years may be required. However eventually the probability of such unlocking happening is decent. In fact, the family arrangement announced in December last year is a validation of this. Two, the performance of the holdco will depend on the performance of the underlying investee companies and this needs to be tracked.