Budget Round-up

Affirming that the economy is right on track, Finance Minister Arun Jaitley presented the Union Budget for 2016-17. Citing that the CPI inflation has come down to 5.4% from 9 plus, he said it is huge relief for the public.

Tax

Infrastructure and agriculture cess to be levied.

Excise duty raised from 10 to 15 per cent on tobacco products other than beedis

1 per cent service charge on purchase of luxury cars over Rs. 10 lakh and in-cash purchase of goods and services over Rs. 2 lakh.

SUVs, Luxury cars to be more expensive. 4% high capacity tax for SUVs.

Companies with revenue less than Rs 5 crore to be taxed at 29% plus surcharge

Limited tax compliance window from Jun 1 - Sep 30 for declaring undisclosed income at 45% incl. surcharge and penalties

Excise 1 per cent imposed on articles of jewellery, excluding silver.

0.5 per cent Krishi Kalyan Cess to be levied on all services.

Pollution cess of 1 per cent on small petrol, LPG and CNG cars; 2.5 per cent on diesel cars of certain specifications; 4 per cent on higher-end models.

Dividend in excess of Rs. 10 lakh per annum to be taxed at additional 10 per cent.

Personal Finance

No changes have been made to existing income tax slabs

Rs 1,000 crore allocated for new EPF (Employees' Provident Fund) scheme

Govt. will pay EPF contribution of 8.33% for all new employees for first three years

Deduction for rent paid will be raised from Rs 20,000 to Rs 60,000 to benefit those living in rented houses.

Additional exemption of Rs. 50,000 for housing loans up to Rs. 35 lakh, provided cost of house is not above Rs. 50 lakh.

Service tax exempted for housing construction of houses less than 60 sq. m

15 per cent surcharge on income above Rs. 1 crore

Social

Rs. 38,500 crore for Mahtma Gandhi MGNREGA for 2016-17

Swacch Bharat Abhiyan allocated Rs.9,500 crores.

Hub to support SC/ST entrpreneurs

Government is launching a new initiative to provide cooking gas to BPL families with state support.

LPG connections to be provided under the name of women members of family: Rs 2000 crore allocated for 5 years for BPL families.

2.87 lakh crore grants to gram panchayats and municipalities - a quantum jump of 228%.

300 urban clusters to be set up under Shyama Prasad Mukherji Rurban Mission

Four schemes for animal welfare.

Health

2.2 lakh renal patients added every year in India. Basic dialysis equipment gets some relief.

A new health protection scheme for health cover upto 1 lakh per family.

National Dialysis Service Prog with funds thru PPP mode to provide dialysis at all district hospitals.

Senior citizens will get additional healthcare cover of Rs 30,000 under the new scheme

PM Jan Aushadhi Yojana to be strengthened, 300 generic drug store to be opened

Education

Scheme to get Rs.500 cr for promoting entrepreneurship among SC/ST

10 public and 10 private educational institutions to be made world-class.

Digital repository for all school leaving certificates and diplomas. Rs. 1,000 crore for higher education financing.

Rs. 1,700 crore for 1500 multi-skill development centres.

62 new navodaya vidyalayas to provide quality education

Digital literacy scheme to be launched to cover 6 crore additional rural households

Entrepreneurship training to be provided across schools, colleges and massive online courses.

Objective to skill 1 crore youth in the next 3 years under the PM Kaushal Vikas Yojna-FM Jaitley

National Skill Development Mission has imparted training to 76 lakh youth. 1500 Multi-skill training institutes to be set up.

Energy

Rs. 3000 crore earmarked for nuclear power generation

Govt drawing comprehensive plan to be implemented in next 15-20 years for exploiting nuclear energy

Govt to provide incentive for deepwater gas exploration

Deepwater gas new disc to get calibrated market freedom, pre-determined ceiling price based on landed price of alternate fuels.

Investments and infrastructure

Rs. 27,000 crore to be spent on roadways

65 eligible habitats to be connected via 2.23 lakh kms of road. Current construction pace is 100 kms/day

Shops to be given option to remain open all seven days in a week across markets.

Rs. 55,000 crore for roads and highways. Total allocation for road construction, including PMGSY, - Rs 97,000 crore

India's highest-ever production of motor vehicles was recorded in 2015

Total outlay for infrastructure in Budget 2016 now stands at Rs. 2,21,246 crore

New greenfield ports to be developed on east and west coasts

Revival of underserved airports. Centre to Partner with States to revive small airports for regional connectivity

100 per cent FDI in marketing of food products produced and marketed in India

Dept. of Disinvestment to be renamed as Dept. of Investment and Public Asset Management

Govt will amend Motor Vehicle Act in passenger vehicle segment to allow innovation.

MAT will be applicable for startups that qualify for 100 per cent tax exemption

Direct tax proposals result in revenue loss of Rs.1060 crore, indirect tax proposals result in gain of Rs.20,670 crore

Agriculture

Total allocation for agriculture and farmer welfare at Rs 35984 crores

28.5 lakh heactares of land wil be brought under irrigation.

5 lakh acres to be brought under organic farming over a three year period

Rs 60,000 crore for recharging of ground water recharging as there is urgent need to focus on drought hit areas cluster development for water conservation.

Dedicated irrigation fund in NABARD of Rs.20.000 cr

Nominal premium and highest ever compensation in case of crop loss under the PM Fasal Bima Yojna.

Banking

Banks get a big boost: Rs 25,000 crore towards recapitalisation of public sector banks. Jaitley says: Banking Board Bureau will be operationalised, we stand solidly behind public sector banks.

Target of disbursement under MUDRA increased to 1,80,000 crore

Process of transfer of government stake in IDBI Bank below 50% started

General Insurance companies will be listed in the stock exchange

Govt to increase ATMs, micro-ATMs in post offices in next three years

These Are the World's Most Miserable Economies

Misery index of inflation, unemployment shows 2015 economies about as depressed as expected, while economists see more of same this year.

Thanks to off-the-charts inflation, Venezuela will probably retain the dubious honor of being the most miserable economy for a second year.

Galloping inflation at an annual average of 98.3 percent last year alongside 6.8 percent unemployment earned the South American country the runaway top spot on the 2015 misery index. With no end in sight for Venezuela's economic woes — estimates in Bloomberg surveys predict consumer price growth of 152 percent and joblessness averaging 7.7 percent — economists polled for the 2016 index see it remaining the unhappiest country.

The ranking of 63 economies is compiled by adding a country's jobless rate and inflation, a long-standing calculation in which a higher score indicates more misery. Venezuela's 159.7 tally for the 2016 misery index done by Bloomberg quadruples the next-worst ranking Argentina.

The global slump in crude prices has been especially destructive in Venezuela, where oil makes up 95 percent of exports. Falling revenue is further weighing on budget strains, as Venezuela owes as much as $10 billion in foreign bond payments this year.

President Nicolas Maduro, who has declared an "economic emergency," told lawmakers last month that it was time to raise gasoline prices and that he'd look at adjusting fixed currency rates. Prices at the pump in Venezuela are the cheapest in the world, even as costs for everyday items and luxuries are surging — a dinner for two at a nice restaurant might demand more than a month's worth of minimum wage. 

Meanwhile, Maduro's new economy minister has said that price growth doesn't exist in "real life," blaming speculation, usury and hoarding among the business class.

In Argentina, authorities are in the midst of overhauling the national statistics agency and have stopped reporting some economic indicators until that's done, after being accused for years of releasing dodgy data.

While Venezuela and Argentina are tackling inflation, rounding out the top five unhappiest economies in 2016 are those desperately trying stop unemployment from deepening: South Africa, Greece and Ukraine.

Elsewhere in the world, the picture isn't quite as bleak. There were success stories last year, with Poland ranking No. 42 on the scale, versus a No. 19 spot initially projected at the start of 2015, in part due to lower-than-expected joblessness. But 2016 might see Poland climb the misery index amid an increasingly uncertain fiscal and economic outlook (including a possible debt downgrade) caused by the new ruling party's costly campaign promises.

The world's happiest economies this year will look similar to last year's rankings. Thailand, in part due to unique structural issues that allow more people to count as employed, will stay as least miserable. Singapore, for which survey data is newly available this year, will debut at second-best. Switzerland, Taiwan and Japan will keep top-five status from 2015.

Switzerland's case is cautionary for fans of the misery index: While the Swiss are slated to enjoy continued low joblessness, economists see falling consumer prices this year. Discounts can be great for consumers, but also could portend deeper problems within the economy. Switzerland, for its part, is still trying to maintain currency stability since dropping its currency cap a year ago.

Economists are looking for signs of improvement in Russia, Romania, and Ireland — each of which will achieve a more favorable position this year, according to the survey. After contracting by 3.7 percent in 2015, on the back of sinking oil prices and inflation-dampened consumer spending, economists expect a gradual "L-shaped" recovery for Russia, with the world's largest energy exporter seen returning to 1.3 percent annual growth in 2017.

Misery index calculations were compiled using the median estimates in Bloomberg economic surveys from the past three months. Figures for 2015 inflation and unemployment data reflect the average over the year and use the most current data available for each country.

Sub-zero is becoming the new mantra in government bonds after 2016's yield plunges –BII

Brazil's 5,500 Bankruptcies in 2015 Signal Deeper Credit Crisis

In his two decades covering Brazil, Fitch Ratings’s Joe Bormann says he’s never seen the nation’s companies in such a dire state. 

To appreciate just how bad things are, consider this: Brazilian courts granted more than 5,500 bankruptcy filings in 2015, the most since 2008, according to Sao Paulo-based credit rater Serasa Experian.

Brazil’s deepest two-year recession in more than a century and plummeting commodity prices are leaving businesses in industries from steel to air travel among the most at risk of default, according to Fitch. And more pain is looming in Latin America’s biggest economy as borrowing costs soar, predicts Bormann, who oversees a team of 60 analysts responsible for rating more than 500 companies in the region.

“It’s legitimately a credit crisis,” he said.

No Brazilian company has raised financing in overseas bond markets since June as an unprecedented corruption scandal at the state-owned oil producer and ratings downgrades have prompted investors to shun the nation’s financial assets. Fitch and Standard & Poor’s cut Brazil’s bond rating to junk last year. The local currency, which declined 33 percent last year, has slipped 0.8 percent this year.

“Nothing has gotten better,” said Wilbert Sanchez, founding partner and managing director at TCP Latin America, a financial firm in Sao Paulo. “Now, they’re just throwing in the towel.”

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Succession failure

Family businesses in the Arabian Gulf need to address the problem of succession planning

THE grand mufti of Saudi Arabia recently added a surprising new item to the familiar list of worries plaguing his region. Chess, he pronounced, is “a waste of time and money and a cause for hatred and enmity between players.” Without disputing the mufti’s judgment, Schumpeter would like to add a different worry: succession in family businesses. Like chess, poorly planned succession is a “waste of time and money and a cause for hatred and enmity”; unlike chess, it has the potential to undermine some of the country’s foremost economic institutions.

Succession is a problem for family businesses the world over. The Family Business Institute calculates that only 30% of such businesses survive into the second generation, only 12% into the third generation and only 3% into the fourth. But the problem may be bigger in the Gulf than anywhere else. Around 80% of the companies in the region, producing more than 90% of its non-oil wealth, are family-owned or controlled. The number of relatives clamouring for a job in these firms is surging, partly because the population is so young (the average age of citizens in the Middle East and north Africa is well below the global average) and partly because governments are desperate to shift workers from the public to the private sector (in the United Arab Emirates 90% of employed citizens work for the state).

These family firms are mostly fairly recent creations—the products of the oil and property booms of the 1970s and 1980s that turned people who were lucky or well-connected enough to own prime bits of land into moguls. Over the next decade up to half the region’s business families, controlling assets worth perhaps a trillion dollars, will hand the reins to the next generation.

That is a worrying prospect. A proper succession requires good governance. Yet too many of the region’s businesses blur the line between what belongs to the firm and what belongs to the family: they spend company money as if it were their own and employ family members without subjecting them to proper vetting. And if disputes occur, the region’s courts are not equipped to cope. The World Bank reports that they take an average of 575 days to resolve a commercial dispute. An estimated 70% of Saudi families have at least one succession problem tied up in court.

The two most obvious results of a botched succession are incompetent leaders and feuds. Family tradition often conspires against merit: families routinely favour the eldest son regardless of his ability. Locals say there are examples of incompetents “all around”, though they are reluctant to name names. The scope for feuds is increased by the complexity of family structures, thanks to high fertility rates and occasional polygamy. Abdulaziz Al Ghurair, chairman of the Family Business Network, a regional body, predicts that more than half the businesses will split over succession. A less obvious consequence is what might be called “functioning dysfunction”: companies get around incompetent heads by creating parallel structures so that the real power is held by people with minor titles, or by avoiding naming a CEO at all.

One of the most famous family disputes was reportedly solved by royal intervention. Two relatives, Abdullah and Majid, inherited joint control of Al-Futtaim Group, a Dubai-based empire, part of which now operates the Mall of the Emirates with its famous ski slope. The dispute proved so damaging that Sheikh Mohammed bin Rashid al-Maktoum, then crown prince and now emir, stepped in, locking them in a room and refusing to let them out until they had divided up the empire. But even the most enlightened royal intervention is no substitute for reliable rules.

Badr Jafar, the 36-year-old head of Crescent Enterprises, a conglomerate, is leading a campaign to provide just such rules. He argues that regulators should compel companies to make a clearer distinction between corporate property and family property. But he adds that companies need to change from within. They should borrow mechanisms that are popular with family companies around the world—such as family constitutions, family meetings and family offices—and adapt them to local traditions.

Mr Jafar is the perfect man to make this pitch: his company is based in Sharjah, one of the most conservative emirates, but he was educated at Eton and Cambridge. He has helped establish a pressure group, the Pearl Initiative, to support the case for better corporate governance. He has secured the support of global organisations, including the World Economic Forum.

Capitalism with Gulf characteristics

Mr Jafar can also point to several notable advances in the region, some of which predate his activities. W.J. Towell, an Omani company that employs 150 family members, has introduced regular family gatherings to promote family cohesion. The Zamil Group, a Saudi conglomerate with more than 100 family members on the payroll, demands that both family and non-family executives go through a “future leaders programme”, which uses psychometric tests to assess their abilities. The Abdullatif Alissa Group, another Saudi conglomerate, has gone even further, replacing all family members with professional managers and limiting the family’s role to board membership. A growing number of companies are creating family offices to help make the distinction between family and corporate resources. Ten years ago almost nobody was talking about this subject, says Mr Jafar. Today 50% of business families “have it on their minds, 30% in their mouths and 20% on paper.”

With luck, even more companies will put it on paper soon. Corporate governance might sound like an ineffective way to take on serious problems such as Islamist extremism and state breakdown. But the region has no chance of escaping from these conflagrations without improving its economy and creating jobs for the young. The last thing it needs is for companies to be ruined by incompetent heirs or torn apart by pointless disputes.

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Taxing tipplers

India’s governments struggle with their addiction to booze

 

Blind faith needed

IN LUCKNOW they call it “evening medicine”. In Bangalore the slang is “oil”. Among tamils it is “water”. The Indian government is less poetic. It classes the stuff as IFL, IMFL or IML, terms that stand for imported foreign liquor, Indian-made foreign liquor and Indian-made liquor. But in all its many layers the Indian government remains just as addicted to, and sometimes just as confused by, the demon alcohol as any wine-drenched Urdu bard.

Most Indians do not drink at all, and per person Indians are far more abstemious than others elsewhere (see chart). Yet those who do drink show a preference for the strong stuff. By fast-growing volume India is the world’s third-biggest consumer of alcohol, and far and away the biggest consumer of whisky. Such IMFL brands as Royal Stag and Officer’s Choice, unknown in other markets, rank among the world’s top ten best-selling whiskies. Even in beer Indians exhibit a taste for the bracing. Draught beers high in alcohol make up four-fifths of the local market.

Governments everywhere tax booze and control its sale, but few do so as heavily or as capriciously as India’s. It is not just that the federal government imposes a tariff of 150% on imported spirits. Local licensing fees and taxes, along with a range of gouging state controls on the alcohol trade, stick consumers with end prices that are often five or six times those at the distillery gate. Granted, cheaper, less palatable alternatives exist to real whisky. In Delhi a plastic 0.6-litre bottle of brown liquid whose wonky label proclaims “Star Deluxe 80 Proof” retails for just 140 rupees, or $2. Unlicensed hooch, widely available in India, costs a fraction of that. Sadly it sometimes also kills or blinds. In 2014, 1,700 Indians died after imbibing toxic home brew—mainly as a result of lethal methanol unwittingly being manufactured rather than ethanol.

India’s 29 states and seven union territories have adopted wildly different approaches to alcohol. In the west prim Gujarat has banned it entirely since 1961. By contrast the little territory of Puducherry on the Coromandel coast earns two-fifths of its revenue from an excise tax on booze. Some states auction wholesale and retail licences, or apportion them to friends of the party in power. Others operate their own monopolies. Tamil Nadu’s state monopoly employs 30,000 people and runs more than 6,000 outlets.

Officially tipplers in Mumbai need a licence to consume alcohol. A lifetime pass costs 1,000 rupees and a day ticket five rupees. In theory failing to have one can incur a five-year jail sentence. In Delhi the minimum legal age is a silly 25. Recently police, at the behest of the national government, raided a municipal official’s home to embarrass the local government with the shock discovery that he owned two bottles more than the 12 allowed by local law.

In a bow to Gandhian austerity, India’s constitution lays down the aim of reducing alcohol consumption. Like America in the 1920s, many Indian states have tried prohibition before abandoning it. The odd thing is that some keep trying. Kerala imposed stiff controls last year, and Bihar plans to do so in April. But Manipur and Mizoram, hill states in the north-east, are giving up their bans. They cite rising criminality, the danger of poisonous hooch, loss of state revenues and an inability to control the flow.

A continent masquerading as a country: Explore India in our interactive map

Meanwhile other states are simply seeking better ways to milk India’s passion for drink. Andhra Pradesh, whose 51m people already hand over nearly $2 billion a year in alcohol taxes, recently lowered duties on the cheapest Indian-made alcohol and raised them on higher-end potions. It was a carefully calculated bid to earn more from bigger volumes. Revenues have indeed soared, not only from higher local consumption but also because of a surge of smuggling into neighbouring states. Karnataka, dependent on alcohol for nearly a quarter of state revenue and already struggling to plug smuggling from cheaper Goa, has stiffened border checks to stem this new tide. To the north, the state of Punjab actually slaps higher taxes on alcohol “imports” from the rest of India to protect its own distillers.

Taken together, it is an ungainly mix of prudishness and excess, of tangled laws and hefty profits. It says much about the state of India today. In some sectors of the alcohol industry, order is beginning to prevail. For instance, after years of trying to slash a way through thickets of bureaucracy and vested interests, big multinational firms now manage the bulk of the beer industry. Yet despite promoting the idea of a unified national goods and service tax to replace India’s current plethora of federal and state taxes as a key objective of its reform programme, the government of the prime minister, Narendra Modi, has explicitly stated that alcohol will still be taxed the old way. It is too rich a brew for state governments to give up

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Rajan Explains What’s Exactly Wrong With Public Sector Banks

For every ₹100 of loan given by public sector banks, ₹17 worth of loans are in a dodgy territory. ₹6.2 have become a bad loan, where the repayment of the loan by the borrower has stopped happening. ₹7.9 has been restructured i.e. the repayment of the loan has been placed in a moratorium for a few years.

In a speech he made last week Raghuram Rajan, the governor of the Reserve Bank of India, put forward some very interesting data points.

It is well known by now that the lending growth of public sector banks has been very slow as they grapple with burgeoning bad loans. Nevertheless, agglomerated data on the loan growth of public sector banks is generally not available in the public domain.

As Rajan said:

Non-food credit growth from public sector banks, the more stressed part of the system, grew at only 6.6% over the calendar year 2015. Industrial credit growth for PSBs was only 3.3% while growth in lending to agriculture and allied lending was only 10.4%. The only area of strength was personal loans, where growth was 16.9 %.

Banks give out loans to the Food Corporation of India to run its operations. After adjusting for these loans, what remains is the non-food credit growth. The overall non-food credit in 2015 grew by around 9.3% (actually between December 25, 2014 and December 24, 2015) against 6.6% of public sector banks. This tells us very clearly that the loan growth of public sector banks has been significantly slower than the overall non-food credit growth.

In fact, the only area where lending of public sector banks has been robust enough is what RBI refers to as personal loans. These personal loans are different from what banks refer to as personal loans. Personal loans as categorised by RBI include home loans, vehicle loans, education loans, credit card outstanding, loans given against fixed deposits, shares and bonds and what banks call personal loans.

How does the situation of public sector banks look in comparison to private sector banks? As Rajan said:

In contrast, non-food credit growth in private sector banks was 20.2 %, in agriculture 25.4%, in industry 14.6%, and 23.5% in personal loans. Put differently, in each of these areas except personal loans, loan growth in private sector banks was at least 10 percentage points higher than public sector banks, while loan growth in personal loans was 6.6 percentage points higher.

The loan growth of private sector banks at 20.2% was significantly higher than that of public sector banks at 6.8%. As Rajan put it:

The most plausible explanation I have is that the stressed balance sheet of public sector banks is occupying management attention and holding them back, and the only way for them to supply the economy’s need for credit, which is essential for higher economic growth, is to clean up. The silver lining message in the slower credit growth is that banks have not been lending indiscriminately in an attempt to reduce the size of stressed assets in an expanded overall balance sheet, and this bodes well for future slippages.

Hence, public sector banks have been going slow on lending primarily because they already have a huge amount of bad loans piled up and they don’t want to continue to lend indiscriminately and have more bad loans piling up. What Rajan is essentially saying here is that the public sector banks could have continued on their indiscriminate lending spree and expanded on their loan books. In the process, the total amount of bad loans as a proportion of the total loans given out by banks would have come down, at least for a short time.

The fact that they did not do that is a good thing, feels Rajan. But the damage of their indiscriminate lending in the past is now coming out in the open. Take a look at the following table.

Extent of the problem

The bad loans plus restructured assets plus the assets written off in total made up for 17% of the books of public sector banks. This means that for every ₹100 of loan given by public sector banks, ₹17 worth of loans are in a dodgy territory. ₹6.2 have become a bad loan, where the repayment of the loan by the borrower has stopped happening. ₹7.9 has been restructured i.e. the repayment of the loan has been placed in a moratorium for a few years. In some cases, the borrower does not have to pay the interest during the moratorium period. In some other cases, the tenure of the loan has been extended. Further, ₹3 out of every ₹100 has been written off, with no hope of recovery of the loan.

Now how do private sector banks and foreign banks perform on the same parameters? Take a look at the following table.

Divergent NPA trends

What the table tells us very clearly is that the situation in private banks and foreign banks is significantly better than public sector banks. In private sector banks  ₹6.7 out of every ₹100 of loans is in a dodgy territory. In case of foreign banks, the number is even lower at ₹5.8.

What this tells us very clearly is that the problem of bad loans is largely limited to public sector banks. And it is interesting that the large borrowers are primarily responsible for the mess in the banking system. This becomes clear from the following table. Public sector banks make up for close to three-fourths of the Indian banking system.

Divergent NPA trends

As can be seen from the table medium and large industries are primarily responsible for the mess in the banking sector. Rajan also said during the course of his speech that all bad loans were not because of malfeasance. As he said:

Let me emphasize that all NPAs are not because of malfeasance. Indeed, most are not. Loans can go bad even if the promoter has the best intent and banks do the fullest due diligence before sanctioning. Nevertheless, where there is evidence of malfeasance by the promoter, it is extremely important that the full force of the law is brought against him, even while banks make every effort to put the project, and the workers who depend on it, back on track.

Let’s sincerely hope that this happens, else we will have a situation where banks will have to write off more and more of their bad loans, with the taxpayer having to pick up the ultimate bill. And that can’t possibly be a good thing.

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SBI, BoI Q3 Shockers: The Real UPA Scam Was In Messing Up The Banks

Quiz: Where did the UPA do the maximum damage? (a) 2G scam; (b) Coalgate; (c) CWG scam; (d) Banking sector scam(s).

You can choose any answer and you would not be wrong, but my pick would be (d) the banking sector near-scam, where cronies got crores of loans from nationalised banks for dubious projects which have now gone bad and are staining banks’ balance-sheets with red ink.

Economic revival is impossible without a robust banking sector, and that is precisely what is missing right now.

It is not that the rot is being discovered only now. Even while the UPA was in power, a lot of these bad loans were being quietly written off. According to this Indian Express report just two days ago, 29 public sector banks wrote off Rs 1,14,000 crore of bad loans in just three years, from 2013 to 2015. This was more than they did in the previous nine years.

Today’s crop of banking sector results shows that there is no end to the bad news. Close on the heels of horrid results from Punjab National Bank, Dena Bank, Central Bank and Allahabad Bank earlier this week, the last three of which saw a huge pileup of losses, the country’s biggest bank,State Bank of India, has reported shocking results. Net profits plummeted by 62 percent in the October-December 2015 quarter (Q3) compared to the year before, to Rs 1,115 crore.

But the really scary number is the level of gross bad loans – it went up by a steep Rs 15,957 crore to Rs 72,791 crore. The level of bad loans is more than 60 percent of the bank’s market valuation of around Rs 1,18,000 crore (as on 11 January). It shows how badly the market sees the performance of nationalised banks.

Nor is the market moping in vain. Another result (also announced today 11 January) was even worse. Bank of India, one of the top five public sector banks, plunged into a loss of Rs 1,510 crore in the third quarter. This loss figure – in just one quarter, mind you – is more than the entire valuation of United Bank of India (UBI). Put another way, Bank of India has lost enough in one quarter to buy one whole bank.

The point of giving you these numbers is simple: the real scams, whether 2G or in aviation or in coal, always have a counterpart in the banking system which has lent them money. While the banking system may not recognise them as a scam and merely as bad lending decisions, the linkage is undeniable. Behind every scam there is likely to be a bank (or banks) which has put its money on the line.

For example, Vijay Mallya’s Kingfisher owes more than Rs 7,000 crore to banks, including the State Bank of India. The airline’s failure has thus damaged banks more than Mallya.

The bad results in the third quarter of this year are due to the Reserve Bank’s insistence that banks should start recognising the real state of their balance-sheets by providing for stressed loans which look bad but have not been recognised.

But the worst is not over. Most banks may end up disclosing more bad loans in the fourth quarter, which will end this March. Then it will all hang out.

At last count (ie, before the current quarter), bad loans of banks were around Rs 4 lakh crore. But the end of the next quarter, it could be closer to Rs 5 lakh crore, depending on how much of their wounds banks reveal to the public.

The point is this: a lot of these loans would be crony loans, loans made to people favoured by the powers-that-be.

The Indian economic revival is being stymied by the fact that the necessary condition for revival – a healthy banking sector – is not yet in sight.

The next time Rahul Gandhi asks where are the achche din, the answer should be: they will come once we have fixed the damage you have done to the Indian banking system.

Barron’s 2016 Roundtable, Part 3: 12 Stocks That Could Outperform

From left: William Priest, Scott Black, Meryl Witmer Photo: Brad Trent

While stock market selloffs are painful, there is an upside to all that downside: a fresh profusion of bargain-priced shares. Just ask the three top-notch investors featured in this final installment of the 2016 Roundtable—Scott Black, William Priest, and Meryl Witmer. Value investors all, they suddenly see ample opportunities that didn’t exist a few months ago to invest in companies with attractive prospects, strong financials, and invitingly cheap shares.

Scott, the founder and president of Boston’s Delphi Management, told our Jan. 11 gathering of Wall Street savants that he’s on the hunt for companies with accelerating earnings growth. He appears to have found them in multiple and diverse industries, ranging from semiconductors to sneakers to generic drugs. Scott builds financial models the way Gaudi must have built his architectural models: piece by exacting piece. One could learn a lot from his process about how companies prosper and grow.

Bill, a new face at our annual confab, captains New York’s Epoch Investment Partners, which he co-founded after doing time, and doing well, elsewhere on the Street. At Epoch, he’s all about free cash flow—how companies generate it, and how they return wealth to shareholders. No raging bull, he recommends staying defensive in rock-solid issues, like CVS Health (ticker: CVS), one of his four favorite picks for the new year.

Meryl, a general partner at New York’s Eagle Capital Partners, is hungry for knowledge and contrarian to the core. Once she finds a company, typically little-known, whose outlook is appealing and stock mispriced, she burrows into the business and its financials until she understands them better than the boss. That could well be the case with her current recommendations, including a specialty-coatings company and a Belgian industrial conglomerate. Want to know about liquid-fertilizer production techniques? You have come to the right source.

As readers of earlier Roundtable issues know, the focus this year was on disquieting trends in the global economy that could halt the bull market’s advance. In the dictionary, opportunity precedes trouble, but as this issue’s stellar stockpickers remind us, in markets the opposite pertains.

Barron’s: Scott, what appeals to you in this crazy, mixed-up market?

Black: I have five stocks whose underlying theme is sustainable earnings power—rising earnings power, in fact. We are deep value investors; all five have low valuations on an absolute, not a relative, basis. Townsquare Media[TSQ], based in Greenwich, Conn., sells for $10.48 [closing price on Jan. 8]. There are 27.4 million shares, fully diluted, and the market capitalization is $287 million. The company doesn’t pay a dividend. Townsquare is the third-largest radio-station operator in the U.S., with 309 stations in small markets. The company also has more than 325 companion Websites.

Townsquare bought North American Midway Entertainment, the largest runner of state and local fairs in the U.S., last year, for $75.5 million, or 6.7 times Ebitda [earnings before interest, taxes, depreciation, and amortization]. North American Midway runs 650 live-music and non-music branded events, with more than 16 million annual attendees. It is the No. 1 provider of rides, games, and food at fairs and festivals. Townsquare’s CEO, Steven Price, is a finance person

.

Your kind of guy.

Black: Townsquare had $478 million in revenue last year, including North American Midway. This year, with the help of $10 million in political advertising and 12% growth in live events, we estimate revenue will rise to $520 million. We foresee radio Ebitda of $121 million, based on 30% margins, and Ebitda of $22 million in the rest of the business, based on margins of 18.5%. If operating income is $90 million and interest expense is $30 million, profit before tax would be $60 million. Taxed at 39.6%—although it doesn’t pay taxes, due to net operating loss carryforwards [a tax benefit stemming from prior losses]—Townsquare could earn $36.2 million, or $1.32 a share. The stock is selling for 7.9 times this year’s expected earnings.

Witmer: How long does the tax shelter last?

Black: It lasts through 2018. Townsquare has $606 million in net debt. Free cash could total between $1.82 a share and $2.19 this year, well above reported earnings. The stock is selling for 6.2 times estimated discretionary cash flow.

Management is aiming to deleverage the balance sheet. Gross debt currently equals 5.7 times Ebitda, and the company plans to reduce it to five times Ebitda this year. The goal is to get down to four times Ebitda in the next year or two. In the latest quarter, the Ebitda-to-interest ratio was 3.9 times. Townsquare also has a $50 million bank line of credit, which it hasn’t tapped.

Scott Black: 2016 Outlook, Plus 1 Stock Pick

The founder of Dephi management and long-time Roundtable member says analysts’ estimates are far too rosy, but he still sees a few opportunities for value investors.

Witmer: Has it been public for a long time?

Black: It came public about 18 months ago. Oaktree Capital Group [OAK] owns 45% of the stock. Because Townsquare’s stock is so cheap, Oaktree is likely to hold it long term, which means more than two picoseconds.

My second stock, Foot Locker [FL], is one of the few bricks-and-mortar retailers doing well. It is a leading seller of athletic running gear and apparel. The stock closed Friday at $62.70; there are 140.9 million fully diluted shares, and the market cap is $8.8 billion. The company pays a dividend of $1 a share, and the stock yields 1.6%. The store count has barely increased in the past four years, and stands at 3,432. Earnings have grown in that period at a compounded annual rate of 35%, from $1.07 a share to $3.56. Sales per square foot are up 8%, compounded, to $490 from $360.

The company generates about 70% of its sales in the U.S., and 30% overseas, mostly in Europe. Online growth has run at 12% of revenue, but will probably trend higher. Nike products represent 70% of revenue.

What will drive growth from here?

Black: By adding some new stores and remodeling others, Foot Locker plans to grow square footage by 2% to 2.5% in the next few years. It has set a goal to lift revenue to $10 billion by 2020 from $7 billion now. It wants to take sales per square foot up to $600, and Ebit [earnings before interest and taxes] margins from 11.4% to 12.5%. Management’s stated objective is to grow earnings by 10% or more per year.

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Black: “It is hard to believe that a company [Lam Research] with so much proprietary knowledge sells for only 10 times expected earnings.” Photo: Jenna Bascom

Foot Locker will finish the January fiscal year with revenue of $7.41 billion and earnings per share of $4.27. These are my estimates, not the Wall Street consensus. I budgeted for 4% same-store sales growth in fiscal 2017, and 2% square-footage growth. Ebit could total just over $1 billion. Taxed at 35%, the company could earn $658 million in fiscal 2017, or $4.75 a share. It plans to buy back $300 million of stock, or five million shares. The stock sells for 12.1 times fiscal-2017 estimated earnings, excluding $5.31 a share in net cash.

Operating sources of cash could total $838 million next year. We’ve got capital spending at $275 million, including $50 million in expenditures to relocate corporate headquarters. That leaves free cash flow at $563 million. Return on equity is 20%; return on capital, 20%-plus.

How is the competition doing?

Black: Finish Line [FINL] has been struggling.

We have had few tech-stock recommendations today. One tech stock we like is Lam Research [LRCX]. The company is a semiconductor-equipment maker focused on front-end chip production. The stock is trading for $70.48. There are 174.4 million fully diluted shares, and the market cap is $12.3 billion. Lam pays an annual dividend of $1.20 a share, for a 1.7% yield. Lam is strong in two areas: wafer etch, where it has a 50% market share, and chemical vapor deposition, where it has a market share in the high-30% area. Lam also is involved in wet-clean and photoresist, another component of semiconductor manufacturing, in which it has a smaller market share. Lam is the only semiconductor-equipment manufacturer whose revenue and earnings grew last year.

Why was it such a standout?

Black: It serves faster-growing markets, and it has gained market share. The company is benefiting from 3-D NAND memory and finFET, or multilayer chip technology. Its current business mix is 72% memory, 18% foundry, and 10% logic. Lam reports in dollars, even though most of its sales are in Asia. In the latest quarter, Taiwan accounted for 28% of revenue; Japan, 18%; Korea, 17%; China, 16%; Southeast Asia, 8%; and the U.S., 9%. Lam struck a deal last year to buy KLA-Tencor [KLAC], a leader in chip-inspection tools.

In the year ended June 2015, Lam reported $5.26 billion in revenue. We expect revenue to rise 11% in the current fiscal year, to $5.86 billion. Operating profit could total $1.3 billion, and profit before taxes, $1.22 billion. The company has a low tax rate of 15%, yielding net income of $1.036 billion. Divided by 172 million shares, that’s $6.02 in earnings per share. The company has $11.30 a share in net cash, although that will disappear when the KLA deal is completed. Lam sells for 9.8 times fiscal-2016 estimates. Pro forma return on equity and return on capital are 18.5%.

What is your earnings forecast for 2017?

Black: After adding deal-related cost savings, deducting additional interest expense, and adding another 80 million shares that Lam will issue, we get earnings power of $7.60 a share in fiscal 2017, a dollar more than Lam was projected to earn before the deal. This is a smart, highly accretive acquisition, in a complementary business. It is hard to believe that a company with so much proprietary knowledge sells for only 10 times expected earnings. Many of Lam’s scientists have ties to Stanford University. Lam funds all sorts of research-and-development projects at Stanford. The CEO, Martin Anstice, has done an excellent job.

Like Abby, I like Mylan [MYL], a generic-drug company. [Cohen recommended Mylan in last week’s Roundtable issue.]

Give us your thoughts on the company.

Black: The stock closed Friday at $49.42. There are 514 million fully diluted shares; the market cap is $25.4 billion, and there is no dividend. Mylan has approximately 1,400 products. It has 40 manufacturing sites worldwide, and has more than 260 ANDAs pending.

Translate, please?

Black: It stands for abbreviated new drug applications. Mylan plans to seek approval for a generic version of Advair [a GlaxoSmithKline (GSK) asthma treatment] and Copaxone [a treatment for multiple sclerosis sold by Teva Pharmaceutical Industries (TEVA)]. Advair is an $8 billion drug; Copaxone is $3.3 billion. Mylan also sells the high-margin EpiPen [an epinephrine auto-injector used to treat life-threatening allergic reactions]. It has a 95% market share.

Last year, the company bought Abbott Laboratories ’ [ABT] generics business, primarily focused on Europe, for $5.3 billion. The unit’s earnings are a bit of a black box, but here are the numbers. In the past four years, Mylan grew revenue at a compounded annual rate of 9.1%. Operating income grew by 17%, and earnings per share climbed 36%, to $2.34, from 68 cents. In August 2013, Mylan detailed a new five-year goal of 13% annual revenue growth. It expects to earn a minimum of $6 a share in 2018. The company generates 48% of its revenue in North America, 28% in Europe, and 24% in the rest of the world.

One question we ask is, Will the government reduce the price paid by Medicaid and Medicare for generic drugs?

Meryl Witmer: This Stock Could Rise 60%

The Roundtable veteran makes the case for Axalta auto paint and coating company, an undervalued spinoff that could prove recession-proof.

How do you answer?

Black: It is unlikely, but the company has built up a huge reserve in the event this happens. It was $592 million at the end of last year. We expect Mylan to report revenue of $9.67 billion for 2015, rising 10%, to $10.64 billion, in 2016.

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Priest: “In general, I would stay away from materials and most energy companies, and be wary of the industrial sector.” Photo: Jenna Bascom

Schafer: On what basis do you make estimates like this? I have never owned these companies because it is too hard to figure out how they are going to grow.

Black: Historically, Mylan has grown annual revenue between 9% and 10%. It is filing for all sorts of new drugs, and management has run the business well. Gross margins this year could be around 58%, producing $6.17 billion. We model pretax profit at $3.02 billion. The tax rate is only 18% because the company redomiciled abroad; it is headquartered in the United Kingdom. But this gets you to net income of $2.48 billion, or $5.02 a share. The Street is at $4.95 to $4.96. The stock trades for 9.8 times earnings. Return on equity is 24%.

My last name, U.S. Bancorp [USB], is based in Minneapolis. It is probably the most conservative big bank in reserving for loan losses. The stock trades for $39.70; there are 1.766 billion shares, and the market cap is $70 billion. The company pays a $1.02 dividend, for a yield of 2.6%. In 2014, U.S. Bancorp had the highest return on equity among the majors, at 14.7%. It had the highest return on assets, at 1.54%, and one of the best efficiency ratios, at 53.2%. As of third-quarter 2015, return on assets was 1.44% and the efficiency ratio, 53.9%.

Where does the bank rank in asset size?

Black: It is No. 5 in the U.S. in assets. The bank is targeting 5% to 7% annual growth in net interest income, 7% to 9% growth in noninterest income, and 3% to 5% growth in noninterest expense. It won’t meet those targets this year, due to the low interest-rate environment, although for every 50-basis-point [half-percentage point] uptick in rates, net interest income will increase by 1.7%, because assets reprice faster than liabilities. The bank aims to grow earnings per share by 8% to 10% a year, with an efficiency ratio in the low-50% range.

U.S. Bancorp operates in four business segments. Payment services and credit cards account for 30% of revenue, wealth management is 11%, consumer and small-business loans is 42%, and the wholesale banking and commercial real estate unit is 17%. The bank operates in 25 contiguous states from the West Coast to the Midwest. Net interest margins have been stable at 3.04%. The bank’s Tier 1 equity ratio is off the charts, at 9.2%. The most impressive fact is that U.S. Bancorp has the best reserve for loan losses to nonperforming assets of any major bank in the U.S., at $3.965 billion. The nonperforming assets, including other real estate loans, are $1.525 billion. The coverage ratio is 2.6 times.

Priest: What is the book value?

Black: Book value is about $23 a share. I have modeled a 4% increase in net interest income for 2016, to $11.5 billion. After provisioning for loan losses, it is $10.3 billion. Noninterest income is $9.6 billion. Noninterest expense could increase by 3.5%, to $11.5 billion. Profit before taxes of $8.4 billion, taxed at 27%, gets you to $6.13 billion in after-tax earnings. We assume the bank will spend $2 billion to buy back 50 million shares, which puts earnings per share at $3.52. The price/earnings ratio is 11.3—low for a quality bank.

Thank you, Scott. Bill, are you ready?

Priest: Sure! We put out a piece toward the end of last year, stating that we expect equity markets to struggle to post positive returns in 2016. Global growth is poor. There has been a modest tightening in monetary policy, which I don’t expect to last, and there is a real risk of a blowup in emerging markets, particularly China, which contributed 46% of the growth in the world economy in the past five years. Money managers focused on emerging markets are hemorrhaging assets, and the bottom in these markets isn’t near. Given this backdrop, investors need to be defensive. That means sticking with consumer-staples, health-care, and some technology stocks. In general, I would stay away from materials and most energy companies, and be wary of the industrial sector.

Our investment approach focuses on free cash flow. There are only five things a company can do with it: Pay a cash dividend, buy back stock, pay down debt, make an acquisition, or reinvest in the business. Most companies do a little of everything, but the key is generating a premium return in excess of your cost of capital. Companies that can do that usually trade at a premium. CVS Health is one we like.

Give us the details, please.

Priest: CVS sells for around $93. The market cap is a little over $100 billion. The company’s free cash flow and earnings are almost identical. CVS could report $5.20 a share in earnings for 2015, probably $5.80 in 2016, and $6.50 in 2017. Free cash flow could go from $5.30 to a range of $4.90 to $5.50. The company runs one of the largest retail-pharmacy chains in the U.S. Annual revenues are just over $150 billion. It is also one of the largest pharmacy-benefit managers.

2 Health Care Stocks for a Slow Growth World

Speaking at the Barron’s Roundtable, Epoch Investment Partners CEO Bill Priest makes the case for CVS and Teva Pharmaceuticals.

CVS is benefiting from several tail winds. One is the expansion of health-care insurance coverage under the Affordable Care Act, or Obamacare. Also, like many companies, it is benefiting from the aging of the baby boomers. Sales of specialty pharmaceuticals and generics are increasing, and, last year, CVS made two strategic acquisitions. It bought Omnicare, a leader in the institutional-pharmacy market, with a 40% market share; Omnicare probably took some business away from McKesson [MCK], which lowered its fiscal-2016 earnings guidance today [Jan. 11]. CVS also acquired 1,672 pharmacies from Target [TGT] for $1.9 billion in cash. That’s very cheap; they couldn’t build this business for that price.

Are you referring to the pharmacies within Target stores?

Priest: Yes. They will be rebranded as CVS pharmacies. CVS has provided 2016 guidance for revenue to be up more than 17%, and for adjusted earnings to come in between $5.73 and $5.88 a share. The company continues to return a large amount of free cash flow to shareholders. CVS generates close to a 6% shareholder yield if you combine a 4% yield from stock buybacks and a yield of almost 2% from a cash dividend.

Witmer: Do you mean the company is shrinking its share count by 4%?

Priest: On a net basis, yes, although this leads to another point. Some companies buy back their shares, but the impact on share count is offset by share issuance in connection with the exercise of employee stock options. That isn’t the case at the companies in which we invest. We are careful in measuring the net effect of buybacks.

My next stock, Synchrony Financial [SYF], was spun out of General Electric [GE]. It is the largest private-label credit-card company in the U.S. Synchrony has a little more than 800 million shares outstanding, and the stock sells for $29. Tangible common equity is just over $13 a share. The company could report $2.60 a share in earnings for 2015, and could earn $2.80 in 2016 and $3.10 for 2017. [Synchrony reported on Jan. 22 that it earned $2.65 a share in 2015.] Synchrony has a 40% share of the $100 billion private-label credit-card market.

Retailers like private-label cards because they bypass the networks and their costs are lower. They have access to more customer data than they receive from a general-purpose card used in their stores. Also, retail partners receive a portion of the profits of the card portfolio. Spending on Synchrony credit cards is growing at a faster rate than the industry. Account balances are also growing faster. Synchrony receivables are growing by double digits compared to a growth rate of 4% for private-label cards and 3% for the industry in general.

Gabelli: The company has its own clearing network.

Priest: Private-label cards at large merchants account for 70% of Synchrony’s revenue. The company also has a consumer-credit business at smaller merchants, which contributes 20%. And it provides financing for elective medical procedures and veterinary procedures. Synchrony is a pure play on the American consumer. The most troubling aspect of these sorts of companies is the percentage of receivables tied to borrowers with low FICO credit scores. Throughout the industry, it is about 20%. We would like to think Synchrony has a good handle on its borrowers, but if credit risk increases among consumers, these companies might feel it a bit. In short, with Synchrony, one has a highly liquid, well-capitalized balance sheet and a motivated management. We expect a share-buyback program and a cash dividend later this year.

NorthStar Realty Europe [NRE] is a tiny company with a $680 million market cap, about $1.8 billion of debt, and $320 million of cash. There are 63 million shares outstanding, and the stock yields 5.5%. NorthStar is a New York Stock Exchange–listed real estate investment trust. It invests exclusively in European commercial real estate, nearly all Class A space in the U.K. and on the Continent. It is trading at a large discount to net asset value. This portfolio was assembled before the European Central Bank embarked on its current, expansive monetary policy, which means all the properties are likely going to be revalued upward, given the lower discount rate that now exists.

David Hamamoto, the chairman of NorthStar Realty Finance [NRF], is the key executive behind this entity, as well. He is a smart guy who previously worked at Goldman Sachs. NorthStar Realty Europe is selling for $10.53 a share. Net asset value at cost is $16 per share, but at today’s value, it is closer to $20. One may receive meaningful price appreciation from the current price, plus a dividend.

Black: I owned NorthStar Realty Finance. It almost wound up in bankruptcy protection in 2007-08, due to a mismatch of assets and liabilities. How do you know that won’t happen again?

Priest: Hamamoto learned his lesson.

Rogers: A brush with bankruptcy is all it takes.

Priest: NorthStar Realty Finance spun off NorthStar Realty Europe last year. It has been transparent about what is happening at NRE.

Next, Vodafone Group ’s [VOD] Nasdaq-listed shares are trading around $32. The market cap is $85 billion. Vodafone is one of the top three wireless telecom providers. It is a low-risk, modest-total-return story, with upside of 10% to 12%. We don’t see much downside. The current yield exceeds 5%, and the company is transitioning from a negative free-cash-flow position to a positive one in the next few years. Capex growth peaked in 2014-15. It is going to trend down in the future. Growth, if it comes, will come from more 4G data consumption. Europe accounts for 70% of Ebitda, and the regulatory regime there is improving. India contributes 10% to 11% of revenue, and South Africa, 8%. Vittorio Colao, the CEO, owns 11 million ordinary shares, worth about 25 million pounds [$35 million]. Periodically, there are rumors they will link with another telecom company, which could produce significant synergies, depending on the terms.

Gabelli: Buying Liberty Global [LBTYA] would be a logical next step. Vodafone is a cheap stock and a good way to play currency movement between Europe and the U.S.

Thanks for your thoughts, Bill—and Mario. Meryl, we know the wait will be worth it.

Witmer: The market has fallen sharply and quickly, creating some good opportunities for us. Axalta Coating Systems [AXTA] is one. It trades for $25 a share and has about 245 million shares outstanding, including options. The company manufactures specialty paints for cars, trucks, and industrial machinery. The management team, together with Carlyle Group, bought the business from DuPont [DD] at the beginning of 2013, and took it public in the fall of 2014 at $19.50 a share. Our investment thesis begins with management, which has done an exceptional job in continuing to build the company. DuPont milked it for cash, but Axalta’s chief executive, Charles Shaver, and chief financial officer, Robert Bryant, transformed the business by bringing in top talent, implementing accountability across the organization, and investing for growth.

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Meryl Witmer: “Different things spur us to look at potential investments. One is the sale of a company by DuPont.”Photo: Jenna Bascom

How fast is Axalta growing?

Witmer: Ebitda has increased by more than 30% since 2012, to an estimated $865 million last year, even with flattish revenue due to currency head winds. Management has undertaken initiatives to add another $100 million to pretax earnings in the next two years. The crown jewel is the automotive-refinishing business, which is No. 1 globally with a 25% market share. Barriers to entry are large, given its distribution, scale, technology, and relationships with key customers. Axalta provides both the paint and color-matching technology, and works with body-shop owners to move vehicles through quickly. It helps the owner manage productivity and profitability.

The auto-refinishing industry is consolidating in the U.S., and Axalta is well positioned, with a 44% share of the market supplying the top multisystem operators. As these operators buy more body shops, Axalta gets more business. The refinishing business is driven by collisions, which tend to increase as more miles are driven and more cars are on the road. It is an annuity stream.

The light-vehicle paint business has a 19% global market share. Since the LBO, the company has invested in new plants in Germany and China to expand production. It has won more than 30 new contracts with barely a loss. The contracts will continue to drive revenue in 2016 and beyond.

What do you figure Axalta is worth?

Witmer: We assume modest top-line growth of 3% to 4%, with profit-margin expansion just from cost-savings initiatives. We also assume most of the free cash flow in coming years is used to pay down debt, which enhances the value of the equity. We see earnings per share increasing from $1 a share in 2015 to about $1.95 in 2018. In addition, Axalta has $309 million in noncash depreciation and amortization expense. Capital-spending needs are about $80 million a year. The difference amounts to 94 cents a share, which we add to earnings, to arrive at $2.85 a share in after-tax free cash flow in 2018. A business of this quality deserves at least a 14 multiple of free cash flow. We have a target price of about $40 in two years.

Schafer: We also own Axalta. It has one of the best management teams I have ever seen. The company’s success also speaks to the poor job done by DuPont.

Witmer: Different things spur us to look at potential investments. One is the sale of a company by DuPont.

Gabelli: Ouch! In this case, management bought it for a cheap price and flipped it as an initial public offering.

Witmer: Management made a good return on the IPO because they increased profitability dramatically, not because they loaded the company with debt.

We started looking at my next recommendation, Tessenderlo Chemie, because it bought a small company from DuPont. It is controlled by an industrialist, Luc Tack. At the end of 2015, Tessenderlo [TESB.Belgium], based in Belgium, announced the acquisition of the industrial assets of Picanol Group [PIC.Belgium], another Belgian company controlled by Tack, for 26 million Tessenderlo shares. Pro forma, the combined company will have 69 million shares outstanding. At a current 25 euros a share, Tessenderlo will have a market cap of €1.8 billion [$2 billion]. Net debt is only €90 million, for an enterprise value of €1.9 billion. The combined company will have four segments. Agro will generate about half of Ebitda. A weaving-machine business acquired from Picanol will account for 30%. The other segments are Bio-Valorization and Industrial Solutions.

What is bio-valorization?

Witmer: The Bio-Valorization business buys animal hides and bones and processes them to make pharmaceutical-grade collagen and food-grade collagen. Another part of the business processes animal fats.

In the Agro business, Tessenderlo produces liquid fertilizers, mainly in the U.S., and other fertilizers in Europe. It also has a niche crop-protection business. We are particularly excited about the liquid-fertilizer business. The company combines sulfur, often sourced from the waste stream of oil refineries, with either nitrogen or potassium to produce a liquid fertilizer.

Sulfur is a major nutrient required by crops. Historically, sulfur supplementation was unnecessary because gasoline and diesel fuel released sulfur into the atmosphere, and it was deposited onto farmland by rain. Government regulations taking sulfur out of fuel diminished the amount of sulfur content in the atmosphere. Also, less coal being burned by power plants; that’s contributed to sulfur deficiency in the soil. A field deficient in sulfur might yield a much smaller crop.

Gabelli: Is this the business they bought from DuPont?

Witmer: No, that is in the niche crop-protection business. Interestingly, in China, there is no need for sulfur fertilization.

Schafer: Who else is in this business?

Witmer: Kugler, a privately held company. Also, Koch Industries is probably going to add 10% capacity to the industry by getting the sulfur from one of its owned refineries. That is the best and cheapest way.

Gabelli: If this is such a nice business, why would Tessenderlo’s controlling shareholder add a more mundane business, diluting its impact?

Witmer: It is possible the deal will get voted down because he is valuing one business at more than people think it is worth and the other at less. But it is possible he is combining these assets because he has his eye on a bigger deal and wants critical mass. There are other ways to achieve that. The shareholders I know are voting against the deal.

Tack has an exceptional track record as an investor and a business operator. He became CEO of Picanol in July 2009 after a rights offering. In 2008, Picanol reported €282 million of revenue. Ebitda was negative, and the company had €40 million of debt. He quickly cut costs, invested in research and development to improve the product pipeline, and used free cash flow to pay down debt and build up cash. By 2010, the business was profitable, and it probably generated €450 million in revenue and €89 million in Ebitda last year.

When did he get involved with Tessenderlo?

Witmer: In November 2013, Tack acquired the French government’s 27.5% stake in Tessenderlo for €192 million. Through a rights offering and open-market purchases, he has increased his stake to 33%. He became CEO in December 2013 and he has been working to improve and grow Tessenderlo’s businesses by reducing operating expenses, making smart capital expenditures, and changing the culture of the company.

To value the business, we normalize 2015 earnings, adding back some one-time charges. Then we add Piconal’s earnings, to get €2.11 in fully taxed pro forma earnings per share. Plant expansions could add around 40 euro cents per share, which puts future earnings at €2.50. The company deserves a multiple of at least 13 times earnings, as it is essentially debt-free. The Bio-Valorization unit didn’t make money last year, but could be profitable in 2016, adding €3 per share of value. Net operating loss carryforwards are worth a few euros per share. Add it up, and we get a target price of €37, and growing from there. If the merger with Piconal is voted down, using the same valuation criteria, our target price for Tessenderlo is €40. We are voting no. [On Jan. 25, the exchange offer for Piconal was withdrawn by Tessenderlo’s board.]

Black: Have you met with management?

Witmer: I haven’t met them, but we have spoken with them. That wasn’t so easy to do; we e-mailed them requesting a conversation several times, and they turned us down.

But we are excited to find a business of this quality run by a great operator, with no debt, and in a nice niche business.

My next pick is Navigator Holdings [NVGS]. The stock is trading for $12 a share. The company has 55 million shares outstanding and about $500 million of debt. It operates a fleet of 29 semi-refrigerated handysize ships [handysize vessels are of moderate size, with a capacity between 15,000 and 35,000 DWT, or deadweight tonnage], designed to carry cargo ranging from liquefied petroleum gases, or LPGs, such as propane and butane to ethane, ethylene, and ammonia. Compared with a large gas carrier, which is three times the size, a handysize ship is more flexible in terms of the cargo it can carry and the ports it can serve.

In addition to the high degree of technical competence required to handle its various cargos, Navigator has excellent operational and commercial capabilities, which allow it to run at more than 95% utilization and quickly adapt to changing circumstances. It has a great management team, with significant ownership of around 2.5 million shares, and discipline regarding capital allocation.

What drives the business?

Witmer: Navigator’s business is supply- driven. The more butane, propane, and such that needs to be moved over water, the more demand there is for its services. Drivers of supply are natural-gas drilling, which in turn is driven by U.S. gas fracking [hydraulic fracturing] and the global buildup of liquefied natural gas, and increased shipping of ethane and ethylene. The U.S. has access to extremely cheap ethane, which is used to produce ethylene. As the U.S. increases its supply of ethylene, and as the plants and ports required to move it come on-stream in the next few years, the opportunities for Navigator will continue to improve. Inexplicably, the stock trades with the price of oil. When oil was $80 a barrel, Navigator was generating about $1.60 a share in after-tax free cash flow and trading in the $20s. Since then, oil has fallen by more than 50%, and Navigator’s after-tax free cash flow has increased by more than 25%, to over $2 a share, and the stock is down, not up.

How do things look for the company next year?

Witmer: Navigator recently disclosed that it has already contracted a significant portion of its capacity for 2016 at rates higher than those in 2015. Navigator has nine ships ordered that will be delivered over the next year and a half. With those at current day rates, after-tax free cash flow could be about $3 a share. Even if shipping rates decline 20%, the company would still earn about $1.65, with all 38 ships. Based on announced export capacity expansions, we believe the supply of seaborne LPG, as well as ethane and ethylene, should keep the industry at a healthy utilization rate. We consider Navigator a real bargain, and have a price target of at least $25 a share.

Black: In the short term, the company will have negative free cash flow because it is spending $44 million per ship on new ships. Once they get to that steady state in a year and a half or so, they will generate free cash.

Witmer: They don’t have negative free cash from operations. It is because they are growing the fleet. To calculate maintenance capital spending, we take the replacement cost of the entire fleet, less scrap value, and divide by the average life of the ship. In 2016, we charge them for $30 million of capital spending when actual spending for anything beside new ships is $5 million.

Black: To me, that is operational.

Gabelli: I don’t see it as operational.

Black: As Warren Buffett said, the tooth fairy doesn’t pay for capital expenditures.

Gabelli: The stock is cheap. Buy it.

Black: I already own it.

Gabelli: Buy more.

Witmer: I’m going to stop here.

That sounds like a wise decision. Thanks, Meryl–and everyone