Sunday, November 25, 2007
Ok, let's start with the clichés first. We all know that the profit motive is at the centre of capitalism, the raison d'être of an organisation. So profit is the purpose of an organisation and the shareholder (to serve whom the organisation exists) is the primary stakeholder.The organisation uses various resources to generate a profit. In economic terms, it uses land, labour, organisation and capital (LLOC) i.e. all the resources it uses can be classified in some way or the other into the above heads. If we take the 4 Ms: man, machine, materials and method, they are merely a re-statement of the above LLOC. Yet, most organisations I know tend to confuse this balance, i.e. they tend to focus excessively on one or the other of the above baskets. In some companies I have seen, I notice an excessive and almost myopic focus on labour i.e. doing things.
We have customers who tell us what to make from time to time. Through the TQM/ TPM/ six-sigma mindset that flows up and down the auto value chain, we all have this huge focus on the 4 Ms mentioned above. Most of the talk is about machine productivity, labour standards, (material) wastage, overall equipment uptime or line efficiency (OLE), inventory control etc. In other words maximising throughput per unit of capital employed. So either you reduce the capital employed for a given level of output (as in stagnating markets in the developed world where they use outsourcing and innovation to do this), or you maximise throughput for a given level of capital (as in developing countries, where demand is buoyant but capital is expensive and scarce). But the companies are only focused on doing things (i.e. labour) also called manufacturing in layman terms. Now compare this to a bank, as in, what does a bank do? Is there any physical transformation in its product? A bank captures 'profit' by ensuring that it raises funds cheaper than what it lends at (assuming it gets back all the money it lent out in the first place).
But this 'work' produces profit, which comes from managing capital, one of the four economic resources mentioned above. Let's look at organisation, often called management quality. The ability to capture and maintain a near-monopoly is the key skill for Microsoft's shareholders. Of course, the company's PR Department will argue that this skill comes under labour i.e. the ability to build the world's best software. But ask any user of Netscape and they will agree with my classification above. (Fortunately, this column is not read by people at Microsoft.) Or Berkshire Hathaway. A small group of wise men are brought and held together. They sit down around a coffee table and understand risk and opportunity better than anybody we know. Why and how do they stay together? I don't know, but this ability, which creates profit, must be put under the basket called organisation.
Under this head, I will also put the ability to handle risk and the other side of the coin, opportunity. A good insurance company, for example, (or a good derivative trading outfit, aka an investment bank) makes a profit because it charges more premium than it pays out. And it keeps enough risk capital on standby (either on or off its balance sheet) to make sure that it never goes bust, especially during those sudden cataclysmic crises that happen every so often these days.
Last, let's come to land. In Ricardian terms land used to mean anything whose supply was not controlled by human beings. The simplest example was land itself. In those days, if you owned land, you got to charge rent, from which came the term economic rent. These days, the concept covers every such situation where you earn profit merely because you are there. So if Tata Steel owns some fabulous mining leases in iron ore and coking coal, it can afford thrice the labour cost of its competitors. SAIL, which also has the same quality mines in iron ore, can afford four times the labour cost. This source of profit, a chunk of which is then lost to organised labour, is called land.
In the same spirit, Infosys 'mines' a seam of solid, mathematical/ logical skills to give itself nonpareil code-writing capability. This is a combination of land and labour, a good example of a case where an organisation starts with one source of profit, but goes on to build another one across the LLOC basket. Infosys started with a critical resource, code-writing skills, but has built skills to exploit another source of profit, business solutions, which is a skill layered over its generic capability. Yet, compared to a GE for example, I have not seen an Infosys use its balance sheet and its vast cash reserves to build a treasury. It is quite obvious that the company chooses to under-perform its profit potential. Perhaps it has weighed the profit potential (from treasury activities) against the risk and decided against exploiting it. I am told that early in its history, the company lost money in the markets. But to now get to the nub of my point. I don't think too many companies examine their organisation design, to see whether they are able to exploit all the sources of profit possible. Every external interface of the company creates an external stakeholder. Does the company examine each such interface to see how it is losing money or exploiting the relationship for profit?
For example, the company I used to work for earlier was one of the best-rated auto component companies, according to a CNBC poll. Yet, it was my personal opinion that we gave away 40-50% of our net profit by choosing to stay with a single-supplier of steel. One part of the management team argued that we cannot shift to multiple-suppliers without the customer's explicit approval. My counter-argument was that perhaps we, as management, were averse to building “strategic sourcing” skills that allowed us to scour the globe for alternate suppliers. How many vendor/ material-substitution proposals have we given to our customers in the past five years?
So we had chosen to stay 'ignorant' at the vendor interface, taking the prices we are given under the garb of customer interest. But in making this compromise, we have sacrificed shareholder interest.
And finally, I will establish the link with markets with yet another cliché. “Companies create wealth/value but markets measure them". I have often seen that markets don't value the various streams of profit differently i.e. the profits of an auto component company are measured on par with the profits of a bank/ insurance company. For a better understanding of the nature of profit, it is important to first analyse why (and how) the company makes money in the first place. For example, an auto component company makes profits from labour after losing whatever it does to its suppliers, bankers or even employees. It makes money (as in case of my company) after over-paying its suppliers, bankers etc. The residual profits are real and are less likely to be lost again. These profits are then redeployed into a set of real machines, plant, building, which will always have value, as long as the business has any role in society.
Compare this to a bank, which makes money during the boom because it borrows cheap and lends dear. The bank puts all its profits back into its balance sheet, leaving its past profits exposed to the same risk of default. Suddenly, after the recession hits, investors are left wondering how much of the past "profits" of the bank were real. The catch is that risk levels have stayed constant (or have increased) in the bank's balance sheet, while they have actually reduced in the autocomp co's balance sheet.
Yet, the market would value a typical bank at a P-E level higher than that of the typical autocomp co.
Let me summarise: profit is the objective of any organisation and it comes from the management of four key economic resources (LLOC). Most organisations are good at (managing) one or the other of the above (resources). Organisations need to grow in depth, i.e., learn to do things better, manage one resource. They need to grow in breadth i.e. know enough about managing other three resources better. What they know is wealth, what they don't is risk.
The Sensex is currently showing range bound movement with positive inclinations. The main trend of the market remains bullish. The Sensex witnessed a correction since beginning of the week as the Subprime concerns hovered around the investor sentiment. The market saw a brutal sell-off on Wednesday as US Federal policy makers lowered their growth forecast for the next year to 1.8% from 2.5% as anticipated in June. The Sensex fell below 19K, shedding over 750 points during intra-day trades. Asian markets, too, collapsed over 2-3% as a stronger yen and a weaker outlook for the US economy dampening the investor sentiment. Oil prices also jumped over $99 for the first time on Wednesday as the dollar limped against the other currencies and energy supplies remaining tight globally. Despite pressure from the US, the OPEC opted not to raise its production until its next meeting in December.
The benchmark Sensex index showed strength on Friday by gaining over 327 points at close but overall the index slipped 780 points or 4% to 18,853 for the week ended 23rd Nov 2007. The broad based Nifty, too, saw a pullback on Friday but dropped 299 points or 5% to 5,609 for the week ended 23rd Nov 2007. However, the BSE Mid-Cap index showed a solid strength in previous week and hit the record high of 8730 on Monday, slipped 502 points or 6% at the end of the week. The BSE Small-Cap followed the suit and hit the record high of 10,691 on Tuesday but lost 501 points or 5% at the end of the week.
The shares of Deccan Aviation, jumped over 23% to a 52-week high on Wednesday on speculation that it will merge with Kingfisher Airlines Ltd and may show some profit in the second quarter of 2008. The real estate company Omaxe Ltd also rose to record high as company planned to develop properties overseas in places such as Dubai in the United Arab Emirates (UAE). Among the new listings, Religare Enterprises, a financial services provider led by promoters Ranbaxy Laboratories, listed on a premium of 75% at Rs323.75 and shot up to Rs600 despite the Sensex lost over 4% on that day.
During this week, the FII remained net sellers in equities as they sold over Rs3,321 crore stocks till November 21st while, the domestic mutual funds sold around Rs268 crore of stocks. The annual inflation based on the wholesale price index slipped to 3.01% in the week ended 10th Nov 2007 against expectations of 3.20%.
Saudi Arabia-based realty firm Tanmiyat group is planning an investment of around $3 billion in a township project in India, a top company official said.
The group has zeroed in on Bangalore for the project, its first-ever in the Indian market.
"We are in the final stages of fine-tuning our plans for this township project. We will be ready with the final blueprint within the next 2-3-months," Tanmiyat group's Managing Director Bharat Thakkar
This would be a mixed-use project and would be completed in phases over a five-year time span, he said.
The project would be distinctive and unique in many respects and "since this is our first venture in India, we will use the project to position ourselves rightly in the market to facilitate our growth thereafter," Thakkar said.
The group was still fine-tuning various aspects of the project, including the investment structure for it, he added.
"The equity component is still fluid and we have yet to decide whether we want to load a debt component onto the project," he said, adding that the average size of the group's projects has been in the range of $2.5-3 billion.
Being a mixed-use project, apart from residential accommodation, the project would also have commercial infrastructure.
"Bangalore is well-known for its IT, BPO and bio-tech establishments and these three would constitute focus areas for us," Thakkar said
Companies in the engineering and construction sectors have never had it better. With increasing allocation of funds towards infrastructure development, the fortunes of these companies have changed dramatically. The spill-over effect from these investments has also pepped up the outlook for the equipment industry. Offering a proxy play on the infrastructure growth story of India, the equipment industry appears set to grow at a blistering pace.
While the stocks in this segment enjoy premium valuations, the burgeoning order books stand testimony to strong prospects. What are the demand accelerators for this industry? How are the companies planning to take advantage of the demand? What are the key factors that will determine their success? Here are a few takes on the underlying trends.
Growth drivers in place
Demand for infrastructure and construction equipment (ICE) is set to increase, given the growing thrust on infrastructure development. The Eleventh Five Year Plan, entailing an investment of about $492 billion on infrastructure projects alone, is likely to be the main growth driver (incremental investment of about $40 billion annually).
While this will directly benefit engineering and construction companies, it will also buoy the demand outlook for the equipment industry. In addition to this, the fact that equipment costs typically constitute about 4-24 per cent of the total project cost also brings to fore the growth that this industry could witness. Notably, the equipment industry has grown by about 25-30 per cent annually over the past couple of years.
The availability of easy credit options to purchase infrastructure and construction equipment is also a positive. While in the past larger companies (equipment users) enjoyed easier access to credit from the big banks and other financial institutions, their smaller counterparts were not as lucky in tapping capital, and often forced to postpone their purchases. This scenario has changed with the emergence of equipment financing companies with focus on small and medium-sized contractors. Such financing options will not only help these companies get easier access to financing solutions but will also help expedite their purchase decisions.
For instance, the presence of companies such as SREI Infrastructure and Finance, Birla Global Finance and Cholamandalam DBS Finance, which cater to small and medium-sized contractors, has widened the financing options for the user companies. Interestingly, SREI also provides assistance to its customers throughout the lifecycle of the equipment. However, given the strong demand scenario, financing options in the market leave sufficient scope for expansion.
Going forward, exports can emerge as a strong growth driver, given the current domestic market bias of these companies. In this context, evolution of R&D capabilities and an established low-cost manufacturing base are likely to act as enablers. However, given the blistering growth in domestic demand, it could well take a few years before these companies decide to increase focus on exports.
Equipment rentals – the next trend
The purchase decisions of ICE also depend on the criticality of their function to the user’s business operation. In contrast to equipment acquisition, which burdens the purchaser’s balance sheet, hiring or leasing options by equipment rental companies for not-so-critical equipment offers an easier option for the user. Predominantly unorganised, the rental businesses could witness more action given the flexibility they provide the users.
In the organised market, players such as Quipo Equipment Rental and Sanghvi Movers have established their presence. Sanghvi, which rents out cranes, has a fleet size of about 260 cranes and enjoys a 50 per cent market share in the segment. Quipo has set up equipment banks across the country and provides equipment on rent. Additionally, it takes deposits of idle equipment and provides returns thereon to owners on their idle assets. The business model of Quipo, promoted by SREI Infrastructure and Finance with Ingersoll Rand, Swedfund and L&T as key stakeholders, has gained popularity. Its association with Ingersoll and L&T has also benefited the company by way of discounts on equipment purchases, after-sales support services and joint market development for rental services. Gremach Infrastructure Equipments and Projects is another player that rents out construction and earth-moving equipment.
Funding capacity expansion
Most of the ICE companies, in order to meet the rising demand, have embarked on capacity expansion. While the expansion in capacity has predominantly been focused on existing offerings, a few companies have also sought to expand their product portfolios. The funding of these capex plans has seen a differing trend across companies.
While companies such as Action Construction Equipment and Gremach Infrastructure tapped the primary market via an initial public offering, Bharat Earth Movers raised funds through a follow-on public offer. Given the overwhelming response to the public offers of these companies, more such companies could tap the primary market. Material-handling company Tecpro Systems, for instance, is slated to go the IPO way soon. Some companies, however, went the private equity way. Escorts Construction Equipment raised about $17 million from US-based Darby Overseas Investments. Quipo was another company that chose the private equity route; it attracted funding of about $50 million from GIC of Singapore and IDFC. Sanghvi Movers has also used debt to fund its expansion. Notably, Indian subsidiaries of MNC players have attracted increased investments from their parent company.
Foreign companies – eyeing the Indian pie
Given the growth prospects of this industry, it is not surprising that MNCs have marked their presence in this segment.
While some have set up Indian subsidiaries, others have formed strategic alliances with domestic players. The UK-based JCB and Germany-based Schwing Stetter have established proprietary businesses in the country. Notably, the Indian subsidiaries of both these firms have raked in significant business over the recent years — JCB India, for example, has evolved to become the group’s largest market, having recorded four times’ increase in sales over the last five years. Alternately, companies such as Terex Vectra, a 50:50 joint venture between Terex Corporation of the US and Vectra Ltd of the UK, have also etched their presence. Joint ventures and strategic tie-ups between global and domestic players has also been a popular model. While global equipment leader Caterpillar has an alliance with GMMCO, Komatsu has tied up with L&T. Hitachi Construction holds a 40 per cent stake in Telco Construction Equipment Company. This space could see more action with more foreign companies announcing plans to enter the Indian market. For instance, Scania of Sweden has announced its India entry with a tie-up with L&T. Yanmar Construction Equipment Company of Japan has also announced its India foray.
Critical success factors
The entry of several players in this space, while good for market expansion, has also increased the competition for existing domestic players. Further, increasing imports from low-cost countries such as China could also add to the pressure. In the light of increase in competition, factors such as distribution network, technology tie-ups, pricing strategies and after-sales service can emerge as key differentiators. While multinational companies have an edge over domestic ones when it comes to technology, the latter score in terms of the reach of their distribution network. Raw material cost, going forward, could also emerge as a significant challenge. In this context, global players with presence across various countries could be at an advantage if the cost dynamics were to shift in favour of some other country.
The market may remain tentative ahead of the derivatives expiry on Thursday. The last few days have been choppy as the buying by domestic institutional investors was negated by the FII selling in both the cash and derivatives markets.
The signals on the derivatives front are mixed. The open interest in Nifty futures rose by 20 per cent to 34 lakh shares from 28 lakh shares last week. The PCR has been sliding and is currently 0.77 against 1.05 last week. This points to an oversold situation as more calls rather than puts are being written. But the implied volatility is still hovering around 30, which is higher than average, with both calls and puts trading at a premium. Implied volatility, which reflects expectations about future volatility, is lower when investor sentiment is bullish and tends to rise as bearishness and caution sets in.
There has been build-up in 5900 call options, which account for open interest of 26 lakh shares as on date. The open interest in the 6000 call options stands at 21 lakh shares. As far as the put open interest is concerned, the 5500 put saw a build-up of 20 lakh shares, while the figures for the 5600 put stood at 15 lakh shares. This demonstrates a wide trading range, in the immediate future.
Autos and FMCG stocks were the top gainers last week, whereas fertilisers and refinery stocks gave up some of their gains after the stupendous rally seen earlier.
Keep a watch on Escorts, Tata Tele and GMR as there was a huge build-up in open positions on these counters.
Investors with a two-three year perspective can consider exposure to the Apollo Tyres stock. The company has reported strong profit growth in the latest half-year.
Margin expansion has been achieved in the wake of softer prices of key inputs such as rubber, higher capacity utilisation, greater operating efficiencies and higher replacement sales. Capacity expansion, entry into product lines such as truck-bus radials, off-road tyres and industrial tyres suggest strong earnings prospects. At the current market price of Rs 40, the stock trades at a P-E of around 12 times the trailing 12-month earnings.
Apollo Tyres is the market leader in the truck and bus (T&B) and LCV tyres with a share of 30 per cent. The company earns almost 65 per cent of its revenues from the replacement market and the rest from the OE (original equipment) sales and exports.
The replacement market has been considered the main growth driver for the tyre industry in the past. But the buoyant trends in automobile sales over the past few years and India’s rise as a manufacturing hub for global automakers, has prompted the company to focus on OE sales, especially in passenger cars.
The company is following a strategy of initiating association with a manufacturer as an after-sales partner and becoming an OE partner once volumes pick up. The company is already an OE partner for Tatas, Suzuki and General Motors. It is likely to be the after-sales partner for the Rs 1 lakh car of the Tatas, and is evaluating partnerships with Skoda and Hyundai.
To sustain growth amidst stiff competition in the replacement market, the company is enhancing its retail presence by tying up with Reliance Retail for the sale of CV (commercial vehicle) tyres and is revamping about 500 dealerships into high-end outlets.
The company is also looking at the ‘Tyre Plus’ concept, which will see outlets selling products complementary to tyres such as alloy wheels.
The company is setting up a new plant at the existing location in Vadodara for making off-the-road (OTR) tyres, which may aid higher margins.
Production will commence in the next 12-18 months, for which the company has tied up with BEML (Bharat Earth Movers). Apollo is also planning production of speciality and industrial tyres such as docking tyres and those used in forklifts.
But what may hold better potential from a long-term perspective is the foray into the production of radial tyres for the CV segment. India has low levels of radialisation at less than 5 per cent for trucks and buses due to constraints such as higher costs and maintenance involved and poor road infrastructure.
The fast improving highway infrastructure, the Supreme Court ban on the overloading of vehicles and the move towards a hub and spoke model are expected to indirectly rev-up the demand for radial tyres as they offer better fuel efficiency, have longer life and turn out to be cheaper in the long-run. Apollo Tyres is setting up the required capacities in Tamil Nadu for truck, bus and light truck radial tyres, along with high and ultra-high performance passenger car radial tyre. This will be completed by 2010.
The company has also set-up a re-treading facility at Haryana, which could be a cost-effective option for passenger car and small truck owners. The company also plans to build a manufacturing unit in Eastern Europe, which will start off by making radial tyres for passenger cars. The company already has a toehold in Europe (one of the largest tyre markets) through Dunlop Tyres, South Africa, which was acquired last year. Apollo Tyres’ entry into Europe will begin with exporting tyres from its new factory in Tamil Nadu.
For the six months ended September 2007, net sales were up 13 per cent to Rs 1718.45 crore and net profits were up by a whopping 175 per cent.
Operating margins for the April-September 2007 half year has been at the 12-13 per cent levels compared to the 7-8 per cent levels in the same period last year.
Margins are likely to be a concern in the next few quarters as prices of natural rubber, a key raw material has shot up to around Rs 95 per kg in the last one-two months after cooling off to Rs 80 per kg in May-June. Low production in Malaysia and Thailand plus the beginning of the lean season in India may continue to pressurise the margins.
Also, the prices of other petroleum-based raw materials such as carbon black, styrene butadiene rubber (SBR) and poly butadiene rubber (PBR) are tightening, thanks to the soaring crude oil prices. The last price increase was in May 2007 on passenger car tyres.
Given the rising raw material costs, the company expects to increase prices in the next two quarters to keep the margins neutral. But in the process, it may face resistance from OEMs and stiff competition from peers. There is also an ongoing dispute in the Kanwar family which may have a bearing on the stock price.
Relentless selling amid high volatility saw the Sensex swing in a wide range of 1,789 points last week. The index scaled to a high of 19,971 early in the week and thereafter tumbled to a low of 18,183.
The index made a lower high and lower bottom for the third week in a row. The Sensex eventually ended the week with a loss of 845 points at 18,853. The index broke its monthly support (S2) of 18,290, during the week, but recovered smartly from lower levels on account of short covering.
The 14-day RSI (Relative Strength Index) for the Sensex is in oversold zone at 23. An RSI less than 30 is said to be oversold, while an RSI of more than 70 indicates an overbought situation.
The pull-back is likely to last for a couple of days. However, the index may face stiff resistance around the 19,500 level, above which the upmove is likely to accelerate. On the downside, the index is likely to test its major support zone of 17,000 to 17,300 in the near term. The Sensex is likely to face resistance around 19,530-19,750-19,960 this week, while it is likely to find support around 18,170-17,960-17,750 on the dowside.
The NSE Nifty moved in a range of 587 points. From a high of 5982, the index tumbled to a low of 5394 before settling with a loss of 298 points at 5609.
The index has taken mid-term (50 days moving average) support at 5415. On its way up, it is likely to face resistance at its short-term, 20 days moving average, which is placed at 5785.
The Nifty may face resistance around 5835-5900-5970 this week, while on the downside, the index is likely to find support at 5385-5315-5245.
Investors can subscribe to the initial public offering from Jyothy Laboratories at the cut-off price. Private equity investors in the company are seeking to offload their stake to the public through this offer for sale in the price band of Rs 620-690 per share. This mid-sized FMCG company has managed healthy profit growth and market share gains over the past five years by focussing on lucrative niche segments within FMCGs such as fabric care, dish wash and insect repellents.
The company also has an extensive rural reach, with over 60 per cent of sales originating from outside Urban India.
The risk to earnings prospects arise from possible entry by multinationals/Indian competitors into some of the company’s business segments, requiring higher promotional outlays. However, balancing out this risk, the offer price factors in a significant valuation discount to other FMCG players.
At the two ends of the price band, this offer values Jyothy Labs at 19-21 times its earnings for the year-ended June 2007. FMCG players such as Emami, Marico and Dabur trade at trailing P-E multiples of 25-35 now.
Local players re-rated
The past couple of years have seen a rapid re-rating of home-grown FMCG companies such as Dabur or Marico in the stock markets. As a result, the valuation discount that such companies historically suffered vis-À-vis their multinational peers has been effectively wiped out.
Local and smaller FMCG companies have managed superior growth rates by adopting two sets of strategies.
Those such as Marico (hair oil, conditioners, edible oil) and Dabur (health supplements, foods, herbal personal-care products) have focussed on segments and geographies where MNCs do not have a significant presence, thus insulating themselves from the bruising price wars and competition seen in big FMCG categories such as laundry or shampoos.
A second set of players such as Emami and Cavinkare have managed to carve out a market share in larger categories despite MNC presence. They have used competitive pricing and deep regional distribution to address the under-served mass market for FMCGs.
Mass market focus
Jyothy Labs appears to have used a combination of both strategies. It has focused on niche products, targeting value-conscious consumers in the rural and semi-urban markets through low-priced products. Having entered the fabric care market through its flagship whitening brand — Ujala — Jyothy Labs has managed to carve out a 72.7 per cent share of this market (as of July 2007), wresting share away from Reckitt Benckiser (Robin Blue) and Unilever (Ala) which were established in this segment. Jyothy’s subsequent product launches — Maxo mosquito coils and Exo Dishwash bars — have also met with reasonable success by acquiring a strong presence in South India.
Ujala Stiff N Shine (a liquid instant starch), a recent launch, has also captured a lucrative niche. This is despite competition from players such as Reckitt and Unilever in each of these segments.
The company also has significant distribution reach in rural and semi-urban centres, especially in the southern markets. The distribution network gives the company an edge over larger players which do not have a significant presence outside of the urban centres. The rural and semi-urban markets for FMCG products have also been witnessing higher rates of growth than urban markets over the past couple of years.
Though the company’s foray into larger FMCG categories such as laundry (Ujala Washing Powder) and soaps (Jeeva) has not been successful, a national rollout of brands such as Exo and Ujala Stiff N Shine, planned by 2008, could help sustain growth.
Unlike categories such as laundry, personal wash or shampoos, segments such as fabric care and insect repellents are characterised by low levels of market penetration and, thus, offer higher growth potential, even if new players do enter the fray. Jyothy’s businesses — fabric care, repellents and dish wash products — have managed CAGRs of 13, 9 and 48 per cent respectively over the past three years, ahead of category growth rates. The company has seen its sales grow at about 7 per cent and net profits at about 50 per cent CAGR over the past four years. While Jyothy Labs’ growth rates have beaten the sector, its return ratio (RONW) is significantly lower, at 16.5 per cent than that of other listed FMCG players. However, the lower returns are a function of the company’s reliance on own manufacture rather than third party vendors for sourcing of products.
Recent investments (Rs 110 crore capex in 2007), to build manufacturing facilities at multiple locations/tax havens across India, may give the company greater control over its margins, given the savings in taxes and logistics costs. As the company’s products are mainly positioned on the “value-for-money” plank, the cost advantage may be crucial.
Despite its track record, investors in Jyothy Labs have to take cognizance of certain risks. The company has a narrow brand portfolio with Ujala and Maxo accounting for the lion’s share of its sales/profits. A foray by any large FMCG rival into either of these categories could hurt the company’s earnings significantly. The company has traditionally contained its adspend-to-sales ratio in the 9-10 per cent range; but a spike may be unavoidable if a battle for turf ensues. As a relatively small player in the FMCG business, the company may lack staying power, should a large MNC or domestic competitor attempt to break into one of its key categories. Second, the manufacturing-led model will lead to less flexibility in the cost structure, should the demand environment slow down.
However, the company’s brand portfolio and its extensive distribution network would make it a desirable acquisition candidate in the event of heightened competition.
Offer details: The offer for sale seeks to raise Rs 275-306 crore at the two ends of the price band and the proceeds will go to a set of institutional investors. There is no equity dilution resulting from the offer, promoters will continue to hold 69 per cent of the post-offer equity. The offer opened on November 22 and will close on November 27.
It took a little over 18 months for the benchmark index of the Indian stock market to double from 10,000 levels to the dizzying heights of 20,000. Not to be left behind, the Nifty too breached the 6000 level on November 1, from a shade below 3000 last June. One would think this would have made the job of ferreting out multi-baggers (stocks whose prices have risen several times over) easy. But could you have spotted these multi-baggers through some in-depth research into th ese companies in June last year? Maybe not!
Indeed, the list of multi-baggers over the past year and half would leave an investor confused. Street-sense says that capital goods, real-estate and infrastructure, the most fancied sectors in the stock market in the past year, would have been the ones to yield multi-baggers over the past year and a half. But there is no specific sector theme to the stocks that made it to the top. Companies from the infrastructure, capital goods and real-estate sectors are, in fact, missing from the top 20.
Unitech comes in at the 38th position in spite of witnessing its stock price rising 5.6 times. It would also have been quite difficult to catch these stocks last year, even had you pored over their financials. The majority of the multi-baggers owe their stellar returns to the market “re-rating” them (allowing them a larger price-earnings multiple), rather than an impressive expansion in their earnings. Which are the stocks heading the multi-baggers list? Is there a pattern to them? Let us find out.
Jai Corp, Walchandnagar Industries, State Trading Co, India Infoline and BAG Films lead the list of top 10 multi-baggers since June 2006 (when the Sensex was at 10,000). These stocks naturally represent the big gainers among the 1,033 listed stocks on the NSE. Others that make it to the list are Autolite (I), KS Oils, REI Agro, Nicco Corporation and Goldstone Technologies. All these stocks had risen tenfold or more in the period under review — June 19, 2006 to November 16, 2007 (we chose these dates as they represent Sensex levels of 10,000 and 20,000 respectively).
Would you have put Jai Corp on your “buy” list last year, based on its business prospects? Maybe not. Seeking an explanation for why a Rs 19 stock in a matter of just one-and-a-half years rose to Rs 1,000, we find that Jai Corp is into such businesses as steel, plastic processing and spinning yarn facilities. But this was not why it was sought after.
The stock came into the limelight because of speculation that the promoters of a mega corporation have an indirect stake in the company and plan to use it as their infrastructure vehicle. This partly explains the stock price rising by over 67 times. The fact that only 15 per cent of its stock is freely available to the investing public may also have helped its stratospheric rise.
In the second slot, we have Walchandnagar Industries Ltd (WIL), whose story is a different one; though the fact that the stock has risen by nearly 20 times its price tag of Rs 450 in June last year. WIL is engaged in the manufacture of sugar plants, cement plants, nuclear power and space equipment and other engineering products. Notwithstanding the decent results posted by it over the past year (72 per cent profit growth), interest in the stock has been stoked by reports of indirect stake held by some influential politicians in the stock.
Apart from these, companies that operate in “sunrise” businesses and seen as offering high potential, such as India Infoline (broking), Goldstone Technologies (IPTV services), BAG Films (media), Nicco Corporation (entertainment parks) and REI Agro (basmati rice) feature in the top ten multibaggers (see Table).
Surging on ‘potential’
For five of these companies, namely WIL, State Trading Corporation, India Infoline, BAG Films and Rei Agro, earnings have risen, but their PE multiples have expanded even more, as investors have marked them up on the strength of their forays into promising new businesses. There are a couple of stocks which did benefit from a change in fundamentals.
The spike in prices of the shares of Autolite and Nicco Corporation is explained mainly by a turnaround in profitability. Nicco recorded a profit of Rs 6 crore last year as against a loss of Rs 16 crore in the year ago. Autolite, which makes lights and tubes, posted around Rs 5 crore profit, compared to a loss of Rs 3.3 crore in the earlier year. Both companies continued a sharp ramp-up in earnings numbers in the first six months of the current fiscal.
Though spotting the multi-baggers in advance was difficult, there was actually a good chance you held one in your portfolio. In the over 1,000 stocks reviewed on the NSE, shares of more than 490 companies, over half, gave a 100 per cent return between June 19 and November 17. Most of the stocks enjoyed both domestic as well as foreign investors’ attention, leading to a hefty rise in prices. Over 60 companies saw their stock price rise five-fold or more. Stocks of 12 companies multiplied 10 times or more.
Small-caps in limelight
It is a known fact that retail investors have an unexplained penchant for stocks trading at low absolute prices, and these dotted the list of multi-baggers. While the multi-baggers, in general, did not huddle close to any specific sector theme, the market-cap status of stocks did play a role.
Results showed that out of the 490 companies that doubled their value in these 18 months, 409 were small-caps, i.e. companies with a market capitalisation of Rs 2,500 crore or less. In this set of small-cap companies, the average share price rise was 3.4 times, higher than the average share price rise in mid-caps as well as large-caps at 2.4 times for each respectively.
Mid-caps are companies that have market capitalisation between Rs 2,500 crore to Rs 10,000 crore.
These results are not surprising because this period has largely seen the mid-cap (103 per cent) and small-cap indices (107 per cent) exceeding the returns of the bellwethers such as the Sensex (97 per cent) or the Nifty (98 per cent).
In the mid-cap space, around 61 companies were multi-baggers (they at least doubled in value) while only 23 large-caps (companies with a market capitalisation of Rs 10,000 crore or more) were a part of the list. This data clearly indicates that cheap stocks of lesser-known companies delivered a more stellar rise than stocks of widely-tracked, larger companies.
If the multi-baggers were not entirely sought after for their strong earnings growth, the stocks that fell most sharply in this period were certainly swayed to a greater extent by fundamentals. Companies such as Aztecsoft, Nova Petrochem, Thiru Arooran Sugar and Suryalakshmi Cotton Mills head the list of worst performing stocks over this period.
Other laggards include Dhampur Sugar, Celebrity Fashions, Shah Alloys, Uttam Sugar Mill, Simbhaoli Sugars and Sakthi Sugars.
Unlike the multi-baggers, whose share prices have gone up as a result of better growth potential, rather than actual earnings, the laggards appear to have declined directly in response to their profit performance.
Finally, discussion on multi-baggers from 10k to 20k would be incomplete without mention of the following companies. IFCI, despite its unimpressive financials, saw a stellar rise, following the announcement that the management had put a 26 per cent equity stake on the block. Reports of the company’s real-estate holdings and its long list of suitors helped the stock move up from Rs 9 to Rs 90, gaining a whopping 900 per cent in the process.
India may not yet be ready for Internet protocol TV, but that didn’t deter investors putting their money into IOL Broadband. From being a little known entity, the Rs 53-share gained almost 10 times its value in a matter of months, without the fundamental picture changing too much.
On the other hand, stocks such as Gujarat Mineral Development Corporation (832 per cent), Reliance Natural Resources (740 per cent), KLG Systel (500 per cent) and Welspun Gujarat Stahl (480 per cent) rode excellent earnings growth.
Fundamentally sound companies that turned out to be multi-baggers include TV18 India, Everest Kanto, Elecon Engineering, SREI Infrastructure Finance, Kotak Mahindra Bank and Larsen and Toubro.
In some cases, niche business areas attracted investors’ attention. Educomp (e-learning), Alphageo (seismic surveillance), Aban Offshore (oil rigs), Karuturi Networks (a leading cultivator of flowers), and Rolta (digital mapping) are prime examples.
Reliance Industries (RIL) has netted Rs 3,662-crore profit from sale of a part of its equity holding in its subsidiary Reliance Petroleum. This amount is almost equal to the net profit reported by the company for the second quarter of this fiscal.
RIL announced late on Friday night that it has offloaded 18.04 crore shares representing 4.01 per cent of RPL’s equity through the exchanges raising Rs 4,023 crore. Post the sale, RIL’s holding in Reliance Petroleum will fall to 70.99 per cent. There will also be an increase in the number of shareholders in Reliance Petroleum from 12 lakh to 16 lakh, according to a press release from the company.
Going by these numbers, RIL’s average selling price per share of Reliance Petroleum works out to Rs 223 compared to the average acquisition cost of Rs 20 per share as per its books.
The total amount raised from the sale of shares is about a fifth of the cash generated by RIL from operations in 2006-07.
The transaction is likely to help RIL double its per share earnings in the third quarter on a sequential basis, all other things remaining equal. The company had an EPS of Rs 27 in the second quarter; the divestment profit alone will add Rs 27 per share, before tax, to third quarter earnings.
RIL’s timing of divestment appears perfect given that the Reliance Petroleum stock was on a sustained uptrend from mid-September till it reversed trend on November 5.
The stock more than doubled in value in this period to touch a peak of Rs 295 before dropping back. Since the trend reversal on November 5, the stock has been consistently falling and closed at Rs 209 on Friday.
Towards the later stages of the rally, the stock was driven by reports that Chevron, which holds 5 per cent equity in RPL, is planning to exercise its option to pick up another 24 per cent stake. Chevron, however, denied that there were any such plans for the moment.
Reliance Petroleum stock’s rally was accompanied by a surge in trading volumes. Average daily trading volume shot up from 92 lakh shares in the early August – mid-September period to 4.28 crore shares between mid-September and now.
Though RIL has offloaded 18.04 crore shares through the exchanges, it is interesting to note that not one of the transactions figures in bulk deals. The high daily volumes appear to have helped RIL camouflage its divestment transactions