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Monday, July 6, 2015

Changing to become better

Some companies are reducing debt, restructuring, undertaking organic and inorganic expansion, diversifying and resuffling the top deck to fast-track growth


Investors complain that they find it difficult to know when to enter and exit the market. The investment strategy of buy low and sell high is overly simplistic to be true. No one knows what is the high and what is the low of a stock. Many figures float around such as 52-week high and low, five-year high and low and even all-time high and low.
Apart from absolute price, discounting is another factor that investors look at to take exposure to a stock. Investors often track highs and lows of valuations in terms of price to earnings ratio (P/E), price to book value (P/BV), dividend yield and so on to take investment calls. Again, this is highly subjective and depends on market conditions.
In a prolonged bull-run, valuations can touch unimaginable levels. This mean investors looking at highs and lows of valuation ratios will hardly gain from a long bullish phase. This is because such investors might prefer to exit based on high valuations early in the bull-run. Similarly, if the bear phase persists for multiple years, investors might prefer to stay away from the market despite pathetic valuations.
In short, whether it is absolute price or valuations, the business of buying at the lower level and selling at the higher level sounds good in theory but is not practical.
As a matter of fact, the stock market is always puzzling. It discounts possibly everything under the sun and that, too, on a real-time basis. Information flows into the market from numerous sources. In a way, each investor participating in the market is a source of information.
Eventually, market sentiments will drive the market and decide the fortunes of a majority of stocks. The phrase rising tide lifts all boats is appropriate for the bull phase of the market. The probability of stocks moving north is on the higher side in a bull market. Thus, there is no need to break one’s head about where to invest. On the contrary, in a bear market, it is difficult to spot winners.
Whether it is a bull or a bear market, there are winners and losers at any point in time. One can easily come across investors cribbing about past mistakes owing to a variety of reasons such as not entering the market at the lower level or exiting too early at the start of a bull-run or not booking profit at record high level, buying company A instead of B and so on. The fact of the matter is it is essential to scan the market on a continual basis for investment and keep investing.
Instead of timing the market, be in the market all the time. This does not mean one should not book profit or exit a loss-making position. It means investment is a 24x7 business. No break is allowed.
Sentiments, greed and fear are short-term phenomena. A trend will emerge influencing the market and subsequently vanish. Ultimately, it is the quality of a stock and its performance that will eventually deliver results over the medium to long term. This has been proved time and again and will hold in future as well.
At present, there are risks as well as opportunities. On the upside is the postponement by Morgan Stanley Capital International (MSCI) of shuffling the MSCI Emerging Markets Index by including the Chinese A class shares, which are also referred as mainland Chinese stocks. The possibility of their inclusion had spooked the Indian market as this would have increased the weight of Chinese stocks in the index, resulting in outflow from other emerging markets including India. However, MSCI has postponed the decision on restructuring over the issue of access to the Chinese market.
On the downside is the worry about a possible spike in interest rates by the US Federal Reserve (Fed). This time, the Fed seems to be serious about a rate hike, which could be a reality as early as September 2015. This is among the biggest worries at the moment. Any increase in interest rates will puncture the liquidity-driven rally in stocks across the world. Even the International Monetary Fund (IMF) has requested the Fed not to increase interest rates till calendar year (CY) 2016. In June 2015, the IMF has revised downwards the US economic growth estimate for CY 2015 to 2.5% from 3.1% projected by it in April 2015.
This apart, there is talk in the market that the global bond bubble is about to burst. Market experts believe that bonds are highly overvalued at US$ 76 trillion. Around one-fourth of all the government bonds in Europe have a negative rate of return. This abnormality gives credence to market talks.
In the European Union, Greece seems to be a perpetual spoiler. Negotiations between Greece and the international creditors continue without much success, with both sides playing endless mind games. The creditors are not convinced with the reforms undertaken by Greece. This could mean Greece moving closer to default and a step closer to eventual exit from the European Union. This could spook global financial markets and result in turmoil as well.
In India, economic growth and corporate earnings are not in sync. The Reserve Bank of India (RBI) early June 2015 lowered the economic growth forecast from 7.8% to 7.6% for the fiscal ending March 2016 (FY 2016). Even this prediction seems to be on the higher side considering the ground reality and business confidence. The turnover of around 4,000 companies crawled 1%, while profit declined 1.8% in FY 2015. The 30 companies constituting the S&P BSE Sensex reported a 2.2% decline in adjusted profit and sales grew a mere 2.3% last fiscal. This is against the expectation of double-digit growth expected in the bottom line.
In its first cut in interest rate in the current fiscal, the RBI reduced the repo (lending) rate to 7.25% from 7.5%. Banks borrow from the RBI at the repo rate. However, despite the shaving, the concern is the central bank revising the inflation projection up to 6% by January 2016 from 5.8% in April 2015. Invariably, this means it might defer interest rates cuts. Lower interest rates are necessary to lift demand for goods and services.
A possible drought could add to inflation worries. The India Meteorological Department has revised down the southwest monsoon forecast from 93% to 88% of the average rainfall for the June-September period. The possibility of deficient monsoon has already dampened corporate spirits. Monsoon has arrived late. But the recent downpour has lowered the possibility of drought. In response, the market has witnessed a recovery.
Reforms are not happening at the expected pace and scale to lift the standards of living of a significant portion of the 1.2 billion people, which represents a huge business potential. Foreign portfolio investors (FPIs) are pulling out money from the market. FPIs net sold US$ 903.9 million of equities in May 2015, while they net sold US$ 449.4 million in the month till 25 June 2015 from the domestic equity market. The rupee at 63 (25 June 2015) against the US dollar is on shaky ground. It could plunge further if the US dollar remains in demand and firm in global markets. If FPI offloading continues, it will put additional pressure on the rupee.
Market conditions remain uncertain, making investors jittery. Investing in equities seems to be way too risky. Despite these problems, India remains a bright spot on the global map. Its economic growth is far better compared with the developed world. Thus, remaining away from the market is not the solution.
In this scenario, it is better to adopt a stock-specific approach. Importantly, the stock-screening criteria should become more stringent. In fact, several company-specific developments are taking place that can significantly boost business.
Many companies are focusing on reducing debt in response to business slowdown and pressure on the bottom line. A few firms have already reduced debt by a considerable quantum. Such companies can now concentrate on their businesses rather than worrying about the debt burden and interest outgo.
Also, companies have gone for restructuring to streamline their businesses and turn profitable or improve their profitability and cash flows. The reorganization could have been undertaken with various objectives such as to better utilize financial resources, create greater accountability and responsibility, raise funds and strengthen the balance sheet. Besides de-merger is another visible corporate action in response to market expectation.
There are industry-specific events, too, that can have a favorable impact on demand, which will generate greater quantum of revenue for companies. Indeed, company- specific events can be influenced by industry-specific factors.
For instance, the government is all out to encourage domestic manufacturing of defense equipments under the Make-in-India campaign. Action is already visible, with a few domestic companies forming joint ventures with foreign players with relevant expertise in defense equipment for domestic production. Investors can map industry happenings and their influence on companies. Such stocks can be termed as action stocks. These companies can be scanned for investment.
Capital Market picked 16 companies based on various company- and industry-focused parameters (see table: Action stocks). These include de-mergers, corporate restructuring, expansion plans, joint ventures and collaborations, debt reduction, strategic equity investments, financial equity investment, mergers and acquisitions, foraying into new geographies, business diversification by entering new industries or businesses, change in the top management and ambitious revenue targets.
Basically, investors will be betting on the transformation to translate into better sales and profit. For this, investors need to understand the rationale behind the move and, if convinced, pick the companies for investment.
Biocon, the country’s largest biopharmaceutical company, might witness some action in the current fiscal. Subsidiary Syngene International filed a draft red herring prospectus with the Securities and Exchange Board of India in April 2015 to seek approval for an initial public offering (IPO). This will be offer for sale is to offload around 11% of the holding in Syngene. Along with subsidiary Biocon Research, Biocon owns 84.5% of Syngene. The value unlocking will help to fund research and development programs including the pipeline of biosimilars and novel biologics including oral insulin at various stages of development.
Syngene offers contract research services including discovery and development of novel molecular entities across industrial sectors including pharmaceutical, biotechnology, agrochemicals, consumer health, animal health, cosmetic and nutrition companies. Bangalore has a team of 2,000 scientists and laboratory and manufacturing facilities.
Global pharmaceutical players such as Bristol-Myers Squibb, Abbott Laboratories and Baxter International have long-duration partnerships with Syngene, which reported revenue of Rs 707.7 crore in FY 2014 and Rs 617.5 crore in the nine months ended 31 December 2014. A new facility is being set up in Mangalore to make molecules for innovator companies in the pharmaceutical, agrochemical and other industrial sectors.
Clients of the maker of biologics, biosimilars, differentiated small molecules and affordable recombinant human insulin and analogs has a rich pipeline of biosimilars and biologics are spread over 85 countries.
Greenply Industries is working on a mega expansion plan. Outsourcing of product requirement will be increased to 30% from 20% over two years to improve the return on capital. Land has been acquired in the Chittoor district of Andhra Pradesh for setting up a medium-density fiberboard (MDF) unit as the capacity utilization level of the existing facility has touched 90%.
The project, to cost around Rs 600 to Rs 650 crore, will be equally funded through borrowing and internal accruals. The plant is expected to go commercial by FY 2019.
The wood-based products supplier of plywood and allied products and MDF is the largest player with 30% market share of the domestic organized plywood market and 30% of the domestic MDF market. The decorative business was demerged and listed in November 2014.
The target is to clock growth in revenue of 10-12% in the current fiscal. The margins are expected to improve 70 to 100 basis points on account of better product mix and cost control.
Max India is in the process of demerging the existing businesses into three listed companies. This is an attempt to unlock value. Moreover, investors will be in a better position to access the businesses post split. Upon completion of the demerger, Max India will be renamed Max Financial Services (MFS). MFS will focus on the flagship life insurance business through 72.1% shareholding in Max Life. There are good chances that MFS will emerge as the first Indian listed company dedicated to the life insurance business. This is the most attractive part of the story.
The second entity, Max India, will continue to manage investments in the high potential health and allied businesses comprising Max Healthcare, Max Bupa and Antara Senior Living. These businesses are in the growth phase. The third entity will look after investment activity of the specialty film packaging subsidiary, Max Specialty Films, and will be called Max Ventures and Industries (MVIL). Started in 1989, the specialty packaging films business has been consistently profitable.
As part of the demerger scheme, the shareholders will receive one equity share of MFS (face value Rs 2). Further, the shareholders will receive one equity share of Max India (face value Rs 2) for every one equity share held in MFS and one equity share of MVIL (face value Rs 10) for every five equity shares held in MFS.
ITC, the country’s largest cigarette producer, is looking to diversify the revenue stream. The thrust is on the fast-moving consumer goods (FMCG) segment, and the efforts seem to be yielding desired results. The branded packaged food products has emerged the fastest-growing business in FY 2015. Indeed, the milestone of US$ 1 billion turnover was crossed by the segment by reporting a 12.1% growth in revenue to Rs 6411 crore. The category offers staples, snacks and meals, confections and beverages. The brands include Aashirvaad, Sunfeast, Bingo!, Yippee!, Kitchens of India, mint-o, B Natural, Candyman and GumOn. New product segments will be entered to enhance the product portfolio going ahead.
The aspiration is to become the country’s number one FMCG company by achieving revenue of Rs 1 lakh crore by FY 2030. Besides cigarettes, the largest and most profitable segment, the diversified portfolio includes FMCG, paperboards and packaging, agriculture related businesses, hotels and information technology.
Among the top 10 companies by market value had cash of Rs 7896.2 crore and current investment of Rs 6135.1 crore end March 2015. The debt-free company issued bonus shares in the ratio of 1:1 in August 2010.
Ambitious management talk is soothing to the ears if the firm in question has achieved targets in the past. Additionally, such companies can be held accountable by investors and their performance can be benchmarked against targets set by the management.Motherson Sumi Systems (MSSL) is an overwhelming example in this context. Key targets for the fourth five-year plan completed in FY 2015 were set in FY 2010.
The performance has been good across parameters: revenue (actual US$ 5.5 billion v target of US$ 5 billion), overseas revenue (growth of 84% v 70%), geographical presence (25 countries v 27), return on capital employed (RoCE) (consolidated 26% v 40%) and dividend payout ratio (37% v 40%).
Over the next five years, the intention is to become a US$ 18-billion company by revenue. The ROCE target is 40% and dividend payout ratio of 40%. The company will be adopting dual strategy of organic growth and acquisitions to reach this target.
Established in 1986, the joint between Samvardhana Motherson group and Sumitomo Wiring Systems (Japan) is the largest auto ancillary company in the country and ranked 55th in the world. Among the world’s leading manufacturers of automotive rear-view mirrors is also among the leaders in instrument panels, bumpers and door trims in Europe. There is presence in 25 countries across six continents.
Among the leading commercial vehicle and passenger bus makers, Ashok Leylandreported a financial turnaround in FY 2015, with profit of Rs 133.9 crore as against loss of Rs 164.1 crore in FY 2014. It could be just the beginning as the net profit margin is merely 0.85%. Around 1.05 lakh vehicles were sold in FY 2015, which is lower compared with 1.15 lakh in FY 2013. Invariably, this means there is tremendous scope to improve the financial performance and achieve true turnaround.
The market share of the medium and heavy commercial vehicle (M&HCV) segment was increased to 28.6% last fiscal from 26.1% earlier. Also, the market share in the intermediate vehicle domain rose on the back of new products. Exports volume grew 31.7% in FY 2015.
As per the annual report for FY 2015, considering the expected growth in the industrial, construction and mining sectors, M&HCV sales are likely to keep the growth momentum intact in FY 2015. The Society of Indian Automobile Manufacturers has projected growth of 13%-15% for M&HCVs and 3%-5% for the light CVs in the current financial year. If the projected demand materializes, there might be another year of sterling performance. Debt is intended to be reduced from Rs 9069.9 crore, with debt-to-equity ratio of 2.8 times end FY 2015.
V-Guard Industries is looking to increase revenue from the non-south market. Thirty per cent of the revenue of the Kochi-headquartered electric and electronics goods maker came from the non-south market in FY 2014 as against 25% in FY 2013 and 16% in FY 2010. The efforts to diversify revenue streams by geography are likely to continue as the southern market is facing slowdown in demand. Also, the focus will be on expanding the network in existing markets.
The strong brand in the southern region manufactures and markets voltage stabilizers, invertors and digital UPS systems, pumps, house wiring, electric water heaters, fans and solar water heaters. Lately, manufacturing has been taken up of induction cook tops, mixers and grinders and switchgears.
A third wire factory is being set up in Coimbatore in Tamil Nadu, which houses the wire and cable factories. The plant is likely to start production in two years. After their launch in Kerala and later in Karnataka last fiscal, mixer grinders will be rolled out in other southern markets as well. A target of 15% growth in revenue has been set for the current fiscal. Decline in the prices of copper is expected to improve profitability.
Kalyani group company Bharat Forge might be among the major beneficiaries of the government’s renewed emphasis on domestic manufacturing of defense equipment as part of the Make-in-India program. Other focus areas are the railways, power and aerospace sectors.
In October 2014, a long-term partnership was announced with France-based Safran to supply critical high integrity forged and machined components for commercial aircraft applications to the latter’s global affiliates. Both will be exploring other opportunities in the Indian civil and military aerospace. In February 2014, a strategic alliance was entered into with defense and security company Saab to partner and address key Indian army air defense projects.
Efforts are on to de-risk the business model by reducing excessive dependence on the auto segment. The non-auto segment contributed 38% to the consolidated revenue in FY 2015, while the remaining portion came from the auto segment. There are 10 manufacturing plants across four countries. The clientele boasts of 35 global marquee original equipment manufacturers and tier I companies across automotive and industrial applications.
Change in promoters and management might be a crucial trigger for United Spirits(USL). Despite facing bad press owing to the association with Vijay Mallya, currently the chairman of USL and head of the UB group, London-based largest spirits companies in the world Diageo Plc completed the acquisition of USL in CY 2013 from the UB group. The fate of Mallya remains uncertain. However, Diageo has managed to place its men at crucial positions to run the show. Anand Kripalu was appointed as the chief executive officer in May 2014. India’s largest beverage alcohol company’s flagship brands include McDowell’s No.1 Whisky and Royal Challenge. The share of premium brands in the revenue increased to 30% in FY 2015 compared with 27% in FY 2014.
Cleaning up the mess left by the previous management is almost through with appropriate provisioning and write-offs. Now, energies can be concentrated to take the business to greater heights.
There are hundreds of companies that are troubled owing to their highly-leveraged balance sheets and resultant interest burden. In challenging economic and business conditions, this debt not only pinches but might even bring down the entire enterprise. Commercial and passenger vehicle maker Force Motors stands out in this context. The debt-free company had borrowings of mere Rs 10.7 crore end March 2015 compared with Rs 485.7 crore end March 2008. There was cash of Rs 306.8 crore end March 2015 as against Rs 219.6 crore end March 2014.
The manageable leverage makes it possible to face the cyclical nature of the automobile industry. The product range includes small commercial vehicles (CVs), multi-utility vehicles (MUV), light CVs, sports UVs and agricultural tractors.
Turnover has increased 2.5 times over the past five years. Going forward, the thrust is on expanding capacities to sustain the growth momentum and cater to incremental demand. In February 2015, a plan was unveiled to establish a factory at Chakan in Pune to manufacture motor vehicles parts such as engines, gearboxes and axles, with capacity of 50,000 sets per annum. Land is in possession and necessary permissions are being sought.
Conclusion
Valuations of some of the selected companies might be on the higher side. Besides, a few stocks are trading at record levels. This might put off investors. MSSL reported and all-time high of Rs 534 in April 2015 and currently commands a P/E of 46.8. The rally in the stock and premium valuations reflect its healthy performance over the last five years and equally robust targets. Similarly, Greenply recorded a historic high of Rs 1276.8 in November 2014. Again, ambitious expansion plans indicate exciting times ahead.
Valuations might also be elevated on signs of turnaround. This partially explains the P/E of 59.4 commanded by Ashok Leyland and 170.9 by Kokuyo Camlin. However, profitability needs to soar.
For companies such as Ashok Leyland, Bharat Forge, Force and Tata Motors, economic recovery is critical. This is particular true for turnaround stocks. If the demand scenario recovers, it will be icing on the cake. For instance, Ashok Leyland can build on the foundation of the turnaround achieved in FY 2015.
Importantly, investors should appreciate the risks associated with these stocks as most of them have expansion plans in place. For MSSL, inorganic growth is the inseparable part of the growth strategy. However, the target companies or businesses always come at a premium to the market.

Based on a variety of themes, developments and initiatives, these companies are likely to have action-packed years going ahead. In the present scenario of attractive potential not translating into desired results, these actions stocks are worth a glance.

source: capitalmarket

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