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STRATEGY THEMATIC
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Gaurav Mehta
Tel: +91 22 3043 3255 gauravmehta@ambitcapital.com
Attractive Valuations* BHEL Tata Power Co. Cadila Health. Cummins India Castrol India Exide Inds. Torrent Pharma. GSFC Voltas Sadbhav Engg. Bajaj Electrical Mahindra Life. ICRA Nestle India Asian Paints Lupin Titan Inds. CMC Elgi Equipment ITC BHEL IN TPWR IN CDH IN KKC IN CSTRL IN EXID IN TRP IN GSFC IN VOLT IN SADE IN BJE IN MLIFE IN ICRA IN NEST IN APNT IN LPC IN TTAN IN CMC IN ELEQ IN ITC IN 13,240 4,592 2,621 2,117 2,068 2,018 911 607 545 340 327 206 168 7,683 5,171 3,814 3,219 555 211 31,969 2,045 1,468 1,289 670 460
Moderate Valuations**
Rich Valuations*** GlaxoSmith C H L SKB IN Coromandel Inter CRIN IN CRISIL EID Parry Supreme Inds. CRISIL IN EID IN SI IN
Source: Ambit Capital research; * Trading below 5 year P/E, P/B, EV/EBITDA (on at least 2 of these 3 measures) ** Trading below either 5 year P/E, 5 year P/B or 5 year EV/EBITDA (on 1 of these three measures) *** Trading above 5 year P/E, P/B, EV/EBITDA
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Please refer to disclaimer section on the last page for further important disclaimer.
Strategy
Source: Ambit Capital research. * 10xers is a term popularized by the American business guru Jim Collins in his latest book Great by Choice. We are avid fans of Mr.Collins and have tried to apply his thinking in the Indian context of rapid economic change and insufficient data.
Obviously, over the years, these 10Xers have delivered better RoCEs, RoEs and EPS CAGR than an average firm and this has contributed to their stellar performance versus the benchmark. This can be readily seen in exhibit 2.
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Exhibit 2: 10Xers over BSE100 - RoE, RoCE and EPS
FY96-11 10xers v/s BSE100 Measure EPS (CAGR %) EPS (CAGR/Standard deviation) RoE (Change- last 5 yrs v/s first 5 yrs)* RoE (CAGR/Std Dev) RoCE (Change- last 5 yrs v/s first 5 yrs)* RoCE (CAGR/ Standard deviation)
Source: Ambit Capital research, Capitaline * For example, for a firm listed since 1996, this will be the change between the average value for FY20072011 over the average for FY1996-2000
Average 10Xers 28 0.53 15.1 0.02 13.9 0.03 BSE100 12 0.34 1.8 (0.11) 0.5 (0.11)
Median 10Xers 28 0.50 12.2 0.03 9.4 0.04 BSE100 12 0.21 (0.7) (0.02) 0.4 (0.02)
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a. Investment The first step in a firms value generation process is obviously investment.
Exhibit 4: Markers of greatness - Investment
FY96-11 10Xers v/s BSE100 Measure Gross Block (Change- last 5 yrs v/s first 5 yrs, %)* Gross Block (CAGR/Standard deviation) Net Block (Change- last 5 yrs v/s first 5 yrs, %)* Net Block (CAGR/Standard deviation)
Source: Ambit Capital research, Capitaline * For example, for a firm listed since 1996, this will be the change between the average value for FY20072011 over the average for FY1996-2000
Average 10Xers 1483 0.82 1466 0.61 BSE100 714 0.74 659 0.46
Median 10Xers 820 0.82 793 0.58 BSE100 313 0.66 295 0.41
The 10Xers invest more (much more) than the average BSE100 firms (see the first and third rows of the table shown above). While this is to be expected, the more interesting finding from Exhibit 4 is that the 10Xers have shown more consistent and calibrated growth. This is evident from the fact that the CAGR to standard deviation ratio (i.e. better growth adjusted for noise) is higher for 10Xers versus the benchmarks on both gross block and net block.
Strategy b. Conversion to sales After having made the investment decision, it is vital that a firm translates its investments into better sales. This can be monitored by measuring the change in asset turnover ratio or the growth in sales figures themselves.
Exhibit 5: Markers of greatness - Conversion to sales
FY96-11 10Xers v/s BSE100 Measure Fixed assets turnover (Change- last 5 yrs v/s first 5 yrs)* Fixed assets turnover (CAGR/Standard deviation) Sales (CAGR %) Sales (CAGR/ Standard deviation ) Source: Ambit Capital research, Capitaline * For example, for a firm listed since 1996, this will be the change between the average value for FY20072011 over the average for FY1996-2000 Average 10Xers 0.82 0.05 28 0.99 BSE100 0.59 (0.08) 16 0.91 Median 10Xers BSE100 0.83 0.04 25 0.97 (0.01) (0.10) 15 0.71
Again, the 10Xers havent just shown better improvement on both Asset Turnover and Sales than the average BSE100 firms but have also achieved it in a more consistent and calibrated manner. This has meant higher CAGR to standard deviation ratio (i.e. better growth adjusted for noise) for the 10Xers versus the average firm on both these measures. c. Pricing discipline
After ensuring translation of higher investments to sales, the next key decision for a firm is pricing. What 10xers are able to do is to maintain pricing discipline. The concrete measure at this stage is operating margins.
Exhibit 6: Markers of greatness - Pricing discipline
FY96-11 10Xers v/s BSE100 Measure PBIT margin (Change - last 5 yrs v/s first 5 yrs)* PBIT margin (CAGR/Standard deviation) Source: Ambit Capital research, Capitaline * For example, for a firm listed since 1996, this will be the change between the average value for FY20072011 over the average for FY1996-2000 Average 10Xers 9.9 0.06 BSE100 (0.7) (0.02) Median 10Xers 3.1 0.02 BSE100 (0.6) (0.01)
Yet again, the 10Xers were found to be better both in terms of PBIT margin improvement as well as better CAGR to standard deviation ratio on this measure versus the average firm. (In fact the average BSE100 firm seems to have shed PBIT margin over the past decade.) d. Balance sheet discipline Whilst all the action described above takes place on the P&L, in a high cost of capital market like India, it is essential that a firm focus on maintaining Balance Sheet discipline. We look for improvements on debt-equity and current ratios to assess a firms ability to maintain a healthy Balance Sheet.
Strategy
Exhibit 7: Markers of greatness - Balance sheet discipline
FY96-11 10Xers v/s BSE100 Measure Net Debt Equity (Change- last 5 yrs v/s first 5 yrs)* Net Debt Equity (CAGR/Standard deviation) Current Ratio (Change- last 5 yrs v/s first 5 yrs)* Current Ratio (CAGR/Standard deviation) Average 10Xers (1.02) (0.59) (0.03) (0.00) BSE100 (0.25) (0.32) (0.23) (0.06) Median 10Xers BSE100 (0.71) (0.31) (0.13) (0.05) (0.24) (0.01) (0.26) (0.08)
Source: Ambit Capital research, Capitaline * For example, for a firm listed since 1996, this will be the change between the average value for FY20072011 over the average for FY1996-2000
The 10Xers again score better not just on magnitude changes but also on CAGR to standard deviation ratio on both net debt equity and current ratio measures than the average firm. Interestingly, whilst the 10xers seem to have delevered 3-4x more than the broader market over the past decade, it is encouraging to note that the broader market has also reduced its leverage over this period. e. Cash generation Eventually everything that a firm does should lead to better operating cashflow generation (especially over the long time periods that we are using here). Healthy cash generation also then feeds back toward funding investments for the future growth of the firm (which in turn kicks off the whole virtuous cycle all over again).
Exhibit 8: Markers of greatness - Cash generation
FY96-11 10Xers v/s BSE100 Measure CFO (Change- last 5 yrs v/s first 5 yrs, %)* CFO (CAGR/Standard deviation)
Source: Ambit Capital research, Capitaline * For example, for a firm listed since 1996, this will be the change between the average value for FY20072011 over the average for FY1996-2000
The 10Xers again score better both on magnitude change (3-4x better than the average firm) as well as CAGR to standard deviation ratio versus the average firm.
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Threshold or Medians for BSE500 firms (over FY06-FY11) 80% 0.95 0 (0.03) 80% 1.0 0.07 0.06 0.03 (0.01) 0.04 0.10 82% 0.13 33% 0.27 0 (0.05) 0 (0.07)
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Quantifying greatness
From the universe of BSE500 firms, after removing Financial Services firms and firms with insufficient data, there were 396 firms which we scored on the six headings highlighted on the previous page. The cut-off for greatness was placed at 66.7%* and there were just 71 firms (less than 18% of the total population of 396 firms) which could manage a score above this cut-off.
Exhibit 10: Distribution of firms on the greatness score
90 80
* The greatness score is calculated by assigning equal weights to the 6 factors outlined in Exhibit 9 on the previous page. Thus each of these 6 factors carries a weight of 16.7%. The scoring on sub-criteria within each of these factors is binary with a firm getting either 1 or 0 based on whether it has done better than the respective threshold or not. These scores are then cumulated to arrive at a final greatness score on 100 for the firm.
Zone of mediocrity
218 firms score < 50%
Greatness beckons
Only 71 firms score > 67%
70
No. of firms
60 50 40 30 20 10 0 0%-10% 10%-20% 20%-30% 30%-40% 40%-50% 50%-60% 60%-70% 70%-80% 80%-90% 90%-100%
Greatness Score
In the next exhibit, we present key financial data on the three zones defined above Mediocrity (217 firms), Good but not great (107 firms), and Great (71 firms) based on their degrees of greatness.
Exhibit 11: Zones of greatness - Financial summary
Mediocre Number of firms Mcap (US$ mn) Share price (3-year CAGR) Gross block (3-year CAGR) Sales (3-year CAGR) EPS (3-year CAGR) CFO (3-year CAGR) RoE (3-year average) RoCE (3-year average) Debt equity PE (FY11) PB (FY11) EV EBITDA (FY11)
Source: Ambit Capital research, Capitaline
Good but not great 107 523 30% 25% 20% 17% 14% 20.1 20.3 0.48 15.0 2.2 8.3
Great 71 552 38% 14% 21% 27% 17% 27.6 28.7 0.29 12.4 2.6 7.5
218 417 12% 15% 14% -2% 0% 12.9 12.3 0.75 12.5 1.5 7.4
With regard to fundamentals, the superiority of Great firms compared to the other two groups is evident in Exhibit 11. However, the bottom three rows of the exhibit show that the 71 Great firms are actually trading at a 10% valuation discount to 107 Good but not great firms. Of these 71 great firms, only 25 clear our accounting and corporate governance filters and this gives us our final list of 25 great companies. We present the Great 25 in the next section (Step 3).
Strategy
Moderate Valuations**
Rich Valuations***
Source: Ambit Capital research, Bloomberg, Capitaline. * Trading below 5 year average P/E, P/B, EV/EBITDA (on at least 2 of these 3 measures) ** Trading below either 5 year average P/E, 5 year P/B or 5 year EV/EBITDA (on 1 of these three measures) *** Trading above 5 year average P/E, P/B and EV/EBITDA
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Source: Ambit Capital research, Capitaline * Cash flows reversed from negative to positive during the period and hence CAGR cannot be computed
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Exhibit 14: The Great 25 Forward looking data
Sr. Ticker No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 BHEL IN TPWR IN CDH IN KKC IN CSTRL IN EXID IN TRP IN GSFC IN VOLT IN SADE IN BJE IN MLIFE IN ICRA IN NEST IN APNT IN LPC IN TTAN IN CMC IN ELEQ IN ITC IN SKB IN CRIN IN CRISIL IN EID IN SI IN Company BHEL Tata Power Co. Cadila Health. Cummins India Castrol India Exide Inds. Torrent Pharma. GSFC Voltas Sadbhav Engg. Bajaj Electrical Mahindra Life. ICRA Nestle India Asian Paints Lupin Titan Inds. CMC Elgi Equipment ITC GlaxoSmith C H L Coromandel Inter CRISIL EID Parry Supreme Inds. Mcap (US$ mn) 13,240 4,592 2,621 2,117 2,068 2,018 911 607 545 340 327 206 168 7,683 5,171 3,814 3,219 555 211 31,969 2,045 1,468 1,289 670 460 3-month ADV (US$ mn) 21.2 6.3 1.2 2.3 0.6 4.4 0.2 0.8 2.0 0.3 0.3 0.1 0.4 2.6 4.1 7.7 17.3 0.3 0.1 27.2 1.1 0.9 1.5 0.3 0.2 FY11-13 EPS CAGR (%) 9.1 3.9 17.7 2.6 5.3 13.6 17.2 3.2 -9.9 22.3 13.5 30.5 6.3 21.5 16.7 18.8 26.8 7.6 -4.1 18.8 20.0 18.9 18.5 DNA 30.5 FY11-13 BVPS CAGR (%) 23.3 16.2 24.5 11.5 12.2 19.5 22.9 24.4 14.7 23.5 17.6 11.4 11.6 51.4 23.9 26.4 34.1 18.4 20.4 11.2 12.1 7.8 19.7 DNA 30.4
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Exhibit 15: The Great 25- Business activity description
Sr. No. Ticker Company Business activity description Bharat Heavy Electricals Limited manufactures power plant equipment. The Company's products include gas turbines, generators, thermal sets, diesel shunters, turbo sets, hydro sets, power transformers, switch gears, circuit breakers and boilers. The Company also manufactures compressors, valves, rectifiers, pumps, capacitors, oil rigs, as well as castings and forgings. Tata Power Company Limited generates and supplies electricity in Mumbai and its suburbs. The Company also constructs and operates independent power plants as well as captive power plants for industrial concerns. Tata Power also provides various services related to electricity distribution, erects and commissions transmission lines, and is diversifying into the telecommunications market. Cadila Healthcare Ltd. manufactures, and markets healthcare solutions ranging from formulations, active pharmaceutical ingredients, vaccines, diagnostics, health and dietetic foods, animal healthcare to cosmeceuticals. The Company's products are available in tablets, capsules, injections, liquids, dry syrups, powders, granules, and ointments. Cummins India Limited manufactures internal combustion engines, including diesel, reciprocating piston, gas turbine and gasoline engines. The Company also manufactures generating sets and public transport-type passenger motor vehicles, including luxury coaches and air-field buses. In addition, Cummins India Ltd. operates a computerized and fully-equipped research and development facility. Castrol (India) Limited manufactures and markets automotive and industrial lubricants and specialty products. The Company's products include lubricating oils, greases and brake fluids. The Company also manufactures cable filling compounds, jellies, waxes and other items. Exide Industries Ltd. manufactures a wide range of lead and electric storage batteries. The Company's batteries are used for automobiles, railways, aircrafts, power stations, telephone exchanges, and other uses. Torrent Pharmaceuticals Ltd. manufactures bulk drugs and pharmaceutical formulations. The Company's formulations include cardio-vascular, psychotropic and anti-biotic drugs while its bulk drugs include atenolol, ciprofloxacin and norfloxacin. Torrent Pharmaceuticals has wholly owned subsidiaries in several regulated and less regulated international markets. Gujarat State Fertilizers & Chemicals Limited manufactures fertilizers and chemicals in four product areas: Finished Products, Intermediate Products, Polymers and Fibre Products. The Company also maintains trading activities in nylon products, petrochemicals, industrial gases and plastics. Voltas Limited offers engineering solutions for a wide spectrum of industries in areas such as heating, ventilation and air conditioning, refrigeration, electro-mechanical projects, textile machinery, machine tools, mining and construction equipment, materials handling, water management, building management systems, indoor air quality and chemicals. Sadbhav Engineering Limited provides construction services, with a focus on irrigation, roads and highways, and mining operations. The Company constructs earthen dams and canals, rehabilitates and upgrades roads, and excavates overburden of mineral properties. Bajaj Electricals Limited manufactures electric fans and general lighting items, such as lamps, special lamps, fluorescent tubes, and lighting fixtures. The Company also manufactures consumer durables like small electrical appliances. Mahindra Lifespace Developers Limited specializes in the construction and operation of commercial and residential property complexes, projects management services and business centers. ICRA Limited provides investment information and credit rating services in India. Nestle India Ltd. manufactures brand name milk products and other food products The Company's products include Everyday dairy whitener, milk powder and ghee, Milkmaid sweetened condensed milk and Cerelac weaning foods. Nestle's beverages include Nescafe and Sunrise coffee and Nesfit enriched glucose powder. Nestle also manufactures Maggi noodles, soups and sauces. Asian Paints Limited manufactures a wide range of decorative paints, varnishes, enamels, and black & synthetic resins. The Company, through its subsidiaries, also manufactures specialty industrial chemicals and vinyl pyridine latex products which are used in the manufacture of rubber tires. Lupin Limited manufactures bulk actives and formulations. The principal bulk actives manufactured by it include Rifampicin, Pyrazinamide, Ethambutol (anti-TB), Cephalosporins (anti-infectives) and cardiovasculars. The company also possesses competencies in phytomedicines, in which medicines are made out of plant and herbal resources supported by the discipline of modern medicine. Titan Industries Ltd. manufactures and retails jewelry and watches. The Company produces quartz analog electronic watches, watch movements, step motors and watch cases. CMC Ltd. provides computer users with a range of computer software and hardware support services. The Company's services comprise of hardware maintenance, site preparations, installation and commissioning of systems, software development, education and training.
BHEL IN B H E L
GSFC IN G S F C
VOLT IN Voltas
10
11
BJE IN
Bajaj Electrical
12 13
14
15
16
LPC IN Lupin
17
18
CMC IN CMC
12
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Sr. No. Ticker Company Business activity description Elgi Equipments Limited manufactures reciprocating and screw type air compressors, diesel engines. generators and pumps, garage equipment, auto products and heat pressure cleaners. Elgi markets a range of wheel balancers, oil suction units, AC recovery plants, mobile service units, and pasteurizer and bottle washers. The Company operates in India and markets its products globally. ITC Limited, a member of BAT Group of UK, is a holding company, which has a diversified presence in Cigarettes, Hotels, Paperboards & Specialty Papers, Packaging, Agri Business, Packaged Foods & Confectionery, Branded Apparel, Greeting Cards and other FMCG products.
19
20
ITC IN
ITC
21
Glaxo SmithKline Consumer Healthcare Limited manufactures and sells malted milk food products. The SKB IN GlaxoSmith C H L Group's products, which include energy & protein products, cereals, baby foods, ghee & butter, are sold under the "Horlicks", "Boost", "Viva", "Brylcream", "Eno", "Maltova" and "Gopika" brand names. CRIN IN Coromandel Inter CRISIL IN CRISIL Coromandel International Ltd. manufactures fertilizers and pesticides. The Company produces both chemical and organic fertilizers, insecticides, fungicides, herbcides, and plant biostimulant. Crisil Ltd. operates a credit rating agency in India. The Company specializes in the areas of risk identification, classification and assessment, across a broad spectrum of industries. E.I.D. - Parry (India) Limited is a diversified manufacturer of fertilizers, pesticides, sugar, ceramics, electronics and seeds. The Company is also diversifying into the manufacture of organic fertilizers, biopesticides, acetic acid, wall tiles and horticultural activities. Supreme Industries Limited manufactures industrial and engineered molded products and storage and material handling crates. The Company also manufactures chemicals, multilayer sheets, multilayer films, packaging films and expanded polyethylene foam, PVC pipes and fittings, molded furniture and disposable EPS containers.
22 23
24
25
SI IN
Supreme Inds.
Source: Bloomberg
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Buy Sell
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