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Ambit Capital Report

Ambit Capital Report

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Published by ndtvonline
A report by Ambit Capital on why leading companies struggle when they reach the top.
A report by Ambit Capital on why leading companies struggle when they reach the top.

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Published by: ndtvonline on Jun 18, 2013
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11/08/2013

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  June 07, 2013
Strategy 
THEMATIC
 Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that AmbitCapital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Please refer to disclaimer section on the last page for further important disclaimer.
 
 Analyst contacts
Saurabh Mukherjea, CFA 
Tel: +91 99877 85848saurabhmukherjea@ambitcapital.com
Gaurav Mehta
Tel.: +91 22 3043 3255gauravmehta@ambitcapital.com
Consultant: Anirudha Dutta
Tel: +91 98201 34825anirudha0765.dutta@gmail.com
The most prominent ‘fallen angels’
Name Period*
Hero MotoCorp 2004,09TVS Motor 2004,09Ranbaxy Labs. 2005,10Tata Motors 2006,11Tata Steel 2007,12Bharti Airtel 2007,12Indian Hotels 2007,12Bharat Forge 2007,12
 Source: Ambit Capital research; Note: * 2004, 09indicates that these companies, which were ‘greatfirms’ in 2004, have been identified as ‘fallenangels’ in 2009.
Sustaining leadership
Name Period*
Berger Paints 2003,08 Asian Paints 2004,09Larsen & Toubro 2004,09Dabur India 2005,10CRISIL 2005,10Nestle India 2006,11Balkrishna Inds 2007,12TCS 2007,12
 Source: Ambit Capital research; Note: * 2003, 08indicates that these companies have been identifiedas sector leaders in 2003 as well as in 2008.
Why do great Indian companies self-destruct?
Over 80% of ‘great’ Indian companies slide to mediocrity in a shortspan of time led by poor strategic decision-making fuelled by ’hubrisand arrogance‘. Such faulty strategic decisions usually result in poorcapital allocation which destroys RoCE and creates financial stress.Thus, the importance of evaluating and tracking strategic decisions toachieve long-term outperformance cannot be over-emphasisedalthough it is an area that is often overlooked. Through a series ofnotes, we will analyse management strategies of select companies.Our aim is not only to understand the past better but also to set aframework for analysing the future.
The systematic slide to mediocrity 
 
 We find that the average probability of a sector leader remaining a sector leader five years later is only 15%, implying that 85% of BSE500 companiesslide towards mediocrity. In fact, the average probability of a ‘great’ company becoming a sector laggard five years later is 25%. Even the Nifty ‘churns’ by around 50% or so every decade (as compared to around 25% for developedmarkets and around 30-40% in other major emerging markets). The tendency for large, successful companies to slide down the market-cap spectrum is notconfined to the Nifty.
 Why do successful firms slide with such regularity?
Promoters, in their own explanations for underperformance, tend to citeexogenous factors (such as business cycle, Government interference, risingcompetitive intensity or the macro environment). However, such explanationsare not always convincing because within the same sector (and hence subjectto the same regulatory and competitive forces), whilst some firms are sliding,others are rising. Contrast, for example, the performance over the past fiveyears of Infosys vs HCL Tech or Bajaj Auto vs TVS Motors. In our view, the slideis primarily due to poor strategic decision making.
Our framework and forthcoming research on this subject
 
In the first of a series of strategy notes, we present our framework to analyseand evaluate why companies slide in performance. The framework is primarily based on the works of Jim Collins and William Thorndike. The framework andthe case studies will help you understand how certain companies achievedgreat success, how they stumbled and how some of them recovered. The pastis relevant because it gives a peek into the future and is potentially adeterminant whether a company comes out of the rut to regain greatness. Thisfirst note has a preponderance of discussions on Tata group companies(owing to its virtue of being the largest and most diverse corporate group inIndia), an imbalance which subsequent notes will correct.
Investment implications
 
Our analysis shows that Tata Steel, Tata Motors, Titan and TTK Prestige are atan inflection point today. A cyclical turnaround in the domestic market couldpropel a turnaround at Tata Motors. Tata Steel, however, has larger challenges of sorting out the problems at Corus, even if the domestic demand were to see an upswing. Titan and TTK Prestige have had a great run for adecade and the key question is will growth stall over the next five years. Wehave no firm answers, but we prefer Tata Motors over Tata Steel. TTK Prestigeremains on our BUY list (we do not cover Titan at present but like TTK Prestige,Titan is also on our ten-baggers list).
 
 
Strategy 
 AmbitCapitalPvt Ltd
2
 
CONTENTS
Executive summary………………………………………………………………… 3
 
Introduction……………………………………………………………………….. 18
 
The ‘greatness’ framework………………………………………………………20
 
Self-destruction quantified……………………………………………………… 22
 
Identifying ‘fallen angels’………………………………………………………. 24
 
How and why do great companies fall?.................................................. 27
 
Case study: Titan…………………………………………………………………. 41
 
Case study: TTK Prestige………………………………………………………… 50
 
 What we will cover in our forthcoming notes…………………………………62
 
 
 
Strategy 
 AmbitCapitalPvt Ltd
3
 
Executive summary 
More than 80% of ‘great’ Indian companies slide to mediocrity in a brief span of time. Super successful companies usually become victims of their own successbecause after a while, ’hubris and arrogance‘ sets in and the promoter and/or management make ill-judged strategic decisions. More than anything to do withthe business cycle or with regulation or competition, this point emerges forcefully from our observations of corporate India over the past decade. Such faulty strategic decisions usually result in poor capital allocation which destroys RoCEand creates financial stress. Therefore, the importance of evaluating and trackingstrategic decisions to achieve long-term outperformance cannot be over-emphasised although it is an area that is often overlooked. Through a series of notes, we will analyse the management strategy of select companies, which willhelp you to understand not only the past but hopefully set a framework for analysing the future as well.
Exhibit 1: Factors used for quantifying greatness (as used in the 2012 model)
Head Criteria1 Investments
a. Above median gross block increase (FY10-12 over FY07-09)*b. Above median gross block increase to standard deviation
2 Conversion to sales
a. Improvement in asset turnover (FY10-12 over FY07-09)*b. Positive improvement in asset turnover adjusted for standard deviationc. Above median sales increase (FY10-12 over FY07-09)*d. Above median sales increase to standard deviation
3 Pricing discipline
a. Above median PBIT margin increase (FY10-12 over FY07-09)*b. Above median PBIT margin increase to standard deviation
4 Balance sheet discipline
a. Below median debt-equity decline (FY10-12 over FY07-09)*b. Below median debt-equity decline to standard deviationc. Above median cash ratio increase (FY10-12 over FY07-09)*d. Above median cash ratio increase to standard deviation
5Cash generation and EPSimprovement
a. Above median CFO increase (FY10-12 over FY07-09)*b. Above median CFO increase to standard deviationc. Above median EPS increase (FY10-12 over FY07-09)*d. Above median EPS increase to standard deviation
6 Return ratio improvement
a. Improvement in RoE (FY10-12 over FY07-09)*b. Positive improvement in RoE adjusted for standard deviationc. Improvement in RoCE (FY10-12 over FY07-09)*d. Positive improvement in RoCE adjusted for standard deviation
 Source: Ambit Capital research. Note: * Rather than comparing one annual endpoint to another annual endpoint (say, FY07 to FY12), we prefer toaverage the data out over FY07-09 and compare that to the averaged data from FY10-12. This gives a more consistent picture of performance (asopposed to simply comparing FY07 to FY12).
80% of companies slide into mediocrity…
 
…thanks to managementhubris and arrogance
 

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