June 07, 2013
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Saurabh Mukherjea, CFA
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The most prominent ‘fallen angels’
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.
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.
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).