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India’s Best And Worst Capital Allocators
On a cross-cycle basis we find that RoA drives share prices in India. Unfortunately, India’s RoA seems to be on a secular downtrend driven by falling profit margins and falling asset turnover. After showing that RoA ‘persistence’ is high at the sector level (but low at the stock level), we go on to identify market neutral pair trades across a range of sectors. Over the past five years, India’s RoA has fallen thrice as much as the MSCI EM’s RoA. As a result, India’s RoA premium to the MSCI EM has disappeared raising questions about India’s 40% P/E premium to the MSCI EM (exhibits A & B). Second, the main drivers of India’s RoA decline over the past six years have been a reduction in PAT margins (down 130bps or 12% between FY06FY08 (which we call phase 1) and FY09-FY11 (which we call phase 2) and a reduction in asset turnover (down 0.2x or 17% between the two phases). Third, we show that the sectors most afflicted by falling RoA – Non-ferrous Metals, Capital Goods, Shipping, Realty, Cement, Automobile, Steel, Hotels & Restaurants – have either seen heavy capex (in a country where the cost of capital is amongst the highest in the world and rising higher still) or largescale acquisitions or rapid foreign entry. Conversely, most sectors that have shown RoA improvement – Packaging, Entertainment, Paints, Mining & Mineral Products, Plastic Products, Media – are relatively capital light and have not been involved in the acquisition of large overseas assets. Fourth, we show that at the sector level RoA persistence is high in India i.e. sectors which have above-average RoA in phase 1 continue to have above-average RoA in phase 2. The same applies to sectors that have “belowaverage” RoAs. Only 19% of the total sectors defy this rule of RoA persistence. In contrast, companies do NOT display such RoA persistence. Even more interestingly, we find that RoA varies more within sectors than across sectors. Our findings suggest that investors should first focus on the sector call (given the relative stability of sector level RoAs and given the ability of RoAs to drive shareholders’ returns) and then make stock calls within their chosen sectors. In the table on the right we have shown the sectors which have displayed the most RoA improvement across the two phases. For investors who would like to bet on RoA changes within sectors without taking market risk, we highlight the following pair trades: 1. Construction- Long ENGR, Short IVRC (Momentum trade) 2. FMCG- Long BRIT, Short ZYWL (Mean reverting trade) 3. Automobiles- Long AL, Short TVSL (Mean reverting trade) 4. IT- Long HCLT, Short MPHL (Mean reverting trade) 5. Banks- Long PNB, Short SBIN (Momentum trade) 6. Capital Goods (Electrical Equipment)- Long SUEL, Short CRG (Mean reverting trade)
Saurabh Mukherjea, CFA
Tel: +91 22 3043 3174 firstname.lastname@example.org
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Exhibit A: India’s RoA premium over MSCI EM dwindles…
14% 12% 10% 8% 6% FY06 FY07 FY08 FY09 M EM RoA SCI FY10 India RoA
Source: Ambit Capital research
Exhibit B: …raising questions about India’s P/E premium
120% 100% 80% 60% 40% 20% 0% Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 May-05 May-06 May-07 May-08 May-09 May-10 Jan-11 May-11
Source: Ambit Capital research
Exhibit C: The only sectors with RoA increase across the FY06-11 period
Sector Packaging Entertainment Mining & Mineral products Paints/Varnish Plastic products Media - Print/Television/Radio Banks
Source: Capitaline, Ambit Capital research
RoA Change 1.8% 1.8% 1.6% 1.3% 0.3% 0.2% 0.0%
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 Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Please refer to the Disclaimers at the end of this Report.
Strategy: India’s best and worst capital allocators
Section 1: Focus on RoA
Given the difficult economic environment in India and abroad and given the adverse impact political gridlock in India is having on business outcomes in this country, we looked for a way to assess companies more dispassionately. Our search led us to analyzing capital allocation decisions of companies more closely because, whilst companies cannot control the economic and political environment, they can control the capital allocation decisions that they make. One way to assess the quality of a company’s capital allocation decisions is to examine its RoA across a full business cycle. So we have taken the last six financial years – FY06-FY11 and broken it into two phases: Phase 1 is FY06-FY08 Phase 2 is FY09-FY11.
We calculate the average RoA in phases 1 and 2 for BSE500 companies. That then allows us to calculate the change in RoA across Phase 1 & 2. This comparison of RoA across phases 1 & 2 throws up several investment implications which the rest of this note delves into: In this section we show the link between RoA and share price returns. In section 2 (on page 4) we analyse why RoA is on a secular downtrend in India. Section 3 (on page 10) looks at the persistence in RoA patterns across sectors i.e. sectors which are good at generating RoA tend to remain so. Stocks, however, do not display persistence to such an extent. Sections 4-9 (on page 12-28) then focus on specific sectors. We rank the stocks in each sector based on their change in RoA across the two phases. We then construct a pair trade for each sector using stocks with diametrically opposite RoA profiles. The intent is to build pairs which investors can use to generate returns for investors without exposing them to market risk.
The link between RoA and shareholder returns In the table below we have broken the BSE500 into five quintiles based on individual stock’s change in RoA between the two phases. Quintile 1 consists of the stocks with the biggest improvement in RoA and Quintile 5 contains the stocks with the lowest improvement (or the sharpest drop) in RoA.
Exhibit 1: RoA change (Phase 1 vs Phase 2) and the link to market performance
Quintile 1 2 3 4 5 Average Investment Returns 162% 114% 126% 39% 11% Median Investment Returns 64% 18% 22% -8% -7%
Source: Ambit Capital research Note: Returns are measured over Mar 31, 2008 to Mar 31, 2011 period
As the table above shows, whether we use average returns or median returns, investment returns drop gradually as we move from Quintile 1 towards Quintile 5.
Ambit Capital Pvt Ltd
Strategy: India’s best and worst capital allocators Exhibit 2: RoE change (Phase 1 vs Phase 2) and the link to market performance
Bucket 1 2 3 4 5 Average Investment Returns 260% 126% 20% 34% 12% Median Investment Returns 84% 32% 13% 10% -28%
Source: Ambit Capital research. Note: Returns are measured over Mar 31, 2008 to Mar 31, 2011 period
Just as Exhibit 1 focuses on showing the link between RoA and investment returns, Exhibit 2 shows the link between ROE and investment returns. Clearly, both ROE and RoA have a significant impact on investment returns. However, in the majority of this note we focus on RoA for two reasons: RoA strips out the impact of capital structure. Hence by focusing on RoA we make it harder for companies which have used more gearing to outshine companies which have used less gearing. As the next section of the note shows, our analysis shows that gearing has not changed significantly in India between Phases 1 and 2. Hence the correlation between companies with high RoA and high ROE is relatively high - 0.85 and 0.87 respectively for Phases 1 and 2 at a sector level (We remove Air Transport from our analysis because even though this sector’s PAT remains negative through the entire period, the equity values turn negative in the second phase thereby resulting in a positive RoE number which is meaningless.)
Ambit Capital Pvt Ltd
other Emerging Markets have not seen this sort of RoA drop – MSCI EM’s RoA fell by only 9% between the two phases as opposed to the 27% drop seen for India (see table on the next page).shows that of the two factors.Strategy: India’s best and worst capital allocators Section 2: The downtrend in RoA As shown in the charts below.which uses Dupont analysis to breakdown RoA into PAT Margin and Asset Turnover .On a decline RoA 16% 14% 12% 10% RoA RoE 20% 15% 10% 5% 0% 25% Exhibit 4: RoE Trend. in this section we explore the drivers of this secular downtrend. Exhibit 3: RoA Trend. Source: Ambit Capital Research. RoA and ROE have been on a secular downtrend for BSE500 across the last 5 years. Even more worryingly for investors in Indian Equities. This RoA decline is all the more worrisome for investors in the Indian market because it raises questions about the sustainability of the current 40% premium that India enjoys over MSCI EM on a P/E basis. a reduction in Asset Turnover has been the bigger driver. Before we enter sector specific analysis. Exhibit 7 on the next page .On a decline RoE 8% 6% 4% 2% 0% FY06 FY07 FY08 Year FY09 FY10 FY11 FY06 FY07 FY08 Year FY09 FY10 FY11 Source: Ambit Capital Research. Comparing India and MSCI EM RoA over the last six years highlights India’s relatively steeper decline more clearly (see chart below). Exhibit 5: India’s dwindles… 14% 12% 10% 8% 6% FY06 RoA premium over MSCI EM Exhibit 6: …raising questions about the P/E premium that India enjoys over MSCI EM 120% 100% 80% 60% 40% 20% 0% Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 FY07 India RoA FY08 FY09 MSCI EM RoA FY10 PE Premium Source: Ambit Capital research Source: Ambit Capital research Ambit Capital Pvt Ltd 4 .
7% 9.8% 3.6% -1% Phase 1 Phase 2 Change Phase 1 Phase 2 Change Source: Capitaline. Consumer Durables. Ambit Capital research.18 Phase 2 0.2% -0. Exhibit 8: RoE Declines (Phase 1 vs Phase 2) RoE 20.44 0.6% 3. Foreign entry into India: Some sectors in Exhibit 11 – Capital Goods.3% Rank in the Indian market 1 2 1 4 1 1 1 1 Note: Data refers to CY10 for Global and Asia Sales and FY10 for Indian Sales. Indian firms have found it particularly hard to hold their ground in the face of rising foreign competition (see table below). Company.9 0. Shipping and Textiles have been hit more by global overcapacity whereas Telecomm Services and Cement have been hit more by local overcapacity). please note that the above table if for BSE500 universe exFinancials Exhibit 8 (which uses Dupont analysis to breakdown ROE into PAT Margin.3% -12% Asset Turnover 1.4% 5.98 -0.4% 23.9 3.27 6.91 1. Steel. Ambit Capital research Rising cost of capital: A number of the sectors named on the next page have been capital hungry sectors – Capital Goods.18 0.6% % chg 9. Textiles. please note that the above table if for BSE500 universe ex-Financials So what has led to a PAT margin drop by 130bps over this period? And why has Asset Turnover dropped by 17% over this period? To understand this better.20 -17% Phase 1 Phase 2 Change Phase 1 Phase 2 Change Phase 1 Phase 2 Change Note: Phase 1 here is the FY06-08 average while Phase 2 is the FY09-FY11 average Source: Capitaline.98 -0. Power Generation & Distribution have been highly capital consumptive sectors in a country with rising cost of capital (see chart below).7% 9. Focusing first on PAT margin decline. Cement.24 3.4% -1. Exhibit 11 points towards three interesting points: Overcapacity: A number of sectors in Exhibit 11 – Shipping.1% -25% PAT Margin 10.4% -1. Agro Chemicals – have seen rapid foreign entry over the last 3-4 years particularly from Chinese and Korean firms.9% 1.6% 2. Telecom Services .54 2. Ambit Capital research. we turn next to sectors that have contributed to declines in each of these two parameters. Asset Turnover and Equity: Asset ratio) shows that PAT margin reduction and Asset Turnover reduction have been by far the bigger drivers of ROE decline (compared to a small decline in the Equity: Asset ratio).8% 62. Exhibit 9: Positioning of global players in their respective segments in the Indian consumer durables market (from our recent thematic “No Juicy Apples”) Company Nokia Samsung (Electronics) LG Sony Suzuki Unilever Colgate Reckitt Benckiser India Sales (USD bn) 3. Steel.1% % chg 15% -5.44 India as % of global sales 6. Source: Bloomberg. Non Ferrous Metals. Ambit Capital Pvt Ltd 5 .4% -27% PAT Margin 10.20 -17% Eq to Asset Ratio Change Phase 1 Phase 2 Change 62.3% -12% Asset Turnover Phase 1 1.3% 6.3% -3.Strategy: India’s best and worst capital allocators Exhibit 7: RoA Declining (Phase 1 vs Phase 2) RoA 12.have become characterized by either global or local overcapacity (eg.
4% -8.Hardware Source: Capitaline.7% -1.Electrical Equipment Textiles Consumer Durables Gas Distribution Agro Chemicals Auto Ancillaries Power Generation & Distribution Castings.1% -5.5% Ambit Capital Pvt Ltd 6 .9% -2.3% -1. Exhibit 11: Top Sectors with declining PAT Margins (Phase 1 vs Phase 2) Sector Shipping Hotels & Restaurants Miscellaneous Cement Non Ferrous Metals Capital Goods .) 10 9 8 7 6 5 Aug-10 Sep-10 Jul-10 Jan-11 Nov-10 Dec-10 Feb-11 Oct-10 Brazil China India Malaysia Philippines Source: Ambit Capital research.7% -1.9% -1.a.9% -1.7% -1.9% -1.2% -3.2% -2. Ambit Capital research PAT Margin Change -13.7% -4.Strategy: India’s best and worst capital allocators Exhibit 10: Indian banks' lending rates amongst the highest in the EM universe (from our Economy piece titled “India Inc needs affordable capital”) Base lending rates (in % p. Forgings & Fastners Steel Telecomm-Service Fertilizers IT .3% -3.4% -3.9% -3.
30) (0. Realty) or because the economic environment has not been particularly conducive over the last three years (Capital Goods). Realty– but the returns from such capex have been elusive either because of overcapacity (Auto. Metals.11) (0. Refineries. Ambit Capital Pvt Ltd 7 . Steel. Steel.Electrical Equipment Cement Logistics IT .15) (0.12) (0.42) (0.18) (0.Software Plastic products Finance Retail Source: Capitaline. Exhibit 13: Sectors with the highest increase in assets (% increase Phase 2 vs Phase 1) Sector Ship Building Computer Education Healthcare Realty Infrastructure Developers & Operators Construction Entertainment Cement Automobile Steel Non Ferrous Metals Telecomm-Service Hotels & Restaurants IT . Asset Increase 207% 193% 171% 169% 155% 150% 123% 115% 108% 108% 97% 97% 95% 94% 92% 92% 91% Foreign acquisitions – In some of these sectors – Auto.11) (0.22) (0. Capital Goods.45) (0.Software Auto Ancillaries Hotels & Restaurants Shipping Computer Education Telecomm-Service Chemicals Plastic products Source: Capitaline. Exhibit 12 points to a number of interesting points: Inability to sweat fresh capex – The table above has a number of sectors where we have seen heavy capex over the last 3-4 years – Auto.18) (0. Non-ferrous metals – Indian firms have been notable acquirers of large foreign assets (see table below) which have had lower asset turnover ratios.Strategy: India’s best and worst capital allocators Exhibit 12: Top Sectors on Asset Turnover decline (Phase 1 vs Phase 2) Sector Automobile Diversified Refineries Capital Goods-Non Electrical Equipment Non Ferrous Metals Steel Realty Construction Capital Goods .19) (0.36) (0.32) (0.59) (0. Steel. Ambit Capital research.37) (0.10) Moving on to Asset Turnover decline. Ambit Capital research Turnover Change (0. Nonferrous metals.21) (0.18) (0.24) (0.
706 1.37) (0.7% -8. Exhibit 15: Top Sectors with RoA decline Sector Non Ferrous Metals Shipping Capital Goods .300 847 703 625 In light of the challenges highlighted above (around maintaining PAT margins and Asset Turnover) it is not surprising that the sectors whose RoAs fell the most across these two phases are as follows: Shipping.1% -0.Electrical Equipment Realty Cement Steel Hotels & Restaurants Automobile Capital Goods-Non Electrical Equipment IT .18) -29% -26% Share Price Performance* 27% -36% -23% -66% -6% 4% -27% 117% 20% 105% 12% -1% Source: Ambit Capital research.Materials and Automobiles Acquirer Materials Tata Steel Ltd Hindalco Industries Ltd JSW Steel Ltd Kohinoor Foods Ltd Essar Global Ltd Tata Chemicals Ltd Automobiles Tata Motors Ltd Hero Motocorp Ltd Mahindra & Mahindra Ltd Eicher Motors Ltd Source: Bloomberg Target Announcement Date Announced Total Value (USDmn) 12.1% -3% -3% Asset Turnover Change (x) (0.21) (0.972 1.30) (0.Strategy: India’s best and worst capital allocators Exhibit 14: Key acquisitions by Indian firms. If we focus now on the other end of the RoA spectrum – on sectors which have shown an RoA improvement across the two periods – see table below – we find that these sectors have.7% -6.9% -13.780 5. shown PAT margin and asset turnover improvements.4% -1. Ambit Capital Pvt Ltd 8 .15) (0.22) (0.0% -7.4% -8.Software Average Median RoA Change -9.3% -7% -6% PAT Margin Change -3. Capital Goods. Steel. Realty.0% -5.4% -3. Non Ferrous Metals.432 1.59) (0.2% -0.18) (0. Hotels. by and large.36) (0.8% -8.3% -4.0% -4.8% -5. Auto and IT . Cements.005 Corus Group Ltd Novelis Inc/GA JSW ISPAT Steel Ltd Nagarjuna Fertilizers & Chemicals Essar Steel Algoma Inc General Chemical Industrial Products Inc 17-Oct-06 11-Feb-07 23-Dec-10 8-Aug-11 15-Apr-07 31-Jan-08 Jaguar Land Rover Operations Hero Motocorp Ltd Ssangyong Motor Co Volvo AB 26-Mar-08 16-Dec-10 23-Nov-10 10-Dec-07 2.3% 1.* Share price performance as calculated from Mar 31st 2008 to Mar 31st 2011.6% -5.7% -5.421 1.7% -0.32) (0.Software (see Exhibit 15).
0) Share Price Performance* -21% 6% -10% 105% 26% -27% 77% 22% 6% Source: Capitaline.0% -0.3% 0. which has shown negative shareholder returns and Banks.01) 0.3% 4. Hence their PAT margins have not been impacted meaningfully by the rising cost of capital in India.8% 1. Ambit Capital Pvt Ltd 9 .07 (0.Print/Television/Radio Banks Average Median RoA Change 1.8% 1.00) (0.02 (0.0) (0.3% 0.02) (0.5% 1. which has clocked negligible change in RoA).4% 1% 1% Asset Turnover Change (x) 0. So why have the sectors shown in the table above been able to improve their RoAs? Relatively few acquisitions: Very few Indian firms in the sectors shown above embarked upon global acquisitions.6% 1.0% 1% 1% PAT Margin Change 2. * Share price performance as calculated from Mar 31st 2008 to Mar 31st 2011.0% 0.10) 0.Strategy: India’s best and worst capital allocators Exhibit 16: The only sectors with RoA improvements across the two phases Sector Packaging Entertainment Mining & Mineral products Paints/Varnish Plastic products Media .7% 0. Ambit Capital research.7% 0.2% 0. Capex light: The sectors shown in the table above are relatively capex light (with the exception of Mining.02 (0.
Thankfully. If it turns out that RoA is immensely volatile and fluctuates dramatically from one period to the next. Also. clearly focusing on past trends will then be of limited value. most sectors which generate above average RoA in phase 1 of our study are also likely to display above average RoA in phase 2 of our study. In statistical terms. In fact.Software Capital Goods-Non Electrical Equipment Automobile Logistics Cement Capital Goods . there is an 82% correlation between sectoral RoAs across phases 1 & 2.Strategy: India’s best and worst capital allocators Section 3: Autocorrelation and Variability The whole premise of analyzing RoA is predicated on the consistency and stability of this metric. Forgings & Fastners Alcoholic Beverages Telecomm-Service Textiles Miscellaneous Consumer Durables Trading IT .Hardware Refineries Ship Building Glass & Glass Products Hotels & Restaurants Air Transport Service Source: Ambit Capital research Ambit Capital Pvt Ltd 10 . at the sector level RoA is relatively stable i. only 19% of sectors – the two middle columns of the table below – switch from above average to below average (or vice versa) across the two phases. sectors which have below average RoA in Phase 1 are also likely to stay below average in Phase 2.Print/Television/Radio Pharmaceuticals Construction Sectors with below average RoAs in Phase 1 and 2 Telecomm Equipment & Infra Services Packaging Entertainment Sugar Cables Infrastructure Developers & Operators Healthcare Plastic products Banks Retail Agro Chemicals Power Generation & Distribution Diamond.Electrical Equipment Sectors with above average RoA Sectors with below average in Phase 1 but below average in RoA in Phase 1 but above Phase 2 average in Phase 2 Steel Realty Shipping Non Ferrous Metals Plantation & Plantation Products Computer Education Tyres Media .e. Gems and Jewellery Finance Edible Oil Fertilizers Paper Castings. Exhibit 17: Persistence in RoA across the two phases Sectors with above average RoAs in Phase 1 and 2 Mining & Mineral products Paints/Varnish FMCG Gas Distribution Chemicals Diversified Auto Ancillaries Crude Oil & Natural Gas IT .
Ambit Capital Pvt Ltd 11 . We then structure pair trades around our expectation of how RoA will evolve going forward for specific companies. Analysing RoA within sectors In the sector specific sections which follow we look at cross-cycle RoA performance for the constituents of each sector and thereby identify the best and worst RoA performers inside each sector.Strategy: India’s best and worst capital allocators At the stock level. however. this suggests that the first investment call should be on the sector as. These two points – (a) sectoral RoAs are more stable than stock level RoAs across time. from a RoA perspective. Mean reverting pair trades: Here we go long (short) on the firm which has UNDERperformed (OUTperformed) its sectoral peers on RoA over the past 6 years.28 0. our pair trade strategies fall under two broad categories: Momentum pair trades: Here we go long (short) on the firm which has outperformed (underperformed) its sectoral peers on RoA over the past 6 years. Exhibit 18: Regression Results (Phase 2 over Phase 1) Sector Level Correlation Coefficient R Square Source: Ambit Capital research Stock Level 0.72 Within Sector 1.53 0.69 0. The correlation for stocklevel RoAs across two periods is a mere 53% suggesting that sector level RoA is far more stable across time than stock level RoA.FMCG. Our forensic accounting model ranks BSE500 stocks in each sector into four quartiles – quartile A is the 25% of stocks with the best accounting quality and quartile D is the worst 25% of stocks from an accounting quality perspective. We have mean reverting pair trades in the following sectors. Moreover. Banks. making a call on RoA at the stock level is a tricky affair.47 1.68 Continuing on this thread. and (b) at a point in time. We have momentum pair trades in two sectors. it is a more stable unit of analysis than individual stocks are. this flight to quality has been especially more stark in the last three year period. 3 and 5 years across a variety of metrics. Automobiles.Construction. Hence investors need to use tools such as our forensic accounting model to identify high quality companies within their chosen sectors. * This is standard deviation / average. the picture is very different. Capital Goods (Electrical Equipment). RoAs fluctuate more WITHIN A SECTOR THAN ACROSS SECTORS. we showed that companies with better accounting quality have generated superior stock market performance across 1. Given the high variability in RoA across stocks in a specific sector. The same point also emerges from regression analysis – see table below. Information Technology. Secondly.46 Source: Ambit Capital research. In a note dated 9th May. variability in RoAs is greater within a sector than across sectors – have important investment implications: Firstly. You might want to think of these companies as India’s best and worst capital allocators over the past six years given that they are being compared to their closest listed peers on a like-for-like basis across a lengthy period of time. 2011. Exhibit 19: Variability in RoAs: Across and within sectors Coefficient of Variation* Phase 1 Phase 2 Across Sectors 0.82 0. once we are within sectors.e. we show in the table below that variability of return on asset ratios across sectors is lower than within sectors i.
16 -0.51 0.28 -0.09) (0.Deconstructing RoA (Change from Phase 1 to Phase 2) Firm Absolute* Sector Relative* Profit Asset Profit Asset RoA RoA Margin Turnover Margin turnover Change Change Change Change Change change 19% 0% 0% 0% -1% -1% -1% -1% -2% -2% -2% -4% -6% -7% -2% 0% -1% -1% 3% -1% 0% -1% 0% -1% -2% -4% -2% -6% 0. NCC IVRCL Patel Engg.36) (0.15 -0. CCCL Bloom Ticker ENGR IN EQUITY PUNJ IN EQUITY ERIE IN EQUITY SINF IN EQUITY LT IN EQUITY GMON IN EQUITY SADE IN EQUITY HCC IN EQUITY AHLU IN EQUITY NJCC IN EQUITY IVRC IN EQUITY PEC IN EQUITY CCCL IN EQUITY Vascon Engineers VSCN IN EQUITY Source: Capitaline.08 0. The figures here are as sourced from Capitaline and may differ somewhat from the bottom up numbers of our sector leads. Exhibit 20: Construction.05) 0. the driver for lower RoA in this sector has been a reduction in PAT margin and a reduction in Asset Turnover.745 477 889 497 22. NCC IVRCL Patel Engg.29 -0.Construct.368 673 358 490 295 577 981 705 208 311 16% 2% 8% 6% 17% 10% 8% 6% 21% 7% 8% 11% 11% 9% 13% 2% 7% 6% 18% 3% 12% 1% 22% 7% 8% 9% 15% 16% 17% 6% 6% 6% 17% 5% 12% 4% 28% 7% 8% 9% 15% 11% 15% 4% 7% 6% 17% 6% 11% 4% 24% 7% 8% 10% 14% 12% 25% 6% 8% 6% 18% 6% 11% 4% 23% 5% 7% 7% 10% 4% 39% 5% 7% 5% 17% 4% 7% 2% 22% 6% 6% 4% 10% 6% RoA Phase 2 2011 Average 39% 0% 0% 0% 14% 0% 10% 1% 0% 3% 4% 0% 5% 6% 34% 4% 7% 6% 16% 5% 9% 2% 22% 5% 6% 6% 8% 5% RoA Change 19% 0% 0% 0% -1% -1% -1% -1% -2% -2% -2% -4% -6% -7% In Top Half on Accounting? YES YES NO NO YES NO NO NO YES YES NO NO NA NA Ahluwalia Contr.04 0.99 (0.06 (0.Strategy: India’s best and worst capital allocators Section 4: Construction With the exception of EIL.25) (0. Hind. we focus on our long-short trade on this pair.15 0. Simplex Infra Larsen & Toubro Gammon India Sadbhav Engg. Ahluwalia Contr.29 -0. Simplex Infra Larsen & Toubro Gammon India Sadbhav Engg. Ambit Capital research As the table below shows. Hind.28 -0.60) 0.11 -0. no other firm in this sector has been able to improve its RoA between Phase 1 and Phase 2.07 0.20) (0.20 (0. Exhibit 21: Construction. AHLU IN EQUITY Vascon Engineers VSCN IN EQUITY Source: Capitaline. Profit Margin and Asset Turnover for the firm in absolute terms from Phase 1 to Phase 2 while the ‘Sector Relative’ changes highlight the same measures for the firm relative to the sector.36) (0. a consulting firm.00 -0.24) 0. Ambit Capital Pvt Ltd 12 . CCCL Bloom Ticker ENGR IN EQUITY PUNJ IN EQUITY ERIE IN EQUITY SINF IN EQUITY LT IN EQUITY GMON IN EQUITY SADE IN EQUITY HCC IN EQUITY NJCC IN EQUITY IVRC IN EQUITY PEC IN EQUITY CCCL IN EQUITY Mkt Cap RoA RoA RoA Phase 1 RoA RoA (USD mn) 2006 2007 2008 Average 2009 2010 2.20 (0.16) 19% 0% 0% -1% -1% -1% -1% -2% -2% -2% -2% -4% -6% -7% -3% -1% -2% -1% 2% -2% -1% -2% -1% -1% -3% -4% -2% -6% 1. Ambit Capital research * The ‘Firm absolute’ figures here indicate the changes in RoA.07 Firm Name Engineers India Punj Lloyd Era Infra Engg.16 0.How they stack up on RoA Changes Firm Name Engineers India Punj Lloyd Era Infra Engg. In light of EIL’s positive RoA trend and IVRCL’s negative RoA trend.Construct.
The increasing proportion of slow moving Andhra Pradesh irrigation projects and captive road projects in FY2010 and 2011 moderated revenue CAGR to 16% over FY2008-2011 from 51% CAGR over FY2005-2008. resulting in low capital investment requirements for this business. EIL’s order book at the end of June -2011 is Rs68bn and LSTK segment accounts for ~64% of the order book. The company has a negative working capital cycle as it takes mobilization advances from clients to execute contracts. EIL posted revenue growth of 41% and net earnings growth of 29%. Going forward whilst we do not expect similar revenue growth as in the last three years. building and power) and this entails heavy working capital investments in the business. EIL mostly provides overall project management services and has back-to-back contracts for civil construction jobs. The increasing proportion of lump sum turnkey EPC contracts (LSTK) in the revenue mix since FY08 (60% in FY11 versus 25% over FY05-08) has resulted in revenue CAGR of 56% over FY2008-2011 compared with a decline of 7% over FY2005-2008.Strategy: India’s best and worst capital allocators Analyst: Nitin Bhasin nitinbhasin@ambitcapital. EIL. In the recently reported 1QFY12 numbers. transportation. with people and computers as its main assets. Whilst company level EBITDA margin declines may lead to net margin decline (LSTK has a lower EBITDA margin). We highlight that neither of these segments require any meaningful capital investments.Engineers India (ENGR IN) EIL provides consultancy and project management services primarily in the hydrocarbon and petrochemical sectors. As the company focuses only on its core businesses and does not have any BOT aspirations. historically IVRCL’s RoAs (4%-8%) have always been significantly lower than EIL (19%-39%). Short IVRC (Momentum trade) Long Trade.2X in FY2011 (0. most of its capital employed remained invested in the business rather than future investments. Its foray into related engineering sectors such as renewable energy and nuclear power can add more revenue streams and also bring some more benefits of operating leverage to net margins. This coupled with high revenue growth increased the capital employed turnover to 2. thus keeping the capital employed requirements low. In the construction segment. high revenue growth in LSTK businesses along with no meaningful requirement of gross block or working capital led to high operating leverage thus driving PAT by 39% CAGR over FY2008-2011. incremental improvements in asset turnover are expected on account of continuing revenue growth in LSTK and consultancy business growth picking up. RoAs will increase from hereon on account of asset turnover increasing more than the decline in net margins.IVRCL Infra (IVRC IN) IVRCL is engaged in civil construction across different sectors (water/irrigation. Short Trade. EIL is a debt free company and works on an asset light model. Ambit Capital Pvt Ltd 13 .6X in FY2008).com Tel: +91 22 3043 3203 Pair Idea: Long ENGR.com Tel: +91 22 3043 3241 Analyst: Chhavi Agarwal chhaviagarwal@ambitcapital. Whilst the average EBITDA margins on this fast growing LSTK projects were lower than the consultancy business. This should allow EIL to maintain revenue growth momentum in the near-term. Therefore.
3X in FY2012 from the current level of 1.5X in FY2008. we believe IVRCL will have to raise debt in order to fund its BOT aspirations.3bn invested in subsidiaries over FY2208-11) and rising working capital requirements.20 7. IVRCL has to invest ~Rs1. Given that captive orders are slow moving due to the lack of availability of capital.20 8.20 4.3X in FY2008.20 2.Parabolic outperformance.20 3.1% in FY2008. IVRCL’s order book at the end of June 2011 is Rs237bn and captive orders (road) continue to account for 20%~25% of the order book. We expect debt-equity to increase to 1.20 1. Despite revenue growth picking up over next couple of years.20 ENGR/IVRC Price Ratio Technical analyst: Gaurav Mehta gauravmehta@ambitcapital. A large amount of incremental capital will be invested in businesses which will not add to net margins in the near-term.3% over FY2009-2011(9.20 Mar/06 Mar/07 Mar/08 Mar/09 Mar/10 Mar/11 Jul/05 Jul/06 Jul/07 Jul/08 Jul/09 Jul/10 Nov/05 Nov/06 Nov/07 Nov/08 Nov/09 Nov/10 Jul/11 14 Source: Ambit Capital research Ambit Capital Pvt Ltd . Execution delays in the slow moving orders increased working capital requirements hence capital employed turnover declined to 2. we expect revenue growth to be only ~10%-12% in FY2011.0X in FY2011 from 0. pulling them lower to 2. Rising working capital requirements in FY12.0X in FY2011 from 2.6% over FY2006-2008) as moderate revenue growth resulted in low fixed overhead costs absorption. At the end of FY2011.20 5.com Tel: +91 22 3043 3255 6. High interest costs compounded the impact on net margins. increasing BOT equity infusions and declining net earnings margins will keep RoAs at low levels. we expect high leverage costs to keep PAT margins low.0X. increased the Debt:Equity to 1. Price Ratio Exhibit 22: ENGR over IVRC. Increasing investments in the BOT assets (Rs6. mainly in IVRAH which owns underperforming road BOT assets and stalled real estate projects.8bn in BOT road projects in FY2012 and post that another Rs6bn over the next three years.Strategy: India’s best and worst capital allocators Average EBITDA margins declined to 9.20 0.8% in FY2011 from 5. We expect RoA to decline by another 100bps over next couple of years. expect trend to continue 9. nearly 30% of the capital employed was invested in BOT assets. IVRCL continues to face execution issues and revenue grew by only 2% YoY in 1QFY12. Given that IVRCL does not generate positive cash flows.
25 0.31 GlaxoSmith C H L SKB IN EQUITY Godrej Consumer GCPL IN EQUITY Source: Capitaline. Gillette India Dabur India Bloom Ticker CLGT IN EQUITY ZYWL IN EQUITY NEST IN EQUITY ITC IN EQUITY REIA IN EQUITY KLD IN EQUITY JYL IN EQUITY PG IN EQUITY MRCO IN EQUITY TGBL IN EQUITY HMN IN EQUITY BRIT IN EQUITY GILL IN EQUITY DABUR IN EQUITY Mkt Cap (USD mn) 2.13 -0.343 1.Strategy: India’s best and worst capital allocators Section 5: FMCG Inspite of FMCG’s obvious cash generative qualities and inspite of its robust profit margins.21) (0.162 31. Exhibit 23: FMCG.67) (3.22) (0.How they stack up on RoA Changes Firm Name Colgate-Palm.26 0.64 0.254 3.68 0.67 -3.16 -0.98 (0.69) 0.07) 0.60 -0.05 -0.06) (0.715 2. Zydus Wellness Nestle India ITC REI Agro Kwality Dairy Jyothy Lab. P & G Hygiene Marico Tata Global Emami Britannia Inds.11 -0. Ambit Capital research * The ‘Firm absolute’ figures here indicate the changes in RoA.Deconstructing RoA (Change from Phase 1 to Phase 2) Firm Absolute* Firm Name Colgate-Palm.16) (0.18 -0. Profit Margin and Asset Turnover for the firm in absolute terms from Phase 1 to Phase 2 while the ‘Sector Relative’ changes highlight the same measures for the firm relative to the sector. the majority of firms in this sector have seen their RoAs fall between Phase 1&2 as rising competition and overseas acquisitions take their toll.39 0.59 (0.21 -0.132 2.446 1.06 0.31) 41% 24% 9% 5% 4% -1% -1% -1% -2% -2% -2% -3% -3% -9% -9% -59% 6% 7% 2% 1% 0% -2% 1% 0% 2% 3% -10% 2% -2% -3% 1% 1% 0.63 0. Ambit Capital research Exhibit 24: FMCG.20 -0.39) 0.10 (0.99 -0.463 519 8. The figures here are as sourced from Capitaline and may differ somewhat from the bottom up numbers of our sector leads. Gillette India Dabur India Bloom Ticker CLGT IN EQUITY ZYWL IN EQUITY NEST IN EQUITY ITC IN EQUITY REIA IN EQUITY KLD IN EQUITY JYL IN EQUITY PG IN EQUITY MRCO IN EQUITY TGBL IN EQUITY HMN IN EQUITY BRIT IN EQUITY GILL IN EQUITY DABUR IN EQUITY Sector Relative* Profit Asset Profit Asset RoA RoA Margin Turnover Margin turnover Change Change Change Change Change change 40% 22% 8% 4% 3% -2% -2% -3% -3% -3% -3% -4% -5% -10% -10% -60% 6% 7% 1% 0% 0% -2% 0% 0% 1% 2% -10% 1% -3% -4% 0% 0% 0.19) (0. P & G Hygiene Marico Tata Global Emami Britannia Inds. Zydus Wellness Nestle India ITC REI Agro Kwality Dairy Jyothy Lab.345 984 1.628 RoA RoA RoA Phase 1 RoA 2006 2007 2008 Average 2009 50% 15% 78% 23% 24% 6% 10% 18% 51% 20% 13% 13% 26% 0% 40% 150% 56% 139% 21% 25% 25% 5% 11% 18% 31% 33% 13% 26% 17% 40% 60% 59% 19% 25% 25% 4% 8% 16% 38% 24% 12% 28% 22% 28% 58% 52% 98% 113% RoA RoA Phase 2 RoA 2010 2011 Average Change 121% 40% 104% 28% 28% 3% 7% 15% 37% 23% 9% 18% 17% 24% 43% 27% 40% 22% 8% 4% 3% -2% -2% -3% -3% -3% -3% -4% -5% -10% -10% -60% In Top Half on Accounting? NO YES YES YES YES YES NO NA NO YES NO NO YES NO YES NO 82% 131% 128% 105% 18% 24% 25% 5% 10% 17% 40% 26% 13% 23% 22% 34% 53% 87% 35% 26% 23% 2% 8% 11% 41% 21% 6% 12% 21% 23% 42% 27% 45% 96% 31% 29% 3% 7% 20% 34% 25% 15% 19% 14% 24% 50% 30% 42% 0% 0% 31% 4% 0% 13% 0% 22% 7% 25% 16% 0% 35% 24% 96% 113% GlaxoSmith C H L SKB IN EQUITY Godrej Consumer GCPL IN EQUITY Source: Capitaline. Ambit Capital Pvt Ltd 15 .13 (0.894 1.202 349 558 274 1.
Importantly.Strategy: India’s best and worst capital allocators ColPal has been the RoA star across the two phases although we note that its RoA uplift in FY08 was mainly driven by a reduction in share capital as a result of its move to return cash to shareholders. firstname.lastname@example.org Tel: +91 22 3043 3285 Pair Idea: Long BRIT. we expect ebidta margins for the company to see an improvement by 200-300 bps and (assuming constant asset turn) overall RoA for the company could see improvement by 500 bps over the next 2-3 years. Its strong growth during the period FY06-11 was led by brands such as ‘Sugar Free’.Zydus Wellness (ZYWL IN) Zydus Wellness is a niche player in the FMCG space. On an aggregate basis we expect industry growth could be in the region of 20%. Raw Material Inflation trends are also moderate as compared to the recent past. Its operating margin saw a decline by 300bps during the period FY06-11 and this trend had the maximum impact on the RoA of the company. On an aggregate basis. Our view is that competitive intensity in these niche categories has seen a significant increase over the last 2-3 years (launch of margarine and facewash products by other players) and this in our view could have significant impact on growth profile and margin trends of the company. RoA for the company could see a meaningful decline by 500-700 bps led by decline in asset turn and margins over the next 2-3 years. it reported growth of more than 60% in sales and a 10% point expansion in margins which resulted in a nearly doubling of average RoA to 40%. GCPL’s RoA has been dragged down from FY09 onwards due to its several acquisitions which have progressively led to lowering of RoA as against the high RoA legacy portfolio. In our opinion. During this period.Britannia (BRIT IN) Britannia Industries had significantly underperformed its FMCG peers on account of margin challenges during the period FY06-11. However. In our opinion. ‘Nutralite’ and ‘EverYuth’. asset turnover during the same period was healthy and remained above trend. This increase in competitive intensity is also corroborated by a significant slowdown in sales growth momentum reported by the company over past 2-3 quarters. Analyst: Vijay Chugh vijaychugh@ambitcapital. Short trade. Britannia has over last several years taken significant steps to strengthen some of its key brands such as ‘Good Day’. At the other extreme. Price Ratio – see charts on the next page Ambit Capital Pvt Ltd 16 . Short ZYWL (Mean reverting trade) Long Trade.com Tel: +91 22 3043 3054 Analyst: Ashvin Shetty. the growth outlook for the biscuit and packaged food category is very encouraging and this should benefit the company significantly. ‘Nutri Choice’ and ‘Tiger’ which we believe will help in protecting margins.
00 0.40 1.Reinforcing our forward looking hypothesis on reversion 1.10 1.70 1.Strategy: India’s best and worst capital allocators Exhibit 25: BRIT over ZYWL (Longer Term).20 4.70 0.20 1.20 1.20 3.60 0.20 0.40 Jan/10 Mar/10 May/10 BRIT/ZYWL Price Ratio Jun/10 Jan/11 Mar/11 Sep/10 May/11 Feb/10 Aug/10 Nov/10 Jun/11 Apr/10 Jul/10 Source: Ambit Capital research Ambit Capital Pvt Ltd Aug/11 17 Dec/09 Feb/11 Apr/11 Dec/10 Oct/10 Jul/11 .80 0.20 Mar/06 Mar/07 Mar/08 Mar/09 Mar/10 Nov/05 Nov/06 Nov/07 Nov/08 Nov/09 Nov/10 Mar/11 Jul/05 Jul/06 Jul/07 Jul/08 Jul/09 Jul/10 Jul/11 BRIT/ZYWL Price Ratio Technical analyst: Gaurav Mehta email@example.com 4.90 0.70 3.70 2.30 1.70 0.50 0.com Tel: +91 22 3043 3255 Source: Ambit Capital research Exhibit 26: BRIT over ZYWL (Shorter Term).RoA improvements have led to BRIT underperforming ZYWL massively 5.20 2.Signs of bottom formation.
23) 0. Exhibit 28: Automobiles. Ambit Capital research * The ‘Firm absolute’ figures here indicate the changes in RoA. The figures here are as sourced from Capitaline and may differ somewhat from the bottom up numbers of our sector leads.68 0. M&M Maruti Suzuki Eicher Motors Ashok Leyland Tata Motors Bloom Ticker BJAUT IN EQUITY HH IN EQUITY ESC IN EQUITY TVSL IN EQUITY MM IN EQUITY MSIL IN EQUITY EIM IN EQUITY AL IN EQUITY TTMT IN EQUITY Sector Relative* Profit Asset Profit Asset RoA RoA Margin Turnover Margin turnover Change Change Change Change Change change 15% 10% 5% -2% -3% -4% -6% -9% -11% 6% 2% 4% 0% -1% -3% 7% -1% -3% (0. M&M Maruti Suzuki Eicher Motors Ashok Leyland Tata Motors Bloom Ticker BJAUT IN EQUITY HH IN EQUITY ESC IN EQUITY TVSL IN EQUITY MM IN EQUITY MSIL IN EQUITY EIM IN EQUITY AL IN EQUITY TTMT IN EQUITY Mkt Cap (USD mn) 9.682 17.58 Source: Capitaline. thanks to burgeoning demand in India.13) (1.How they stack up on RoA Changes Firm Name Bajaj Auto Hero Motocorp Escorts TVS Motor Co.531 9.Deconstructing RoA (Change from Phase 1 to Phase 2) Firm Absolute* Firm Name Bajaj Auto Hero Motocorp Escorts TVS Motor Co.26 0. Bajaj Auto has been the transformational story in the sector.8% 4.86 0. the majority of Auto firms have seen their RoA drop over the last 6 years.1% 6% 1.56 -0.092 738 1.27 (2.15) 20% 15% 10% 3% 2% 1% -1% -4% -6% 6% 2% 4% 0% 0% -3% 7% -1% -2% 0.75 -0.387 8.31) (0. PAT margins have held up for most of the Auto companies.2% 4.32 0. Profit Margin and Asset Turnover for the firm in absolute terms from Phase 1 to Phase 2 while the ‘Sector Relative’ changes highlight the same measures for the firm relative to the sector.30 0.Strategy: India’s best and worst capital allocators Section 6: Automobiles Maintaining the pattern seen in the preceding sections. Tata Motors has struggled to digest JLR as evidence by its RoA drop in FY09 and weak recovery thereafter. At the other extreme.621 506 9. However.32) (1.594 RoA RoA RoA 2006 2007 2008 0% 44% 1% 23% 22% 35% 16% 18% 0% 33% 0% 21% 21% 10% 17% 18% 26% 31% 1% 16% 19% 10% 15% 14% Phase 1 RoA RoA RoA Average 2009 2010 2011 26% 36% 1% 20% 20% 18% 16% 17% 19% 33% 5% 9% 12% 9% 3% 4% 40% 63% 7% 19% 20% 16% 7% 7% 64% 43% 0% 0% 21% 16% 0% 10% 5% Phase 2 RoA In Top Half on Average Change Accounting? 41% 46% 6% 3% 17% 16% 12% 7% 5% 15% 10% 5% -2% -3% -4% -6% -9% -11% NA YES NO NO NO YES NO NO YES 434 10. Exhibit 27: Automobiles.34 0.25) 0.84 -1.7% Source: Capitaline. Ambit Capital research As is well known.6% 2.12 (0. Ambit Capital Pvt Ltd 18 .
000 units in FY12 and with Pantnagar facility providing savings of around Rs40. this subsidiary accounted for nearly 36% of the total consolidated capital employed.Strategy: India’s best and worst capital allocators Pair Idea: Long AL. we expect contribution from these major initiatives to increase significantly specially from FY13. going forward. the major reason for decline in RoA has been the significant capex in new facilities (Pantnagar) as well as the investments made by the company in joint-ventures such as Nissan (for light commercial vehicles) and John Deere (for construction equipment).72x in FY11 despite sales growing at a CAGR of 16% over FY06-11. the company saw a strong bounce back in FY11 when net earnings nearly doubled over FY10 on the back of strong volume growth of 33% (helped by strong industry growth as well as market share gains). Similarly. While the profit margin of the company has remained more or less constant: from 5. it is expected contribute significantly to both the top as well bottom-line. However.5% in FY11.53x in FY06 to 1. Over longer term we expect this category will significantly underperform on growth relative to the overall two wheeler market.Ashok Leyland (AL IN) Ashok Leyland’s standalone RoA has come down significantly over the years from 16% in FY06 to 10% in FY11. Similarly.TVS Motors (TVSL IN) TVS Motors’ standalone RoA has remained more or less constant between FY06 to FY11 at 10%.000/vehicle (in the form of lower taxes and duties). The production from the Pantnagar facility is expected to go up from 13. a drop of nearly 600bps. Short Trade. and c) Nearly 25% of sales are from Mopeds. Similarly. we expect RoA of TVS Motors to remain at the current levels on account of following: a) The company continues to invest increasingly in unrelated business such as TVS Energy and TVS housing. As at FY11-end the total investment in TVS energy stood at Rs518mn. the average RoA for FY09-FY11 at 6% has remained at the same level as the average RoA for FY06-FY08.com Tel: +91 22 3043 3285 Long Trade. This should help improve the RoA. going forward. Ambit Capital Pvt Ltd 19 . With TVS Group appearing serious about these venture. As at March 2010. especially FY08 and FY09. there could be significant investments going forward in these ventures. Short TVSL (Mean reverting trade) Analyst: Ashvin Shetty ashvinshetty@ambitcapital. b) The company also continues to invest significantly into its loss making Indonesian subsidiary.000 units in FY11 to 36. However. the average RoA for FY09-11 is lower than the average RoA for FY06-FY08 by nearly 900bps.7% in FY05 to 5. nearly 7% of the standalone networth. the investments in joint-ventures with Nissan and John Deere should start yielding positive contribution with expected launches of light commercial vehicles in 2QFY12 and construction equipment in 4QFY12. The total capex for Pantnagar along with investments in these jointventures constituted nearly 25% of the total net assets as at FY11-end while contributing marginally to the revenues/profits thereby suppressing the return ratios. saw significant drop in profitability (and hence RoA). Operating performance of this subsidiary continues to be weak with the company recording gross margin loss in FY09 and FY10. While the interim period between FY06 and FY11. The average asset-turnover dropped from 2.
40 1.80 0.com Tel: +91 22 3043 3255 1.Close to recent lows indicating good opportunity to play a reversal 1.20 Mar/06 Mar/07 Mar/08 Mar/09 Mar/10 Nov/05 Nov/06 Nov/07 Nov/08 Nov/09 Nov/10 Mar/11 Jul/05 Jul/06 Jul/07 Jul/08 Jul/09 Jul/10 Jul/11 20 Source: Ambit Capital research Ambit Capital Pvt Ltd .40 0.Strategy: India’s best and worst capital allocators Price Ratio Exhibit 29: AL over TVSL.20 AL/TVSL Price Ratio Technical analyst: Gaurav Mehta firstname.lastname@example.org 0.00 0.
Rolta India Glodyne Techno. A drop in asset turnover can be attributed to falling billing rates even as these firms kept investing in new office space and computer hardware. KPIT Infosys. Mindtree Persistent Sys Infosys Core Projects HCL Technologies Geodesic NIIT Tech. Mphasis’ presence at the top of the table is ironic given the corporate governance issues bedeviling the firm. Asset Turnover drops have resulted in RoA reduction for the majority of the sector.297 750 5. Bloom Ticker MPHL IN EQUITY POL IN EQUITY HEXW IN EQUITY PATNI IN EQUITY TECHM IN EQUITY OFSS IN EQUITY KPIT IN EQUITY RLTA IN EQUITY GLOT IN EQUITY INFTC IN EQUITY MTCL IN EQUITY PSYS IN EQUITY INFO IN EQUITY CPTL IN EQUITY HCLT IN EQUITY GEOD IN EQUITY NITEC IN EQUITY WPRO IN EQUITY TCS IN EQUITY SIEL IN EQUITY ALDS IN EQUITY FTECH IN EQUITY Mkt Cap RoA RoA RoA Phase 1 RoA RoA RoA Phase 2 RoA In Top Half on (USD mn) 2006 2007 2008 Average 2009 2010 2011 Average Change Accounting? 2. Wipro TCS Sterling Intl Allied Digital Fincial Tech. Patni Computer Tech Mahindra Oracle Fin.892 3. Exhibit 30: IT.504 229 243 26.088 51. Ambit Capital research Whilst Financial Tech’s presence at the wrong end of the table is not surprising (given the capital consumptive nature of the exchanges in which FTech is investing in).431 929 218 1. Hexaware Tech.391 1. Infotech Enterp.Strategy: India’s best and worst capital allocators Section 7: Information Technology Although PAT margins have held up for the majority of firms in the IT sector.699 328 602 365 398 350 326 41.How they stack up on RoA Changes Firm Name MphasiS Polaris Soft.608 14% 2% 17% 9% 37% 18% 12% 14% 22% 13% 27% 19% 35% 26% 25% 21% 23% 31% 48% 14% 36% 31% 16% 14% -2% 15% 7% 15% 14% 10% 28% 23% 19% 23% 34% 12% 32% 29% 34% 30% 46% 14% 34% 16% 22% 9% 6% 15% 25% 15% 18% 13% 36% 9% 17% 25% 33% 9% 24% 12% 35% 20% 41% 10% 22% 51% 18% 8% 7% 13% 23% 16% 15% 12% 29% 15% 21% 22% 34% 16% 27% 20% 31% 27% 45% 13% 31% 33% 39% 16% 16% 17% 52% 20% 22% 14% 35% 10% 4% 15% 33% 12% 25% 15% 29% 17% 35% 0% 22% 17% 34% 17% 11% 22% 15% 16% 16% 12% 26% 16% 32% 18% 26% 11% 17% 13% 20% 21% 37% 0% 14% 14% 0% 20% 0% 0% 13% 19% 10% 0% 22% 13% 16% 18% 26% 7% 0% 0% 21% 19% 39% 0% 0% 4% 37% 18% 13% 20% 27% 18% 16% 13% 28% 13% 17% 17% 28% 10% 21% 14% 23% 19% 37% 0% 18% 11% 19% 9% 6% 6% 4% 2% 1% 1% -1% -2% -4% -5% -6% -6% -6% -6% -7% -8% -8% -12% -13% -21% YES YES YES NO YES YES YES NA NA NO NO NA YES NO YES NO NO YES YES NA NA NO Source: Capitaline. Ambit Capital Pvt Ltd 21 .Serv.846 416 375 1.
01 0. higher proportion of onsite business as it acquired EAS consultant Axon.04) 0.18 0.18) (0. KPIT Infosys. Hexaware Tech.17) 0.31) (0.00 0. losses in its BPO operations and rising proportion of lower margin RIM revenues.26 -1.03) (0.com Tel: +91 22 3043 3211 Analyst: Subhashini Gurumurthy email@example.com (1.14 (0.13 -0. Axon increasingly offshores more revenues. As its forex losses wound to a close in FY11.Strategy: India’s best and worst capital allocators Exhibit 31: IT.14 0.10 0.26 0. losses in BPO come to a close in FY12 and RIM contracts mature. Ambit Capital Pvt Ltd 22 .28 -1. Profit Margin and Asset Turnover for the firm in absolute terms from Phase 1 to Phase 2 while the ‘Sector Relative’ changes highlight the same measures for the firm relative to the sector.64 -0.46) (1. RoA was further impacted from the goodwill as a result of the Axon acquisition.24) (0.27) (0. Wipro TCS Sterling Intl Allied Digital Financial Tech.36 0.09 -0.11) (0.01 -0. whilst RIM is likely to help HCLT be a close business optimisation partner.04 0.33) (0.22) 0.15 -0.36 (0. The figures here are as sourced from Capitaline and may differ somewhat from the bottom up numbers of our sector leads.41 0. Consulting led EAS will ensure HCLT remains more relevant to its clients and wins greater proportion of difficult to break into deals.04 Firm Name MphasiS Polaris Soft.28) (0.54 -0. the top of the bottom third of the peer group.03 0. RoA is expected to expand.06 0.Deconstructing RoA (Change from Phase 1 to Phase 2) Firm Absolute* Sector Relative* Profit Asset Profit Asset RoA RoA Bloom Ticker Margin Turnover Margin turnover Change Change Change Change Change change MPHL IN EQUITY POL IN EQUITY HEXW IN EQUITY PATNI IN EQUITY TECHM IN EQUITY OFSS IN EQUITY KPIT IN EQUITY RLTA IN EQUITY INFTC IN EQUITY MTCL IN EQUITY PSYS IN EQUITY INFO IN EQUITY CPTL IN EQUITY GEOD IN EQUITY NITEC IN EQUITY WPRO IN EQUITY TCS IN EQUITY SIEL IN EQUITY ALDS IN EQUITY FTECH IN EQUITY 19% 9% 6% 6% 4% 2% 1% 1% -1% -2% -4% -5% -6% -6% -6% -6% -7% -8% -8% -12% -13% -21% 11% 6% 12% 7% 8% 12% 1% 4% 4% 3% -5% -2% -1% 3% -1% -12% -14% -1% -1% -16% 5% -201% 0. Rolta India Infotech Enterp.15) 0. CFA ankurrudra@ambitcapital. driven by 700bps margin erosion although Asset turnover improved by 0. Mindtree Persistent Sys Infosys Core Projects Geodesic NIIT Tech.36x.15 -0. Patni Computer Tech Mahindra Oracle Fin. Ambit Capital research * The ‘Firm absolute’ figures here indicate the changes in RoA.14) 23% 13% 10% 10% 8% 7% 5% 5% 3% 2% 1% -1% -1% -2% -2% -2% -3% -4% -4% -8% -9% -17% 11% 6% 12% 7% 8% 12% 1% 4% 4% 3% -4% -2% -1% 4% -1% -12% -14% -1% -1% -16% 5% -201% 0.17) (0. GLOT IN EQUITY HCL Technologies HCLT IN EQUITY Source: Capitaline.07 0. Glodyne Techno.08 (0.23 (0.32 0.82) (0. We expect HCLT to display the strongest long term growth rates in the sector given its strong presence in EAS and RIM with stronger margin defense from its competitive pricing.Serv. Short MPHL (Mean Long Trade: HCL Tech (HCLT IN) HCLT has seen its RoA fall by 700bps to 11%. Analyst: Ankur Rudra. HCLT's margin erosion has been driven by forex losses in FY09-10.com Tel: +91 9833700195 Pair Idea: Long reverting trade) HCLT.
60 1.80 Technical analyst: Gaurav Mehta gauravmehta@ambitcapital. Mphasis has also restarted making capex in new lower cost geographies such as Sri Lanka in an effort to provide lower cost delivery to HP.00 0. key ratio support at 1 HCLT/MPHL Price Ratio 2. Application Management and ITO it is likely to see substantial erosion in its RoA.20 1. Mphasis primarily utilised leased space keeping its RoA higher. Rising capex and falling margins are likely to take a toll on RoA and ROCE over the next 3-5 years.60 0. Ratio Chart Exhibit 32: HCLT over MPHL. Mphasis' capex slowed down substantially in FY09-10 even as subcontracted work grew from HP.Mphasis (MPHL IN Equity) Mphasis has seen its RoA expand by 2000bps to 40%. This has been hard to come by as management has kept focussing on meeting demand from HP through FY08-10.Reversal in place.00 1.Strategy: India’s best and worst capital allocators Short Trade .01 times.40 1.20 Mar/06 Mar/07 Mar/08 Mar/09 Mar/10 Mar/11 Jul/05 Jul/06 Jul/07 Jul/08 Jul/09 Jul/10 Nov/05 Nov/06 Nov/07 Nov/08 Nov/09 Nov/10 Jul/11 23 Source: Ambit Capital research Ambit Capital Pvt Ltd . This was primarily driven by unprecedented demand by its parent HP at reasonable billing rates.40 0. This has journey has begun with several acquisitions over the last 6 months as HP (currently ~70% of revenues) has begun to run dry.80 0. With billing rates and incremental business from HP under pressure due to HP's loss of competitiveness and near saturation of migration of existing customers Mphasis' future depends substantially on developing its non-HP business. the highest in its peer group. delivery capabilities and acquisitions to build credible practices outside of BPO.com Tel: +91 22 3043 3255 1. as its margins expanded by 800bps and asset turnover 1.20 2. As Mphasis increasingly tries to develop its non-HP business by investing in Sales & Marketing.
8% 1. Presumably.9% 0.1% 1.0% 1.3% 1.6% 1.058 1.2% 1.6% 0.4% 0.6% 1.5% 0.9% 0.8% 204 -2.439 0.1% 1.6% 0.9% 942 0.0% 1.3% 0.9% 0.6% 0.9% 0.4% 1.2% 1.4% 1.2% 1.2% 1.3% 536 1.9% 0.0% 1.1% 0.7% 0.2% 636 0.101 1.2% 0. the lack of M&A (due to regulatory obstacles) and the artificially suppressed savings rates on deposits have helped banks.3% 0.3% 1.8% 0.9% 0.3% 0.6% 1.4% 1.9% 1.4% 0.2% 1.7% 0.0% 1.7% 1.4% 1.2% 1.4% 1.3% 1.117 0.0% 1.0% 1.5% 1.4% 1.7% 1.222 1.4% 1.9% 0. & Sind Bank Bloom Ticker IIB IN EQUITY KMB IN EQUITY AXSB IN EQUITY VYSB IN EQUITY BOB IN EQUITY J&KBK IN EQUITY SBTR IN EQUITY DBNK IN EQUITY PNB IN EQUITY SIB IN EQUITY UCO IN EQUITY INBK IN EQUITY YES IN EQUITY CBK IN EQUITY OBC IN EQUITY SBBJ IN EQUITY CBOI IN EQUITY ICICIBC IN EQUITY UNBK IN EQUITY HDFCB IN EQUITY FB IN EQUITY BOMH IN EQUITY BOI IN EQUITY CUBK IN EQUITY DHLBK IN EQUITY VJYBK IN EQUITY ANDB IN EQUITY UNTDB IN EQUITY SBIN IN EQUITY CRPBK IN EQUITY IDBI IN EQUITY SBMS IN EQUITY SNDB IN EQUITY DEVB IN EQUITY ALBK IN EQUITY KBL IN EQUITY IOB IN EQUITY PJSB IN EQUITY Mkt Cap RoA RoA RoA Phase 1 RoA RoA RoA Phase 2 RoA (USD mn) 2006 2007 2008 Average 2009 2010 2011 Average Change 2.3% -0.8% 0.1% 0.5% 1.4% 0.5% -1.877 1.6% 1.5% 0.5% 2.015 1.1% 1.1% -0.2% 0.1% 0.4% 0.8% 0.9% 1.9% 1.4% 0.729 0.1% 1.1% 1.8% 0.4% 808 0.7% 0.1% 0.Credit Bank Allahabad Bank Karnataka Bank IOB Pun.481 1.5% 1.9% 1.5% 0.1% 574 0.4% 1.0% 1.8% 1.5% 0.7% 0.1% 0.5% 28.2% 0.0% 1.4% 1.9% 0.9% 0.0% 0.Bank UCO Bank Indian Bank Yes Bank Canara Bank Oriental Bank St Bk of Bikaner Central Bank ICICI Bank Union Bank (I) HDFC Bank Federal Bank Bank of Maha Bank of India City Union Bank Dhanlaxmi Bank Vijaya Bank Andhra Bank United Bank (I) St Bk of India Corporation Bank IDBI Bank St Bk of Mysore Syndicate Bank Dev.1% 0.5% 1.7% 0.1% 814 0.7% 1.590 1.1% -0.6% 679 1.3% 0.1% 1.7% 0.4% 0.4% 0.5% 0.0% 1. Ambit Capital research Ambit Capital Pvt Ltd 24 .8% 0.0% 0.5% 0.806 0.2% 450 1.4% 0.0% 1.0% 1.2% 0.3% 0.5% 0.4% 0.1% 1.3% 0.3% -0.4% 1.2% 0.4% 1.2% 1.6% 1.2% 0.025 0.5% 2.1% 0.4% 0.481 1.9% 1.2% 1.1% -0.7% 0.1% 0.0% 0.7% -0.1% 0.2% 3.7% 1.4% 0.9% 0.3% 39. RoA has gone up for the vast majority of stocks in the banking sector.8% 1.2% 24.1% 1.1% 1.5% 1.554 0.0% 1.0% 0.3% 6.220 1.4% 1.3% 0.2% 0.164 1.509 1. Bank Axis Bank ING Vysya Bank Bank of Baroda J & K Bank SBT Dena Bank Punjab Natl.9% 0.3% 0.3% 7.806 1.5% 1.1% 0.2% 1.4% 1.1% -0.3% 1.9% 0.0% 0.7% 1.2% 0.5% 1.1% 0.1% 0.2% 0.8% 0.4% -0.8% 0.7% 0.975 1.3% 1.9% 1.8% 0.0% 1.1% 0.9% 1.0% 0.5% 2.1% 1.8% 1.0% 0.9% 1.6% In Top Half on Accounting? YES YES NO NO YES YES NA NO YES YES NO NO NO NO NO NA YES YES YES YES YES YES YES YES NO NO NO NO YES YES NO NA NO NO NO YES YES NO Source: Capitaline.2% 0.493 0.2% 1.8% 833 0.6% -0.0% 1.5% 0.7% 1.0% 1.1% 827 0.9% 1.9% 0.1% 0.2% 0.1% 2.8% 1.1% -0.8% 5.8% 0.0% 0.8% 0.2% 0.1% 0.7% 1.6% 0.4% 1.9% 1.2% 1.5% 0.2% 1.2% 1.0% 0.3% 1.441 1.0% 0.4% 1.Bank South Ind.7% 0.2% 1.7% 0.7% -0.5% 1.3% 0.6% 0.3% 1.4% 0.1% -0.1% 1.5% 214 0.0% -0.6% 0.6% -1.4% 0.6% 1. the barriers to entry into the sector.6% 1.0% 0.0% 0.6% 0.8% 1.3% 1.1% 0.2% 0.1% 1.2% 0.0% 1.5% 1.6% 1.3% 0.3% 1.9% 0.9% 1.3% 1.1% 1.7% 8.3% 1.4% 0.5% 0.6% 0.2% 4.6% 1. Exhibit 33: Banks.4% 1.6% 1.7% 0.1% 1.6% 1.2% 1.3% 1.0% 8.4% 0.0% 0.9% 0.0% 0.1% 0.Strategy: India’s best and worst capital allocators Section 8: Banks In stark contrast to the other sectors analysed in the note so far.8% 1.0% 772 0.2% 0.0% 1.2% 0.1% 1.5% 1.3% 0.3% 1.0% 1.6% 0.1% 1.9% 1.2% 12.6% 1.6% 0.6% 1.391 1.9% 0.7% 1.5% 0.How they stack up on RoA Changes Firm Name IndusInd Bank Kotak Mah.5% 0.3% 1.2% 1.0% 1.1% 1.4% 0.9% 2.5% 0.9% 0.2% 1.1% 0.1% 0.0% 1.1% 0.8% 0.9% 1.9% 0.3% 0.8% 0.5% 1.9% 1.9% 0.2% 403 1.2% -0.048 0.7% 1. the overall health of economy.9% 0.0% 0.9% 2.3% 0.8% 0.9% 0.7% 0.2% 0.2% 1.0% 745 0.7% 1.8% 0.3% 0.0% 1.
00 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% -1% -1% 8% 2% 4% 4% 5% 2% 3% 3% 2% 2% 2% 1% -3% 2% 1% 1% 1% 0% 1% -1% -2% 0% 0% -2% 0% -1% -2% -2% -1% -1% -3% -3% -3% -2% -4% -6% -7% -9% 0.00 -0.00 0.00 -0.0% 0.2% -0.Deconstructing RoA (Change from Phase 1 to Phase 2) Firm Absolute* Firm Name IndusInd Bank Kotak Mah.1% 0.Strategy: India’s best and worst capital allocators As is well known.01 0.00 -0.00 0.3% 0.01 0.00) 0.00) 0.00 0.00 (0.1% -0.00 0.01 -0.3% 0. A range of old private sector and public sector banks bring up the rear.4% -0.2% 0.00 0.00 (0.00 0.00 0.1% -0.00 -0.0% 0.1% 0.00 0. Exhibit 34: Banks.7% 0.00 0.00 0.2% 0.00 0.00) (0.3% -0.00 (0.00 0. The figures here are as sourced from Capitaline and may differ somewhat from the bottom up numbers of our sector leads.01 -0.01 0. Bank Axis Bank ING Vysya Bank Bank of Baroda J & K Bank SBT Dena Bank Punjab Natl.00) 0.6% 8% 2% 5% 4% 6% 3% 3% 3% 3% 2% 3% 1% -2% 2% 1% 1% 1% 1% 2% 0% -2% 1% 0% -1% 0% -1% -1% -1% 0% -1% -2% -3% -3% -2% -4% -5% -7% -9% 0.01) 0. Profit Margin and Asset Turnover for the firm in absolute terms from Phase 1 to Phase 2 while the ‘Sector Relative’ changes highlight the same measures for the firm relative to the sector.00) 0.01 (0.2% 0. Ambit Capital Pvt Ltd 25 .0% 0.00 0.00 0.00 0.00 -0.3% 0.00 0.00 0.1% -0.0% -0.1% 0.00 0.1% 0.02 0.01) (0.00 0.01 0.4% 0. Ambit Capital research * The ‘Firm absolute’ figures here indicate the changes in RoA.4% 0.2% 0.1% -0.1% -0.00 0.00 (0.1% 0.01 0.01 (0.00) 0.00 0.00 0.Credit Bank Allahabad Bank Karnataka Bank IOB Pun.00 (0.00 0. Indus Ind Bank has been the RoA star of the sector as the exABN management team has turned around the bank’s fortunes.01 -0.01 -0.01 (0. & Sind Bank Bloom Ticker IIB IN EQUITY KMB IN EQUITY AXSB IN EQUITY VYSB IN EQUITY BOB IN EQUITY J&KBK IN EQUITY SBTR IN EQUITY DBNK IN EQUITY PNB IN EQUITY SIB IN EQUITY UCO IN EQUITY INBK IN EQUITY YES IN EQUITY CBK IN EQUITY OBC IN EQUITY SBBJ IN EQUITY CBOI IN EQUITY ICICIBC IN EQUITY UNBK IN EQUITY HDFCB IN EQUITY FB IN EQUITY BOMH IN EQUITY BOI IN EQUITY CUBK IN EQUITY DHLBK IN EQUITY VJYBK IN EQUITY ANDB IN EQUITY UNTDB IN EQUITY SBIN IN EQUITY CRPBK IN EQUITY IDBI IN EQUITY SBMS IN EQUITY SNDB IN EQUITY DEVB IN EQUITY ALBK IN EQUITY KBL IN EQUITY IOB IN EQUITY PJSB IN EQUITY Sector Relative* Profit Asset Profit Asset RoA RoA Margin Turnover Margin turnover Change Change Change Change Change change 0.6% -0.00 0.00) 0.0% 0.00 (0.00 0.Bank UCO Bank Indian Bank Yes Bank Canara Bank Oriental Bank St Bk of Bikaner Central Bank ICICI Bank Union Bank (I) HDFC Bank Federal Bank Bank of Maha Bank of India City Union Bank Dhanlaxmi Bank Vijaya Bank Andhra Bank United Bank (I) St Bk of India Corporation Bank IDBI Bank St Bk of Mysore Syndicate Bank Dev.00) 0.01 -0.00 0.1% 0.3% 0.01 (0.2% 0.00 -0.0% 0.1% 0.00 0.Bank South Ind.02 0.00) 0.00 0.1% -0.00 0.00 0.00 0.3% -0.00 -0.00) 0.00 Source: Capitaline.1% 0.00 0.01 0.
Engineering and Textiles are the highest contributors to incremental loan book growth).78%) and FY09-FY11 (1. In fact. While we acknowledge the impressive core performance as reflected in recent NII performance.05% of assets during FY06-FY08) and a ~25bps benefit from better operating efficiency. with ~40% of its 1. Other Metals. The stock quotes at 1. SBI has been unable to capitalize on its strengths as its RoAs have trended down despite a 25bps benefit accruing from higher treasury profits (0. Going forward.State Bank of India (SBIN IN) State Bank of India (SBI) has disappointed in terms of its return ratios over the period FY06-FY11 with core RoAs having declined by ~30bps from around 1. nearly two-thirds of which (26bps) was driven by better operational efficiency and the rest by lower credit costs. We expect PNB to sustain an EPS CAGR of 21% over FY11-FY13E and maintain RoEs ahead of 22% (RoAs likely to marginally improve to 1. PNB also benefits from a superior deposit franchise (CASA consistently at 40%) that manifests itself in relatively lower interest expenditure (as a proportion of interest earned. PNB spends ~57% as interest. Despite an interest rate upcycle during Phase 2. In fact.560 branches located in rural India. Infrastructure.Punjab National Bank (PNB IN) Punjab National Bank (PNB) emerges as one of the most consistently performing state-owned banks with steady-state core RoAs at a little over 1% over the period FY06-FY11.3%).Strategy: India’s best and worst capital allocators Analyst: Krishnan ASV vkrishnan@ambitcapital. This suggests a disciplined approach to asset pricing. Given that these sectors are heavily dependent on our domestic as well as global growth outlook (on which we remain reasonably bearish). PNB has witnessed a ~37bps improvement in core RoAs between the periods FY06-FY08 (0. we do not judge the P&L performance in isolation.15%).92% of assets in FY09-FY11. when broken into the two phases of 3 years each.3x our FY12E ABVPS of Rs714 and is likely to comfortably outperform its larger peers. especially in light of the sectors that have contributed to SBI's incremental loan book growth (Iron & Steel. we expect higher credit costs to almost completely offset any potential improvements in core profitability trends. driven by weak core performance that has resulted in a 36bps decline in NIMs between the two phases. Short SBIN (Momentum trade) Long Trade . ~10% points lower than the average for other banks in the system).7% (during FY09-FY11). we see further stress building up in SBI's books. PNB has been able to broadly protect its margins even as the cost of funds rose by nearly 80bps from 4. CFA pankajagarwal@ambitcapital. Short Trade .com Tel: +91 22 3043 3206 Pair Idea: Long PNB.2% of assets during FY09-FY11 from -0. PNB is positioned as a banker of choice in its strongest geographies (northern states) on either side of the balance sheet.0% (during FY06-FY08) to 0.com Tel: +91 22 3043 3205 Analyst: Pankaj Agarwal. we draw comfort from the fact that PNB observes pricing discipline (especially on the asset side) and generates relatively higher yields on its portfolio of risky assets.12% of assets in FY06-FY08 to 4. Gems & Jewellery. Despite running a relatively riskier loan book of a little over $50bn. This reflects SBI's mispricing of assets: the average yield on advances has actually drifted down by ~10bps across this period despite FY09-FY11 consistently witnessing higher interest rates than FY06-FY08. Ambit Capital Pvt Ltd 26 . While we believe that the core operating trends may indeed sustain (NIMs as % of average assets likely to improve by ~30bps). This in turn helps the bank generate net interest margins of to 4%. We remain cognizant of the balance sheet risks that SBI is vulnerable to.
60 0.65 0.35 0.com Tel: +91 22 3043 3255 0.40 0.5 on the price ratio to bring in accelerated outperformance PNB/SBIN Price Ratio 0.45 0.Strategy: India’s best and worst capital allocators The stock quotes at 2x our standalone FY12E ABVPS estimates of Rs991 and is likely to under-perform on a risk-adjusted return basis.25 0.Rising relative strength of PNB versus SBIN augurs well.30 0. a break above 0. Price Ratio Exhibit 35: PNB over SBIN.50 0.55 Technical analyst: Gaurav Mehta firstname.lastname@example.org Jul/05 Mar/06 Jul/06 Mar/07 Jul/07 Mar/08 Jul/08 Mar/09 Jul/09 Mar/10 Jul/10 Mar/11 Nov/05 Nov/06 Nov/07 Nov/08 Nov/09 Nov/10 Jul/11 27 Source: Ambit Capital research Ambit Capital Pvt Ltd .
83 -0.029 1. Electrical Equipment.26 (0.27 -1.90) (0.43 0. Suzlon (an almost perfect case study of how a successful company can depress its RoAs through overseas acquisitions and heavy capex) brings up the rear. Ambit Capital Pvt Ltd 28 .61) 17% 15% 9% 9% 3% 0% -1% -1% -1% -11% -12% -20% 5% 7% 3% 4% 2% 0% 0% 2% 4% -1% -2% -34% 0. Exhibit 36: Capital Goods.Electrical Equipment The normal pattern of sagging RoAs due to falling PAT margins and falling Asset Turnovers holds true for this sector. As one would expect. Two T&D specialists.06 -0.How they stack up on RoA Changes Firm Name Alstom Projects Crompton Greaves BHEL BGR Energy Sys.731 2. are the RoA leaders in this sector.46) (0.44 Crompton Greaves CRG IN EQUITY Source: Capitaline. Profit Margin and Asset Turnover for the firm in absolute terms from Phase 1 to Phase 2 while the ‘Sector Relative’ changes highlight the same measures for the firm relative to the sector.61 (0.12) (0.48) 0. Alstom and Crompton Greaves. Ambit Capital research Exhibit 37: Capital Goods.891 25.79 -0.45) (1.38 -0. Electrical Equipment.31 0. Kalpataru Power Suja Towers Thermax Havells India Areva T&D ABB Suzlon Energy Bloom Ticker ABBAP IN EQUITY BHEL IN EQUITY BGRL IN EQUITY KECI IN EQUITY KPP IN EQUITY SUTL IN EQUITY TMX IN EQUITY HAVL IN EQUITY ATD IN EQUITY ABB IN EQUITY SUEL IN EQUITY Profit RoA Margin Change Change 9% 8% 2% 2% -4% -7% -8% -8% -9% -18% -20% -27% 2% 4% -1% 1% -1% -3% -3% -1% 1% -4% -5% -37% Sector Relative* Asset Profit Asset RoA Turnover Margin turnover Change Change Change change 0.724 3. K E C Intl.949 860 471 458 341 1.31) (0.28 -0.13 -0. K E C Intl.487 15% 21% 21% 0% 9% 17% 0% 26% 22% 35% 28% 26% 32% 20% 27% 12% 16% 16% 18% 32% 32% 33% 30% 22% 21% 31% 26% 9% 16% 14% 9% 38% 20% 19% 26% 13% 22% 24% 25% 10% 14% 16% 14% 32% 25% 29% 28% 20% 33% 31% 24% 9% 10% 6% 6% 30% 14% 12% 15% 34% 34% 27% 12% 11% 11% 0% 13% 18% 10% 3% 29% 30% 31% 15% 8% 9% 6% 29% 16% 0% 0% 0% 32% 32% 27% 12% 10% 9% 6% 24% 16% 11% 9% -7% 9% 8% 2% 2% -4% -7% -8% -8% -9% -18% -20% -27% In Top Half on Accounting? YES YES YES NA NO NO NA YES YES YES YES NO -3% -11% Source: Capitaline. The figures here are as sourced from Capitaline and may differ somewhat from the bottom up numbers of our sector leads. Ambit Capital research * The ‘Firm absolute’ figures here indicate the changes in RoA.595 1.Deconstructing RoA (Change from Phase 1 to Phase 2) Firm Absolute* Firm Name Alstom Projects BHEL BGR Energy Sys.69) (1.51 -0.72 -0.Strategy: India’s best and worst capital allocators Section 9: Capital Goods.00) (0. Kalpataru Power Suja Towers Thermax Havells India Areva T&D ABB Suzlon Energy Bloom Ticker ABBAP IN EQUITY CRG IN EQUITY BHEL IN EQUITY BGRL IN EQUITY KECI IN EQUITY KPP IN EQUITY SUTL IN EQUITY TMX IN EQUITY HAVL IN EQUITY ATD IN EQUITY ABB IN EQUITY SUEL IN EQUITY Mkt Cap RoA RoA RoA Phase 1 RoA RoA RoA Phase 2 RoA (USD mn) 2006 2007 2008 Average 2009 2010 2011 Average Change 874 3.56) (0.
much awaited payment of $202mn from Edison Mission in 4QFY12. Whilst in the home market we expect PGCIL to downgrade its capex guidance for the XII five year plan (as 80% of its capex is dependant on new generation projects which are getting delayed). going forward. on the international front we expect weakness given that 28% of Crompton's international revenues in FY11 came from Europe and North America (geographies which are facing sovereign debt crisis). reported only 6% YoY growth in working capital loan despite 30% YoY growth in revenues. which increased 557bps over FY0611 despite rising competition and industry operating at lower utilizations. The proceeds from Hansen stake sale. Short Trade. The total capex in Suzlon Wind (the standalone entity) and the investments made towards acquiring Hansen and REpower constituted nearly 1. It is to be noted that in FY11 Suzlon’s business model.com Tel: +91-22-3043 3259 Pair Idea: Long SUEL. This is equivalent to 8% of consolidated net debt.Suzlon (SUEL IN) Suzlon’s RoA has come down significantly over the years from 26% in FY06 to 0% in FY11.3bn. Avantha Power. Also Suzlon managed to enter into an agreement to sell a 26% stake in Hansen for Rs8. Ambit Capital Pvt Ltd 29 . One of the main reasons for Suzlon's losses is its over leveraged balance sheet (FY11 net debt: equity was 1.Crompton Greaves (CRG IN) Crompton's RoA has increased by 50% from 21% in FY06 to 30% FY11. Short CRG (Mean reverting trade) Long Trade.Strategy: India’s best and worst capital allocators Analyst: Bhargav Buddhadev. bhargavbuddhadev@ambitcapital. an Avantha Group company. It is to be noted that Crompton's peers reported average ~200bps decline in EBITDA margins over FY06-11 sighting rising competition and volatile raw material prices. and Suzlon’s turnaround to profitability coupled with minimal capex is likely to turn Suzlon FCFF positive. Suzlon has already started deleveraging its balance sheet as shown by its working capital/revenues ratio declining from 68% to 40% on a YoY basis and as evidenced by consolidated net debt remaining flat (FY11 vs FY10) at Rs105bn. However. This made only a marginal contribution to revenues and hence suppressed all the return ratios.62x of the total net assets as at FY11end. we expect RoAs to come under pressure as Crompton's margins are likely to come under pressure given difficulties at home and abroad.59x in FY11 despite sales growing at a CAGR of 22% over FY07-11. In fact since FY09 Suzlon has reported losses with average RoAs being negative 5% compared to +20% over FY06-08. We also note that Crompton is the main cash generative entity in the Avantha Group.64x in FY07 to 0. This in turn will help in lifting its RoAs. However. which is working capital intensive. Its average asset-turnover dropped from 0.3x) driven by the acquisition of REpower and Hansen coupled with lower capacity utilization (FY11 utilization was ~40%). filed a DRHP over a year ago as it needs equity for its power plants. This is on the back of improvement in EBITDA margins. One of the main reasons for Crompton's rising margins has been falling raw material cost as a % of revenues which as per management is on the back of higher outsourcing and better product mix. email@example.com Tel: +91-22-3043 3252 Analyst: Puneet Bambha.
On a downward trajectory 3.50 1.45 0.50 Jun/06 Jun/07 Jun/08 Jun/09 Jun/10 Feb/06 Feb/07 Feb/08 Feb/09 Feb/10 Feb/11 Jun/11 Source: Ambit Capital research Exhibit 39: SUEL over CRG (Shorter Term).00 0.Strategy: India’s best and worst capital allocators Price Ratio Exhibit 38: SUEL over CRG (Longer Term).10 Jun/10 Jan/11 May/10 May/11 Jan/10 Jun/11 Aug/11 30 Oct/05 Oct/06 Oct/07 Oct/08 Oct/09 Aug/10 Mar/11 Oct/10 Sep/10 Mar/10 Jul/10 Feb/10 Nov/10 Feb/11 Nov/09 Dec/09 Source: Ambit Capital research Ambit Capital Pvt Ltd Dec/10 Apr/10 Oct/09 Oct/10 Apr/11 Jul/11 .00 2.Pick up in relative strength SUEL/CRG Price Ratio 0.50 3.25 0.50 SUEL/CRG Price Ratio Technical analyst: Gaurav Mehta firstname.lastname@example.org 0.30 0.com Tel: +91 22 3043 3255 2.00 1.40 0.20 0.15 0.
CFA Sarojini Ramachandran Regions India / Asia India / Asia India / Europe India / Asia UK / US Desk-Phone (022) 30433295 (022) 30433289 (022) 30433053 (022) 30433228 +44 (0) 20 7614 8374 E-mail email@example.com ankurrudra@ambitcapital. CFA Parita Ashar Puneet Bambha Ritika Mankar Ritu Modi Industry Sectors Banking / NBFCs IT/Education Services Consumer/Automobile Power/Capital Goods Metals & Mining Construction.com Ambit Capital Pvt Ltd 31 .com nitinbhasin@ambitcapital. CFA Ashvin Shetty Bhargav Buddhadev Chandrani De.com Managing Director .com firstname.lastname@example.org email@example.com vkrishnan@ambitcapital. Infrastructure.com sarojini@panmure. Infrastructure Derivatives Research Technology Banking Construction. Cement NBFCs Metals & Mining / Media / Telecom Power/Capital Goods Economy Cement Consumer IT/Education Services Consumer (incl FMCG.com gauravmehta@ambitcapital.Strategy: India’s best and worst capital allocators Institutional Equities Team Saurabh Mukherjea.com firstname.lastname@example.org email@example.com pankajagarwal@ambitcapital. Automobiles) Desk-Phone (022) 30433239 (022) 30433211 (022) 30433285 (022) 30433252 (022) 30433210 (022) 30433203 (022) 30433255 (022) 30433291 (022) 30433205 (022) 30433241 (022) 30433206 (022) 30433223 (022) 30433259 (022) 30433175 (022) 30433292 (022) 30433246 (022) 30433264 (022) 30433054 E-mail aadeshmehta@ambitcapital. Retail.com firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com bhargavbuddhadev@ambitcapital. CFA Chhavi Agarwal Gaurav Mehta Hardik Shah Krishnan ASV Nitin Bhasin Pankaj Agarwal.com ritumodi@ambitcapital. CFA Research Analysts Aadesh Mehta Ankur Rudra.com Shariq Merchant Subhashini Gurumurthy Vijay Chugh Sales Name Deepak Sawhney Dharmen Shah Dipti Mehta Pramod Gubbi.com firstname.lastname@example.org email@example.com paritaashar@ambitcapital.Institutional Equities – (022) 30433174 saurabhmukherjea@ambitcapital.
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