Turnaround Candidates

Will these companies come out of the eclipse this year?

Despite volatility, the Sensex is testing higher levels and is up by almost 94 per cent from the lows it reached in March this year. Investors too are making the most of this opportunity by sticking to fundamentally strong counters and keeping the investment strategy simple. But, on second thought, doesn’t it also make sense to be different from the rest and still chalk out a different investment strategy and pick stocks that the markets have ignored due to the companies currently incurring losses, but having potential to catch investors’ fancy sooner rather than later.

In keeping with this strategy, we, at Dalal Street Investment Journal, have selected turnaround candidates from a host of loss-making companies. It might sound a bit odd, but it does make sense at this point of time to go for such companies which despite

Despite volatility, the Sensex is testing higher levels and is up by almost 94 per cent from the lows it reached in March this year. Investors too are making the most of this opportunity by sticking to fundamentally strong counters and keeping the investment strategy simple. But, on second thought, doesn’t it also make sense to be different from the rest and still chalk out a different investment strategy and pick stocks that the markets have ignored due to the companies currently incurring losses, but having potential to catch investors’ fancy sooner rather than later.

In keeping with this strategy, we, at Dalal Street Investment Journal, have selected turnaround candidates from a host of loss-making companies. It might sound a bit odd, but it does make sense at this point of time to go for such companies which despite odds are thinking out of the box to pull themselves out of the quick sand and turn themselves profitable. The ‘Turnaround Candidates’ story is an annual exercise for DSIJ, where we find such hidden gems which are currently making losses but have the potential to turn around during the year and give better returns to the investors. It is easier to pick such stocks when the economy is on the upturn and everything is hunky dory, but in a gloomy scenario when the uncertainty increases, selecting such stocks becomes tougher.

The one trend that we have seen since 2004 is that the number of loss-making companies has declined drastically after the economy started to pick up pace. It should be noted that there were about 1082 loss-making companies in 2004. This number came down by 30 per cent to 755 companies in 2005 and further fell by 38 per cent to 469 companies in 2006. In 2007, when the economic growth was at its peak, the loss-making companies fell to just 249 companies. But it was in 2008 that economies across the world, including India, felt the jitters of the global financial crisis. Result: the number of loss-making companies increased to 349. While the global economy is yet to come out of the woods completely, many would expect this number only to increase. On the contrary, what’s heartening to know is that India Inc has showed strong resilience in FY09 and this number has actually declined by as much as 50 per cent to just 173 companies! If we dissect the 2009 numbers further, we see that the loss-making companies have declined drastically in the B group, S group and – to our own amazement – the Z group! Thus, while in B group the number of loss-making companies has come down to 69 from 128 companies previously, in the S group the number has fallen to 7 from 18 previously and in Z group the number is a mere 5 from 124 previously (refer table). This, according to us, is quite an achievement considering that FY09 has not been too kind on India Inc. Besides, we also believe better cost management initiatives and the amendments to the AS 11 could be the reason for this drastic drop in loss-making companies in FY09.

The fact of the matter is that investors need to see the advantages of holding a turnaround candidate. Firstly, when other companies would be doing business as usual, managements of turnaround candidates would be busy thinking out of the box to bring their companies into profits. Thus, this is the time when management initiatives would be at their best, with the management coming up with innovative ways to drive the topline and manage the costs. Secondly, with the worst already being discounted in the price of these companies, there may be very limited downside risk in these companies. Thus, even if the market corrects for some reason, there is a good probability that these counters would fall the least. In fact, if these companies start showing signs of turning around, they could turn investors’ favourites and might end up giving fantastic returns. The best example of this would be the performance of our last year’s recommendations, which have given an average return of 44 per cent, while the Sensex gave returns of 3.73 per cent during the same period. But, when these companies turn around into profits, the return is even better. For example we had identified Crompton Greaves as one of the turnaround candidates in 2002, which was then trading at Rs 51. This company not only turned around, but has also given fantastic appreciation considering the fact it is currently trading at Rs 1,535 (after adjusting for splits). As in the past, this year too we have gone through the painstaking process and selected five turnaround candidates which we feel would do well in the coming 18-24 months. We reckon that these companies would not only turn around, but also give good returns on the bourses if investors continue to be patient with these counters.

Order Book Getting Stronger
Artson Engineering
BSE CODE: 522134        CMP: RS  48.65

Artson Engineering (AEL), which is in the business of developing products and systems in fuel handling and tankage construction activities in the refinery sector, is a perfect example of how a series of events can take the company to abyss levels. It was a chain of events that resulted into AEL incurring losses in FY09. While AEL was already reeling under pressures in FY08 and was referred to the Board for Industrial and Financial Restructuring (BIFR) on account of shrinking topline as well as bottomline, the general economic slowdown

further reduced the contractual work, thus impacting its topline.

The delays in receipt of client-supplied materials worsened the problems and resulted in contractual time extensions. These contractual extensions eventually contributed to unexpected over-run expenses. So in FY09, the company posted a topline of Rs 34.40 crore and a loss of Rs 17.14 crore as compared to Rs 52.03 crore and Rs 12.33 crore respectively in FY08 (18 months). But there are certain factors which are now indicative of a revival of positive forces in the company. The current order book of the company is around Rs 248 crore which is around seven times of its FY09 revenues. The strong backing of Tata Projects’ management (after it acquired a 75 per cent stake in AEL in January 2008) also provides comfort to the investors and last but not the least, the company has posted good topline and a decent bottomline in Q1FY10 (See table of last five quarters). The impact of TPL is vindicated from the fact that AEL’s current order book stands at Rs 248 crore.

Of the total order book position, Rs 191 crore belongs to HPCL and the Mittal Bhatinda Refinery which is to be completed by June 2010. So the topline does not seem to be any problem going ahead. The margins too are expected to be better in these orders. Although there are these many positives in the company, it may not turn around in FY10 as the higher interest cost and brought forward losses may impact its bottomline. But we expect the company to turn black in 2011. We foresee a decent capital appreciation from the counter and one can therefore look at the counter with a 15-18 months’ perspective.

Holding The Reins Tight
Finolex Cables
BSE CODE: 500144        CMP: RS 43.00

Finolex Cables (FCL) a manufacturer of copper-based electric and communication cables looks a perfect

turnaround candidate. Slump in demand and a sharp fall in copper prices globally forced FCL to undersell its products by 35 per cent in FY09. Thus, with realisations dropping, revenues took a hit along with the operating profits getting squeezed further. A sharp jump in interest and the depreciation cost coupled with forex derivative transaction losses pushed FCL into losses of around Rs 35.49 crore - its first in the last ten years. But the fortunes for FCL are changing, the primary reason being the escalation in demand for its products. Though FCL was not able to quantify this in terms of order book in our discussion with the management, they assured that currently whatever is produced is being sold in the market. Secondly, FCL has already increased its product prices by 15 per cent and with copper prices in an uptrend, FCL wouldn’t hesitate to increase its prices further. Besides, its new electric cable plant at Roorkee is strategically placed to cater to the strong demand of the northern markets. That apart, FCL has also implemented a cost rationalisation drive, and tight control on its manpower and energy cost. While its manpower cost increased only 7 per cent in FY09 compared to 38 per cent in FY08, FCL brought down its energy usage by 7-8 per cent. Besides, with a tight control on its working capital requirements, it is now saving on interest cost. Explains M. Viswanathan, Director & CFO: “At the end of FY09 the receivables position or inventory are all at lower levels than the previous year, thus enabling us to squeeze that much cash flow out of the balance sheet, which results in lower interest cost.” But FCL’s strategy to move up the value chain will make all the difference from the coming fiscals with it now focusing on manufacturing high voltage cables up to 66 KV and CFLs. Though a very negligible contribution to the revenues today, it will help FCL to place its sales growth in a different trajectory altogether. With its market cap to sales of just 0.50x, FCL looks an attractive bet. What will sweeten it further are the liquid investments worth Rs 143 crore, which is almost 22 per cent of its market cap.

A Strong Dose Of Vitamins
Ranbaxy
BSE CODE: 500359        CMP: RS 335.35

Ranbaxy, which snapped its four consecutive quarters of losses this quarter (Q2FY09), is one of the companies that we feel will turn around and will continue its performance going forward.  The slide of one of the biggest pharmaceutical companies of India from its top position can be attributed to factors like banning of 34 products by USFDA due to non-compliance with their norms and appreciation of the dollar by 22.9 per cent last year. All this was enough to hammer the price of the company’s share by 40 per cent compared to a 33 per cent fall in BSE HC in CY08. However, things are changing for good now. Daiichi Sankyo, the majority owner of the Ranbaxy, has overhauled the management of the company giving a new thrust to resolve the issue with the US FDA. The rupee has largely remained stable and is not appreciating. Last but not the least, the company has submitted a corrective operation action plan to the US FDA for its Paonta Sahib facility and has sent a request for the re-inspection of its Dewas manufacturing facility. The management is hopeful that it will start exporting from the Dewas facility by December 2009. Early signs of revival are clearly visible in the com-pany’s Q2CY09 results. Its net revenue on a consolidated basis for Q2CY09 declined on a YoY basis by 0.7 per cent and was Rs 1,879.2 crore but witnessed good improvement sequentially and was up by 19.2 per cent. The net profit for the company declined by 55.7 per cent and was Rs 65 crore before any exceptional item. Nevertheless, if we take the exceptional item the fall is just 1.9 per cent. What is comforting is that the company has returned into operating profit after two quarters. We feel that the management action will start yielding results and will give good capital appreciation for its shareholders.

Keeping Good Health
Fresenius Kabi Oncology
BSE CODE: 532545       CMP: RS 72.65

Not many would have heard the name Fresenius Kabi Encology as this is the new avatar of Dabur Pharma. The company was taken over by the Germany-based player Fresenius Kabi in 2008 and that should help it post good growth in the coming quarters due to strong parent reach and product profile. The company has set its vision statement to be a ‘world leader in Oncology Genercis’ and is moving in that direction. Till now the company has been more focused on the semi-regulated and unregulated markets but as a part of the growth strategy it wants to focus aggressively on the regulated markets of the US, Europe and Japan.



Currently, the company gets 70 per cent of its revenue from exports and we believe that this would continue to dominate the company’s revenue stream even in the future. Last year, the company posted a loss of Rs 77.7 crore on sales of Rs 274.1 crore. One of the reasons for suffering this huge loss was due to a change in management control wherein the company settled ESOPs in cash and thus cancelled them out. At the same time the company also terminated the previous distribution agreement by paying termination charges. It also commissioned its second manufacturing unit at Baddi which resulted in higher depreciation and operational costs. We feel that these are expenses which are one time in nature and hence a recurrence of the same may not be there in the next balance sheet. The effect of the turnaround is visible on the company’s first quarter numbers wherein it reported sales of Rs 102.57 crore with a profit of Rs 26.81 crore. We are expecting the company to report net profit in the region of Rs 100 crore for the full year. With equity capital of Rs 15.82 crore (FV of Re 1), the EPS for FY10 would be Rs 6.32. The CMP of Rs 72.60 gives a P/E of 11.48 times. We feel the company should offer at least 30 per cent capital appreciation in the next six months with a price target of Rs 95.

Steering It Well
Sona Koyo Steering Sys
BSE CODE: 520057        CMP: RS 12.20

Sona Koyo Steering Systems (SKSS) is largest manufacturer of steering in India for passenger cars and utility vehicles. It slipped into red and posted loss of Rs 31.03 crore (profit of 25.19 crore in FY08) against sales of Rs 693.13 crore for FY09. The reason for such fall in profit was due to increase in cost of raw material and interest expenses Nevertheless, things have improved now, price of commodity has come down, and interest rate has eased. Even there has been revival in the down stream companies who use company’s product. Apart from this company has launched Profitability Improvement Programme (PIP) to improve the profitability. SKSS took steps like working capital management, increasing localization, customer negotiation, employee cost restructuring and reduction in sales and administration cost. These steps have clearly shown its result in Q1FY10 results. SKSS posted profit of Rs 0.86 crore against loss of Rs 1.63 crores during the corresponding period of the previous year. Overall sales increased by 20 per cent in the same time. Total sales posted for Q1FY10 was Rs 187.08 crore. What is remarkable is improvement in EBIDTA it increased by 57.6 per cent in absolute terms and as margin it increased by 200 basis points and stands at 8.8 per cent now. What makes us believe that this company will give good capital appreciation to the investors is company’s good clientele that includes Maruti, Hyundai etc and future order from Tata Motors for its 'Nano' car. Furthermore, company’s couple of plants will start production from November 09 adding more to their topline.