Cable and Satellite Sector - Strong profit visibility

The Rs 21,000-crore cable and satellite sector is likely to improve profitability on the back of higher subscriber base, lower costs and improving average revenue per user.

The consolidation activity and the Telecom Regulatory Authority of India’s (Trai’s) recently-proposed norms on foreign direct investment in the cable and satellite sector could hasten corporatisation and make operations of service providers more profitable.

 

EYEING PROFITS
FY12 estimates in Rs cr	Net  sales	Ebitda	Net  profit	EV/Ebitda (x)
Den Networks	1,431	277	90.0	10.3
Dish TV	1,993	577	136.0	7.8
Hathway Cable	1,195	87	87.0	7.6
WWIL	453	139	-8.4	7.2
Source: Analyst reports

The organised sector, comprising multi-system operators (MSOs) and direct-to-home (DTH) players, is sitting on huge losses due to this leakage and high customer acquisition costs.

However, analysts say the recent acquisition by Reliance Communications (RCom) of India’s third-largest national MSO, Digicable, fund-raising by MSOs Hathway and DEN Networks, as well as the proposed norms will bring the much-need capital.

This will not only help national MSOs consolidate but also compete against DTH players, which are spending heavily to acquire new customers. In a short period, DTH players have notched up 20 million subscribers in a market of 110 million cable and satellite connections.

Faster growth for the organised segment
What is attracting players such as RCom and will be of interest to other foreign cable operators is growth of the organised sector. IDFC Securities estimates that while the overall sector will grow 14.5 per cent annually between 2009 and 2015 to Rs 48,000 crore, the share of organised players will grow from Rs 4,100 crore now to Rs 24,000 crore by 2015. If VAS (value-added services) revenues are included, the share will jump by 6.5 times to Rs 34,000 crore, it says. This means the share of organised players, which is currently less than 20 per cent, will grow to about 70 per cent. A large part of this is likely to come from the rise in the number of declared subscribers as well as DTH subscribers.

From 11 per cent now, the number of DTH homes is likely to move up by a factor of three, contributing over a third of total subscribers over the next six years. Going ahead, the six players in the DTH space and large national MSOs are likely to focus on profitability once their subscriber acquisitions stabilise and consolidation reduces competition.

Not yet there
Most players are making losses due to revenue leakage and high subscriber acquisition costs. DTH operators are among the heaviest advertisers as they compete against cable operators as well as other DTH players to attract subscribers by giving heavy subisidies. The six DTH players are estimated to be sitting on losses of Rs 7,000 crore and have so far spent Rs 15,000 crore on setting up operations.

However, as the subscriber base increases and higher average revenue per user (ARPU) from VAS services kicks in, they could see profits at the operating level in the next two years. Dish TV, the only listed player, for example, is already making profits at the operating level with a subscriber base of nearly six million. Similarly, among MSOs, DEN networks, with 10 million subscribers, is making profits at the net level. In addition to the higher base, VAS revenues from broadband, advertising, gaming, movie-on-demand and recording services are likely to improve ARPUs from under $3.8 to $6.3 over the next five years, adding to profits.

Den Networks
The country’s second-largest MSO has used the inorganic route to expand its network to 77 cities in just two years. It would use the Rs 360 crore it raised from an initial public offer some time ago to add 3.1 million digital connections to its existing base of 10 million, with a significant portion going towards digitisation. Given its execution capabilities, aggressive expansion and improved declaration of subscriber numbers by cable operators, its revenues are expected to grow 43 per cent annually to Rs 1,320 crore by FY13, believes IDFC Securities. Its syndication business under a joint venture with Star TV should add about Rs 600 crore to the kitty. The stock is expected to give over 40 per cent returns over the next one year.

Dish TV
While the company has raised about Rs 1,500 crore that it will use to scale up its six-million subscriber base to about eight million by 2013, it is likely to make profits at the net level only in the last quarter of FY2012. Though expenditure is coming down due to fixed content costs and higher subscriber base, subsidies, at Rs 2,500 per customer, are delaying profits in the most competitive DTH environment in the world. The well-funded balance sheet, expanded subscriber base and lower content as well interest costs are likely to help the company record a profit of Rs 136 crore for FY12. Expect over 35 per cent returns over the next one-and-a-half years from these levels.

Hathway Cable
The company is India’s largest MSO with a 30 per cent market share of the digital subscriber base. The Rs 480-crore initial public offer equity infusion should help the company aggressively expand its customer base and reach revenues of Rs 1,700 crore by FY13. Coupled with strong growth from the high-margin broadband business, Hathway’s operating profit is likely to grow five times to Rs 630 crore, with net profit reaching Rs 210 crore by FY13. Given its reach, the company is likely to be the biggest beneficiary of the move towards digitisation. At the current price, the stock is expected to give 40 per cent returns over a one-year period.

Wire and Wireless
This Zee group company wound up its head-end in the sky (HITS) operations and suffered revenue loss as its experiment with new technology failed to take off due to high content costs. Elara Securities expects the company to report higher profitability as its analog cable operations are positive at the operating profit level. The stock has corrected considerably due to the failed experiment with HITS and offers an opportunity as the company now focuses on expanding its digital cable business. Elara Securities has a set target of Rs 24, while the stock currently trades at Rs 14.

MIC Electronics Limited - Multibagger

MIC Electronics- Seemingly good prospects, but one should wait

MIC Electronics Limited. is a leader in the design, development & manufacturing of LED Video Displays, high-end Electronic and Telecommunication equipment and development of Telecom software since 1988. Importantly, MIC has no real competitor in India in its LED business and is currently enjoying monopoly position in the market.

However, during the last one year, the performance of the company has deteriorated, and has not improved as evident from the latest June quarter results. The demand for its LED solutions seems to have shrunk in the last 1 year. So, does it culminate into an ever-lasting situation ? Well, not exactly.

Looking into the future, I can see enough demand for its LED true colour displays, and also for its LED lighting solutions, which have proved to be quite efficient. The LED lighting solutions are finding wide-spread usage, and should be omnipresent by the next decade, as LEDs represent the most energy and cost-efficient lighting source, consuming 10 times less power than CFLs and being biodegradable. In India, Railways is implementing LED lighting systems in a big way.

I would not put in numbers for the growth expected in the segment of LED displays, but a quick comparison with developed countries like US, UK really tell us that how short we are on our billboard advertizing expenditure, and thus with businesses growing like never before, advertizing is one space which will flourish like anything.

Performance

As I mentioned that performance was not that great over the last year. The company reported Rs 305 cr in revenues for 2008-09 and a bottomline of Rs 68 Cr, with diluted EPS at Rs 5.77. The performance was actually satisfactory till March, but the sales and profit dipped in the June quarter with both sales and profit dipping by more than 50% in the June quarter. The current market price stands at Rs 52, and if I take into account the diluted EPS (outstanding 1,74,81,725 convertible share warrants issued at Rs. 122/-each on preferential basis have been considered.), then the valuation satnds at a P/E of 9. However, the probability of conversion seems remote.

Fund Raising

MIC Electronics has decided to raise an amount of Rs 218.96 crore by issuing warrants to various promoters, non-promoters and from international markets. The company would offer 93,75,000 warrants at Rs 44.36 per share amounting to Rs 41.58 crore and would further issue 71,25,000 warrants at Rs 44.36 a piece, aggregating to Rs 31.60 crore to various promoters and non-promoters.

Further, the company would raise $30 million (nearly 145.77 crore) by issuing Global Depository Receipts (GDRs) and American Depository Receipts.

The company has contemplated resorting to another issuance of warrants, as I said earlier that the possibility of conversion of earlier issued warrants seems remote. Thus in effect we can consider the above accounted valuations, which is not that high. Although the future of the company seems good, but one should await positve developments in the income statement, before taking an exposure.

MIC Electronics Limited. is a global leader in the design, development & manufacturing of LED Video Displays, high-end Electronic and Telecommunication equipment and development of Telecom software since 1988. An ISO 9001: 2008 certified, it has marked presence in the highly dynamic domains of:

•  LED Video, Graphics and Text Displays
•  LED Lighting Solutions
•  Embedded, System and Telecom software
•  Communication and Electronic Products

Today, MIC's flagship products are LED Video Displays (indoor / outdoor / mobile), that have become an integral part of Sports Stadiums, Transportation Hubs, Digital Theatres and Theme Parks, Advertisements and Public Information Displays.

Headquartered at one of the fastest emerging IT cities, Hyderabad (India), it has nation wide presence in the form of a vast network of marketing, sales and service support centres in all metros of India. To meet the demand of its products worldwide, it has offices in Australia,Korea and USA. Now the company is gradually setting up operations in other international markets.

Investor sentiments as fears of a double-dip mount

With the global economy slowing, interest rates about as low as they can go, governments getting austere and banks being investigated for stress, it is getting harder for investors to keep putting on their bullish faces.

Heading into the first full week of the second half, investors are still committed to riskier assets such as equities and high-yield bonds in their portfolios, but are being battered with questions about whether this is the right stance.

Reuters asset allocation polls for June showed investors cutting stocks a bit, but retaining a long-held overweight bias toward them. They also moved into the riskier end of bonds, seeking yield. But markets themselves are telling another story.

After a brief rally early last month, world stocks have fallen almost steadily. What was shaping up to be a gain on Friday was only the second up day in nine sessions that have seen stocks lose around 8%.
At the same time, bond yields are painting a picture of deep concern about the future. Citi’s composite world bond yield is only 1.8%, while short-term US and euro zone yields are only 0.6%.

“There is growing concern over the possibility of a double-dip recession in developed markets ,” said Rob Carnell, chief international economist at ING Commercial Banking.

“In consequence, people want to keep their money as liquid as possible in case things start to turn down.”
Just about everything has been turning down from bond yields, to stocks, economic indicators and the Baltic Freight Index, a proxy for world trade.

ARMAGEDDON?

There are two implications from this. Either investors banking on a stock revival are wrongly positioned or bond yields are wrong pricing in something approaching an investment and economic Armageddon.
Fred Goodwin, the “Mr Macro” analyst at Nomura, leans to the latter. He says that once a recovery has begun to take hold, as now, double-dip recessions are very rare. The one in 1980-82 , he reckons, only came about after the Federal Reserve had raised interest rates closer to 10%.
“Positioning (now) for the double-dip , a Japan scenario, or a Depression does not offer compelling risk-reward at these levels of bond yields,” Mr Goodwin said in a note.
Others are similarly unimpressed by the idea that another recession is on the way, particularly when it comes to corporate earnings performance, the main driver behind stock movements.

“A number of factors have been in place preceding previous global earnings recessions including an inverted global yield curve, excess inventories and unsustainably high profitability . None of these factors are apparent now,” Citi equity strategists said in a note.

That said, it is hard to see where investors would find grounds to be bullish if the current recovery slowdown — epitomised by the latest manufacturing surveys — starts gain momentum.
Reliance on Chinese and other emerging market growth could hardly be guaranteed if their main commercial markets started to retrench. 

And deflation fears are growing enough to prompt investors such as those at HSBC’s absolute returns team to buy 25- and 30-year bonds. They want to grab a near 4% yield they expect will soon fall as demand drives the price higher.
STRESS
The week ahead is not likely to offer much that will help investors make up their minds about the future.
The Bank of England and European Central Bank hold separate meetings, but both are likely to keep interest rates on hold.
Germany will also auction some 10-year Bunds on Wednesday. Some auctions have been disappointing because record low yields have put people off. But this auction is expected to attract plenty of buyers because of a massive amount of cash that will be returned to Bund investors the same week from other maturing German issues.
Austria might provide a better stress test, when it auctions € 1.3 billion of benchmark bonds on Tuesday. The country is highly exposed to debt-stricken Hungary and is seen by markets as riskier than Germany and other core euro zone sovereigns.
Investors, meanwhile, will also be looking for any early results from the European Commission’s stress tests on European banks, designed to see how they would cope with crises.
Results for some of the biggest banks will be given to EU finance ministers on July 13 but leaks or announcements could come before then, especially about German regional and Spanish saving banks. 

While Investing in Markets, Watch the Grass Grow

Image: Abhijeet Kini

A s the markets trade higher by 41 percent from mid-May last year, many are beginning to challenge the sacred dictum of “mean reversion”. The heretics are quick to point out that on only three occasions during the entire period did the market dip by more than 10 percent, and the worst of these bear hugs led to just a 13 percent tumble. With corporate earnings rebounding in style led by 7 percent plus GDP growth and commodity prices cooling off, are we likely to witness M.S. Dhoni defending the cause of the vanishing bear any time soon? Not really. The recent level of the BSE Sensex is exactly the same as on September 30, 2009. One look at the dismal numbers for gross capital formation during the last fiscal puts to rest the dream of the next roaring bull market driven by resurgent infrastructure investments and policy reform. So, are all the old mantras such as buy and hold, diversification and the need to maintain a balanced outlook about the future no longer valid? To my way of thinking, the most important lessons of the year gone by all point in the other direction.

The first lesson is best expressed in the words of Niels Bohr, Nobel laureate for Physics in 1922: “Prediction is very difficult, especially if it’s about the future.” Most of the wise men were trumpeting the dawn of a new age for the telecommunications sector with Bharti Airtel being the leader of the pack. But then, first the nuptials were called off and when the second bride came to the party, TRAI played spoilsport for the entire industry. A serious investor must recognise that he really has no clue about what will happen next week, let alone next year.

Your columnist had the ignominy of learning the second lesson when he got infatuated with the price of raw sugar on international commodity exchanges. Much wiser — and need I mention it, poorer — for the experience, it has finally sunk home that when something is too good to be true, it usually is. Typically, most individuals are happy to wait for a “clearance sale” to get the best bargain. The only instance the rules change for most is while buying a share! The fear of missing out leads to comic behaviour — buying high and selling low.

The third lesson on offer last year was, prepare for the unexpected. Perhaps, the best example was the probability that most investors assigned to a sovereign default 12 months ago and the consequences of the farce in Greek bonds as it unravelled. So the best protection against being caught off guard is to expect to be surprised. If what “everybody knows” is reflected in the stock price, the price will hardly move when it turns out to be true. Since everybody knows nothing of any value, it’s best to avoid the herd. Instead, try to find a less obvious opportunity that others have somehow overlooked.

So, what is the way forward? Paul Samuelson hit the nail on the head: “Investing should be dull…like watching watching grass grow. If you want excitement, take some money that you are happy to lose and go to Las Vegas.”

This article appeared in Forbes India Magazine of 04 June, 2010

Taking Stock Of the Market

Given where the stock markets are, it is difficult for an average investor to decide whether to buy or sell. Here's making it easier

Image: Alok Brahmbhatt

NO REASON TO SMILE Shankar Sharma of First Global expects a market correction

I n the best of times, Shankar Sharma is the kind of man who can piss the eternal optimist off with his grim, almost Taleb-esque predictions. Over the last one year, the Nifty has moved up 15 percent while stocks of medium-sized companies rose three times as much. These are the kind of returns that have left investors in every other part of the world beady-eyed and glazed over with envy. Add to this the facts coming from the manufacturing economy: Automobile sales are robust and truck operators are back in the market looking to expand their fleets. These are indications of an economy on the trot.

But the chief strategist at broking firm First Global sounds resolute in his forecast: The markets will fall 20 percent. That’s 3,500 points waiting to be lopped off the BSE Sensex. “The correction will happen when you least expect it to happen,” he says. “We need to understand the world economy is not in the best of health and expecting Indian equities to do well is misplaced hope,” he adds with gravitas.
The problem with Sharma is he’s the kind of grim Oracle you can’t wish away. He’s the man who called the debacle that was 2008 much earlier than anybody else did.

Now, Ridham Desai works two kilometres away from where Sharma operates out of. The head of equities business at Morgan Stanley looks every part a man who believes the market will gain 10 percent over the next couple of months. He says Indian stocks are valued just about right — in fact, there’s some steam left in prices — and that the Sensex will breach 19,000 by the end of the year.

Why? Because, while the recovery so far from the economic slowdown has been led by consumption surge, growth is now coming on the back of investments that add capacities. Not just that, capacity utilisation in India’s manufacturing and services companies is going up sharply. There are gains to be had from that as well. He’s doesn’t care much for the fires burning in Europe and other parts of the world. The problem is, like Sharma, Desai cannot be ignored at all. Last year, he argued the Sensex would move from 14,000 to 19,000. It almost, almost got there.

But the bigger problem is for regular investing folks. Do you align with the Sharma camp and simply focus on protecting your backside? Or do you go with Desai’s world view and hitch your wagon to the stars?

Portfolio Players
Let us face it. It is not easy taking a call on the markets today. This is one of those extraordinary times when even the professional investors go numb with paralysis. In the web of complex variables that dictate the day-to-day movement of the stock market, there is no one who can see beyond current volatility.

The markets have surprised all classes of investors too often in the last couple of years. Fund managers repeatedly failed to outperform broad-market indices and old correlation theories between risky assets and safe havens turned to dust. Investors who sold off and went into cash hopelessly watched as the market suddenly turned course and gave 50 percent returns in less than a year. Most people who made money did so serendipitously. But the sort of punishment that the actively bullish and bearish investors got for their decisions has made most of them wary of taking a decision again.
But given that inertia isn’t a legitimate investing strategy, we must look for intelligent clues from the domestic and foreign markets and try to decode what the volatility and the rigorous imprisonment of the stock market in a 10 percent range tell us.

The first place to start, of course, is capital flows. Foreign institutional investors (the here-today-gone-tomorrow guys) hold the key to the Indian markets. And second-guessing their behaviour isn’t easy. For instance, in May, FIIs moved out large sums of money—a net Rs. 9,910 crore —leading to a sudden fall in the market. Their immediate provocation: The US economy was showing signs of sputtering to life. And the Indian rupee had strengthened, thus converting to more dollars and making it unattractive to bring in funds into the market. The Sensex was hovering at around 16.000, not much more than where it started five months ago.

Yet in the following month, investor attendance was overwhelming at the Morgan Stanley annual investor summit in India. There was one big fly in the ointment though. Even the largest global fund managers were worried stiff about the European crisis and its impact on the world markets. “They are convinced as ever with the India story, but the global overhang still remains,” says Desai.

Now, there’s some evidence to suggest FIIs could end up as net sellers over the next few months. Emerging market investment expert Mark Mobius, who is the chief strategist for global investment firm Templeton, says that Indian equity valuations are not cheap compared to the historical averages. If investors like him follow this logic to stay away from the markets or even dilute their portfolio, the market would go back to being flattish till the year-end. Remember that stock prices have already factored in the expected earnings of corporate India in 2010-11. It is a compelling opportunity for FIIs to cash out now and return once valuations weaken a bit.

Image: Alok Brahmbhatt

SEEING VALUE Ridham Desai of Morgan Stanley says the market is priced just right

Besides, the rupee will maintain an uptrend over the long term. The economic growth differential between India and the developed world is as wide as ever. Further, the world’s rogue currency Renminbi has lost its de facto peg to the dollar and could appreciate. This, in turn, would have a knock-on effect on the rupee and push it up too.

Any such appreciation now will put off FIIs unless interest rates also harden to give them higher returns, say experts. “In an utter global panic or distress situation, many FIIs tend to follow the herd while selling risky assets in a wave of risk aversion. And if this wave hits the markets at the peak, every $4 billion or so can easily knock off 1,000 points or more from the Sensex,” says Devendra Nevgi, founder and principal partner at Delta Global Partners, a firm which manages the home office for clients in the US.

In the event of a huge FII sell-off, it will be up to the domestic financial institutions (DFIs) to display a much larger firepower to buoy up the markets. DFIs like Life Insurance Corporation (LIC) have committed to invest Rs 60,000 crore ($12 billion), about the same amount they invested into the equity market last year. If domestic demand and corporate earnings continue to appear robust, DFIs may well step in if the FIIs exit, as they did in May this year. But their investment can only arrest a fall. Whether they can contribute to a big upward move in the Sensex looks improbable.

Yearnings per Share
Last year, after the global recession, Indian companies posted a V-shaped recovery in earnings. For three consecutive quarters ending March 2010, earnings, when compared to a rather dismal 2008-9, seemed very good. Stock prices ran up across industry segments.

Around this time last year, we looked at the market and realised there was a lot of untapped value trapped in stocks of well-run companies. We knew that it was a rare opportunity that wouldn’t last long and hurried to reveal it to the readers. The 20 stocks that we ended up recommending across industry segments haven’t failed us: Our portfolio has risen 54% till date, grossly outperforming the benchmark Nifty index which rose by 15 percent.

Though the global economy has been spooked again, first by Dubai and later by the European contagion, corporate earnings growth will hold the key to valuations going forward. How are they likely to be?

According to a Morgan Stanley report, the broad market earnings (minus the energy sector) are almost at the peak of the previous cycle. The report says that earnings growth will likely to slow down in the coming quarters after a V-shaped recovery driven by a low base effect. However, the consensus estimates for earnings per share (EPS) for the Sensex stocks is at Rs. 1,105 for 2010-11, as compared to Rs. 897 for 2009-10, an increase of 23 percent. This increase is likely to be skewed by a jump in the heavyweight Reliance Industries’ fortunes, given the new income from gas. “The current stock prices have already factored in the FY11 earnings though some opportunities can be uncovered with a lot of research,” says Templeton’s Mobius.

The Bouquet of Choice
So where are the surprises going to come from? And how to choose the hidden gems? In the current context, three factors seem to deserve over-riding consideration: higher capacity utilisation, greater pricing power and investment-led growth.

Analysts say that in a sector like automobiles where demand is strong, companies like Tata Motors could benefit from both higher capacity utilisation and a bout of price increases. In industries like fast-moving consumer goods and commodities, the softness in petrochemical and energy prices is likely to keep input costs low. If they are able to hold on to prices, companies like Hindustan Unilever and Procter & Gamble could see a smart increase in earnings. And then, the substantial growth from investments already committed could bring the biggest winners. Desai expects that the big growth opportunity in infrastructure makes one take a look at even a company like Larsen and Toubro that is trading expensive.



“Today much of the growth has been consumption led. At some point, investment led growth has to set in across the board,” says Desai.

In such cases, the tipping point is usually achieved when the consumption curve has reached its highest point and begins a decline. That means companies are typically working at full capacity. Unless they reinvest in additional capacity, they won’t find growth.

Indian companies may well be preparing for the next cycle of investment. In the last one year, the average debt-to-equity ratio has come down from 0.7 percent in 2008-09 to 0.5 percent in 2010-11. That puts them at a comfortable position to borrow when the time for new investments comes. Already the cash hoard available with the top 1,000-odd Indian firms has ballooned to $61 billion.

Besides, capacity utilisation in key sectors like cement, steel and oil refining is again close to 90 percent. If the economy grows at 8 percent, some of the large companies could quickly exhaust the spare capacity. This will push them to build new manufacturing as is evident in the cement sector. Across a wide variety of firms, manufacturing capacities are being upped.

Automobile companies are also building new plants. Robust home sales are leading to demand growth for the products of companies like Asian Paints and Samsung (By the way, capacity increases has begun at both these firms). Reliance Industries is increasing its polyester manufacturing capacity. A recent report released by research agency Crisil says that investment growth will continue in India, despite the slowdown. The report estimates that across 11 key sectors such as power, telecom, oil, gas, cement, metals and automobiles, the projected project aggregate industrial capital expenditure is to be to the tune of Rs 10.5 lakh crore during 2009-10 to 2011-12.

Now, when the investment cycle begins to kick in, it would start to adversely impact the return on equity. The firms that comprise the elite Nifty 50 have generated an average return on equity of 17 percent, down from about 22 percent two years ago. But investors of 2009-10 didn’t allow that to deter them. The Price they paid for a given book value had only risen along with this fall in return on equity.

Image: Reuters

THE HUNTER Templeton’s Mark Mobius says investment opportunities can be found even now

The World’s Mine Oyster
India’s trade deficit stands at 10 percent of GDP. And the country has heavily depended on consumption to spur growth. A large part of India’s deficit is financed from flows from the global financial markets. Any global imbalance could impact the Indian macro-environment pretty severely.

This is also why India is considered a high beta market. That is, Indian markets follow the trend in mature markets like the US in both directions, but move more violently than them. In technical parlance, there is a high correlation between international markets and the Indian market. On the basis of daily returns, the Indian markets have a correlation of 35 percent with the Dow Jones Index. And on the basis of value, at around 55 percent, the extent of correlation is even higher.

And over the last one year, the Dow Jones and the Nifty have developed a correlation of more than 90 percent. That is as “coupled” as they come.

Running for Cover
Clearly, any global shocks could spell trouble for the Indian markets.

This is a reality that even Indian investors have begun to recognise. And they’ve begun looking for better alternatives. High net worth investors are now particularly obsessed with safety—and the market is beginning to provide them just that.

The flood of structured products that have hit the market is a testimony to this trend. We are not talking of the infamous derivative contracts here, but structures designed for capital conservation. These products are offered to investors in the form of non-convertible debentures where the product is divided into equity and debt. Investors may not get the complete upside of the market, but in most cases, they do get their capital back. Till three months ago, this market accounted for around Rs. 5,000 crore. Much of the investment in this market had come two years ago and these structures had at the most managed to protect the capital of investors and generated very little return. But they do look attractive to jittery investors.

Many experts now expect the size of this opportunity to double over the next few months. Given the spectre of uncertainty in the market, firms like ABN Amro, Citicorp and Barclays are back with these products. Over the last month, Citicorp has managed to sell non-convertible debentures worth Rs. 1500 crore in the market.

At the same time, the demand for funds hawking an alternative asset strategy is gradually picking up. ICICI Prudential and HDFC Mutual Fund, the two biggest mutual fund houses, are on the verge of launching gold exchange-traded funds (ETFs). Milestone Capital Advisors, one of the largest domestic private equity funds, has recently launched Milestone Bullion, a portfolio management scheme that invests 40 percent in physical gold, 40 percent in physical silver and 30 percent in gold-linked capital protection structure. “Investors want assurance and they want to invest into asset classes that are different from equity. Nobody really knows where the equity markets are headed. So in such times, gold and silver get a preference,” says Navin Kumar, director, fund raising and head of investor relations at Milestone.

These are just some of the examples that show investors are exercising caution. The big question is should they be.

What Next?
In some sort of seasonal affective disorder, investors can allow themselves to be plunged into a mood of gloom. It is as big a crime in the market as reckless buying of stocks. The smarter thing, then, is to exercise caution without losing oneself to the inertia arising out of fear.




Some might call it a tad optimistic, but there is an alternative view gaining currency: That India might actually turn out to be a beneficiary of all the global uncertainty, as emerging markets become a safe haven for international investors. In such a situation, a huge amount of inflow can be expected into the Indian market.

In the past though, every time the world has landed in a crisis, money has flown back into US Treasuries and ended up strengthening the dollar. After all, that has always been seen as the only safe haven for global investors.

Yet for most part, the India story looks intact. The investment mood will come to reflect that sooner or later. This isn’t the time for excessive risk-taking, but neither is it too early for action. Forget calling the market as either bullish or bearish. The opportunity for the investor today is in those stable and safe stocks that are perfectly poised to benefit from each growth impulse coming from the economy. Often, such stocks turn out to be large caps, though that is not a rule.

So how should investors navigate the uncertain future? In our next story, we lay out some investment ideas and select stocks that we reckon could help you tread safely—and pocket some decent gains too.

 

This article appeared in Forbes India Magazine of 16 July, 2010

A Guide to Forbes India 20 Stocks Portfolio

Here's why we picked the 20 stocks and why you too should have them in your portfolio

by Pravin Palande, T Surendar | Jul 6, 2010 

 

There are stocks in the market and there are stocks in the market that do well. Our recommendations belong to the latter category. Make sure your portfolio has them in the coming year:

AUTO
In Auto, we look for companies that have pricing power and should, ideally, not be affected by any negative international shocks. We have included Auto ancillaries in this segment.

1. Exide Industries
Exide Industries operates in the domestic markets and is a leader in batteries. The company is a market leader in batteries for two-wheelers and has seen a capacity expansion of 35 percent in the current year. There is a huge demand from both the replacement market as well as original equipment manufacturers and this will do well for the company. The core return on capital employed of Exide works out to 85 percent. The management is confident of maintaining a double digit growth rate for the next five years and see electric cars and hybrid cars as a big opportunity. Markets see a 20 percent upside for this stock for the next one year.

2. Escorts
Escorts is a domestic, auto and an agri-play company all packed together. This company can ride on the agriculture and monsoon story of India as 70 percent of the revenues of the company are based on selling tractors. And this segment has already registered 48 percent growth in the last year. The stock has moved up by 100 percent over the last year but looking at the overall prospects of the Indian economy, this company will only benefit. Escorts has only a 17 percent share in the tractors segment and this can only go up. The company has done some financial restructuring whereby the debt: equity ratio has been bought down to 0.3:1. Debt is down by Rs. 200 crore.

3. Maruti Suzuki
Another domestic demand growth story. Maruti Suzuki is under margin pressure but volumes will easily go up by 15 percent in the domestic market. Maruti has a huge market share in the small car business. And this business is on a growth path. At some level the stocks appears fully priced.

But this is one company that has pricing power and other companies can only follow. The company is also increasing its focus on moving into non-EU territory where a chunk of its export volumes were dependent. The company crossed the 1 lakh sales mark in the month of May 2010 showing a growth of 28 percent over last year. This company is a clear long term buy and we are not setting any targets for appreciation.

POWER & INFRASTRUCTURE
1. BGR Energy
Power generation is expected to go up in the next three years and there is a 30 percent growth in capacities and BGR is expected to be a major participant in this. BGR Energy is engaged in power equipment and construction.

Based on a recent Goldman Sachs report, BGR is expected to add $4.7 billion in orders and report 43 percent sales growth CAGR (compound annual growth rate) and 33 percent ROE (return on equity) over the next two years.

There is an order inflow of $2 billion - $2.5 billion each for FY’11 E and FY’12 and
compare this to the earlier year of FY2010 where the same number was $0.8 billion. Over the next year, analysts expect BCG’s share price to move up by about 25 percent

2. Rural Electric Corporation (REC)
REC deals with the power sector in India. The company basically lends to state electricity boards (SEBs) in India and is riding on the growth in the investments in the power sector. The company falls under the ministry of power and provided 16 percent of the total debt required by SEBs and expects its loan book to grow by 25 percent in the next 5 years. Looking at this growth rate, the company is now looking for funding requirements.

The company is raising $400 million through ECB for five years at a 6 month London Interbank Offered Rate + 175 bps (basis point) which is considered very cheap. The company provides finance to the power sector in India and since this segment is expected to do well, this company looks attractive. The stock has an upside of 25 percent from here onwards and looks like a decent buy at this price.

3. Unity Infrastructures
The company wants to increase revenues to Rs. 5,000 crore in the next 4 years and has moved up by 40 percent over the last 3 years and this growth will continue. For FY’10, It had an order book of Rs. 3,800 crore. Now, the company wants to move out of Mumbai and get into Pune, Goa, and Kolkata.

The average contract size of the company has increased from Rs. 50 crore to Rs. 200 crore. Earlier, building and housing orders were the biggest pullers for this company. Now the company concentrates on irrigation, water supply and transportation.

Orders in this segment have increased from Rs. 300 crore in FY’06 to Rs. 1,900
crore today. The revenue visibility of the company is good as the average execution of the order book is around 24 months. Even the National Housing Association of India has awarded the company projects worth Rs. 25,700 crore. It is expected that the order book position to improve by 30 percent from here onwards which means an order book of around Rs. 3,500 crore for FY’12.

The company has grown and maintained its growth rate when many of the peer companies were showing a decline in growth in FY’09. It has always maintained a constant growth in its order book positions.


4. IVRCL
IVRCL is expecting revenues of Rs. 7,000 crore for FY’11 and has an order book of Rs. 35,000 crore. The company, which is an integrated play on infrastructure, is a complete India story. Earnings are expected to grow at above 20 percent for the company in the next two to three years. The company is taking higher exposure to power and other industrial projects and a land sale is expected to release cash for the company. The company has also become active in irrigation and water projects, whose order book works out to Rs. 17,000 crore. The company will ride the infrastructure story in India and the stock is still fairly priced and an upside of 25-30 percent can easily be expected from here onwards.
5. JSW Steel
JSW steel is one of the lowest cost steel producers in the world and it is just not a steel company. The group has diversified interests in mining, carbon steel, power, industrial gases, and port facilities, aluminium, and cement and information technology. The company has a capacity of 7.8 million tonnes. At current market price, stock is trading at 6.4 multiples of its FY’11 earnings.

6. Crompton Greaves
This company should benefit from the thrust that India is giving to the power sector. The company is engaged into advanced electrical products related to power generation, transmission and distribution and also consumer products like fans, luminaries and light sources. The company has a book of Rs. 3,400 crore in the standalone business and Rs. 6,400 crore on consolidated basis.

The company has cash of Rs. 470 crore and operates on a high ROE of 38 percent. The company is trading at 19 times FY’11 earnings. Presently trading at Rs. 250, we can expect a price appreciation of 30 percent in the next one year.

7. ESAB India
A welding equipment manufacturer, and an MNC subsidiary, of England-based company Charter Plc. Since consumption of steel and steel based products should go up, we feel that this company would do well on the back of this demand. Its global revenue is 1.03 billion pounds.

In India, welding equipment market has a size of Rs. 3,500 crore out of which 50 percent is seen as unorganised market. Competitors for Esab include Ador Welding, Ador Fontech, Lincoln Electric (and various other smaller players).

Since the company is an MNC subsidiary, where the parent owns 56 percent, the local company gets advantage of technology transfers very easily.

BANKING & FINANCE
1. Yes Bank
Yes Bank, by any standards, is still a small bank in the private banking space. But the company is on the right track and expects to show an earnings growth of 35 percent in the next two years. The company is putting special focus on the SME market and at the same time has plans to get into the high margin business of micro-finance. Overall, its collaborative model with other banks has worked well and it plans to open more branches over the country. The company is already delivering an ROE of 19 percent.

2. Bajaj Finserv
Bajaj Finserv has everything going strong for itself. The company is in news because it is now in a position to give its stake to Allianz at a much higher price due to changes in some RBI guidelines. Its portfolio includes insurance, consumer finance, financial advisory and is also planning for an asset management.

The company has good promoters and some of its group companies are showing huge growth rates riding on consumer finance and auto loans. Its life insurance has delivered its first full year profit and the auto finance division has shown a growth of 70 percent to Rs. 25.2 crore.

3. ICICI Bank
ICICI bank is on the sell recommendation for most brokerage houses. One of the reasons being that the bank was acquiring Bank of Rajasthan for a profit to book ratio of 3 times with a swap ratio of 1:4.7. But the bank is going through a lot of interesting changes. This is high risk recommendation as the ROE is also low at 8 percent. This is our contra bet. We think, under Chanda Kochhar, the bank is doing some interesting changes.

The bank is increasing its CASA (current and savings account) deposits, concentrating on high capital adequacy ratio, keeping controls on operating costs and reducing unsecured retail portfolios. For March 2010, the CASA ratio stood at 41 percent, the highest
in the last seven years.

The bank has reduced NPA (non performing assets) from Rs. 1,400 crore in the first quarter of FY’10 to Rs. 500 crore in quarter 4 of FY’10. Its non-banking subsidiaries are also gaining market share which includes insurance, mutual funds and broking services.

We would like to believe in the changes that the management is bringing through and expect that things can only change for the better. The bank is one of the few large cap stocks in this group and can deliver around 15- 20 percent in a year’s time.

4. Andhra Bank
Retail loan book is expected to grow by 50 percent this year which means that the bank will be able to maintain last year’s growth of 48 percent. The bank is slowly making ways into retail finance and for FY’10 almost 16 percent of its loans were disbursed in this segment. The bank has become very active in education loans, consumer loan and home loans. The bank operates through 1,700 branches all over India.

Available at a good price, the bank is very well run. The bank is still available at a P/BV of 1.45 times. It is much lower than most banks in this range and the business keeps expanding.

DOMESTIC GROWTH
1. Zee Entertainment
Riding on the back of a robust economy, media stocks are expected to show
high growth potential. Zee Entertainment has concentrated on regional areas and some of its powerful properties are in the Marathi and Bangla space. The regional GEC (general entertainment channels) for the company are also doing well.

The company’s DTH segment is growing fast and it is the leading player in this market. The company has improved its cash position. Its subscriber revenues are growing faster than its competitors. And it has an increasing regional focus. The company has a cash position of Rs. 520 crore. The company has already shown an almost 100 percent growth over the last year in its stock price but still has huge potentials for the future. The stock can go up by 25 percent from here.

2. HDIL
This is a very high risk stock. The company has a huge presence in Mumbai where the real estate market has been rising for a long time. Though some feel that real estate market can correct from these levels, it may or may not happen. For those who want to take an exposure in this sector, HDIL is a decent bet.

For HDIL, growth is primarily driven by transferable development rights (TDR) prices. TDR prices are at Rs. 3000 per square foot now and are expected to go up further as the High Court in Mumbai has given a ruling that it will not allow an increase in FSI (floor space index). The company is planning to ride on the strong demand from mid-income residential projects and has launched a 2.75 million sq. feet of residential projects in Mumbai.

HDIL is a high risk stock with a beta of 2. IF the market moves up by 25 percent, chances are that this stock has the potential to give you much more than that. But same is true if the market falls. This stock will fall fastest.

3. Asian Paints
This company leads pricing power in the paints segment. Strong pricing power is something that works very well for Asian Paints. For every 1 percent hike in retail prices, Asian Paints gains 3 percent in EPS (earnings per share). Now from July 1, the company has gone in for a price rise and it will help net profits by 5 percent. There is a possibility that the volumes of the company will fall marginally because of the price rise. Overall, Asian paints is in a comfortable position because other players only follow the direction of this company thus competition should not eat into the market share.

On FY’11 earnings, the stock is available at a P/E (price to equity) of 22 times and has managed to give good returns.

4. Glaxo
There is a lot happening in the pharma space. Glaxo Smithkline is one of the few companies that managed to maintain growth and introducing new products in the market.

GSK launched Mycamine, an antifungal antibiotic, in-licensed from Astellas, Japan. The Company also launched the Stiefel range of products in Cosmetic dermatology therapies. Stiefel Laboratories Inc. was acquired in the recent past by the parent GSK Plc. With this, GSK is expected to further strengthen
its leadership position in the Dermatology segment. The company is richly priced at a P/E of 57 times on historical earnings.

SOFTWARE & TECHNOLOGY
1. Mphasis
The world is still in a crisis. We have maintained that this is not a time to get into stocks which are heavily dependent on international factors like rupee appreciation, US slowdown and the Euro debt trap.

But in software segment, some companies can actually do well even if the world is not in a healthy position. The demand for application services has actually been robust and that is what is doing well for some companies. Mphasis is one company that is on the radar of many analysts. It has already given around 55 percent growth over the last one year but there is a lot to come from this company.

Application services, for Mphasis have done really well clocking a 25 percent growth YOY (year-on-year) in the last quarter ended FY’10. Its billable rates are steady and this works well for the company as 90 percent of their revenues come from time and material projects. The company has Rs. 1,400 crore in cash, and has recently begun a series of acquisitions. Almost, 70 percent of the business still comes from the partnership with HP & remaining 30 percent from independent clients.

2. HCL Tech
HCL Tech is another interesting company that has shown a faster growth rate as compared to the big three of Indian software over the last four quarters. Even if its BPO operations are not doing well, IT infrastructure growth continues at 15 percent and client addition is strong. The company has recently bagged a $500 million project for a period of 5 years. Even manufacturing has shown a revival after two quarters at 10 percent growth.

Discretionary spending is returning sooner than expected, and we expect HCL to be a key beneficiary from the revival in ERP (enterprise resource planning) consulting projects. Besides, its valuation is cheap compared to its peers.

How to identify Multibagger Stocks?

Rakesh Junjunwala rightly defined the stocks markets as “Markets are like women always demanding, unpredictable and volatile.” No one know whats next. For an instance take it – Does any one knows when this recession is going to end ? No, no can say it accurately, one can just predict but as all know that the future is uncertain.

But what one can do is spot out some value stocks in this badly beaten markets and think of long term investment in them. But a question comes here that which company to invest in?
The answer to the above question is invest in the company in which you have faith and confidence and more over of which you are aware of.

Here are few easy steps to identify Multibagger stocks.

1. Go for a company which gives regular dividend. Dividend paying stocks mostly lie in A group category.
2. Preferably go for a Mid cap stock which in future can become a large cap. Mid cap stock have a greater chance to move upwards and that to fast. Preferable a stock whose market cap is less than 1000 Crores.
3. Go for a stock in a particular sector which is in boom.
4. Look out for the companies financial. In this check out the companies profit f last 4-5 years and check it out that it is increasing every year. One can also check out EPS of the company.
5. Check out whats running these days, Say for example there is a invention of a new technology which will be in demand in a near future. An excellent example is invention of 3G. Even TATA Nano can be taken in consideration as it is only one of its kind being the cheapest car in the world.
6. Check out for a companies order value. There are various companies which have a good amount of orders for future which are of great importance to a company.
7. One can also look out for a company which has good amount of land / property. Unitech had a lot of lad which can in the eyesight by end of 2005. An investment of Rs 40,000 then would be worth over 1 crore by the end of 2007.
8. Last and not the least be confident in your stock.

Few don’t s in selecting a multibagger stock.

1. Don’t select a Penny Stock.
2. Don’t loose hope in your company.
3. Don’t depent on others , do your own research.

Happy Investing.

The ITC King’s Gambit

Y.C. Deveshwar is determined to give ITC a life beyond tobacco and make it an FMCG giant. He will need that to secure the company’s future — and his own:

B y the time you read this, the 15-member board of directors of ITC would have swiftly concluded its meeting scheduled for the morning of June 18. The mood inside the board room in Virginia House, the headquarters of India’s largest tobacco company, would have been understandably buoyant. This is ITC’s centenary year. And the main agenda for the board meeting — to discuss the proposal for a special 1:1 bonus share issue — would have been expeditiously cleared.

For Yogesh Chander Deveshwar — Yogi to his colleagues on the board — this would mark the perfect beginning of the end. By the time he steps down in April 2012, he would have spent more than 15 years as chairman, easily the longest serving in ITC’s history. But that’s not a sobriquet that Deveshwar really cares about.

He’s already made it amply clear in media interviews, including one to this magazine, that he’s looking for a longer innings.

On the face of it, Deveshwar may have a legitimate reason: He’s in the throes of transforming ITC from a cigarette maker to a fast moving consumer goods (FMCG) company for the past decade or so. In the last three years, he’s really upped the ante — and taken on a plethora of global and local rivals including Unilever, Procter & Gamble, Pepsi Foods, Britannia, Nestle and Parle Agro, all at one go.

So far, ITC’s non-tobacco FMCG business is just about Rs. 3,700 crore. In this year’s five year rolling plan — a ritual that all ITC chairmen have religiously stuck to — Deveshwar says he’s banking on the FMCG business growing to nearly four times that size (Rs. 12,000 crore) during this period, even as ITC aims for a turnover of Rs. 55,000 crore. (Put simply, the FMCG target is a bit like adding four times Marico’s current turnover.) And quitting in the middle of the surge would seem rather tame.

Clearly, while Deveshwar is preparing the ground for an extension, most insiders reckon the final nod from the board may not come till the last moment. There’s also the seemingly small matter of convincing its erstwhile owners British American Tobacco (BAT) to support his candidature. BAT has about 32 percent stake and two board seats. And the two folks it has picked for the job, Hugo Powell and Anthony Rhys, are both former FMCG veterans from Unilever. And while BAT hasn’t interfered with ITC’s management in the last decade and a half after a failed attempt to take majority stake, it isn’t likely to give in to Deveshwar’s campaign now without driving a hard bargain. Want to know why? We’ll come to that in a bit.

Meanwhile, most rivals who’ve witnessed Deveshwar’s bare-knuckled assault from close quarters are keeping their eyes peeled on the succession issue. For, a change in leadership will invariably affect how the future plans of ITC are carried out. Already, Deveshwar’s aggressive expansion of market share has raised eyebrows both inside ITC and outside. The CEO of a leading Indian FMCG firm, who wishes to remain unnamed, says he is astounded at the kind of money ITC is putting up to buy market share in the personal care business. Soaps and shampoos are among the biggest categories in the personal care space. And in trying to build a Rs. 500 crore business, ITC is said to have lost about Rs. 250-odd crore this year alone.

Where’s the End Game?
A well-known columnist in a leading business newspaper claims she received a call from Deveshwar after she referred to some “illogical” players in the FMCG industry in one of her recent columns. He gently enquired in his avuncular manner whether she was indeed referring to ITC. “What is his real end game? Do you really know?” she enquires, puzzled.

It is a question that holds the key to ITC’s future. Ideally, Deveshwar would want nothing better than to be remembered as the man who helped build India’s largest consumer product firm. After all, reducing the dependence on the not-so-desirable core tobacco business has proven to be no mean task. For four decades, ever since ITC’s first Indian chairman A.N. Haksar took charge from BAT in 1969, every leader has tried his best to diversify beyond tobacco, but without much success.


In Deveshwar’s era, however, ITC has clearly achieved more than a measure of progress. Today, about half of its net revenues of Rs. 18,000 crore comes from cigarettes, and the other half from hotels, paper boards, infotech, agri-business and now increasingly, foods and personal care. Of these, Deveshwar inherited hotels and paper board, the only two other businesses of any real scale, from his predecessors. In the early part of his era, he did discover and nurture e-Choupal, the concept of a rural trading platform using a digital technology backbone. It fired the imagination of the business community and academia, winning a plethora of awards and even providing material for a Harvard Business School case study. At one point, ITC was opening six e-Choupals a day across the rural hinterland. In the end, hobbled partly by tight regulations and its own inherent complexities, the business never quite grew into a sustainable growth engine and remained only a visible symbol of ITC’s corporate social responsibility.
 
Photo: A N Haksar: The Times of India Group. © BCCL; J N Sapru and K L Chugh: Prashant Panjiar / indiatodayimages.com; Y C Deveshwar: Amit Verma

Today, his big bet is on foods and personal care. He’s already totted up losses of more than Rs. 2,035 crore on the FMCG business (insiders say that actual losses are far bigger if one considers the initial incubation costs that may have been absorbed by the tobacco division’s hefty profits). His colleagues say that Deveshwar would like more time to personally handhold the new businesses, put them on a stronger footing and demonstrate success, before leaving.

And to be fair to him, not too many CEOs in contemporary India can claim to stay focussed on their end goal in the teeth of such heavy losses. But then, hardly any of them would have perhaps made it to the board of a company the size of ITC at the age of 37 like he did back in 1984, a time when board seats were reserved for those in their 50s.

A Career in Audacity
Clearly, Deveshwar knew how to take bold decisions. A former ITC senior executive remembers the time when he returned from Air India to confront a complex situation. Godfrey Philips had launched Four Square Specials, a mini version of Four Square Kings. It was making deep inroads into ITC territory. One option was to introduce a similar variant of Gold Flake and stop the intruder. But it ran the risk of downgrading the Gold Flake franchise. And the entire marketing team inside ITC baulked at the prospect of tinkering with a mega brand. Deveshwar, who was then the head of the tobacco division, went against the advice of his entire team and singlehandedly went ahead with the launch of Gold Flake Filter. He focussed on promoting Gold Flake Kings to manage the possibility of any brand dilution. It worked splendidly. Volumes grew several-fold. And Gold Flake became a veritable cash machine for ITC.

But nothing could have possibly prepared him for the challenges of leading ITC when his turn finally came in 1996. BAT and ITC had just fallen out. In a bid to wrest control of the company, BAT had ended up dividing the organisation into two camps: Those that favoured the re-entry of BAT. And those that didn’t. It was a bloody, no-holds-barred battle. K.L. Chugh, his predecessor, had chosen to aggressively lead the company into financial services, international commodity trading and edible oils. He had even contemplated an entry into power.

None of them proved effective — and ITC lost lots of money. This provided the perfect launch-pad for BAT to mount its offensive against Chugh. BAT wanted ITC to stick to the knitting. That’s exactly what it had done in the UK starting in 1989, dismantling and unbundling a set of diversifications that were remarkably similar to that of ITC. See graphic on the .

In January 1996, Deveshwar inherited a fractured organisation. Morale was low, and a number of top leaders soon went to jail on charges of foreign exchange violations. He formed an interim management committee to manage the affairs of the company, created a separate legal team to deal with all the Enforcement Directorate cases piled up against the company and began to tone up the governance system inside the company. He created a three-tiered system: The board of directors to focus on strategic supervision, a corporate management committee to dealwith strategic management and a divisional management committee with operational responsibility.


After the Enforcement Directorate fiasco, when incriminating documents had been found in the chairman’s office, Deveshwar completely sanitised it. So you’ll rarely find a piece of paper lying around in his room. Instead, his room is choc-a-bloc with ITC products!
 
He also made a few quick calls on the portfolio and the structure of the company. The paper board business was bleeding, almost on the verge of bankruptcy. Not many folks inside the company were in the mood for another bout of adventurism. They wanted ITC to get rid of it, just like it had done with the financial services business. But Deveshwar stuck to his guns. He brought back the hotels and paper board business inside an integrated structure — so that they could receive adequate support from ITC’s cash flows. “The earlier diversifications did not receive full-blooded support in terms of investments to help them grow,” says the chairman. He also put in place a system of checks and balances to ensure that businesses did not take undue risks.

By all accounts, Deveshwar did a commendable job of bringing the company back on the rails. The hotels and paperboard business gradually began to turn around. His colleague and executive director, Anup Singh, describes him as a “master strategist”. For the first five years, Deveshwar did little else but put in place strong systems. He also made sure that BAT officials did not interfere in the day-to-day management of the company. “Typically, a BAT official would sit in for the initial interim committee meetings. Deveshwar made sure that they didn’t and were only privy to what was discussed at the board by virtue of their two board seats,” says a senior corporate executive.

Consolidation and Growth
Gradually, the company began to rediscover its moorings. And so, by 2002, he had begun the search for new growth pastures. During a visit to the World Economic Forum at Davos, Deveshwar and his group human resources chief Anand Nayak ran into Harvard University professor Krishna Palepu. Palepu’s work on the relevance of diversification to growth in emerging markets struck a chord with ITC’s big boss. So from 1998, Palepu began to advise ITC on its corporate strategy.

One of the issues that Palepu dwelt on was how to leverage ITC’s distribution strengths. That, in turn, prompted Deveshwar to start looking at a large FMCG play. His reasoning: ITC already had the relevant brand management skills. Sure, the large distribution system needed tweaking, but there was little doubt that it was a formidable strength — and above all, it had a huge cash hoard (at current estimates, close to Rs. 12,000 crore) to fund the expansion. There was another reason: Compared to the high gestation hotels and paper board business, the FMCG business was relatively a low gestation one.

It started with the lifestyle retailing business. Initially, the plan was to diversify the Wills trademark from cigarettes to the lifestyle retailing category. With the ban on tobacco advertising, ITC realised that it would have to look for alternate ways to keep alive its trademarks. Simultaneously, it had to withdraw the Wills brand from the cigarette business, so that it did not constitute surrogate advertising.

ITC’s entry into retail shook up the market: It rented out properties at astronomical rates in prime locations. Its merchandising standards were world-class and in the initial period, there were rumours that it even burnt the unsold stock rather than sell the mark-downs. But so far, ITC has struggled to find its feet in the retailing business, despite reworking rentals and getting out of a spate of bad
property deals.

The big foods foray was next. And the learning curve was pretty steep there. Take Bingo, its first product in the branded snacks category. First of all, Bingo was manufactured in a central location in north India and transported all over the country. That resulted in the cost of freight being very high. It also severely tested the distribution system that was skewed towards convenience stores.

ITC had to expand its reach and invest significantly in new infrastructure to achieve the width of distribution to take on PepsiCo’s Lay’s. Its media muscle was formidable, in keeping with Deveshwar’s philosophy of spending like the market leader. Yet Pepsi played its cards smartly.

Like all ITC products, Bingo too passed through several quality tests in a bid to ensure that the product was superior than Lay’s. In normal trade practice, these products enjoy a shelf life of four months. As a strategy, ITC decided to stick to a six month shelf life, according to insiders. Pepsi used this to its advantage by promising the trade fresh stocks from its regionally distributed manufacturing locations.

Image: Goutam Roy for Forbes India

The Prince Kurush Grant is a possible successor to Deveshwar, but will he get his chance?

Somewhere along the line, in their quest for turnover, the top brass in the food division allowed the demand forecasting plan go haywire. And there was a huge pile-up of unsold stock at the distributor level. Finally, faced with an overstocking situation, the company was forced to write off nearly Rs. 25 crore worth of stocks over a period of two years. Ravi Naware, CEO of the foods division, was forced to take premature retirement after the setback. Despite this, Bingo finger snacks — Mad Angles — did reasonably well.

For biscuits too, ITC is said to have used a deep discounting strategy to push stocks into the trade. Seventy percent of its portfolio consists of glucose biscuits, where margins tend to be very tight. With Parle being the reference brand in the category, ITC has no option of raising prices without losing share. By ITC’s own admissions, Parle is also considered one of the best working capital managers and has a formidable distribution model.

On Aashirwad atta, ITC did achieve success. And it derived some advantage from the sourcing strengths of its e-Choupal network to reduce costs and improve the level of localisation. With a 52 percent share of the branded atta market, ITC will have to patiently look to convert unbranded users. Unbranded atta accounts for 90 percent share of the market.

The foods debacle peaking in 2009 was a grim reminder of the cash-on-tap syndrome. If a cash-rich company like ITC decides to chase turnover, it could end up blowing up a lot of it without too much gain. “We allocate capital with a venture capitalist’s mindset. We’ve made it known that cash is always available for businesses that are performing,” says K. Vaidyanath, executive director.

Lessons Learnt
So ITC was careful with its next major foray: Personal care. Reports suggest that the business plan was scrutinised thoroughly to ensure that the growth was profitable.

Till date, ITC has rolled out four brands in the soaps and shampoo market in a tiered manner: Wills Essenza in the super premium category, Fiama di Wills in the premium category, Vivel for the mass market and Superia for the popular segment.The product quality is impeccable — and ITC has signed up a bevy of stars — from Deepika Padukone to Kareena Kapoor to  Hrithik Roshan — to endorse the different brands. Yet market share gains have been much slower to come through. ITC has a 5 percent share each in soap and shampoo categories.

So what does Deveshwar plan to do now? “In the consumer business, you need scale to build a franchise. It is a chicken-and-egg problem. We will infuse life into these businesses so that they can stand on their own legs,” says Deveshwar.

Now, here’s his dilemma: Unless he pushes for scale, his chances of reducing ITC’s dependence on tobacco will be slim. And in foods and personal care, Deveshwar reckons he has the best opportunity to build share and volumes. But both businesses are also the grazing ground of the smartest multinationals in the world, including Unilever, P&G and Nestle and some of the best-run local firms like
Britannia and Parle.

In the next few years, the pressure will mount inside ITC to push for scale. And that pressure will come from the corner office. According to senior executives, Deveshwar has increasingly been driving the strategy himself in a bid to ratchet up the growth rates at ITC. Many of the key decisions — on which product category to attack, how to position and even pack sizes — nowadays emanate from him. It was his decision to enter the snackfoods business and even branded atta. He even visits the market on a regular basis, moving from shop to shop, assessing the company’s performance. In effect, Deveshwar is now emotionally committed to the FMCG business.

Having developed a beachhead, Deveshwar says the next phase of growth will be about launching sharply differentiated products. In its Bangalore research and development centre, a team of scientists led by former GE scientist C.C. Lakshmanan is hard at work to address the convergence of health and well-being across agri-produce, functional foods and personal care, says Deveshwar.

The Tall Leader
Thanks to his long stint at the helm, Deveshwar virtually towers over the other leaders in the company. The fact that he earns close to three times more than the next senior most director also adds to the “power distance”.

Besides, other than the four executive directors who get permanent seats at the corporate management committee, all the other members are deemed as “invitees”. That somewhat reduces their ability to challenge decisions — and cuts out any possible dissent. In the last few months, insiders say that there have been some reports of dissent from within on the larger FMCG strategy being put down with an iron hand.

It is his mastery of the brief that helps Deveshwar do this. He prepares intensively before every corporate management committee, often working till 4 a.m. Even now, he makes detailed notes on every single page that is sent to him before coming in for a meeting.

Image: Goutam Roy for Forbes India

K Vaidyanath of ITC

 
A larger-than-life chairman does ensure that decisions get pushed through quickly. But it also heightens the chances of failure, especially if there is heavy centralisation of decision-making. Technically, the businesses may be run by CEOs, who in turn report to a director. But in a lot of the cases, the chairman directly signs off on most key decisions. It ends up making the system somewhat dependent on him.

Since 2000, ITC has not had any new director on the board, except for Kurush Grant, who was elevated to the board in March this year. Grant is now the point person in charge of FMCG.

Considered a whiz in the tobacco business, his elevation to the board was perhaps long overdue. But for two consecutive years, the nominations committee, headed by the chairman himself, did not find any occasion to meet.

Grant is also the only person who is seen as a possible successor to Deveshwar, if he chooses to step down in 2012. But by then, Grant would have spent only two years as executive director.

Will They Bat for Him?
By all accounts, the task of turning around and profitably growing the FMCG business will take a lot more time than Deveshwar’s current tenure allows. And almost the entire board, consisting mostly of retired bureaucrats and finance professionals, is likely to push for continuity, rather than plump for a new leader.

Deveshwar will, of course, need the support of BAT. The issue is: What does he offer them? The London-headquartered BAT is still keen on gaining control of ITC. But Deveshwar has so far ensured that BAT is kept at bay.

He’s actively canvassed support from the government to keep ITC an independent, professionally managed firm, much like Larsen & Toubro. ITC is today viewed as a company that looks after the interest of Indian farmers. And the support from the financial institutions has ensured that BAT is unable to increase its stake. And earlier this year, the government’s decision to ban FDI in tobacco may have been the final spoke in the wheel for BAT.

In the recent past, ITC has increased its dividend payout ratios from 35 percent to 50 percent to keep shareholders like BAT happy. With Philip Morris looking to make strong inroads in India with Marlboro, Deveshwar may want to fight the new challenger by allowing BAT to bring in a brand like Kent into India. Or he could promise to make the government see reason and reverse the FDI ban on tobacco and/or take on local manufacture of BAT brands to service Asia-Pacific.

But the big threat for Deveshwar is to ensure that at no time does his big FMCG foray severely dent ITC’s financial performance. So far, none of this has affected the performance of the company. Partly because the tobacco business is so strongly placed that it continues to sustain consistent price hikes.
ITC has generated a total shareholder return of 24 percent since 1996, which would be among the highest in its peer group, says Vaidyanath.

As a diversified conglomerate, as long as its enterprise value is higher than the sum of parts valuation, ITC may not face any perceptible threat.

In 1989, in UK, BAT faced a sudden hostile bid from James Goldsmith (Jemima’s father) and was finally forced to jettison all its new businesses and stick to the knitting.

Today, that’s the last thing on Deveshwar’s mind.
 
 The BAT-ITC Saga: Diversification vs Focus

Why ITC took a leaf out of BAT’s book on diversification and stuck to it even as BAT went back to its core tobacco business

1960S
The London-headquartered British American Tobacco begins to diversify into paper and pulp, cosmetics and the food industry. Till then, it had stayed focussed on cigarettes only.

BAT gives up control of ITC under the new FERA norms. In 1969, ITC is forced by the MRTP norms to reduce its share of the cigarette business to less than 50%. It begins to figure out ways to diversify beyond tobacco. It chooses hotels and paper and paperboard.

1970S
Rechristening of BAT Industries in the late 70s reinforces the thrust on diversification.

ITC opens its first hotel in Chennai — the ITC Welcomgroup Hotel Chola — in 1975.
Meanwhile, it begins its struggle to expand into hotels and paper board. The Imperial Tobacco Company of India becomes India Tobacco Company in 1970 and I.T.C. Ltd in 1974.

1980S
BAT expands into financial services in the 1980s, with the acquisition of Eagle Star in 1984, Allied Dunbar the following year, and the Farmers Group in 1988. Chairman Patrick Sheehy lays down the four pillars of the business: Cigarettes, financial services, paper and retail. In 1989, investor James Goldsmith (socialite Jemima’s father) mounts an unsolicited takeover attempt. It fails, but quietly under new chairman Martin Broughton, BAT begins the re-focus on the core tobacco business and financial services. Broughton sells off packaging unit.

ITC continues its diversification spree into financial services. ITC managers are seconded to BAT operations as part of a management development programme.

1990S
BAT continues its overseas expansion into Eastern Europe and Far East, unlocking new growth in tobacco. In 1998, BAT Industries divests its financial services businesses. BAT begins nudging ITC to follow on its footsteps. ITC takes no heed. In 1990, it acquires Tribeni Tissues Limited, a specialty paper manufacturing company and a major supplier of tissue paper to the cigarette industry from BAT.

And under chairman Chugh, ITC seeks out newer avenues, including an investment in power. ITC’s diversification runs into heavy weather, with financial services, branded edible oils and international trading toting up huge losses. BAT uses the failed diversifications as a ploy to drive a wedge inside ITC and demand control of the company. Chugh steps down under a cloud. Y.C. Deveshwar steps in.

2000S
BAT continues its international march with a series of new investments in countries such as Turkey, Egypt, Vietnam, South Korea and Nigeria. Yet in India, BAT has to remain content with 32% stake in ITC and two board seats. It describes ITC as an associate company.

ITC begins its expansion into FMCG. Hotels and paperboards regain momentum under an integrated structure. Tobacco continues its sterling performance. To signal its multi-business status, it is now called ITC Ltd. With no further FDI in tobacco, BAT doesn’t have much hope of controlling ITC.
 

This article appeared in Forbes India Magazine of 02 July, 2010