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

20 stocks you must own

Around this time last year, Mumbai was still impatiently waiting for the arrival of the monsoons. It would have been the season’s best reprieve for anxious investors who were till then reeling under the heat of a global market meltdown. In retrospect though, it may have been the ideal starting point for Indian investors.

Exactly a year before now, in our first cover story on the markets, we had recommended that investors resume buying. We had recommended a portfolio of 20 stocks that would mirror an array of opportunities the Indian economy presented.

A year later, barring two companies, the portfolio has ended with positive returns. Three companies P&G, Page Industries and Pidilite have returned 100%. Five other stocks gained 70%.

On the whole, the Forbes India 20 portfolio was up 54%, compared to 45% of the mid-cap index (most of our recommendation was from this category). The broad market went up by 15% during the same time.

To be honest, there were enough easy pickings. Many companies were powering ahead before the global bust and yet, their valuations had fallen off the cliff. Almost all our stock picks had a strong domestic story that helped insulate them from the global instability.

But that was last year. Many Indian companies are now quickly reaching their pre-slump level in sales. Having scaled back expansion plans, they will soon churn out their full capacities, leaving little headroom for volume growth.

Investors have already guessed that Indian companies will continue to perform well, and lapped up stocks at prices that have already discounted the current financial year’s earnings.

Our considered opinion is that any investments in the stock market may not yield above-average returns in the next one year. 

High net-worth individuals (HNIs) have already moved from equities to structured debt products to signal the flight to safety. The fog of global uncertainty hasn’t quite lifted. On the contrary, economist Paul Krugman has predicted the makings of the third Depression. To cut a long story short, it will, therefore, be more difficult to construct a portfolio that will return as much as the one we chose last year.

In a fast growing economy, there are bound to businesses that will deliver better than average returns. We tend to lean towards the views of experts who reckon that the valuations of Indian markets at a P/E ratio of 18 times 2010-11 earnings cannot be considered as expensive. The historic average tends to be 20, while a ratio of 24 could well enter the danger zone.

High net-worth individuals (HNIs) have already moved from equities to structured debt products to signal the flight to safety. The fog of global uncertainty hasn’t quite lifted. On the contrary, economist Paul Krugman has predicted the makings of the third Depression. To cut a long story short, it will, therefore, be more difficult to construct a portfolio that will return as much as the one we chose last year.

In a fast growing economy, there are bound to businesses that will deliver better than average returns. We tend to lean towards the views of experts who reckon that the valuations of Indian markets at a P/E ratio of 18 times 2010-11 earnings cannot be considered as expensive. The historic average tends to be 20, while a ratio of 24 could well enter the danger zone.

There is a fundamental difference in the theme this year. Our immediate focus is to preserve capital, while aiming for decent returns (the long term returns from equities in India is 15%). So we’ve left out the relatively small companies, which typically fall harder in a downswing. Some of the other parameters have not changed. “This market is above fair value and investors should not overpay for growth,” says Rajeev Thakker, CEO of Parag Parikh Financial Advisory. We’ve retained our focus on picking stocks that have a large domestic play. We’ve also focussed on sectors that have shown dramatic consumption trends: Real estate, auto, banks and financial services. We’ve added the fast-growing infrastructure sector too.

Here’s a sense of why we selected some of the stocks and themes.
In the auto segment, we picked India’s largest car maker Maruti, tractor firm Escorts and battery maker Exide Industries. These stocks have run up in the recent past and seem fully valued. But the demand for small cars has continued to surge forcing Maruti to set up another plant. Trading at a P/E of 16, the stock still has a lot of steam.

Exide rides indirectly on the growing automobile sales – it makes nearly two-thirds of the batteries that go into cars and trucks. Exide’s core return on capital employed (ROCE) is at 85% and its management believes electric vehicles and hybrid vehicles could well be its next big opportunity.

The banking sector at the moment is valued on the higher side. But ICICI Bank is a good buy at 1.85 times the book value. Under CEO Chanda Kochhar, it has signaled a clear return to profitable growth. Yes Bank, on the other hand, plans to foray into the high-return micro-finance business. It is trying to improve its public deposits too. For the long term investor, this is one bank to catch at an early stage.

Bajaj Finserv is a good insurance play. The stock has performed well over the past three months, up 28%, after benefitting from RBI’s circular on revised norms for transfer of shares to overseas entities.

There are some unusual names in the portfolio. BGR Energy is one. BGR Energy is engaged in power equipment and construction and it is expected that the power generation capacities are expected to peak in India. Based on a recent Goldman Sachs report, BGR is expected to add USD 4.7 billion in orders and report 43% sales growth CAGR and 33% RoE over the next two years. Over the next year, analysts expect BCG’s share price to move up by about 25%.

Then there is IVRCL, the integrated infrastructure player, which gave a guidance of Rs 7,000 crore for its top line in 2010-11. It has a huge order book of Rs. 32,000 crore. On 2010-11 numbers, the company trades at a P/E of 12.2 times.

Indian IT firms may have lost a bit of their margins, but of late, they’ve gained at the expense of global tech majors Accenture and Oracle. We sense value in HCL Tech, which is fast improving its standing among the top four and has registered the strongest revenue growth in three of the last four quarters. Aggressive bidding during the slowdown gave HCL entry into marquee client accounts. Discretionary spending is returning sooner than expected, and we expect HCL to be a key beneficiary from the revival in ERP consulting projects. Besides, its valuation is cheap compared to its peers. 

Samruddhi cement

 

Investors with a two-three year perspective can buy the stock of Samruddhi Cement Limited (Rs 475)- the demerged cement business of Grasim Industries that listed on the bourses last week.

The stock is a value pick within the cement sector, given its moderate valuation, control over the northern market, and low leverage that gives it the scalability to expand and add capacities.

Samruddhi Cement will soon be merged with UltraTech Cement, also an Aditya Birla Group company, at the announced swap ratio of 7:4. Shareholders of Samruddhi Cement can hold the stock as it trades at a discount to the price warranted by the swap ratio (UltraTech’s current market price would warrant a price of Rs 507 per share for Samruddhi).

Post-merger, the combined entity (48.8 million tonnes) will become the single largest cement manufacturer in the country with an all-India presence.

With a significant pie of the northern cement market, Grasim’s cement business did better (despatches up 15 per cent vs all-India average 12 per cent) than most of the other frontline cement companies in the last one year.

At an estimated enterprise value (EV) of Rs 5800/tonne ($125/tonne), the stock of Samruddhi Cement is at a modest valuation; peers are trading at an EV band of Rs 6000-8000 a tonne.

Strong points for merger

In 2009-10, though players of the South showed a lacklustre performance with correction in prices, the northern players did well with improved prices on tight supply conditions. UltraTech Cement, which is now a predominant player in the West and southernmarket , will gain access to markets of the North after its merger with Samruddhi Cement. UltraTech Cement will have a close to 20 per cent share of the grey cementmarket in India, post the merger.

Operating efficiency

The merger is also likely to be earnings accretive. Though UltraTech Cement’s share capital will expand by 120 per cent with a fresh issue of 14.95 crore shares, earnings growth will be considerable enough to make the deal value-accretive.

The combined entity’s PAT will stand 140 per cent higher than the standalone PAT of UltraTech Cement (calculated based on FY-10 profit figures). Theearnings per share will stand around Rs 97; higher by Rs 10 per share for the present set of UltraTech shareholders.

The merged entity may be also be among the more efficient cement producers in the country.

For FY-10, Grasim Industries’ standalone numbers showed net profit margin improve by four percentage points to 19 per cent.

UltraTech did not fare up to the mark of Grasim as its realisations were hit badly by drop in cement prices in the South. Prices in the South were on an average down by around Rs 20-30/bag in the year.

At the operating level, there has been a significant saving, particularly in fuel costs. Thanks to the higher drawing from captive thermal power plants for the power needs. As a percentage of sales, power costs for UltraTech Cement dipped to 20 per cent in FY-10 from 27 per cent in FY-09. Grasim Industries made a two percentage point saving (power costs as a percentage of sales dropped to 16 per cent from 18 per cent).

The combined captive power capacity of UltraTech Cement and Samruddhi Cement will stand at 504 MW post-merger; 268 MW from Samruddhi Cement.

On the raw material front, most of the manufacturers in the industry including UltraTech Cement have however been seeing increase in costs with prices of limestone, gypsum and coal going up.

Capex plans

Post the commissioning of the 3.1-million tonne grinding unit at Kotpuli, Rajasthan, in the March quarter, the combined capacity (with the UltraTech Cement) of the company stands at 48.8 mtpa.

The company intends to spend Rs 4475 crore over the next two years in capex activities for the cement business.

The debt-to-equity ratio of UltraTech Cement is 0.34 (outstanding loans as of end-FY10 is Rs 1605 crore).

The debt that will move with Samruddhi Cement to UltraTech Cement is estimated around Rs 2,500 crore; with equity too expanding, the burden of debt will not be significant (The debt-to-equity ratio of the combined entity will be less than 0.5).

Sector prospects

The cement despatches growth in 2009-10 was encouraging at 12 per cent compared with the previous year’s 9.5-10 per cent.

What is of concern is the huge addition to supplies following capacity expansion in the industry. According to an industry estimate, 48 million tonnes of capacity was added in FY-10, which has led to 29 million tonnes of fresh production.

The sector though might see flat prices for cement (or even some correction) in the near term; offtake will, after a blip (due to closure of construction activities for the Common Wealth games and monsoon), recover as construction activities catch up and metro railway work commences in most states.

Rakesh Jhunjhunwala Portfolio - Latest - May 2010

NOT VERIFIED
 

Name Of Company	No. of Shares
GEOJIT BNP PARIBAS FINANCIAL SERVICES LIMITED	18,000,000
PRAJ INDUSTRIES LTD	11,678,624
HINDUSTAN OIL EXPLORATION CO. LTD	5,385,143
VICEROY HOTELS LIMITED	4,250,000
GEOMETRIC LIMITED	3,860,000
PUNJ LLOYD LIMITED	3,790,000
PRAJ INDUSTRIES LTD	2,798,000
TITAN INDUSTRIES LTD.	2,787,755
KAJARIA CERAMICS LTD	2,502,642
LUPIN LIMITED	2,183,581
KARUR VYSYA BANK LTD	2,041,224
PROVOGUE (INDIA) LIMITED	1,900,000
HINDUSTAN OIL EXPLORATION CO. LTD	1,887,273
BILCARE LTD.	1,735,425
VIP Industries	1,263,000
J.B.CHEMICALS & PHARMACEUTICALS LTD.	1,251,650
AGRO TECH FOODS LTD.	1,153,700
LUPIN LIMITED	1,065,254
TITAN INDUSTRIES LTD.	1,038,306
GEOMETRIC LIMITED	850,000
RALLIS INDIA LTD.	746,588
AUTOLINE INDUSTRIES LIMITED	731,233
ION EXCHANGE (INDIA) LTD.	650,000
PRIME FOCUS LIMITED	632,500
CRISIL LIMITED	550,000
VICEROY HOTELS LIMITED	500,000
INFOMEDIA 18 LIMITED	489,479
DWARIKESH SUGAR INDUSTRIES LIMITED	450,000
ZEN TECHNOLOGIES LTD.	450,000
ZEN TECHNOLOGIES LTD.	450,000
RISHI LASER LTD.	380,000
BILCARE LTD.	267,500
PRIME FOCUS LIMITED	250,000
INFOMEDIA 18 LIMITED	210,698