Cover Story : REBOOTING THE ECONOMY

As such, the Government of India is now focused on accelerating the economic activity, which slowed down quite sharply during the tenure of the UPA II regime. This is visible from the steps taken by both the UPA II (towards the end of its tenure) and the current NDA government. Though there is a slight difference in the approach of both the governments, the key element remains the rapid growth in economic activity by laying emphasis on capex revival and generating employment to boost the manufacturing and service sectors’ growth rate. It is expected that the NDA government might bring back the growth rate possibly to early double digits by the end of its five-year tenure ending in 2019.

The UPA II government, in order to boost the manufacturing sector, gave thrust to ‘revival in the capex cycle’ by offering certain direct tax incentives (see table) and concessions so that the companies/industries could augment their capacities and generate new employment opportunities. This was more to do with the existing entities and mostly for domestic consumption. However, the NDA government, while continuing the previous government’s scheme, launched its new program titled ‘Make in India’ which is more focused towards attracting FDI to set up manufacturing facilities for industry and products in new areas with the objective of both domestic consumption as well as exports. This will help in funding projects with foreign participation for longer duration along with balancing the trade deficit by increasing exports and reducing dominance on imports.

The incentives provided by the central government to boost capex in the manufacturing sector include investment allowance (additional depreciation) at the rate of 15 per cent to manufacturing companies that invest more than Rs 1 billion in plant and machinery acquired and installed between April 1, 2013 and March 31, 2015. Further, in order to provide a further fillip to companies engaged in manufacturing, an additional deduction of 15 per cent of cost of new plant and machinery is extended for investments exceeding Rs 250 million (acquired and installed during any previous year until March 31, 2017).

There are companies in certain industries or sectors which have undertaken capex during the past few years and are expected to undertake capex programmes going forward. This is largely to do with removal of capacity constraints and bottlenecks so as to move on to a high revenue growth trajectory. Some of the companies that have undertaken capex or are expected to do so might opt for a mix of internal accruals and external funding. The reliance on external funding should be such that it does not impact the profitability of the company adversely. Usually the return ratios such as return on equity and return on capital employed tend to get impacted during the period during which the capex is undertaken and a year or two thereafter. This is because the asset being generated does not contribute to profitability during the construction phase and after commissioning of the asset, the interest which was being capitalised earlier get charged to the profit and loss account.

We have identified a few companies that have incurred huge capex based on the following three criteria i.e. highest addition (Gross Block + CWIP) during the last five years, highest CWIP as on March 31, 2014, and highest CWIP as a percentage of Gross Block as on March 31, 2014 (as stated in the table below). Some of these companies have availed the benefit of the scheme launched by the previous central government to revive economic activity by providing a boost to the manufacturing sector.

Apart from the above, companies in certain sectors like aerospace, defense, automotive and automotive ancillary, fertilisers, gems and jewellery, etc. are likely to see momentum in capex to boost manufacturing activity as well as exports based on the ‘Make in India’. These companies could be in the listed as well as unlisted space.

Note: We have considered capex by companies mostly in the manufacturing sector and have ignored companies in sectors such as oil & gas, power, telecom, etc.

CAPEX AND ITS EFFECTS

The focus this time is on companies that have installed additional capacity in a bid to take care of increasing demand. How has this impacted their financial performance? Here are the details

The below stated companies have incurred substantial capacity addition during the last 2-3 years and further capacity addition is underway, thereby resulting in deterioration in debt/equity ratio. The return ratios have also taken a hit partly on account of this and we believe that once the expanded capacities get streamlined these will start contributing to the volumes and profitability of the company. The asset turnover will witness a gradual increase and improvement will be witnessed in operating margins and return ratios too.

The revenue growth will be visible both on account of volume push due to capacity addition and realisation improvement due to economic activity gaining momentum. This will result in better profitability as a result of margin improvement and absorption of fixed overheads on a large revenue base.

We believe that over a period of 2-3 years these stocks might get re-rated and show strong upside in their stock performance.

BASF India

BASF | BSE CODE: 500042 | FACE VALUE: Rs.10 | CMP: Rs.1292.00

BASF India is a leading transnational company in the Indian chemical industry. The company’s product range includes leather chemicals, textile chemicals, agrochemicals, dispersions, and specialty chemicals and plastics. These activities have the strong technological support of BASF AG. It is headquartered at Mumbai, with manufacturing facilities in Thane, Mangalore and Dadra.

BASF India’s revenues grew from Rs 3,118 crore to Rs 4,669 crore and EPS grew from Rs 25.9 to Rs 28.9 between FY11-14. The operating margin and PAT margin on a downward trend contracted by 60 bps and 100 bps to 5.8 and 2.6 per cent respectively during the same period.

Hindalco Industries

HINDALCO | BSE CODE: 500440 | FACE VALUE: Rs.1 | CMP: Rs.143.00

Hindalco Industries is one of the leading producers of aluminium and copper. The company’s aluminium units across the globe encompass the entire gamut of operations, from bauxite mining, alumina refining and aluminium smelting to downstream rolling, extrusions, foils, along with captive power plants and coal mines.

Their copper unit, Birla Copper, produces copper cathodes, continuous cast copper rods and other by-products, such as gold, silver and DAP fertilisers. It has the world’s largest aluminium rolling company and one of the biggest producers of primary aluminium in Asia. Its copper smelter is the world’s largest custom smelter at a single location. It is a company of the Aditya Birla Group.

Hindalco revenues grew from `23859 crores to `27851 crores between FY11-14. The EPS witnessed a reduction from `10.9 in FY11 to `6.8 in FY14. This was largely due to contraction in operating margin and PAT margin which has been on a downward trend and contracted by 310 bps and 370 bps to 10.7 and 4.7 per cent respectively during the same period. Company’s return on capital employed has been halved in last five years. It has come down from 7.7 per cent at the end of FY10 to 3.9 per cent at the end of FY14

Maruti Suzuki India

MARUTI | BSE CODE: 532500 | FACE VALUE: Rs.5 | CMP: Rs.3625.00

Maruti Suzuki India (formerly Maruti Udyog), a subsidiary of Suzuki Motor Corporation of Japan, is India’s largest passenger car company, accounting for over 50 per cent of the domestic car market. The company offers full range of cars from entry level Maruti 800 and Alto to stylish hatchback Ritz, A-star, Swift, Wagon R, Estillo and sedans DZire, SX4 and sports utility vehicle Grand Vitara. The company is engaged in the business of manufacturing, purchase and sale of motor vehicles and spare parts (automobiles). The other activities of the company include facilitation of pre-owned car sales, fleet management, and car financing. They have four plants, three located at Palam Gurgaon Road, Gurgaon, Haryana and one located at Manesar Industrial Town, Gurgaon, Haryana.

Maruti Suzuki India’s revenues grew from Rs 36,618 crore to Rs 43,701 crore between FY11-14; its EPS also grew from Rs 78 in FY11 to Rs 90.10 in FY14. The operating and PAT margin witnessed contraction in FY12, which however started showing improvement thereafter. The operating margin stood at 11.2 per cent in FY14 registering an improvement of 100 bps over FY11. However, its PAT margin stood at 5 per cent in FY14, lower by 60 bps as compared to FY11.

SAIL

SAIL | BSE CODE: 500113 | FACE VALUE: Rs.10 | CMP: Rs.77.00

Steel Authority of India (SAIL) is a leading steel-making company in India. It is a fully integrated iron and steel maker, producing both basic and special steels for domestic construction, engineering, power, railway, automotive and defense industries and for sale in the export markets. It is also among the five Maharatnas of the country’s central public sector enterprises.

SAIL’s revenues grew from Rs 43,307 crore to Rs 46,698 crore between FY11-14; however its EPS witnessed a decline from Rs 11.50 in FY11 to Rs 6 in FY14. The operating and PAT margin witnessed contraction in FY12 but started showing improvement thereafter. The operating and PAT margin was on a declining trend from FY11 to FY14 as economic growth was on a downturn. Its operating and PAT margin declined from 19.2 and 10.3 per cent in FY11 to 9.2 and 3.5 per cent in FY14 respectively.

Tata Steel

TATASTEEL | BSE CODE: 500470 | FACE VALUE: Rs.10 | CMP: Rs.397.00

Tata Steel is the world’s 10th largest steel company and the world’s second most geographically diversified steel producer. The company has major operations in India, Europe and Southeast Asia. They have manufacturing units in 26 countries and a presence in 50 European and Asian markets. The company, together with its subsidiaries, engages in the manufacture and sale of steel products in India and internationally. They offer hot and cold rolled coils and sheets, galvanized sheets, tubes, wire rods, construction rebars, and bearings.

Tata Steel’s revenues grew from Rs 29,396 crore to Rs 41,711 crore between FY11-14; however its EPS after witnessed a decline for three years from Rs 69.90 in FY11 to Rs 50.80 in FY13, registering growth but remaining lower than that of FY11 at Rs 65.30. The operating margin witnessed a continuous downtrend and reduced from 39.7 per cent in FY11 to 29.1 per cent in FY14. The PAT margin also witnessed a downtrend from 21.5 per cent to 12 per cent between FY11 to FY13 but witnessed an improvement to 13.9 per cent in FY14.

UltraTech Cement

ULTRACEMCO | BSE CODE: 532538 | FACE VALUE: Rs.10 | CMP: Rs.3067.00

UltraTech Cement is the largest manufacturer of grey cement, ready mix concrete (RMC) and white cement in India. It is also one of the leading cement producers globally. It has an installed capacity of 62 million tonnes per annum (MTPA) of grey cement. UltraTech Cement has 12 integrated plants, one clinkerisation plant, 16 grinding units, and six bulk terminals.

The company’s revenues grew from Rs 13,113 crore to Rs 20,280 crore and its EPS grew from Rs 50.30 to Rs 76.70 between FY11-14. The operating margin and PAT margin remained slightly volatile during FY11-14; it remained lower in FY14 at 18 per cent and 9.3 per cent respectively as compared to FY11.