TURNAROUND CANDIDATE

The Indian equity market has been witnessing a continuous uptrend since one and a half years now. Every month, frontline and broader market indices are touching new highs, barring for a few months in between. As the rising tide lifts all boats, the rising market helps lift many stocks to their 52-week high or even lifetime high. This is despite the fact that nothing may have changed materially at the ground level with regard to the fundamentals of the company. Although the formation of the new government at the centre had ushered in high hopes that the economy will turn the corner sooner rather than later and corporates will follow the suit, nothing substantial has changed and recovery still looks a few quarters away.

The December quarter financial results of India Inc. will bear testimony to this. Even for the last quarter of FY15, analysts are not very optimistic. According to CRISIL, it expects India Inc.’s revenue growth to slip to a seven-quarter low of 2.5 per cent on a year-on-year (YoY) basis in the March 2015 quarter. In the preceding quarter as well, revenue growth was a tepid 5.4 per cent. On the profitability front, though, they foresee a marginal uptick in EBITDA margins.

This above discussion does not mean that we are going to see an imminent fall in the market but the upside will not be as spectacular as we witnessed over the last one and a half years. Nonetheless, we at DSIJ believe that there are themes and companies that will definitely yield good returns to investors from here on. One of such themes is turnaround companies. This is our annual exercise wherein we identify hidden gems that made losses in the last few financial years or the last financial year but are likely to post profit in this financial year (FY15). The transition of companies from loss-making to profit-making makes them an ideal investment opportunity and gives better return to their investors (See: Performance Flashback of 2014 Recommendations).

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Although earlier we used to wait for companies to declare their full year financial results to be able to pick out turnaround candidates, we have now started resorting to the first nine months’ performance to gauge if they will be profitable for the entire financial year. The idea is to catch them early and help our readers generate alpha.

For this year’s exercise, we started with the entire universe of traded stocks and chose around 2,700 companies. Out of these, 744 companies were those that incurred loss in the last financial year i.e. FY14 while 467 companies from this list posted losses even in FY13. We took into consideration only those companies that have made business losses in the course of normal operations and not due to some extraordinary or exceptional items. Post this we analysed the financial performance of these companies for the nine months’ ending December 2014. We studied even those companies that have made losses in 9M FY15 and tried to gauge if they had the possibility of a turnaround in FY15.

Later, we studied every individual company, going beyond its financials and including the track record of the management and strategies adopted to help turn the fortunes of the company. These activities provided us a list of almost 10 companies. However, we selected four companies viz. Asahi India Glass, Kokuyo Camlin, Phillip Carbon India and Dhanlakshmi Bank to be able to present a diversified portfolio to our readers. These companies are expected to undergo a turnaround in FY15 and will outperform the broader market in the next one year.

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The common thread that unites all these pearls of turnaround companies is fall in the commodity prices. The expected recovery in the overall economy and change in the guard of management has played equally important role.

There is no trend as such emerging from the list of turnaround candidates. The list comprised of companies from various sectors. Nonetheless, representation from retail that too from textile industry was high and was represented by companies like, Gokaldas Exports, V2 Retail and Cantabill that have turned around in the first nine month of FY15.

Performance Flashback of 2014 Recommendations

The share price performance of our last year’s turnaround candidates is spectacular and can beat any index that may compare with in the same time frame. The average return provided by our recommendations is 140 per cent compared to 37 per cent by the Sensex - almost four times better than the Sensex. The best performance was of the shares of HCC that yielded return of 202 per cent. Nevertheless, what is interesting is that this company is the only one from among our last year’s recommendation that has not turned around on a consolidated but on a standalone basis. The next best performer was SKS Microfinance that grew by 174 per cent. In fact, all our recommendations doubled expect for Crompton Greaves that is up by 45 per cent in the same period.

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ASAHI INDIA GLASS

Here Is Why

• Improvement in economy to drive growth of company’s existing product.

• Company making inroads into the commercial vehicle and tractor segment.

• Lower commodity prices and stabilisation in rupee to aid profitability.

Asahi India Glass (AIS), formerly known as Asahi India Safety Glass, is an integrated glass manufacturing company promoted jointly by Asahi Glass, Japan and the Labroo family. It was originally set up as a vendor to Maruti. Now it is India’s largest manufacturer of automotive glass with over 70 per cent market share and supplies to all the leading original equipment manufacturers (OEMs) in the country. Its business comprises three verticals: automotive, which constituted 57 per cent of revenues at the end of Q3 FY15; architectural float, which constituted 37 per cent of revenues; and others like consumer glass and solar glass contributing the remaining around 6 per cent of the revenues.

The company has 10 manufacturing facilities spread across the country along with three warehouses-cum-sub-assembly units. Within the automotive sector its revenues are largely driven by the Indian passenger vehicles’ OEM segment and the company commands 70 per cent of the market share with clients like Maruti, Hyundai, etc. Going ahead, the company has plans to increase its presence in replacement and exports, and also in commercial vehicles and tractors. In terms of capacity, the company has total installed glass capacity of 1,200 metric tons per day, which is only second to Saint Gobain in India.

However, the company has been making losses since FY12. The reasons for such losses can be attributed to subdued demand in glass products due to slowdown in economic growth (automobile and the realty sectors being the major customers of the company), increase in input cost due to higher energy prices (glass is a highly energy-intensive industry, movements in fuel and energy prices (these play a vital role in the cost of operations and profitability of glass manufacturers), and depreciation in the Indian rupee that made imports dearer. All these factors adversely impacted the performance of the company.

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Regardless, now all the situations that had led to the company into posting losses are expected to improve. The economy, we believe, has bottomed out and will see acceleration in growth in the coming quarters. As economy improves the demand for automobile and real estate will also increase and that will help the company to recapture its revenue growth. Even during deceleration of the economy in FY13 and FY14, the company’s dominant position in its market sphere helped it to post growth in revenue, which increased at a CAGR of 12.8 per cent. The latest IIP figure of 5 per cent for the month of February clearly shows where the economy is heading and we believe that the company can easily surpass the growth number it has demonstrated in the last couple of years.

This will further be aided by the company’s effort to make inroads into the commercial vehicle and tractor segment. The architectural segment will get a boost now as it is gaining popularity in residential building in addition to retail and commercial asset classes. More than the topline, it is the bottomline that will see a dramatic improvement in coming times. From a profit of Rs 16.78 crore for FY11, the company made a loss of Rs 97 crore for FY13 before improving it to a loss of Rs 47 crore for FY14. As the Indian rupee has stabilised and the energy prices have settled at a much lower level, we will see the company make a turnaround in FY15. For 9M FY15 the company has already turned around and posted profit of Rs 23.34 crore against loss of Rs 51.87 crore in the same period last year. Better control of cost along with lower interest burden has helped the company to post profit.

When it comes to valuation, the scrip of AIS is trading at a trailing 12-month price to earnings ratio of more than 70x, which looks stretched. However, with the type of growth the company is exhibiting, we believe it will give decent returns to its investors.

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KOKUYO CAMLIN

Here Is Why

• Favourable demographics to drive growth of company’s product.

• Draws major synergies after alliance with Kokuyo S&T Co., Japan.

• Setting up a manufacturing and assembling facility at Maharashtra that will give company size, scale and scope.

There is no doubt consensus among the economists of India that the country is at a sweet spot of economic growth and will witness a higher trajectory for a sustained period of time. One of the factors that will help it to achieve this feat is favourable demography. With the second-largest population in the world and almost a fifth of that below the age of 20, education remains one of the key growth sectors in the country. This sector will get further encouragement due to the government’s continuous effort to provide education for all under the various articles of the Indian Constitution.

The Indian stationery market is closely related to literacy in general and the education sector in particular and Kokuyo Camlin (KCL), one of the oldest companies in India in the stationery business, will therefore definitely be one of the prime beneficiaries of the country’s education drive which aims to increase the literacy level from its current 74.04 per cent. Besides the education sector, the company’s products also include office stationary which offers an equally promising market opportunity.

KCL, which was started 80 years ago in the early 1930s as a partnership firm known as Dandekar & Co., has come a long way from the manufacturing of fountain pen ink, stamp inks, chalks, etc. to a leading company in the Indian school and office stationary market, selling more than 2,000 stock-keeping units (SKUs) under such brands as Camel, Camlin, Exam, Flora and Kokuyo. KCL, that has been making losses in the last three years due to adverse market conditions, higher spend towards raw material, purchase of traded goods, and employee expenses, has now taken various concrete steps that assure of an imminent turnaround in the company’s financial performance.

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This company changed hands in 2011 when the majority shareholding passed on to the new Japanese incumbent, Kokuyo S&T Co., from its promoter shareholders, the Dandekars. Post this corporate transaction, the company went under restructuring in terms of management and new professionals were inducted to assist in running the business. The management has already started implementing various initiatives such as Kaizen, the Japanese philosophy and concept of continuous improvement, especially in manufacturing processes that will help scale up the overall efficiency of the company.

In addition to this, the company also believes that to achieve sustainable high growth, innovation and introduction of new products is important, following which it has now set up an R&D centre. This will help it to keep on adding new products to its already rich product line. In other developments, KCL has divested the entire stake of 65.77 per cent in its loss-making non-core pre-school chain business (Alphakids) so that the entire management would be focusing on developing the core business.

To align with the focus of the new management, KCL has raised Rs 103.2 crore via rights issue for setting up an integrated manufacturing facility at Maharashtra. It has already acquired land and expects to start operations in 2016. Once completed, this plant will help the company to gain leverage in terms of economies of size, scale and scope and will lead to the next leg of growth. This will also help company to manage its cost of raw materials and purchases of traded goods since it will start manufacturing more items in-house.

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KCL drew 56 per cent of its total revenue from school stationary whereas the remaining 44 per cent from office stationary at the end of FY14.  To neutralize the seasonality impact of the school stationary business and further diversify its product offering, it is now launching new products in the office stationary, arts and chemical segments. As a first step, it introduced Kokuyo notebooks and staplers in select markets in FY14.

The impact of all the initiatives taken by KCL in the last couple of years is already reflected in the financials of the company. In the first nine months of FY15, KCL has already turned its numbers into black though it will be in nominal red if we remove the other income, a majority of which has been by way of cash raised through a rights issue. Nonetheless, the company has exhibited 16 per cent growth in topline in 9M FY15 on a yearly basis to Rs 380.82 crore and has posted profit of Rs 0.6 crore in the same period. Since the March quarter is a strong one for the company, we believe it will comfortably be in black at the end of FY15. Hence, we advise our readers buy this counter at every dip with a long-term investment horizon.

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PHILLIPS CARBON BLACK

Here Is Why

• Improvement in the automobile sector to drive the demand of the company’s product.

• Favourable movement of raw material prices to aid margin.

• Contribution from its power business to grow.

A fall in commodity prices is churning its own winners and losers.  Companies whose performance fell due to higher commodity prices are returning back with a vengeance. Phillips Carbon Black (PCBL), a flagship company of the RP-Sanjiv Goenka Group is one of such companies that slipped into loss a couple of years back due to slowdown in overall economy in general and the automobile sector in particular. The performance was also impacted by the higher prices of crude oil. PCBL manufactures carbon black (CB) and uses derivates of crude oil carbon black feedstock (CBFS). With crude oil prices remaining at an elevated level in FY13 and FY14, this led to higher cost of manufacturing CB.

At the same time, dumping of CB in India by China and a few other countries severely impacted the company’s financial performance. The reason why Chinese manufacturers could produce at a lower price and dump their product in India was due to use of carbon black oil or CBO as raw material, which is found in abundance in China and has a price advantage compared to carbon black feedstock (CBFS).

Nevertheless, as the prices of crude oil have fallen by more than 50 per cent from its June 2014 high, the difference in the raw material prices used by Chinese and Indian manufactures are narrowing down and making Indian CB more competitive so that the net benefits of CB imports will be wiped out. What will also help Indian manufacturers is growth in the domestic automobile sector which will mainly be driven by the lower fuel prices as well as the new Motor Vehicle Act expected this year and a series of fresh launches. The tyre industry remains one of the major end-users of carbon black. With enhanced tyre manufacturing capacity coming into stream and the expectation of growth in exports, the demand for CB will be pushed up.

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PCBL, which is a leading player in the CB industry in terms of capacity (49 per cent share), production (44 per cent share) and exports (77 per cent share), is well-positioned to benefit in the long term from the expected growth in the domestic CB industry. To exploit this opportunity the company is well-prepared and has commissioned a facility to produce 50,000 mtpa carbon black at its Kochi plant during Q4 FY14. With this, the company’s total capacity has increased to 472,000 mtpa. The company’s domestic operations are at four locations viz. Durgapur (West Bengal), Kochi (Kerala), Mundra (Gujarat) and Palej (Gujarat).

Besides CB, the company also generates power using waste gases generated in the manufacturing of CB.  PCBL generated 3 per cent of revenues and 48 per cent of EBITDA from surplus power sales in FY14. The average selling price was Rs 3.2 per unit. Power is generated using lean gases formed as a by-product. Therefore, margins in power are more than 90 per cent at the EBITDA level and around 70 per cent at the EBIT level. PCBL sells excess power to the grid at market rates. As power generation is linked with CB production, PCBL is focusing on optimising CB production at plants in regions where the sale of power fetches higher NRV (net realisable value). This will help the company to improve the profitability of its power segment. An increase in NRV should entirely flow into PAT in the absence of additional cost and tax exemption on the sale of power.

What is also exciting and interesting for investors about the company is its investment in CESC, a promoter group company engaged in power generation and distribution. PCBL owns 0.17 crore equity shares of CESC, which is valued at little more than Rs 100 crore at the current market price as on April 15, 2015. This forms almost Rs 30 per share of PCBL. What this implies is that the turnaround business of PCBL is available at just Rs 108 per share (CMP of PCBL is Rs 138 less Rs 30 per share from its investment in CESC). Therefore, we advise our readers to add this scrip to their portfolio.

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Dhanlaxmi Bank

Here Is Why

• More focus on profitable growth.

• Various steps taken to control non-performing assets.

• Institutional investors have increased their stake in last couple of quarters.

If you have to identify one of the most important factors that make difference in the performance of a company, it has to be the quality of the management. Corporate history is full of stories where the change in guard of the company has changed its fortune in both ways. This fits perfectly to Dhanlaxmi Bank that has witnessed couple of change in guard in last few years.

Dhanlaxmi Bank is an old private sector bank, based out of Thrissur with 280 branches and 396 ATMs covering 160 centres across 15 states at the end of FY14. The bank with its earlier management (before 2012) had witnessed stress in terms of both capatilisation and losses largely due to aggressive growth strategy that resulted into large operating expenses. For example large numbers of branches were opened by the previous management during 2009-12 and the bank had given huge salary hikes along with large number of recruitments. The head count of the bank increased from 1250 to 4500 in the same time. All this resulted into operating expenses increasing by almost five times. Nonetheless, as new management has assumed the office in May 2012, they started taking corrective steps and reduced employee strength to 2500 from 4500 earlier in two years ending FY14.

This is accompanied with massive cut in salaries and controlling of other cost. All this has resulted into reduction of operating and administration expenses by 25 per cent in last two years ending FY14. This is further going to decrease as percentage of interest income helping bank’s effort to turnaround.

Other reasons bank suffered losses was due to higher slippages and large number of assets going bad. This was primarily due to aggressive growth strategy adopted by the previous management. During 2009 to 2012 bank oversaw loan advances growing to Rs 10200 crore from Rs 3200 crore. The huge increase, particularly in 2011-12, was made overlooking the basic guidelines for credit approval.This resulted into NPA going up to Rs 1,214 crore.

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Nonetheless, with new management at the helm of affairs, bank has adopted two long-standing strategies to turnaround the bank. The first one is aimed at cost rationalisation and second one is income generation. Bank has also taken steps to resolve higher NPAs issues. Bank has leveraged technology to control its NPA. For example technology has been enabled for providing information about the problem accounts (wherever even a single day default arises) to branches on a daily basis with every branch having a designated officer to follow up with delinquent customers. Special Task force has been constituted at a regional level to monitor collections in case of delinquent accounts. Other measures include identifying wilful defaulters, enforcing the SARFAESI Act (which allows banks to auction properties of loan defaulters), one-time settlements, sale of assets to Asset Reconstruction Companies and filing cases with the Police and Services Fraud and Investigation Department of India. The new management expects that the gross NPA ratio to come down to around 4 per cent and net NPA to around 2.5 per cent in next few years. The recent increase in the NPA ratio is also reflection of the strategy adopted by the management to ratio rationalise the advances book and free it from low yielding corporate advances, huge retail advances, loans for construction equipment and commercial vehicles, among others, he said. Therefore we may see moderate growth this fiscal as bank is focusing on branch-level profitability, improving net interest margin and asset quality and better recoveries. The bank has also gone through capital raising exercise in last one year to shore up its capital adequacy. At the end of December 2014, bank’s CAR under Basel III stood at 11.68 per cent compared to 9.78 per cent in the same period last year.

We believe all these strategies will take some time (more than a year) to play out; however, bank has already started performing and for 9MFY15 its net interest income and profit has grown at a rate of 9.5 per cent and 121 per cent respectively to Rs 221 crores and 25 crores respectively. Even on valuation basis shares of the bank is currently trading at price to adjusted book value of 0.85x, which looks attractive. In last couple of quarters even the institutional investors have also increased their stake in the bank marginally by 0.2 per cent.