Laggards To Leaders
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It has been a testing and tiring time for the Indian investors as the equity markets have remained quite volatile. Though the markets are hovering all the time, the right investing opportunities have remained scarce. Amid dearth of prospects investors always look for stock specific opportunities. Usually the investors look towards sticking to fundamentally strong counters and keeping the investment strategy simple. However, on second thought, doesn’t it also make sense to be different from the rest and still chalk out a different investment strategy and pick stocks that the markets have ignored due to the companies currently incurring losses, but have potential to catch investors’ fancy sooner rather than later. Considering this similar idea, we present you turnaround candidates. It might sound a bit odd, but it does make sense at this point of time to go for such companies, which despite odds are thinking out of the box to pull themselves out of the quick sand and turn profitable.
The Turnaround Candidates’ story is an exercise where we find hidden gems which are currently making losses but have the potential to turn around during the year and give better returns to the investors. It is easier to pick such stocks when the economy is on cups of change (rather upturn) and everything is hunky dory, but in a gloomy scenario when the uncertainty increases, selecting such stocks becomes tougher.
In the current uncertain situation we feel not many would like to take a bold step and recommend a loss-making company. However, at Dalal Street Investment Journal we have always backed our recommendations with strong reasoning. Hence, rather than just recommending a company which has managed to turn around, we have analysed other aspects of the company also.
As they say - catch them young, we also feel the same. Keeping with this strategy, we have selected turnaround candidates from a host of loss-making companies. However we made a slight change in our strategy. Unlike earlier times, when we used to wait for annual results of companies to find the companies which have turned profitable, we have reduced the time frame to 9M financials. The strategy has been simple, but practical and effective.
We restricted our search to the BSE 500 companies. This was to ensure that our selection remains attributed to companies with higher trading volumes. We first sorted out the companies that have managed to turn around in the 9MFY14 as compared to 9MFY13. This provided us with a list of around 10 companies from different sectors. To further narrow it down, we only selected those who have posted a positive bottomline in the December 2013 quarter. We have tried to exclude all those who have managed to put in a strong bottomline on account of exceptional items or extra ordinary income. This provided us with a list of only four companies viz- Century Textiles, Crompton Greaves, HCC and SKS Micro Finance.
One common thread between the four companies is that they faced the wrath of economic downturn. While Crompton Greaves has been suffering from downturn in domestic power sector and also global factors impacting its consolidated performance, HCC had been witnessing pressure on the account of depleted infrastructure growth and higher debt burden coupled with rising interest rate scenario. Even SKS Micro Finance faced the issues of higher governmental control in certain regions that it operated. But as the going gets tough, the tough gets going. And these companies have managed to break the shackles. In our cover story going forward we have provided a detailed analysis of why these companies are likely to perform well.
The fact of the matter is that investors need to see the advantages of holding a turnaround candidate. Firstly, when other companies would be doing business as usual, managements of turnaround candidates would be busy thinking out of the box to bring back their companies into profits. Thus, this is the time when management initiatives would be at their best, with the company coming up with innovative ideas to drive the topline and manage costs. Secondly, with the worst already being discounted in the price of these companies, there may be very limited downside risk in these companies. Thus, even if the market corrects for some reason, there is a good probability that these counters would fall the least. In fact, if these companies start showing signs of turning around, they could turn investors’ favourites and might end up giving fantastic returns.
Like we had done in the past, this year too, we have gone through the painstaking process and selected four turnaround candidates who we feel would do well in the coming 18-24 months. We reckon that these companies would not only turn around, but also give good returns on the bourses if investors continue to be patient with these counters.
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Crompton Greaves
Crompton Greaves, a household name in India for its products like fans, lights and other electronic consumer goods, was also the dearest stocks for investors. However, a chain of events resulted in the company losing its sheen on the bourses.
The company which was known for its strong financial performance, strong management bandwidth and strong ability for in-organic growth, eventually faced problems on all the fronts. While the financial performance of the company witnessed a few cracks on account of intense global competition and economic down turn, the management bandwidth came under scrutiny as the outgoing CEO allegedly sold his stake. The corporate governance matter worsened after the management bought the corporate jet costing more than Rs 270 crore. Amidst all this, the company’s global subsidiaries ( company acquired through its aggressive approach) were seen as a major drag on its consolidated performance. No wonder, the scrip witnessed a significant beating on the bourses as investors’ confidence was dented.
However as they say, when the going gets tough, the tough gets going. When most on the street expected Crompton Greaves to bite the dust, the company was scripting a strategy to bounce back. And if we take a look at the financial performance of the company for the 9MFY14, the efforts seems to be yielding returns. For the 9MFY14, the company’s consolidated EBITDA reported a loss of only Rs 7.50 crore as against the EBITDA loss of Rs 132 crore posted in 9MFY13.
However the changes came overnight. It was a strategic change brought by the management that helped the company get back on track. As stated by the management it had the following focus points.
The first was a renewed focus on Crompton's core strength - power systems, including transmission and distribution equipment and switchgears - which accounted for two-thirds of the company's sales. The second focus area was to foray into renewable energy solutions, a furiously expanding sector worldwide, given the concerns about global warming. Crompton began selling transformers and other power equipment for wind offshore and solar photovoltaic plants in markets, including Europe and the US.
Apart from that, also part of the diversification was an entry into the oil and gas sector for industrial products. Here the management said that oil and gas is a new vertical segment that they are developing where they will sell a full electrical solution, including breakers, transformers, variable speed drives, motors and automation. Another positive point was boosting consumer goods sales, which contributed around 20 per cent to its topline. Crompton, for instance had begun selling its fans in Europe. It also kept a close eye on costs. Despite its numerous acquisitions overseas, it concentrated on its manufacturing in low cost locations like India, Indonesia and Eastern Europe.
The impact of these initiatives on the company's financials is now clearly visible with consolidated losses reducing at EBITDA levels. If investors could recollect, in FY2013, the company’s international operations had been a drag on consolidated margins, partly due to restructuring at the Belgium facility. The best part is, international orders accounted for 60 per cent of the company’s total order inflow of Rs 2624 crore showing an increase of 15.7 per cent YoY for 3QFY2014.
The management has assured that new international orders have been booked at higher margins. It expects international operations to report positive EBITDA by 1QFY2015. As for the international segment, both Belgium and Hungary facilities have improved their performance post restructuring exercise. Although Canada operations are still reporting losses, they have bagged a few high margin orders which will aid them to breakeven in 1QFY2015. The US operations have also been restructured and with a change in management, turnaround in US operations is also expected soon.
We are of the opinion that the company’s margins have bottomed out and operating margin is expected to gradually improve over the next 12 months. We are expecting the performance to be positive from Q1FY15. We recommend a buy with a target price of Rs 155-160 in the next one year.
| Crompton Greaves |
|---|
| Particulars | Amount (Rs Crore) |
|---|
| Sales | 13101.4 |
| % Change | 11.17 |
| NP | 202.87 |
| % Change | -9.21 |
| PBIT | 428.38 |
| % Change | 9.35 |
| Equity | 125.84 |
| EPS (Rs) | 3.22 |
| CMP (Rs) | 120.6 |
| P/E (x) | NA |
| (Trailing Four Quarter Data) |
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Hindustan Construction Company (HCC)
Infrastructure is a key sector for any developing economy like India. The country's infrastructure plays a vital role in deciding its economic growth. However, during recession or economic slowdown, this sector is the first to take a beating as most of the policy concentration of the government goes into the survival of the economy. Further, due to policy paralysis during the same period, most of the existing infrastructure projects come to a stagnant phase and the new ones cease to float into the market. However, the economic cycle has started showing early signs of revival and the infrastructural sector too is showing considerable activity. Furthermore, additional infrastructural activities are expected to be seen after the upcoming general election.
The revival in the economy and infrastructure sector can be clearly seen from the latest results posted by various Indian listed companies. As the economy revives, after changing business cycle, there is a lot of talk about the infrastructure companies. Here is one infrastructure company, Hindustan Construction Company (HCC), which is turning out to be profitable on nine-month basis for current financial year 2014.
HCC, with its nearly about 100 years of engineering heritage, has executed most of India's landmark infrastructural projects. The company has successfully completed almost 25 per cent of India's Hydel Power generation and over 50 per cent of India's nuclear power generation capacities, over 3364 lane km of expressways and highways, more than 207 km of complex tunnelling and over 324 bridges. Some landmark projects successfully executed by HCC are the Bandra Worli Sea Link, Mumbai (India's first and longest open sea cable-stayed bridge); the Kolkata Metro (Farakka Barrage in West Bengal) and India's largest nuclear power plant in Tamil Nadu.
For the past few years, one of the problematic areas for the company was its subsidiary Lavasa Corporation. However, the overall development work in Lavasa has picked up with over 5300 construction workers on ground. HCC's institutional sales have gathered momentum and 165 channel partners have come on board as of December 31, 2013. With the help of its operational efficiency, the company has been able to complete 628 residential units, till date. In Mugaon, around 10 lakh sq ft development has commenced, while in Dasve, around 8 lakh sq ft of residential, commercial and social development is in progress. Around 1.6 lakh tourists visited this private hill station during the last preceding quarter.
On financial front also, HCC was able to control its raw material cost and maintain employee cost at the same level of last year for the first nine months of the current financial year 2014. The company's cost control measures helped it to post a net profit of Rs 56.22 crore during 9MFY14 against consistent loss for the last two years during the same period. Interestingly, HCC's 9MFY14 EBITDA margin boosted to 16.15 per cent, which is highest between that for last 5 years for the same. These numbers clearly indicate the early signs of revival and good operational efficiency for the company. Also, the management is willing to continue to implement measures aimed at further improvement on all financial parameters. On orderbook front too, the inflow of substantially big orders during the preceding quarter gives confidence and good revenue visibility for the company.
The general election in the country will be over after May 2014 and thereafter, there are expectations for infrastructural activities to pick up in the country. Further, the company's subsidiary Steiner is expected to turn around and post profit in current financial year. Moreover, half year's balance sheet shows some easing on its debt. Hence we have selected this infrastructural company as a turnaround candidate.
| HCC |
|---|
| Particulars | Amount (Rs Crore) |
|---|
| Sales | 3867.65 |
| % Change | -3.43 |
| NP | 5.96 |
| % Change | -104.21 |
| PBIT | 569.03 |
| % Change | 68.8 |
| Equity | 60.66 |
| EPS (Rs) | 0.1 |
| FV (Rs) | 1 |
| CMP (Rs) | 12.26 |
| P/E (x) | 128.24 |
(Trailing Four Quarter Data)
|
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Century Textiles & Industries
Belonging to the BK Birla group, Century Textiles & Industries is a diversified unit having interest in business areas like Textiles, Cement, Rayon and Paper & Pulp. After operating through only one cotton textile mill till 1951, the company has made a rapid progress since then. Apart from textiles the company has made significant inroads in other sectors apart from the textile sector.
The main reason why this company has found its place in this story is because of the turning fortune that is visible from the results of the first nine months of fiscal 2013-14. In fact it can be said that the first signs were visible from Q4FY13 itself. As after posting a loss of Rs 52.44 crore for 9MFY13 the loss decreased to Rs 34.49 crore for FY13. And the company turned back in 9MFY14 posting a profit of Rs 7.62 crore. Let us look at the reasons for the turnaround in the profits and also the sustainability going forward.
First of all let us take a look at the textiles segment of the company. This segment contributes about 25 per cent of the revenue. In the last nine months of the fiscal, favourable currency and improvement in the markets like US and Europe has been the main factor that had drove the growth in the textile sector. The same philosophy has played for this company too. Also the other factor that has played its part is the favourable raw material prices. China, a major textiles producer for about two decades is now focusing on other sectors, which should open up opportunities for other textiles producing countries such as India and Bangladesh. In the reported nine months the textile segment has witnessed growth of five per cent on YoY basis to stand at Rs 1241 crore. We believe that this is likely to augur well for the company and the focus of the company has been on high priced premium branded goods, which are in demand in high-end markets.
The next segment that comes is the cement. This segment contributes 47 per cent of the revenues as of 9MFY14. The cement segment witnessed three per cent growth on YoY basis for the said period. We believe that this segment too is likely to be a major driver for the company going forward. It is believed that post the general elections, the inertia that we have seen in infrastructure spending is likely to reverse. This is the only and the biggest trigger for the cement sector as of now and the company will also be a beneficiary of the same.
The next biggest segment for the company is the paper & pulp division. This segment contributes 26 per cent of the revenues. In the reported nine month this segment witnessed a growth of 42 per cent on YoY basis for 9MFY14 to stand at Rs 1286 crore. The sector is likely to project a growth of about eight per cent going forward. This is likely to be a major boost for the company. Also, the management has said in the annual report for the last fiscal that with its state of the art machines, comprehensive product range and multiple sources of cellulose/fiber options is well placed to cater to the need of the consumers.
Coming to the financial front, as mentioned earlier the company has posted a profit of Rs 7.62 crore for 9MFY14 as against a loss of Rs 52.44 crore reported during the same period last fiscal. What is more encouraging is that the EBITDA margins for 9MFY14 had expanded by 165 basis points on YoY basis to stand at 11.33%. We believe that the stock is well poised to witness better growth going forward in turn rewarding investors. Hence we recommend a buy for long term investors.
| Century Textile |
|---|
| Particulars | Amount (Rs Crore) |
|---|
| Sales | 6426.65 |
| % Change | 14.03 |
| NP | 57.18 |
| % Change | 2272.61 |
| PBIT | 366.34 |
| % Change | 71.06 |
| Equity | 93.04 |
| EPS (Rs) | 6.15 |
| CMP (Rs) | 300.75 |
| P/E (x) | 48.94 |
| (Trailing Four Quarter Data) |
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SKS Microfinance
Former President of USA John F. Kennedy, once said that a rising tide lifts all boats. This was exactly the case for microfinance institutions (MFIs) in the year 2009 and 2010 when the going was easy. There were more than 500 such companies charging more than 30 per cent to their borrowers. The irony was that despite the presence of a large number of players, rate of interest charged were high.
However, the tide receded after Andhra Pradesh Microfinance Ordinance in October 2010 was made into an Act putting these companies in spotlight. Many smaller boats dashed to pieces. Nonetheless, SKS Microfinance (SKS) with tall masts not only survived the receding tide but is now floating smoothly.
The second coming of SKS Microfinance is nothing short of spectacular. The company which earned a net profit of Rs 174 crore at the end of FY10 had posted a huge loss of Rs 1361 crore at the end of FY13. Total revenue too declined from Rs 959 crore to Rs 472 crore in the same period. Return on average assets and return on average equity declined from 4.9 per cent and 21.5 per cent at the end of FY10 to -46.7 per cent and -118.9 per cent respectively at the end of FY12. Nonetheless, things changed as the company engineered the turnaround strategy that helped it to return to profitability in the third quarter of FY13 after posting losses in the previous seven consecutive quarters.
The company adopted the strategy of cleansing its balance sheet, continuous improvement in cost efficiencies, raised capital and protected non-AP portfolio from any contagion. The company provided fully for the Andhra Pradesh (AP) exposure and therefore net Non- Performing Asset (NPA) from AP portfolio came down to nil at the end of Q2FY13 from Rs 1431 crore at the end of Q3FY11. Total branches operated by the company also came down from 2403 at the end of Q3FY11 to 1256 at the end of Q3FY14, which helped other expenses to cut down by 61 per cent in the same period. Total employee strength has also been reduced by 65 per cent in the same period resulting in the decline of employee cost by 54 per cent. This turnaround strategy was well received by the investors and is reflected in the increase in the stake of institutional investors in the company. Non-promoter institutional holding has increased from 25.5 per cent at the end of Q3FY11 to 43.38 per cent at the end of Q3FY14. Through a qualified institution placement (QIP), company raised almost Rs 300 crore from equity investors. What is also important to note is that despite the turmoil faced by the company in its AP business, its non-AP portfolio remained almost insulated and the collection efficiency has always been more than 95 per cent.
Going ahead, we believe that the company will continue its profitable growth path and will achieve the guidance set by the company of gross loan portfolio of Rs 2800 crore and net profit of Rs 60 crore for FY14. Another factor, in addition to its turnaround strategy, which helped the company achieve its target during and after the turmoil, is the fact that many small MFIs withdrew from the market which resulted in a decrease in competition. This helped SKS to expand and spread its operations outside Andhra Pradesh and also within the state to borrowers who were earlier with other MFIs. The better funding environment and lesser competition also helped the company to expand.
Shares of SKS are currently trading at a price to book value of 4.5 times, which looks a little bit stretched, but looking at high return on assets of 2.9 per cent and a likelihood of recovery of its dues from AP portfolio, for which it has provided fully, will be a book value accretive. Hence we believe there is still steam left in SKS share and one can take exposure to the counter.
| SKS MICROFINANCE |
|---|
| Financial Highlights | FY09 | FY10 | FY11 | FY12 | FY13 | 9MFY14 |
|---|
| Total revenue (Rs crore) | 554 | 959 | 1270 | 472 | 353 | 380.69 |
| Profit after tax (Rs crore) | 80 | 174 | 112 | -1361 | -297 | 42.37 |
| Total assets (Rs crore) | 3039 | 4047 | 4326 | 1681 | 2511 | 2385 |
| Return on average asset | 3.90% | 4.90% | 2.30% | -46.70% | -15.80% | 2.90% |
| Return on average equity | 18.30% | 21.50% | 7.50% | -118.90% | -74.40% | 20.30% |
| (Trailing Four Quarter Data) |