Value Creation in India: Since how long and not just how much

India Infoline News Service | Mumbai |

Historical comparison reveals that equities are one of the best asset classes for value creation. Although it is often reinforced to investors that past performance is no guarantee of future returns, but the fact is that it usually is. The article showcases select case studies from last 10-15 years to give insights on the type of companies and sectors that have created value, the ones that haven't and the role of the government.

The lure of any asset class is best comprehended, and even justified, through comparison. Take the case of Gold which has generated 230 per cent return since 1994 till date. But for Equities, the corresponding percentage is 520 per cent (and excluding dividends)! In real estate, although no reliable data is available for the last 20 years, property values in Mumbai and Delhi have delivered 47% and 44% respectively in the last five years as per Liases Foras. Its prudent to note that Nifty, during same period, fetched 124% return in what essentially was a depressed period for the stock markets and a great time for Gold. So, its clear and evident that Equity stands out in almost every comparison and is one of the most attractive options available to an investor, irrespective of the economic class he or she belongs to.
 
Its often reinforced to investors, like a pet sermon, how past performance is no guarantee of future returns, but the fact is that it usually is. Despite the change in eras, the time-tested formula for making money hardly ever undergoes a change. At 83, Warren Buffet still beats the market with his consistent and common sense investing philosophy and style. A drill down of what worked in the past and what didnt, can help us arrive at a fair picture of what we ought to do in future.
 
The Indian equity market, in the context of value creation, has witnessed astonishing results in the past two decades. Its practically impossible to review all success stories (and even failures), but we have zeroed in on select case studies to convey the larger picture. We have only picked up relatively large-sized companies across sectors (data has not been adjusted for equity dilution though), thereby skipping stocks with relatively lower market capitalization.
 
A large part of wealth creation, we find, has happened in the Consumer and Financial sectors. Industries exposed to the global economy like IT, Pharma, Metals and Minerals are next in line. Company-wise, Axis Bank, Kotak Mahindra Bank and Hindustan Zinc are three super wealth creators who have impressed with their speed as well as consistency in generating returns over the years. 
 
In the case of Axis Bank, the spectacular show can be chiefly attributed to the leveraging of the FY05-09 growth-investment cycle that achieved economies of scale. While their loan book swelled 9 times between FY06 and FY13, an aggressive 4 times branch expansion during the same period kept deposit franchise free from dilution. Coupled with a benign liquidity environment, Axis drove material net interest margin (NIM) and return on asset (RoA) expansion that brought about rapid earnings growth, not mere balance sheet growth.
 
Kotak Mahindra made the most of the banking opportunity to become the most efficient lender with one of the highest NIMs in the industry at 4.5-5.5%, even as the loan book grew at 34% CAGR between FY06 and FY13.
 
For Hindustan Zinc, the turning point proved to be the acquisition by Sterlite in 2002-03. Thanks to the astute take over, the erstwhile immobile PSU transformed itself into the worlds largest integrated and most efficient zinc-lead manufacturer in quick time, thereby doubling its reserves at the lowest cost of production in the lowest quartile of the global cost curve.
 
Lupin, IndusInd Bank, Titan and Eicher Motors have been consistently growing their market caps at an impressive pace in the last 5, 10 and 14 year periods. IndusInd, HDFC, HDFC Bank and Bajaj Finance have prospered largely due to their diversified operations, strong processes, superior asset quality, consistent growth & return ratios with no significant margin deviations across rate cycles. In case of IndusInd, the change in loan profile from short-cycle working capital funding to an evenly balanced corporate to consumer financing mix has tremendously helped its cause.
 
Among consumer businesses, ITC has been a wealth creator due to its sheer market dominance in its cash cow business of cigarettes. For Asian paints, the more than 50% market share comes from its unmatched distribution network. In sharp contrast, Hindustan Unilevers strategic moves have not yielded the desired results. The 2001 power brand strategy that narrowed focus on selective brands actually opened the flood gates of markets dumped by HUL and worse, even HULs core segments suffered from intense competition in due course. To make matters worse, its new forays into food business could not take off.
 
Sun Pharma has judiciously cashed in on the generic opportunity in US while Ranbaxy was most embarrassingly marred with FDA issues. Hero has been a consistent wealth creator but an abrupt break-up with Honda caused focus to shift overnight on developing in-house R&D capabilities for catering to export markets besides causing astronomical bleeds in marketing and promotion.
 
In recent years, TCS has turned into the biggest market cap player due to its huge scale up in last 5 years. The prime drivers of this boost have been its full service capability, price flexibility (willingness to execute on fixed price contracts). In contrast, Wipro found the going tougher due to a relatively weaker client profile, small sized accounts, lack of aggression in executing integrated large deals in infra management and a largely anemic BPO growth. Infosys was a consistent performer for long but has suffered in last couple of years due to non-alignment with market dynamics, inflexible premium pricing, senior level exodus and impaired project deliveries.
 
More often than not, the government has no business to be in business. In India, governmental control has been among the top adverse impacts on the value creation prospects for PSUs. A glaring case in point is the Oil sector. ONGC, IOC and HPCL all are plagued by sticky problems of under-recoveries even as the governmental stance on subsidy sharing remains opaque. Even when subsidy sharing is announced, a good part of it gets rolled over to the next year due to budgetary constraints. This obviously strains PSU balance sheets and swells the loan burden. Government should either grant PSUs full price and subsidize customers directly or delist these companies in the larger interest of minority shareholders. Talk of other PSUs like NTPC, SAIL and BHEL and one is instinctively reminded of the huge policy paralysis of the past few years in the context of mining & environmental clearances and land acquisition which have, directly and indirectly, wrecked investor wealth.
 
While we have witnessed great Banking success stories, government major SBI has hardly performed to its potential.  In fact, a simple bank fixed deposit would have proved more attractive than an investment in the SBI stock in the last decade, on a risk adjusted basis. The culprits behind this sluggish growth are poor origination processes, ineffective monitoring, 7 times jump in Gross NPAs since FY07, constant government interference, frequent leadership changes, lack of timely recapitalization among others.
 
Government policy, to a large extent, has impacted certain private players as well who would have otherwise possibly made it to the wealth generators list. Bharti was largely de-rated by the 2G scam in Telecom and the ensuing regulatory uncertainty. Reliance, a consistent wealth creator till 2-3 years ago, was another victim of government arbitration in the last two years and the business headwinds it faced made matters even worse. The Governments inability across areas whether in terms of dismal infrastructure spends or its blind eye to critical reforms was a prime reason for the sub-optimal wealth creation of many other companies.
 
The success stories mentioned above bear testimony to the fact that astute management and smart execution are the valued drivers of value creation. Theres no rocket science in knowing that investor value sky rockets only due to time-tested triggers like clear market visibility, clean governance, continual thrust on innovation, high return ratios and valuation comfort (Even great businesses wont deliver returns if bought at astronomical valuations).
 
In conclusion, India will be the worlds fourth largest economy in the world by the end of this decade. Equity, as always, is bound to do well in the long run, provided we place faith in selective wealth creation companies who consistently back their conviction with their credence. In other words, one should look for those players who measure their profitability in terms of longevity, not merely quantitatively. Since how long, not merely how much, is the question to ask.
 
The article first appeared in the 28th anniversary edition of the Dalal Street Investment Journal on May 4th 2014

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