“E-I-C
Analysis
of
Capital
Goods
Sector”
EXECUTIVE SUMMARY An investment is a commitment of funds made in expectation of some positive rate of return in future. An investor makes some sacrifice in the present in the hope of desiring benefits in future. Now the most common question that arises is, which stocks to pick from the wide range of securities and sectors. This calls for Security Analysis and Security valuation. The Indian stock market is semi-strong and is very volatile. The economies of different countries like USA & China have bearing on our economy. An example to mention is US recession which caused crash in stock market. Excluding such systematic risk, one can evaluate the future prospects of the company using fundamentals. Kotak Mahindra is one of India's leading financial conglomerates, offering complete financial solutions that encompass every sphere, from commercial banking, to stock broking, to mutual funds, to life insurance, to investment banking, the group caters to the financial needs of individuals and corporates. The group has a net worth of over Rs. 5,609 crore, employs around 17,100 people in its various businesses and has a distribution network of branches, franchisees, representative offices and satellite offices across 344 cities and towns in India and offices in New York, London, Dubai, Mauritius and Singapore. The Group services around 3.6 million customer accounts. It has won awards like Best Performing Equity Broker in India – CNBC Financial Advisor Awards 2008, Avaya Customer Responsiveness Awards (2007) in Financial Services Sector and so on. In the light of all the above, I have undertaken a project on “E-I-C analysis of Capital Goods Sector”. This is an effort put to know the intrinsic value of the Capital goods companies like Bharat Heavy Electricals Limited and Larsen & Toubro. Here, I am undertaking a study based on the fundamentals of the company through financial statement analysis. An investor should make thorough comparison of the prices of the security with its true value. Value here refers to the intrinsic worth or the Value anchor. Only with the help of such evaluation the investor can decide as to buy hold or sell.
Babasabpatilfreepptmba.com
1
“E-I-C
Analysis
of
Capital
Goods
Sector”
Topic of the study:
“E-I-C Analysis of Capital Goods Sector” Name of the organization
: KOTAK SECURITIES, Hubli.
Main Objective: “To evaluate the performance of Capital Goods companies under study using EIC Analysis.”
Sub objectives: 1.
Analyzing the environmental factors that affect the security prices.
2.
Industry analysis of Capital goods Sector
3.
To assess the fundamentals of the company in light of financial statements.
4.
To arrive at intrinsic value of the company thus enabling the investor in assessing the worth of the security.
5.
I had keen interest to enrich my knowledge in stock market.
Framework of study: The proper order to proceed in Fundamental analysis is, First, to analyze the overall economy and securities markets. Second, analyze the industry with in which a particular company operates. Finally, analysis of the company should be considered. The above analysis involves making a careful estimate of expected stream of benefits and required return of common stock. The intrinsic value then can be obtained through P/E ratio or earning multiplier approach.
Babasabpatilfreepptmba.com
2
“E-I-C
Analysis
of
Capital
Goods
Sector”
Data Collection Approach: Secondary Data: The study is mainly based on analysis of financial statements of the company i.e. balance sheet and profit and loss account. The same has been collected through; •
Company websites and other related websites.
•
The information is also collected from various magazines like Indian survey 2008 by The Hindu
•
News papers
Sample Size: Two large cap companies are taken for study. They are; •
Bharat Heavy Electricals Limited
•
Larsen & Toubro
Need for the study: Due to the present volatility in stock market, the biggest question that arises is whether to invest in stocks or not? If yes, then which stocks to invest? How are the securities valued? There is no precise answer to this and nobody can predict the stock movements exactly. Fundamental analysis or EIC analysis is one of the approaches to security valuation. EIC analysis gives the intrinsic value of the firm. An investor can compare the present market price with the intrinsic value of the stocks and make his decisions regarding investments in these stocks.
FINDINGS: Economy: •
When come to the economic factors the global economies are getting interrelated, the Indian market will no longer be limited to domestic economic situation. Especially the US market has a strong bearing on Indian stock market.
Babasabpatilfreepptmba.com
3
“E-I-C
Analysis
of
Capital
Goods
Sector”
Industry – (Engineering – Heavy):
•
The demand driver for this sector is the Order book.
•
Most of these companies have an order book to sales ratio in the range of 2.5-4 times FY07 revenue. This implies that for the next two-to-three years, even if the companies do not get fresh orders, they can still maintain revenue growth of 3040 per cent..
•
The IIP growth during April - January 2007-08 has declined to 8.7% when compared to 11.2% IIP growth during 2006-7. Tight monetary policy has resulted in high interest rates which have been the major factor contributing to the decline in IIP growth.
Company: •
When Liquidity ratios are concerned, BHEL has an upper hand over L&T. The Current ratio, quick ratio and cash ratios of BHEL are better than L&T.
•
But Efficiency ratios show the other picture. Total assets turnover, fixed assets turnover ratio, inventory days and debtors turnover of L&T are better than BHEL. L&T is able to utillise its assets more efficiently.
•
When Solvency ratios are studied, we see that the debt component in BHEL has been reduced to 0.1(FY07) from 0.8 (FY05). The debt of BHEL has substantially reduced in FY07 to 0.1as a result of redemption of 8.85% Non-convertible, secured,
Redeemable Taxable Bonds worth Rs.500 crores •
Profitability ratios: The GPM has been increasing and so is the NPM. This shows
that the companies are performing efficiently and are using the resources in an optimum way. The EPS and DPS has consistently increased in BHEL because of increased earnings and constant number of shares. Whereas in case of L&T, the EPS has reduced in FY07 to Rs.48 due to increased number of shares arising from issue of bonus.
Babasabpatilfreepptmba.com
4
“E-I-C •
Analysis
of
Capital
Goods
Sector”
Market based returns: the P/E ratio which shows investors expectations have increased for both the companies. L&T has higher P/E ratio of 33.48 as compared to 11.48 of BHEL.
•
When compared to the specific indicators like sales growth, the BHEL will be in the first place then followed by L&T
•
The Volatility of returns is high in BHEL as compared to L&T. Hence L&T is better because it is more consistent.
•
The value anchor for BHEL is Rs.2644 and for L&T is Rs.3996.2
Recommendations: 1. Intrinsic value of BHEL is Rs.2644 and the present market price is Rs.1870. Hence it is recommended to buy BHEL stock as its current market price is lower than its fair value range. Market price < Value range BHEL Rs.1870
< Rs.2600 to Rs.2700
BUY
2. Intrinsic value of L&T is Rs.3, 996.2 and the present market price is Rs.2981.85. Hence it is recommended to buy L&T stock as its current market price is lower than its fair value range. Market price < Value range L & T
Rs.2981.85 < Rs.3950 to Rs.4050 BUY
3. After a close scrutiny of economy industries and companies in considering the risk, it may be recommended that international economy might affects the firms export prospects, the price competition it faces from competitors, or the profit it makes from abroad. Investor should properly analyze both globally and domestically before taking investment decision.
Babasabpatilfreepptmba.com
5
“E-I-C
Analysis
of
Capital
Goods
Sector”
4. The investor also should consider the budget decision and present years forecast of different sectors
COMPANY PROFILE THE KOTAK MAHINDRA GROUP: Kotak Mahindra is one of India's leading financial conglomerates, offering complete financial solutions that encompass every sphere of life. From commercial banking, to stock broking, to mutual funds, to life insurance, to investment banking, the group caters to the financial needs of individuals and corporates. The group has a net worth of over Rs. 5,609 crore, employs around 17,100 people in its various businesses and has a distribution network of branches, franchisees, representative offices and satellite offices across 344 cities and towns in India and offices in New York, London, Dubai, Mauritius and Singapore. The Group services around 3.6 million customer accounts. Kotak Group Products & Services: •
Bank
•
Life Insurance
•
Mutual Fund
•
Car Finance
•
Securities
•
Institutional Equities
•
Investment Banking
•
Kotak Mahindra International
•
Kotak Private Equity Babasabpatilfreepptmba.com
6
“E-I-C •
Analysis
of
Capital
Goods
Sector”
Kotak Realty Fund
KOTAK SECURITIES:
Kotak Securities Ltd. 100 % subsidiary of Kotak Mahindra Bank is one of the oldest and largest broking firms in the Industry with a market share of 8.5 % (as on 30th September). Kotak Securities offerings include stock broking through the branch and Internet, Investments in IPO, Mutual funds and Portfolio management service. Its Accolades include: •
Best Performing Equity Broker in India – CNBC Financial Advisor Awards 2008.
•
Avaya Customer Responsiveness Awards (2007) in Financial Services Sector.
•
Best Brokerage Firm in India by Asiamoney in 2007.
•
The Leading Equity House in India in Thomson Extel Surveys Awards for the year 2007.
•
Euromoney Award (2006 and 2007) - Best Provider of Portfolio Management: Equities.
•
Avaya Customer Responsiveness Awards (2006) in Financial Institution Sector.
•
Asiamoney Award (2006) - Best Broker in India.
•
Euromoney Award (2005) - Best Equities House in India.
•
Finance Asia Award (2005) - Best Broker in India.
Babasabpatilfreepptmba.com
7
“E-I-C
Analysis
of
Capital
Goods
•
Finance Asia Award (2004) - India's best Equity House.
•
Prime Ranking Award (2003-04) - Largest Distributor of IPO's.
Sector”
Kotak Securities is the first in providing many products and services which have now become industry standards. Some of them are: •
Facility of Margin Finance to the customers.
•
Investing in IPO’s and Mutual Funds on the phone.
•
SMS alerts before execution of depository transactions.
•
Mobile application to track portfolios.
•
Auto Invest - A systematic investing plan in Equities and Mutual funds.
•
Provision of margin against securities automatically against shares in your Demat account.
Kotak Securities has a full-fledged research division involved in Macro Economic studies, Sectoral research and Company Specific Equity Research combined with a strong and well networked sales force which helps deliver current and up to date market information and news. Kotak Securities is also a depository participant with National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL), providing dual benefit services wherein the investors can avail brokerage services for executing the transactions and the depository services for settling them. It process more than 600000 trades a day which is much higher even than some of the renowned international brokers. Kotak Securities network spans over 310 cities with 867 outlets. Kotak Securities Limited has over Rs. 4000 crore of Assets Under Management (AUM) as of 31st December, 2007. The portfolio Management Service provides top class service, catering to the high end of the market. Portfolio Management from Kotak Securities comes as an answer to those who would like to grow exponentially on the crest of the stock market, with the backing of an expert.
Babasabpatilfreepptmba.com
8
“E-I-C
Analysis
of
Capital
Goods
Sector”
WHY KOTAK SECURITIES? Kotak Securities sees investing from customer’s perspective, and make recommendations based on their needs. The important goals of Kotak Securities is to simplify investing for customers, along with that they also provide long term values to their customers. Kotak Securities has a million reasons for customers to choose it. Listed below are a few: STABILITY: We are a 100% subsidiary of Kotak Mahindra Bank and one of the oldest and largest broking firms in the Industry. We have been the first and only NBFC to receive the license to be converted into a bank. INNOVATORS IN THE INDUSTRY: Kotak Securities has been the first in providing many products and services which have now become industry standards. •
First to provide Margin Financing to the customers.
•
First to enable investing in IPO’s and Mutual Funds on the phone.
•
Providing SMS alerts before execution of depository transactions.
•
Launching of Mobile application to track portfolio.
•
Auto Invest - A systematic investing plan in Equities and Mutual fund.
•
Provision of margin against securities automatically against shares in your Demat account.
RELIABILITY: Kotak Securities accolades are a testimony to our services and high standards. Kotak Securities has been awarded as: •
Best Performing Equity Broker in India – CNBC Financial Advisor Awards 2008
•
Avaya Customer Responsiveness Awards (2007) in Financial Services Sector
•
Best Brokerage Firm in India" by Asiamoney in 2007
•
The Leading Equity House in India' in Thomson Extel Surveys Awards for the year 2007.
•
Euro money Award (2006 & 2007) - Best Provider of Portfolio Management: Equities.
Babasabpatilfreepptmba.com
9
“E-I-C
Analysis
of
Capital
Goods
Sector”
VALUE: Whether you are a customer with a small or large wallet size, customers can expect Kotak Securities to bring value to customers in every form. •
Quality Research
•
Quick trade execution
•
Low brokerages
•
Accounts that suit your investment profile
•
Risk Profiler
•
Superior Customer Service
SERVICE: Kotak Securities believe in high standards of service and that's precisely what they offer. It's an honor to be awarded the most customer responsive company award in the Financial Institution sector by AVAYA Global Connect Award both in 2006 and 2007. ROBUST TECHNOLOGY: Kotak securities developed proprietary trading platform which is robust and among the best in the industry. It has more than 150 technology professionals constantly working on upgrading and speeding up all systems. CENTRALISED RISK MANAGEMENT SYSTEM: Unlike many other players Kotak Securities has a centralized risk management system. This allows them to offer the same levels of service to customers across all locations. EXCEPTIONAL RESEARCH: Unlike most other competitors Kotak Securities has their own in house research team. Their in house research team is among the best in the industry and they have years of experience in the financial markets. They scan through the plethora of stocks and find the scrip’s that have a high potential of providing you good returns. Our investors get research Technical, Fundamental, Derivatives, Macro-economic and mutual fund research.
Babasabpatilfreepptmba.com
10
“E-I-C
Analysis
of
Capital
Goods
Sector”
LARGE PRESENCE: Kotak Securities is present in 309 cities with 867 offices all over the country. Its employee strength extends beyond 5000. OFFERINGS OF KOTAK SECURITIES: Once customers invest with Kotak Securities, they can enjoy access to a wide range of products and services to help them make the most of their investments. •
Easy Equity
•
Easy Derivatives
•
Easy IPO.
•
Easy Mutual Fund
•
Easy Insurance
•
Kotak Portfolio Management.
EASY EQUITIES: Investing in equities was never so easy. As the Best broker in India Kotak Securities products and services are focused at making investments in equities as simple as writing a cheque. Research: "What do I Buy?" Isn't this a common question we all have while investing in equities? Kotak Securities in house research team is among the best in the industry and they have years of experience in the financial markets. They scan through the plethora of stocks and find the scrip’s that have a high potential of providing good returns. SMS Alerts: Customers can get expert tips and recommendations as SMS on their mobile phone so that customers know what to invest in at all times. Trinity Account: A 3 in 1 account that integrates Trading, Bank and Demat account. With Trinity Account transactions will be seamless and very convenient. Competitive Brokerages: Kotak Securities brokerage rates are among the most competitive in the industry. Low brokerage rates let customers concentrate on investing their savings without worrying about the cost of investment.
Babasabpatilfreepptmba.com
11
“E-I-C
Analysis
of
Capital
Goods
Sector”
Call and Trade: Customers can capitalize on market opportunities even when their computer is inaccessible. Call & Trade essentially provides the convenience of trading in equities by making a simple phone call. KEAT: This superior trading platform to monitor market movements, view your gains and losses and order placements instantaneously. Know more M-Trade: It is exclusively designed to give instant access to the stock market through mobile phone, thereby allowing to catch every little market movement when customers are on the move. Kotak Securities News: It provides access to all news related to a stock, right from its results, earnings, bonus, share holding patterns etc. Also helps in knowing about market developments, latest happenings, stock movements and lots more. Twin Advantage : Customers can not only get exposure against the cash margin in their trading account but can also automatically provide with exposure against the shares lying idle in their DP account.
EASY DERIVATIVES: If customers are not averse of taking risks, derivatives can prove to be a good investment option especially with Kotak Securities research. Kotak Securities has strived to make investing in derivatives simpler. It provides derivatives seminars educate new entrants in the derivatives market to be more equipped with knowledge and techniques. Once the customer has the knowledge of investing in derivative instruments Kotak Securities daily derivative reports will provide customers with strategies that may yield good returns. Customers can also refer to the Kotak Securities Academy to learn more about derivatives. EASY IPOS: Investing in IPO’s is not complex anymore; Kotak Securities has made investing in IPO’s very simple. Customers have to do is one phone call, and that's all. No paperwork no queues, simply pick the phone or log on to www.kotaksecurities.com and place their order within seconds. Babasabpatilfreepptmba.com
12
“E-I-C
Analysis
of
Capital
Goods
Sector”
Kotak Securities also provide with you with information on IPO News, Forthcoming IPO’s and a lots more. EASY MUTUAL FUNDS: No more paperwork, no more queues.Kotak securities have made investing in mutual funds as simple as dialing a pizza. Customers can now invest in over 1000 different mutual fund schemes through us. And to make this choice of choosing between which mutual funds scheme to invest in, it offers customers an exclusive research. Investment
in
mutual
fund
can
be
made
simply
by
logging
on
to
www.kotaksecurities.com or just making a phone call. No paperwork no queues. Simply pick the phone or log on to www.kotaksecurities.com and place order. EASY INSURANCE: Kotak Securities brings customers a sure and secure insurance option without the hassles and worries of a conventional insurance plan. With minimal paperwork and procedures, customers get the dual benefit of a risk cover and savings. What's more, at the end of the term, a minimum of premiums paid by customers will be returned depending on the option they choose.
FINANCIAL PLANNING GROUP AND PORTFOLIO MANAGEMENT: A structured portfolio is essential for reducing the risk of capital erosion as a result of short-term volatility. With Kotak Financial Planning Group, these portfolios are more than just structured-they're tailor-made, too. In today's complex financial environment no one asset class tends to consistently outperform another. Kotak Securities Financial Planning Group aims to help clients grow exponentially on the crest of the stock markets. And since the market is unpredictable by nature, the only way to beat it is constant monitoring. That's where the integration with Kotak Securities proves invaluable. Clients benefit from the in-depth research, the wide network of experts, the international
Babasabpatilfreepptmba.com
13
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
presence, and from the constant tab on the Indian and global financial scenario of Kotak Securities.
About Financial Planning Group: The financial planning and distribution arm of Kotak Securities is involved in defining financial goals, identifying investment vehicles and achieving them. The group commenced its operations in the year 2003. Present over 30 locations with a large team of relationship managers, has always
endeavoured in servicing clients; closely
understanding their needs, financial goals and advising ethically. Products: This is done through quality service and access to a wide range of products; products that are customizable. The financial planners thoroughly discuss and understand the desires of each client. Their financial goals. Their risk appetite. Their time constraints. Products offered range from those promising aggressive returns (MFs and PMS) to those that aid diversification (Commodities, Gold, Equities etc.) to those that aim for capital protection like insurance and capital guarantee products. Portfolio Management Service: Kotak Securities brings with it years of experience, expertise, research and the backing of India's leading stock broking house. The portfolio managers have over 10 years of understanding diverse investment instruments and needs. Kotak Securities is one of India's oldest portfolio management companies. It is also one of the largest with an AUM worth Rs.2500 crore. And for those who wish to grow their wealth exponentially-it is also one of the best. The Portfolio Management Service combines competent fund management, dedicated research and technology to ensure a rewarding experience for its clients. Every investment portfolio is carefully engineered for clients in a phased manner. Relationship managers help clients monitor, assess and tweak their portfolio at every level. Relationship Managers dispense personalized advice and ensure clients receive quarterly research reports, account performance statements and MIS at their doorstep. A Babasabpatilfreepptmba.com
14
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
dedicated website and a customer service desk allow clients to keep a constant tab on their portfolio's performance. All in all, it translates into zero paperwork.
Babasabpatilfreepptmba.com
15
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
INTRODUCTION TO THE TOPIC INVESTMENT SCENARIO: Investment is the employment of fund on assets with an aim of earning income on capital appreciation. Investment means the present consumption is sacrificed to get return in future. Investment is good only for the purpose to get return from the selected or choosing securities so; investors have to see the fundamental analysis. In fundamental analysis, we can broadly classify into three types. One is Economic Analysis; Industry analysis and company analysis. These three are very important base of the securities or stock of market. We have to study about this fundamental analysis. An Indian stock market has been no different. Memories of its crash of December 1990 are still there in the minds of many. After record rise in proceeding few years the index fell precipitously and investor loss heavily. This phenomenon repeated every now and then. Though the equity cult is fast spreading among the investor the hard fact is majority of stocks continue to remain volatile to date. All these are pointers to the fact that the investor market is no longer holding an olive branch to investor in equity. Much of the danger associated with it can be avoided and it need not be such nerve raking experience, provided one approaches it as a rational decision making process. In short Security analysis and portfolio management are hard work, requiring discipline and patience, and the work is not always rewarded with exceptional returns.
Babasabpatilfreepptmba.com
16
“E-I-C
Analysis
of
Capital
Goods
Sector”
INTRODUCTION TO THE CONCEPT OF SECURITY ANALYSIS: An investment is a commitment of funds made in expectation of some positive rate of return in future. An investor makes some sacrifice in the present in the hope of desiring benefits in future. The motive behind investment varies from person to person. Some people invest in order to gain a sense of power or prestige. Often the control of corporate enterprises is a driving motive. For most investor however their interest in investment is largely pecuniary to earn a return on their money. But the return on stock market security is subject to risk. Risk incase refers to the uncertainty surrounding actual realization of the rate of return offered by an investment. The time element refers to period of waiting required to reap the return. Accordingly early investment decision has three key aspects. They are, Return Risk Time There fore, investment process must be considered in terms above aspects. One should approach any scheme of investment as a rational decision making process, in which he should attempt to select a package of portfolio securities that meets predetermined set of goals. These investors goal are usually expressed in terms of return. Almost all the cases, the hard fact are that return and risk are inseparable. Further the maximum higher the return the grater the risk. Therefore the ultimate decisions to be made in the investment are two. What securities to be held How many rupees should be allocated to each. These decisions are made in three steps. 1. Security analysis 2. Security evaluation Babasabpatilfreepptmba.com
17
“E-I-C
Analysis
of
Capital
Goods
Sector”
3. Portfolio analysis, selections and management. Securities are marketable financial instruments that bestow on their owners the right to make specific claims on particular assets. An individual security provides evidence of their creditor ship or ownership depending on whether it is bond or stock, respectively. A bond is loan that is paid off with interest; the investor lends money to the borrowing company that issued bond. In contrast, stock ownership represents a cash investment a future of a corporation; the investor owns a part of a corporation and share in its profits. SECURITY ANALYSIS: (a) Traditional investment analysis, when applied to securities, emphasizes projection of prices and dividends. That is, the potential prices of a firm’s common stock and future dividend stream are forecast, and then discounted back to the present. b) Basically modern security analysis deeply rooted in the fundamental concept. But the more modern approach to common stock analysis emphasizes risks and return estimate rather than mere price and dividend estimates, of course dependent on share price and accompanying the dividend stream. SECURITY EVALUATION: It refers to the act of assessing the true worth of security. Before committing the fund on stock exchange securities, the investor should make thorough comparison of the prices of the security with its true value. The price refers to the price quoted for the security at the stock exchange at a given movement of time. Value refers to the intrinsic worth. Only with the help of such evaluation the investor can decide as to buy hold or sell. DIFFERENT APPROACHES TO EVALUATION: There are essentially three approaches or school of thoughts on the matter of security price evaluation, classified as
Babasabpatilfreepptmba.com
18
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
(a) Fundamental Approach: The concept of time value of money is the business of this approach. Money has a time value. A rupee now is worth more than rupee a year from now. For different securities, future benefits may me received at different times. Even when the amount of future payment is the same, differences in the speed of their receipt may create differences in value. Time value of money suggests that earlier receipt is more desirable than later receipt, even when the both are equal in the amount of certainty. Because, earlier receipt can be re invested to generate additional returns before later receipt come in. The force operating is the principle of compound interest. Framework: The proper order in which to proceed in Fundamental analysis is, first to analyze the overall economy and securities markets. Second, analyze the industry with in which a particular company operates. Finally, analysis of the company should be considered. The above analysis involves making a careful estimate of expected stream of benefits and required return of common stock. The intrinsic value then can be obtained through the present value analysis that is, the dividend discounts model. An alternative method of valuation is the P/E ratio or earning multiplier approach.
ECONOMIC ANALYSIS
INDUSTRY ANALYSIS
COMPANY ANALYSIS
Babasabpatilfreepptmba.com
19
“E-I-C
Analysis
of
Capital
Goods
Sector”
STRATEGIC CONSIDERATIONS OF ECONOMIC, INDUSTRY AND COMPANY ANALYSES ARE AS FOLLOWS: (1) Economic Analysis: 1. A study of economic trends as indicated by rate of growth in gross national product, employment, aggregate corporate profits, interest rate, exchange rates, savings and investments, monsoon positions. 2. An analysis of the relationship between economic trends and economic policies and the stability of such relationships. 3. A study of world economic trends and their impact on Indian economy. (2) Industry Analysis: 1. Implications of projected growth in gross national product for various industries. 2. Implications of plan priorities and plan expenditure for various industries. 3. Vulnerability of an industry for government regulations, and control of prices and production. 4. Implications of industrial and fiscal policies of government for an industry. 5. Analysis of competitive conditions as reflected in any barriers to entry. (3) Company Analysis: 1. Trend analyses of company’s market share. 2. An analysis of turn over of assets, operating and production efficiencies through ratio analysis. 3. Leverage and coverage ratio analysis. 4. An analysis of book value per share. 5. An assessment of quality of management 6. An analysis of price .to .earning multiples. 7. An analysis of growth in sales and dividends. The basis tenets of this approach are as follows: Each share has an intrinsic value. It can be determined by discounting the future stream of benefits that does accrue to the holder of the security. For instance if rupees 100 now is = rupees 100 + R after one year. Where R is the rate of return then the next question is if Babasabpatilfreepptmba.com
20
“E-I-C
Analysis
of
Capital
Goods
Sector”
we get rupees hundred after one year how much is it worth now. Rupees 100 + R after one year = 100 now. Therefore rupees 100 after one year = 100/100 + R and if R = 12 % then 100/112 = .0893. (b) Technical Approach: Technical analysis is an alternative approach to predicting the stocks price behavior. Technical analysis is frequently used as a supplement to fundamental analysis rather than as a substitute for it. Thus technical analysis can frequently does, confirm findings based on fundamental analysis. Technical analysis is viewed mainly through price and volume statistics. It helps in measuring price . volume, supply . demand relationship for overall market as well as for individual stocks. Technicians seldom rely upon a single indicator, as no one indicator is infallible; they place reliance upon reinforcement provided by groups of indicators. (c) Modern Approach: Markovitize led down the foundation for this approach in 1951. He studied capital market with the help of fairly sophisticated method of investigation and in general arrived at the following conclusions. •
Stock markets are reasonably efficient in reacting quickly and rationally to the flow of information.
•
Successive price changes are independent. As a result past price behaviour cannot be used to predict future price behaviour.
•
In the capital market, there is a positive relation ship between the risk and return. This indicates, in general, investment in several securities would reduce the variability of return and hence the risk ness of a portfolio.
Babasabpatilfreepptmba.com
21
“E-I-C
Analysis
of
Capital
Goods
Sector”
Insights of the topic: The intrinsic value of an equity share depends on multitude of factors. The earnings of the company, the growth rate and the risk exposure of the company have a direct bearing on the price of the share. These factors in turn rely on the host of other factors like economic environment in which they function, the industry they belong to, and finally companies’ own performance. The fundamental school of thought appraised the intrinsic value of shares through E-I-C Analysis. Let us now understand what is fundamental analysis. WHAT IS FUNDAMENTAL ANALYSIS: Fundamental analysis is the analysis, wherein the investment decisions are taken on the basis of the financial strength of the company. There are two approaches to fundamental analysis, viz. •
E-I-C analysis or the Top Down approach to Fundamental analysis, and
•
C-I-E analysis or the Bottom up approach.
ECONOMY-INDUSTRY-COMPANY ANALYSIS: In the Top down approach, first of all the overall Economy is analyzed to judge the general direction, in which the economy is heading. The direction in which the economy is heading has a bearing on the performance of various industries. That’s why Economy analysis is important. The output of the Economy analysis is a list of industries, which should perform well, given the general trend of the economy and also an idea, whether to invest or not in the given economic conditions. MEASURING A COMPANY'S FINANCIAL HEALTH: Gaining a true picture of a company's finances means not only scrutinizing the financial statements but also analyzing relationships among various assets and liabilities, thus
Babasabpatilfreepptmba.com
22
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
highlighting trends in a company's performance and changes in its financial strength relative to its competitors. General Steps to Fundamental Evaluation: Even though there is no one clear-cut method, a breakdown is presented below in the order an investor might proceed. This method employs a top-down approach that starts with the overall economy and then works down from industry groups to specific companies. As part of the analysis process, it is important to remember that all information is relative. Industry groups are compared against other industry groups and companies against other companies. Usually, companies are compared with others in the same group. For example, a telecom operator (Verizon) would be compared to another telecom operator (SBC Corp), not to an oil company (ChevronTexaco). Economic Forecast: First and foremost in a top-down approach would be an overall evaluation of the general economy. The economy is like the tide and the various industry groups and individual companies are like boats. When the economy expands, most industry groups and companies benefit and grow. When the economy declines, most sectors and companies usually suffer. Many economists link economic expansion and contraction to the level of interest rates. Interest rates are seen as a leading indicator for the stock market as well. Below is a chart of the S&P 500 and the yield on the 10-year note over the last 30 years. Although not exact, a correlation between stock prices and interest rates can be seen. Once a scenario for the overall economy has been developed, an investor can break down the economy into its various industry groups. Group Selection: If the prognosis is for an expanding economy, then certain groups are likely to benefit more than others. An investor can narrow the field to those groups that are best suited to benefit from the current or future economic environment. If most companies are expected to benefit from an expansion, then risk in equities would be relatively low and an Babasabpatilfreepptmba.com
23
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
aggressive growth-oriented strategy might be advisable. A growth strategy might involve the purchase of technology, biotech, semiconductor and cyclical stocks. If the economy is forecast to contract, an investor may opt for a more conservative strategy and seek out stable income-oriented companies. A defensive strategy might involve the purchase of consumer staples, utilities and energy-related stocks. To assess a industry group's potential, an investor would want to consider the overall growth rate, market size, and importance to the economy. While the individual company is still important, its industry group is likely to exert just as much, or more, influence on the stock price. When stocks move, they usually move as groups; there are very few lone guns out there. Many times it is more important to be in the right industry than in the right stock! The chart below shows that relative performance of 5 sectors over a 7-month time frame. As the chart illustrates, being in the right sector can make all the difference. Narrow Within the Group: Once the industry group is chosen, an investor would need to narrow the list of companies before proceeding to a more detailed analysis. Investors are usually interested in finding the leaders and the innovators within a group. The first task is to identify the current business and competitive environment within a group as well as the future trends. How do the companies rank according to market share, product position and competitive advantage? Who is the current leader and how will changes within the sector affect the current balance of power? What are the barriers to entry? Success depends on an edge, be it marketing, technology, market share or innovation. A comparative analysis of the competition within a sector will help identify those companies with an edge, and those most likely to keep it. Company Analysis: With a shortlist of companies, an investor might analyze the resources and capabilities within each company to identify those companies that are capable of creating and
Babasabpatilfreepptmba.com
24
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
maintaining a competitive advantage. The analysis could focus on selecting companies with a sensible business plan, solid management and sound financials.
Business Plan: The business plan, model or concept forms the bedrock upon which all else is built. If the plan, model or concepts stink, there is little hope for the business. For a new business, the questions may be these: Does its business make sense? Is it feasible? Is there a market? Can a profit be made? For an established business, the questions may be: Is the company's direction clearly defined? Is the company a leader in the market? Can the company maintain leadership? Management: In order to execute a business plan, a company requires top-quality management. Investors might look at management to assess their capabilities, strengths and weaknesses. Even the best-laid plans in the most dynamic industries can go to waste with bad management (AMD in semiconductors). Alternatively, even strong management can make for extraordinary success in a mature industry (Alcoa in aluminum). Some of the questions to ask might include: How talented is the management team? Do they have a track record? How long have they worked together? Can management deliver on its promises? If management is a problem, it is sometimes best to move on. Financial Analysis: The final step to this analysis process would be to take apart the financial statements and come up with a means of valuation. Below is a list of potential inputs into a financial analysis.
Babasabpatilfreepptmba.com
25
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
26
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
OPERATIONAL DEFINITIONS: Economic Analysis: Economic analysis refers to analyze the factors or indicators of the economy that affects the stock market. This is also called non-diversifiable risk analysis where the risk associated with the securities can not be diversified. Industry analysis: Industry analysis refers to analyze the plan, priorities and vulnerability of an industry for government regulations. The competitive conditions as reflected in any barriers to industry also taken in to consideration. Company Analysis: Company analysis includes analyze the company as potentiality for growth, present performance, risk associated with securities are considered as important. Correlation: Correlation is a statistical measure of the degree to which the security returns move together. The positive correlation means the variables move together. The negative correlation suggests that move in opposite direction and zero correlation shows that no tendency to very either positive or negative direction. Beta: It measures the sensitivity of the return of a security to changes in returns to the market portfolio. It may be positive or negative. The positive beta measures that if 1% changes market index, more than 1% in individual security and vice versa.
Babasabpatilfreepptmba.com
27
“E-I-C
Analysis
of
Capital
Goods
Sector”
PROJECT DETAILS Topic of the study:
“E-I-C Analysis of Capital Goods Sector” Name of the organization
: KOTAK SECURITIES, Hubli.
Main Objective: “To evaluate the performance of Capital Goods companies under study using EIC Analysis.”
Sub objectives: 6.
Analyzing the environmental factors that affect the security prices.
7.
Industry analysis of Capital goods Sector
8.
To assess the fundamentals of the company in light of financial statements.
9.
To arrive at intrinsic value of the company thus enabling the investor in assessing the worth of the security.
10.
I had keen interest to enrich my knowledge in stock market.
Framework of study: The proper order to proceed in Fundamental analysis is, First, to analyze the overall economy and securities markets. Second, analyze the industry with in which a particular company operates. Finally, analysis of the company should be considered. The above analysis involves making a careful estimate of expected stream of benefits and required return of common stock. The intrinsic value then can be obtained through P/E ratio or earning multiplier approach.
Babasabpatilfreepptmba.com
28
“E-I-C
Analysis
of
Capital
Goods
Sector”
Data Collection Approach: Secondary Data: The study is mainly based on analysis of financial statements of the company i.e. balance sheet and profit and loss account. The same has been collected through; •
Company websites and other related websites.
•
The information is also collected from various magazines like Indian survey 2008 by The Hindu
•
News papers
Sample Size: Two large cap companies are taken for study. They are; •
Bharat Heavy Electricals Limited
•
Larsen & Toubro
Babasabpatilfreepptmba.com
29
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
ECONOMY ANALYSIS: The level of economic activity has an impact on investment in many ways. If the economy grows rapidly, the industry can also be expected to show growth and vice-versa. The analysis of macro economic environment is essential to understand the behaviour of the stock prices. The commonly analysed macro economic factors are as follows; 1. Global economy 2. Gross Domestic Product (GDP) 3. Industrial growth rates 4. Savings and investments 5. Government budget and deficit 6. Price level and inflation 7. Interest rates 8. Balance of payment(BOP), forex reserves,& exchange rates 9. Infrastructural facilities and arrangements. 10. Sentiments 1. Global economy In recent years, globalization of capital flows hassled to the growing relevance of emerging capital markets and India is one of the countries with an expanding stock market that is increasingly attracting funds from the FIIs. In particular, deregulation and market Liberalization measures, rapid developments in communication technology and computerized trading systems, and increasing activities of multi national corporations have accelerated the growth of Indian capital market. From 1999 onwards, Indian firms are raising capital from the US market by listing themselves in US exchanges. The economic dailies as well as official publications have been full of stories of a newfound alliance between the NSE and the NASDAQ. Through these news reports, market regulators, traders, and the general investing public in India have become sensitized to the US stock market movements.
Babasabpatilfreepptmba.com
30
FII Activities (Monthly) * Purchase ( Rs Date Crore ) “E-I-C Analysis Apr-2008 47624.50 Mar71159.40 2008 Feb73776.60 2008 Jan-2008 103678.20 Dec85586.40 2007 Nov89035.90 2007 Oct-2007 21981.40
MF Activities (Monthly) Sale ( Rs Investment ( Rs Investment ($US Crore ) Crore) mm) of Capital Goods Sector” 46803.10 821.20 238.70 71289.90
-130.40
-32.20
72043.20
1733.30
429.80
116713.90
-13035.70
-3231.60
80007.10
5579.10
1383.00
96380.90
-7345.10
-1820.90
20749.80
1231.60
305.20
Finally, a quick examination of stock market movements of these two markets suggests that there exists a substantial degree of inter dependence between the US and Indian stock market indices. Facts about FII activities for 2007-08: There was a lot of turmoil in the stock market since January 2008.We can see that FII’s have sold there stake significantly. Indian markets are semi-strong markets and hence they are largely dependent on FII activity. 2. Gross domestic product: GDP indicates the rate of growth of the economy. GDP represents the aggregate value of the goods and services produced in the economy. It consists of Personal consumption expenditure, gross private domestic investment and Government expenditure on goods and services and net exports of goods and services. The estimates are available on annual basis. The growth rate of economy points out the prospects for the industrial sector and the return investors can expect from investment in shares. Higher growth rate is more favourable to the stock market. The GDP of industry sector is in a growing trend with an average of 8.5% whereas the Chinese GDP has an average of 10.5%. Hence the biggest competition is faced by China.
FY01 FY02 FY03
Babasabpatilfreepptmba.com
FY04
FY05
FY06
31
â&#x20AC;&#x153;E-I-C
Analysis
Agriculture (%)
of
Capital
Goods
Sectorâ&#x20AC;?
na
6.2
-6.9
10.0
0.7
3.9
Industry (%)
6.3
2.7
7.0
7.6
8.6
8.7
Services (%)
5.6
7.1
7.3
8.2
9.9
10.
3. Industrial growth rates: The current phase of growth is as much due to the investment demand as consumption demand. Capital goods industries are in a continuous growth phase for the last four years, and there are no reports of any slackening yet. Intermediate goods (that go into the manufacturing process like nuts and bolts, fittings and fixtures, yarn, etc) should see a growth phase now, as the new capacities added over the last four years will start producing. Basic goods consist of actual chemicals and minerals that are the feedstock of all manufacturing process.
YOY% change weight 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
Basic Capital Intermediate 35.5 9.6 10.8 3.0 6.9 1.6 5.5 3.7 2.6 4.9 5.4 5.5 6.7 9.3
9.3 9.2 5.3 11.5 5.8 12.6 6.9 1.8 -3.4 10.5 13.6 13.9 15.8 16.1
26.5 5.3 19.4 8.1 8.0 6.1 8.8 4.7 1.5 3.9 6.4 6.1 2.5 10.9
Consumer durables 5.3 16.2 25.8 4.6 7.8 5.6 14.1 14.5 11.5 -6.3 11.6 14.4 15.3 12.5
Babasabpatilfreepptmba.com
Consumer IIP non-durables 23.3 100.0 11.2 9.1 9.8 13.0 6.6 6.1 4.8 6.7 1.2 4.1 3.2 6.7 5.8 5.0 4.1 2.7 12.0 5.7 5.8 7.0 10.8 8.4 11.0 8.2 8.7 11.3 32
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
4. Savings and investments: Saving and investment is the portion of amount that is saved and invested by the people and corporate. Moderate level of saving and high investment is favourable to stock market, but increase in savings rate indicates little scope for further improvement. It is obvious that growth requires investment which in turn requires substantial amount of domestic savings. The table below depicts the favourable trend in savings as well as investments. As % of GDP 2003 Gross domestic savings rate 26.4 Gross domestic investment rate 25.2 Source: The Hindu (survey of Indian industry 2008)
2004 29.7 28.0
2005 31.1 31.5
2006 32.4 33.8
5. Government budget and deficit: The budget draft provides an elaborate account of the government revenues and expenditure. Fiscal deficit measure the difference between government spending and revenues. Since government borrowing must offset the budgetary shortfall, large amounts of government borrowing can force up the interest rate by increasing the total demand for credit in the economy. Year
Fiscal deficit(as % of GDP)
2003 5.9 2004 4.5 2005 4.0 2006 4.1 2007 3.7 Source: The Hindu (survey of Indian industry 2008) 6.
Revenue deficit (as % of GDP) 4.4 3.6 2.5 2.6 2.0
Price level and inflation:
Babasabpatilfreepptmba.com
33
“E-I-C
Analysis
of
Capital
Goods
Sector”
Along with the growth of GDP, if the inflation rate also increases, then the real rate of growth would be very little. Especially the demand in the consumer product industry is significantly affected. The industries which come under Government price control policy may lose the market, for ex: Sugar. If there is a mild level of inflation, it is good for stock market but high rate of inflation is harmful. 7.
Interest rates:
Interest rate is the cost of borrowing depends on nature of instruments, which will be decided by demand and supply of money and controlled by RBI. It indicates the attractiveness of future investment opportunity and it is key determinant of business expenditure. High interest rate reduces the value of future cash flow as well as opportunities for investment. 8. Balance of payment (BOP), forex reserves, & exchange rates: Exchange rate measures the value of the rupee over the foreign currency. Exchange rate decides international competitiveness of domestically produced goods and it can affect import export, import and the rate of inflation domestically. The BOP (balance of payment) is the record of a country’s money receipts from and payments abroad. The difference between receipts and payments may be surplus or deficit. The BOP is a measure of the strength of rupee on external account. If the deficit increases, the rupee may depreciate against other currencies, thereby affecting the cost of imports. The Forex reserves are also increasing year on year which shows a positive sign. The reserves as on March 05 were Rs. 619116 crore and have been growing. On June 07 the forex reserves stood at Rs. 869449. This reserve amount includes SDR’s, Gold, Foreign currency assets, Reserve tranche position in IMF. 9. Infrastructural facilities and arrangements: The capital goods industry is driven by this factor. Investment in infrastructure developments indicates positive signal to the sectors in the economy, especially manufacturing companies related to transportation. In order to gain from the trade the Babasabpatilfreepptmba.com
34
“E-I-C
Analysis
of
Capital
Goods
Sector”
transaction costs should be low. So the better facility reduces the cost of trade and enables the companies for making profit. More specifically to mention are: •
Adequate and regular supply of electric power at a reasonable tariff
•
A well developed transportation and communication system
•
Assured supply of basic industrial raw material
•
Responsive financial support for fixed assets and working capital.
With
reference
to
such
importance
of
infrastructure,
our
finance
minister
Shri.P.Chidambaram mentioned that, to sustain 9 percent GDP growth, investment in infrastructure should be increased from 4.6 percent to around 8 percent of GDP over the Eleventh Plan period (2007/12). Hence the capital goods industries will play a major role in providing for this. 10. Sentiments: The sentiments of consumers and businessmen have an important bearing on economic performance. Sentiments influence consumption and investment decisions and have a bearing on the aggregate demand for goods and services Thus to sum up: ‘India is not on autopilot to greatness. But it would take an incompetent pilot to crash the plane'. These words of Mr. Edward Luce very aptly define the contours of the Indian economy. The economy has been growing at an average annual growth rate of nearly 6% since the 1980s, and at over 8% during the last three years. Besides, India has also shown considerable resilience during the recent years and avoided adverse contagion impact of several shocks. This has precipitated to increased confidence in the country's financial markets with a consistent increase in gross domestic investment rate from 25% of GDP in FY03 to 33% in FY06. The gross domestic saving rate has also improved from 26% to 32% over the same period, contributed by a significant turn around in public sector saving. A case in this point is that the inflows into mutual funds alone have multiplied 10 times in the last decade and is currently at all time highs!
Babasabpatilfreepptmba.com
35
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
For this buoyancy to sustain, the country will have to tide over several stumbling blocks.
Inherent flaws... First, the poor state of the physical infrastructure, both in terms of quantity and quality. While with the healthy fundamentals of the domestic financial sector and the enhanced interest of foreign investors, funding should not pose a problem, issues relating to regulatory framework and rapid execution need to be addressed by the government. Second, the
fiscal consolidation. The recent budget of the central government targets a
gross fiscal deficit of 3% of GDP by 2009. This requires fiscal empowerment, which is possible through two routes (i) elimination of subsidies or (ii) elimination of tax exemptions. While in any economy fiscal consolidation is hard, it is particularly so in our setting Third, India is set to remain one of the youngest countries in the world in the next few decades. This 'demographic dividend' cannot be used to the economy's advantage unless prerequisites such as skill upgradation and sound governance to realize it are put in place. Fourth, there is a need to shift the emphasis from foreign institutional investment to attracting foreign direct investment, which is less volatile. This requires a more favorable investment climate in general both for domestic and foreign capital. Global Imbalances... As India does not depend on the international capital market for financing the fiscal deficit, the extent of adverse consequences of the global developments would be muted. However, there could be a spillover effect of global developments on domestic interest rates and thus on fiscal position. Also, a faster rise in rates overseas could lead to a shift in investor confidence to the international markets. Further, should there be a reversal of capital flows, asset prices may decline. With this there is a risk that rise in interest rates in
Babasabpatilfreepptmba.com
36
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
general could impact the housing market and expose the balance sheet of the households to interest rate risk, increasing the risk of loan delinquencies for banks. Banks in India have invested significantly in government debt and other fixed income securities. If a rise in international rates gets reflected in domestic interest rates, banks will also have to mark down the value of their investment portfolio. Multilateral confidence... Finally, there needs to be the confidence of the investor community on multilateral aspects such as political stability, terrorism combating ability and significance at global economic platforms (such as the IMF and World Bank). While we do not intend to sound pessimistic about the continued resilience of the economy to global and internal shocks, investors investing in the India story should assess these grounds before judging the 'market risk' to be assigned to a stock. Weighing this with the premium expected to be earned over and above the risk free rate (10 year GSec yield), will help you correctly align your portfolio as per your risk profile.
Babasabpatilfreepptmba.com
37
“E-I-C
Analysis
of
Capital
Goods
Sector”
IMPACT OF BUDGET 2008-09 ON ENGINEERING:
From a policy perspective, however, there has been a growing consensus that a privatepublic partnership is required to remove difficulties concerning the development of infrastructure in the country. The realization finally seems to be setting in. This makes the future of the Indian engineering sector extremely bright. Apart from highway development and construction and modernization of airports, the potential for the sector lies in the oil and gas space, where high global demand has led to increased action in exploration and production activities. However, scale and execution capabilities remain the mantras for success. Budget Measures: •
Fourth UMPP at Tilaiya to be awarded shortly; Chhattisgarh, Karnataka, Maharashtra, Orissa and Tamilnadu urged to bring five more UMPPs to the bidding stage by extending the required support.
•
Rajiv Gandhi Grameen Vidyutikaran Yojana to be continued during the Eleventh Plan period with a capital subsidy of Rs 280 bn; allocation of Rs 55 bn for FY09.
•
Rs 8 bn to be provided for Accelerated Power Development and Reforms Project (APDRP) in FY09.
•
Exemption from 4% additional duty of customs has been withdrawn on power generation projects (other than mega power projects), transmission, sub transmission and distribution projects, and specified goods for high voltage transmission projects.
Babasabpatilfreepptmba.com
38
“E-I-C
Analysis
of
Capital
Goods
Sector”
•
Custom duty on project imports reduced from 7.5% to 5%
•
Defence allocation to be increased by 10%.
•
Excise duty being exempted on end-use basis, on refrigeration equipment (consisting of compressor, condenser units, evaporator, etc) above 2 TR (tonne refrigeration) utilising power of 50 KW and above.
•
Parent company allowed to set-off the dividend received from its subsidiary company against dividend distributed by the parent company; provided that the dividend received has suffered DDT and the parent company is not a subsidiary of another company.
Budget Overview: Key Positives: Power play: Since power utilities are one of the biggest consumers (generation, transmission and distribution) for engineering companies, reforms introduced in the power sector like privatisation of SEBs will help in strengthening the order book size. Huge addition in power generation capacity, in order to meet the demand supply gap will be a big positive for the sector. Infrastructure development: The government is focusing on development of infrastructure like housing, airports, roads and ports. This will be big positive for engineering and construction companies. Industrial ‘act’: Industrial divisions of engineering companies are likely to benefit from the increased focus on automation and capacity addition plans drawn by the India Inc. Key Negatives:
Babasabpatilfreepptmba.com
39
“E-I-C
Analysis
of
Capital
Goods
Sector”
Captive competition: Duty free import of T&D equipments by captive power generation units, if allowed by government, can have some impact on margins of the T&D majors because of competition. People problem: Engineering companies, across the board, are facing troubled times retaining key employees. This is due to increased levels of competition for talent from MNCs, who have deep pockets and thus better paying capabilities. As a result of increasing levels of attrition, some companies are facing execution issues. COMPANY IMPACT: •
Allocation of UMPPs to support growth if equipment and service providers like BHEL, L&T and Siemens.
•
Greater focus on the T&D front to be beneficial for ABB, Siemens, Crompton Greaves, Emco, Bharat Bijlee. Also, companies providing T&D project services like Jyoti Structures and Kalpataru Transmission to benefit.
•
Removal of exemption from additional customs duty on power generation, transmission and distribution projects to benefit domestic companies like BHEL, L&T, Siemens and Reliance Energy.
•
Skill development initiatives to pare pressure of attrition from companies like L&T and BHEL.
•
Increase in defense allocation to aid prospects of Tata Power, L&T and Bharat Electronics.
Babasabpatilfreepptmba.com
40
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
INDUSTRY ANALYSIS: If one were to consider one of the biggest beneficiaries from any countryâ&#x20AC;&#x2122;s infrastructure sector development, engineering companies have a vital role to play. As in any other sector, choices for a retail investor are high for an equity investment. However, it does that mean each stock in the sector is a BUY? In this article, we have tried to discuss the dynamics of this sector and the key aspects that one should look in, before selecting an engineering stock. PROFILE: Engineering, as a sector, has many facets. A company from this sector can be an equipment manufacturer (like transformers and boilers), execution specialist (say BHEL, L&T, Engineers India) or a niche player (like Thermax in environmental solutions, Voltas in electro-mechanical projects, ABB for automation technologies and so on). To define the user industries in broad terms are power utilities, industrial majors (refining, automotive and textiles), government (public investment) and retail consumers (pumps and motors). Thus, every company has a specific role to play in the industry and is looking forward to cater a specific target market. Given this backdrop, prospects of a particular company in the engineering sector have to be viewed with respect to the specific user industries. So, if the engineering sector does well, not all companies stand to benefit in equal proportion. When will an engineering company grow? It is highly dependent on the level of private and public sector investment in the economy. When investments in capacities and infrastructure gains momentum, more jobs are created and demand for goods in general increases. This in turn leads to higher economic growth. Historically, the growth of the engineering sector has been sensitive to economic performance (as is evident from the graph below). The industry is relatively less fragmented at higher end, as competencies required are high. It is therefore that the
Babasabpatilfreepptmba.com
41
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
barriers to entry are also high. But in some cases, competition is also global in nature (like dam construction, roads, refineries and power plants).
Letâ&#x20AC;&#x2122;s have a look at the demand drivers for this sector :
Order Book: An engineering company can derive revenues from domestic as well as global markets. Usually, there is something-called order book that is declared by most of the companies in its annual report. This is nothing but the quantum of projects that have been won, but are still to be executed. Therefore, order book position indicates the future growth prospects. Babasabpatilfreepptmba.com
42
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
Most of these companies have an order book to sales ratio in the range of 2.5-4 times FY07 revenue. This implies that for the next two-to-three years, even if the companies do not get fresh orders, they can still maintain revenue growth of 30-40 per cent. Domestic market: The power sector accounts for approximately 60% of total revenues for this sector. Therefore, growth in power capacities is very important for engineering companies. So letâ&#x20AC;&#x2122;s have a brief look at key fundamental factors that influences power sector performance. Historically, politics have played a vital role in shaping the power sector as opposed to economics (profitability in easy terms). What a retail investor has to keep in mind is that power capacities will only increase when there is a political will to charge consumers for what they consume. Industrial sector pays higher tariffs while agricultural sector derives power free of cost. This is the root cause for the poor financial health of the SEBs (state electricity boards). SEBs are financially weak and private sectors have been reluctant to invest, as they are apprehensive of receiving money for the quantity of power supplied to the SEBs. Retail investors have to keep in mind that India is power deficient (demand is more than supply). The simple way to gauge growth of a engineering company that is targeting the power sector is to understand what kind of capacity SEBs and private sector players are planning. It costs Rs 30-35 m to set up one MW of power capacity. If a player is planning to set up a 1,000 MW plant, then the project size could be around Rs 30 bn to Rs 35 bn. This could be assumed roughly as the potential addition to the order book. If public sector power majors are expanding capacity, then it has to be borne in mind that public sector engineering companies benefit the most (as a matter of preference).
Babasabpatilfreepptmba.com
43
“E-I-C
Analysis
of
Capital
Goods
Sector”
Industrial and Infrastructure spending: The industrial sector contributes around 30% of the total revenues of engineering sector. The demand from this segment largely depends on GDP growth, which in turn is a function of the quantum of infrastructure spending and capacity expansion plans of corporate India. A lot depends on government policies. Formulation of policies favorable to industrial sector can boost the investments and expansion plans for both private and public sector companies. Talking of policies, when government increases participation of foreign companies in infrastructure development, the sector gets a fillip. Demand growth in this sector is fuelled by expenditure in core sectors such as power, railways, infrastructure development, and private sector investments and the speed at which the projects are implemented. The top line trends of major engineering companies since last five years have shown a high degree of correlation with the IIP (Index of Industrial Production) growth. Thus a fair idea can be taken about the sector looking at the IIP growth. Let’s look at the correlation in the graph below.
Exports: While an engineering company from India could tap global markets for contracts, there is a vast difference when it comes to competitors. Players like Bechtel and GE have muscle power and have executed projects on a global scale. This is one of the reasons increasing
Babasabpatilfreepptmba.com
44
“E-I-C
Analysis
of
Capital
Goods
Sector”
contribution from international markets is not easy for any company. Retail investors have to tread with caution on this front. Due to intense competition in the international arena, suppliers do not enjoy much bargaining power. Moreover, in order to win big contracts you need to have big balance sheet size, because only some part of entire contract money is paid up front and rest comes after installation of project. Moreover, in some cases, the engineering company buys stake in the projects during the financial closure. Key points to be kept in mind before investing… •
Order book and operating margins: Order book, as we had said earlier, indicates a company’s standing in a year in terms of future growth in revenues. A consistent rise in order book on a year on year basis (and not quarter on quarter) is also vital. Though order book may be huge for a company, it has to be remembered that operating margins are low in projects. In a downturn, operating margins of an engineering company comes under pressure. If a company acts as an engineering agency (i.e. buys and installs equipment), margins tend to be on the higher side.
•
Balance sheet size: One should look at the balance sheet size of the company. It will tell you whether company is capable of bagging and executing big contracts. In order to win big contracts and execute them, company needs huge working capital. In this case, past track record of projects executed could be useful (available in the balance sheet).
•
Revenue growth: Usually, an engineering company derives a large share of revenues in the third and fourth quarter. So, quarter on quarter comparisons is meaningless in this sense.
•
Valuation ratios: One of the key factors used when it comes to putting a value for an engineering company is market capitalization to sales. Why the emphasis of assigning a value to revenues and not to earnings? The ability to grow for any
Babasabpatilfreepptmba.com
45
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
engineering company is dependent on the kind of order book, which then translates into revenues. Internationally, the average of 0.4 times to 0.5 times is a benchmark. If price to earnings is used, it has to be remembered that the sector is highly dependent on the economy. So, a P/E in line with the long-term economic growth could be useful. Apart from what all has been said above, investor needs to look at the past record of the management, its vision and its focus on business. After all itâ&#x20AC;&#x2122;s the management of the company who is the final decision-maker and the future of the company solely depends on the decisions taken by it
Babasabpatilfreepptmba.com
46
“E-I-C
Analysis
of
Capital
Goods
Sector”
PORTER’S FIVE FORCE MODEL:
•
Supply: Abundant supplies is available across most segments, except for technology intensive executions.
•
Demand: Demand growth in this sector is fuelled by expenditure in core sectors such as power, railways, infrastructure development, private sector investments and the speed at which the projects are implemented. The Govt. has been spending heavily on this sector and this has fuelled the growth of capital goods industry
•
Barriers to entry: Barriers to entry are high at upper end of the industry as skilled manpower and technologies, and ability to fund large projects are a prerequisite. However at the lower end, the industry is more fragmented.
•
Bargaining power of suppliers: Bargaining power of suppliers is low because of intense competition. However, in technology driven high-end segments, suppliers have the upper hand. Babasabpatilfreepptmba.com
47
“E-I-C •
Analysis
of
Capital
Goods
Sector”
Bargaining power of customers: Bargaining power for technology driven segments is low as there are very few producers of engineering goods. And moreover the customer has very less bargaining power in such industry as compared to FMCG
•
Competition: Majority of the companies compete in terms of pricing, experience in specific field, product differentiation and timely completion of projects. The sector is less fragmented at top because the competencies required are high. The other competitor is China which is providing equally good competition.
.
Babasabpatilfreepptmba.com
48
“E-I-C
Analysis
of
Capital
Goods
Sector”
COMPANY ANALYSIS Company Analysis is the leg in the EIC analysis sequence. It may be organized into two parts, 1] Study of Financials. 2] Study of other factors. The companies taken for EIC Analysis in this project are’ 1] Bharath Heavy Electricals Limited [BHEL] 2] Larsen and Toubro [L&T]
Babasabpatilfreepptmba.com
49
“E-I-C
Analysis
of
Capital
Goods
Sector”
PROFILE OF THE COMPANIES UNDER STUDY: BHARAT HEAVY ELECTRICALS LIMITED [BHEL]: OVERVIEW: BHEL is the largest engineering and manufacturing enterprise in India in the energyrelated/infrastructure sector, today. BHEL was established more than 40 years ago, ushering in the indigenous Heavy Electrical Equipment industry in India - a dream that has been more than realized with a well-recognized track record of performance. The company has been earning profits continuously since 1971-72 and paying dividends since 1976-77. BHEL has acquired certifications to Quality Management Systems (ISO 9001), Environmental Management Systems (ISO 14001) and Occupational Health & Safety Management Systems (OHSAS 18001) and is also well on its journey towards Total Quality Management.
Babasabpatilfreepptmba.com
50
“E-I-C
Analysis
of
Capital
Goods
Sector”
BHEL has, •
Installed equipment for over 90,000 MW of power generation -- for Utilities, Captive and Industrial users.
•
Supplied over 2,25,000 MVA transformer capacity and other equipment operating in Transmission & Distribution network up to 400 kV (AC & DC).
•
Supplied over 25,000 Motors with Drive Control System to Power projects, Petrochemicals, Refineries, Steel, Aluminum, Fertilizer, Cement plants, etc
•
Supplied Traction electrics and AC/DC locos to power over 12,000 kms Railway network.
•
Supplied over one million Valves to Power Plants and other Industries.
BHEL's operations are organised around three business sectors, namely Power, Industry - including Transmission, Transportation, Telecommunication & Renewable Energy - and Overseas Business. This enables BHEL to have a strong customer orientation, to be sensitive to his needs and respond quickly to the changes in the market. BHEL's vision: “To become a world-class engineering enterprise, committed to enhancing stakeholder value”. The greatest strength of BHEL is its highly skilled and committed 42,600 employees. Every employee is given an equal opportunity to develop himself and grow in his career. PRODUCT PROFILE: •
Established in the late 50’s, Bharat Heavy Electricals Limited (BHEL) is, today, a name to reckon with in the industrial world.
•
It is the largest engineering and manufacturing enterprise of its kind in India and one of the leading international companies in the power field. Babasabpatilfreepptmba.com
51
“E-I-C •
Analysis
of
Capital
Goods
Sector”
BHEL offers over 180 products and provides systems and services to meet the needs of core sectors like: power, transmission, industry, transportation, oil & gas, non-conventional energy sources and telecommunication.
•
A wide-spread network comprising 14 manufacturing divisions, 8 service centres, 4 power sector regional centres, 18 regional offices, besides a large number of project sites spread all over India and abroad, enables BHEL to be close to its customers and cater to their specialised needs with total solutions - efficiently and economically.
•
An ISO 9000 certification has given the company international recognition for its commitment towards quality. With an export presence in more than 60 countries, BHEL is truly India’s industrial ambassador to the world.
OVERSEAS BUSINESS: BHEL, ranking among the major power plant equipment suppliers in the world, is one of the largest exporters of engineering products & services from India. Over the years, Babasabpatilfreepptmba.com
52
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
BHEL has established its references in around 60 countries of the world, ranging from the United States in the West to New Zealand in the Far East. BHEL's export range covers individual products to complete Power Stations, Turnkey Contracts for Power Plants, EPC Contracts, HV/EHV Sub-stations, O&M Services for familiar technologies, specialized after-market services like Residual Life Assessment (RLA) studies and Retrofitting, Refurbishing & Overhauling, and supplies to manufacturers & EPC contractors. RESEARCH AND DEVELOPMENT: To remain competitive and meet customers' expectations, BHEL lays great emphasis on the continuous upgradation of products and related technologies, and development of new products. BHEL's commitment to advancement of technology is reflected in its involvement in the development of futuristic technologies like fuel cells and superconducting generators. BHEL's investment in R&D is amongst the largest in the corporate sector in India. Products developed in-house during the last five years contributed about 7% to the revenues in 2005-06.
Babasabpatilfreepptmba.com
53
“E-I-C
Analysis
of
Capital
Goods
Sector”
COMPANY MANAGEMENT: Board of Directors: Name
Designation
Mr. Ashok K Aggarwal
Director
Mr. Anil Sachdev
Director
Mr. S K Jain
Director
Dr. Surajit Mitra
Director
Mr. Sanjay M Dadlika
Director
Mr. Shekhar Datta
Director
Mr. K Ravi Kumar
Chairman and Managing director
Mr. B S Meena
Part Time Director
Mr. Madhukar
Director
Mr. C S Verma
Director
Mr. A K Mathur
Director
Mr. S Ravi
Part Time Director
Mr. B P Rao
Director
Mr. C P Singh
Director
Mr. Manish Gupta
Director
Babasabpatilfreepptmba.com
54
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
55
“E-I-C
Analysis
of
Capital
Goods
Sector”
COROPORATE NEWS: •
Power equipments built by state-run Bharat Heavy Electricals (BHEL) registered a record generation of 454.6 billion units of electricity in 2007-08, compared to 432.6 billion units in the year-ago period.
•
State-run power plant equipment maker BHEL has won orders worth around Rs 20.30 billion from Bharathiya Rail Bijlee Company (BRBCL).
•
The power ministry agreed to give power equipment manufacturer Bharat Heavy Electricals (BHEL) a few of NTPC`s supercritical 660mw and 800mw projects on a negotiated basis.
•
The government-owned Bharat Heavy Electricals (BHEL) has secured the staterun Chhattisgarh State Electricity Board`s (CSEB`s) contract to set up two power plants in Korba district quoting Rs 19.6 million per Mw, the lowest it has ever quoted for a power plant in the country,
•
State-run BHEL and Nuclear Power Corporation on Friday signed a memorandum of understanding (MoU) to float a joint venture (JV) company for executing nuclear power projects in India and abroad
•
Bharat Heavy Electricals (BHEL) will sign a memorandum of agreement (MoA) with Nuclear Power Corporation of India to float a joint venture for manufacturing equipment for nuclear power plants.
•
Bharat Heavy Electricals (BHEL), India`s biggest power equipments maker has further enlarged its global footprint with a foray into a new market New Caledonia, with a prestigious export contract for environment friendly circulating fluidized bed combustion (CFBC) boilers.
Babasabpatilfreepptmba.com
56
“E-I-C •
Analysis
of
Capital
Goods
Sector”
Bharat Heavy Electricals (BHEL) is likely to spend nearly Rs 50 billion over the next three years in its yet-to-be-formed joint venture companies with power utility NTPC and Nuclear Power Corporation of India (NPCIL)
•
Bharat Heavy Electricals (BHEL) bagged orders worth around Rs 20.30 billion for the supply and installation of the main plant package at the upcoming 1,000 MW Nabinagar Thermal Power Project in Bihar, involving four units of 250 MW each.
•
Bharat Heavy Electricals (BHEL) plans to buy a local engineering company to expand capacity. The power-equipment maker may buy a company of a size of about Rs 4 billion.Bhel is seeking to expand capacity to help the country’s effort to add at least 600 gig watt of electricity by 2030.
Babasabpatilfreepptmba.com
57
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
LARSEN AND TUBRO [L&T]: CORPORATE OFFICE:
OVERVIEW: Larsen & Toubro Limited (L&T) is a technology, engineering, construction and manufacturing company. It is one of the largest and most respected companies in India's private sector. Seven decades of a strong, customer-focused approach and the continuous quest for world-class quality have enabled it to attain and sustain leadership in all its major lines of business. L&T has an international presence, with a global spread of offices. A thrust on international business has seen overseas earnings grow significantly. It continues to grow its overseas manufacturing footprint, with facilities in China and the Gulf region. The company's businesses are supported by a wide marketing and distribution network, and have established a reputation for strong customer support. L&T believes that progress must be achieved in harmony with the environment. A commitment to community welfare and environmental protection are an integral part of the corporate vision Strategic Mission - LAKSHYA (Hindi for Target) To compete and grow in a globalised business environment, L&T is implementing a strategic plan (LAKSHYA) for 2005-10. The plan has been drawn up in consultation with a leading international strategy consultant. It has set ambitious growth targets for each business. Also included are opportunities for diversification of L&T's business portfolio
Babasabpatilfreepptmba.com
58
“E-I-C
Analysis
of
Capital
Goods
Sector”
ORGANIZATION STRUCTURE:
Babasabpatilfreepptmba.com
59
“E-I-C
Analysis
of
Capital
Goods
Sector”
HISTORY: The evolution of L&T into the country's largest engineering and construction organization is among the most remarkable success stories in Indian industry. L&T was founded in Bombay (Mumbai) in 1938 by two Danish engineers, Henning Holck-Larsen and Soren Kristian Toubro. Both of them were strongly committed to developing India's engineering capabilities to meet the demands of industry. Beginning with the import of machinery from Europe, L&T rapidly took on engineering and construction assignments of increasing sophistication. Today, the company sets global engineering benchmarks in terms of scale and complexity..
GLOBAL PRESENCE: L&T has a global presence. A thrust on international business over the years has seen overseas revenues growing steadily. The company has manufacturing facilities in India, China, Oman and Saudi Arabia. It has a global supply network with offices in 10 locations worldwide, including Houston, London, Milan, Shanghai, and Seoul. Customers include global majors in over 30 countries.
SUBSIDIARIES AND ASSOCIATES: The L&T Group has a number of subsidiaries & associates worldwide. •
Engineering and Construction
•
Machinery and Industrial Products
•
Information Technology
•
Financial Services
Babasabpatilfreepptmba.com
60
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
TECHNOLOGY: In every sphere of L&T's operations, technology is the key enabler, reinforcing its leadership position, and sustaining its competitive strengths. While for some, technology is a means to an end, for L&T, technology represents endless possibilities ENGINEERING AND CONSTRUCTION: In engineering and construction, L&T's technology capabilities include a strategic mix of in-house strengths and the expertise of its joint venture partners. Engineering Centers at Mumbai, Vadodara and Delhi carry out process design and simulation, analysis of computational fluid dynamics, mechanical design, failure analysis and trouble shooting. L&T has set up an engineering and project management centre in Abu Dhabi, to undertake oil and gas related projects as well as engineering and consultancy services.
An engineering centre in Sharjah is an extended arm in the Gulf. This is supplemented through collaborations with key partners: L&T-Valdel for engineering services in the upstream hydrocarbon sector, L&T-Chiyoda for the mid and down stream sectors, and L&T Sargent & Lundy for the power sector. The engineering services provided by L&T's Engineering Design Research Centers at Chennai and Kolkatta include feasibility studies, project reports, system engineering, architectural, structural and civil design for infrastructure development projects.
Babasabpatilfreepptmba.com
61
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
L&T-Ramboll Consulting Engineers provides civil engineering and consultancy services for a wide range of projects in the transportation sector - ports, airports, highways and bridges. MANUFACTURING: L&T's design & engineering capabilities in manufacturing enable it to set new benchmarks in terms of scale, sophistication and speed. The Company has dedicated engineering centres at the manufacturing locations. Two 'Technology Development Centres' have been set up to develop new products and manufacturing technologies. L&T also collaborates with the organisations like ISRO to bolster its capabilities in the strategic sectors of aerospace, defence and nuclear power. L&T's Electrical and Electronics Division, is a pioneer in the design of switchgear and switchboards that are engineered for tropical conditions. It has built further on this experience, and has leveraged its R&D strengths to develop a host of new products and features. In 2006-07, the division filed applications for over 80 patents. Cumulatively, L&T's Electrical & Electronics Division has applied for and secured 247 patents - a landmark for an Indian company. Patent applications cover innovations made on a variety of low voltage indigenously developed switchgear products like the air circuit breakers (ACBs) and moulded case circuit breakers (MCCBs), medical products, petroleum dispensing pumps, tooling solutions and switchboards TECHNOLOGY SERVICES: L&T provides its global clients with the winning edge through the development of optimal solutions. L&T's e-engineering services leverage the Company's own engineering heritage and experience. The Embedded Systems unit provides technological assistance across a broad spectrum - design, maintenance, re-engineering, testing, prototyping and industrial design.
Babasabpatilfreepptmba.com
62
“E-I-C
Analysis
of
Capital
Goods
Sector”
Board of Directors: Name
Designation
Mr. Subodh Bhargava
Additional Director
Lt. Gen. Surinder Nath
Non Executive Director
Mr. K Venkataramanan
Whole Time Director
Mr. Y M Deosthalee
Whole Time Director
Mr. J P Nayak
Whole Time Director
Mrs. Bhagyam Ramani
Director
Mr. K V Rangaswami
Whole Time Director
Mr. A M Naik
Chairman and Managing director
Mr. N Mohan Raj
Nominee Director
Mr. M V Kotwal
Whole Time Director
Mr. Thomas Mathew T
Nominee Director
Mr. U Sundararajan
Non Executive Director
Mr. R N Mukhija
Whole Time Director
Mr. S N Talwar
Non Executive Director
Mr. V K Magapu
Whole Time Director
Mr. M M Chitale
Non Executive Director
Babasabpatilfreepptmba.com
63
“E-I-C
Analysis
of
Capital
Goods
Sector”
CORPORATE NEWS: •
L&T to develop Rs 35 bn integrated commercial complex at Navi Mumbai.
•
L&T to bag Rs 480 bn order in Joint Venture with Mitsubishi Heavy Industries.
•
L&T secures Rs 20 bn contract from Bombay Dyeing for developments at the Textile Mills & Spring Mills complexes at Worli and Wadala regions of Mumbai respectively.
•
Cairn had awarded a Rs 6 billion contract to L&T in February for the laying of a heated pipeline for transporting crude oil from Barmer in Rajasthan to Salaya in Gujarat.
•
Larsen & Toubro (L&T) bagged four orders worth Rs 16.87 billion from the Government of Rajasthan, Bhushan Steel-Orissa, SAIL Bokaro Steel Plant and the Damodar Valley Corporation (DVC). The orders are for water supply projects, sinter plant and cold roll mill and a coal handling plant
•
Larsen & Toubro`s (L&T) through its E&C division`s refinery projects business unit received Rs 5.76 billion order from Hindustan Petroleum (HPCL).
•
Larsen & Toubro (L&T), India`s biggest engineering company, has made public its plans to ramp up its manufacturing capacity of super-critical boilers and supercritical turbine generators to 4,000 mw per annum. The foundation stone for the upgraded facility was laid at Hazira on Mar. 19, 2008.
•
The Heavy Engineering Division of India`s largest engineering company Larsen & Toubro (L&T) bagged a contract valued at Euro 28 million (Rs 1.70 billion) for supply of the Coal Gasifier and Syngas Cooler assembly to Hebi Coal and Electricity Co of China.
•
Larsen & Toubro (L&T), a USD 5 billion technology, engineering and construction company with global operations, announced on Tuesday, that the electrical & electronics division (EBG) of the company bagged Rs 747 million contracts to supply SCADA system for onshore control centers (OCC) for
Babasabpatilfreepptmba.com
64
“E-I-C
Analysis
of
Capital
Goods
Sector”
offshore operations of Oil and Natural Gas Corporation (ONGC). L&T has been awarded this project by outbidding international competitors.
ANALYSIS OF COMPANY FINANCIALS B. LIQUIDITY RATIOS These ratios measure the firm’s liquidity position. It is firm’s ability to meet its short term obligations. There are three types of ratios through which the liquidity position can be assessed. They are •
Current ratio
•
Quick/acid-test ratio
•
Absolute cash ratio.
1.
CURRENT RATIO:
It is calculated as following Current Ratio = Current Assets / Current Liabilities Relevance: • Current Liability coverage: Higher the current ratio, greater is the assurance we have that current liabilities will be paid. • Buffer against losses: Current Ratio shows the margin of safety available to cover shrinkage in non cash current asset values when ultimately disposing off or liquidating them • Reserve of liquid funds: It is the measure of margin of safety against uncertainties and random shocks to the company’s cash flows.
Limitations:
Babasabpatilfreepptmba.com
65
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
It is static measure of resources available at a point in time to meet the current obligations. The current reservoir of cash does not have a logical or causal relation to its future cash flows. These cash flows depend on factor excluded from the ratio i.e sales, expenditure, cash, profits.
BHEL 2004-05
2005-06
L&T 2006-07
2004-05
2005-06
2006-07
Current assets 133430.00
16330.78
21062.97
8795.41
9535.45
11884.66
84459.00
10320.02
14420.11
5556.57
6910.55
9337.26
1.58
1.58
1.46
1.58
1.38
1.27
Current liabilities Current Ratio
Babasabpatilfreepptmba.com
66
“E-I-C
Analysis
of
Capital
Goods
Sector”
Current Ratio
1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0
2004-05
2005-06
2006-07
BHEL
1.58
1.58
1.46
L&T
1.58
1.38
1.27
Interpretation: BHEL- The cash and cash equivalents have increased from Rs.4133.97 crore in 2005-06 to Rs. 5808.91 crore in 2006-07 reflecting the sound liquidity of the company. On the other hand, this increase has been set off by decrease in loans and advances. L&T- The ratios of current assets to liabilities is in decreasing trend. The ratio signifies how much assets are available with them for every rupee of obligation. The company had 24% (2006 to 2007) increase in current assets whereas the liabilities increased by 39% in FY07. This was on account of advances to customers and unpaid expenses Based on current ratio we can say BHEL is better–off than L&T as far as liquidity is concerned. 2.
QUICK RATIO:
A more stringent test of the liquidity uses the Liquidity ratio, also known as the Quick or the Acid Test Ratio which includes the assets most quickly convertible to cash. This is a better test of liquidity as it handles issues of window dressing.
Babasabpatilfreepptmba.com
67
“E-I-C
Analysis
of
Capital
Goods
Sector”
Quick (Acid Test) Ratio = (Current Assets – Inventory) / Current Liabilities
BHEL 2004-05 130519.0
CA-Inv
2005-06
2006-07
12586.41
16845.30
8795.41
9535.45
11884.66
84459.00
10320.02
14420.11
5556.57
6910.55
9337.26
1.55
1.22
1.17
1.18
1.06
0.95
0 CL
L&T
Quick ratio
2004-05
2005-06
2006-07
Quick Ratio
2 1.5 1 0.5 0
2005
2006
2007
BHEL
1.55
1.22
1.17
L&T
1.18
1.06
0.95
Interpretation: 3 -D
Co lumn 1
3 00 0 2 00 0 1 00 0 0
BHEL
Quick ratio is also called as acid test ratio. The industry standards say 1:1 ratio is L&T
preferable. Both the companies have maintained except for L&T in the FY07 this is because of large amounts due to customers and it also shows that greater amount of assets is tied up in inventory. BHEL stands strong as compared to L&T.
Babasabpatilfreepptmba.com
68
“E-I-C
Analysis
of
Capital
Goods
Sector”
ABSOLUTE CASH RATIO: This ratio tests the liquidity on an immediate basis as it tests for liquidity with the cash and near cash items only. Absolute cash ratio indicates whether a firm has enough shortterm assets to cover its immediate liabilities without selling inventory. This ratio is also known as acid-test ratio. Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution. Furthermore, if the acid-test ratio is much lower than the liquid ratio, it means current assets are highly dependent on inventory. It is expressed as Absolute Cash Ratio = (Current Assets – Stock – Debtors)/ Current Liabilities
0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0
2004-05
2005-06
2006-07
BHEL
0.38
0.4
0.4
L&T
0.15
0.08
0.12
Interpretation: Again in cash ratio, L&T falls behind BHEL. The later being a PSU was able to maintain its liquidity better than L&T. especially in the FY06 the value is very low. The reason for this is, the balance of fixed deposits with scheduled banks is less as compared to other years. This amount is utilized to meet the expenses of the company
Babasabpatilfreepptmba.com
69
“E-I-C
Analysis
of
Capital
Goods
Sector”
B. TURNOVER RATIOS Efficiency or Turnover Ratios measures the efficiency of asset management. Each turnover ratio defines the asset differently. These ratios are based on the relationship between the level of activity, represented by sales or cost of goods sold and levels of various assets.
FIXED ASSETS TURNOVER RATIO: The firm may wish to know its efficiency of utilizing fixed assets. This ratio measures sales per rupee of investment in fixed assets and is given by, Fixed assets turnover Ratio=Net sales/Gross block Sometimes Net fixed assets (depreciated value) are used for computing the turnover ratio. As a result the ratio may be higher in the case of an old established company as compared to new one, other things being equal. This may render comparison of firm’s over a period or with other firms meaningless.
Babasabpatilfreepptmba.com
70
“E-I-C
Analysis
of
Capital
Goods
Sector”
FA TURNOVER RATIO
8
6.55
6.33
6.29
6 4.17
4
3.5 2.63
2 0
2004-05
2005-06
2006-07
BHEL
2.63
3.5
4.17
L&T
6.33
6.55
6.29
Interpretation: Gross Block and capital Work in progress increased by Rs. 312.99 crore, and Rs. 117.97 crore during the year 07 due to Capital expenditure incurred on ongoing capacity augmentation programme at various manufacturing units and the erection and commissioning facilities at project sites has lead to increase in the ratios of BHEL. The capital expenditure on capacity addition has lead to increase in the ratio of BHEL. On the other side L&T has been able to maintain stable ratio of around 6 times which is far more than BHEL. Interpreting the reciprocals, we may say that for generating a sale of Re.1, BHEL needs Rs.0.24 investment in fixed assets as compared to L&T which needs investment of Rs.0.16. TOTAL ASSETS TURNOVER RATIO: This ratio shows the firm’s ability in generating sales from all financial resources committed to total assets. The ratio is also known as the investment turnover ratio. The
Babasabpatilfreepptmba.com
71
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
higher the turnover ratio, the more efficient is the management and utilization of assets while low turnover ratio is indicative of underutilization of available resources and presence of idle capacity Total Assets turnover ratio= Net Sales/total assets Where; Total assets = Net fixed Assets + Current Assets BHEL Net sales Total assets Total assets turnover
L&T
2004-05
2005-06
2006-07
2004-05
2005-06
2006-07
9527.14
13374.03
17237.53
13049.79
14734.80
17578.84
14387.00
17313.06
22051.71
9855.35
11113.11
14028.70
0.66
0.77
0.78
1.32
1.33
1.25
Total assets turnover Ratio
1.5 1 0.5 0
2004-05
2005-06
2006-07
BHEL
0.66
0.77
0.78
L&T
1.32
1.33
1.25
Interpretation: L&T is more efficient than BHEL in utilizing the assets. L&T has been efficient enough to generate sales more than a rupee for every one rupee invested in fixed and current
Babasabpatilfreepptmba.com
72
“E-I-C
Analysis
of
Capital
Goods
Sector”
assets together. BHEL over the 3 years have increased the sales per rupee invested. The BHEL’s vision for 2012 insists the company to improve its efficiency . INVENTORY DAYS: A financial measure of a company's performance that gives investors an idea of how long it takes a company to turn its inventory (including goods that are work in progress, if applicable) into Sales. Inventory turnover ratio = Cost of Goods Sold/Average inventory Inventory Days = Inventory turnover ratio/360 Cost of goods sold include material cost, labour cost and other manufacturing expenses such as fuel & power, repairs & maintenance, consumable stores, insurance on goods, and so on. Average inventory is taken as = (Opening inventory + closing inventory)/2 Generally a high inventory turnover is indicative of good inventory management. A low inventory turnover implies excessive inventory levels than warranted by production and sales activities, or a slow moving or obsolete inventory. A high level of sluggish inventory amounts to unnecessary tie-up of funds, reduced profits and increased costs. A high turnover ratio is to be carefully analysed. A high inventory turnover may be result of a very low level of inventory which results in frequent stock-outs; the firm may be living from hand to mouth BHEL 2004-05 COGS Avg inv Inv Turnover Inventory days
2005-06
L&T 2006-07
2004-05
2005-06
2006-07
8681.63
11195.08
14046.92
11239.16
12452.88.
14336.45
226.34
295.87
316.07
237.34
221.33
218.68
38.36
37.84
44.44
47.35
56.26
65.56
9.39
9.51
8.10
7.60
6.40
5.49
Babasabpatilfreepptmba.com
73
“E-I-C
Analysis
of
Capital
Goods
Sector”
Inventory days
10
5
0
2004-05
2005-06
2006-07
BHEL
9.39
9.51
8.1
L&T
7.6
6.4
5.49
Interpretation: In terms of efficiency, L&T outlasts BHEL. But very high ratio of L&T may become a problem for it. The turnover ratio tells how many times the inventory of finished goods is converted to sales in a year. The ratios of both the companies reveal a good turnover of sales and reduced inventory holding period. Since these companies have huge orders in hand, we can expect the companies to perform better.
DEBTORS TURNOVER A ratio used to work out how many days on average it takes a company to get paid for what it sells. It is calculated by dividing the figure for trade debtors shown in its accounts by its sales, and then multiplying by 360. Debtor days = (debtors ÷ Sales) ×360 This indicates whether debtors are being allowed excessive credit. A high figure (more than the industry average) may suggest general problems with debt collection or the financial position of major customers. Babasabpatilfreepptmba.com
74
â&#x20AC;&#x153;E-I-C
Analysis
2004-05 Sales Debtors Drs Turnover Debtors days
of
BHEL 2005-06
Capital
2006-07
Goods
2004-05
Sectorâ&#x20AC;?
L&T 2005-06
2006-07
10336.40
14525.49
18738.95
13254.56
14883.68
17900.59
6726.71
7168.07
9695.82
6726.71
4814.16
5504.64
1.54
2.03
1.93
1.97
3.09
3.25
234.28
177.65
186.27
182.70
116.44
110.70
Debtors tunover ratio
300 200 100 0
2004-05
2005-06
2006-07
BHEL
234.28
177.65
186.27
182.7
116.44
110.7
L&T
Interpretation: Collection of debtors is more efficient in case of L&T. In case of L&T, there has been a decrease in the in debtors days. In case of BHEL, Debtors in absolute terms increased by
Babasabpatilfreepptmba.com
75
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
Rs. 2527.75 crore mainly due to increase in turnover. In terms of days of turnover it increased from 177 days in 2006-07 to 187 days in 2006-07. The price of capital goods in high and the payments are usually made in parts hence the collection period is more as compared to the inventory turnover.
C. SOLVENCY RATIOS: TOTAL DEBT RATIO: This ratio depicts the proportion of the interest bearing debt in the capital structure. This ratio is given by; Total debt ratio = Total Debt/Total Debt+Networth Total debt will include short and long term borrowings from financial institutions, debentues, deferred payment arrangements for buying capital equipments and bank borrowings, public deposit and any other interest bearing loan.
BHEL 2004-05 TD TD+NW Total debt ratio
2005-06
L&T 2006-07
2004-05
2005-06
2006-07
536.98
558.24
89.33
1859.06
1453.57
2077.75
6563.88
7859.62
8877.59
5228.19
6093.74
7846.18
0.08
0.07
0.01
0.36
0.24
0.26
Babasabpatilfreepptmba.com
76
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
Total debt ratio 0.4 0.2 0
2004-05
2005-06
2006-07
BHEL
0.08
0.07
0.01
L&T
0.36
0.24
0.26
Interpretation : The debt component in BHEL is very low, almost nil that is because the Secured loan of Rs. 500 crore towards bonds were redeemed during the year and repaid on its maturity. Unsecured Loan represents assets taken on lease. The company being a PSU is funded mostly by equity. The debt ratio of L&T is more when compared to BHEL this component is used to finance the growth plans.
DEBT EQUITY RATIO: It is a measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets. DER = long-term debt / Shareholder's Equity
Babasabpatilfreepptmba.com
77
“E-I-C
Analysis
of
Capital
Goods
Sector”
A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing. The debt/equity ratio also depends on the industry in which the company operates.
Debt-Equity Ratio 0.2 0.1
0
2004-05
2005-06
2006-07
BHEL
0.08
0.07
0.01
L&T
0.13
0.1
0.19
Interpretation: There is just a nominal component of debt in BHEL. The sharp decrease in the ratio during the FY07 is due to redemption of bonds worth Rs.500crs. the company further plans to increase its authorized capital to Rs.2000crs from the present level of Rs.325crs On the other hand, decrease in debt due to conversion of FCCB’s.. The ratio is again more in the FY07. The increase was due to sharp increase in unsecured loans, both short-
Babasabpatilfreepptmba.com
78
“E-I-C
Analysis
of
Capital
Goods
Sector”
term and long term to finance its present activities and also to supplement the growth plans. INTEREST COVERAGE RATIO: The interest coverage ratio is a measurement of the number of times a company could make its interest payments with its earnings before interest and taxes. The interest coverage ratio shows the number of times the interest charges are covered by funds that are ordinarily available for their payment. The lower the ratio, the higher the company’s debt burden and embarrassment to the firm regarding its payment of the interest charges ICR = EBDIT / Total Interest Expense
BHEL
EBDIT Interest expenses Interest coverage ratio
L&T
2004-
2005-
2006-
2004-
2005-
05
06
07
05
06
2006-07
1663.03
2623.10
3779.40
1340.13
1388.72
2038.82
81.41
58.75
43.33
53.99
75.07
33.93
20.43
44.65
87.22
24.82
18.50
60.09
Babasabpatilfreepptmba.com
79
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
Interest Coverage Ratio 100
50
0
2004-05
2005-06
2006-07
BHEL
20.43
44.65
87.22
L&T
24.82
18.5
60.09
Interpretation: The coverage reveals the margin with which the firm can meet its financial obligations. The coverage ratios of BHEL have been increasing due to the reduced debt component in their capital structure. Whereas the ratio of L&T reveals that coverage is low due to the increased interest and brokerage payments in the year 2006. The ratio of BHEL are high as compared to L&T due to less obligations
D. PROFITABILITY RATIOS The profit margin ratios state how much profit the company makes for every dollar of sales. The net profit margin ratio is the most commonly used profit margin ratio. A low profit margin ratio indicates that low amount of earnings, required to pay fixed costs and profits, is generated from revenues. A low profit margin ratio indicates that the business is unable to control its production costs. The profit margin ratio provides clues to the company's pricing, cost structure and production efficiency. The profit margin ratio is a good ratio to benchmark against competitors. Babasabpatilfreepptmba.com
80
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
GROSS PROFIT MARGIN: The gross profit margin reflects the efficiency with which management produces each unit of product. This ratio indicates the average speed between the COGS and the sales revenue. When we subtract the GPM from 100%, we obtain the ratio of COGS to sales. Both these ratios show profits relative to sales after the deduction of production cost and indicate the relation between production cost and selling price. =Gross Profit/net sales A high GPM implies that the firm is able to produce at relatively lower costs.
BHEL 2004-05
L&T
2005-06
2006-07
2004-05
2005-06
2006-07
Gross Profit (EBIT) 1663.03
2623.10
3779.40
1340.13
1388.72
2038.82
9527.14
13374.03
17237.53
13049.79
14734.80
17578.84
0.17
0.20
0.22
0.10
0.09
0.12
Net sales GPM
Gross Profit Margin 0.3 0.2 0.1 0
2005
2006
2007
BHEL
0.17
0.2
0.22
L&T
0.1
0.09
0.12
Babasabpatilfreepptmba.com
81
“E-I-C
Analysis
of
Capital
Goods
Sector”
Interpretation The Gross Profit Margin for both the companies is in increasing trend. This is a positive sign.BHEL has better Gross Profit Margin as compared to L & T. The COGS has been decreased to the extent of 2% and 3% for BHEL and L & T respectively. Though there was an increase in operating expenses, this was set-off by more sales. This reason holds good to both the companies.
NET PROFIT MARGIN: Net Profit Margin Ratio establishes a relationship between net profit and sales and indicates management’s efficiency in manufacturing, administering and selling the products. This ratio is the overall measure of firm’s ability to turn each rupee sales into net profit. This ratio is more important to shareholders. A high net profit margin is advantageous. It is taken as a percentage.
BHEL 2004-05 Net Profit (PAT) Net sales
2005-06
L&T 2006-07
2004-05
2005-06
2006-07
953.41
1679.16
2414.70
983.85
942.39
1403.02
9527.14
13374.03
17237.53
13049.79
14734.80
17578.84
0.10
0.13
0.14
0.08
0.06
0.08
GPM
Babasabpatilfreepptmba.com
82
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
0.25
0.12
0.2
0.1
Sectorâ&#x20AC;?
0.08
0.15
0.06
0.1
0.04 0.05 0
0.02 2005
2006
2007
GPM
0.17
0.2
0.22
NPM
0.1
0.13
0.14
0
2005
2006
2007
GPM
0.1
0.09
0.12
NPM
0.08
0.06
0.08
BHEL
L&T
Interpretation: The interpretation has more meaning when the ratios are analysed jointly. In case of both the companies, the GPM has been increasing and so is the NPM. This shows that the companies are performing efficiently and are using the resources in an optimum way
OPERATING EXPENSE RATIO: It is calculated by taking the ratio of operating expenses to sales for a period. The percentage that remains after deducting the operating expense ratio, is the percentage of revenue that is available to cover interest, taxes, earnings to owner
Babasabpatilfreepptmba.com
83
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
BHEL 2004-05
2005-06
Sectorâ&#x20AC;?
L&T 2006-07
2004-05
2005-06
2006-07
Operating exp Net sales
8681.63 11477.83 14218.78 12376.68 13697.31
15835.60
9527.14 13374.03 17237.53 13049.79 14734.80
17578.84
Op exp ratio 0.91
0.86
0.82
0.95
0.93
0.90
Operating expense ratio 1 0.9 0.8 0.7
2005
2006
2007
BHEL
0.91
0.86
0.82
L&T
0.95
0.93
0.9
Interpretation: The operating expense ratio is decreasing for both the companies. This implies that the company is left with more income to cover its obligations and also give good returns to its stakeholders. BHEL expense ratio is impressive as it is left with 18% of its sales to meet its expenses of interest, taxes and earnings.
Babasabpatilfreepptmba.com
84
“E-I-C
Analysis
of
Capital
Goods
Sector”
RETURN ON EQUITY RONW essentially checks the return on investment (ROI) of the owners’ fund also known as the Net Worth or NW. RONW assess the Profit Distributing Ability(PDA) of the company, i.e. how much profit will the owners/shareholders get for every unit of investment they have made. Return on Net worth =
PAT/ Net worth
BHEL 2004-05 PAT Net Worth
2005-06
L&T 2006-07
2004-05
2005-06
2006-07
953.41
1679.16
2414.70
983.85
942.39
1403.02
6026.89
7301.38
8788.26
3369.13
4640.17
5768.43
0.16
0.23
0.27
0.29
0.20
0.24
ROE
Return on equity 0.4 0.2 0
2005
2006
2007
BHEL
0.16
0.23
0.27
L&T
0.29
0.2
0.24
Interpretation: The Return on Equity is showing favourable trend. In case of L&T, the ROE has reduced in the FY06 but that was due to increased borrowings to finance the growth of the company. in the FY07 , the returns are again increased.
Babasabpatilfreepptmba.com
85
“E-I-C
Analysis
of
Capital
Goods
Sector”
RETURN ON CAPITAL EMPLOYED (ROCE) RATIO ROCE explains the overall utilization of funds by a business enterprise. It says how much profits we earn from the amount invested by the Shareholders. Capital Employed means the long-term funds employed in the business and includes the shareholder s fund, debentures and long-term loans. Profit before Interest and Tax is considered for computation of this ratio to make numerator and denominator consistent. It is calculated as – ROCE=Profit before Interest and Tax (PBIT) / Capital Employed x 100 %
BHEL 2004-05 PBIT Capital employed
2005-06
L&T 2006-07
2004-05
2005-06
2006-07
1663.04
2623.10
3779.40
1340.13
1388.72
2038.82
6563.88
7859.62
8877.59
5228.19
6093.74
7846.18
0.25
0.33
0.43
0.26
0.23
0.26
ROCE
Interpretation: Here the returns are studied in comparison with capital employed i.e. Debt plus Net worth. The sharp increase in the ratio of BHEL in FY07 was due to substantial increase in PBIT(44%) which is not met by proportional increase in Capital employed(12%). Whereas L&T saw an increase of 46% in PBIT which was partially set off by increase in capital employed (30%). RETURN ON TOTAL ASSETS: ROTA tells us how well management is performing on all the firm's resources. However, it does not tell how well they are performing for the stockholders. The ROTA of a company determines its ability to utilize the Assets employed in the company efficiently
Babasabpatilfreepptmba.com
86
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
and effectively to earn a good return. The ratio measures the percentage of profits earned per Rupee of Asset and thus is a measure of efficiency of the company in generating profits on its Assets. It is calculated as -
ROTA=Profit before Interest after Tax (PBIT) / Total Assets x 100 %
BHEL 2004-05 PBIT Total assets ROTA
2005-06
L&T 2006-07
2004-05
2005-06
2006-07
1663.03
2623.10
3779.40
1340.13
1388.72
2038.82
14387.22
17313.00
22051.71
9855.35
11113.11
14028.70
0.12
0.15
0.17
0.14
0.12
0.15
Interpretation: The sales generated for every rupee invested in fixed assets is more or less same for both the companies. BHEL gives 12%, 15% and 17% returns on total assets for FY05,FY06 and FY07 resp. and L&T has given returns of 14%, 12% and 15% resp. BHEL has been able to generate 2% more returns than L&T in FY07.
Babasabpatilfreepptmba.com
87
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
Return on Total Assets 0.2 0.1 0
2005
2006
2007
BHEL
0.12
0.15
0.17
L&T
0.14
0.12
0.15
EARNINGS PER SHARE The portion of a company's profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company's profitability. Companies often use a weighted average of shares outstanding over the reporting term. EPS can be calculated for the previous year ("trailing EPS"), for the current year ("current EPS"), or for the coming year ("forward EPS"). Note that last year's EPS would be actual, while current year and forward year EPS would be estimates. The EPS is of two types, one Basic and the other Diluted(which considers the potential shareholders on account of convertible bonds). It is calculated as EPS = PAT/ Number of shares outstanding. Where, EPS= earnings per share PAT= Profit after tax
Babasabpatilfreepptmba.com
88
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
Earnings per share 100 50 0
2005
2006
2007
BHEL
38.95
68.6
98.66
L&T
70.85
67.53
48.36
Interpretation: BHEL: Since the number of shares has remained constant, the rise can be fully attributed to the increased earnings over the years. The earnings has increased by 153% over the period of three years L&T: The EPS is in downward trend. This is due to the change in the number of shares outstanding as a result of convertibles. The basic EPS is always more than diluted it considers only the existing outstanding shares and not the convertibles, potential stock option etc.
DIVIDEND PER SHARE: A performance metric used to gauge the quality of a company's earnings per share (EPS) if all convertible securities were exercised. Convertible securities refer to all outstanding convertible preferred shares, convertible debentures, stock options (primarily employee based) and warrants. Unless the company has no additional potential shares outstanding (a relatively rare circumstance) the diluted EPS will always be lower than the simple EPS.
Babasabpatilfreepptmba.com
89
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
DPS = Total Earnings/ (No of Shares outstanding + No of possible convertible shares) This is a conservative metric because it indicates somewhat of a worst-case scenario. On one hand, everyone holding options, warrants, convertible preferred shares, etc. is unlikely convert their shares all at once. At the same time, if things go well, there is a good chance that all options and convertibles will be converted into common stock. BHEL 2004-05 Dividends Shares outstanding
2005-06
L&T 2006-07
2004-05
2005-06
2006-07
195.81
354.90
599.66
357.21
302.25
368.25
24.48
24.48
24.48
12.67
13.30
27.94
8.00
14.50
24.50
28.19
22.73
13.18
DPS
Dividend per share 30 20 10 0 BHEL L&T
2005
2006
2007
8
14.5
24.5
28.19
22.73
13.18
Interpretation: BHEL: The dividend per share has increased from Rs.8 in the FY05 to Rs.24.5 in FY07 i.e. 206% growth. This phenomenal growth is due to the increased earnings and constant
Babasabpatilfreepptmba.com
90
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
equity share capital. The Board of Directors in January, 2007 recommended the issue of Bonus Shares in the ratio of 1:1 to the Shareholders of the company. L&T: The dividend paid is more than BHEL. In FY07, the number of outstanding shares was increased to 27.94 as compared to FY06, 13.03. DIVIDEND PAYOUT RATIO: It is also known as payout ratio. It measures relationship between the earnings belonging to the ordinary shareholders and the dividend paid to them. In otherwords, D/P ratio shows what percentage share of PAT or preference dividend is paid to the owners by the total profits/earnings available to them. D/P ratio =Dividend per share/EPS*100 If the D/P ratio is subtracted from 100, retention ratio is obtained. This ratio shows what percentage of the net profits are retained in the business Retention ratio = 100 - D/P ratio
BHEL
L&T
2004-05
2005-06
2006-07
2004-05
2005-06
2006-07
DPS
8.00
14.50
24.50
28.19
22.73
13.18
EPS
38.95
68.60
98.66
70.85
67.53
48.36
Pay-out ratio
0.21
0.21
0.25
0.40
0.34
0.27
Retention ratio
0.79
0.79
0.75
0.60
0.66
0.73
Babasabpatilfreepptmba.com
91
“E-I-C
Analysis
of
Capital
Goods
Sector”
Dividend Pay-out ratio 0.4 0.2 0
2005
2006
2007
BHEL
0.21
0.21
0.25
L&T
0.4
0.34
0.27
Interpretation: Both the company’s payout ratios met the industry standard which was 20% for FY07. Thus, the companies are good in paying dividends. .
MARKET BASED RETURNS: These are several common stock ratios that convert key bits of information about the company; to a per share basis. They are used to assess the performance of the company for stock valuation purposes and helps investors take investment decisions. PRICE EARNING RATIO:
P/E ratio = Market Value per Share / Earnings per Share
Babasabpatilfreepptmba.com
92
“E-I-C
Analysis
of
Capital
Goods
Sector”
P/E is a valuation ratio of a company's current share price compared to its per-share earnings. A high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E.
The market price per share may be the price prevailing on a certain day or the average price over a period of time. The EPS is simply the PAT less preference dividend divided by number of shares outstanding.
BHEL 2004-05 MPS EPS
2005-06
L&T 2006-07
2004-05
2005-06
2006-07
383.70
1123.48
1130.38
497.58
1216.30
1619.15
38.95
68.60
98.66
70.85
67.53
48.36
9.85
16.38
11.46
7.02
18.01
33.48
P/E ratio
The P/E ratio is used to value the firm’s performance as expected by investors. P/E ratio reflects investor’s expectations about the growth of the firm’s earnings. Industries differ in growth prospects; accordingly, the P/E ratios for industries vary widely.
Interpretation: The ratio is higher incase of L&T. This means that investors are expecting a lot from L&T when compared to BHEL. Though BHEL is equally good the investors are expecting more from L&T and this has lead to decrease of P/E ratio.
Babasabpatilfreepptmba.com
93
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
The P/E ratio reflects the growth prospects, risk characteristics, shareholder orientation, corporate image, and degree of liquidity.
PRICE TO BOOK VALUE
Price to book Ratio =Market price per share /book value per share Where, Book value = Share capital + Reserves &surplus/ No.of shares Price to Book Ratio is used to compare a stock's market value to its book value. A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company.
In a way this ratio reflects the contribution of a firm to the wealth of society when this ratio exceeds 1, it means that the firm has contributed to the creation of wealth in the society. BHEL 2004-05 MPS BV
2005-06
L&T 2006-07
2004-05
2005-06
2006-07
383.70
1123.48
1130.38
497.58
1216.30
1619.15
246.24
298.31
359.06
256.94
335.61
202.65
1.56
3.77
3.15
1.94
3.62
7.99
PBR The ratio of both the companies is showing a positive trend i.e. the ratio is more than 1 which is favorable and which means the company has contributed significantly to the creation of wealth of society.
Babasabpatilfreepptmba.com
94
“E-I-C
Analysis
of
Capital
Goods
Sector”
COMPOUNDED ANNUAL GROWTH RATE: To measure the historical growth, the compounded annual growth rate (CAGR) is calculated.
• SALES
CAGR= [Sales for 2007/Sales for 2005] 1/2 - 1
L&T
BHEL = [17237.53 / 9527.14] ½ -1
= [17578.84/ 13049.79] ½ -1
=1.345 – 1
=1.16 – 1
= 0.345 or 34.5%
= 0.16 or 16%
Thus the historical growth of BHEL is more than that of L&T. the reason for huge growth is the result of growing infrastructure facilities and the orders in hand.
• EARNINGS PER SHARE
CAGR (EPS) = [EPS for 2007/EPS for 2005] 1/2 – 1
BHEL
L&T
Babasabpatilfreepptmba.com
95
“E-I-C
Analysis
of
Capital
Goods
= [98.66/ 38.95] ½ -1
= [48.36/70.85] ½ -1
=1.591 – 1
= 0.83 – 1
= 0.591 or 59.10%
= (0.17)or 17%(decrease)
Sector”
There has been consistent growth in the EPS of BHEL due to the increased earnings and constant number of shares. The EPS of L&T has decreased over a period of three years as a result of increased number of shares due to conversion (diluted EPS).
• DIVIDEND PER SHARE
CAGR (DPS) = [DPS for 2007/DPS for 2005] 1/2 - 1
BHEL
L&T
= [24.50/ 8.00] ½ -1
= [13.18/28.19] ½ -1
=1.75 – 1
= 0.68– 1
= 0.75 or 75%
= (0.32)or 32%(decrease)
There has been consistent growth in the DPS of BHEL due to the increased earnings and constant number of shares. The DPS of L&T has decreased over a period of three years as a result of increased number of shares due to conversion in FY06 and FY07 (diluted EPS).
VOLATILITY OF ROE:
Babasabpatilfreepptmba.com
96
“E-I-C
Analysis
of
Capital
Goods
Sector”
It is calculated with the help of the following =Range of ROE over the period of 2005-07/ Average ROE BHEL
L&T
= (0.27-0.16)/0.22
= (0.29-0.20)/0.25
= 0.5
= 0.36
The volatility in returns of L&T is low when compared to that of BHEL.
Babasabpatilfreepptmba.com
97
“E-I-C
Analysis
of
Capital
Goods
Sector”
SUSTAINABLE GROWTH RATE (EXPECTED GROWTH RATE):
The get a handle over the kind of growth that can be maintained, sustainable growth rate is calculated. It is the maximum rate at which the firm can grow by using internal sources (retained earning) and additional external debt without increasing its Debt-equity ratio.
= Average Retention ratio * Average ROE
L&T
BHEL = 77.67 * 0.22
= 66.33 * 0.25
= 0.1708 or 17.1%
= 0.1658 or 16.58%
Babasabpatilfreepptmba.com
98
“E-I-C
Analysis
of
Capital
Goods
Sector”
CALCULATION OF EXPECTED SHARE PRICE (VALUE ANCHOR):
The valuation is inherently an uncertain and imprecise exercise. It would be naïve to put great faith in a single point intrinsic value estimate. Hence it would be wise to define an intrinsic Value range ex: Rs.30 to 38. Given this value range , the decision rule may be as follows; The expected share price is calculated by Intrinsic value = P/E Ratio * Expected EPS Where, Projected EPS = Current EPS + g (20.25 %)
Market price
Decision
Less than Value range
Buy
Between value range
Hold
More than Value range
Sell
Babasabpatilfreepptmba.com
99
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
Ex: The projected EPS is Rs.5 and the appropriate PE multiple is 6.87. The value anchor is Rs.34.35. Now take a value range, assume Rs30 to Rs38. Given this range, the decision rule may be as follows; Market price
Decision
Less than Rs.30
Buy
Between Rs.30 to Rs.38 Hold More than Rs.38
Sell
Babasabpatilfreepptmba.com
100
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
BHEL
BHEL Weighted average price - FY08 (annexure)
2,111.83
Current share price (as on 25.4.2008)
1,870.00
P/E ratio (as on 25.4.2008) Present EPS # (post bonus, FY08 provisional)
37.91 58*
Expected growth
20.25
Projected EPS {EPS+(EPS*g)}
69.75
EXPECTED SHARE PRICE (Projected EPS*P/E ratio) *Taken from company performance highlights
2644
Interpretation :
Value anchor (intrinsic value) = Rs. 2644 Value range= Rs.2600 to Rs.2700 Current market price (25-4-08) = Rs 1870 Since market price is less than intrinsic value, the stock is worth buying The expected share price for BHEL is Rs.2644. Based on the fundamentals, the EPS is calculated and growth of 20.25% is added for the subsequent FY09. Babasabpatilfreepptmba.com
101
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
102
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
L&T:
L&T
Weighted average price - FY08 (annexure)
3,002.59
Current share price (as on 25.4.2008)
2,981.85
P/E ratio (as on 25.4.2008)
62.13
Present EPS # (post bonus, FY08 provisional)
53.6
Expected growth
20%
Projected EPS {EPS+(EPS*g)}
64.32
EXPECTED SHARE PRICE
3,996.2
Interpretation: Value anchor (intrinsic value) = Rs. 3996.2 Value range = Rs.3900 to Rs.4050 Current market price (25-4-08) = Rs 2981.25 Since market price is less than intrinsic value, the stock is worth buying. Once the market price exceeds intrinsic value, it is to be sold Thus the expected share price of L&T is more than that of BHEL. This is due to the high P/E ratio.
Babasabpatilfreepptmba.com
103
“E-I-C
Analysis
of
Capital
Goods
Sector”
FINDINGS:
ECONOMY: •
When come to the economic factors the global economies are getting interrelated, the Indian market will no longer be limited to domestic economic situation. Especially the US market has a strong bearing on Indian stock market.
•
The important factors that have bearing on stock market are FII inflows, exchange rates. The most important being the GDP, infrastructure facilities, IIP, etc which have a direct bearing on price of the stock.
INDUSTRY – ( Engineering – Heavy ) :
•
The demand driver for this sector is the Order book.
•
Most of these companies have an order book to sales ratio in the range of 2.5-4 times FY07 revenue. This implies that for the next two-to-three years, even if the companies do not get fresh orders, they can still maintain revenue growth of 3040 per cent..
•
The IIP growth during April - January 2007-08 has declined to 8.7% when compared to 11.2% IIP growth during 2006-7. Tight monetary policy has resulted in high interest rates which have been the major factor contributing to the decline in IIP growth.
Babasabpatilfreepptmba.com
104
“E-I-C
Analysis
of
Capital
Goods
Sector”
COMPANY: •
When Liquidity ratios are concerned, BHEL has an upper hand over L&T. The Current ratio, quick ratio and cash ratios of BHEL are better than L&T.
•
But Efficiency ratios show the other picture. Total assets turnover, fixed assets turnover ratio, inventory days and debtor’s turnover of L&T are better than BHEL. L&T is able to utillise its assets more efficiently.
•
When Solvency ratios are studied, we see that the debt component in BHEL has been reduced to 0.1(FY07) from 0.8 (FY05). The debt of BHEL has substantially reduced in FY07 to 0.1as a result of redemption of 8.85% Non-convertible, secured, Redeemable Taxable Bonds worth Rs.500 crores. Incase of L&T, also the debt has decreased. The bonds have been redeemed in FY06 but simultaneously Zero coupon bonds were issued. This decrease has lead to increased interest coverage ratio.
•
Profitability ratios: The GPM has been increasing and so is the NPM. This shows that the companies are performing efficiently and are using the resources in an optimum way. The returns on equity and capital employed have been rising due to increased earnings.
•
The EPS and DPS have consistently increased in BHEL because of increased earnings and constant number of shares. Whereas in case of L&T, the EPS has reduced in FY07 to Rs.48 due to increased number of shares arising from issue of bonus.
•
Market based returns: the P/E ratio which shows investors expectations have increased for both the companies. L&T has higher P/E ratio of 33.48 as compared to 11.48 of BHEL.
•
Fundamentals of those companies are quite strong. None of the fundamental signals for disinvestments for moving out of computer and software industry.
• CAGR SALES
34.5
16%
CAGR EPS
% 59.1
-17%
% Babasabpatilfreepptmba.com
105
“E-I-C
Analysis
of
CAGR DPS SUSTAINABLE GROWTH RATE VOLATILITY •
Capital
Goods
75% 17%
32% 16.58
0.5
% 0.36
Sector”
When compare to the specific indicators like sales growth, the BHEL will be in the first place then followed by L&T
•
The CAGR EPS for L&T has come negative due to reduced EPS on account of bonus issue.
•
The Volatility of returns is high in BHEL as compared to L&T. Hence L&T is better because it is more consistent.
•
The value anchor for BHEL is Rs.2644 and for L&T is Rs.3996.2
RECOMMENDATIONS
1. The valuation is inherently an uncertain and imprecise exercise. It would be naïve to put great faith in a single point intrinsic value estimate. Hence it would be wise to define an intrinsic Value range. Ex: 2600-2700.
2. Intrinsic value of BHEL is Rs.2644 and the present market price is Rs.1870. Hence it is recommended to buy BHEL stock as its current market price is lower than its fair value range. Market price < Value range BHEL Rs.1870
< Rs.2600 to Rs.2700
BUY
3. Intrinsic value of L&T is Rs.3, 996.2 and the present market price is Rs.2981.85. Hence it is recommended to buy L&T stock as its current market price is lower than its fair value range.
Babasabpatilfreepptmba.com
106
“E-I-C
Analysis
of
Capital
Goods
Sector”
Market price < Value range L & T
Rs.2981.85 < Rs.3950 to Rs.4050 BUY
4. After a close scrutiny of economy industries and companies in considering the risk, it may be recommended that international economy might affects the firms export prospects, the price competition it faces from competitors, or the profit it makes from abroad. Investor should properly analyze both globally and domestically before taking investment decision. 5. The investor also should consider the budget decision and present years forecast of different sectors 6. However, there are such things as a final answer to security values, a dozens experts arrive at twelve different conclusions. Market values are fixed only in part by balance sheet and income statement; much more by hopes and fears of humanity; by greed, by act of god, where the investor should carefully consider the emotional factors influence the market. 7. Of all the systems, the researcher is of the view that fundamental analysis even today holds good. It demands, may insist on information about the company. It requires subjecting a company’s performance and its financial statements to in-depth scrutiny. It also calls for the company and industry in which the company operates 8. Fundamental analysis is the effective tool to differentiate penny stocks from fundamentally good company with good growth prospects. 9. It is to be kept in mind that to gain maximum returns, fundamental analysis is to be studied in combination with technical analysis
Babasabpatilfreepptmba.com
107
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
108
“E-I-C
Analysis
of
Capital
Goods
Sector”
CONCLUSION In current market scenario all stocks have been valued at discounted price and hence the current market price is very low for most of the stocks. They really fluctuate badly without any scientific reasons and the reasons given in the news are just market perception, which has no base. Indian stock market is not matured and hence the fluctuation in the share prices is tremendous. When the example of L&T and BHEL who are really performing well up to the expectations is considered,. L&T's 52 weeks high and low prices are - Rs 4,690 and Rs 1,539 at NSE.& BHEL's 52 weeks high and low prices are - Rs 2,930 and Rs 1,178 at NSE In Indian share market, the share price movement does not show the performance of the Company. In case of L&T and BHEL, under fundamentals, the share price data primarily fluctuate due to •
Present performance,
•
Guidance of future performance given by the company (In case of L&T the same is not available),
•
Present order book,
•
Contracts won by these Companies. When they win any big ticket contracts the share prices generally goes up.
•
New contracts expected to win (under negotiation)
These are the basic fundamental reasons for share price movement apart from various economic factors like demand-supply of securities, market liquidity, FII inflows, etc. these economic factors also have the bearing on the stock market. Indian market is a Semi-strong market and other economic factors have a bearing on it. Investment in securities is more fruitful when it is done for a long period. While investing in any of the securities one should look into fundamentals of the company but should not ignore technical analysis completely. Investment in stocks is serious business. Hence all the homework is to be done before plunging onto anything.
Babasabpatilfreepptmba.com
109
â&#x20AC;&#x153;E-I-C
Analysis
of
Capital
Goods
Sectorâ&#x20AC;?
Bibliography Websites :www.equitymasters.com www.indiaearnings.com www.bseindia.com www.nseindia.com www.finance.yahoo.com www.myiris.com
Magazines and Newspapers:Money Today Indian survey for 2008 Business world Business Line Business Standard
Books:Essentials of Financial Management-I M Pandey Financial Management 4th Edition-Khan & Jain Investment Analysis & Portfolio Management-Prassana Chandra
Babasabpatilfreepptmba.com
110
“E-I-C
Analysis
of
Capital
Goods
Sector”
ANNEXURES BHEL:
Babasabpatilfreepptmba.com
111
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
112
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
113
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
114
“E-I-C
Analysis
of
Capital
Goods
Sector”
For 2005 & 2006
For 2006 & 2007:
Post bonus EPS = Rs. 98.66*1/2 = Rs. 49.33
Babasabpatilfreepptmba.com
115
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
116
“E-I-C
Analysis
of
Capital
Goods
Sector”
LARSEN AND TOUBRO:
Babasabpatilfreepptmba.com
117
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
118
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
119
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
120
“E-I-C
Analysis
of
Capital
Babasabpatilfreepptmba.com
Goods
Sector”
121
“E-I-C
Analysis
of
Capital
Goods
Sector”
For 2005 & 2006
For 2006 & 2007
Babasabpatilfreepptmba.com
122