wealth creation study 2008-2013

Uncommon Profits

By Raamdeo Agrawal

13 December 2013

18th Annual Wealth Creation Study2008-2013

www.motilaloswal.com18th Annual Wealth Creation Study

1

Discussion Points

18th Wealth Creation Study Findings

Theme: Uncommon ProfitsEmergence & Endurance

Market Outlook

Conclusions

2

Wealth Creation 2008-13Study Findings

3

Concept of Wealth CreationThe process by which a company enhances market value of the capital entrusted to it by its shareholders

Net Wealth CreatedChange in Market Cap over the study period (2008-13),adjusted for corporate actions like dilutions

Study Methodology

4

Biggest Wealth CreatorsTop 100 Wealth Creators subject to the condition that stock performance beats the benchmark (Sensex)

Fastest Wealth CreatorsThe top 100 wealth creators are sorted by fastest rise in their adjusted stock price

Most Consistent Wealth CreatorsBased on no. of times a company appeared in the last 10 studies

Study Methodology (contd)

5

Rank,Company

NWC (Rs cr)

Price CAGR

1. TCS 228,376 31

2. ITC 163,506 25

3. HDFC Bank 87,218 19

4. Infosys 83,930 15

5. Sun Pharma 59,244 27

Rank,Company

NWC (Rs cr)

Price CAGR

6. ONGC 56,665 5

7. HDFC 55,875 12

8. Tata Motors 51,827 17

9. Hind Unilever 51,552 15

10. Wipro 46,865 11

Top 10 Biggest Wealth Creators

TCS has swapped places with ITC which was No.1 last year

Total wealth created during 2008-13: Rs18+ lakh crores

IT, Financials, Consumer dominate top 10 BiggestWealth Creators

6

Rank,Company

Mult.(x)

Price CAGR

1. TTK Prestige 28 95

2. Eicher Motors 10 59

3. Page Industries 8 51

4. Wockhardt 8 50

5. Grasim Inds 8 50

Rank,Company

Mult.(x)

Price CAGR

6. GRUH Finance 7 47

7. GSK Consumer 7 47

8. Supreme Inds 6 45

9. Lupin 6 45

10. Godrej Cons. 6 44

Top 10 Fastest Wealth Creators

TTK Prestige is the fastest Wealth Creator again.

If only these 10 stocks were held as a portfolio in 2008, average price CAGR for the next 5 years would have been 53% (8x) compared to 4% CAGR of Sensex.

7

Rank,Company

WCS (x)

04-13CAGR

1. Asian Paints 10 36

2. Kotak Mahindra 10 36

3. Sun Pharma 10 33

4. Hindustan Zinc 10 32

5. ITC 10 27

Rank,Company

WCS (x)

04-13CAGR

6. Axis Bank 10 27

7. HDFC Bank 10 26

8. M & M 10 25

9. Bosch 10 23

10. H D F C 10 22

Most Consistent Wealth Creators

Asian Paints is Most Consistent Wealth Creator

Consistent Wealth Creators are invariably consistentValue Creators i.e. RoE above CoE threshold of 15%

8

Wealth Creators v/s Sensex

Wealth Creators defy the commonly heard maxim in equity markets - "High return, high risk".

In 2008, Wealth Creators' P/E is lower than benchmark (i.e. lower risk), and yet 2008-13 returns are higher.

Mar-08 Mar-13 5-yr CAGR

BSE Sensex 15,644 18,836 4

Wealthex – re-based 15,644 34,891 17

Sensex EPS (Rs) 833 1,190 7

Wealthex EPS (Rs) 1,099 2,313 16

Sensex PE (x) 19 16

Wealthex PE (x) 14 15

9

Wealth Creation by Industry

Consumer and Technology have beaten the erstwhile two-time leader Financials in Wealth Creation.

Technology sector is poised to emerge as India's largest Wealth Creating sector in the near future. Unlike Consumer sector, Tech valuations are reasonable relative to earnings growth and RoE

Industry(No of cos.)

WC(Rs cr)

2013 (%)

2008 (%)

Cons & Retail (24) 445,578 24 5Technology (7) 419,709 23 5Financials (23) 360,480 20 13Healthcare (14) 193,461 11 3Auto (11) 167,856 9 3Oil & Gas (5) 108,042 6 23

Industry(No of cos.)

WC(Rs cr)

2013 (%)

2008 (%)

Cement (5) 69,149 4 2Metals (2) 33,469 2 17Media (3) 15,608 1 1

Cap Goods(2) 12,954 1 10Others (4) 14,989 1 18Total 1,841,294 100 100

10

Wealth Creation by PSUs hit the floor

Over the years, value has migrated from PSUs to private companies across sectors - Banking, Telecom, Oil & Gas, Metals & Mining, Utilities, Capital Goods etc.

28 30 26 18 25 16 22 24 20 11

49 51

36

25

35

2730

2720

9

1999-2004

2000-2005

2001-2006

2002-2007

2003-2008

2004-2009

2005-2010

2006-2011

2007-2012

2008-2013

No of PSUs % Wealth Created

11

Wealth Creation by base RoE

2008-13 saw near perfect correlation between RoEand Price CAGR.

Sustained Value Creation (i.e. RoE > Cost of Equity) is the basis of sustained wealth creation.

36

1115

1215 14

1712

18 1521

24

<15 15-20 20-25 25-30 30-35 >35

PAT CAGR (%) Price CAGR (%)

2008 RoE Range

2008-13 Average PAT CAGR: 16%

2008-13 Average Price CAGR: 17%

12

Wealth Creation & Valuation Metrics

In 2008-13, highest P/E stocks have delivered highest returns.

During tough times, enduring quality stocks get expensive and yet deliver superior returns.

P/E in2008

No. of Cos.

% Wealth Created

Price CAGR %

PAT CAGR %

<10 22 14 16 1410-15 21 15 11 1115-20 23 32 22 1920-25 15 17 23 2025-30 11 18 16 25>30 8 5 24 26

Total 100 100 17 16

13

Wealth Creation & Valuation Metrics (contd)

As with P/E, highest P/B band delivered highest return and also accounted for highest share of Wealth Created

P/B (x) No. of Cos.

% Wealth Created

Price CAGR %

PAT CAGR %

<1 3 1 22 301-2 18 11 10 162-3 20 16 13 113-4 19 10 21 204-5 8 11 23 255-6 8 15 16 16>6 24 37 25 19

Total 100 100 17 16

14

Payback ratio (Mkt Cap / 5-years forward PAT) of less than 1x in 2008 did ensure superior wealth creation.

This ratio remains the most reliable indicator of superior Wealth Creation across market cycles.

Payback Ratio (x)

No. ofCos.

% Wealth Created

Price CAGR %

PAT CAGR %

<1 24 12 24 221-2 39 41 16 142-3 25 36 18 17>3 12 11 16 15

Total 100 100 17 16

Wealth Creation & Valuation Metrics (contd)

15

Wealth Destruction

Wealth Destroyed was almost equal to Wealth Created.

Reliance factions, PSUs accounted for 1/3rd of Wealth Destroyed.

Company Wealth Destroyed PriceRs crores % Share CAGR (%)

Reliance Industries 112,788 7 -7Reliance Communication 92,070 5 -36MMTC 89,143 5 -29NMDC 82,209 5 -17DLF 70,292 4 -18Reliance Power 61,923 4 -21B H E L 57,362 3 -16S A I L 50,556 3 -20Bharti Airtel 46,025 3 -7NTPC 45,350 3 -6Total of Above 70,720 41Total Wealth Destroyed 1,714,037 100

16

Rs crores

Theme Study

Uncommon Profits


18

Theme Discussion Points

Uncommon Profits: What & why

Emergence & Endurance: What & why

Framework to identify Emerging Value Creators

Methodology to shortlist Emerging Value Creators

Why Enduring Value Creators?

Methodology to shortlist Enduring Value Creators


Uncommon Profits in companies

=

Uncommon Wealth Creation in markets

A simple mantra for Wealth Creation …


Uncommon Wealth Creation #1

0

50

100

150

200

25019

8819

8919

9019

9119

9219

9319

9419

9519

9619

9719

9819

9920

0020

0120

0220

0320

0420

0520

0620

0720

0820

0920

1020

1120

1220

13

Ambuja Cement Sensex - Rebased

Ambuja up 420x in 25 years; 27% CAGR

Sensex up 45x; 16% CAGR


Uncommon Wealth Creation #2

0

150

300

450

600

75019

98

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

HDFC Bank Sensex - Re-based

HDFC Bank up 64x in 15 years; 32% CAGR

Sensex up 7x; 14% CAGR


“Over the long term, it’s hard for a stock to earn a

much better return than the business which

underlies it earns. If the business earns 6% on

capital over forty years and you hold it for that forty

years, you’re not going to make much different than

6% return – even if you originally buy it at a huge

discount. Conversely, if a business earns 18% on

capital over 20 or 30 years, even if you pay an

expensive looking price, you’ll end up with one hell

of a result.”

– Charlie Munger, VC, Berkshire Hathaway

What leads to Uncommon Wealth Creation?


Uncommon Profits in companies

=

Uncommon Wealth Creation in markets

In simple words …

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• Uncommon Profitability (%) = RoE > Cost of Equity

• Uncommon Profit (abs) = (RoE – CoE) x Equity employedwhere RoE = Return on Equity

Cost of equity = Opportunity cost of equity or Risk free rate + Equity risk premium

• In Indian context, Cost of Equity = 15%

• Consistent Uncommon Profit earning companies

are Value Creators

What is Uncommon Profit?

25

What is Emergence & Endurance?

• Emergence is first entry of a company into the Uncommon Profit zone i.e. RoE > 15%

• The next challenge is Endurance i.e.sustaining RoE > 15% for several years ahead

26

Uncommon Profit & Company Lifecycle

Pre-Emergencestruggle for survival

Time

PAT

POINT OF EMERGENCE

Post-Emergence strugglefor Endurance

Introduction Growth Maturity

(b) Decline

(a) Renewal

27

Uncommon Profit Case Study #1

Titan Industries (YoE: 2003)

… Uncommon Wealth Creation

26x in 5 years (85% CAGR),

130x in 10 years (59% CAGR)

Uncommon Profit generation …

28


Gruh Finance (YoE: 2003)


10x in 5 years (60% CAGR),



29


Bharti Airtel (YoE: 2005)




30

Framework to identify Value Creators

Contribution of various factors to abnormal profitsContributing factor High Performers Low Performers

Emergence Sustainability Emergence Sustainability

Year 2% 3% -7% -5%Industry 37% 44% 12% 13%Corporate-parent 18% 19% -4% 2%Segment-specific 43% 34% 99% 90%Source: Paper by Anita McGahan & Michael Porter

Year – Economic cycleIndustry – Industry-level factors like size of profit pool,

competition, stability, strategic opportunity, etcCorporate Parent – Promoter or majority ownerSegment-specific – Company-specific factors like quality of

management, strategy/unique value proposition, etc

31

Value Creators: Industry-level factors

#1 Size of profit pool10 highest PAT sectors (2013)Sector Rs crores % shareFinancials - Banks 84,154 21Energy - Oil & Natural Gas 39,963 10Technology - Software 34,702 9Financials - NBFCs 32,376 8Mining & Minerals 27,261 7Energy - Refineries 22,774 6Utilities 22,349 6Automobiles 21,931 6Healthcare 16,518 4Metals - Non-Ferrous 10,520 3Total of above 312,547 79Grand Total 394,786 100

32


#1 Size of profit pool (contd)

10 lowest PAT sectors (2013)Sector Rs croresAviation -5,695Telecom - Service & Eqpmt -3,972Shipbuilding -410Sugar -212Shipping -203Glass & Glass Products -166Ceramic Products -163Paper -18Printing & Stationery -10Electronics 1Total of above -10,846Total Profit Pool 394,786

33



Highest PAT CAGR (03-13) with minimum PAT of Rs 2,000 crores in 2013

Sector 03-13 PAT PAT Sector 03-13 PAT PAT

CAGR (%) Delta CAGR (%) Delta

Textiles L to P 5,653 Infra Developers 28 6,233

Realty L to P 3,799 Metals - Steel 28 3,006

Fertilizers L to P 2,821 Metals - Non-ferrous 27 9,556

Cement 57 7,825 Healthcare 20 13,843

Tech - Software 54 34,239 Capital Goods 19 5,413

Gems & Jewelry 46 3,176 Tobacco Products 18 6,275

Financials - NBFC 46 31,647 Banks 18 67,998

Mining & Minerals 46 26,627 Auto Ancillaries 17 2,917

Automobiles 39 21,101

Chemicals 29 3,115 TOTAL CORP. SECTOR 20 331,719

34



35



36

#2 Competitive landscape & bargaining power


Porter’s 5 forces framework to assess competition & bargaining power

37

#3 Value Migration


38

#4 Stability of industry


5551

1804

11440

715

4078

2337

0

2000

4000

6000

8000

10000

12000

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Baltic Freight IndexCyclicality makes industries risky

39

#5 Emergence of new industry /strategic opportunity


0

300

600

900

1,200

1,500

Feb-

10

May

-10

Aug

-10

Nov

-10

Feb-

11

May

-11

Aug

-11

Nov

-11

Feb-

12

May

-12

Aug

-12

Nov

-12

Feb-

13

May

-13

Aug

-13

Nov

-13

Jubilant Foodworks Sensex - Rebased

Jubilant up 6x in under 4 years;CAGR of 65% v/s 7% for Sensex

Uncommon Wealth Creation

40

Value Creators: Corporate-parent factors

3Is – Integrity + Intelligence + Initiative

#1 Value system

#2 Processes

#3 Capital allocation

#4 Management skill v/s Luck

41

Value Creators: Company-specific factors

#1 Unique value proposition / Strategy

#2 Nature of business:Consumer Adv v/s Production Adv

#3 Market leadership or pioneering

42

Pitfalls to avoid in Emergence

#1 Pre-empting emergence

#2 Emergence during peak of good times

“…the risk of paying too high a price for good-quality

stocks – while a real one – is not the chief hazard

confronting the average buyer of securities.

Observation over many years has taught us that the

chief losses to investors come from the purchase of

low-quality securities at times of favorable business conditions.”

– Benjamin Graham in his book The Intelligent Investor

43

Methodology for Emerging Value Creators

#1 Age criterionSelect listed companies below 25 years of age

#2 Meaningful Emergence15% RoE for first time with minimum PAT size, say, Rs 10 crores

#3 View on corporate-parent/managementbased on group performance, Annual Reports, payout policy, etc

#4 Avoid cyclicalsIncorporating stability of industry

#5 Valuation check considering risk of non-EnduranceP/E typically not exceeding 20x

44

Backtesting during 2001 to 2008Emerging Value Creators’ financial & stock market performanceCompany Year of P/E (x) 5-year post emergence (%)

Emerg. in YoE PAT CAGR Price CAGR Rel Perf.Shriram Transport 2001 1 56 85 60Accelya Kale 2008 3 36 60 56Shriram City Union 2004 3 45 70 58GRUH Finance 2003 4 33 60 22Plastiblends (I) 2004 4 1 4 -8Manappuram Finance 2007 4 123 70 64Havells India 2004 7 P to L 39 27Cera Sanitaryware 2008 7 36 29 17KPIT Tech 2004 8 36 4 -7Blue Dart Express 2001 9 22 45 20Titan Industries 2003 12 53 85 46Hitachi Home 2006 12 14 22 11Tata Elxsi 2001 16 20 23 -3Emami 2007 18 31 33 27Suprajit Engg. 2006 18 21 0 -12IL&FS Invt Managers 2007 18 32 9 3Asahi India Glass 2002 19 25 51 21AVERAGE 10 24 41 24

45

Backtesting during 2001 to 2008

Applying Value Creator checklist items (“amplifiers”) Industry Profit pool size Nature of business Leadership

Amplifier No. of cos.

5 years post-emergence (%)PAT CAGR Avg RoE Price CAGR Rel. Perf.

Industry Profit PoolHigh 10 26 29 55 37Low 7 21 37 20 4

Nature of business advantageConsumer 9 21 34 46 31Production 8 27 30 34 16

Leadership i.e. among top 3 playersYes 10 19 32 45 28No 7 31 32 34 18

Portfolio avg 17 24 32 41 24

46

Backtesting during 2001 to 2008

Optimized portfolio with Amplifiers

Company P/E (x) 5-year post emergence (%)

in YoE PAT CAGR Price CAGR Rel. Perf.

Manappuram Finance 4 123 70 64

Shriram Transport 1 56 85 60

Titan Industries 12 53 85 46

Havells India 7 P to L 39 27

Blue Dart Express 9 22 45 20

AVERAGE 7 – 65 43

47

Emerging Value Creators to bet on now

Potential Value Creators by applying methodology for years 2009-13

(Rs crores) FY13 1HFY14 Nov-13

PAT PAT Gr. % RoE % PAT Gr. % Price Mkt Cap P/E (x)

With amplifiers

Bajaj Finserv 1,574 18 24 36 739 11,760 7

Bajaj Corp 161 38 35 15 231 3,410 19

Zydus Wellness 97 43 44 29 544 2,127 20

Symphony 59 11 29 27 408 1,427 23

Others

Cairn India 11,882 49 25 6 324 61,868 5

48

Why Enduring Value Creators

Emerging Value Creators are rare(we could get only 17 in 8 years 2001-08)

Enduring Value Creators too outperform despite being fully discovered and fairly discounted

A suitable methodology may helpto shortlist Enduring Value Creators

49

Methodology for Enduring Value Creators

#1 Quality & Longevity criteriaRoE >= 15% for each of the last 10 consecutive years

#2 View on corporate-parent/managementbased on group performance, Annual Reports, payout policy, etc

#3 GrowthLast 3-year CAGR of at least 15%

#4 Value-enhancing growthPostive delta RoE over the last 5 years

#5 Reasonable valuationNot more than 50% premium to market i.e. P/E typically not exceeding 30x

50

Backtesting during 1999 to 20082008 Enduring Value Creators’ financial & stock market performance

Company 2008-13 P/E

PAT CAGR

Price CAGR

Rel. Perf.

2008 2013

Berger Paints 19 40 36 12 31

Torrent Pharma 28 38 34 9 13

Asian Paints 22 33 29 28 43

Castrol India 15 27 23 20 33

Colgate-Palmolive 16 27 23 22 34

Marico 18 26 22 26 37

City Union Bank 26 25 21 7 8

H D F C 20 12 8 25 19

Wipro 13 11 7 19 18

Glenmark Pharma -1 -1 -5 19 20

AVERAGE 16 24 20 21 20

51

Enduring Value Creators to bet on now

Applying methodology for years 2004 to 2013; preferred bets highlighted

Company 2010-13 2003-13 P/E Price Return CAGR

PAT CAGR % Avg RoE % (x) (INR) 08-13 (%)

City Union Bank 28 23 7 49 25

Axis Bank 28 20 10 1,155 11

Suprajit Engg 24 31 11 39 34

Torrent Pharma 27 26 15 462 38

HCL Technologies 47 26 16 1,087 25

M & M Financial 36 22 17 296 28

Zydus Wellness 28 37 20 544 38

VST Industries 25 31 20 1,664 37

HDFC Bank 32 18 23 661 19

Astral Poly Technik 29 30 24 250 35

GRUH Finance 28 27 26 233 47

ITC 21 29 34 320 25

Hindustan Unilever 16 77 40 594 17

Page Industries 42 62 44 5,265 51

52

Market OutlookRisk-Reward favorable

53

Corporate Profit to GDP down to 10-year low levels

Market Outlook

54

Market Cap to GDP reasonable at 61%

Market Outlook

55

Interest rates at recent high levels; could correct sharply

Market Outlook

56

Earnings Yield to Bond Yield at 0.8x below LPA

Market Outlook

57

Sensex EPS is expected to grow 15% in FY15

Market Outlook

58

Sensex forward P/E at 16x is almost at 10-year average

Market Outlook

59

Uncommon Profits in companies = Uncommon Wealth Creation in stock markets.

Successful Emergence of Value Creators is very rare; a strong corporate-parent in a non-cyclical business significantly increases the probability.

Endurance of Value Creators is mainly threatened by disruptive innovation/competition, major regulatory changes, and capital misallocation.

State-owned companies have become marginalized in Wealth Creation with their share collapsing from 51% in 2005 to 9% in 2013.

The worst is over for Indian equities; the risk-reward equation is favorable for long-term investing.

In Conclusion

Thank You !&

Happy Investing For

Uncommon Profits

wealth creation study 2008-2013

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