15 L Investments in These Cos would’ve Earned 45 L in 5 Yrs

Dr Reddy’s, Cairn among 15 that have improved return on capital employed

Drug maker Dr Reddy’s Labs, truck-financing company, Sriram Transport Finance, oil exploration firm Cairn India and Mcleod Russel feature in a list of 15 companies which have steadily improved their return on capital employed, or RoCE, between FY08 and FY12. RoCE is a measure of how gainfully a company is able to deploy or use its capital. A company which can generate higher profits from a lower capital base will always be better off compared to firm which needs higher capital to generate the same level of profit. In other words, a company with higher RoCE will be preferred over a company with a lower RoCE. This is reflected in the fact that companies with high RoCEs like most leading FMCG companies command premium valuations.
An analysis by the ET Intelligence Group of BSE 500 companies shows that between FY08 and FY12 there were 15 companies which improved their RoCEs, out of which 12 — Bata India, Supreme Industries, Dr Reddy's Labs, Kajaria Ceramics, Shriram Transport Finance, Lupin, Bajaj Finance, Page Industries, M & M Financial, Mcleod Russel, Solar Inds and Cairn India — have emerged as multi-baggers.
Even at the peak of market valuations at the end of 2007, if an investor had bought into each of these stocks by putting in . 100,000, the total investment of . 15 lakh would be worth . 45 lakh today despite the BSE Sensex trading at over 10% below its peak.
It is but natural that leading investment managers often rely on this ratio when taking their investment decisions.
Says Sunil Jain, head of equity research (Retail) at Nirmal Bang Securities, “RoCE is also used for comparing within the peer group while selecting a company for investment. We have seen that the expansion of RoCE generally leads to the expansion of price-to-earnings ratio (P/E). Thus, an investor benefits on two counts. One is through increase in earnings and second is by expansion of P/E. Generally, we avoid recommending stocks with a declining RoCE.”
Says G Chokkalingam, executive director and chief investment manager, Centrum Wealth, “RoCE is a great tool when looking for a defensive investment strategy. “Higher or rising RoCE over the years indicates consistency in growth of both business and profits.”
Although an important tool, RoCE may not always be a pointer to future winners. “This tool has certain limitations – it doesn’t capture possible opportunities arising from turnaround cases, acquisitions or from thematic plays which emerge once in a while in the equity markets,” he said.
Similarly, the market returns of a company also hinge on other variables such as valuation, market sentiment, balance- sheet structure and most importantly future outlook. A rising RoCE indicates robustness of the business – it indicates either rising profitability or a reduction in capital employed. The capital employed can be cut either by reducing the working capital or by paying out excess cashthrough higher dividends.
“Rising RoCE gives glimpse of the performance like growth, management qualities, management’s vision, perception, etc in industry and returns for shareholders in terms of good dividend payouts, safe investment ideas,” says Nilesh Karani, head of research at Magnum Stock Broking.

PETRO REFINING: Falling Margins Dim Growth Prospects

Although crude oil prices soared over 25% in the threemonth period July-September 2012, petroleum refiners have not been impacted adversely. In fact, tight supply of products helped refinery margins to stay high, boosting the valuations of Indian standalone refiners. But a prolonged weakness in refining margins could prove to be a drag on their valuations. A recent report on the industry by financial services firm IDBI Capital says that the Singapore complex gross refining margins, or GRMs, rose 22% month-onmonth in August 2012 to $9.9 per barrel, led by a rise in gasoline, gasoil and Jet-Kero crack spread driven by shutdowns of few key refineries. The strong margins were driven by refinery shutdowns in the US and Venezuela, the report said.
There were production shutdowns in the US Gulf of Mexico in the wake of hurricane Isaac, which took nearly 1 million barrels per day refining capacity off stream. Venezuela’s largest refinery, which suffered a blast and the fire killed nearly 40 people in August, had to be shut down. These incidents pushed the prices of refined products higher benefiting refiners globally.
There are already concerns that the boost to refinery margins would be shortlived. According to a JP Morgan report, refinery margins have demonstrated extraordinary strength recently, underpinned by the combined resilience of gasoline and middle distillate cracks. This appears at odds with the tepid oil demand growth and the precarious state of the global economy, raising the question as to whether the strength is sustainable, the report says.
A prolonged weakness is likely as new refineries get added over the next few years, while those expected to undergo a permanent closure resume operations after ownership changes.
An industry update put out by SBI Caps says that its analysis of major refinery projects expected to come onstream shows that after delays of several years, the majority of large projects are on track to be commissioned in the next two to three years. During 2011, around 1.4-mbpd refining capacity was added, taking the total refining capacity to near 93 mbpd compared to an incremental demand of 0.8 mbpd. In 2012, around 1.6 mbpd refining capacity is likely to come on-stream, compared to the expected demand growth of 0.8 mbpd, according to the report.
Shares of Indian standalone refiners — RIL, MRPL and Chennai Petro — gained around 6-16% during July-August, but analysts are not very positive on their outlook. For instance, a recent report by Kotak Securities said that it expected refining margins to soften further once several Asian refineries restart operations These companies may once again underperform the markets if refining margins continue to weaken further.

CRUDE OIL PRICES: Sentiment, not Biz Factors, to Fuel Prices

The global crude oil industry is now witnessing the emergence of two paradoxical trends. At a time when the global demand outlook for 2012 and 2013 is being revised downwards month after month, oil prices are on a boil. Surely, factors other than demand-supply dynamics are having a major influence on oil prices.
The benchmark Brent crude prices rose over 29% since end-June 2012 to $116 in the first week of September. However, the International Energy Agency (IEA), which represents the OECD nations, or mainly petroleum consumers, has revised downward its total demand forecast for 2012 and 2013.
In its latest monthly report IEA noted that global oil demand would average 89.6 million barrels per day (mbpd) in 2012, which is down from 89.9 mbpd estimated in June and 90 mbpd estimated at the start of the year. Sluggish global economic growth is the main reason for this, with persistently high prices taking its toll as well.
GDP growth estimates for the world’s biggest economies are being revised downward. According to the IEA report, “China endures the majority of the reduction”, with its GDP growth for 2012 pegged at 8% (8.2% earlier) and for 2013 at 8.1% (8.5%). The economic outlook for the US in 2013 has been lowered to 2% now from 2.3% last month.
The reasons behind the spurt in oil prices were mainly non-economic. The re-emergence of geopolitical tensions, production problems in the North Sea and hopes that the world’s major economies would act to ease monetary policy were among the main reasons for the overall increase in global crude oil prices, the Organisation of Petroleum Exporting Countries said in August.
Owing to US and EU sanctions, crude oil exports from Iran have fallen nearly 20% since the beginning of the year to 2.9 mbpd now. Oil prices were also boosted by Fed chairman Ben Bernanke’s hint at a third round of liquidity infusion and Hurricane Isaac, which hit the US coast last week.
However, for crude, the demand growth outlook for 2013 is not bullish. IEA expects oil consumption to grow 0.9 mbpd in 2012 and 0.8 mbpd in 2013.
However, at the same time production growth is expected to be healthy. IEA estimates OPEC’s production at 31.4 mbpd for July 2012, while the ‘call on OPEC’ – the volume OPEC needs to produce to balance the global demand and supply – “will recede to 30.4 mbpd for Q4, 12 and to 30.1 mbpd in 2013”.
However, oil prices are expected to be driven by sentiment and liquidity for a while before economic factors prevail.