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Transcript of Mind of an Analyst
Manish Chokhani September 2004 1
The Mind of a Business Analyst
Applied Lessons for Investment Bankers and Research Analysts
ENAM Securities 2August 2004
AgendaComponents of an average recommendation
What requires to be validated
First Principles of Financial Analysis
Valuation Principles
Valuation Shortcuts and Market Cycles
Business Analysis – Circle of Competence Approach
Macro Economic, Political and Social Factors
Buyer Characteristics and Compulsions
Slotting the Recommendation
Recap the Valuation
ENAM Securities 3August 2004
An Average Recommendation Here are the financials
Past two years, next two yearsCurrent business trajectory is goodThis is the P/E , this is the EPS or something similarly cheap sounding
Here are some comparable valuations Local, regional, global
Occasionally:Chance to buy a good business…Unique Promoter …Great Shareholders/ Funds/Pvt Equity… Backing it
So Buy It
ENAM Securities 4August 2004
What Needs to be Validated?Validity of business financials
Forecast ValidityKey Business DriversAny hidden liabilities/ subsidiaries / etcBusiness CompetitivenessMacro factors at playAppropriate Valuation Tool
Relative validityWhat else is attractiveDecompose by Country / Sector / Mktcap / Promoter
What is driving the deal?Why the deal?Why Now?Who is the intermediary?Whats in it for me?
ENAM Securities 5August 2004
Understand the Business DriversVOLUME
Most loved Consumer focussed UVG stories: eg CellPhones, Retail, Hosing Loans, Media or large addressable markets globally like ITand pharma (buzz on BPO, Textiles…)
PRICEMost loved Pricing Power stories: Brands, OligopoliesExcitable Commodity swings: Cement, Metals…
EFFICIENCYIMPROVING ASSET UTILISATION
Usually Cyclicals – Autos, Engineering due to operating leverage
IMPROVING COST STRUCTURE/ ECONOMIES OF TECHNOLOGYUsually Engineering, PSUs, Conglomerates…
RESTRUCTURINGCatalysts such as Privatisation, M&A, Divestitures, Buybacks…
ENAM Securities 6August 2004
Case Studies
Lets Examine Sustainable Valuations forCement
Autos
IT
Pharma
FMCG
Use 5 key measures that define peak valuations…Sales / G Block
W Cap / Sales
Sustainable or desirable OPM%
Capex requirements
Volume Growth Assumptions
Help us to decide what we lay out and what we get back…
ENAM Securities 7August 2004
Now Lets Attempt a DCF
ENAM Securities 8August 2004
Markets continuously discount all of the above…
Value multiple- Predictable- Sustainable- Scaleable
Use Bond YieldReciprocal (100/8)=12.5xas benchmark
Val
ue
Time
ROE : 25%
ROE : 15%
8% Bonds
Cash
P/E=20x
P/E=12x
P/E=12x
ENAM Securities 9August 2004
“Virility” Symbols (Towers, diversification/ M&A)Bad qlty of IPOsCapex > near-future reqmentsInterest rates spike. Huge Credit expansionRetail euphoriaShock/ Leaders in trouble
Understand Market Cycles – I
Ignored, stagnant Cheap valuationsNegative press
Severe Undervaluation
Important commodities take off (Steel, Gold, etc.)Catalyst/ Regulatory (eg Privatisation, LT Cap gains exemption)Easy Liquidity
Undervaluation
Capex/ IPO/ Credit cycle revivesAsset & Cost inflationTourism/ Media attention“Themes” emerge, New Valuation “Paradigms”
Fair to Over valuation
Bubble
Sharp fall followed by pull back
“Left outers” jump in
Leadership narrows
Correction
Bear Phase
Bust
Symptoms of each hump deceptively similar -- It is the QUALITY which differs:
Eg high quality IPOs & Capex at “Reasonable”Valuation stage vs flood of bad IPOs & far-out-Capexat Bubble stage
ENAM Securities 10August 2004
Resulting in a Swing in Valuation Approaches
• Payback• EV/EBIDTA• P/E• DCF
• Technical Charts• Reflexivity• PE/G• Option Value
MomentumGARPValue
• Dividend Yield• Price/BV• Replacement Cost
BEAR MARKET BULL MARKET BUBBLE MARKET
ENAM Securities 11August 2004
Valuation Measures – CASH FLOW IS THE ONLY REALITY
DCF helps to make assumptions explicit;gives a good RANGEUse probability – don’t fudge the discount rate!Factor in uncertainties and risksTerminal Value is the key – Is all the value residing there?Wider the Optimistic-Pessimistic range – lower the valuation!
P/e = d/e / (k-g)P =d/(k-g)
d = dividend per sharek = shareholder return expectationk = i + r + rp (inflation+real int+risk premium)g = growth in dividend per share
Hence Importance of payouts and cash flows for better valuation
Close approximation of P/E to ROE
Other Methods are all variants for validationEVA – Economic Value Added - Excess return over WACC quantified EVA = ROIC – (IC x WACC) CFROI – Another smart way to do a DCF
ENAM Securities 12August 2004
MARGIN OF SAFETY
Cash flow v/s Bond Valuations
Growth prospects
Gap between Perception and Reality
Knowledge v/s Popularity
Limited downside/ lots of upside
Manish Chokhani September 2004 13
UNDERSTAND “GOOD BUSINESSES”
THE CIRCLE OF COMPETENCE APPROACH
ENAM Securities 14August 2004
BUSINESSES APPRAISALThink long and hard about cycles
Life cycles
Business cycles
Think about sustainability and sources of advantage
Think about external pressures on profitability
Where does this business fit on a profitability distribution?
The financial litmus tests
Think about management and the majority partner
ENAM Securities 15August 2004
Think of Cycles!Nature is cyclical, not linear!
Life Cycles
Business Cycles / Boom-Bust
Seasonality
Innovation / Schumpeter
Market Cycles
ENAM Securities 16August 2004
LIFE CYCLE ANALYSIS
TIMETIME
SALE
SSA
LES
SOFTWARESOFTWARE
JUTEJUTE
ENAM Securities 17August 2004
BUSINESS CYCLES
INTERMEDIATESINTERMEDIATES
FMCG, SERVICESFMCG, SERVICES
CAPITAL GOODSCAPITAL GOODS
CONSUMER DURABLESCONSUMER DURABLES
ENAM Securities 18August 2004
COMMODITYCOMMODITY
EMERGING/EMERGING/SMALL SCALESMALL SCALE
SPECIALISED/SPECIALISED/OLIGOPOLIESOLIGOPOLIES
MONOPOLY/MONOPOLY/CONSUMER FRANCHISECONSUMER FRANCHISE
SUSTABILITY OF ADVANTAGESUSTABILITY OF ADVANTAGE
MANYMANY
HIGHHIGHLOWLOWFEWFEW
SOU
RC
ES O
F A
DVA
NTA
GE
SOU
RC
ES O
F A
DVA
NTA
GE
BOSTON CONSULTING GROUP MATRIX
ENAM Securities 19August 2004
PORTER’S 5 FORCE ANALYSIS
SUBSTITUTE PRODUCTSSUBSTITUTE PRODUCTS
NEW ENTRANTS/ IMPORTSNEW ENTRANTS/ IMPORTS
SUPPLIERSSUPPLIERS BUYERSBUYERSINTRA INDUSTRYINTRA INDUSTRYRIVALRYRIVALRY
ENAM Securities 20August 2004
PROFITABILITY DISTRIBUTION
ROIROI
BANKBANK
RATERATE
ENAM Securities 21August 2004
THE FINANCIAL LITMUSSuperior BUSINESSES
Low asset requirementsLow credit / inventoryMany clients/ economic goodwillDefensible marginsPricing power ( inflation + )Sustainable growthFree cash flows
Most other businessesCapital intensiveWorking capital intensiveWant premium valuation, do not deserve itLikely to be cyclical valuations and themes
ENAM Securities 22August 2004
Now lets talk Micro Focus
Costs
Capital Efficiency
People Issues
“Slack”
ENAM Securities 23August 2004
Costs
Are you aware of implications of:
Inappropriate Amortisation
R&D
Technology
Marketing Requirements
Training ; Leadership!
UNIT COSTS/ measures
ENAM Securities 24August 2004
0
25
50
75
100
Cost of ProducingCement
EnergyConsumption
(Units/ton)
CoalConsumption
(kg/ton)
1998 2003
(%)
050
100150200250
RMC (tons per tonof Steel)
EnergyConsumption(GCAL/TCS)
LabourProductivity
(tons/Man years)
1997 2003
(%)
Corporates have re-engineered costs
1998 2004
Cost of Producing Cement (Rs/tonne) 1,200 900
Energy Consumption (Units/tonne) 110 90
Coal Consumption (kg/tonne) 200 130
Source: ENAM Research
1997 2004
RMC (tons per ton of Steel produced) 4.3 3.1
Energy Consumption (GCAL/TCS) 8.7 7.2
Labour Productivity (tons/Man years) 119 264
Source: ENAM Research
Cost cutting in Cement Industry
Cost cutting by TISCO2004
2004
ENAM Securities 25August 2004
0
100
200
300
400
1995 20030
3
6
9
12
Revenue (LHS) Labour Force (LHS)Revenue/Person (RHS)
(%) (Rs.m)
Corporates have right-sized
Company Staff shed Period (Yrs) % of Labour Force
BHEL 20,000 7 30Tata Motors 10,000 5 29Mahindra & Mahindra 6,500 5 34Bajaj Auto 7,800 6 37Tisco 30,000 8 40ACC 6,000 8 38
Right-sizing across sectors
Source: ENAM Research
Restructuring by Top 10 Corporates
1995 2003
Revenue (Rs bn) 900 2,750
Labour Force (nos) 420,000 335,000
Revenue/Person (Rs m) 2.1 8.2
ENAM Securities 26August 2004
Capital Efficiency
Are you well focussed on:
Asset Turns: Gross Block, Working Capital?
Lean Assets: Owned v/s Rented
Flexible Structures: Outsourcing
Impact of M&A, Restructuring?
People…
ENAM Securities 27August 2004
Efficiency Saved India Inc.
Peak Rate of Custom Duty (%)
0
40
80
120
160
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Working Capital / Sales (%)
4
6
8
10
12
1996 1997 1998 1999 2000 2001 2002 2003
-5
0
5
10
15
20
25
1996 1997 1998 1999 2000 2001 2002 2003
Gro
wth
(%)
Cap Emp Borrowing GFA
-40
-20
0
20
40
60
80
1996 1997 1998 1999 2000 2001 2002 2003
Gro
wth
(%)
Sales PBIT PBT
Source: CMIE
ENAM Securities 28August 2004
Industry consolidation helped profitability
Market share (%)
Sector 1997 2004
Aluminium Top 3 players 77 100
Tyre Top 5 players 72 85
Cement Top 5 groups 32 61
Paper Top 5 players 32 38
Petrochemicals Top player 45 70
Media No. of players Multiple 3 large
Telecom No. of players Multiple 4 large
Source: ENAM Research
ENAM Securities 29August 2004
People Issues
How is the company managed?
Lifetime Employment?
How does it Hire? Train? Retain? Fire?
How does it build skills? LEADERS?
Are they Commandos? Soldiers? Mercenaries?
Succession Plans?
Empowerment?
ENAM Securities 30August 2004
Focus on Micro, Company specific factors
How is Product or Service Quality?Germany/Japan/China v/s India, v/s competition
How is Cost & Capital Efficiency?Frugality as a mindset v/s “professionally managed”
What are their Value Systems?Sugar in the milk
How is their Service to the Customer?The “goodwill” earned
ENAM Securities 31August 2004
Watch Out for Hidden BombsConflict of Interest Structures
Pvt Businesses
Inter Party relationships
Split Ownerships
Loans & Advances
Off balance Sheet Libailities
Unfunded Pensions
Litigations
Family Settlements
… and many more creative reasons why CAVEAT EMPTOR
ENAM Securities 32August 2004
CHOOSING “BUSINESS PARTNERS”Integrity / track record
Ability (not just lucky)
Understanding of key issues
Ambition tempered by reality
Commonality of objectives
Orientation towards minority
Manish Chokhani September 2004 33
MACRO FACTORS TO BEAR IN MIND
ENAM Securities 34August 2004
Do you have Macro Pointers in Mind?
Do you have a point of view about:
Politics as it affects the business
Economics as it affects the business
Demographic Trends
What are Capital Markets Signalling?
Each powerful trend can have disruptive or tidal wave effects on any business
ENAM Securities 35August 2004
Politics
Geo Politics affects addressable markets, terms of trade, cost of doing business…
Effect of SAFTA, ASEAN, WTO/GATT
Risk Premium/Opportunity of Pakistan
Emerging US-India axis ; NAM, ML
Opportunities in “emerging” economies
Outcry against/trends favouring outsourcing
ENAM Securities 36August 2004
Outsourcing to India : Brewing Trouble
Company Outsourcing for
IT ServicesInfosys Goldman Sachs, Aetna, Northwestern Mutual, Am Ex, DHL, VerizonTata Consultancy GE, Honda, UBS, HSBCWipro Transco, HP- Compacq, Nortel, General Motors, Cisco, Sony
ITESMphasis BFL Citi Group, Acenture, Auto Zone, Capital OneSpectramind Dell, American Express, Capital One
PharmaceuticalsCipla Ivax, Watson Pharma, Eon LabsShashun Chemicals Eli Lily, GSK PharmaLupin Laboratories Apotex, APP, Watson Pharma
EngineeringBharat Forge Meritor, Caterpillar, Toyota, Ford, FAW (China)Tata Motors RoverMoser Baer Imation, BASFEssel Propack P&G, Unilever, Colgate
ENAM Securities 37August 2004
Increasing FDI reflects “openness”
Early entrants
Cost Savings(Production Hubs)
GE, Citi IT, State Farm Amex, Bank AmIBM, HP
Research Services Texas Instruments, GE
Recent entrants
JP Morgan, HSBC, PrudentialAccenture, CGE&YDelphiTeva
Microsoft, Sun, IntelGSK, Pfizer, Eli LilyCOVANCE
Likely entrants
BPOs in throngsDeloitte Consulting
Generic Pharma Cos
A number of CROs
Domestic Market Opportunity
Coke, PepsiFord, HyundaiLG, SamsungLafargePort of Singapore, P&OMorgan Stanley, Templeton
McDonalds, Pizza HutHonda, ToyotaNokiaMichelinDubai Port, MaerskHSBC MF, Duestche MF Fidelity MF, ABN MF
Source: ENAM Research
ENAM Securities 38August 2004
Confident Indians going globalLarge Groups
Tata -Tetley, Daewoo , Rover tie-upRIL - FLAG undersea cable,Trevira (Polyester firm in Germany)Birlas - AV Cell (Canada), Copper mines (Aus), Carbon Black (China) etcSterlite - Copper Mines in Australia, Listing on LSEONGC - Stake in: Sakhalin oil fields (Russia), GNOOC oil fields (Sudan)
Auto PartsSundaram Fasteners - Gear casting business of Dana Spicer (UK), Plant in ChinaBharat Forge – Dana Corp Forging business (UK), Forging business of CDP (Germany)
PharmaWochardt-Esparma (Germany)Ranbaxy- RPG Aventis (France)Dr. Reddy’s - Meridian Healthcare (UK),Trigenesis Therapeutics (USA)Cadila – French operations of Alpharma (USA)
IT Wipro - Nervewire, Utilities consulting division of AMS (USA)HCL Tech - BT’s call centre (Ireland)
OthersAsian Paints - Berger International (Singapore)Essel Propack - Propack Holdings (Switzerland),Arista Tubes (UK)Moser Baer - Mmore International (Holland)Atlas Cycle, Ajanta Clocks - Plants in China
ENAM Securities 39August 2004
Macro Economic Indicators
Global and local economic cycles
Capital costs
Interest rates, Currency rates, Inflation
Cost pressures: RMC, Tarriffs, etc
Social Costs / development
Competition is a given
ENAM Securities 40August 2004
Eg: Complete Reversal in IndiaForex reserves
Re. depreciation
Interest rates
External debt
External debt
Forex reserves
Source: RBI, CMIE
Interest rates & Re. depreciation
-6-30369
1215
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Jul
-04
1011121314151617
Rupee/ US$ (LHS) Prime Lending Rate (RHS)
(%) (%)
0
20
40
60
80
100
96-97 97-98 98-99 99-00 00-01 2-Jan 3-Feb 0̀3-04Foreign Exchange Reserves as % of external debtExternal Debt (% of GDP)
(%)
-40
-20
0
20
40
60
94-9
5
95-9
6
96-9
7
97-9
8
98-9
9
99-0
0
00-0
1
01-
02
02-
03
03-
04
0
20
40
60
80
100
120
Trade Balance (LHS) Invisibles (LHS)Capital Receipts (LHS) Total Reserve (RHS)
(US$ bn) (US$ bn)
ENAM Securities 41August 2004
Soft interest rate bias nearing an end..
Forex reserves at a peak
Source: Blloomberg, RBI, CMIE
Inflation making a comeback?Room to grow advances vs investments
Investment Deposit Ratio
35
40
45
50
Jan-
99
Jul-9
9
Jan-
00
Jul-0
0
Jan-
01
Jul-0
1
Jan-
02
Jul-0
2
Jan-
03
Jul-0
3
Jan-
04
Jul-0
4
Rupee volatility on the cards
-6-303
69
1215
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Jul
-04
10111213
14151617
Rupee/ US$ (LHS) Prime Lending Rate (RHS)
(%) (%)
0
3
6
9
12
15
Jan-
95Ju
l-95
Jan-
96Ju
l-96
Jan-
97Ju
l-97
Jan-
98Ju
l-98
Jan-
99Ju
l-99
Jan-
00Ju
l-00
Jan-
01Ju
l-01
Jan-
02Ju
l-02
Jan-
03Ju
l-03
Jan-
04Ju
l-04
(%)
0
20,000
40,000
60,000
80,000
100,000
120,000
93-9
4
94-9
5
95-9
6
96-9
7
97-9
8
98-9
9
99-0
0
00-0
1
01-
02
02-
03
03-
04
(US$m)
ENAM Securities 42August 2004
Understand Market Cycles – II
ENAM Securities 43August 2004
US Interest Rates through cycles
ENAM Securities 44August 2004
Rising commodity prices reflect USD weakness
Non-ferrous Metals AluminiumAluminium Primary OP SPTLondon Metals Exchange Index
All CommoditiesCRB All Commodity Index
Source: Bloomberg
GoldGold AM Fix Prices
Steel MB HR Steel Prices
AluminaEurope Alumina Spot Price
250
300
350
400
450
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04
(USD/ troy ounce)
200
220
240
260
280
300
320
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04150
250
350
450
550
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04
1,000
1,200
1,400
1,600
1,800
2,000
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04
(USD)
1,000
1,200
1,400
1,600
1,800
2,000
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-040
100
200
300
400
500
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04
(USD)
ENAM Securities 45August 2004
Consumption trends across Asia
ENAM Securities 46August 2004
Government P&L A/c AS IT REALLY IS
Deficit of 5-6% of GDP misleading! Receipts only 11%
Centre’s P&L (2004-05E)
Source: Government of India Interim Budget, ENAM Research
Particulars % of GDP
Total Receipts 11-- Revenue Receipts 10
-- Capital Receipts 1
Total Expenditure 15-- Interest 4
-- Defence & Subsidies 4
-- Transfer to States 3
-- Infrastructure & Capital Expenditure 1
-- Administrative, etc. 3
Deficit 4
Total debt (Internal + External) 64
ENAM Securities 47August 2004
States have joined the party!
Source: RBI
Aggregate fiscal deficit of states
0
200
400
600
800
1,000
1,200
1,400
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
E
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
Fiscal Deficit (LHS) % of GDP (RHS)
(Rs.bn) (%)
Power subsidies (% of state fiscal deficit)
State (%)Madhya Pradesh 74
Andhra Pradesh 51
Gujarat 65
Karnataka 65
Maharashtra 28
Tamil Nadu 40
Source: World Bank
ENAM Securities 48August 2004
Profligate Governments…weaken us allCrowds out private sector
Upward pressure on interest rates
Rupee depreciation
Making us “poorer”, costlier, less competitive> poorer!
40%
50%
60%
70%
80%
1980
-81
1982
-83
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
RE
Debt/GDP
Total Central & State debt as a percentage of GDP
Source: RBI
ENAM Securities 49August 2004
Demographics
Income Shifts
Age Group Shifts
Social Shifts
ENAM Securities 50August 2004
Affordability has risen dramatically
Source: ENAM Research
Falling prices and low interest rates have made products easily affordable
1994 2003 Increase in affordability (x)
Housing (Ratio of Hsng Price/Annual Inc.) (x) 6 3 2.0
Housing EMI (Rs.) 1,690 1,250 1.410-year repayment / Rs.100,000 / month
Cost of (in Rs.)21" Color TV 18,000 11,000 1.6Washing Machine 18,000 13,000 1.4Refrigerator (165 Ltr) 12,000 8,000 1.5Cordless Telephone 4,000 2,500 1.6Cellular Phone 25,000 4,000 6.3
All this has led to a boom in retail lending and consumption
ENAM Securities 51August 2004
Wealth effect adds to consumer power
-6-303
69
1215
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Jul
-04
10111213
14151617
Rupee/ US$ (LHS) Prime Lending Rate (RHS)
(%) (%)
Market Cap gain = $75bn
Strong rupee and low interest rates
Gold: 20,000 tonnes = $100bn gain
250
300
350
400
450
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
(USD/troy ounce)
2,000
3,000
4,000
5,000
6,000
7,000
2002 2003 2004Source: Bloomberg
ENAM Securities 52August 2004
1001000
20003000
4000>5000
1998
2003
20070
100
200
300
400
500
600
Popu
latio
n (m
)
Annual income (US$)
1998 2003 2007
Income demographics = Secular consumption growth
Cars: 1998 - 3m, 2003 - 6m, 2007 - 9m
Home Mortgage Outstanding: 1998 – Rs145bn, 2003 – Rs478bn, 2007 – Rs1367bn
Cellular Subscriber: 1998 - 1mn, 2003 - 14m, 2007 - 95m
Tax Payers: 1998 - 10mn, 2003 - 40m, 2007 - 80m
Source: ENAM Research
Volumes Value
Two Wheelers 12% 20%
Cars 13% 20%CAGR (1994 – 2003)
Value growth far exceeds volume growth
TV: 1998 - 70m, 2003 -98m, 2007 - 130m
2 Wheelers: 1998 - 28m, 2003 - 46m, 2007 - 80m
Cable TV Sub.: 1998 - 25m, 2003 - 48mn, 2007 - 80m
Basic Telephone: 1998 – 22m, 2003 – 44m, 2007 - 65m
ENAM Securities 53August 2004
Consumers are under-leveraged
2%
17%
34%
54%
75%
53%
0
100
200
300
400
500
600
700
800
India Thailand Malaysia Taiwan Korea USA0%
10%
20%
30%
40%
50%
60%
70%
80%
Total consumer loans outstanding Consumer loans outstanding / GDP (%)
(USD bn)
Source: ICICI Bank
ENAM Securities 54August 2004
Age profile points to secular growth in demand
Increasing consuming/producing age group
0
400
800
1,200
2001 2013
0 to 19 20 to 34 35 to 60 & above
Total 1,012.4m
Total 1,211.6m
Overall growth 19.7%
Growth 34.4%
The rising consumer class246.8m 331.6m
Source: Census 1991
World Age Population Projected To Decline
ENAM Securities 55August 2004
BRICs : The growth engine of the world
Source: Goldman Sachs BRICs Report
ENAM Securities 56August 2004
Caveats
Leadership!
Macro economic stability
Infrastructure and Institutions
Openness
Education (and Health)
ENAM Securities 57August 2004
Political Contradictions reflect Social flux
Muslim League
CPM CONGRESS
National Conference
BJP
RJDBSPSPDMK
NCPJDSamta party
Telgu DesamAIADMKBJD
Shiv Sena
ENAM Securities 58August 2004
Capital Markets
Be aware of shifts
In sectors
In Leadership
In Valuations?
Where we are in the cycle?
ENAM Securities 59August 2004
Flat markets cloud sectoral shifts!
Sectors (% of Nifty)
Source: CMIE
Share of corporate profit / GDP Share of sector profit % v/s Share of market cap
Should always be at the back of the mind !
1998 1999 2000 2001 2002 2003 (July) 2004
Banking 8 6 5 7 8 10 12
Commodities 42 32 22 23 25 34 37
Cyclicals 19 15 8 7 9 9 15
FMCG 19 27 16 19 21 15 9
Pharma 4 5 7 6 8 7 6
TMT 8 15 43 38 29 25 21
Total 100 100 100 100 100 100 100
ENAM Securities 60August 2004
Similarly, be aware of relative country valuations
P/E (x) Interest RoE (%) EPS Growth (%)2002 2003 2004 rates (%) 2002 2003 2004 2002 2003 2004
China 15 14 13 NA 12 14 15 14 11 6
India 18 15 13 4.5 18 21 24 34 13 16* Indonesia 8 9 8 9.0 27 25 27 53 (7) 10
Korea 11 12 9 3.9 15 14 18 (5) (7) 33
Malaysia 20 16 15 3.1 10 12 13 14 20 9
Phillipines 26 17 13 7.8 6 9 11 (23) 50 30
Singapore 25 18 16 0.8 7 9 10 (19) 37 12
Taiwan 43 20 15 1.1 5 11 15 (9) 124 29
Thailand 16 12 11 1.3 16 21 23 86 35 9
Source: The Economist, Citi group. * Currently witnessing upgradation and growth to be sustained in 2005
High and Stable RoE (EVA +ve), Size and Scalability, Variety and Growth
ENAM Securities 61August 2004
Churn in Top 20 reflects underlying reality shifts
Source CMIE
Note: Names in red indicate exits, in blue indicate new entrants
1998 As ofJune2004Company Name Mkt Cap (Rs. bn) Company Name Mkt Cap (Rs. bn)
Oil & Natural Gas Corpn. Ltd. 402 Oil & Natural Gas Corpn. Ltd. 927Hindustan Lever Ltd. 278 Reliance Industries Ltd. 625Indian Oil Corpn. Ltd. 272 Indian Oil Corpn. Ltd. 464Mahanagar Telephone Nigam Ltd 163 Infosys Technologies Ltd. 354Reliance Industries Ltd. 158 Wipro Ltd 354I T C Ltd. 153 Hindustan Lever Ltd. 286State Bank Of India 129 Bharti Tele-Ventures Ltd. 278Hindustan Petroleum Corpn. Ltd. 110 State Bank Of India 253G A I L (India) Ltd. 106 I T C Ltd. 222Bharat Heavy Electricals Ltd. 86 I C I C I Bank Ltd 194Tata Motors Ltd. 77 Ranbaxy Laboratories Ltd 187Bajaj Auto Ltd 73 Housing Development Finance Corpn. Ltd 151Bharat Petroleum Corpn. Ltd. 63 G A I L (India) Ltd. 144Industrial Development Bank of India 63 Tata Motors Ltd. 141Hindalco Industries 56 Bharat Petroleum Corpn. Ltd. 131Larsen & Toubro 51 Steel Authority Of India Ltd. 122Tata Iron & Steel Co. Ltd. 50 Hindustan Petroleum Corpn. Ltd. 121Castrol India 46 Maruti Udyog Ltd 119Steel Authority Of India Ltd. 43 Bharat Heavy Electricals Ltd. 113National Aluminium Co 39 Tata Iron & Steel Co. Ltd. 110
Total Market Cap 2,418 Total Market Cap 5,270
ENAM Securities 62August 2004
… and the Index hides more than it shows!
0
5,000
10,000
15,000
20,000
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Infosys Wipro Satyam
0
400
800
1,200
1,600
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Ranbaxy Dr Reddy'sCipla Sun Pharma
0200400600800
1,0001,200
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
HDFC HDFC Bank
0
2,000
4,000
6,000
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Zee Hero Honda
IT Pharmaceuticals Banking Media & Auto
020406080
100120140160180200
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1,5002,0002,5003,0003,5004,0004,5005,0005,5006,0006,500
Indexed Sensex (LHS) Sensex (RHS)
All Figures indexed 100= price in 1994
ENAM Securities 63August 2004
Always disaggregate the market
Note : Companies may change characteristics over time!
Global Outsourcers
ITPharmaceuticalsEngineering
Global Commodities
OilMetals
Domestic Demographics
FMCGAutoBanking
Emerging Business
TelecomMediaRetail
Sustainability of Advantage
Sour
ces
of A
dvan
tage
HighLow
Low
Many
ENAM Securities 64August 2004
PSS companies outperform markets over time!Infosys Vs Sensex HDFC Vs Sensex
HLL Vs Sensex MICO Vs Sensex
RIL Vs Sensex
0
100
200
300
400
500
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Reliance Industries (LHS) Sensex (RHS)
0
10,000
20,000
30,000
40,000
50,000
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Infosys Sensex (RHS)
0
100
200
300
400
500
600
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
HDFC Sensex (RHS)
0
100
200
300
400
500
600
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
HLL Sensex (RHS)
0
100
200
300
400
500
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
MICO Sensex (RHS)
ENAM Securities 65August 2004
Multibaggers of the last 10 years
Price as on 14/7/94 Price on 15/7/04 CAGR (%)
Satyam Computers 3 326 62
Infosys Technologies 13 1443 60
Wipro 6 525 56
Sun Pharmaceuticals 21 351 33
Hero Honda 33 460 30
Cipla 41 231 19
Ranbaxy 214 976 16
Zee Telefilms 30 126 15
HDFC 161 550 13
Dr Reddy's 248 749 12
Source: Bloomberg; Adjusted for bonuses and stock splits; NIFTY constituents only
ENAM Securities 66August 2004
Multibaggers since 9/11 : The REAL BSE-30!
Company Price as on Price on CAGR15/7/04 11/9/01 (%)
Oriental Bank 240 34 92
Mahindra & Mahindra 476 68 91
SAIL 33 5 87
Tata Motors 407 75 76
ONGC 654 136 69
Shipping Corp Of India Ltd 117 24 68
Tata Iron & Steel Co Ltd 327 84 57
BHEL 527 135 57
IPCL 157 40 57
Grasim 952 274 51
GAIL 182 53 51
Reliance Energy 571 176 48
ABB 730 225 48
Bajaj Auto 841 266 47
Tata Chemicals Limited 121 39 45
Company Price as on Price on CAGR15/7/04 11/9/01 (%)
National Aluminium Co Ltd 139 48 43
HPCL 288 111 38
Tata Tea 386 150 37
Hero Honda 460 183 36
Tata Power 254 101 36
Sun Pharma 351 141 35
Ranbaxy 976 415 33
ICICI Bank 238 103 32
SBI Bank 431 187 32
Glaxo 603 282 29
Indian Hotels 370 175 28
BPCL 314 159 26
Satyam Computers 326 175 23
ACC 232 128 22
Gujarat Ambuja 275 155 21
Source: Bloomberg; Adjusted for bonuses and stock splits; NIFTY constituents only
ENAM Securities 67August 2004
AOL, Time Warner merger – A lesson to remember
0
20
40
60
80
10019
96
1997
1998
1999
2000
2001
2002
2003
2004
Announcement of Merger
Stock Price of Time Warner: now AOL Time Warner
(US$)
ENAM Securities 68August 2004
Lets Summarise TILL THIS POINT
Value is created through an interplay of:
Macro Trends
Micro Focus
Subtler Nuances
Business Leaders must constantly be on top of these ; good leaders and investors continuously value these.
Real winners understand this and play to create enduring value.
May run out of luck, never out of wisdom !
Manish Chokhani September 2004 69
NOW: BUYER BEHAVIOUR
ENAM Securities 70August 2004
Understand Fund Manager Behaviour!Approaches to Portfolio Construction
Top Down v/s Bottom Up
Value v/s Growth
Think of Where we are in the Market Cycle!
Client RequirementsMatch Needs, Requirements and Abilities
Your OWN Portfolio?
ENAM Securities 71August 2004
Top Down
Bottom Up
MomentumValue Growth
Elements of Valuation
ENAM Securities 72August 2004
KYC and Thyself!
Asset Allocation
Country Allocation
Sector Allocation
Large Cap
SmallCap
Pvt. Banks / Pension Funds / Macro Funds/ Fund of Funds
Regional Funds
Country Funds/ Mutual Funds
HNW / PMS / Absolute Return Funds/ “Hedge” Funds
Relative
Absolute
ENAM Securities 73August 2004
Key Success Factors : Match Your Pitch!
Pvt. Bankers / Pension Funds / Macro Funds
Regional Funds
Country Funds
AbsoluteReturnFunds
• Institutional Marketing• Deployment of Large Pools• Capital Preservation
• Marketing Scale & Scope• Economist
• Fund Manager• Technician
• Stock Picker
CAPITALUBS, GAMGSIC, ADIA
PICTETJANUSGMOLLYOD GEORGE
HSBC, , CIBC, JFICICI, HDFC, UTI
SLOANEABERDEENARISAIGEMICOPPENHEIMER
ENAM Securities 74August 2004
Decomposing Approaches
SectorCountryAsset Class
Top Down
• Equities• Bonds• Currencies• Property• Commodities
– Oil– Precious metals– Natural Resources
• Developed Markets• Emerging Markets• Regional markets
• FMCG• Pharma• Services• TMT• Manufacturing• Cyclicals
ENAM Securities 75August 2004
Category 1980 1990 199930 Largest 9 15 46Remaining 9 14 23S&P 500 9 15 30
Valuation – MegaCap bias
ENAM Securities 76August 2004
Some Lessons from HistoryJapan V/s UK in 1944
Korea V/s India in 1950
Singapore!
Hero Honda V/s Kinetic Honda
Bharti V/s IDEA
Infosys V/s HCL
HDFC Bank V/s SBI
There is NO trade-off between Top- Down and Bottom up
ENAM Securities 77August 2004
Valuation Approaches based on Sentiment Swings
• Illiquid
• Misunderstood
• Hated/Uncovered
• Appraised value
• Institutional Favorites
• UVG Stories
• Imagine it!
• DCF or Option value
• Max Volume
• News Flow
• Volatile
• Technicals
Value Growth Momentum
In Reality, there is no distinction. Growth and Momentum are LongTerm/Short Term Value catalysts
ENAM Securities 78August 2004
Think Client Management WHO is the CLIENT?
WHAT does he want from you?
HOW are you shaping his expectations & mindset?
WHY should he stick to you?
“Most clients would rather have their fund manager fail conventionally than succeed unconventionally.”
— Marc Faber
ENAM Securities 79August 2004
Decompose | Decompose | Decompose
Sectors Large Cap Medium Cap Small Cap TotalFMCGPharmaBanksITTelecomMediaEnggAutosCommoditiesTotal
ENAM Securities 80August 2004
SUMMARYUNDERSTAND YOURSELF OBJECTIVELY
Everybody is not Schumacher or Tendulkar: TAKE HELP, BE SELF AWARE
UNDERSTAND THE INVESTMENT LANDSCAPEA grip of Macro, Micro, Accounting and Street Smartness is REQUIRED
UNDERSTAND THE UNDERLYING INVESTMENT What will make it tick or explode?
UNDERSTAND THE MARKET PARTICIPANTSWho are you playing against and how does he play?
FOLLOW BASIC PRINCIPLES AND STICK TO THEM!
BE HAPPY!
ENAM Securities 81August 2004
How is your Portfolio Tilted?
BUILD A CONSCIOUS LIFESTYLE !
WORK COLLEAGUES
PROFESSIONAL COLLEGUES
OWN INTERESTS
FAMILY
CLIENT TIME
ENAM Securities 82August 2004
HEAVEN AND HELL
AMERICAN SALARY
ENGLISH HOME
GERMAN CAR
CHINESE FOOD
INDIAN WIFE
AMERICAN WIFE
ENGLISH CAR
GERMAN FOOD
CHINESE HOME
INDIAN SALARY
YOUR REAL WEALTH = YOUR HAPPINESS = YOUR STATE OF YOUR REAL WEALTH = YOUR HAPPINESS = YOUR STATE OF MIND = WITHIN YOUMIND = WITHIN YOU