Reblog: Investment Strategy: Confidence boosters

Capital expenditure plans provide clues about the business optimism of companies

Tracking the quarterly results is one of the major ways to read the pulse of an enterprise. Financial and operational performance in the latest three months can shade ample light on the direction of a company. However, the quarterly, half yearly or even yearly results have a serious lacuna. These numbers reveal little about the future. The figures are all about past. In the equity market, what gets counted is the outlook.

There are several questions when it comes to how a company is likely to fare in future. What will be the triggers to drive the top and bottom lines? What are the strategies and initiatives the company is embarking on? What is the optimism of the management and the level of confidence?

Investors can trace information about future expansion or capital expenditure (capex) plans undertaken in the recent past, are underway or at the drawing-board stage. These might provide clues about the business optimism of the management. A company normally commits funds to organic or inorganic projects after doing its homework by assessing the industry dynamics, competition and demand scenario.

Capital Market tracked growth plans of companies based on a variety of sources such as presentation, press releases, media briefing, notes to accounts and stock exchange announcements. The outcome is an interesting set of companies that are investing in assets to ensure expansion of market share and revenues.

Mid-cap Suprajit Engineering touched an all-time high of Rs 170 in January 2015. Since then the stock has reported a sharp correction but only to bounce back. Currently, the counter is trading at Rs 139.6 (5 February 2016) and seemingly moving closer to the historic peak. The buzz at the counter is not without reason. There are several developments that have resulted in buoyancy in the stock price.

Trail production at the Sanand plant in Gujarat had started and one of the major customers has approved the facility. Further, trail production at the Vallam Vadaggal plant in Chennai is expected to start in the fourth quarter of the current fiscal ending March 2016 (FY 2016). A marketing office has been established at Atlanta in the US to make inroads into the North American markets.

Besides, the Speedo cable business was acquired from Pricol in FY 2015. In May 2015, Phoenix Lamps, the manufacturer of Helogen lamps, was purchased to de-risk the product profile. The capacity expansion at the Pathredi facility in Rajasthan is underway.

Phoenix is a market leader in the country, with significant presence in the overseas markets through European subsidiaries Trifa and Luxlite. There is 61.92% stake in Phoenix. The restructuring is expected to be completed in some time. Capex of Rs 30 crore has been earmarked to improve the quality and operational efficiency. This will be largely financed through internal accruals.

The country’s largest automotive cable maker with 15 manufacturing plants close to customers is harboring global ambition. Key automotive clients include TVS Motor Company, Bajaj Auto, Hero MotoCorp, Royal Enfield, General Motors, Tata Motors, Renault Nissan, Volvo Eicher, Atul Auto, Mahle Behr, Lear and Brose India Automotive. John Deere India is a non-auto client. Around 82% of the revenues are derived from the domestic market and remaining 18% from exports.

Pricol aims to achieve turnover of Rs 1450 crore in the current fiscal as against net sales of Rs 1143 crore in the previous fiscal. The target is to achieving revenues of Rs 3000 crore by FY 2020. As part of the transformation strategy, the small-cap company unveiled a new logo in January 2016. The focus will be on entering new markets through acquisitions and tapping new product segments through research and development. The leverage is moderate, with a debt-to-equity ratio of 0.33 times end March 2015.

Pricol in January 2015 bought Melling do Brasil, an automotive power-train manufacturer in Brazil, as a part of the global expansion plans. Melling, renamed as Pricol do Brasil, serves domestic and international customers such as Volkswagen, Fiat, General Motors, Harley Davidson and Mack Trucks. The integrated facility has diverse manufacturing capabilities such as die casting, machining and robotic assembly. This acquisition gives Pricol an entry into the global four-wheel power-train products segment.

Commencing operations in 1974 and headquartered at Coimbatore, Pricol has manufacturing units at eight locations, seven international offices and employee strength of 5,100. The automobile industry is served across segments of two- and three-wheelers, cars and vans, tractors, commercial vehicles (CVs) and off-road vehicles. Also, there are industrial clients.

Pricol is the world’s second largest manufacturer of driver information systems for the two-wheeler segment and also the world’s fourth largest manufacturer of instrument clusters for tractor and off-highway vehicles. In the domestic market, the largest manufacturer of automotive pumps for the two-wheeler and telematics solutions for the tractors and off-highway vehicle segments is also India’s largest manufacturer of speed governors and cabin tilt mechanisms for CVs.

Adani Ports and Special Economic Zone will be expanding existing terminal Adani International Container Terminal Pvt Ltd (AICTPL) at the flagship Mundra port in Gujarat. AICTPL is an equal joint venture (JV) with Terminal Investment, an arm of Swiss-based Mediterranean Shipping Company SA, the second largest shipping liner in the world. The expansion is being carried out to create a trans-shipment hub for the Middle East, South Asia and India.

Post completion of expansion, AICTPL will emerge as the country’s largest container terminal, with a total quay length of 1,460 meters and cargo-handling capacity of 3.1 million 20-foot equivalent unit (Teus). The terminal will be equipped with 15 super post-Panamax quay cranes, capable of handling 18,000-Teu container vessels.

Further, the expansion will position Mundra as the major transshipment hub in the country, the Middle East and South Asia providing congestion-free and cost effective solution. Construction has commenced and the terminal will be commissioned in 15 months.

Also, upon completion, Mundra will emerge as the largest container port in the country, with a cumulative capacity of 6.6 million Teus, with four container terminals spread over an area of approximately 146 hectares. At present, the Mundra port is the largest private commercial port in the country. Adani Port aims to achieve a vision of handling 200 million tonnes (mt) of annual cargo by FY 2020. This expansion will help to move closer to its target. Around 110 mmt of cargo was handled last fiscal.

Apart from Mundra, the other ports in portfolio are Dahej, Hazira, Kandla, Dhamra, Murmugao and Vizag. In aggregate, a cargo volume of 144.25 mt was handled in FY 2015. Also, a free- trade warehousing zone is being operated at Mundra over an area of 168.41 hectares. Approval has been obtained from the Central government to set up another multi-product special economic zone (SEZ) over an area of 1856.5 hectares adjacent to the existing multi-product SEZ at Mundra.

Raymond added 30 new stores and closed three non-performing stores in the December 2015 quarter, taking the total store count to 1,044, with aggregate space of 1.92 million square feet (sq ft). Renovation of 24 stores has been completed, while another 20 stores are under renovation. In the current fiscal, 75 stores are to be renovated. This count will touch 100 by March 2016. As many as 67 stores were opened and 26 closed in the nine months ended December 2015.

A capex of Rs 252 crore was incurred in the nine months ended December 2015. This comprised Rs 130 crore for capacity expansion of the denim and shirting business, Rs 28 crore for the acquisition of Robot System Pvt Ltd and balance for store rollout and maintenance. The product portfolio includes branded textiles, branded apparel, denim, garmenting, luxury cotton shirting, tools and hardware and auto components.

Net debt increased Rs 289 crore to Rs 1726 crore in the nine months ended December 2015. The net debt-to-equity ratio was up a marginal to 1.09 times end December 2015 compared with 1.01 times a year ago. The increase in debt was partly due to capex and partly on account of enhanced working capital requirement. Working capital is expected to decline in the March 2016 quarter, easing pressure on the debt-to-equity ratio.

Owing to the challenging global economic environment, slowdown in major world economies and falling commodity prices, there was slowdown in demand in the export markets and subdued domestic consumer demand in the December 2015 quarter. Also, the earlier onset of the end of season sale adversely affected businesses. Consolidated revenues grew 8% in Q3 of FY 2016 to Rs 1508 crore. However, operating profit measured in terms of earnings before interest, depreciation and amortization declined 5% to Rs 148 crore and net profit plunged 28% to Rs 40 crore. Advertisement and selling and marketing expenses were enhanced 47% to Rs 102 crore. Investment in brand-building and expansion and modernization of the retail network will continue.

Syngene International has drawn capex plans worth around US$ 200 million to be implemented from FY 2016 to FY 2018. The capital spend will be for a research and formulation center. This apart, the focus will be on late-stage and commercial manufacturing including expansion of the active pharmaceutical ingredient (API) plant, the commercial new commercial entity (NCE) manufacturing plant and the biologics manufacturing plant. Last, capex will be incurred for other services and new capabilities including oligonucleotides, viral testing services and antibody-drug conjugates. The funding requirements will be met through internal accruals and debt.

There are plans to set up a new manufacturing facility at the Mangalore SEZ and is in the process of acquiring 40 acres of land and obtaining necessary approvals. The estimated expenditure for setting up the facility is US$100 million and is contingent of various factors. Further, stock exchanges will be intimated appropriate details in the first half of calendar year (CY) 2016 after completing the detailed engineering for the proposed project.

Established in 1994, the subsidiary of Biocon is the country’s first contract research organization, with experience in novel molecule discovery and development services. The integrated service platform offered is for small and large molecules including antibody-drug conjugates and oligonucleotides. Around 95% of the revenues come from overseas market, with 221 clients across multiple sectors.

Hindustan Zinc (HZL) is all set to invest around Rs 8000 crore in expansion of mines and smelting operations over the next three to five years, as per multiple news report published in January 2016. The Vedanta group company aims to enhance the existing ore production levels from to 14 million tonnes per annum (mtpa) from 9.36 mtpa and finished metal production to 1.10 mtpa from 0.85 mtpa. With the latest technology, large investment in capacity expansions and continuous exploration, production will be increased manifold and yet there will be reserves for another 30 years. The 1966-incorpated miner completed 50 years in January 2016.

Also, a new fertilizer plant, with capacity to manufacture 0.5 mtpa of di-ammonium phosphate, is to be set up in the Udaipur district in Rajasthan, with an estimated capital outlay of Rs 1350 crore.

Cash and cash equivalents of debt-free HZL were at Rs 32639 crore end December 2015. Out of this cash hoard, Rs 23581 crore has been invested in mutual funds, Rs 5575 crore in bonds and Rs 3480 crore in fixed deposits. A conservative investment policy of investing in high-quality debt instruments is followed.

Primarily engaged in mining and smelting of zinc, lead and silver, operations include five zinc-lead mines, four zinc smelters, one lead smelter, one zinc-lead smelter, seven sulphuric acid plants, a silver refinery plant and five captive power plants in Rajasthan. Also, a rock-phosphate mine is operated in Maton near Udaipur. There are zinc, lead and silver processing and refining facilities in Uttarakhand. In addition, there are wind-power plants in Rajasthan, Gujarat, Karnataka, Tamil Nadu and Maharashtra, with aggregate captive power capacity of 474 MW and wind power of 274 MW.

Bharat Forge (BFL) plans to set up an integrated automotive components hub in the Nellore district of Andhra Pradesh at an estimated capital outlay of around Rs 1200 crore. The unit will provide employment to around 3,000 individuals. Chairman and Managing Director Baba Kalyani announced the plan in January 2016 at the CII Partnership Summit held in Visakhapatnam in Andhra Pradesh (AP).

Additionally, another memorandum of understanding has been signed with the AP government to set up a multi-modal facility for industrial components, defence and aerospace components including a supply chain. This facility will be located in the Anantapur district. For both these locations, land has been finalized and physical possession will be taken shortly.

The Kalyani group company is the world’s leading power-train and chassis component manufacturer. Customer base includes almost all the leading global automotive original equipment manufacturer (OEM) tier 1 suppliers and various OEMs in the industrial segment. There is significant present in the overseas market, with revenue contribution of around 68%, while the remaining 32% comes from the domestic market.

Several strategic goals have been set to be achieved by FY 2018. The intention is to increase the passenger-vehicle revenues to 15% from 5% of sales. The aim is to foray into the aerospace sector. Contracts have been signed with four marquee customers. Further, the objective is to be debt-free and improve the return on capital employed and return on net worth ratios to over 20% by CY 2018. Last, revenues are to be doubled to Rs 7000 crore by FY 2018.

There are plans to tap the defense opportunity in a major way. The opportunities pursued include components, artillery programs, Defence Research and Development Organization programs and offset programs and services. Currently, components and sub-systems are being supplied to the Indian defense establishments.

Idea Cellular, the country’s third largest telecommunication company with a revenue market share of 18.5%, revised upwards the capex guidance to Rs 7500 crore from Rs 6500 crore given earlier. This is the second upward revision compared with the original guidance of Rs 4500 crore. The increase in capex is owing to the accelerated fourth-generation (4G) telecom services rollout. As many as 3,239 2G cell sites and 7,678 3G and 4G cell sites were rolled out in the December 2015 quarter, taking the network site count for 2G to 1,22,515 and for 3G and 4G to 47,545.

The process of rolling out 4G services has begun, with the launch in four service areas of Tamil Nadu, Kerala, Karnataka and Andhra Pradesh in December 2015 and three service areas of Madhya Pradesh, Punjab and Haryana in January 2016. The 4G services are being expanded in these seven services areas. In the remaining three services areas of Maharashtra, Orissa and North East, the 4G services will be launched by March 2016. The intention is to cover 750 towns and villages in these 10 service areas by June 2016.

The total addition to the gross block including capital work-in-progress was Rs 2310 crore in the December 2015 quarter. This excluded capitalized foreign exchange fluctuation of Rs 27.7 crore, spectrum capitalization and capitalized interest of Rs 1330 crore related to capitalized spectrum.

Recently, an agreement was signed with Videocon Telecommunications for transfer of right to use 5 MHz contiguous 1,800-MHz spectrum for the leadership service areas of Gujarat and Uttar Pradesh-West. The aim is to use this spectrum to launch high-speed 4G services in these markets. On completion of the transaction, the fourth generation (4G) (LTE) service capability will expand to 12 service areas, covering 75% of the revenues and 60% of the industry revenues. The overall spectrum quantum will increase to 280.7 MHz.

In September 2015, the Reserve Bank of India gave in-principle approval to set-up a payments bank to Aditya Birla Nuvo (ABNL). ABNL (51%) jointly with Idea (49%) will set up the payments bank.

The JV partners are likely to launch services by the second half of CY 2016. The JV will leverage Idea’s over two million retail distribution channels across 3.83 lakh towns and villages to promote a range of services such as opening of savings bank account, domestic remittances and merchant payments. The JV will be tying up with third parties to offer a range of credit, investment and insurance products.

As part of forward integration, Shree Pushkar Chemicals & Fertilisers commenced commercial operations for a new reactive dyes plant in January 2016. The plant, with an installed capacity of 3,000 tpa, is located at Lote Parshuram in Maharashtra. Already, the new unit has two months of orders on hand. Reactive dyes is a class of highly-colored organic substances primarily used for dyeing textiles, for cellulosic fibers like cotton and also wool. With reactive dyes, Shree Pushkar emerged as a one-stop shop for dyestuff manufacturers catering to the textile sector. There is an arrangement with Huntsman Corporation for sales of dyestuff. Huntsman is a US-based company and a global player in the manufacture and marketing of dyes and petrochemicals.

Two additional plants for dye intermediates will be commissioned shortly to meet the captive requirement. These two units include H-Acid, with installed capacity of 750 tpa, and vinyl sulphone, with capacity of 1000 tpa. Mutual funds held 8.45% stake in the almost zero-debt mid cap end September 2015.

Established in 1993, the leading manufacturer of K-acid in the domestic market operates in four businesses of dye intermediates (revenue contribution 71%), acid complex (8%), cattle feed (17%) and fertilizers (3%). Products are marketed through 125 dealers across Maharashtra, Gujarat and Karnataka. Lately, units to manufacture mixed fertilizers (20,000 tpa) and sulfate of potash (10,000 tpa) were commissioned.

There is exclusive marketing arrangement with DCM Shriram Chemical & Fertilizers for single super phosphate in Maharashtra and Karnataka and tie-up with Shivam Chemicals for marketing of di-calcium phosphate in Karnataka.

Established in 1935, Cipla (market capitalization Rs 45785 crore) is considered a pioneer in the domestic pharmaceutical industry. But it is lagging compared with new-age peers such as Sun Pharmaceuticals Industries (Rs 206203 crore), Lupin (Rs 81161 crore) and Dr Reddys Laboratories (Rs 53043 crore) on the trading floor in a major way. However, in future, the scenario can change and it might able to catch up with the peers if the grand plan envisaged by the management sees the light of the day.

The aim is to grow the North America business to 20-25% from a mere 8% of overall sales by CY 2020. The intention is to maintain the momentum of filing 10-15 Abbreviated New Drug Applications (Andas) every year and focus on limited competition opportunities. In the North American markets, building of partnerships will continue for launch of first-to-market and differentiated generics such esomeprazole, dymista nasal spray, budesonide respules, escitalopram and finasteride.

At present, the focus is on the domestic and emerging markets, with little presence in the developed markets, where the profit margins are lucrative. With 35 manufacturing facilities, revenues are garnered from over 150 countries. A few of the manufacturing facilities are approved by the US Food and Drug Administration (FDA) and United Kingdom’s Medicines and Healthcare Products Regulatory Agency. There is presence in 30 therapeutic categories and over 1,500 products are on offer. In the domestic market, the third-largest player has a network of 6,500 distributors. As many as 22 of the brands feature among the top 300 brands. In South Africa, the third-largest generics player has a market share of 5%. In other emerging markets, there is front-end presence in 20 markets, with leadership position in Sri Lanka, Yemen, Kenya and Uganda. In the respiratory segment, there is the world’s largest inhalation portfolio of 28 molecules and combinations in multiple dosage forms and strengths that are available in 100 countries including the developed markets.

In the US, 147 Andas have been filed, there is partnership with 20 companies and 60 products have been commercialized. Cipla-label products were launched in the US around a year ago and there is positive response from customers. Lately, a definitive agreement was signed for 100% acquisition of Invagen and Exelan Pharma, both US-based firms. These buys are expected to help accelerate the growth plans.

In the European Union, there is direct presence in 10 countries and business-to-business presence in 30 countries through 50 partners. Key respiratory products salmeterol fluticasone and mometasone have been launched in select European markets. The current focus is on boosting volume market share.

The emphasis is on research. Research & development spend increased to 7.3% (US$ 130 million) of revenues in FY 2015 from 4.5% (US$ 50 million) in FY 2012 Around 200 development projects are underway. The top 50 projects address a market size based on innovator sales of
US $ 30 billion.

Mutual fund owned 6.57 % equity end December 2015 in a moderately leveraged firm with a debt-to-equity ratio of 0.14% end March 2015.

Conclusion

Investors should focus on the bottom lines while evaluating these companies. Healthy financials, with moderate or low leverage is essential to finance the growth plan. A debt-laden balance sheet and growth plans can be a deadly cocktail if the proposed investment meets with dismal demand in future.

Telecommunication companies such as Idea Cellular and Reliance Communication are investing in infrastructure to strengthen their services against the impending attack by Reliance Jio, about to launch its communication services. This is a classic example of preventative capex and may or may not deliver the desired results.

Also, investors should assess the operating profit generated by these companies. Internal accruals are a crucial source of finance. Robust operating profit can ease the funding burden on companies.

Last, these companies should be seen from the medium- to long-term perspective. Investments can take a long time to fructify and investors need to be patient during the intermediate period. In fact, there is risk of failure that can result in wealth destruction instead of creation. This business risk is anyhow not detachable in equity investment.

The original article appears on capitalmarket.co.in and can be found here.