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Are Textile Stocks the Next Goldmine?

Jun 25, 2016

In this issue:
» Which way forward for India-UK trade post Brexit?
» Turmoil in global financial markets after Brexit
» ....and more!
00.00
Rahul Shah, Co-Head of Research

One trend I have seen far too often in the markets is the harmonisation of sector stocks. If leading stocks from a sector are in or out of favour, it's a safe bet that most other stocks from the sector will fall in line.

An article a colleague sent me yesterday took the cake. As many as 30 stocks from the textiles space have become multi-baggers in the last one year. And the best performing stock is up a staggering eightfold. Talk about rising tides!

I immediately got down to business. I did what all of us on the research team are trained to do to understand the investment worthiness of stocks...

Below is the ten-year median return on capital employed (ROCE) of the top-ten best performing textile stocks of the last one year.

Company Name 10-year Median ROCE(%) 1 yr return (%)
Prime Urban Development India Ltd. 2.5 697.0
Vijay Textiles Ltd. 10.8 530.0
Gini Silk Mills Ltd. 13.5 396.8
Sybly Industries Ltd. 2.9 258.0
Haria Exports Ltd. (2.7) 252.9
KG Petrochem Ltd. 11.9 219.9
Alps Industries Ltd. (2.3) 214.1
Himatsingka Seide Ltd. 6.5 189.3
Ruby Mills Ltd. 9.7 200.6
SPL Industries Ltd. 0.9 193.6

Source: Ace Equity (Standalone numbers), Economic Times

One glance at the numbers and it is clear to me I won't look forward to investing in any of these businesses. Not after these gains.

Now, would I have invested in them about a year ago before they'd gone up? If a good quality business is what excites me, then the answer would again be a big no.

Over an entire business cycle, some of the companies have earned ROCEs that would make even a fixed-deposit holder look like a super investor.

When you invest in a company, you expect a median ROCE of at least 15%. And none of the companies mentioned above fulfil this condition. Mind you, these are returns before tax. So if you consider the normal tax rates, the returns would be even lower.

I know I am going to face some stiff resistance here. The sector is apparently riding some huge tailwinds and could emerge as one of the fastest growing over the next few years.

However, we are of the view that profit growth in itself does not mean anything. For a stock to be a wealth creator over the long term, profit growth has to combine with strong ROCEs.

You can double the interest income from an 8% fixed-deposit scheme by doubling your investment. But this does not mean that the 8% scheme is superior to one that offers 10%. Given the choice, you would always prefer to invest in the 10% fixed-deposit scheme.

Most investors, however, fail to take this into account and instead look at growth alone and not in conjunction to the ROCE.

They are gung-ho about profit growth but fail to realise that, just as in fixed deposits, profits can be made to grow by doubling the capital employed by the business. However, what matters is the income you earn from the same capital base - without expanding it.

Of course, you could argue that, in addition to profit growth, the low ROCE could also be a thing of the past. In other words, profit growth as well as ROCE are about to change for the better.

However, I don't see any such possibility on the horizon. Entry barriers remain as low as ever, customers still have bargaining power, competition is still intense, and last but not the least, I don't see the emergence of any pricing power for these companies.

All in all, the competitive analysis doesn't give me any reason to think the long-term trend in return on capital will be any different from the past.

Therefore, if you are thinking textile stocks will be the next goldmine for investors, you may well think again.

Your hard-earned money is better off in a company with far superior returns on capital. Even if it comes with low growth and slightly higher valuations.

Do you agree that textile stocks may disappoint investors from a long-term perspective? Let us know your comments or share your views in the Equitymaster Club.

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03.00 Chart of the day

UK's exit from the European Union looks like it may cause a fair bit of upheaval where trade is concerned. As today's chart shows, the UK is an important trade partner of India. Its share in India's total exports has been steadily increasing over the last five years. In absolute terms too, our imports and exports with UK stand at a significant level.

India-UK Trade Relations: Which Way Forward?


With the Brexit happening, the dynamics of India's trading relations with not only UK but the whole of the EU might undergo a change.

For one, it might mean more demand for Indian exports to the EU as products from UK might lose their duty free status. Further, jobs available to labour from the EU in Britain might see restrictions being imposed, perhaps leading to more opportunities for Indians there. The proposed free trade agreement with EU may also receive a fillip as the UK has in the past opposed a lot of EU decisions.

On the flipside, there are also fears that the EU may dismantle altogether. There has been noise for sovereignty for quite some time in many EU countries. With the Brexit occurring, these voices may come back with renewed vigour. If such a break up were to happen in future, India's trade with the entire region may see big changes.

04.05

Global stock markets fell in the aftermath of Brexit. In a surprise move, Britain voted to leave the European Union in the crucial June 23rd referendum after the 'Leave' campaign secured around 51.8% of the votes. While England voted overwhelmingly for Brexit, Scotland and Northern Ireland backed 'Remain'. This development is likely to have far reaching consequences for the survival of the European Union that was formed 60 years ago after World War II.

The exit of Britain from EU or 'Brexit' has caused mayhem in global financial markets. It sent the pound to its lowest level since 1985 with a decline of 11%. Euro too slumped around 3.3%. Crude prices in global markets plunged as much as 6%. With investors flocking to safe haven, assets such as gold firmed up 4.5%. Barring Britain, Brazil and, Hong Kong all the other markets ended in the red in the week gone by.

The FTSE 100 index was up by around 2% backed by recovery in blue chip stocks. However, indices in Germany and France were down by more than 1% for the week. The US markets were down by 2%. The Japanese market was the biggest loser, plunging by 4%, as currency traders scrambled to buy yen in the financial turmoil. The Japanese currency strengthened by more than 7% against the US$, dropping below 100 for the first time since November 2013.

Back home in India, the Sensex fell by more than 3% but recovery towards the end of the day saw the index ending lower by a mere 0.9% for the week. Among the sectoral indices, only pharma and consumer good managed to stay afloat while stocks from realty and capital goods were biggest losers.

Performance During the Week Ended 24th June, 2016

04.55 Weekend investment mantra

"You only have to do a very few things right in your life so long as you don't do too many things wrong" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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3 Responses to "Are Textile Stocks the Next Goldmine?"

shailesh

Jun 26, 2016

I too think so
Textile is neglected industry
It has not moved up

Like 

SJ

Jun 26, 2016

But if we look at the table you have mentioned, I don't think it gives the true picture because we are talking about median ROCE which I feel is not the right metric here. Over the long term I would go with a compounded annual growth rate figure and if that is good, I would go for the stock.

Like 

SJ

Jun 26, 2016

Agree with you. Infact I feel that any industry that has been there for ages and already facing market competition cannot be a new 'gold mine' unless the companies being talked about are propelled by an innovative edge and vision or driven management teams.

Like (2)
  
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