This industry's quietly giving rise to few multi baggers
(Aug 13, 2015)
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In this issue:
» The worst performing sectors on the stock market
» The big dilemma over stock buybacks in the US
» ....and more!
What do you think is common among stocks like Rai Saheb Spinning & Weaving Mills, Indo Count Industries, Welspun Syntex, Nitin Spinners and Anjani Synthetics? Oh, that's easy, you might say. These are all textile stocks. Indeed. But there's one more commonality.
During the past year, these companies are amongst the biggest gainers of stocks with revenues of at least Rs 2 billion. If this isn't surprising enough, there are as many as ten textiles stocks in the top 50! In other words, one in every five top gaining stocks is from the textiles space.
The BSE does not even have a sectoral index dedicated to textiles. So what has made them all the rage right now?
Well, if various reports are to be believed, everything that can go right for the sector has gone right in the past year or so. For starters, fall in prices of the principal raw material, cotton, has easily been the biggest blessing. Not to forget, it has perfectly synced with the government's efforts to boost growth in the industry.
Furthermore, competition from China and Bangladesh is on a downward spiral. Mind you, these countries were once the biggest roadblocks to the industry's growth.
Last but not least, as Indians move up the consumption value chain, our own home-grown demand will also receive a huge shot in the arm.
With good news pouring in from all quarters, investors are falling over each other to cash in on the trend. And those who invested in the sector a year back are laughing all the way to the bank right now.
In case you are not one of them, well, you are not alone. As a research house, our textiles recommendations over the past year or so have also been few and far between. We missed the textile bus to a large extent. But we don't feel sad about it.
And here's why.
We are of the view that textiles is a difficult business. It throws up one difficult situation after another. Even when you think you have solved every problem, all one gets at the end is a poor return on capital employed. Don't trust us? Well, here are the average returns on capital over the last ten years of the five best performing textiles stocks we mentioned at the start.
Source: ACE Equity
|Rai Saheb Spinning & Weaving Mills
|Indo Count Industries
What's more, the average debt to equity has been on the higher side. Now, a reliable thumb rule is that, over the long term, the return on a stock will equate the return on capital (ROCE) of the underlying business. Therefore, barring the last stock perhaps, these stocks are likely to give returns in the higher single or lower double digits over the long term. Not a very good proposition, we believe.
It's easy to say this time is different. But the long term fundamentals of an industry don't change often. If you ask me, it's dangerous to buy these stocks, especially after they have run up, expecting the fundamentals to change for the better.
And I worry this is precisely what is happening with quite a few of the textile stocks. Investors are driving them up in anticipation of improved fundamentals. But nothing has changed on the ground.
We are in no way saying that all textile stocks are bad. Some of them have the pricing power and the balance sheet strength to make them fit for long term wealth creation. However, in a difficult industry like textiles, these businesses are an exception. So do tread carefully. The kiss of change you expect to turn your textile frog into a handsome prince may never take effect.
What do you think? Are you buying textile stocks in anticipation of improved fundamentals? Let us know your comments or share your views in the Equitymaster Club.
Let us know your comments or share your views in the Equitymaster Club.
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Turning from the pleasant surprise that many textile stocks have delivered over the last year, today's chart of the day takes a look at the very other end of the spectrum. It pegs the S&P BSE Sectoral Indices that have fallen the most from their 52 week highs. And it is none other than the S&P BSE Metal Index that has the ignominy of being the worst on this front. It's down a whopping 40% from its one year high!
This is not completely surprising. Unlike the textile sector that has found itself having a lot working in its favour recently, the metal industry is facing just the opposite fate. Demand is down, prices are down, there's over supply on a global level, and the domestic steel industry has been hit by cheaper imports from China. And if all that wasn't enough, China's move to devalue its currency over the last couple of days is being looked at as the last nail in the coffin. As per an Economic Times report, the second devaluation that China announced marks the biggest two day lowering of the yuan's rate against the dollar in more than two decades.
The Indian government has quickly moved to hike the import duty on iron and steel by 2.5%. Nonetheless, many from the sector believe this will not be enough to stem the tide of aggressive dumping from China. For now, these sudden developments have left metal stocks in a tizzy.
Rough Times for Metal Stocks
There's quite an intriguing debate that's raging amongst policy makers in the US these days. Stock buybacks, where companies repurchase their own shares, are being looked on with raised eyebrows in the country. One of the reasons is probably the fact that US companies have been resorting to buybacks in a huge way.
Sample these numbers from a New York Times report. Since 2004, US companies have spent almost US$ 7 trillion on buybacks. That comes up to a whopping 54% of all profits from S&P 500 companies between 2003 and 2012. Thus it's not entirely surprising that the issue has caught the attention of lawmakers in the country. In fact, they are going to the extent of linking such stock buybacks to stagnant wages in the economy and lack of investments by businesses in productive assets.
We ourselves are of the opinion that something like a stock buyback should be left entirely to companies to decide. There can be no two ways about it. If company managements see opportunity to employ incremental capital productively, they will do so. If not, they should have complete freedom to return it to shareholders. Without any interference from the government that is. A capitalist country like the US would do well remember this most basic of principles.
The Indian stock markets were trading strong today on the back of sustained buying activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 150 points. Gains were largely seen in pharma and banking stocks. Metal stocks were finding themselves on the losing end once again though.
"Time is the friend of the wonderful business, the enemy of the mediocre." - Warren Buffett.
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|This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).
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