No profits! Yet among top 30 Indian companies... - The 5 Minute WrapUp by Equitymaster
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No profits! Yet among top 30 Indian companies...

Dec 22, 2014

In this issue:
» Banks' NPA risks back to 2001-02 levels
» Shocking indebtedness of agri households
» Why Saudi Arabia is not worried about oil prices...
» Roundup on markets
» ...and more!

How do names such as Asian Paints and Bajaj Auto resonate with you? Both of them are very well known names in most Indian households given their strong brand names and long operating history. Interestingly, both were founded in the 1940s before India became independent.

Given their robust business models and strong economic moat, they boast of a solid track record of profitability. It is no wonder that they have been very good shareholder wealth creators. Today they both rank among the top 30 listed companies on the BSE in terms of market capitalization. At a market capitalization of close to Rs 714 billion, Bajaj Auto stands at number 24, while Asian Paints ranks 26 with a market capitalization of about Rs 704 billion. Given their rock solid businesses, pricing power, a history of healthy profitability and strong future growth prospects, these companies are trading at a sizeable premium. Neither of them is available at bargain prices.

Now consider this other company that was just founded in 2007 and is currently still loss-making. But hold your breath... As per an article in the Economic Times, this company is now valued at about Rs 690 billion, almost close to Asian Paints and Bajaj Auto. If this company was listed, it would be among the top 30 companies in terms of market capitalization.

Can you guess which company we are referring to? It's none other than the fast growing giant Indian online retailer Flipkart. Apparently, the company just concluded another major round of funding of US$ 700 million (Rs 43 billion). It must be recalled that the company had raised a whopping US$ 1 billion less than six months ago. With the number of investors crossing the 50 mark, Flipkart Limited (incorporated at Singapore) has filed an application with ACRA Singapore for converting into a Public Company.

Though there haven't been any announcements yet, an IPO seems likely in a couple of years. One of the big reasons the IPO seems quite imminent is that the quantum of money that has been infused in the company has gotten so big that an IPO would be the only likely way for the private equity investors to make a profitable exit. Think for a moment... The company is already valued at such a huge premium. For these investors to make a good return on their investment, the premium is likely to stretch even further in case of an IPO.

There is no doubt that Flipkart has the first mover advantage in a fast growing industry that is still at a very nascent stage. But topline growth alone has little meaning if it doesn't trickle down to the bottomline. So far, the company is loss-making. The growth is being driven by huge infusions of funds. The current optimism of global investors towards the Indian stock markets has been favourable for the company and enabled it to raise huge funds.

If Flipkart is able to quickly scale up its operations and build strong entry barriers, the opportunity could be huge. But in a discount-based business model where customers are quite price-sensitive, consistent profitability considering significant threat from competitors is difficult. It is important to remember that Amazon Inc didn't seem to make money for about two decades. And even now it operates at very thin profit margins.

So all in all, this is a high risk game. It is for investors to make a smart choice.

Do you prefer to invest in companies that have a proven track record, sustainable business models and have a good night's sleep? Or would like to be adventurous and play the high-risk high-return game based on a future promise? Let us know your comments or share your views in the Equitymaster Club.

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Chart of the day
Now premium valuations of listed and unlisted entities are not our only concern. The fact that Indian banks are getting increasingly adventurous when it comes to lending to risky companies is also a worry. As the chart shows, the share of banks' exposure to companies with interest coverage ratio less than 1 time is currently almost as high as in 2001-02. You would remember that these were the years when India Inc was going through a phase of leveraged balance sheets. And without enough profitability to service these loans (interest coverage), most of the loans turned into NPAs. The situation was so bad that institutions like IDBI and ICICI had to write off their NPAs over several years! While it seems that Indian banks are once again flirting with a high NPA problem, the situation may not get out of hand if economic revival accelerates. If not, investors have to be prepared to see a lot of pain in the banking industry.

Banks once again flirting with 2001-02 NPA risks?

Speaking about debt, it is not just the banks or corporate India that are adventurous. Indian households too seem to have got the infatuation to borrowed money. In fact as per a survey by NSSO (National Sample Survey Organisation), quoted by Firstbiz, the average household debt levels in India have gone up multi fold in the past decade. It has gone up by 7 times in urban areas and more than 4 times in the rural areas between 2002 and 2012. But the data that seemed most shocking to us is that over 50% of agricultural households are in debt. Of these, 42% of them owe money to banks and 26% owe to moneylenders. Almost 90% of the households in the states of Andhra Pradesh, Telangana and Tamil Nadu have high debt levels. Amongst the agricultural households, the average amount of unpaid dues was Rs 47,000.

Now, considering that 44% of the estimated agricultural households in the country have jobs under NREGA, there are several households are indebted without any income source. Thus many of these households will continue to borrow to pay off one loan after the other. And in all likelihood create a vicious cycle of bad debt. Thus instead of asking the RBI to lower borrowing rates, the government should pay more attention to the availability of cheaper funds in hinterlands.

The OPEC controls about 40% percent of the world oil market and Saudi Arabia is the cartel's largest producer. Hence, there are stories abound about the secret motive of Saudi Arabia in keeping oil supplies high despite plunging prices. The kingdom, which is dependent on oil revenues, is able to weather lower oil prices due to large reserves built up over the years. Hence unlike non-OPEC member Russia and other nations like Iraq, Iran and Venezuela, Saudi Arabia has lesser reasons to worry about oil prices. It does not need prices substantially above present levels to meet budget goals. Hence instead of cutting produce to drive prices up, it has been more worried about losing market share in energy supplies to US' shale gas. Speculations that the kingdom is forcing lower prices to damage the economies of Russia and Iran have yet to be proven correct. However, what is a given is the fact that tussle for energy market between the OPEC and the US will keep oil prices from moving up substantially in the near term.

The Indian stock markets made a sharp recovery in the final hours of trading today backed by gains in index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 325 points. IT, commodity and banking stocks were amongst the top gainers.

Today's investing mantra
"Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they're going to be higher or lower in two to three years, you might as well flip a coin to decide." - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee and Ankit Shah.

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Equitymaster requests your view! Post a comment on "No profits! Yet among top 30 Indian companies...". Click here!

5 Responses to "No profits! Yet among top 30 Indian companies..."

Dinshaw N Chenoy

Mar 5, 2016

Please state Five of the 30 Indian Compnies.



Dec 23, 2014

high risk and high gain

Like (1)

AB Pereira

Dec 23, 2014

The way Flipkart is building its model of 'All equity and no profitability' gives an indication that it is bound to bite the dust at the time of IPO due to huge premium. As you have rightly said, in this high discount game, big competition (Amazon, snapdeal etc) and no real entry barrier (they started with a mere Rs 4 lakhs if I remember right), the disaster is just waiting. We may be going back to the dotcom bubble n burst days.

Like (1)


Dec 23, 2014

Hi There,

I am a very small trader and investor for BSE and NSE, but interested in Equaity market since I become financially independent that is around 11 years back and have seen the BSE and NSE to tough all time high and crash and again coming back to all time high. I have made huge loss and also good profit during my journey of 11 years,now coming back to the question of how should an investor will approach when investing money in equiety it depends on lots of factors and rules which most of us know quite well, but balacing portfolios are important when doing your allocation, investing in solid so called bluechip is ofcourse trust worthy, but all of them might not be able to generate meaningful return in terms of stock proces,so when you don't want to loose your money at the end of the day you also don't want to just keep it as is , which will defeat the purpose of being in Equiety market, so if any business which is able to generate revenue visibility for longer duration and has chances to improve bottom line in future will make sense to get in with some percentage of your portfolio, but remember that where your risk apatite comes in, becaue new business menaes new startegy may or may not be working for sometime...or

Like (1)

S G Chellappa

Dec 23, 2014

i would like to invest 70% established companies like bajaj auto etc and 30% on growing companies like flipkart. i need to know the existence of such companies.

Like (1)
Equitymaster requests your view! Post a comment on "No profits! Yet among top 30 Indian companies...". Click here!
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