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India Inc: Sweating it out

Feb 26, 2003

The year 1991 heralded the decade of reforms. The Indian industry saw itself staring at international competition as the economy was gradually opened up to the outside world. This article discusses the impact this structural change in the operating environment had on India’s leading 22 companies. For our study we have chosen 22 companies from the manufacturing sector, which are a part of the BSE Sensex today. These companies operate in diverse industries like cement, automobiles, steel, FMCG and lubricants. We analysed the performance of these companies based on parameters like sales growth and measures for operational performance.

Our study reveals that the performance of this group of companies has been quiet encouraging on almost all the parameters we have considered. India manufacturing majors over the past decade have become more profitable. While the topline has grown at a CAGR (compounded annual growth rate) of 18% between FY92 to FY02, we find that the growth in bottomline has been even higher at 23% CAGR.

We look at how Indian Inc has managed this feat.

Analysis snapshot
Average debtors days3843
Average creditors days5366
PBDIT Margins 11.1%11.9%
Working capital/ sales13.6%7.6%
D/E (x)1.20.6
Sales/assets (x)1.11.1

Operationally Indian companies are better off now than they were in FY92. But what is noteworthy here is the fact that operating margins had peaked in FY96, which was incidentally the peak of the industrial growth cycle. But after falling from there on, operating margins of these companies are now showing signs of an upturn. Operating margins of the total set of companies have improved to 11.1% compared to 11.9% in FY92. Though in absolute terms this growth looks small, we must realise that this is on a higher sales base.

  Source: CMIE

The improvement in operating margins is mainly due to the fact that these companies have managed to significantly reduce their power, employee and other operating costs per unit produced. The table below indicates how these expenses have fallen as a percentage of total sales in the period between FY92 and FY02. However, the benefit of lower costs (as a % of sales) has been offset by increase in raw material costs.

Other operating expenses % of sales2.8%2.1%
Power and fuel expenses % of sales4.0%3.0%
Salaries and wages % of sales6.0%4.1%

Companies like Hindalco and Gujarat Ambuja have operating margins that are comparable or sometimes even better than the best international companies in the industry. The table below highlights the list of companies that have performed better as far improving margins are concerned in comparison to others in the study.

Operating profits
Hero Honda Motors Ltd.10.0%16.9%44.8%
Dr. Reddy's Laboratories Ltd.18.5%38.0%47.5%
Cipla Ltd.15.5%23.3%34.0%
Hindustan Lever Ltd.9.9%17.1%31.1%
B S E S Ltd.13.0%25.3%27.9%
I T C Ltd.11.1%20.7%22.5%
Hindalco Industries Ltd.23.6%43.0%21.2%

The companies listed above are the largest companies in their respective industries. Hero Honda for example has the distinction of being the largest producer of motorbikes in the world. What we are trying to indicate here is by the virtue of these companies being the largest in their respective sectors they have been able to improve their operating efficiencies as they are able to exploit scale economies.

Improvement in operating margins has led to a CAGR of 23% in net profits of these 22 companies in the period between FY92 and FY02, which is much higher than the growth in revenues (18%). Apart from operational efficiencies, a sharp fall in the debt to equity ratio has led to this considerable improvement in the net profits of these companies. For the whole set, debt to equity ratio has actually fallen considerably to 0.6 in FY02 compared to 1.2 in FY92. In fact the companies in the study set have managed to reduce their interest expenses as a percentage of total sales to 2.1% in FY02 compared to 3.3% in FY92. This can be attributed to both lower leverage and declining interest rates.

India Inc – Lower leverage
CompanyD/E (FY92)D/E (FY02)
B S E S Ltd.1.40.2
Bharat Heavy Electricals Ltd.1.90.2
Cipla Ltd.1.40.0
Dr. Reddy'S Laboratories Ltd.1.00.0
Glaxosmithkline Pharmaceuticals Ltd.1.10.0
Grasim Industries Ltd.2.00.8
Hero Honda Motors Ltd.1.30.2
Hindustan Lever Ltd.0.60.0
I T C Ltd.1.70.1
Ranbaxy Laboratories Ltd.2.50.1

Apart from operating margins Indian manufacturing sector giants have also shown an improving trend in other operational parameters like working capital to sales ratio. A reduction in the working capital to sales ratio of these companies indicates that they have been able to free cash from operations. For the given set the working capital to sales ratio has declined to 7.6% in FY02 from 13.6% in FY92. Companies like HLL, Hero Honda and Colgate Palmolive command so much clout in the operating environment that the creditors and debtors finance most of their working capital needs.

CompanyWorking capital/Sales
Castrol India Ltd.33.6%8.7%
Colgate-Palmolive (India) Ltd.11.6%-2.8%
Grasim Industries Ltd.32.8%22.7%
Hindustan Lever Ltd.8.3%1.3%
Larsen & Toubro Ltd.44.6%17.8%

The asset turnover ratio, which indicates how well the company is sweating its assets, has however fallen marginally to 1.11 in FY02 from 1.12 in FY92.

CompanySales/ Total assets (x)
Castrol India Ltd.1.51.9
Hero Honda Motors Ltd.1.92.5
Larsen & Toubro Ltd.0.50.5
Nestle India Ltd.1.92.2
Reliance Industries Ltd.0.61.0

The performance companies that have been studied here indicate that these companies have improved their overall performance despite the fact that the structural barriers to reform have existed in the last decade. With the gradual removal of structural barriers and improving an economic environment from here on, a significant amount of value is likely to be further unlocked by these companies. Currently, the Sensex trades at a P/E multiple of 13x (trailing twelve months earnings). Considering the Indian industry’s performance in the past and the fact that the operating environment gets better, the valuations certainly look attractive.

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