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Top 10 companies by ROCE in FY02

Jul 4, 2003

A ratio, which would be an appropriate indicator for gauging shareholder return on capital invested in a particular company is Return on capital employed (ROCE). This ratio indicates how well the company, utilizes shareholder's funds. The ratio goes as below: Profit after tax + interest * 100 / networth + total borrowings (Capital Employed)

To base our study, we have used only the Quantum Universe, as it includes over 90% of total market capitalization of BSE as a whole (we have excluded banks and financial institutions from this exercise). Based on FY02 numbers, let us see who are the top 10 companies and how have they performed over the last decade.

ROCE %
Name of company FY93 FY02 SECTOR
1 NESTLE INDIA LIMITED 14.5 71.5 FMCG
2 HERO HONDA MOTORS LIMITED 20.7 68.8 AUTO
3 I.B.P. CO. LIMITED 11.8 50.5 PETROLEUM
4 HINDUSTAN LEVER LIMITED 24.8 49.6 FMCG
5 BALAJI TELEFILMS LIMITED N.A. 49.4 MEDIA
6 OTIS ELEVATOR CO. (INDIA) LIMITED 9.5 45.8 CONSUMER PRODUCTS
7 VST INDUSTRIES LIMITED 25.8 44.0 FMCG
8 TATA ELXSI LIMITED 0.8 41.4 SOFTWARE
9 DIGITAL GLOBALSOFT LIMITED 18.3 41.1 SOFTWARE
10 INFOSYS TECHNOLOGIES LIMITED 41.2 38.8 SOFTWARE

From the table above, it is apparent that 3 out of the top 10 companies that have a high ROCE are FMCG companies. This indicates that these companies have been the best in utilizing funds and generating value for shareholders. Typically, in the FMCG sector, capital cost is lower due to lack of large-scale manufacturing facilities. Bulk of the capital expenditure goes towards setting up distribution network and investing in brand building. Once a brand (say Nescafe) is established, companies like Nestle are able to leverage on the same and generate higher revenues with minimum incremental investment in promotion. This is one of the reasons why FMCG companies have higher return ratios.

To elaborate further, a significant part of HLLís revenues are derived from sale of products (manufactured by a small-scale player). Most of the FMCG companies are also strong at managing their working capital requirements. Hence, working capital for companies like HLL is negative. This automatically unlocks cash, which the company can invest in its core business. Consequently, investors are rewarded.

Software companies, too, as indicated by the table have high ROCEs. Why do software companies have higher ROCE? Typically, 40% of total revenues are salary cost for software companies. To recover costs and deliver value to shareholders, utilization of human resources is of significance (through a mix of onsite and offshore model). When utilization increases and if this is accompanied by growth in revenue per employee (by providing value-add services), profitability increases. Since tech companies are cash rich (read no debt), ROCE is on the higher side despite absence of revenue visibility. Another interesting find in the top 10 was IBP, which is a pure petroleum products marketing company. The company had an ROCE of over 50% in FY02 and (12% in FY93). However, one should understand that IBP is not a manufacturing company but a pure marketing company.

So, although FMCG and software companies have been wealth generators, few manufacturing majors like Hero Honda have also rewarded shareholders well in the past. It is pertinent therefore, to consider return ratio while making investment decisions.


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