Posted byTCXat April 20. 2012
Hi Donald,
Once again this is very interesting to pursue. and amazing results for ITC!!
| ITC | 2011 | 2010 | 2009 | 2008 | 2007 |
| Revenues | 21120.83 | 18567.45 | 14985.81 | 14032.2 | 12313.83 |
| EBIDT | 7974.79 | 6677.37 | 5348.23 | 4965.65 | 4299.13 |
| Depreciation | 655.99 | 608.71 | 549.41 | 438.46 | 362.92 |
| EBIT | 7318.80 | 6068.66 | 4798.82 | 4527.19 | 3936.21 |
| EBIT Margin | 34.65% | 32.68% | 32.02% | 32.26% | 31.97% |
| Working Capital | 819.34 | -706.17 | 2588.91 | 2041.9 | 1695.22 |
| Net Fixed Assets | 8345.07 | 8142.4 | 7271.91 | 6168.83 | 4744.77 |
| Net Other Assets | |||||
| Invested Capital | 9164.41 | 7436.23 | 9860.82 | 8210.73 | 6439.99 |
| Capital Turnover | 2.30 | 2.50 | 1.52 | 1.71 | 1.91 |
| EBIT/Invested Capital | 79.86% | 81.61% | 48.67% | 55.14% | 61.12% |
| ROIC | 53.51% | 54.68% | 32.61% | 36.94% | 40.95% |
| Economic Profit | 3803.87 | 3173.65 | 2031.91 | 2047.93 | 1864.46 |
| Cumulative EP | 12921.82 | 9117.96 | 5944.30 | 3912.39 | 1864.46 |
| 5 yr EP/Invested Cap | 200.65% |
Please help interpret. This is a much much better business to invest in. Ofcourse, the other part is under-valuation in the stock. But with characteristics like these, I think the business must have compounded very well -and stock valuation would have kept pace!
Ofcourse ITC is a much better business to invest in. But look at the valuations it is trading at. I believe it is trading at a PE multiple > 35x LTM earnings. Clearly the superior dynamics of the business are already reflected in the share price. Clearly, there is no margin of safety.
The task as a value investor lies in identifying superior businesses trading at low PE multiples.
Another useful indicator I look at is Return on Reinvested Capital.
RoRC = Change in Operating Profits / Change in Invested Capital
This metric shows the returns generated on every $ of capital re-invested. If a company has reinvest $100 and increased earnings by only 5 then clearly management is into 'empire-building' i.e. creating a large company and essentially destroying value.
Hi Everyone,
Good discussions here
The best thing about these exercises is that one gets a practical understanding of the levers of growth and the magic these things can have over longer term.
Yes, Mayur has the best ratios and kudos to many of you guys for understanding the change early and allocating a high % to it. One thing which I would like to see in Mayur is - growth in Balance sheet size also. I feel that growing balance sheet with high ROIC etc is also very important eg: BKT.
Ayush
Hi Subbu
Many Thanks for your response.
1. RoRC is a very interesting concept. Balkrishna's case seems to be going in that direction - creating a large company but essentially destroying value!!
In one single day, my learning has taken a leap thanks to folks like you
2. ITC; I looked at the price charts. Has been cheap several times in the last 5 years. whole markets correct, etc. in 2007 base price was 90, today it quotes at 245, or a 22% CAGR stock returns over 5 years - not bad at all. doubling in 3.5 years
http://www.cmlinks.com/moneypore/profilenew/financial.asp?mainopt=16&cocode=13504
But if I were smart and kept an eye out for ITC knowing it is that great a business, I could have picked up ITC at 65 in Mar 2008 (much before the Sep 2008 global crisis so we are not taking of extraordinary situations). And that would be a very handsome 55% CAGR!!!
As you say all this is hindsight ofcoursebut we can be smarter right, by knowing what to wait for? or, is that very difficult in practice? Doesn't the market give you a chance every 2-3 years to make a very insightful capital allocation.
We should be able to get good compounding even from well-known/discovered stocks. I mean keep taking the 20% plus compounding without complaints, and then if you get a chance in 2,3,4 years make a big swoop to average down drastically - and then you are owning a much superior business and getting handsome compounding too!!
Is this doable??
Your welcome TCX.
Yes, I agree with you. Ideally one could do what you prescribe to generate wealth. Companies like ITC are quite cheap during recessions, global financial crises etc. But its exactly at times like these that investors panic and are too scared to enter markets. Assuming you can conquer your behavioural biases and act rational at all times, this is doable and has been done.
Hi TCX,
BKT destroying value?? Please do share your working.
From what I can make out, it may seem so because of the volatility in the margins of the co over last 3-4 years. 2010 was an exceptional year for the co in terms of operating margins and hence the ratios might throw out such results. I don't think a co with a ROCE of more than 20% consistently can be a wealth destroyer. Also, projects like these are capital intensive in nature and take time for the capacity to come up and results to show up.
Ayush
Very interesting points from all participants. Lot to learn from here.
Donald, one small point when you are looking at Economic Profit is that WACC is going to be different for different companies. I think it will be materially different if you start comparing mega-cap companies to small or mid cap ones. So, ITC has access to much lower capital than say, Mayur. So, from that perspective ITC's Economic Profit would be higher than what you have calculated!!
I fully subscribe to Subbu's view, that the problem with ITC (or HDFC Bank or other such perennial value creators) is their valuations. Also, agree with what TCX suggested, you have to wait like a "vulture" (Peter Cundill's words, not mine) and pounce when the market gives an opportunity. Again the problem with a company like ITC is when the overall market turns violently down, it is relatively insulated, so the opportunity cost of getting into other relatively cheaper options at that time is higher!!
Attaching the chart of ITC from 2000 till date. Check the period between 2006 - 2010 where the stock was in a range and the market had gone up and down tremendously in during those days.
My question is to Donald.
you said that "Invested Capital is the sum of Working Capital and net fixed assets, and net other assets (net of noncurrent, non-interest-bearing liabilities)." But this amount must have come from equity as well as debt. But as investors aren't we more interested in Return on Equity rather than Return on total capital. Can you please explain to me more on taking ROIC instead of ROE.
Hi Shruti, even though the question is directed at Donald, let me put my thoughts here and Donald (and others can add).
RoE is extremely important metric to understand the return that is being earned by the owner's cash. However, as an owner I would want to know/understand what return my business in generating on the total capital that is invested. That will tell me what would happen if the company became totally debt free. Or what would be the impact if I put on more debt. To understand the overall quality of a business, it is more important to look at overall return rather than only RoE. RoE can be increased just by increasing debt levels and can provide a wrong picture of the business.
Hi Shruti,
I think PAT Dorsey has explained this the best.... If you still have not read his book, as an analyst you are missing something! following in PAT Dorsey's words
Return on Invested Capital (ROIC) is a sophisticated way of analyzing return on capital that adjusts for some peculiarities of ROA and ROE. It's overall a better measure of profictability than ROA and ROE.
Essentially, ROIC improves on ROA and ROE because it puts debt and equity financing on an equal footing. It removes the debt-related distortion that can make highly leveraged companies look very profitable when using ROE. RoIC uses operating profits after taxes but before interest expenses. Again the goal is to remove any effects caused by a company's financing decisions -does it use debt or equity? - so that we can focus as closely as possible on the profitability of the core business.
Thanks Abhishek and Donald for the clarification.
Thanks Arindam for some good pointers.
I looked at Marico over last 5 years, and it has done one better than ITC!
| Marico | 2011 | 2010 | 2009 | 2008 | 2007 |
| Revenues | 2346.87 | 2001.5 | 1921.85 | 1575.99 | 1373.27 |
| EBIDT | 432.09 | 343.62 | 222.1 | 211.95 | 191.95 |
| Depreciation | 27.63 | 25.21 | 17.03 | 18.93 | 35.19 |
| EBIT | 404.46 | 318.41 | 205.07 | 193.02 | 156.76 |
| EBIT Margin | 17.23% | 15.91% | 10.67% | 12.25% | 11.42% |
| Working Capital | 687.27 | 499.54 | 402.11 | 333.21 | 165.8 |
| Net Fixed Assets | 222.46 | 129.97 | 115.91 | 96.99 | 95.06 |
| Net Other Assets | |||||
| Invested Capital | 909.73 | 629.51 | 518.02 | 430.20 | 260.86 |
| Capital Turnover | 2.58 | 3.18 | 3.71 | 3.66 | 5.26 |
| EBIT/Invested Capital | 44.46% | 50.58% | 39.59% | 44.87% | 60.09% |
| ROIC | 29.79% | 33.89% | 26.52% | 30.06% | 40.26% |
| Economic Profit | 161.82 | 137.79 | 75.23 | 77.70 | 73.73 |
| Cumulative EP | 526.27 | 364.45 | 226.66 | 151.43 | 73.73 |
| 5 yr EP/Invested Cap | 201.75% | ||||
And here's a look at VST Industries!!!
| VST Industries | 2011 | 2010 | 2009 | 2008 | 2007 |
| Revenues | 558.58 | 470.54 | 371.06 | 338.9 | 332.83 |
| EBIDT | 158.31 | 100.17 | 102.3 | 99.91 | 96.33 |
| Depreciation | 24.42 | 17.87 | 15.82 | 13.72 | 11.48 |
| EBIT | 133.89 | 82.30 | 86.48 | 86.19 | 84.85 |
| EBIT Margin | 23.97% | 17.49% | 23.31% | 25.43% | 25.49% |
| Working Capital | -65.87 | -82.32 | -84.37 | -113.12 | -74.15 |
| Net Fixed Assets | 152.42 | 132.59 | 125.44 | 118.85 | 94.83 |
| Net Other Assets | |||||
| Invested Capital | 86.55 | 50.27 | 41.07 | 5.73 | 20.68 |
| Capital Turnover | 6.45 | 9.36 | 9.03 | 59.14 | 16.09 |
| EBIT/Invested Capital | 154.70% | 163.72% | 210.57% | 1504.19% | 410.30% |
| ROIC | 103.65% | 109.69% | 141.08% | 1007.81% | 274.90% |
| Economic Profit | 79.32 | 49.11 | 53.01 | 57.06 | 54.37 |
| Cumulative EP | 292.87 | 213.55 | 164.44 | 111.43 | 54.37 |
| 5 yr EP/Invested Cap | 1416.20% |
http://www.moneycontrol.com/stock-charts/vstindustries/charts/VST#VST
VST 2007 -380
VST 2012 -1975
5yr Price CAGR = 39.05 %
Hi Arindam,
This is getting real interesting! Just to get a broader perspective on why some of these businesses have given such excellent returns, I computed 5 yr Sales, EBIT and Price CAGR with the Economic Profits generated!
| 5Yr | Sales CAGR | EBIT CAGR | Price CAGR | 5Yr EP/ Invested Capital |
| ITC | 14.44% | 16.77% | 25.39% | 200.65% |
| Marico | 14.34% | 26.74% | 35.10% | 201.75% |
| VST | 13.82% | 12.08% | 39.05% | 1416.20% |
Does this data tell us something?? Please help interpret.
I think the problem with VST is that it is reliant on government subsidies, farm credit etc which creates a bit more uncertainty with respect to demand. Overall I'd still consider it a very good stock with decent valuations. But considering the perennial headwinds involved it is never going to trade at a PE multiple of 30+ like Marico or ITC. The market believes that Marico and ITC have stronger, sustainable competitive advantages relative to VST.
Hope it adds value. I think such numbers must be juxtaposed with a reasoning of the drivers behind the numbers.
Hi Subbu,
This was referring to VST Industries - the cigarette maker, not VST Tillers. The makers of the original Charminar brand!
Rgds
Thanks TCX. Upon briefly going through VST Industries, I have no doubt it is a company with good fundamentals. But if you want to compare VST ind with Marico or ITC one has to look at management's plans, diversity of the business i.e. number of strong brands for the future and dividend payout ratio as well.
The problem with such large strong companies like ITC and for that instance even Microsoft is that they have one super product which generates strong margins. Now management has the task of investing the profits generated from these super products into other business lines which may or may not be successful. Microsoft ventured into video games like XBOX etc which may or may not be as profitable as Windows.
Apple, meanwhile has managed to deliver a string of blockbusters from ipod to iphone to ipad.
The valuations of such stocks therefore depend on how management plan to use cashflows and what your opinion of the strength of the other business lines are.
For the calculation of ROIC, Invested capital, should we leave out investements? If yes can you explain why?
Hi Shruti,
This was addressed in an earlier post.
We should specifically exclude excess cash and marketable securities. These generally represent temporary imbalances in the company's cash flow. For example, in Balkrishna Industries Q2 BS, there was some excess 650 Crs+ held in Cash Investments if I remember correctly. The money had just been drawn from ECB for deploying for capex in Q3 and Q4. Usual cash balance for the company is normally 5-10 Crs.
Excess Cash and marketable securities are the short-term cash and investments a company holds over and above its target cash balances to support operations. Target cash balances are usually less than 3% of Sales, depending on the industry.
You can identify excess cash balance and investments- by comparing these in the BS for a few years. Calculating as a percentage of Sales will help highlight big differences.
WACC for ITC could be different from Mayur and is dynamic,it would be changing from year to year based on capital structure
WACC=Ke(E/E+D)+Kd(1-T)(D/E+D)
ITC has zero debt,the second part vanishes and always the cost of equity is higher than cost of debt.
so we have only the first term,ke
ke=risk free rate+beta(excess market returns)
=9+0.33*8=11.64,the WACC would be higher for a company having higher beta