Bluechips: Then and now

As Finance Minister P Chidambaram readies to unfold his 'vision' for the Indian economy early next week, he is faced with the challenge of having to balance the 'wishlist' of corporates in India and the logical move to open up the economy further for more competition, which though 'resisted' by some section (including some corporate circles), can yield desirable long-term results.

Take the case of the telecom and now, the aviation sectors. While we do not believe that a single budget will make a sea change, if one considers the last eleven years, i.e. FY94-FY04, despite inconsistency in policy direction, corporates have come a significant way.

Here, we have ranked the companies (on the basis of operating margin and return on net worth) in FY94 and in FY04 to understand the change in dynamics.

The leaders in FY94 first. . .

Take the case of FY94. The Indian economy was experiencing the first phase of expansion by corporates in terms of capacity addition, post the liberalisation.

In our series of research meetings with the then development financial institutions last week (ICICI and the like), one of the key objectives was to understand the difference in the role of financial institutions and the 'mind set' of corporates in India.

Relatively rigid exchange rate policies, highly regulated sectors, high interest and inflation rates, subsidised money for lending and more importantly, a sense of 'fear' among corporates with respect to competition from global majors were the key growth impediments.

At the same time, since competition was mostly from domestic manufacturers and in the backdrop of protection (high customs duty for instance), corporates were making easy money, as is evident from the operating margins in FY94 (the table below). Sectors like fertilisers, power and energy were operating on a fixed return on capital employed, without taking into consideration the efficiency factors.

Operating margin - Then Company FY94 FY04 Lupin 66.7 22.4 Thomas Cook 58.0 33.2 GMDC 57.6 42.8 MTNL 54.9 30.6 Chambal Fertilisers 49.7 19.0 Himatsingke Seide 47.9 41.2 Neyveli Lignite 46.4 46.5 Hotel Leelaventure 45.9 38.8 Indo Gulf Corporation 38.6 - Essar Shipping 36.9 37.5 (sorted on the basis of FY94)

Return on equity - Then Company FY94 FY04 Madras Cements 93.4 11.7 Bajaj Hindustan 83.4 23.3 TVS Motors 73.6 24.6 Skanska Cementation 57.7 4.4 GTL 56.7 6.0 RPG Cables 54.8 - Usha Martin 53.4 3.7 Torrent Pharma 49.9 20.9 Essel Propack 49.6 6.7 Hotel Leelaventure 48.7 1.6 (sorted on the basis of FY94)

The leaders in FY04. . .

With

the successive governments reducing protection i.e. lowering import duty, de-regulating sectors by allowing increased competition and reducing the role of government in the framing of regulations for sectors, the operating margins of companies have declined drastically in the last eleven years.

Fertiliser companies, which used to enjoy healthy margins, are now faced with further de-regulation and having to invest in cost reduction exercise in a significant manner. At the same time, the return on equity of corporates have also tumbled, which is a consequence of lower profitability.

And the most profitable and the best return on net worth list has also changed. Following is the ranking based on our Quantum Universe of 350 companies in FY04.

Operating margin - Now Company FY04 ONGC 55.2 Rolta India 50.9 GE Shipping 49.6 Balaji Telefilms 48.6 Neyveli Lignite 46.5 Nalco 44.9 GMDC 42.8 Moser Baer 42.3 Hindustan Zinc 42.0 Crisil 41.5

Return on equity - Now Company FY04 HLL 82.8 Nestle 78.5 Jindal Vijaynagar 70.5 Hero Honda 64.0 Bharat Forge 58.6 BRPL 55.2 SAIL 53.9 Swaraj Mazda 51.5 Apar Ind 46.0 Abbott India 46.0

Barring Neyveli Lignite and GMDC, the top operating margin companies list, when compared with FY94, has changed completely. While commodity companies dominate the list for now, as we go forward and the commodity cycle weakens, one is likely to witness a sea change in the list again.

To sum it up, if one compares the operating margins of the BSE-30 companies with that of peers in the global markets (including some in the emerging markets), taking into account the advantages of low cost facilities and access to raw materials into consideration, we believe that margins are significantly higher for select auto and engineering companies. So, valuation have to accorded keeping in mind the downside risk to margins.

As a signatory to WTO, the finance minister has to move the economy towards further de-regulation, which would involve gradual phasing out of subsidy share of the government, allowing corporates to take decisions based on market forces and increased competition.

Fertilisers, energy, banking, commodites, textiles are some of the key sectors that will face the pressure going forward.

This is part of Equitymaster's Budget 2005-06 series. Equitymaster.com is one of India's premier finance portals. The Web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.