Returns for shareholders from top companies plunge

Your blue-chip holdings, such as Infosys Technologies, Grasim Industries, Reliance Industries or Larsen & Toubro, are now delivering lower returns for every rupee of your investment than they did four years ago.

ROE falls

The average return on shareholder funds for an overwhelming majority of the top 100 companies listed on the Bombay Stock Exchange (80 companies for which latest balance-sheets are available) has declined from 25 per cent in 2006-07 fiscal to 19 per cent in 2010-11.

The ROE (return on equity) of Reliance Industries, for instance, dropped sharply from 21 per cent in 2006-07 to 14 per cent in 2010-11. In all, two-thirds of the companies in the BSE-100 universe saw their ROEs decline between 2006-07 and 2010-11.

A combination of factors has impacted profit performance. For some, it is a decline in profit margin on a unit of sales revenue.

For others it is an expansion in equity base without commensurate improvement in profits, as companies raced to pare down their debts due to global uncertainties. For the rest it is their inability to flog their productive assets to generate larger revenues.

For instance, net profit margins for BSE 100 companies have declined from 14 per cent to 12 per cent over the last four years.

Among the blue chips most hurt were IT major TCS and Infosys, for whom the pressure on billing rates hurt profitability despite a steady flow of contracts.

For cement players such as ACC, Ambuja Cement and Grasim Industries, a steady drop in utilisation of assets after capacity additions resulted in poor asset turnover. For companies such as HDIL or Tata Steel, massive equity expansion was necessary to keep under control the debt size relative to equity base (leverage). Leaving out banks and finance companies, the debt-equity ratio for the universe fell from 0.7 times to 0.5 times, mainly on account of equity expansion.

Some companies, however, have managed to buck the falling ROE trend and many of these are, unsurprisingly, from the consumer goods basket. Hindustan Unilever, Nestle India, ITC and Asian Paints are among these. Being inherently cash-rich, they did not resort to borrowing or equity expansion, thereby maintaining high operating efficiency; buoyant consumer spends over the last few years further helped them.

With returns to shareholders falling, should investors brace for low ROEs in future too? There are conflicting views. ROEs could improve to sustainable levels of around 20 per cent, says Mr Manishi Raychaudhuri, Head of Research, BNP Paribas Securities India.

“Asset turnover will remain pretty much stable for the time being. Margins can slightly increase if commodity prices come down, as the Indian manufacturing universe is a net user of commodities,” he says. This, alongside sufficiently de-leveraged balance-sheets, could improve ROEs marginally, he adds.

Mr Ritesh Jain, Head of Investment at Canara Robeco Mutual, however feels that returns are unlikely to improve significantly in the next couple of years, as high interest costs could depress margins.

Measure of value creation

ROE helps investors gauge the value the company creates. It measures the profit the company generates on shareholder funds.

This includes equity capital and surpluses retained from profits in previous years. A company with high ROE is likely to be able to generate more cash internally.

ROEs also indicate how attractive the Indian market is for foreign investors. Higher capital efficiency is often cited as a reason why the Indian market receives premium valuation over its Asian peers.

Incidentally, that gap has been narrowing. The Indian market (as captured by the MSCI India Index) delivered a ROE of 26 per cent, 9 percentage points higher than its Asian peers, in 2007. Now, its ROE is just 2 percentage points higher.

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