An update on the Auto Sector – a guest post

The continuing slow down in the Indian economy, coupled with high interest rates, has finally started telling on monthly auto sales numbers. The recent hike in diesel price has taken away some of the advantage of diesel models over petrol models of vehicles.

In a guest post back in Nov ‘12, Nishit had analysed the 4-wheeler auto segment and its three principal listed players. In an update this month, he examines the likely changes in fortune of Maruti, M&M and Tata Motors.

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We had explored the auto sector in India in last November’s post. We are in the New Year and let us see if things have changed. The month of December was pretty poor with Sales down about 3% year on year. The auto industry is under duress. Earlier, when Petrol price was deregulated in June 2010, it galloped from about Rs 55/litre to Rs 78/litre at the peak.

The rising petrol prices put a break on the sale of Petrol models and this led to a ‘dieselification’ of the Indian auto segment. The market leader Maruti didn’t have too much Diesel engine capacity and hence took a back seat which led to Mahindra and Tata coming to the fore.

While Petrol prices galloped, Diesel prices were not changed for a long time. Typically, Diesel used to be priced Rs 10 cheaper than Petrol. In September 2012, the government went ahead with a hike in Diesel price and the price has gone up to Rs 52/litre. At the same time petrol prices came down to Rs 73/litre. Thus, the price differential between the two fuels, which used to be Rs 10 but had increased to almost Rs 32, was brought down to Rs 21.

Another development which took place was that manufacturers took advantage of the fuel price differential and increased prices of Diesel car models - so their price differential with petrol models of the same vehicle rose to about Rs 1.5 lakhs from the earlier Rs 1 lakh.

Typically, a petrol car, if it gives a mileage of 10 km/litre will cost the owner about Rs 7.30 per km as fuel cost. The diesel version of the same model will cost about Rs 4.30. The breakeven for buyers, which was about 33,000 kilometers has now gone up to above 50,000 kilometers. Typically, most car buyers do not drive more than 10,000 kilometers a year and after 5 years, they replace the vehicle.

The demand and the wait-list for Diesel cars have vanished and they are pretty much available off the shelf. Maintenance expenses of Diesel vehicles also tend to be on the higher side.

The Government is coming up with a plan to hike Diesel prices by up to Rs 10 more this year, with a hike of Re 1 per month. If this happens then price differential between Petrol and Diesel will be back to Rs 10. The breakeven for buyers will go even higher to 75,000 kilometer running.

Petrol cars will make a comeback and the biggest beneficiary of this will be Maruti, which has a strong portfolio of Petrol cars. Mahindra will be the biggest loser as it has a line-up mainly focused on Diesel variants. Tata Motors has a mix of both, but tilted towards Diesel.

As and when the government starts hiking Diesel’s price, it would be time to switch to Maruti from Mahindra. Another key point to watch out for would be any additional excise duties on Diesel vehicles - if they are imposed in the budget. This seems like a remote possibility but anything is possible for a cash-strapped government.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan).

A look at the 4-wheeler auto segment – a guest post

Despite the double whammy of a slowdown in the Indian economy and high interest rates, sales growth of passenger cars, MPVs and SUVs show little signs of abating. This is perhaps an indication of the aspirations and increase in income of the Indian middle-class, since growth in 4-wheeler sales have outstripped that of 2-wheelers.

In this month’s guest post, Nishit takes a look at the top three listed players in the 4-wheeler segment of the auto sector.

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Auto Sales are a very important part of the economy. They serve as a barometer to show the health of the economy. Auto Sales form a part of discretionary expenditure - which can be deferred or lowered by buying a second-hand vehicle.

Auto Sales include Two-Wheeler, Three-wheeler and Four-wheeler sales. Let us focus on Four-wheelers for the moment as they constitute a higher expenditure. As India grows and the purchasing power of the people increases, it will be reflected in Auto Sales. Let us try and explore the Indian Car Market.

In India the major players are Maruti (No. 1, with 40%+ market share), Hyundai at No. 2, M&M at No. 3 and Tata Motors at No. 4. Then we have fringe players like Volkswagen, Toyota, Honda, Ford. Fringe players do not interest us for two reasons: they are not listed in India, and their sales volumes are too small.

(PVs* – Passenger Vehicles; CVs** – Commercial Vehicles)

The three main players of interest for us are Maruti, M&M and Tata Motors. Let us explore each of them.

Maruti (CMP: 1492)

It is best placed amongst all the companies. They have best selling models at various price points. At below Rs. 3 lakh price point are the Alto and EECO; next are Zen/Wagon R/Ritz at the Rs. 3-5 lakh range; followed by Swift and Dzire at the Rs. 5–7 lakh price points, and Ertiga at the Rs. 8-10 lakh price range.

They have the best service network amongst all auto companies. The downside is the lack of a proper diesel range of vehicles. The key point to observe is the pricing of the stock.

M&M (CMP: 943)

M&M has 2 best selling SUVs in their kitty: XUV500 and Quanto. The older Bolero and Scorpio models continue to sell very well. The sub-4 meter Logan has a presence in the passenger vehicle segment. The takeover of Ssangyong, Korea has resulted in new technology being available to the M&M stable. M&M has demonstrated an ability to introduce new models and this resulted in them overtaking Tata Motors to capture the No. 3 slot in India.

M&M is also the largest manufacturer of tractors in India. Any slowdown in the 4-wheeler segment may be offset by tractor sales.

Tata Motors (CMP: 265)

Tata Motors had 2 best sellers in the past: Indica and the Indigo. They have not been able to refresh their product line. The new launch of Nano has not done as well. The Diesel Nano may turn up their fortunes. They are coming up with Manza CS, a sub-4 metre sedan in 2013. The domestic woes are balanced by a strong global sales outlook from Jaguar and Land Rover.

Tata Motors is also the leader in the commercial vehicles segment, with vehicles based on their mini-truck ‘ACE’ platform doing particularly well.

In a nutshell, Maruti is the current leader in the 4-wheeler auto segment with a good product line, pursued by M&M and Tata Motors. The other 4-wheeler manufacturers either have a very fledgling product pipeline or are yet to come out with future plans. Maruti is well positioned with plans for more new launches in 2013.

Two-wheeler sales are showing signs of deceleration, as the economic slowdown hits the common man. Auto sales numbers can be tracked to buy the listed auto companies, or wait for signs of improvement in the economy and lower interest rates to enter.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan).

How to identify a truly great company from a merely good company

In a post back in Dec. ‘09, I had mentioned that the great companies can be distinguished from the good companies by how efficiently they use the money invested in the business to generate higher profits. The post was an introduction to a short series of articles on financial efficiency and profitability ratios.

At that point of time, I had not heard of, or read anything by Jim Collins – the former award-winning teacher at the Stanford Graduate School of Business. In his 2001 book, titled “Good to Great”, Collins has distilled and analysed the results of a 5 years long research project undertaken to identify how merely good companies become truly great companies.

Collins and his team of research associates sorted through all the published information available on more than 1400 US companies, and held countless interviews and discussions to come up with a short-list of 11 truly great companies.

These companies were merely good for many years before they were able to produce sustained great results over a period of 15 years, and significantly outperformed bigger and better known competitors in terms of stock market returns.

The outperformance period of 15 years occurred during the 1970s, 1980s and 1990s – just prior to the dot.com boom and bust. Some of the companies are no longer great companies, and some are almost down and out.

The book is a good read nevertheless, and reveals some universal and timeless principles that can help us to identify (and invest in) the truly great companies in the Indian stock markets. Here is a gist of the principles:

1. The transformation from good to great doesn’t happen suddenly. It is a process of a gradual build-up followed by a breakthrough.

2. Unlike the popular perception of how companies are turned around by high-profile leaders with rockstar-like personalities and egos, the good-to-great leaders are self-effacing, quiet, reserved, and have strong personal integrity. Such leaders ‘are a paradoxical blend of personal humility and professional will. They are more like Lincoln and Socrates than Patton or Caesar.’

3. Good-to-great leaders make sure that they select the right people for the right jobs, and spend most of their time on team building and succession planning. They don’t take the credit for the outperformance of their companies. They give the credit to their team.

4. Once the entire team is on board and the vision and strategy have been agreed upon, there is complete faith in the eventual success – and at the same time, the discipline to confront and overcome adversity and changes in current reality.

5. The good-to-great companies have a culture of discipline – disciplined people, disciplined thought, disciplined action. The culture of discipline combined with an ethic of entrepreneurship produces great sustained performance.

As I was reading the book, the first name that flashed across my mind was ‘Narayanmurthy’. He epitomises all the principles mentioned about good-to-great leaders, and led Infosys to become one of the truly great companies. The succession planning in the company has been an example that others should emulate.

Ratan Tata (Tata Steel, Tata Motors), Anand Mahindra (M&M), Yogi Deveshwar (ITC) are some of the names that also come to mind. Disciplined investing in these companies can generate enormous wealth over the long-term.

I am sure there are several other names that readers may know of.

Why has the Sensex remained rangebound for 10 months?

Many small investors are perplexed about the rangebound Sensex over the past 10 months – trading between 15300 and 18300 in a slightly upward sloping channel.

Of late, the Sensex has been trying to break above the trend line connecting the tops. But every time it has fallen back into the trading range, despite continuous buying by the FIIs.

So what gives? There could be two possible reasons. The first is that most of the Sensex stocks appear fully valued or even over-valued, so action has shifted to the mid and small-cap stocks. The second is that some Sensex-constituent stocks are performing very well, while others have lagged the Sensex.

Trying to analyse the possible first reason would require access to FII buying and selling data that I do not have. It is based on anecdotal evidence. But the second reason can be verified more easily with a quick, back-of-the-envelop calculation.

Here is what I gathered, by comparing the closing prices 10 months ago with that of today’s prices:

Sensex stocks	Price on 12.10.09	Price on 12.08.10	% Gain/ (Loss) in 10 months
ACC	796	837	5.1
BHEL	2424	2496	3.0
Bharti Airtel	351	318	(9.4)
Cipla	298	314	5.4
DLF	425	316	(25.6)
Jindal Steel and Power	619	656	6.0
HDFC	2758	2991	8.4
HDFC Bank	1700	2075	22
Hero Honda	1631	1867	14.5
Hindalco	129	167	29.5
HUL	290	266	(8.3)
ICICI Bank	893	964	7.9
Infosys	2240	2779	24.1
ITC	129	153	18.6
Jaiprakash Associates	160	119	(25.6)
Larsen and Toubro	1657	1805	8.9
Mahindra and Mahindra	458	633	38.2
Maruti Suzuki	1516	1226	(19.1)
NTPC	210	195	(7.1)
ONGC	1245	1267	1.8
Reliance Comm	248	173	(30.2)
RIL	1084	972	(10.3)
Reliance Infra	1357	1095	(19.3)
SBI	2173	2784	28.1
Sterlite	170	168	(0.01)
TCS	581	855	47.2
Tata Motors	550	1024	86.2
Tata Power	1319	1329	0.01
Tata Steel	546	520	(4.8)
Wipro	344	413	20
SENSEX	17027	18074	6.1

Only 13 stocks have outperformed the Sensex in the past 10 months. 1 stock was an equal performer. The balance 16 underperformed the Sensex. Not a very scientific experiment, but one that may give us clues for taking investment decisions.

1. The IT pack – Infosys, TCS, Wipro have outperformed

2. SBI and HDFC Bank have outperformed; HDFC and ICICI Bank have marginally outperformed the Sensex

3. Hindalco has outperformed, but Sterlite and Tata Steel have underperformed

4. Hero Honda, M&M and Tata Motors have outperformed; Maruti Suzuki has underperformed

5. Tata Power and NTPC have underperformed; Jindal Steel and Power have given equal performance with the Sensex

6. Bharti Airtel and Reliance Comm have underperformed

7. ITC has outperformed but HUL has underperformed

8. ONGC and RIL have underperformed

9. ACC, BHEL, DLF, Jaiprakash Assoc, Reliance Infra have underperformed; L&T has marginally outperformed

10. Cipla has underperformed

One school of thought says: Tend the flowers and pull out the weeds. Translated into English, it means hold the outperformers and get rid of the underperformers.

While that may be sound logic, it may not necessarily make good investment strategy. If the Sensex has to move above the trading range, the outperformers have to keep performing, but the underperformers need to pick up the baton and start running.

In other words, if you believe that the Sensex is going to move higher, a contrarian bet on the underperformers is likely to provide good gains. That is not a blanket permit to buy all the underperformers. One still has to do due diligence.

This may not be a bad time to pick up Tata Steel, RIL, Sterlite and, on dips, HUL, NTPC, BHEL. The telecomm sector is best avoided.

About advantages and disadvantages of mergers and acquisitions (M&A) and demergers

As a general rule, mergers and acquisitions (M&A) are value destructive for shareholders. Demergers or spin-offs are value accretive. In simple English, that means, avoid the shares of an acquiring company. But there may be money making opportunities in the companies being demerged or spun off.

There is a difference between a merger and an acquisition. Mergers are rare, as they happen between two companies that are equal in size and reach. Both companies lose their individual identities, and a third company is formed. For example, pharma companies Glaxo Wellcome merged with Smith Kline Beecham, and formed a third entity, Glaxo SmithKline.

In India, the situation was different. A much smaller but profitable and shareholder-friendly EsKayef lost its identity to the bigger but slower growing Glaxo. EsKayef shareholders were given Glaxo shares in the ratio of 1:2.

An acquisition, or a takeover, happens when a bigger company buys out a smaller company, with or without the smaller company's cooperation or willingness to be acquired. The usual motivations are economies of scale, killing a competitor, gaining market share and reach.

The biggest disadvantage of acquisitions is that they fail because of cultural mismatches. Every company is shaped over the years by the vision and background of its promoters or management. This is called 'company culture' - the way they project themselves in the market place, how they treat customers, employees, suppliers and shareholders, their social responsibilities, integrity and commitment, innovating capabilities.

No two companies do business the same way, even within the same sector. When one company acquires another, the cultural differences become very difficult to overcome. This leads to key personnel of the acquired company quitting and leaving with priceless intellectual property and customer relationships built up over many years.

Reverse takeovers, when a smaller company acquires a larger one, are even worse. Like Tata Steel buying Corus or Tata Motors buying Jaguar-Land Rover. In both cases, the the ambition was to become  global companies in quick time. But the prices paid in both cases were too high, and the timing was wrong. The shares of both companies tanked while they scrambled to raise money to cover the huge acquisition debt.

For shareholders of the company being acquired, an advantage could be a bidding war between two or more potential acquirers. This is currently happening with Great Offshore (earlier demerged from Great Eastern Shipping). Without any change in the fundamentals, the share price is going up as two likely acquirers are bidding up the offer price.

Opto Circuits is a notable example of an Indian company that has successfully used the acquisition route to grow its sales and profits quickly. Probably because they have shrewdly targetted companies with complementary products and geographical reach that were not doing well financially.

Demergers and spin-offs happen due to two main reasons:

1. Getting rid of an unwanted or less profitable division or subsidiary - like Larsen & Toubro did with its cement business, and ICI has done with its non-paint subsidiaries. Profitability and share prices of both companies increased significantly.

2. Spinning off a division or subsidiary into a stand-alone company because it has grown in size and value. Mahindra & Mahindra has done this a few times, with its financial services, information technology, holiday resorts subsidiaries.

Investors would do well to look out for companies that have 'hidden assets' in the form of profitable subsidiaries. Sooner or later, these subsidiaries will get demerged or spun off. With reforms in the financial sector a top priority of the Government, I would keep a close watch on companies with asset management (read, 'Mutual Funds') and insurance subsidiaries.

A few companies that come to mind are Reliance Capital (though I'm not particularly fond of the word 'Reliance'), Exide, HDFC, Sundaram Finance, SBI, Canara Bank.

(Interested readers can learn more about M&A from this article.)

Your portfolio of stocks and mutual funds - why you shouldn't diversify

Investment analysts and the pink papers cry themselves hoarse about why investors must diversify their portfolios to mitigate risk and enhance returns.

This is another one of those investment myths that need debunking. Peter Lynch coined the term di'worse'ify about companies who enter unrelated areas of activities. The term applies equally well  for investors.

50 stocks or 20 funds in the portfolio is a classic case of di'worse'ification. Individual investors should try not to have more than 10 stocks or 5 funds in their portfolio. Otherwise it takes too much time and energy to keep track of the performance of individual shares and funds.

The richest individuals in the world tend to have extremely concentrated portfolios. Think about Microsoft's Bill Gates, Oracle's Larry Ellison, Walmart's Sam Walton, Infosys' Narayanmurthy.

While the average investor like you or me can't be compared with the legends mentioned, we can reduce risk and enhance wealth by placing a few concentrated bets on outstanding stocks. The key word here is 'outstanding'.

If you prefer particular sectors, avoid sugar or cement or real estate that give you windfall profits one day and huge losses on another. Concentrate on defensive sectors like FMCG and Pharma. You'll get steady and regular returns through price appreciation and dividends. And the downside will be limited.

So here is a formula for investment success. Buy a few outstanding stocks from the FMCG and Pharma packs - like Colgate, Hind Lever, ITC, Nestle, Glaxo, Lupin, Sun Pharma. These will provide steady returns and limit your losses during bear markets.

Balance such a sector tilt with stalwarts like Reliance, L&T, Bharti, Tata Steel, M&M. For a little extra, albeit risky, return add the odd Maharashtra Seamless and Opto Circuit.

Mutual Fund investors can buy a couple of diversified equity funds (like HSBC Equity, DSPML Top 100, Sundaram Select Focus), a couple of Balanced Funds (like HDFC Prudence, DSPML Balance) and an ELSS fund (like Magnum Tax Gain or Sundaram Tax Saver).

If you feel that such a portfolio is boring or uninteresting, then that is a very good indicator that you will make very good returns! For excitement and adrenaline flow, you can always visit Las Vegas or the Mahalaxmi race course!

Don't be a bull or a bear in the stock market, be an African python

The triangular headed South African python is a truly awe-inspiring reptile - massive in length and weight, immensely strong with an intricately patterned shining skin. The other day, on the National Geographic channel, the camera followed such a beauty as it slowly slithered through the bushes and weeds and glided into a watering hole.

There it hid with only its snout above the water - and waited patiently. Day followed night and night followed day - and still it waited. Animals big and small, arrogant and shy, came to the watering hole for a drink. The python didn't move.

Six days and nights passed - and no body except the camera-person knew that the python was lying in wait. On the 7th evening a herd of deer came for a drink. A younger and frisky member ventured a little further from the water's edge - unaware of the peril.

Suddenly, the water hole exploded into action. With its immense muscle power, the python lunged out like greased lightning and in the blink of an eye had wrapped itself around its prey. The poor animal probably didn't even know what hit him.

The South African python is used to spending weeks and even months without feeding. Some times it eats the odd rodent or bird. But when it really wants to eat, it plans its every move and with infinite patience grabs a large meal so that it won't have to eat for a long time.

Like the python, a successful long term investor does not need to 'feed' (i.e. trade) every day or every month. Once in a long while, the stock market provides an ideal opportunity to grab a few frontline stocks at mouth-watering prices. Back during the 2002-2003 bear market period, stocks like Tata Steel was available at 100, M&M at 90, ITC at 60 (actually 600 for a Rs 10 share). All three subsequently offered bonus shares at 1:2, 1:1 and 1:2 ratios respectively.

There were many other shares going for a song and which made a ton of money for savvy long term investors. Since then, we had a one-way bull-market with V-shaped corrections in 2004 and 2006. But after 5 long years we are now in a full-fledged bear market which seems to have completed its first leg at 12500.

For long term investors, this is the right time to behave like the python. Don't jump yet. Conserve your muscle power (i.e. cash), decide on a few target companies and wait patiently for the market to exhaust its second leg. This will possibly happen in the 15500-16500 range. (A few 'dud' shares in your portfolio can be sold in that range.)

The Q1 results declared so far show that top line growth has been satisfactory for most companies. But margins growth has been far lower and below expectations. With inflation rate still in double digits, interest rates are unlikely to come down any time soon. The lower oil prices and political stability are the silver linings.

The Q2 results are likely to be worse than Q1. The market will probably have a third leg down to test the 12500 bottom, and panic and doom will be all around. Time frame should be around October. That will be the right time to lunge.