The Mind of a Business Analyst

Applied Lessons for Investment Bankers and Research Analysts

Manish Chokhani

September 2004

Agenda
Components of an average recommendation
What requires to be validated
First Principles of Financial Analysis
Valuation Principles
Valuation Shortcuts and Market Cycles
Business Analysis Circle of Competence Approach
Macro Economic, Political and Social Factors
Buyer Characteristics and Compulsions
Slotting the Recommendation
Recap the Valuation

ENAM Securities

August 2004

An Average Recommendation
Here are the financials

Past two years, next two years

Current business trajectory is good
This is the P/E , this is the EPS or something similarly cheap sounding

Here are some comparable valuations

Local, regional, global

Occasionally:

Chance to buy a good business

Unique Promoter
Great Shareholders/ Funds/Pvt Equity Backing it

So Buy It

ENAM Securities

August 2004

What Needs to be Validated?

Validity of business financials

Forecast Validity

Key Business Drivers

Any hidden liabilities/ subsidiaries / etc
Business Competitiveness
Macro factors at play
Appropriate Valuation Tool

Relative validity

What else is attractive

Decompose by Country / Sector / Mktcap / Promoter

What is driving the deal?

Why the deal?

Why Now?
Who is the intermediary?
Whats in it for me?

ENAM Securities

August 2004

Understand the Business Drivers

VOLUME

Most loved Consumer focussed UVG stories: eg CellPhones, Retail, Hosing Loans, Media or large
addressable markets globally like ITand pharma (buzz on BPO, Textiles)

PRICE

Most loved Pricing Power stories: Brands, Oligopolies

Excitable Commodity swings: Cement, Metals

EFFICIENCY

IMPROVING ASSET UTILISATION

Usually Cyclicals Autos, Engineering due to operating leverage

IMPROVING COST STRUCTURE/ ECONOMIES OF TECHNOLOGY

Usually Engineering, PSUs, Conglomerates

RESTRUCTURING

Catalysts such as Privatisation, M&A, Divestitures, Buybacks

ENAM Securities

August 2004

Case Studies
Lets Examine Sustainable Valuations for

Cement

Autos

IT

Pharma

FMCG

Use 5 key measures that define peak valuations

Sales / G Block

W Cap / Sales

Sustainable or desirable OPM%

Capex requirements

Volume Growth Assumptions

Help us to decide what we lay out and what we get back

ENAM Securities

August 2004

Now Lets Attempt a DCF

ENAM Securities

August 2004

Markets continuously discount all of the above

ROE :
25%

Value

P/E=20x

ROE :
15%
P/E=12x

8%
Bonds

P/E=12x

Use Bond Yield

Reciprocal
(100/8)=12.5x
as benchmark

Value multiple
- Predictable
- Sustainable
- Scaleable

Cash
Time

ENAM Securities

August 2004

Understand Market Cycles I

Bubble

Virility Symbols (Towers, diversification/ M&A)

Bad qlty of IPOs
Capex > near-future reqments
Interest rates spike. Huge Credit expansion
Retail euphoria
Shock/ Leaders in trouble

Fair to Over valuation

Capex/ IPO/ Credit cycle
revives
Asset & Cost inflation
Tourism/ Media attention
Themes emerge, New
Valuation Paradigms

Correction
Bear Phase

Sharp fall followed by

pull back
Left outers jump in
Leadership narrows

Severe
Undervaluation
Ignored, stagnant
Cheap valuations
Negative press

Symptoms of each hump deceptively similar -- It is the

QUALITY which differs:

Undervaluation
Important commodities take off (Steel, Gold, etc.)
Catalyst/ Regulatory (eg Privatisation, LT Cap
gains exemption)
Easy Liquidity

Eg high quality IPOs & Capex at Reasonable

Valuation stage vs flood of bad IPOs & far-out-Capex
at Bubble stage

ENAM Securities

August 2004

Bust

Resulting in a Swing in Valuation Approaches

BEAR MARKET

BULL MARKET

Value

Dividend Yield
Price/BV
Replacement Cost

BUBBLE MARKET

GARP

Payback
EV/EBIDTA
P/E
DCF

ENAM Securities

Momentum

Technical Charts
Reflexivity
PE/G
Option Value

August 2004

10

Valuation Measures CASH FLOW IS THE ONLY REALITY

DCF helps to make assumptions explicit;gives a good RANGE

P/e

Use probability dont fudge the discount rate!

Factor in uncertainties and risks
Terminal Value is the key Is all the value residing there?
Wider the Optimistic-Pessimistic range lower the valuation!

P =d/(k-g)

d/e / (k-g)

d = dividend per share

k = shareholder return expectation
k = i + r + rp (inflation+real int+risk premium)
g = growth in dividend per share

Hence Importance of payouts and cash flows for better valuation

Close approximation of P/E to ROE

Other Methods are all variants for validation

EVA Economic Value Added - Excess return over WACC quantified

EVA = ROIC (IC x WACC)
CFROI Another smart way to do a DCF

ENAM Securities

August 2004

11

MARGIN OF SAFETY
Cash flow v/s Bond Valuations

Growth prospects

Gap between Perception and Reality

Knowledge v/s Popularity

Limited downside/ lots of upside

ENAM Securities

August 2004

12

UNDERSTAND GOOD BUSINESSES

THE CIRCLE OF COMPETENCE APPROACH

Manish Chokhani

September 2004

13

BUSINESSES APPRAISAL
Think long and hard about cycles
Life cycles
Business cycles
Think about sustainability and sources of advantage
Think about external pressures on profitability
Where does this business fit on a profitability distribution?
The financial litmus tests
Think about management and the majority partner

ENAM Securities

August 2004

14

Think of Cycles!
Nature is cyclical, not linear!

Life Cycles

Business Cycles / Boom-Bust

Seasonality

Innovation / Schumpeter

Market Cycles

ENAM Securities

August 2004

15

LIFE CYCLE ANALYSIS

SALES

JUTE

SOFTWARE

TIME

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August 2004

16

BUSINESS CYCLES

FMCG, SERVICES

INTERMEDIATES

CAPITAL GOODS
CONSUMER DURABLES

ENAM Securities

August 2004

17

BOSTON CONSULTING GROUP MATRIX

SOURCES OF ADVANTAGE

MANY

FEW

EMERGING/
SMALL SCALE

COMMODITY

LOW

SPECIALISED/
OLIGOPOLIES

MONOPOLY/
CONSUMER FRANCHISE

SUSTABILITY OF ADVANTAGE

ENAM Securities

HIGH

August 2004

18

PORTERS 5 FORCE ANALYSIS

NEW ENTRANTS/ IMPORTS

SUPPLIERS

INTRA INDUSTRY
RIVALRY

BUYERS

SUBSTITUTE PRODUCTS

ENAM Securities

August 2004

19

PROFITABILITY DISTRIBUTION
BANK
RATE

ROI

ENAM Securities

August 2004

20

THE FINANCIAL LITMUS

Superior BUSINESSES

Low asset requirements

Low credit / inventory
Many clients/ economic goodwill
Defensible margins
Pricing power ( inflation + )
Sustainable growth
Free cash flows

Most other businesses

Capital intensive
Working capital intensive
Want premium valuation, do not deserve it
Likely to be cyclical valuations and themes

ENAM Securities

August 2004

21

Now lets talk Micro Focus

Costs

Capital Efficiency

People Issues

Slack

ENAM Securities

August 2004

22

Costs
Are you aware of implications of:

Inappropriate Amortisation

R&D

Technology

Marketing Requirements

Training ; Leadership!

UNIT COSTS/ measures

ENAM Securities

August 2004

23

Corporates have re-engineered costs

Cost cutting in Cement Industry
100

(%)

75

1998

2004

1,200

900

50

Cost of Producing Cement (Rs/tonne)

25

Energy Consumption (Units/tonne)

110

90

Coal Consumption (kg/tonne)

200

130

1997

2004

RMC (tons per ton of Steel produced)

4.3

3.1

Energy Consumption (GCAL/TCS)

8.7

7.2

Labour Productivity (tons/Man years)

119

264

0
Cost of Producing
Cement

Energy
Consumption
(Units/ton)
1998

250
200

Coal
Consumption
(kg/ton)

Source: ENAM Research

2003
2004

Cost cutting by TISCO

(%)

150
100
50
0
RMC (tons per ton
of Steel)

Energy
Consumption
(GCAL/TCS)
1997

Labour
Productivity
(tons/Man years)

Source: ENAM Research

2003
2004

ENAM Securities

August 2004

24

Corporates have right-sized

Restructuring by Top 10 Corporates
400

(Rs.m)

(%)

12

300

200

Revenue (Rs bn)

100

Labour Force (nos)

0
1995
Revenue (LHS)
Revenue/Person (RHS)

Revenue/Person (Rs m)

1995

2003

900

2,750

420,000

335,000

2.1

8.2

2003
Labour Force (LHS)

Right-sizing across sectors

Company

Staff shed

Period (Yrs)

% of Labour Force

BHEL

20,000

30

Tata Motors

10,000

29

Mahindra & Mahindra

6,500

34

Bajaj Auto

7,800

37

Tisco

30,000

40

ACC

6,000

38

Source: ENAM Research

ENAM Securities

August 2004

25

Capital Efficiency
Are you well focussed on:

Asset Turns: Gross Block, Working Capital?

Lean Assets: Owned v/s Rented

Flexible Structures: Outsourcing

Impact of M&A, Restructuring?

People

ENAM Securities

August 2004

26

Efficiency Saved India Inc.

Peak Rate of Custom Duty (%)
80

160

60
G rowth (% )

120
80
40

40
20
0
-20
-40

1996

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

1997

1998

Sales

1999

2000

PBIT

2001

2002

2003

PBT

Working Capital / Sales (%)

12

25
20
G rowth (% )

10
8
6

15
10
5
0
-5

4
1996

1997

1998

1999

2000

2001

2002

1996

2003

1997

Cap Emp

1998

1999

2000

Borrowing

2001

2002

2003

GFA

Source: CMIE

ENAM Securities

August 2004

27

Industry consolidation helped profitability

Market share (%)
Sector

1997

2004

Aluminium

Top 3 players

77

100

Tyre

Top 5 players

72

85

Cement

Top 5 groups

32

61

Paper

Top 5 players

32

38

Petrochemicals

Top player

45

70

Media

No. of players

Multiple

3 large

Telecom

No. of players

Multiple

4 large

Source: ENAM Research

ENAM Securities

August 2004

28

People Issues
How is the company managed?

Lifetime Employment?

How does it Hire? Train? Retain? Fire?

How does it build skills? LEADERS?

Are they Commandos? Soldiers? Mercenaries?

Succession Plans?

Empowerment?

ENAM Securities

August 2004

29

Focus on Micro, Company specific factors

How is Product or Service Quality?
Germany/Japan/China v/s India, v/s competition

How is Cost & Capital Efficiency?

Frugality as a mindset v/s professionally managed

What are their Value Systems?

Sugar in the milk
How is their Service to the Customer?
The goodwill earned
ENAM Securities

August 2004

30

Watch Out for Hidden Bombs

Conflict of Interest Structures

Pvt Businesses

Inter Party relationships

Split Ownerships

Loans & Advances

Off balance Sheet Libailities

Unfunded Pensions

Litigations

Family Settlements

and many more creative reasons why CAVEAT EMPTOR

ENAM Securities

August 2004

31

CHOOSING BUSINESS PARTNERS

Integrity / track record

Ability (not just lucky)

Understanding of key issues

Ambition tempered by reality

Commonality of objectives

Orientation towards minority

ENAM Securities

August 2004

32

MACRO FACTORS TO BEAR IN MIND

Manish Chokhani

September 2004

33

Do you have Macro Pointers in Mind?

Do you have a point of view about:

Politics as it affects the business

Economics as it affects the business

Demographic Trends

What are Capital Markets Signalling?

Each powerful trend can have disruptive or tidal wave effects on any business

ENAM Securities

August 2004

34

Politics
Geo Politics affects addressable markets, terms of trade, cost of doing

business

Effect of SAFTA, ASEAN, WTO/GATT

Risk Premium/Opportunity of Pakistan

Emerging US-India axis ; NAM, ML

Opportunities in emerging economies

Outcry against/trends favouring outsourcing

ENAM Securities

August 2004

35

Outsourcing to India : Brewing Trouble

Company

Outsourcing for

IT Services
Infosys
Tata Consultancy
Wipro

Goldman Sachs, Aetna, Northwestern Mutual, Am Ex, DHL, Verizon

GE, Honda, UBS, HSBC
Transco, HP- Compacq, Nortel, General Motors, Cisco, Sony

ITES
Mphasis BFL
Spectramind

Citi Group, Acenture, Auto Zone, Capital One

Dell, American Express, Capital One

Pharmaceuticals
Cipla
Shashun Chemicals
Lupin Laboratories

Ivax, Watson Pharma, Eon Labs

Eli Lily, GSK Pharma
Apotex, APP, Watson Pharma

Engineering
Bharat Forge
Tata Motors
Moser Baer
Essel Propack

Meritor, Caterpillar, Toyota, Ford, FAW (China)

Rover
Imation, BASF
P&G, Unilever, Colgate

ENAM Securities

August 2004

36

Increasing FDI reflects openness

Cost Savings
(Production Hubs)

Research Services

Domestic Market
Opportunity

Early entrants

Recent entrants

GE, Citi IT, State Farm

Amex, Bank Am
IBM, HP

Texas Instruments, GE

Coke, Pepsi
Ford, Hyundai
LG, Samsung
Lafarge
Port of Singapore, P&O
Morgan Stanley,
Templeton

JP Morgan, HSBC, Prudential

Accenture, CGE&Y
Delphi
Teva

Microsoft, Sun, Intel

GSK, Pfizer, Eli Lily
COVANCE

McDonalds, Pizza Hut

Honda, Toyota
Nokia
Michelin
Dubai Port, Maersk
HSBC MF, Duestche MF

Likely entrants
BPOs in throngs
Deloitte Consulting
Generic Pharma Cos

A number of CROs

Fidelity MF, ABN MF

Source: ENAM Research

ENAM Securities

August 2004

37

Confident Indians going global

Pharma

Large Groups

Tata -Tetley, Daewoo , Rover tie-up

RIL - FLAG undersea cable,Trevira (Polyester
firm in Germany)
Birlas - AV Cell (Canada), Copper mines (Aus),
Carbon Black (China) etc
Sterlite - Copper Mines in Australia, Listing on
LSE
ONGC - Stake in: Sakhalin oil fields (Russia),
GNOOC oil fields (Sudan)

Wochardt-Esparma (Germany)
Ranbaxy- RPG Aventis (France)
Dr. Reddys - Meridian Healthcare
(UK),Trigenesis Therapeutics (USA)
Cadila French operations of Alpharma (USA)

IT

Wipro - Nervewire, Utilities consulting division

of AMS (USA)
HCL Tech - BTs call centre (Ireland)

Others

Auto Parts

Sundaram Fasteners - Gear casting business of

Dana Spicer (UK), Plant in China
Bharat Forge Dana Corp Forging business
(UK), Forging business of CDP (Germany)

Asian Paints - Berger International (Singapore)

Essel Propack - Propack Holdings
(Switzerland),Arista Tubes (UK)
Moser Baer - Mmore International (Holland)
Atlas Cycle, Ajanta Clocks - Plants in China

ENAM Securities

August 2004

38

Macro Economic Indicators

Global and local economic cycles

Capital costs

Interest rates, Currency rates, Inflation

Cost pressures: RMC, Tarriffs, etc

Social Costs / development

Competition is a given

ENAM Securities

August 2004

39

Eg: Complete Reversal in India

Forex reserves

60

Forex reserves
(US$ bn)

80

20

Interest rates

60

40

100

17
16
15
14
13
12
11
10

03-04

02-03

01-02

00-01

99-00

Invisibles (LHS)

Capital Receipts (LHS)

Total Reserve (RHS)

(%)

80
60
40
20
0

Jul-04

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

(%)

Trade Balance (LHS)

External debt

Interest rates & Re. depreciation

(%)

98-99

0
97-98

-40
96-97

20
95-96

-20
94-95

External debt

Rupee/ US$ (LHS)

100

40

Re. depreciation

15
12
9
6
3
0
-3
-6

120

(US$ bn)

96-97

97-98

98-99

99-00

00-01

2-Jan

3-Feb

`03-04

Foreign Exchange Reserves as % of external debt

External Debt (% of GDP)

Prime Lending Rate (RHS)

Source: RBI, CMIE

ENAM Securities

August 2004

40

Soft interest rate bias nearing an end..

Room to grow advances vs investments

Inflation making a comeback?

15

50
Investment Deposit Ratio

(%)

12

45

9
6

40

Forex reserves at a peak

120,000

15

(US$m)

100,000

12

80,000

Jan-04
Jul-04

Jan-03
Jul-03

Jan-02
Jul-02

Jan-01
Jul-01

Jan-00
Jul-00

Jan-99
Jul-99

Jan-98
Jul-98

Jan-97
Jul-97

Jan-96
Jul-96

Jul-04

Jan-04

Jul-03

Jan-03

Jul-02

Jan-02

Jul-01

Jan-01

Jul-00

Jan-00

Jul-99

Jan-99

Jan-95
Jul-95

35

Rupee volatility on the cards

(%)

(%)

17
16

15

03-04

01-02

00-01

99-00

98-99

97-98

96-97

95-96

94-95

93-94

02-03

Rupee/ US$ (LHS)

Jul-04

10
2003

-6

2002

11
2001

-3
2000

20,000

1999

12

1998

1997

40,000

1996

13

1995

1994

14

1993

60,000

Prime Lending Rate (RHS)

Source: Blloomberg, RBI, CMIE

ENAM Securities

August 2004

41

Understand Market Cycles II

ENAM Securities

August 2004

42

US Interest Rates through cycles

ENAM Securities

August 2004

43

Rising commodity prices reflect USD weakness

320

CRB All Commodity Index

Steel

Gold

All Commodities

Gold AM Fix Prices

450

550

MB HR Steel Prices

(USD/ troy ounce)

300
400

450

350

350

300

250

250
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04

150
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04

280
260
240
220
200
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04

Alumina

Non-ferrous Metals
2,000

Aluminium

Europe Alumina Spot Price

London Metals Exchange Index

500

Aluminium Primary OP SPT

2,000

(USD)

1,800

400

1,800

1,600

300

1,600

1,400

200

1,400

1,200

100

1,200

1,000
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04

0
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04

(USD)

1,000
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04

Source: Bloomberg

ENAM Securities

August 2004

44

Consumption trends across Asia

ENAM Securities

August 2004

45

Government P&L A/c AS IT REALLY IS

Centres P&L (2004-05E)
Particulars

% of GDP

Total Receipts

11

-- Revenue Receipts

10

-- Capital Receipts

Total Expenditure

15

-- Interest

-- Defence & Subsidies

-- Transfer to States

-- Infrastructure & Capital Expenditure

-- Administrative, etc.

Deficit

Total debt (Internal + External)

64

Source: Government of India Interim Budget, ENAM Research

Deficit of 5-6% of GDP misleading! Receipts only 11%

ENAM Securities

August 2004

46

States have joined the party!

1,400

Aggregate fiscal deficit of states

(Rs.bn)

(%)

5.5

Source: RBI

Fiscal Deficit (LHS)

% of GDP (RHS)

FY04 E

2.0
FY03

0
FY02

2.5
FY01

200
FY00

3.0

FY99

400

FY98

3.5

FY97

600

FY96

4.0

FY95

800

FY94

4.5

FY93

1,000

FY92

5.0

FY91

1,200

Power subsidies (% of state fiscal deficit)

State

(%)

Madhya Pradesh

74

Andhra Pradesh

51

Gujarat

65

Karnataka

65

Maharashtra

28

Tamil Nadu

40

Source: World Bank

ENAM Securities

August 2004

47

Profligate Governmentsweaken us all

Crowds out private sector
Upward pressure on interest rates
Rupee depreciation
Making us poorer, costlier, less competitive> poorer!
Total Central & State debt as a percentage of GDP
80%

Debt/GDP

70%
60%
50%

ENAM Securities

2000-01

1998-99

2002-03 RE

Source: RBI

1996-97

1994-95

1992-93

1990-91

1988-89

1986-87

1984-85

1982-83

1980-81

40%

August 2004

48

Demographics
Income Shifts

Age Group Shifts

Social Shifts

ENAM Securities

August 2004

49

Affordability has risen dramatically

Falling prices and low interest rates have made products easily affordable
1994

2003

Increase in affordability (x)

2.0

1,690

1,250

1.4

21" Color TV

18,000

11,000

1.6

Washing Machine

18,000

13,000

1.4

Refrigerator (165 Ltr)

12,000

8,000

1.5

Cordless Telephone

4,000

2,500

1.6

25,000

4,000

6.3

Housing (Ratio of Hsng Price/Annual Inc.) (x)

Housing EMI (Rs.)

10-year repayment / Rs.100,000 / month
Cost of (in Rs.)

Cellular Phone
Source: ENAM Research

All this has led to a boom in retail lending and consumption

ENAM Securities

August 2004

50

Wealth effect adds to consumer power

15
12

Strong rupee and low interest rates

(%)

(%)

17
16

Rupee/ US$ (LHS)

Prime Lending Rate (RHS)

Gold: 20,000 tonnes = $100bn gain

450

Jul-04

10

2003

-6

2002

11

2001

-3

2000

12

1999

1998

13

1997

1996

14

1995

1994

15

1993

Market Cap gain = $75bn

7,000

(USD/troy ounce)
6,000

400

5,000
350
4,000
300

3,000

250
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

2,000
2002

2003

2004

Source: Bloomberg

ENAM Securities

August 2004

51

Income demographics = Secular consumption growth

TV: 1998 - 70m, 2003 98m, 2007 - 130m

600

2 Wheelers: 1998 - 28m, 2003 - 46m, 2007 - 80m

500

Population (m)

Cable TV Sub.: 1998 - 25m, 2003 - 48mn, 2007 - 80m

Basic Telephone: 1998 22m, 2003 44m, 2007 - 65m

Tax Payers: 1998 - 10mn, 2003 - 40m, 2007 - 80m

400

Cellular Subscriber: 1998 - 1mn, 2003 - 14m, 2007 - 95m

300
Home Mortgage Outstanding: 1998 Rs145bn,
2003 Rs478bn, 2007 Rs1367bn

200
Cars: 1998 - 3m, 2003 - 6m, 2007 - 9m

100
2007

0
100

1000

2003
2000

3000

Annual income (US$)

Source: ENAM Research

1998

1998
4000
>5000

2003

Value growth far exceeds

volume growth

2007

ENAM Securities

Volumes

Value

Two Wheelers

12%

20%

Cars

13%

20%

CAGR (1994 2003)

August 2004

52

Consumers are under-leveraged

800

75%

(USD bn)

700

70%
54%

600

60%

53%

500

50%

34%

400

40%

300

30%
17%

200
100

80%

20%
10%

2%

0%
India

Thailand

Malaysia

Total consumer loans outstanding

Taiwan

Korea

USA

Consumer loans outstanding / GDP (%)

Source: ICICI Bank

ENAM Securities

August 2004

53

Age profile points to secular growth in demand

Increasing consuming/producing age group

World Age Population Projected To Decline

Total 1,211.6m

1,200
Total 1,012.4m
Overall
growth
19.7%

800
246.8m

Growth
34.4%

331.6m

The rising
consumer class

400

0
2001
0 to 19

20 to 34

2013
35 to 60 & above

Source: Census 1991

ENAM Securities

August 2004

54

BRICs : The growth engine of the world

Source: Goldman Sachs BRICs Report

ENAM Securities

August 2004

55

Caveats
Leadership!

Macro economic stability

Infrastructure and Institutions

Openness

Education (and Health)

ENAM Securities

August 2004

56

Political Contradictions reflect Social flux

CPM
Muslim
League

CONGRESS

RJD
BSP
SP
DMK

NCP
JD
Samta party

BJP
Telgu Desam
AIADMK
BJD

Shiv Sena

National
Conference

ENAM Securities

August 2004

57

Capital Markets
Be aware of shifts

In sectors

In Leadership

In Valuations?

Where we are in the cycle?

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August 2004

58

Flat markets cloud sectoral shifts!

Sectors (% of Nifty)
1998

1999

2000

2001

2002

2003

(July) 2004

10

12

Commodities

42

32

22

23

25

34

37

Cyclicals

19

15

15

FMCG

19

27

16

19

21

15

Pharma

TMT

15

43

38

29

25

21

100

100

100

100

100

100

100

Banking

Total
Source: CMIE

Share of corporate profit / GDP

Share of sector profit % v/s Share of market cap
Should always be at the back of the mind !
ENAM Securities

August 2004

59

Similarly, be aware of relative country valuations

High and Stable RoE (EVA +ve), Size and Scalability, Variety and Growth
P/E (x)

Interest

RoE (%)

EPS Growth (%)

2002

2003

2004

rates (%)

2002

2003

2004

2002

2003

2004

China

15

14

13

NA

12

14

15

14

11

India

18

15

13

4.5

18

21

24

34

13

16*

9.0

27

25

27

53

(7)

10

Korea

11

12

3.9

15

14

18

(5)

(7)

33

Malaysia

20

16

15

3.1

10

12

13

14

20

Phillipines

26

17

13

7.8

11

(23)

50

30

Singapore

25

18

16

0.8

10

(19)

37

12

Taiwan

43

20

15

1.1

11

15

(9)

124

29

Thailand

16

12

11

1.3

16

21

23

86

35

Indonesia

Source: The Economist, Citi group. * Currently witnessing upgradation and growth to be sustained in 2005

ENAM Securities

August 2004

60

Churn in Top 20 reflects underlying reality shifts

Company Name
Oil & Natural Gas Corpn. Ltd.
Hindustan Lever Ltd.
Indian Oil Corpn. Ltd.
Mahanagar Telephone Nigam Ltd
Reliance Industries Ltd.
I T C Ltd.
State Bank Of India
Hindustan Petroleum Corpn. Ltd.
G A I L (India) Ltd.
Bharat Heavy Electricals Ltd.
Tata Motors Ltd.
Bajaj Auto Ltd
Bharat Petroleum Corpn. Ltd.
Industrial Development Bank of India
Hindalco Industries
Larsen & Toubro
Tata Iron & Steel Co. Ltd.
Castrol India
Steel Authority Of India Ltd.
National Aluminium Co
Total Market Cap

1998
Mkt Cap (Rs. bn)
402
278
272
163
158
153
129
110
106
86
77
73
63
63
56
51
50
46
43
39
2,418

Company Name

As ofJune2004
Mkt Cap (Rs. bn)

Oil & Natural Gas Corpn. Ltd.

Reliance Industries Ltd.
Indian Oil Corpn. Ltd.
Infosys Technologies Ltd.
Wipro Ltd
Hindustan Lever Ltd.
Bharti Tele-Ventures Ltd.
State Bank Of India
I T C Ltd.
I C I C I Bank Ltd
Ranbaxy Laboratories Ltd
Housing Development Finance Corpn. Ltd
G A I L (India) Ltd.
Tata Motors Ltd.
Bharat Petroleum Corpn. Ltd.
Steel Authority Of India Ltd.
Hindustan Petroleum Corpn. Ltd.
Maruti Udyog Ltd
Bharat Heavy Electricals Ltd.
Tata Iron & Steel Co. Ltd.
Total Market Cap

927
625
464
354
354
286
278
253
222
194
187
151
144
141
131
122
121
119
113
110
5,270

Source CMIE
Note: Names in red indicate exits, in blue indicate new entrants

ENAM Securities

August 2004

61

 and the Index hides more than it shows!

1,200

10,000

800

5,000

400

Wipro

Satyam

Ranbaxy
Cipla

Dr Reddy's
Sun Pharma

2004

2003

2002

Banking
1,200
1,000
800
600
400
200
0

Media & Auto

6,000
4,000
2,000
0

1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004

15,000

1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004

1,600

Infosys

2001

Pharmaceuticals

20,000

1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004

IT

Sensex (RHS)

HDFC

HDFC Bank

1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004

Indexed Sensex (LHS)

2000

1999

1998

1997

1996

1995

6,500
6,000
5,500
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1994

200
180
160
140
120
100
80
60
40
20
0

Zee

Hero Honda

All Figures indexed 100= price in 1994

ENAM Securities

August 2004

62

Always disaggregate the market

Sources of Advantage

Many

Emerging Business

Global Outsourcers

Telecom
Media
Retail

IT
Pharmaceuticals
Engineering

Global Commodities

Domestic Demographics

Oil
Metals

FMCG
Auto
Banking

Low
Sustainability of Advantage
Low

High

Note : Companies may change characteristics over time!

ENAM Securities

August 2004

63

PSS companies outperform markets over time!

RIL Vs Sensex

Infosys Vs Sensex

HDFC Vs Sensex

10,000

Reliance Industries (LHS)

400
300
200

Sensex (RHS)

Infosys

Sensex (RHS)

HLL Vs Sensex

HDFC

2004

2003

2002

2001

2000

1999

1998

1997

1996

1994

1995

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

100
1994

2004

100
2003

20,000

2002

200

2001

30,000

2000

300

Sensex (RHS)

MICO Vs Sensex

600

500

500

400

400

300

300

HLL

Sensex (RHS)

ENAM Securities

MICO

2004

2003

2002

2001

2000

1999

1998

1996

1995

2004

2003

2002

2001

2000

1999

1998

1997

0
1996

0
1995

100
1994

100

1994

200

200

1997

1999

500

1998

40,000

1997

400

1996

600

1995

50,000

1994

500

Sensex (RHS)

August 2004

64

Multibaggers of the last 10 years

Price as on 14/7/94

Price on 15/7/04

CAGR (%)

326

62

13

1443

60

525

56

Sun Pharmaceuticals

21

351

33

Hero Honda

33

460

30

Cipla

41

231

19

214

976

16

30

126

15

HDFC

161

550

13

Dr Reddy's

248

749

12

Satyam Computers
Infosys Technologies
Wipro

Ranbaxy
Zee Telefilms

Source: Bloomberg; Adjusted for bonuses and stock splits; NIFTY constituents only

ENAM Securities

August 2004

65

Multibaggers since 9/11 : The REAL BSE-30!

Company

Price as on

Price on

CAGR

15/7/04

11/9/01

(%)

Oriental Bank

240

34

92

Mahindra & Mahindra

476

68

Price as on

Price on

CAGR

15/7/04

11/9/01

(%)

National Aluminium Co Ltd

139

48

43

91

HPCL

288

111

38

33

87

Tata Tea

386

150

37

Tata Motors

407

75

76

Hero Honda

460

183

36

ONGC

654

136

69

Tata Power

254

101

36

Shipping Corp Of India Ltd

117

24

68

Sun Pharma

351

141

35

Tata Iron & Steel Co Ltd

327

84

57

Ranbaxy

976

415

33

BHEL

527

135

57

ICICI Bank

238

103

32

IPCL

157

40

57

SBI Bank

431

187

32

Grasim

952

274

51

Glaxo

603

282

29

GAIL

182

53

51

Indian Hotels

370

175

28

Reliance Energy

571

176

48

BPCL

314

159

26

ABB

730

225

48

Satyam Computers

326

175

23

Bajaj Auto

841

266

47

ACC

232

128

22

Tata Chemicals Limited

121

39

45

Gujarat Ambuja

275

155

21

SAIL

Company

Source: Bloomberg; Adjusted for bonuses and stock splits; NIFTY constituents only

ENAM Securities

August 2004

66

AOL, Time Warner merger A lesson to remember

Stock Price of Time Warner: now AOL Time Warner

100

(US$)

80

Announcement of Merger

60
40
20

ENAM Securities

2004

2003

2002

2001

2000

1999

1998

1997

1996

August 2004

67

Lets Summarise TILL THIS POINT

Value is created through an interplay of:

Macro Trends

Micro Focus

Subtler Nuances

Business Leaders must constantly be on top of these ; good leaders and investors
continuously value these.

Real winners understand this and play to create enduring value.

May run out of luck, never out of wisdom !

ENAM Securities

August 2004

68

NOW: BUYER BEHAVIOUR

Manish Chokhani

September 2004

69

Understand Fund Manager Behaviour!

Approaches to Portfolio Construction

Top Down v/s Bottom Up

Value v/s Growth

Think of Where we are in the Market Cycle!

Client Requirements

Match Needs, Requirements and Abilities

Your OWN Portfolio?

ENAM Securities

August 2004

70

Elements of Valuation
Top Down

Value

Growth

Momentum

Bottom Up

ENAM Securities

August 2004

71

KYC and Thyself!

Asset Allocation

Relative

Pvt. Banks / Pension Funds /

Macro Funds/ Fund of Funds

Country Allocation
Regional Funds
Sector Allocation
Country Funds/ Mutual Funds

Large Cap
Small
Cap

Absolute

ENAM Securities

HNW / PMS / Absolute Return

Funds/ Hedge Funds

August 2004

72

Key Success Factors : Match Your Pitch!

Institutional Marketing
Deployment of Large Pools
Capital Preservation

CAPITAL
UBS, GAM
GSIC, ADIA

Regional Funds

Marketing Scale & Scope

Economist

PICTET
JANUS
GMO
LLYOD GEORGE

Country Funds

Fund Manager
Technician

HSBC, , CIBC, JF
ICICI, HDFC, UTI

Stock Picker

SLOANE
ABERDEEN
ARISAIG
EMIC
OPPENHEIMER

Pvt. Bankers / Pension Funds / Macro Funds

Absolute
Return
Funds

ENAM Securities

August 2004

73

Decomposing Approaches

Top Down

Asset Class

Equities
Bonds
Currencies
Property
Commodities
Oil
Precious metals
Natural Resources

Country

Developed Markets
Emerging Markets
Regional markets

ENAM Securities

Sector

FMCG
Pharma
Services
TMT
Manufacturing
Cyclicals

August 2004

74

Valuation MegaCap bias

Category
30 Largest
Remaining
S&P 500

1980
9
9
9

ENAM Securities

1990
15
14
15

1999
46
23
30

August 2004

75

Some Lessons from History

Japan V/s UK in 1944
Korea V/s India in 1950
Singapore!

Hero Honda V/s Kinetic Honda

Bharti V/s IDEA
Infosys V/s HCL
HDFC Bank V/s SBI

There is NO trade-off between Top- Down and Bottom up

ENAM Securities

August 2004

76

Valuation Approaches based on Sentiment Swings

Value

Growth

Momentum

Illiquid

Institutional Favorites

Max Volume

Misunderstood

UVG Stories

News Flow

Hated/Uncovered

Imagine it!

Volatile

Appraised value

DCF or Option value

Technicals

In Reality, there is no distinction. Growth and Momentum are

LongTerm/Short Term Value catalysts
ENAM Securities

August 2004

77

Think Client Management

WHO is the CLIENT?

WHAT does he want from you?

HOW are you shaping his expectations & mindset?

WHY should he stick to you?

Most clients would rather have their fund manager fail

conventionally than succeed unconventionally.

Marc Faber
ENAM Securities

August 2004

78

Decompose | Decompose | Decompose

Sectors

Large Cap

Medium Cap

Small Cap

Total

FMCG
Pharma
Banks
IT
Telecom
Media
Engg
Autos
Commodities
Total

ENAM Securities

August 2004

79

SUMMARY
UNDERSTAND YOURSELF OBJECTIVELY

Everybody is not Schumacher or Tendulkar: TAKE HELP, BE SELF AWARE

UNDERSTAND THE INVESTMENT LANDSCAPE

A grip of Macro, Micro, Accounting and Street Smartness is REQUIRED

UNDERSTAND THE UNDERLYING INVESTMENT

What will make it tick or explode?

UNDERSTAND THE MARKET PARTICIPANTS

Who are you playing against and how does he play?

FOLLOW BASIC PRINCIPLES AND STICK TO THEM!

BE HAPPY!

ENAM Securities

August 2004

80

How is your Portfolio Tilted?

OWN
INTERESTS

CLIENT TIME

PROFESSIONAL
COLLEGUES

FAMILY

WORK
COLLEAGUES

BUILD A CONSCIOUS LIFESTYLE !

ENAM Securities

August 2004

81

HEAVEN AND HELL

AMERICAN SALARY

AMERICAN WIFE

ENGLISH HOME

ENGLISH CAR

GERMAN CAR

GERMAN FOOD

CHINESE FOOD

CHINESE HOME

INDIAN WIFE

INDIAN SALARY

YOUR REAL WEALTH = YOUR HAPPINESS = YOUR STATE OF

MIND = WITHIN YOU

ENAM Securities

August 2004

82