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Jun 10, 2013 06:21 PM IST | Source: CNBC-TV18

Why do great Indian cos self-destruct? Ambit explains

The Nifty churns were almost 50 percent or higher over a decade compared to 25-30 percent seen in the developed markets. Significant emergence of new industries like IT and telecom led to a lot of churn in the index.

NSE benchmark Nifty is touted to experience most number of churns in its constitutents in last one decade compared to indices of developed as well as emerging markets. A recent Ambit report called Why do great Indian companies self-destruct highlights this phenomenon.

In an interview to CNBC-TV18 Pramod Gubbi, VP- Equity Sales at Ambit says that despite the churn factor, there have been companies that have outperformed the share price performance. He gives examples of Titan and TTK Prestige which have delivered good returns over the last decade. However, Gubbi questions if these performances are enough to judge a company going forward or should investors look out for pitfalls.

Also Read: Rajiv Bajaj lashes out at cos opposing quadricycles

He emphasises the importance of understanding and appreciating corporate strategy and management decision making to realise long-term prospects of the company and hence its share price performance.

Below is the verbatim transcript of Pramod Gubbi's interview on CNBC-TV18

Q: You have highlighted many examples like TVS Motors, Infosys, Hero MotoCorp, but the more interesting part of your report alludes to some outperformers of the last five-seven years who you suggest could be at an inflexion point. One should not take their continued growth as given as we look forward, what are your views on that?

A: We assembled upon this idea when in one of our research we found that almost 80 percent of listed companies in India fail to deliver shareholders return even equal to inflation. Another statistics that came was staring at our face was Nifty, India’s benchmark index, is one of the highest churning indices globally. The Nifty churns were almost 50 percent or higher over a decade compared to 25-30 percent that you see in the developed markets and even 30-40 percent in other emerging markets. So, we asked ourselves why is that large Indian companies constituents of the benchmark index do not manage to sustain their position in this index although they had long track record of delivering fundamental share price performance.

The answer to that lay partly into some changes in the recent environment. We had significant emergence of new industries in India like IT and telecom. That led to a lot of churn in the index but at the same time some companies, some sectors that have already been there within those also, we have seen companies performing widely differently which means that external factors are not alone contributing to this churn.

The other factor that emerged was a corporate strategy and management decision making which is where often market participants like us and the buy side investors in general tend to ignore while focusing on the short-term earnings performance or quarterly margin performance, for example. That is why we are trying to light importance of understanding and appreciating corporate strategy and management decision making to understand the long-term prospects of the company and hence the share price performance.

A couple of names that have delivered strongly over the last decade are Titan Industries and TTK Prestige. These have delivered almost 50-80 percent compounded annual growth rate of share price performance over the last decade. Interestingly, both of them have been through phases of difficulty in the early '90s or the late '90s and have managed to come out of that. So, they have been through the full cycle where we are using a lot of research from the likes of Jim Collins and William Thorndike to appreciate this. We have seen them going through full cycle and having recovered from those falls.

Are they back to the stage where management decision making is crucial to watch out for in terms of what they do next to deliver the next leg of performance so that investors can make an informed view of whether this sort of performance is sustainable or should we watch out for some pitfalls?

Q: One of the stocks that you have picked out is Tata Steel, which at alternate points has suffered either from the cyclicality of the business or with regards to their acquisition which was Corus. Why is it that you feel this business is now at an inflexion point?

A: Tata Steel has been through that cycle. We saw one of the best performances from Tata steel between 2001 and 2005. 2005 to 2007 is where the management got aggressive in terms of their expansion plans and someway gives them the benefit of how commodity prices were going; they could have built assumptions which underpinned their acquisition of Corus.

However, if you reach the management discussion and analysis section of their annual reports, the Corus acquisition does not tie in with their stated plans and also what complicated the issue was the valuation at which they bought it. They got into a bidding war with Companhia Siderúrgica Nacional (CSN) and ultimately ended up paying up USD 12 billion when their own new worth was barely USD 2 billion and the external factors which turned after 2008 for it commodity prices.

The opening up or the reduction in import tariffs for Indian steel industry meant the domestic steel operations and the global steel operations went into difficulty. So, that is something that we cannot blame them for.

You can highlight their decision to go ahead and make that acquisition at a time when things were so punchy and after that we saw how both Corus and the domestic operations have performed. The write-off in the good will related to Corus acquisition is in someway an acknowledgement that that acquisition was a failure.

Having acknowledged that, what management does next is the question in. That is why they are at the cusp of either a turnaround or sliding into further mediocrity and insignificance. This is why it is important for investors to watch what management is saying and doing at this point in time to make an informed decision as to whether this will go the TTK and Titan route in terms of successful turnaround or will this slide back into mediocrity forever.

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