In a first-of-its-kind report on effectiveness of boards, Standard Chartered addresses a simple but increasingly pertinent question – what defines an effective board? – and measures 80 companies against it's board effectiveness scorecard. The report titled "Board Independence — it matters," has discovered that about 25 percent of participants have low scores (6.0 and below), while 11 percent have very strong boards.
Speaking to CNBC-TV18, Rahul Singh of StanChart Securities says there are companies with strong managements but low scoring boards like ITC, Idea and Larsen & Toubro. The companies with the lowest board scores are BPCL, Prestige, IOC, SAIL and JP Associates. On the other hand, companies that have put emphasis on boards are likely to have better corporate governance, he says. The companies with the highest board scores are Dr Reddy’s, Marico, Infosys and Axis Bank.
On market, Singh said cyclicals have not yet reached euphoria levels, and banks can rally some more on policy reforms, rate cuts and deceleration in inflation. He advises investors to switch money from consumption sector on to banks.Some of the rural consumption plays are too stretched in particular have run up too fast,” but there have been disappointments across consumer discretionary space.
On the beleaguered infrastructure space, Singh says he likes the roads and ports sectors where balance sheets are cleaner and there is readiness on government’s part to start building again.
Below is the transcript of Rahul Singh’s interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.Latha: First your view on the market itself, why are you concentrating on board quality? Are you getting a sense that on finance parameters markets are looking a bit overbought, are valuations looking stretched at all for you? A: The reason we focused on the board composition or board effectiveness is one of the factors which investor should track because it has been a completely ignored subject. Also, if you look at the correlation between some of the companies which have got good boards versus bad boards there seems to be a very good correlation between companies which have paid attention to the boards have also typically seen much better earnings growth, much better return on earnings (RoE) improvement and more importantly much better premium to the market multiple improvement. So, therefore there does seem to be a composition of board just seems to be an important factor in determining the quality factor. So, I won’t read too much into the fact that we have decided to do this study versus what the market valuations today are. However, the genesis of our report is more to do with the fact that we generally think it is a factor which has been ignored in the Indian corporate sector especially because Nifty companies, 50 percent ownership is with the promoter group. Sonia: Just takes us through the list of companies then whose board scored the highest in effectiveness? A: The companies which have scored high are Marico, Dr. Reddy’s Laboratories, Axis Bank, Infosys, HDFC; they are some known names there but there are some surprises too in the companies with strong boards. Similarly we have found that some of the strong managements which we traditionally know have not paid as much attention to the board quality. The PSUs in general have had a weak board. Primarily also because all of them have the common Chairman and CROs which is a strict no-no as far as board quality goes. So, that is the spread and you have a lot of shades of grey in between. Companies who you would think should have scored high, have not scored so high. Also, we have looked at eight different parameters, so, we have somewhat kept the parameters completely objective and not trying to build any subjective bias in the process. Latha: I am little confused, your highest board scores come in for Infosys. I don’t see Tata Consultancy Services (TCS) in that list. TCS performance has been superlative, why is TCS in the first place not there and secondly how much would your own buys and sells be dependent on this in that case?A: Instead of getting into company specifics what we have done is that we have made buckets of high scores versus average scores versus below average scores and low scores. So, as scoring buckets, the companies with high scores have done better than the companies with median or below average scores and this is over a long period of five years. So, we are just not looking at two or three year period, we are looking at five years and more. So, TCS for example could be more from a two to three year perspective; last two to three years. However, in terms of whether this should drive financial performance or whether this is the only factor driving financial performance? Obviously not! there is a management, there are many industry, regulatory and competitive factors which ultimately drive the financial and the stock performance of any stock. All we are saying is that board composition topic was somewhat ignored as a factor driving quality premium; I don’t think we should ignore it. There is a strong evidence to suggest that companies which have paid attention to the board are those who have also paid a lot of attention to other things in the business and also things around corporate governance. Board of director composition is a very important part of corporate governance and underappreciated in our view. Sonia: Tell us about the companies which have the lowest board scores and would this low board score colour your investment into the stock?A: Over a long period it should, however over the short-term, say a one-two year period --maybe the fundamental factors that drive the earnings or industry factors kind of overshadow these factors. However, some of the companies which have scored low, like I said, aer PSUs; even companies which have strong managements like BPCL for example has a relatively weak board compared to other peers. We have got other names like Prestige, Jaiprakash – some of these companies have had weak boards. Even the companies where we have seen the managements being very strong, the boards are relatively weak for example I would say that for a few names like Larsen and Toubro (L&T), ITC, Zee where all these companies have done very well and they are doing something right. However, on the broad front they have probably not paid as much attention or it is some of the issues which they have not given enough attention to these board composition issues. Latha: What is your view on the market itself? We have seen a fairly decent run up, new highs being notched up even as we speak; Sensex is at a fresh all time high targeting 28,000. Are valuations getting uncomfortable at all, when are you calling for 30,000 for instance before Budget? A: Cyclicals the valuation, they have just gone back to the election time levels so I don’t think that the expectations have gone to euphoria kind of levels at all. My view is the cyclicals rally could continue specifically in banks, more the private sector banks and public sector banks. I think banks is one segment where we think expectations around the policy momentum again coming back. Expectations around inflation coming off and hence rate cut expectations getting built in; some probability of that and also leading up to the Budget where the government has the opportunity and I believe the work has already started in advance for the Budget much before normal years to come out with something which is significantly different from what we saw in July which was the first Budget of the government.
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Sonia: It has been a secular up move up until now. Are there any pockets or any sectors that you would recommend investor’s book their profits out of now? A: I think some of the rural consumption plays are looking a bit stretched, the auto sector ran up too fast in my view. The interest rate cut should help but some of the numbers which are being baked into the FY16-FY17 earnings are on the aggressive side. We have seen a spate of disappointments from the consumer names, almost through across staples and discretionary we have seen disappointments; that is one segment which is looking like it should take a breather maybe a long breather at these levels. That is the sector I would focus on to take money off and put into cyclicals like banks and maybe even oil and gas. Latha: When you say cyclical financials you include PSU banks? A: Yes I would, but in PSU banks we are more choosy so we like State Bank of India (SBI) and Bank of Baroda (BoB). Beyond that it is a bit difficult because the capital adequacy requirements in these companies are massive. So, you will have trading kind of rallies in them which won’t be sustainable because the capital requirements overhang for BASEL III is quite massive. So, therefore private sector banks are going to be much more sustainable, more sticky picks ...if you will, in terms of how one is building up their portfolios. MC Query: What is your outlook on Indian pharma especially Ipca Laboratories? A: We don’t cover Ipca so I can’t comment on it specifically. However, some of the results have seen the impact of channel consolidation resulting in some slowdown. So, that could build up going forward. Frankly it is on the watch list as could it be another potential consumer sector where you could take out the money over the six-nine months and put it back into cyclicals. I don’t think we are ready to take that call as yet but definitely the risk seems to be building up on the pharma sector. Latha: One obviously beleaguered sector, beleaguered in terms of balance sheets is the infrastructure space. We are getting in bits and pieces some incremental good news and one big one could be the tweaking of the Land Acquisition Act clauses especially for PPP projects. Anything you will pick from this pack?A: We like the roads sector. Roads and ports are one sector where we think that there is lots happening and the balance sheets are cleaner, there could be more near-term momentum in terms of the governments readiness to start building again. Therefore these are two sectors I would be more keen on in the infrastructure segment.
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