 "Arvind Singhal")
There is a big shift in companies across the world in the 21st century. The conventional asset-heavy growth model is under assault following the economic slowdown and global macroeconomic volatility. Companies that have reported high growth in sales, market value and profits have also invariably been light on assets and employees.
A cover story in Fortune magazine last November compared Detroit's auto behemoth General Motors with California's electric car company Tesla: "General Motors creates about $1.85 of market value per dollar of physical assets, while Tesla creates about $11. GM creates $240,000 of market value per employee, while Tesla creates $2.9 million." Tesla does not have dealerships, customers order cars online, has fewer employees than a conventional automaker, and a software update can lower a car's chassis. Companies such as Visa, Facebook, Twitter and Apple are major value creators per dollar of physical assets.
Apple sells phones and computers, but outsources manufacturing. Uber is the world's largest car service company but does not own a single vehicle; Airbnb is the largest provider of accommodation but doesn't own a single room.
The 21st century business is asset-light, but owns capital in the form of software, patents, brands, or customer relationships.
DATA PAGES
The trend is similar in India, even though a lot of the new-age companies are yet to go public and enter the BS 1000. In financial year 2011-12, the government-owned crude oil producer Oil and Natural Gas Corporation (ONGC) was the country's top profit earner. It was followed by fellow energy and petrochemical major Reliance Industries. In all, eight out of the 10 most profitable companies that year were capital-intensive commodity producers, utilities or firms that served them. Together, they accounted for three-quarters of the combined profits of the top 10 companies by profit.
Cut to 2014-15 and you find that the profit league table is dominated by capital-light companies. Five of the 10 most profitable companies last year were either technology companies or consumer good majors. They include Tata Consultancy Services, Tata Motors, Infosys, ITC and Wipro.
Today, for corporate India, high physical assets are hurting the balance sheet, as financing the asset requires raising debt or diluting equity. This liability of debt or equity has to be serviced and many companies are struggling to service their bloated balance sheets due to lower than expected growth in revenues and profits. This weighs on the company's profitability and market capitalisation.
The balance sheet, it seems, has now become a marker of performance in corporate India. Most of the BS 1000 companies that defied poor growth are the ones with lean balance sheets and most often with little or no debt on their books, be it Maruti Suzuki, Eicher Motors or Hindustan Zinc.
Asset-light companies would be in a majority and even Hindustan Zinc, which is ranked 10th in net profit in 2015, has the smallest balance sheet in the metal industry, which is a capital-intensive industry. Last fiscal, Hindustan Zinc's total investment in assets was a third of Vedanta's and Tata Steel's, and less than half of Hindalco's.
Assets vs profits
The dichotomy between corporate size as defined by physical assets and financial performance is visible across BS 1000 companies. Nine-tenths of the combined net profit of the entire sample is accounted for by companies that collectively own 45.3 per cent of the combined assets of all BS 1000 companies.
Saurabh Mukherjea, CEO (Institutional Equities), Ambit Capital is not surprised. "You don't have to be big to be successful in India. India is a dynamic economy with lots of growth opportunities hidden beneath the surface. Companies need the right ideas and products to grow fast and profitably, rather than access to large capital," he says.
This turns the conventional corporate growth model on its head. It was believed that there would be growth only if the management could somehow arrange enough resources to enter new markets or build new factories or make big-ticket acquisitions. The 20th century model of large assets is under assault following the economic slowdown at home and global macroeconomic volatility.
The future belongs to companies with innovative product line-ups and the ability to excite customers. This explains the steady rise of companies such as Maruti Suzuki, Eicher Motors, Asian Paints, Bosch, Britannia Industries, Relaxo Footwear, Cera Sanitaryware, Interglobe Aviation (Indigo Airlines), Divi's Laboratories, Cadila Healthcare, Page Industries, Ajanta Pharma and Natco Pharma, among others. Information technology heavyweights such as TCS, Infosys, Wipro and HCL Tech are, of course, asset-light.
These companies seem to own relatively fewer physical assets compared to traditional private and public sector giants, but are more profitable and have substantially higher market capitalisation. For example, TCS accounted for less than one per cent of BS 1000 companies' combined assets in the last fiscal, but 7.3 per cent of the sample's combined profits. The corresponding ratio for Maruti Suzuki is 0.4 per cent and 1.4 per cent, respectively. Asian Paints accounts for 0.08 per cent of combined sales and 0.5 per cent of combined net profit.
Smart capital allocation has been key to superior operational and financial performance in capital-intensive industries such as cement, metals, textile and tyres. Companies such as Shree Cement, Ultratech Cement, Hindustan Zinc and Vardhman Textiles continue to outperform their peers, thanks to a combination of conservative finances and efficient manufacturing.
The contrast between the 'old' and the 'new' is most stark on the bourses. Three years ago, Reliance Industries, the company with corporate India's biggest balance sheet, was also the country's most valuable firm. Now, TCS is the most valuable company on the bourses with assets one-eighth that of the erstwhile leader. The tech major is not alone; seven out of the 10 most valuable firms in the list are asset-light companies in sectors such technology, consumer goods and pharmaceuticals.
However, Raamdeo Agrawal, joint managing director, Motilal Oswal Financial Services, blames it on the business cycle, and is more optimistic. "You should not over-analyse the relative poor performance of capital-intensive companies beyond a point. Most of these companies are suffering on account of a sharp dip in private investment in India and global slowdown rather their own missteps. The dichotomy that you are talking about will disappear once growth resumes," he said.
Others say that traditional behemoths are paying a price for either over-investing outside India or overestimating India's growth potential during the boom years. "Most companies facing a storm are either those with large overseas exposure such as Tata Steel and Hindalco. Then we have companies that over-leveraged their balance sheets, betting on faster growth to take care of the debt. A slowdown in growth and demand has now left them with financially unviable projects," says G Chokkalingam, founder & CEO, Equinomics Research & Advisory.
Whether it's due to the business cycle or a miscalculation by some companies, the new growth dynamic is creating new winners that could fundamentally change India's corporate landscape.
The rise of new brands
There is another category of companies that have found a specific niche in their industries and have built a strong brand and seen success.
Take, for example, Eicher Motors, which is the BS Company of the Year (read story on page 26). Until a few years back, its Royal Enfield division was a niche player selling a few thousand units of its premium leisure motorcycle, accounting for less than one per cent of the motorcycle market. Today, its market share is a little under five per cent and it is the fifth largest motorcycle maker in the country. The company's revenues and profits have nearly quadrupled in the last three years. There is a four-month waiting period for the Royal Enfield Bullet at a time when 'conventional' motorcycle makers are selling their products at a discount, giving us a glimpse of the future.
For analysts, Eicher is a perfect example of a business built around a protective moat protected from the cyclicality of the industry. "Eicher has a unique product portfolio in the industry that is positioned as a lifestyle product rather than a standard means of commuting that its peers do. This insulates it from the industry growth cycles," says Dhananjay Sinha, head, institutional equity, at Emkay Global Financial Services.
It also helps that Eicher plays in a relatively small corner of the motorcycle market, allowing its management and brand team to be more focused. During the first eight months of FY16, Royal Enfield accounted for less than three per cent of the country's two-wheeler industry sales. This provides Eicher with the opportunity to grow by converting traditional motorcycle buyers to its products, a luxury not available to volume leaders such as Hero MotoCorp.
Away from the glamour of lifestyle motorcycles, Relaxo Industries has scripted a similar churn in the footwear industry. The Delhi-based company virtually came from nowhere to become the country's second largest footwear maker and a market leader in the non-leather daily-wear category. Relaxo prospered by filling in the product gap left open by incumbents such as Bata and Liberty Shoes. Unlike its peers, it stayed away from the high-end leather category and focused its manufacturing and design resources on non-leather products for daily wear.
Customers liked the combination of modern design with value-for-money pricing. Its Sparx range of casual footwear and shoes is one the largest and most widely distributed brands in the industry. The company's brand equity remains small compared to global footwear giants or even the domestic market leader such as Bata, but Relaxo now possess the resources to scale up investment in new product development and brand promotion. Its revenues have doubled in the last three years while profits are up two-and-a-half times.
Bengaluru-based Page Industries scripted a similar shake-out in the inner-wear category. While Relaxo prospered by building brands from scratch, Page Industries tied up with Jockey International and made it one of India's most-loved apparel brands. Page's success lies in its combination of domestic manufacturing with liberal investment in branding, sales and distribution. It was something new for the fragmented innerwear industry and Jockey became the fastest growing brand and an industry leader within a few years of its launch. Page's revenues and profits have more than doubled in the last five years, making it the most valuable textiles and garment maker on the bourses.
It's the same story in sanitaryware, where Cera Sanitaryware, the recipient of the Business Standard Star SME award, is now more profitable and valuable than incumbent and market leader HSIL (formerly Hindustan Sanitaryware). In ceramic tiles, Kajaria is now way ahead of the industry veteran H&R Johnson, now part of Prism Cement.
The e-commerce players
The entire e-commerce set stands out in being asset-light. These companies invest in technology, but since they do not manufacture or hold inventory, their requirement for physical assets is limited. "New brands have grown by offering higher margins to their retailers and sellers rather than by spending large sums on brand promotion like incumbents. The strategy is especially effective in e-commerce, where customers' brand loyalty is thin and price is the biggest draw," says Arvind Singhal, chairman and managing director of retail and consumer consultancy Technopak.
The trend has been helped by strong consumer growth in the last few years. Till last year, consumer spending was growing at six per cent a year, aiding companies with the right products to take a bigger size of the pie than in the past. Total consumer spend in India is estimated to be around $550 billion, says Technopak.
Singhal foresees more growth opportunities for smaller, niche brands, as the traditional retail hierarchy of distributors-wholesalers-retailers is replaced by a direct channel between manufacturer and sellers. "In the older model, many brands and products were successful simply because they controlled the supply chain. Now every brand needs a strong USP (unique selling proposition) to remain relevant under the new regime, except for a handful of big brands that offer standard products," Singhal adds.
Old is gold
The new economic environment has not been bad for incumbents in general. Industry leaders such as Maruti Suzuki, Asian Paints, Britannia Industries, MRF and Bosch further extended their lead by staying focused and playing to their strengths. Their leadership became their USP and a key source of competitive advantage in a slowing market. These companies didn't waste their resources or size on unnecessary diversification, putting them in an advantageous position when growth became scarce.
Ambit's Mukherjea blames it on the corporate capital allocation strategy. "In business it's easier to gain initial success but to sustain it promoters have to learn to make the right capital allocation time after time. This is what differentiates great companies from ordinary ones," he says. In this scheme of things, companies struggle not because of a problem in their product or industry but due to wrong investment decisions.
It's not the time to fret about losers, however, but to focus on future leaders. "Old companies have always made way for new entrants in India. Half of the companies typically drop out of the league table every 10 years, on average. And we are better off betting on future leaders rather than mourning about the decline of yesterday's leaders," Mukherjea says. Of course, he is talking about the changing membership of the 30-stock S&P BSE Sensex index, but it applies equally to the BS 1000.
| The problem of corporate debt |
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Corporate indebtedness reached a new high in 2014-15. At the end of the last fiscal, BS 1000 companies together owed around Rs 31.6 lakh crore to their creditors, up 6.3 per cent on a year-on-year basis. Adjusted for cash and equivalents on their books, their net debt was up 7.1 per cent in FY15 to Rs 21.3 lakh crore. The debt-equity ratio went up from 0.83 to 0.86 on a net basis and from 1.13 to 1.16 on a gross basis. Aggregates, however, hide the enormous variation in individual balance sheets. The number of debt-free BS 1000 companies went up from 197 to 209 last fiscal. Together, these companies account for 60 per cent of the combined net profit and half of the combined market value, and were sitting on Rs 3.9 lakh crore of cash and equivalents last fiscal. |
On the other hand, the 791 indebted companies accounted for 85 per cent of all assets and 81.5 per cent of combined revenues.
Thus, corporate liabilities and companies' ability to service them (by generating cash and profits) lie on two different boxes. Companies such as Coal India, Infosys, TCS, ITC and Maruti Suzuki are floating in cash, but have few avenues to invest in new assets.
In absolute terms, Reliance Industries had the highest debt last fiscal at Rs 1.12 lakh crore, followed by Power Grid Corp and NTPC. However, these companies generate more than adequate profits and enjoy high market capitalisation.
At the other extreme, there are companies that have invested aggressively by raising loans but are now finding it tough to service the debt. The vicious cycle of indebtedness, poor profitability and stagnant demand has hurt such firms. Thus, companies in the power, infrastructure and metals sectors - such as Jaiprakash Associates, Suzlon, Bhushan Steel, Adani Power, Jindal Steel and Power and GMR Infrastructure - have been pushed to the brink of insolvency. Their market capitalisation is now a fraction of their total liabilities, making them technically insolvent.
