Special Feature     23-Apr-19
Stocks: In the family
Group companies offer downside protection to the flagship and hold potential for capital gains to the shareholders
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The stock market is hovering near its all-time highs. The S&P BSE Sensex recorded a historical intra-day milestone of 39,270 on 1 April 2019, gaining 5,979 points, or 18%, from the 52-week low of 33,292 in October 2018. The NSE Nifty 50 conquered the summit of 11,761 during trading on the first day of the new financial year, appreciating 1,756 points, or 18%, from the yearly low of 10,005 in October 2018.

The rally has been largely driven by renewed buying by foreign portfolio investors (FPIs). They were on the fence in January 2019, with outflows at the net level. Subsequently, foreign funds turned big-time buyers, with net investment of Rs 15328 crore in February 2019 and Rs 33116 crore in March 2019. FPIs had net invested Rs 9780 crore in Indian equities in the month till 8 April.

In contrast to the rapid climb of the Sensex and the Nifty, the S&P BSE Small-Cap index is 35% and the S&P BSE Mid-Cap index 19% away from their lifetime peaks. Thus, the two categories have plenty of steam left and present buying opportunities till the time they start commanding rich valuations.

Elections to the Lok Sabha are taking place in the current financial year. The results and formation of a new government are mega events needing careful monitoring. Another marker is the Union budget that will be presented by the new government in July. In the election frenzy, unrealistic promises are being made by political parties. Implementing them will be detrimental to the health of the economy.

The Central government stared at a shortfall of Rs 50000 crore in direct tax collection for the financial ended March 2019 (FY 2019). It could meet the fiscal deficit target of 3.4% by rolling over payment of oil subsidies to the current FY and through inter-PSU divestments. The Reserve Bank of India (RBI) has pared the growth forecast for the current year to 7.2% in its latest policy meet early April 2019 from 7.4% determined in January 2019.

The International Monetary Fund in April 2019 shaved off India's FY 2020 and FY 2021 economic growth projection by 20 basis points (bps), citing loss of momentum as the key reason. It has estimated GDP growth rate of 7.3% for FY 2020 as against the earlier calculation of 7.5%. The FY 2021 GDP growth has been revised to 7.5% compared with the previous bet of 7.7%. Earlier, the Asian Development Bank, too, lowered the economic growth sight to 7.2% for FY 2020 from 7.4% predicted earlier.

Global economic slowdown and weak investment cycle are blamed for the downward revision. According to the Central Statistics Office estimates, the domestic economy grew 7% in FY 2019. In all, the budget exercise is not going to be an easy task. In fact, it will be tight-rope walking.

The RBI reduced interest rates by 25 bps, or 0.25%, early April 2019. Banks are expected to pass on the second rate cut in the last two months. Country's largest lender State Bank of India brought down interest rates on home loans. Lower interest rates, hopefully, should stimulate the economy.

The US economy seems to have slowed down and could be heading to a recession. The IMF has lowered the global economic growth forecast to 3.3% in the calendar year (CY) 2019 compared with 3.6% in CY 2018 and 4% in CY 2017.

There is no clarity on Brexit, an event risk for investors across the globe. The trade war between the US and China, the world's largest trading nations, is still lingering and seems still away from being settled. The US president continues with his hit-and-run strategy. In a surprise move, the US in April 2019 moved to impose tariff on US$ 11 billion of imports from the European Union (EU). The EU is expected to retaliate.

In the current scenario, the focus should be on downside protection and the value that investors can extract from their investments. Capital Market attempted to pick such stocks. Pure holding companies were ignored. Also, those operating in industries requiring presence through a web of companies in the form of subsidiaries were ignored. For instance, companies from pharmaceutical and software industries with domestic and overseas subsidiaries were weeded out. Many companies have sizable subsidiaries, joint ventures (JVs) and associates. In an ideal scenario, the parent has a core business that is profitable and well managed. The flagship acts as a holding company for several other businesses. Such companies present alluring targets.

There are several frontline stocks qualifying for the investment theme. Reliance Industries (RIL), ITC, Housing Development and Finance Corporation (HDFC), ICICI Bank, Indian Oil Corporation (IOC) among others have several businesses. Apart from their core operations, they have established presence across industries through group companies. RIL has forayed into organized retail, telecommunication and media apart from the bread-and-butter activity of oil refining and petrochemicals.

India's largest manufacturer and marketer of cigarette ITC's portfolio consists of hospitality, paper and fast moving consumer goods. HDFC is active in almost every financial services segment including commercial banking, life and general insurance and mutual funds. ICICI Bank is present in life and general insurance, mutual funds and stock broking. Country's largest oil refiner and marketer IOC runs several businesses such as lubricants, petrochemical products, transportation of oil and gas and oil and gas exploration.

Large companies looking to diversify is normal as they have to deploy the large amount of cash that their main operation generates. Sum of the parts is a relevant method to arrive at the right value of
these companies.

There are rare but interesting instances of group companies outperforming the parent by a huge margin. HDFC's currently value of Rs 3.55 lakh crore is far lower compared with HDFC Bank's value of Rs 6.24 lakh crore.

Taking RIL, ITC, HDFC, ICICI Bank and IOC as benchmarks, companies with similar attributes having market capitalization below Rs 1 lakh crore were shortlisted. Only those with an established core business and with unrelated businesses as part of their investment were preferred. In challenging times, the parent has the option to monetize these investments. The group companies could be listed. The new businesses go to de-risk the balance sheets by reducing dependency on one or two core businesses.

There are several companies that have unlocked value in their group companies through initial public offerings (IPOs). Such IPOs have not only shored up the profit of the parent but also have provided it with hard cash. Other strategic advantage is the ability to offer stock options in the group companies to retain employees.

On the other side, new ventures require funding on a regular basis. They require time to break even and generate profit. Thus, they could spoil the profit and loss account and balance sheet of the parent.

Also, it is difficult to arrive at the right valuation for the parent with a diverse set of businesses. Such companies are difficult to analyze and do not get the desired premium on the trading floor unless the assets are up for sale. The phenomenon is known as holding company discount. In short, one plus one need not add to two.

Ashok Leyland is the world's fourth largest manufacturer of buses and the largest supplier of defense logistics vehicles and India's largest bus maker. The capacity is to produce 1.7 lakh vehicles per annum. The overall medium and heavy commercial vehicles (M&HCV) truck volumes grew 11% to 1.23 lakh and M&HCV bus volumes de-grew 2% to 20,220 units in FY 2018. The light commercial vehicle (LCV) volumes jumped 25% to 54,508. Capital expenditure of Rs 800 to Rs 1000 crore was incurred in FY 2019 and Rs 1000 crore including allocation for electric vehicles is likely in the current fiscal year.

The flagship of the Hinduja group has increased equity stake in subsidiary Hinduja Leyland Finance to 61.85% from 57.2%. The non-banking finance company (NBFC) has a wide range of options for financing commercial and personal vehicles including M&HCVs, LCVs, cars, multi-utility vehicles, three- and two-wheelers, tractors and construction equipment. There are 349 branch offices and 1,550 business locations spread across 23 states and two Union Territories. Housing finance commenced in September 2015. Subsidiary Hinduja Housing Finance, whose focus is on affordable housing loans, reported revenues of Rs 2092.5 crore and profit of Rs 167.5 crore in FY 2018.

Mahindra & Mahindra operates in around 22 key industries through several subsidiaries and associate companies. There is presence in over 100 countries. Among the major listed group companies are Tech Mahindra, Mahindra Holidays, Mahindra & Mahindra Financial Services, Mahindra Lifespaces, Swaraj Engines, EPC Industries and Mahindra Logistics. These operate in diverse sectors such as aerospace and defence, automobile aftermarkets, agri, farm equipment, financial services, hospitality, information technology, real estate, organized retail, logistics and two-wheelers. Subsidiary Mahindra Logistics's IPO in FY 2018 was oversubscribed eight times. The largest IPO of the M&M group booked profit of Rs 386 crore, thereby unlocking substantial value for the shareholders.

Associate company Tech Mahindra, with 26.15% equity stake, provides software solutions. The 1,200 branches of subsidiary Mahindra & Mahindra Financial Services, a rural NBFC, provide finance to buy automobiles, mainly tractors. Subsidiary SsangYong Motor Company is the fourth largest South Korean-based automobile producer.

The share in the overall domestic automobile market was 10.9%. The largest utility vehicles maker commanded a 25% market share in FY 2018. The second-largest CV producer and the largest small CV maker in India is also the country's largest tractor manufacturer, with a market share of 42.9% and operating 16 plants in the country and six in the US, seven in Africa, two in Australia, two in Turkey and two in South Korea.

Pharmaceuticals producer Biocon operates in the three business segments of branded formulations, small molecules and biologics. Branded formulations include finished dosage business in India and overseas. The small molecules division comprises differentiated active pharmaceutical ingredients or bulk drugs and generic formulations. The biologics division looks after innovation in biologics development including novel molecules and biosimilars.

Among key developments, biosimilar Pegfilgrastim Fulphila, co-developed by Biocon and Mylan, received marketing approval in the EU. In all, Fulphila is now approved in the US, EU, Canada and Australia. Ogivri (brand), a biosimilar trastuzumab, has received marketing approvals in the EU and in Australia. Additionally, regulatory nods have been obtained for biosimilar trastuzumab in various other emerging markets.

Listed subsidiary Syngene International offers contract research and manufacturing services ranging from lead generation to clinical supplies to pharmaceutical and biotechnology companies across the world. Syngene's services include integrated drug discovery and development capabilities in medicinal chemistry, biology, vivo pharmacology, toxicology, custom synthesis, process research and development, current good manufacturing practices manufacturing, formulation and analytical development along with clinical development services. Syngene and Merck KGaA in the December 2018 quarter signed an agreement extending ongoing collaboration for three years until the CY 2022. Also, Syngene commissioned a new laboratory infrastructure for client Baxter under the collaboration agreement.

Zydus group company Cadila Healthcare aspires to be a research-based pharmaceuticals producer by CY 2020. The focus of the fourth largest domestic pharmaceutical player, with a market share of 4.1%, is on the therapeutic segments of oncology, respiratory, pain and gynaecology. The reach extends to over three lakh doctors and five lakh retail partners in the domestic market. The thrust is on building 25 mega brands in the country. The second largest animal healthcare provider in India has consolidated presence through acquisition of Zoetis.

The eighth largest pharmaceuticals producer in the US by total prescription has revenues of over US$ 900 million. Over 330 products have been filed in the US for approval since the commencement of the filing process in FY 2004. So far, 246 approvals have been received. Key concerns faced by the Indian drug manufacturers in the US include price erosion, customer consolidation, supply chain disruption, increased generic competition and challenges in the complex products.

Listed subsidiary Zydus Wellness has three pillar brands: Sugar Free, a low-calorie sugar substitute; EverYuth, a range of skincare products; and Nutralite, a cholesterol-free table spread. Sugar Free is the undisputed market leader, with a share of 94% in the low-calorie sugar substitute. Zydus Wellness is in the process of acquiring Heinz India, thereby propelling the consolidated entity to among the leading consumer wellness solutions providers in India. Heinz India, with revenues of US$ 160 million, owns popular brands Glucon-D, Complan and Nycil. The distribution muscle of Heinz India comprises over 800 distributors, 17 lakh retailers, 21 warehouses and a 1,000-strong field-force.

Exide Industries is a leader in packaged power technology. A wide range of lead acid storage batteries from 2.5Ah to 20,600Ah capacity are designed, manufactured and marketed to service a diverse set of industries including automotive, power, telecom, infrastructure, computer, railways, mining and defence. Brand Exide is synonymous with batteries and portable energy solutions across industries.

The country's largest storage battery producer, with the widest range of conventional flooded as well as latest valve-regulated lead-acid batteries, exports to South East Asia and Europe. The nine factories are strategically located across the country. Of these, two units are dedicated to home uninterrupted power supply systems. Capital expenditure of Rs 750 crore was incurred in FY 2018, primarily in different manufacturing plants.

The technical collaborations with Shin Kobe and Furukuwa of Japan, Oldham of the UK and East Penn Manufacturing of the US provides an edge in manufacturing capabilities. A joint venture was formed in June 2018 with Switzerland-based Leclanché SA, one of the world's largest energy storage solution providers, to build lithium-ion batteries for the domestic electric vehicle market.

The Rajan Raheja group company's wholly owned life insurance subsidiary Exide Life Insurance Company commenced operation in FY 2002. Exide Life served over 15 lakh customers and managed assets of over Rs 12500 crore end FY 2018. Total premium income was over Rs 2500 crore and reported profit before tax Rs 60 crore.

The Murugappa group company EID Parry holds the distinction of setting up the country's first sugar plant at Nellikuppam in Tamil Nadu in CY 1842. Nine sugar factories have a capacity to crush 45,800 tonnes of cane per day and generate 160 MW of power and four distilleries have a capacity of 234 kilo liters per day. The nutraceuticals business holds a strong position in the growing wellness segment, mainly catering to the world market with its organic products. EID Pany has a 100% stake in Parry Sugars Refinery India Pvt Ltd and US Nutraceuticals Inc, US. Parry Sugars Refinery imports raw sugar from international markets and produces refined sugar.

There is significant presence in the farm inputs business through subsidiary Coromandel International. Coromandel is the country's second largest phosphatic fertilizer player and is in the business segments of fertilizers, specialty nutrients, crop protection and retail. Around 4.5 million tonnes of a wide range of fertilizers are manufactured and marketed. Around 800 rural retail centers are operated in Andhra Pradesh, Telangana, Karnataka and Maharashtra. Revenues were Rs 11044 crore and profit Rs 659 crore in FY 2018. The bio-pesticide business of Eid Parry was bought in FY 2018. The acquisition will provide access to the high-growth bio-pesticide segment in Indian, North American and European markets.

Gujarat Fluorochemicals is the largest producer of chloromethanes, refrigerants and polytetrafluoroethylene in India. India's largest and the world's fourth largest poly tetra fluoro ethylene plant accounts for 11% of the global capacity. Capacity of caustic soda or chlorine is 1,34,750 tonnes per annum (tpa), refrigerant gas 65,000 tpa and chloromethane 1,08,500 tpa. The focus is on fluorine chemistry, used in pharma molecules, dose efficient and eco-friendly crop protection chemicals, automotive, semis, mobile telephony, oil and gas and high-speed local area network cables.

Subsidiary Inox Leisure is the country's second largest multiplex chain operator and is in the business of setting up, operating and managing chain of multiplexes under the brand Inox. There is presence in 67 cities in 19 states with 136 multiplexes and 557 screens. Inox Leisure reported profit of Rs 114.6 crore on revenues of Rs 1348.1 crore in FY 2018.

Another subsidiary Inox Wind is a fully integrated player in the wind energy market, with plants near Ahmedabad in Gujarat, Una in Himachal Pradesh and new facility in Madhya Pradesh, one of the largest in Asia. Also, Inox Wind provides end-to-end turnkey solutions for wind farms. Inox Wind is a drag on consolidated financials, with revenues of Rs 212.4 crore and loss of Rs 157.2 crore in FY 2018.

Incorporated in 1995, Info Edge is among the country's leading online recruitment, matrimony, real estate, education and related services classifieds platform. The business portfolio comprises domestic recruitment portal naukri.com, job portal naukrigulf.com focused on the Middle East market, offline executive search portal quadranglesearch.com and fresher hiring site firstnaukri.com. Other portals include online matrimony classifieds www.jeevansathi.com, online real estate classifieds 99acres.com and online education classifieds shiksha.com. The online player has a network of 62 offices in 43 cities and an employee base of 4,049 in India and offices in Dubai, Bahrain, Riyadh and Abu Dhabi.

Importantly, investment is undertaken in early-stage start-ups to tap into the growing and vibrant Indian internet market. These investments can provide a significant upside in the medium to long term. Among these investments, with 27.7% stake, is Zomato Media Pvt Ltd, operating an online food guide portal zomato.com, is the most promising. HSBC Global Research valued Zomato at US$ 3.6 billion in March 2019. Info Edge holds 27.7% in Zomato.

Other key investments are online price comparison site for insurance Policy Bazaar, supplementary online learning platform mertination and men's grooming range USTRAA. Investment of Rs 2 crore will be made in Wishbook Infoservices Pvt Ltd through wholly-owned subsidiary. Wishbook operates B2B cataloguing app and acts as marketplace for manufacturers, distributors, wholesalers, retailers and sellers.

Sundaram Finance, an NBFC, provides loans for commercial vehicles, passenger cars, tractors and construction equipment and provides specially designed working capital products such as fuel finance and tyre finance. Other products comprise home loans, mutual funds and non-life insurance products and information technology services. Apart from offering business process outsourcing, a wide range of financial products and services are distributed. Assets under management grew 14% to Rs 28,102 crore end December 2018 over a year ago. Interim dividend of 50% or Rs 5 per share was declared in January 2019.

Key subsidiaries and associates include Royal Sundaram General Insurance Company, Sundaram Asset Management Company (AMC), with equity stake of 100%, and Sundaram BNP Paribas Home Finance, with equity holding of 50.10%. Importantly, all the three subsidiaries are making profit. Royal Sundaram reported profit of Rs 83.3 crore, Sundaram AMC Rs 38.2 crore and Sundaram BNP Paribas Rs 136.4 crore in FY 2018. Sundaram AMC and Sundaram BNP Paribas have paid dividends in FY 2018.

Royal Sundaram is India's first private sector general insurer and offers motor, health, personal accident, home and travel insurance. Ageas Insurance International NV in February 2018 acquired 40% equity stake in Royal Sundaram from the existing Indian shareholders. The stake of Sundaram Finance declined to 50% consequent to the divestment. Ageas Insurance controls 40% and the other Indian shareholders hold the remaining 10% equity.

Godrej Industries manufactures and markets oleo-chemicals, their precursors and derivatives, bulk edible oils, estate management and investment activities. Associate company Godrej Consumer Products, with equity stake of 23.8% end December 2018, makes personal- and household-care products. The largest household insecticide and hair-care players in emerging markets is building presence in three emerging markets of Asia, Africa and Latin America across three categories of home-, personal-wash- and hair-care.

Subsidiary Godrej Properties, with 53.6% equity stake, is a real estate and property developer. Established in 1990, the country's largest publicly listed developer by booking value over the past three years has delivered 18 million square feet of real estate in the past five years and possess an estimated 145 million square feet of developable area across various cities. The 58% subsidiary Godrej Agrovet produces animal feed, agri-inputs, poultry, dairy and oil palm. Godrej Agrovet has a JV with the ACI Group in Bangladesh for the feed business and with Tyson Foods, US, for the poultry and processed food business. Godrej Agrovet's listed subsidiary Astec LifeSciences operates in the crop protection segment.

Godrej International & Trading and Godrej International undertake international trading. Wholly owned subsidiary Natures Basket operates fresh food and gourmet stores. Natures Basket operated 34 stores across three cities of Mumbai, Pune and Bangalore end December 2018.

Great Eastern Shipping Company is the country's largest private sector shipper, with presence in tankers transporting crude and products and dry bulk. Shipping assets include crude carriers, with capacity of 16,08,683 dead weight tonnage (dwt), product carriers of 9,87,207 dwt, gas carriers of 2,73,466 dwt and dry bulk carriers of 1,026,462 dwt. The impeccable track record consists of making profit and paying dividends in each of the last 30 years. Institutional investment remains high, with mutual funds holding 21.4% equity stake end December 2018.

There is presence in the offshore segment through wholly-owned subsidiary Greatship (India), one of India's largest offshore oilfield services providers. The offshore segment consists of logistics and drillings, with assets comprising four jack-up rigs, four platform supply vessels, eight anchor-handling tug-cum-supply vessels (AHTSV), two multipurpose platform supply-and-support vessels and five remotely operated underwater support vessels. A sharp slowdown in the investment in the exploration and production segment has resulted in drastic fall in the day rates for the offshore assets in general. The day rates for both AHTSV and platform supply vessels have declined to around 50% from 45% since FY 2014. Loss of Rs 14.8 crore on revenues of Rs 1057 crore was recorded in FY 2018.

Conclusion

Loss-making subsidiaries, JVs and associates are a drag on consolidated financials. The parent ends up funding these ventures at regular intervals. The mode of financing includes subscribing to rights issue. Even if group companies are profitable, they should be paying sufficient dividends so as to become a source of income to the flagship.

Many times, subsidiaries are floated to enter into related or unrelated areas that the parent is not able to or does not want to foray due to the danger of diluting its valuation but at the same wants to spread the risk by diversifying or to ensure supply of raw materials and intermediates.

Despite all kinds of advantage that the investment theme offers, holding company discount remains a key overhang. The stock market seldom recognizes the value of the businesses of group companies unless these assets are up for sale. The strategic value does not get reflected in the market capitalization of the flagship. In such a situation, investors are left holding such stocks till the parent considers the investment ripe for monetization through stake-sale.

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