(Stocks covered: RITES Ltd, Bharat electronics Ltd, BEML Ltd, HAL, CONCOR, ELGI Equiments Ltd, Laurus labs, Sasken Tech)
Ignorance is the biggest
hindrance to growth but still the good thing about ignorance is that it itself
does not pose as a hindrance…it does not obstruct the path on its own. And
that’s exactly why Prejudice is most dangerous because it can mislead to wrong
path while the traveller is assured of righteous which eliminates the chance of a course correction. Wrong path is more destructive than no path. And so we can
see that religion is not marred by ignorance but prejudice. Most of our wrong
choices and mistakes are not out of ignorance but prejudice.
Here, I remember when IPO of one
of the defense PSUs, Bharat Dynamics Ltd was launched. At that time a message degrading
R&D capability of BDL was doing the rounds that India's premier missile
manufacturer spends as much on research as our hair oil company Marico. The
message said that for 3 years period 2015/16/17 Marico spent some 80 cr on
R&D while BDL spent just 85 cr. That message also came to me. But I told
them to stop spreading nonsense. Why nonsense? Because PSU defense companies
like BDL, BEL, HAL etc. do not do the major R&D work for their products. It
is DRDO who spends money on R&D as per Govt. budget allocation (Ministry of
Defense. However ISRO reports to PMO, which is busy in all other works so does
not interfere much and that’s why ISRO has much freedom and much advanced
R&D system). DRDO has established these PSU’s painstakingly and over
decades. Like BDL was founded by some 60-70 scientists of DRDO in 1969.
So DRDO does the major R&D on
behalf of these PSU’s. DRDO develops the foundation technology and then the
final manufacturing is done by these defense PSU’s. Just like DRDO developed
the Akash missile's foundational technologies then BDL and BEL are doing the
manufacturing of this. So one needs to add the R&D done by DRDO before
arriving at misleading conclusions.
Indian PSU’s are often ridiculed
and blamed for being inefficient, lethargic, living on government support and
devoid of any energy. Indian PSU stocks trade at extremely lower levels as
compared to their private counterparts. Talks are there always to sell them to
private sector in order to make them “better”. Government is also planning massive
disinvestment process of these PSUs.
But are these PSUs really that inefficient?
A) R&D
investments are the basic mantra for economic growth
Recently I was talking to an
analyst about investing into PSU stocks like BEL, Rites. He told me that these PSUs
are useless as they lacked terribly in innovation. Then I asked him whether he
knew the share of R&D in India by private sector. He answered in negative.
I told him to give a ballpark figure keeping in view his high regard for
private sector. He said that that should be the highest. But I told him that
things are actually in reverse. Private sector investment in R&D is the
lowest in India at 37% against a global average of 71%. Most of the R&D
(63%) in India is still being done by government sector where central Govt. has
45.4% share, PSU has 4.6%, State govt. has 6.4% and Higher education sector
6.8%. So, central Govt/PSUs have 50% share of Indian R&D expenditure which
is massive. However, Govt. share in R&D in US is 10%, in China it is 15%,
Canada/UK 7%, Korea 11%. Our State governments need much work to do here but this
also shows that there is a tradeoff between wasteful subsidies and innovation.
In Govt/public sector, DRDO has maximum share of 31.6% of R&D expenditure
followed by Department of space (DOS) (19.0%).
India lacks badly in R&D and
we spent 0.7% of its GDP on R&D in 2017-18. Most of the developed countries
spent more than 2% of their GDP on R&D like the US (2.8), China (2.1),
Israel (4.3) and Korea (4.2). Our spending is around .7% for almost two decades
now. This is one of the reasons for the dismal growth of our industries in last
decade or so. We were/are not good enough to compete at global levels. That’s
why in spite of being one of the biggest markets of smartphone not a single
component of smartphone is manufactured in India. Our consumer electronics
goods industry is fully under the control of global giants and Indian players
are reduced to fringe players.
Further, most of the R&D in
private sector is done by drug/pharmaceuticals and transportation/auto sectors…around
50%. Tata motor (around 4000 cr) is the big gun here and in fact at 99th
place it is the only Indian in top 100 global spenders in R&D and if we add
R&D of JLR (some 15000 cr) then Tata motor is at 13th place. You will be surprised to know that defense PSU giant Bharat Electronics Ltd. spends around 9% of its turnover on R&D!!! Its top-line is 12000 cr. Further,
foreign firms also account for major chunk of R&D being done in India which
is included in this 37% share of private sector. And if we look further deeply
into R&D done by our private sector we can see that the focus is mostly on
process or incremental innovation to reduce the cost or improving the
efficiency…the focus is never on breakthrough product. That’s why though we
spend quite a bit in Pharma but still we just export low cost generic medicines
and compete on the basis of cost and as other countries like Philippines are
also upping the ante in generics so the sailing is getting tougher for Indian
generic players. Our manufacturing exports include low margin high volume
products like refined petroleum, cotton, leather goods etc. There is no Indian
brand in manufacturing at global level.
a) R&D
work by Indian defense organizations
On the contrary, look at the
achievements of ISRO in space technology which has catapulted it into being one
of the biggest commercial players in the space industry globally. ISRO has
developed space technologies almost scratch in India as no other country is
willing to share highly sophisticated and premium space technology. Apart from
building these from scratch, ISRO has done the same at extremely low cost.
These low cost but premium products will pave the way for ISRO to achieve grand
success commercially across the globe. ISRO’s Mangalyaan mission cost $74
million (500 cr) against $671 million spent by the NASA on similar missions.
The cost was lower than the cost of Hollywood blockbuster movie Gravity.
Similarly, Chandrayaan-2 mission last year cost around Rs 978 crore. Though
there is a difference in the tenure of the missions of NASA and ISRO and
shouldn’t be compared one to one but still they are way cheaper and the main
aim was not to spend longer time at Mars or Moon but to demonstrate/test the
technical ability to reach there. In the future, we will see more advanced,
mission critical and complex missions to space.
Some people think that low cost
is due to low cost of engineers and scientists in India. But this is not the
case. Space missions involve thousands of hi-tech critical components
where there is no scope for failure. Sourcing these components from other
countries would have been very costly so ISRO marched towards the tough part of
developing these locally. And while doing so, ISRO has created and promoted
many private players who have supplied these components to ISRO at fraction of
cost of importing it. ISRO built the technology and the same was licensed to
private players who then did the manufacturing.
Similarly, our Navy has also done
quite a work in R&D and India is almost self-sufficient in manufacturing
Hi-tech super critical navy ships required by Indian navy. In Missiles, DRDO
has done a great work and we are almost self-sufficient in missile technology.
Recently, Brahmos missile (joint venture with Russia) has been a grand success
story of DRDO which is being touted as one of the best globally. It is capable of travelling at speeds of up
to Mach 3.0 (three times the speed of sound, around 3400 KMPH) and it travels
at low altitudes so it is very difficult to be detected by radars. China is extremely worried over BrahMos because these are not even detected by S-400 missile defense
systems china is procuring from Russia. Just before hitting its target, BrahMos
performs `S-manoeuvre’ to evade any anti-missile defence system which makes it
very deadly. The high speed gives it enormous kinetic energy which can rip
apart even large warships. In case of a short swift war with China, India can
wreak havoc at Chinese military infrastructure, radar and air defense systems. India is planning to sell these to Vietnam
& Philippines which has made china extremely worried because it knows that
it has no answer to these missiles.
Surface to Air Akash missile was developed
by DRDO and manufacturing was taken by defense PSUs BDL (Bharat dynamics Ltd)
and BEL (Bharat electronics Ltd) and both have also engaged private players
like Tata and L&T for critical components like missile launchers and almost
300 other small private players for smaller components. Akash has a kill
probability of 88 per cent for the first missile and 99 per cent for the
second. Almost 90% of Akash missile components/cost are made in India.
Recently, DRDO has developed
Seeker technology and used the same on BrahMos missiles successfully and this
will lead to the savings of around 15000-20000 cr as the same are imported
right now and this comprises some 30-35% of the cost of a missile. Seeker
technology equips a missile to hit its target with pinpoint accuracy and this
technology is a closely guarded secret so local development is a great
achievement. There is already demand for both these missiles from other
countries and very soon we’ll see India securing large export orders for both
these.
People in India try to ridicule
Hindustan Aeronautics Ltd (HAL) for huge delay in making India’s first Light
combat aircraft (LCA) “Tejas”. But delay was mainly caused by regular changing of
specifications/requirements by IAF. We don’t always need the best technology in
the world. We need better technology than the rivals. The best way to promote
localization is to create a basic product which can serve most of our needs and
then we can make incremental improvements in it over the period of time. In
case of Tejas, the responsibility of making incremental improvements should
have been given to IAF. Similar model is used by Indian Navy and this is one of
the reasons of success of local manufacturing in Navy.
Tejas LCA was meant as a
replacement for ageing MIG-21 and it was to fight against Pakistan’s JF-17
(supplied by China). And Tejas is a better aircraft than MIG-21 in all respect.
Like, I was reading that Tejas has a tighter turn radius of 350 metres, smaller
than F-16 which helps in dogfight. And F-16 is better than JF-17 anytime. Tejas
have an advanced autopilot feature that automatically pulls up Tejas if it is
going down too fast and crossed the danger line of altitude and this makes
Tejas one of the safest fighter aircraft. JF-17 don't have such features. In
case if engine failure, Tejas has a parachute feature to regain control or
minimize casualty. In the absence of these safety features, 3 JF-17 have
already been crashed. JF-17 was poised to compete against Tejas in Lima-2019 Aerospace
Exhibition and also at Bahrain International Airshow to woo the potential
customers but at the last moment JF-17 had pulled out both times.
India has very large defense
budget and it is clear that we have no other option but to focus on local
procurements. This no option may be the thrust India needs to focus within
India. If India wants to be a significant player in defense export market then
first of all these products should be used by Indian army itself. Like, a
number of countries has shown willingness for Tejas but unless the same is used
by IAF other countries will also be apprehensive. Tejas should be used and
tested first by IAF improving/rectify it further before offering it for
exports.
Tejas has used General Electric
F404 engine and its radar system has been procured from Israel. But still a
fighter aircraft is not just about engine alone. Engine costs some 25% of the
total cost of a fighter aircraft. But other critical components have been
developed locally in India like fuselage, landing gear, AESA radar, control
system, networking, sensors, weapon management system, braking system, oxygen generator
and many other subsystems. Aeronautical Development Agency (ADA) undertook the design
work on Tejas with zero previous experience but still they did a great work.
ADA had used advanced technology at every opportunity-advanced computational
fluid dynamics for the aerodynamic design, a mock-up designed for the first
time in India entirely on the computer, advanced carbon fibre composite
material for the structure, advanced avionics in the cockpit. India is also
working on developing indigenous Kaveri engine to replace GE F404 engine in the
future upgraded versions of Tejas and it will take another 2 years or so.
Just remember that these defense
products developed by our defense organizations are one of the most complex,
sophisticated and strategic products which are critical to the national
security of a nation. They involve very complex and highest levels of technology
and expertise…much higher than any other industrial product (our regular cars,
machines etc.). And our defense organizations are making complete products not
just components. And if other countries are showing interest in procuring these
(deals are at final stages) then that shows that our defense organizations have
been successful in developing globally acceptable high quality/strategic
product while our private sector firms have not achieved much success in
producing globally accepted premium quality industrial products.
b) Government
R&D investments have done better
So as we can see from above,
Govt. R&D investments have produced great results in developing niche high
tech critical technologies in space and defense. On the contrary, if we can see
the R&D efforts of private sector in IT services, Pharma and Auto sectors
which comprise the major chunk of R&D investments-the focus is never on
breakthrough technology development. Our IT sector survives on low cost of
highly skilled professionals. In spite of so much talent we could never
developed/created an IT product like Java, Oracle. In Auto sector, R&D
efforts are mainly driven by the need of the hour due to stiff competition from
global giants. Our behemoth Reliance industries spends just .5% of its topline
on R&D. Somehow, the focus is not on innovation though there are valid
reasons for this. Like in medicine, tight control over pricing of the medicine
push away the investments in developing new breakthrough medicines because
developing a new cure costs billions.
I
have seen people talking about PSUs that they had been formed to create
employment in the country. But employment was just the secondary objective. The
main aim behind the creation of PSUs was to develop critical technologies in
heavy industries and strategic/core sectors for self-reliance. Due to focus on
developing high end technologies after independence, India was ahead of most of
other developing countries. But then we lost the track in developing and
further modernizing these technologies. Private sector was playing the role of
assistant to Govt. in core sectors. Non-core sector
was left for private sector but private sector was content in having monopoly
conditions in protected market and this hit us very badly in product
development. When our economy was opened, global hi-tech players just threw our
local manufacturers into the dust.
After the onslaught of global
giants, when private manufacturers were crushed but heavy industries PSU like BHEL
still managed to hold their forte. BHEL is in power sector producing top
quality power equipments which are powering India for almost 60 years. Power plants
constructed by BHEL are running smoothly even beyond their useful life all over
India that too when Indian coal has very high ash content but BHEL was able to
develop technology to handle this issue efficiently. BHEL
still is one of the biggest R&D spenders in the country; it spent 750 cr in
2017-18 (820 cr in 2018-19) which is 2.7% of its turnover and it was at 10th
place in India. Our Auto maker Maruti spent 1.1% of its topline on R&D.
The fortunes of BHEL in recent years were hit hard due to the entry of cheap
Chinese players in power sector and focus on solar power from thermal due to
pollution woes. Chinese players have inferior power products but they dented
the market due to low cost which is due to the fact that Chinese players get
big export subsidies, low tax and interest rates while BHEL has to fight with
higher tax and interest rates. This was something which should not have been
allowed to happen at the cost of local players. We can’t allow foreign players
to capture our market by undercutting. They should compete on merit.
(Image BHEL: Gas Turbine)
It is
worthwhile to mention that in 2018-19 BHEL secured 97 patents in India which
was the highest for an Indian company. It is noteworthy that BHEL earned this
in the presence of our IT giants like TCS/Infosys. Though global chip
maker Qualcomm was the leader with 405 patents followed by BASF with 232
patents granted, Tata group was at 3
rd place with 211 patents. In
2018-19, apart from Tata, BHEL was the only Indian firm in the top 20 patent
winners in india. At present, BHEL is working on to develop technology for
generation of methanol from high ash Indian coal.
As shared earlier Defense PSU giant Bharat Electronics Ltd. spends around 9% of its turnover on R&D!!! Its topline is 12000 cr.Another PSU BEML has spent 3.4% (104 cr) of its turnover on R&D in 2019-20.
One of the reasons for lower
success of make in India in defense is the stiff technical specifications (GSRQ)
by Indian Army while procuring defense products which is difficult for the likes
of DRDO, Defense PSU, Ordnance factories and private sector. Now there are
calls from ministry to lower down these specifications so as to promote local
products because we don’t need advanced products like US as we are not fighting
wars across the globe. We are to guard our borders so we need to focus on our
requirements. Army/Defense sector can do improvements on these later on. Similar
model was followed by China and many other countries to grow local defense
industry.
Turther, Govt undertakings operate under
the eyes of CAG, CBI and CVC (called 3Cs) which limit their freedom and risk
taking ability otherwise they can do even better. These agencies question every
decision taken by PSUs, so even in R&D they are forced to avoid taking high
risks on breakthrough innovations due to fear of failure and questioning from
these 3Cs. In fact, in order to free these PSUs from the eyes of 3Cs, govt.
wants to bring down the ownership in these PSUs below 51% (though there is
issue regarding the meaning of “Control”).
Recently, India has secured an
export order (300 cr) of Weapon locating radar (WLR) from Armenia competing against
defense power-house Russia and Poland. WLR has been developed by DRDO and BEL.
Now India is looking at other markets for this as India has edge because of
lower price with more or same specifications. So far India shied away from
defense export markets due to geopolitical issues but now government is looking
at export market very seriously.
We
can see that apart from investing much higher in R&D as compared to private
sector (Indian companies only) Govt. sector has been able to create and develop
more innovative products and technologies. In other words, their return
quotient or innovation index is much better than private firms.
c) Net
profit is a wrong measure to evaluate the contribution of PSUs to economic
growth
I have seen many attempts to evaluate PSUs by comparing their performances (Profit & Loss account) with private sector counterparts and straightforward conclusions are derived fairly easily just on the basis of profit & loss statement. But great thing about life is that it is multidimensional (not just 3D). Net profit is just one dimension of multi-dimensional growth matrix and this growth matrix becomes more complex when we raise the platform from micro level (Firm level) to macro level (Economy level).
Growth (profit) for a corporate firm is an individual (linear) phenomenon while for the economy the same is a comprehensive (inclusive) phenomenon. Actually GDP is a composition phenomenon but GDP growth is a distribution phenomenon. Economic growth occurs when wealth is distributed. That’s why when a private bank like ICICI decides to close a loss making remote town branch (or decides not to open a branch) then this will increase their profits but when SBI opens a branch in a remote town/village then it does hit their profits but it results in economic growth (wealth creation). Another way to see this opening of a bank branch by SBI is that it distributes income (wealth) from SBI to village in the form of investments in Branch (assets/employees) which results in further growth of wealth (Because village as a whole also grows due to availability of banking... result is the higher production and so economic growth). So loss to SBI is an investment for the economy. Hence, net profit is a very inefficient barometer to measure growth at macro level (economy) just like GDP which is good enough to measure “Income generated in an economy” but not “wealth” created.
I have seen SBI branches in remotest places in India and so it is not appropriate to compare SBI to other private sector banks just on the basis of net profit. Once I was posted in a small town in MP (Sarni) and there was no other mobile services working properly (no tower) except BSNL and BSNL broadband internet was a pleasant surprise for me when dongles of other providers were too slow. So value of PSUs can’t be judged on the basis of net profits but their contribution to economic growth which I think is massive. Like PSUs are required to procure around 25% of their procurements from MSME vendors so this process may result in higher costs and execution delays but the impact of economic growth is much higher in the form of development of these MSMEs and employment generated through these MSMEs. We can see PSUs are distributing their wealth more comprehensively. Concentration of wealth in the hands of few is not good for an economy. It has to be distributed. Socio-economic impact of PSUs is very high.
Like, the role and importance of Indian railway can’t be gauged from profit and loss account alone. Now, as private players will be allowed to run passenger trains so they can choose profitable routes thus maximizing profits. So there is a much higher purpose behind PSUs and if these can be made better then they can provide massive boost to economic growth. As they are dealing with public money so there are processes, checks and control measures to avoid any willful mishap like fraud etc. So there are tendering norms (against selective buying), L1 norms for awarding contracts, regulatory agencies like CAG, CBI and CVC etc. This is to ensure the fulfillment of objectives and to stop the misuse of power and public money. So these checks and controls can make PSUs bulky and slow moving at times but safeguarding of public money is also equally important. The need is to choose a midway to allow more freedom.
That’s why private firms are more nimble and a firm like Reliance can source crude oil at spot market to get the benefit of big temporary fall in prices but state owned refineries like IOCL are required to issue tenders for the same. This is one of the reason for Reliance to have high GRM (It has highest Nelson Complexity Index for its refineries; Recently IOCL’s Paradip refinery is having high NCI. Then Reliance’s refineries are near coast saving money, big size). But now as controls/managements are getting better so state owned refineries are also allowed to source crude at spot prices. Recently IOCL has set up a trading desk in Delhi to source cheap crude at spot prices just like Reliance. IOCL/HPCL/BPCL are setting up a massive refinery (60MT almost double of Reliance’s biggest) at west coast.
But there is a risk with the concentration of power/agility in a thundering juggernaut like Reliance. Fraudulent managements can siphon off the shareholder’s wealth by taking dubious decisions thus leaking out the money. We have seen many examples recently in the cases of Vijay Mallaya, Yes bank, DHFL, Videocon, IL&FS. So there was a purpose behind CAG and CVC to have an eye on the working of PSUs and this acts as a check against these destructive frauds though this has a cost on PSUs in the form of bulkiness. We can’t afford a Videocon, Satyam in critical sector like defense. But still there are better ways to ensure more freedom for better agility (which I’ll discuss in a separate post in more details) by empowering their managements…like Singapore’s Temasek Holdings which acts as Investment company where portfolio companies are managed by their independent boards. Tamasek can independent business decisions and Singapore govt has no role in it. . However, in any case the RISKS of existence threatening frauds are much lower in PSUs.
And if you ask me then these lesser risks should lower the cost of equity capital of a PSU just like bulkiness may raise the cost of equity (At times I find calculations of cost of equity somewhat funny and not much worthy in practical life…but still a fair theoretical concept to understand the factors making a firm more risky than the other.)
PSU is not an Indian concept and they are still used globally for achieving socio-economic goals. In fact, State owned enterprises (SOE) have played major role in the stunning economic growth of China. Government is required to invest in sectors which are strategic for the nation long term growth and safety like Defence, Energy, Mining etc. Government is required to play a major role in high risk sectors where private sector has lesser appetite for risk like take for example Semiconductor, AI, advanced telecommunication tech etc. Govt. has access to cheap capital and it can afford to take risks much better. Indian private sector has failed to capture and develop the massive opportunities in sectors like Solar power, Electronics goods, Semiconductor, telecom equipment and so now it is better if Govt. (through PSUs) invests in creating these capacities in India. I’ll discuss more on Govt. investments in these sectors in a separate post on development of semiconductor industry in India.
d) Private
sector’s big failure in developing products for global markets
In the absence of R&D
investments, our private sector has chosen the easy way of having technical
collaboration with global players on license or royalty basis. Due to this
licensing of technologies, they can only focus on Indian markets. Notable case
is our battery makers Exide Industries and Amara Raja- You can see them forging
technical collaborations or JVs with foreign partners for Indian markets only.
They still do not have their own technology. They have brand and distribution
strengths in tough Indian market which forces global players to enter into
partnerships with them which was not the case with electronics goods like TVs,
smartphones etc. and global players just captured the Indian market fully as
they ventured to create their own brand promotion and distribution clout.
This inability of our private
sector to focus on developing hi-tech top quality products for Indian and
global markets is the reason that our manufacturing sector is stagnant at 17%
of our GDP for almost a decade. Further, due to this our merchandise exports
are also stagnant for last 10 years or so. India can’t survive in the highly
competitive export market with low cost alone because many new countries like
Bangladesh (in textile), Philippines (in generics) are coming to capture market
from India as in low value added products their cost structure is still lower
than India. Selling tea and cotton in global market is not a big deal as there
is very low value addition so entry barriers are very low.
Indian private players have so
far failed to build “products” with strong “Brands” for global markets. Because
the focus is not on developing product as they are content in being a component
supplier to global players. For India to be a global power, we need to focus on
products. Just make a look at all the listed Indian companies in stock market
and try to find a player with strong global product/brand. You may not find
many.
But still there are success
stories like Mahindra tractors. You can see Mahindra tractors (Swaraj Brand)
roaring in American fields. American farmers are very quality and brand conscious
and this is indeed a big achievement by Mahindra. But we need many more like
this.
Here
I want to mention another such Indian company which I like very much. The name
is ELGI Equipments Ltd which I think is the first Indian premium global brand
in capital equipment space-air compressor.
The
likes of Bharat forge are great but they are just component suppliers to
foreign producers. But ELGI has chosen the tough path of developing branded product in
B2B segment that too in premium segment, creating manufacturing facilities in
US/Italy etc. It has very strong brand recall and it is seventh largest player
globally and in the last 10-12 years ELGI has increased export share in its
turnover (around 2000 cr) to 50% which is a great feat and it will grow further
due to the launch of innovative products like oil free compressors at almost
the same cost of an oil-lubricated one. In Indian market, ELGI is a closed
second to global giants like Atlas copco and Ingersoll Rand. ELGI spent around
4% of turnover on R&D in 2018-19 (it was 3.4% in 2017-18) which is quite
good by any standards and this is the reason it has maintained the edge and
premium-ness in its products. On the contrary, once a formidable force Kirloskar
Pneumetic spends just 1% on R&D.
The Kirloskars
are here for decades but they faltered big time on growth. Once they were the
leading industrialists in India competing with the mighty Reliance/Tatas but
they just could not find the right path. They were the very first in focusing
on product approach and they did a great job in developing hi-tech technologies
locally. They were way ahead of other generic industrialists of India with
their focus on brand power and globally competitive products. Their brand
strength is such that people in Africa uses “Kirloskar” word for Pumps…they
believe that meaning of Kirloskar is pump. Shantanurao Kirloskar was the
visionary behind the spectacular growth of the group. He was the one of very
few Indian businessmen like Tatas who treated their employees like a family. He
was man behind the formation of the Federation of Indian Chamber of Commerce
& Industries (FICCI) in 1927. But still, the good thing about the group is
that they are almost debt free and some restructuring here and there may
catapult them back to growth as an Indian leader in manufacturing. I really
want them to do great and I am looking to pick stocks like Kirloskar brothers
and Kirloskar electric.
ELGI
is a premium player with very premium product offerings. They never tried to be
a low end low quality player. They have matched their product quality with the
best in the globe and this is one of the reasons for their success in highly
quality conscious export market like US. ELGI is now investing big for branding
and taking part in trade shows across the globe. Air compressors are ubiquitous
because every factory need needs compressed air, and therefore a
compressor-whether it is mining, food processing, medicine, railway braking,
petrol pumps…everywhere. Recently, ELGI has launched its AB (Always Better)
series at the Hannover industrial fair is one of the mainstay of its strategy
in global success. ELGI has invested 5 years in developing this and these
products have the potential to revolutionize the business. The global oil-free
air compressor market will grow much faster due to environmental impact of
oil-lubricated air compressors. Also, the industries like food and
pharmaceuticals only use the oil-free ones.
I
think this one to be the major beneficiary of coming expected growth of manufacturing
in india and current problems faced by Chinese players across the globe.
Capital investments were low in India in the last 2-3 years but this will pick
up pace as most of the economy cleanup (NPAs) has been over and India is
looking big at local manufacturing. ELGI may get more market share as many weak
players will leave the market due to covid crisis.
Its
profits this year have been fallen but there is more to the story. Actually
ELGI is expanding in newer markets in Europe and it is investing for creating marketing
and supply chain infrastructure from the scratch rather than acquiring the
existing distributors which is very costly. It has acquired some in the past
though in other markets. So they are building a team of 70 people whose salary cost is hitting
NP along with other fixed costs by some 40 cr (will hit for next 3-4 years).
Then some costs they incurred in India this year won't be happening in
future...some 10 cr or so. Their employee cost is up by 60 cr to 400 cr in
2019-20 from 340 cr.
But i
like companies taking pain in building a premium brand. Brand strength and
customer loyalty in B2B segment is much stronger than B2C. ELGI is taking great
pain, efforts and investments in building a great premium Indian industrial
brand. Good dividend player...low debt...good cash in the books. ELGI was in
investment mode so far and I believe its current earning profile is not
reflecting the true potential because this one is going to reap the benefits of
investments in superior product quality and distribution across the globe. I have started adding this one from 140
recently and will add more of in the future.
Similarly, I remember when I
picked pharma giant Biocon few years ago at 40
(Click here for earlier post on Biocon). My main reason for investing
was its very superior R&D focus. At that time many analysts were negative
on this one but Biocon was my only pick in Pharma sector and it has delivered
big time so far- 10 times returns so far as it is trading at 400 now. I am
still holding it. Last 3-4 years were very bad for Indian generic pharma
players due to competition in low entry barrier generics but Biocon is one of
the very few which has given great returns. Biocon was in complex generics and
at present the biggest player in very complex bio-similar segment which
requires very high investments in R&D as compared to small molecule
generics. After Biocon, now I have picked Laurus labs as the next pharma high
growth candidate which is another stunning player with very superior R&D
capabilities in manufacturing complex APIs. During covid market fall I added
good chunk of my portfolio in it around 300-330 and it is already touching 600.
But still a worthy candidate for any portfolio.
e) Whether
India’s R&D Intensity ratio of .7% is really that poor?
India spends some .7% of its GDP
on R&D which is considered very low by global standards. But I think more
than the absolute amount we fared badly even in getting the most out of these
R&D (.7%) investments. We fare worse in Innovation quotient or innovation
rank. This is due to faulty (or risk averse) approach to innovation. Most of
the Private sector’s R&D investments are in Pharma and Auto sector where
due to the nature of business (faster technology changes, regulatory and global
competition) they are “forced” to invest in R&D otherwise they would have
been content in doing run of the mill business churning out low tech low
quality mas products for local market. Like, in Pharma R&D investments are
into reverse engineering a medicine for producing the generic version which is
less risky but very less innovative.
Further, I think R&D
Intensity ratio (calculated as total R&D investments divided by total GDP,
which is .7% for India, 2.8% for US, 4.3% for Israel/Korea) does not render
much information about the innovation potential of a country just like overall
GDP figures do not provide any information about the quality of national income
(sustainable, promoted with high debt or investments or consumption). Actually,
R&D investments are directed by the nature of industries an economy
primarily deals with like an economy which is primarily based on tourism will
have very low R&D Investments because the share of other industries are
smaller as compared to tourism. But still, it is possible that in those
industries they were doing some breakthrough innovations. That’s why observed
R&D intensity ratio is greatly impacted by the composition of industries in
a particular economy like if we take the case of South Korea which invests big
in R&D but this is due to the nature of industries it is operating in. Korea
is a big force in ICT (Information and communications technology) industry
which an R&D intensive sector. Similarly a country can be a force in low
R&D intensive industries like chemicals.
And so if we account for the
industry structures of an economy along with standalone R&D intensity then
the resultant modified R&D Intensity gives different results. Standalone
high R&D intensity economies like South korea and Finland are ranked much
lower when their industrial structure is accounted for. It simply means that
they are average in industry agnostic innovation index. They do not spend much
on R&D unless they are forced to due to industry specific dynamics. This,
however, can’t take away the stunning performance of R&D of these countries
in ICT industry.
In
the absence of industry specific R&D requirements, R&D investments are
governed by perceived high returns for R&D work or innovations. And that’s
why the countries like US are ranked much higher in Innovation as compared to
their overall R&D intensity. This is due the fact that innovators see high
returns for their innovations in US (due to favorable regulatory environment as
I have mentioned earlier about tight price control on medicine pricing in India
discourages R&D investments). Further, countries like US have vast market
size for products which increases the revenue potential of any breakthrough
innovation. Also, Govt in US provides highly supportive environment for R&D
investments which reduce the cost of doing R&D. All these factors result
into higher propensity to invest in R&D which is not affected by the nature
of a particular industry.
Strategy&, a business unit
within Price Waterhouse Coopers is publishing an annual report of the top 1000
most innovative companies in the world for over 12 years. So far, it has found
no statistically significant relationship between R&D spending and
sustained financial performance. Strategy& has found that the top 10 most
innovative companies are rarely the top 10 spenders on R&D.
So when we account for the industry
composition of Indian economy then this .7% R&D investment may not look
that poor. Like, manufacturing is around 16% of Indian economy which is lower
as compared to other countries like China/Korea having almost 30% share of GDP.
But as Indian manufacturing does not involve high R&D intensive industries
like ICT so this figure is not low in itself. Also Agriculture accounts for
some 16% share of GDP in India which is just 1% in US (although the size is
very large in US) but Indian agriculture is very backward with very low farm
sizes. Low farm size forces farmers to avoid using innovative
products/machinery and this is one of the biggest hindrances in the growth of
Indian agriculture and R&D investments. So when
we account for these factors we can see that R&D intensity rate is not that
bad; our Govt. just needs to create a rewarding environment for R&D and
Innovation so that people are motivated to try novel ideas.
India is a preferred location for
global giants for captive R&D investments due to low salaries for highly
qualified engineers and research professionals. Like in integrated circuit (IC)
designs, India has great capabilities and many MNCs have established their IC
design research centers in India but most of the work done in India is transferred
to other countries where manufacturing of ICT products is done. But off late,
startup culture is growing big in India and many Indian startups have developed
some great innovative products but most of them are acquired by global giants
which now are seeing Indian startups as some sort of R&D outsourcing. Many
of Indian startups in Chip designing have been acquired by global giants like
Qualcomm. But still due to recent focus on startups and innovations, India has
improved its ranking in Global Innovation Index from 81 to 52 between 2015 and
2019.
Many Indian startups are doing great work in manufacturing fabless semiconductor chips in India like Cirel Systems, Signalchip, Mymo Wireless, Saankhya Labs etc. Some like Mymo are in fact making 5G products.
B) PSUs are best
suited for Investments by Government for economic growth
India was and still is a poor
country with large population which means that availability of private capital
for investment will be risk averse and costly. In poor economies, demand supply
equations are erratic and supply may not be able to create the demand making
private capital apprehensive to invest in such variable scenarios. Fewer
investments mean less income generation and so low demand which makes this a
classic chicken-egg dilemma. This is where government has to take the lead role
in making investments because government can arrange capital much cheaper and
can also impact the demand scenario with its efforts/schemes.
After witnessing satisfactory growth in last 10-15 years, now India needs large investments for
taking the economy towards next leg of growth. In last two decades, IT services
and Pharma sectors played the major role in economic growth as they brought
huge amount of wealth to India through exports. Auto sector has also grown big
but it is not in “Income generation” but in consumption of generated income. In
agriculture, we are yet to realize our true potential…production is increased
but not the income of the farmers. In this period, we have done a grave mistake
in ignoring the very important sectors like electronics goods and telecom which
are very large and getting very important strategically. IT/Pharma sectors are
matured now and they itself are looking for next growth catalysts and for that
they are also required to make big investments (like in R&D). Our Auto
sector is also stagnant now…its next leg of growth will come either from
exports (only options is low cost Car Africa) or high growth in other sectors
in India apart from IT/Pharma. So without any second thought we need to invest
more locally. As of now, investments are some 28% of our economy while the rest
is consumption and government spending. China is around 42% and it is having
this share for quite a long time and this is where India needs big improvement.
Our Investments touched some 40% around 2010-11 but keeping in view the size of
our country and population we need to take this figure to high forties for
longer periods of time. Right now our investments are more or less equal to
developed countries.
And so the question is- from
where these investments will come? First of all, let me tell you all that
cheaper and easy credit is the first pre-requisite for investment growth in an
economy. As of now, private sector has not impressed that much at all in last
decade or so. Just look at the quantum of NPAs in sectors like power, steel and
other infrastructure like road etc. There is no doubt that most of these NPAs
are not strategic mistakes but willful frauds. Then, private sector has avoided
taking high risks in investing into much needed sectors like semiconductors,
electronics goods. They have opted for less risky avenues like infrastructure
like power plants/roads to have long term revenue contracts. If we can see they
have just tried to replace government firms like NTPC here who are already
doing good job for long time. In these infrastructure related sectors there are
less execution risks (though fraud risks are huge).
Why risks are less in infra? I
have explained the same in my previous Blogpost related to Value investing that
infra debt is less risky. Debt and infrastructure are made for each other…made
in heaven. The loans taken by normal business entities like Telecom, FMCG,
Steel, chemicals are more risky than infra loans because there is tough
competition in these industries and often it is happening that two competitors
are fighting hard for same business/market share with loans and as we can guess
one is going to bite the dust and his loans will turn NPA i.e. the fight we are
seeing in telecom now. So debt to normal businesses is very dangerous and
requires high skills in allocation of debt. If one particular sector is already
having high debt and chances of demand in that sector may go down or there may
be severe competition and price war coming so in that case caution is required
in allocating loans to that sector.
But Infra is different. Due to
competition and miscalculations by businesses, we can create excess (redundant)
capacity in steel sector but can we lay extra gas pipeline of 5000 KM length??
Can we make another road parallel to a newly constructed road?? Can we make an
additional Airport or another power plant without long term PPA? So as we can
see there is hardly any scope for redundancy in infra and if properly planned
(like costs during bid stage) then chances of failure are very less in Infra.
That’s why I feel there should be low chances of NPA in infra but it needs
lower interest rates. So in my view
government should have motivated private sector to invest in other import heavy
sectors like ICT and energy.
a) Better
to choose change in management style and land sale than disinvestment
But you can’t expect private
sector to take big risks in investing into high risk ICT sectors with high
interest rates, weak government policies in promoting local products. And this
is where I think PSUs have much greater role to play. The calls for
disinvestments of PSUs are made citing weak and inefficient management though I
have shown that this is just a misconception. But still, if there is a need to
further strengthen the board and management of these PSUs then I do not think
disinvestment is the only option. Let’s make management of these PSUs independent
with government just playing the role of a strategic and majority
shareholder/investor only with no interference in the management like in the
case of Maruti Suzuki JV for manufacture of cars in India where Suzuki was
having the majority of the management control for running the firm which was a
big success. Management decoupling is much easier then selling these highly
profitable PSUs cheaply. This is just like selling the family gold and this
disinvestment is not an infinite source of funding but if government can make
these PSUs better and more profitable in partnership with private sector then
it can reap the benefits in the form of higher dividends/taxes forever. Also,
with the grand success of ISRO globally there should be no doubt about the
efficiency of government owned and operated firms.
Further, most of PSUs have large
valuable land holding across India. In my view it is much easier and better for
the government to sell these land holdings rather than selling these PSUs.
Believe me, land sale alone can generate gigantic sums. Once, I was reading
that BSNL (biggest PSU loss maker) has done the valuations of 1/3rd
of its prime land holdings and the same was some 65000 cr!!! Can you imagine it
was just 1/3rd. Same is the case with BEL, BEML, HAL, BHEL, Railways,
New India Assurance and many more others.
b) PSUs
as investment vehicles for directing the economy
Most importantly, government can
control its investment target for pumping up the economy much better with these
PSUs. Like, when there is a confidence crisis in an economy then it becomes
very difficult to induce private sector to invest in the economy even with low
tax and interest rates. We are facing the same situation right now in India.
Confidence of the businessmen and consumers is the biggest driving force behind
any economic growth. Take the example of Solar power manufacturing- India is a
big importer of solar power components but we can’t afford to build huge solar
capacity on imports. This will destroy our economy and in that case thermal
power is better for us. So now, India needs investments into solar energy
manufacturing. So far, it has not happened…may be due to any reason. But
government can’t force private industry to invest for solar energy. However, it
can ask the likes of BHEL and BEL to invest for the manufacturing of silicon
wafer in India. Both have the required expertise to do the same efficiently.
c) India
needs large investments in semiconductor industry
India needs huge investments in
semiconductor and electronics goods industry because they are the biggest
imports now and we are not in a position to let this happen for a long time
from hereon as the demand for these are growing very fast (fastest growing
segment). Some halfhearted efforts have been done by government to promote the
local manufacturing but they are a big failure. I think here the best option is
to have a public private partnership. The likes of BHEL and BEL are best suited
for this role as they have the expertise for electronics. BHEL is already
making silicon wafers for solar panels for ISRO…though not on large scale but
still they have the knowledge. BEL is also having the expertise in chip design.
So both BEL and BHEL coming together and in partnerships with a private player
is the way to go.
Recently Indian government has
announced 3 incentive schemes for promoting the manufacture of electronics
goods in India which somehow went unnoticed by media. I think more promotion of
these schemes is required across media platforms. Taiwan is the largest chip
manufacturer in the world (its TSMC is the global giant) and then Samsung
(south Korea) is the next. Both countries have friendly relations with India
and I think there is no doubt that our Government should welcome them to create
facilities in India in partnership with Indian firms or on technology transfer
basis. Taiwan is facing tough time in its manufacturing facilities in China due
to ongoing US-China cold war and US is pressing it to leave china and to invest
in US. So Taiwan has valid reasons to invest in world’s next biggest market for
semiconductors.
Then, India already has a great
chip design talent and a number of startups have developed great innovative
fabless chips. Chip design is the first step in the entire chip fabrication and
it is very complex part. Chip manufacturing requires huge upfront capital
investments. So there are increasing numbers of firms which are Fabless-means
they do everything related to chip but not the chip manufacturing, they design
and sell the hardware but don’t do the manufacturing of silicon wafers.
Qualcomm is the global fabless giant and others are Broadcomm, AMD, and Nvidia-they
are all from US. In many instances, Indian fabless startups were acquired by
these global giants. Here, I think there is a need for PSUs to make strategic
investments in these startups which will promote R&D in India and these
important technologies will remain with India. PSUs have large amounts of cash
in its books like BEL has some 4000-5000 cr cash and it spends big on chips for its
products. Hence the likes of BEL should promote startups in this sector.
Recently, BEL and Wipro have developed a system on chip (SoC) that can be used
for civil applications such as tablets and mobile phones.
Now is the time for India to get
big on semiconductor industry in India and it is good that Indian government is
taking some right steps in announcing incentives schemes for manufacturing and
investments in India. I will be explaining this sector in much detail in
another post related to this sector.
As of now I have made small
investment in Sasken technologies (invested at 480) which I think can do
something big in fabless chip manufacturing sector growth in India. Sasken was
one of the very few in India to focus on product development (IP based) in IT
rather than focusing on run of the mill low value third party software
services. It was among very few Indian IT companies who invested for R&D
for IP developments in communications sector and still holds 70 valuable
patents. Semiconductor and telecom are its major revenue sources. They have
good capabilities in Chip design and hardware design and I like it as it is a
pure play on Chip/semiconductor sector as other large IT players have small contribution
from this sector. They used to be major supplier of IT Product to Nokia phones
but then Nokia lost the race in smartphones and then another big customer the
network equipment maker Nortel collapsed. So they were in reconstruction mode
and done some real transformation. But amid all this transformation they have
maintained their normal run rate of cash generation and avoided useless
spending on acquisitions
.
After the restructuring, apart
from chip design and semiconductor Sasken is focusing on IOT,
vehicle-to-vehicle communication, 5G, Telecommunication and satellite
communication, machine learning and consumer electronics. Major customers of Sasken include Intel,
Qualcomm, Intel, British Telecom, Honeywell, Sony, Inmarsat, Harman, Motorola
Solutions, Texas Instruments, GE etc. In Fabless chip manufacturing, Sasken
works for third party Fabless manufacturers like Qualcomm and it has the
capability to develop entire product from the scratch like it has designed and
developed satellite phones for Inmarsat from end to end. Sasken’s chip design
Recently in Jan-2020 it has been selected by Taiwan Fabless giant Mediatek for
its IOT programme for AI-enabled semiconductor chipsets. Recently it has
partnered with Qualcomm for auto sector to support their customers in the
adoption of the ‘Qualcomm Snapdragon Automotive Cockpit’ platform and ‘Qualcomm
Automotive Wireless Solutions’. Sasken has partnered with Qualcomm and Mediatek
for around 15 years and its products are used in their chips.
Good management…regular dividend
payer…normal dividend yield is 3-4% but it distributes big special dividends
quite regularly which shows the willingness of the management to share the
wealth with shareholders. Last year they paid Rs. 35 as special dividend. They
did the same by paying Rs. 25 as special dividend in 2016 and in 2014 and 2015
they paid Rs. 20 & 25. Most importantly, even now they have cash of 340 cr
against market cap of 700 cr. So with 50% cash holdings and PE of 7-8 makes it
very cheap and worthy of investments. CMP 480.
C) In stock
market investing, management integrity > Ability
Now, finally coming to investment
in PSU stocks where I have seen all sorts of weird theories for not investing
in PSU stocks. And if you ask me- in most cases these PSU stocks have not
performed well only due to these weird theories itself not otherwise. But let
me remind you the biggest risk in stock investment. It is not the execution
risk (the company doesn’t perform well) of the management but the risk of
having a fraudulent management which will wipe out all the wealth in a single stroke.
We have seen the cases of satyam, DHFL, Videocon, Geetanjali etc. where fraud
management destroy everything. Worst part is that management integrity risk is
most difficult to judge or analyse. I always say that I am not worried at all
when my stock does not performed well due to industry level crisis because an
able management will be able to sail through difficult times. But there is no
remedy or hope when management itself wants to steal the shareholder’s share of
wealth.
I have seen our so called great
analysts assigning low valuations to management skills of the PSU firms (which
I have proved wrong) but they never assign high comparative valuations to
management integrity and honesty of the PSUs which will even out any valuation
difference. Just compare the likes of Anil agarwal of Vedanta Ltd with PSU
mining giants like NMDC. Anil agarwal was always having dubious credentials but
recently the board of Vedanta is facing the criticism for going for the
delisting of Vedanta ltd at very cheap price. Price offered by the board is 88
vs some 200 book value. Delisting is not wrong but management must pay fair
price to the shareholder and not being opportunistic during market mayhem.
Whether the final bid price made by shareholders is high or not but the low
price asked by management says a lot about the integrity of the management. And
these types of managements can wipe out the wealth in a single master stroke
and for the bad luck of Indian investors there are a lot of such types of
dubious stocks lurking around in our stock market.
Just compare the same with NMDC
which always tried its best to help the tribal dislocated due to mining while
Vedanta is always under criticism for destroying the local tribes and
environment.
That day I was checking Advanced
enzymes technologies. I can’t say that its management is not honest but still
some actions raise the doubts and this makes the final decision making very difficult. I liked it during IPO time but made an exit last
year at 220. Somehow the vibes were not that comforting. And when we have
negative vibes without any reason then we have to dig very deeper in the books
of accounts to find the red flags. They earned some 350-370 cr in last 3-4
years and after putting some 100-120 cr in assets they have some 200 cr
cash...but dividends are just like peanuts and they are buying companies
outside India. So i have seen that these acquisitions are typical signs of
money leaking out so i think this requires much deeper investigations...not
analysis like who is the promoter/shareholder of acquired companies, what is
the value addition to its business, how much goodwill they have paid for the
same and whether they have acquired just an asset or a business for which
goodwill paid can be justified?? In their books their net assets are 200 cr but
goodwill is 300 cr!! Just for a perspective, their goodwill in 2016 just before
IPO was 171 cr (it was revised to 220 cr in 2018 AR, don't know why) and this
has been increased to 300 cr after IPO while revenue is increased to 440 cr
from 300 cr while the assets have been doubled. So my only worry is the doubts
on the intention of the management. They have done the IPO and i was also very
positive on the business but management could not prove their will to share the
wealth with shareholders. I may be wrong but this happens with a lot of IPO
stocks.
Then, there is Parag Milk. I
liked Parag due to its focus on Cheese business because Milk is a very tough
business and there is no product differentiation exists among all the milky
warriors. But as I consider IPO's from unknown people risky so I refrained from
investing large sum in it. Somehow I lost my trust in its management because they
talk so much...always talking...launching so many products when there is no
need as they should focus on Cheese and whey protein only. So it may appear
that with so much noise they may be suppressing the cries of some wound. Their
foray into too many products and brands is what irks me the most. Cheese,
protein supplement, premium milk, mango drink- all this is getting too much as
these all have huge working capital requirements apart from large spends on branding.
It has bad debts which are far higher as compared to other market players/industry
norms. They have much higher bad debt provisions which cast doubts on their
topline/business strategy. Then there is export subsidy issue which comprises
the biggest chunk of their bottom line. Though these issues can also be a sign
of management inefficiency, not necessarily a crooked management. But if we
look at them launching so many products along with other red flags then the
story looks dubious. But still Parag is a very strange case. I have seen many
junk companies like sanwaria, Manpasand beverages and it was very easy decision
to discard them as junk because their cooked financials are easily exposed as
their products were not visible in the market which is the conclusive evidence
that their topline is fake. But Parag i have seen the products
everywhere...even this January when i was in Punjab i found its products
available everywhere though i was thinking that it is just a western India
player. But still, not getting comfortable I made an exit at loss and put the
money in other stocks like TV18 and Clariant where I recovered my losses quite
early.
But i am not saying that both Parag and Advanced enzymes are not trustworthy...just want to share that these types of actions raise the doubts and we need to be extremely careful in ignoring all the business prospectus, historical performances and financial soundness.
So if you ask me then this integrity
& honesty factor of PSUs should be valued much higher.
D) Some great
PSU stocks for investments
I have invested quite a bit in
PSU stocks. So I am just sharing my views in brief on some of the best PSU
stocks. I will explain these in much detail in some other blog posts.
Rites Ltd (CMP 255, market
cap 6300 cr): Indian needs massive investments in its infrastructure if it wants to capture next leg of strong economic growth. Railway Infrastructure is the missing link so far and thankfully India has realized this and massive investments are being made in Dedicated freight corridors and Metro projects across the nation. So Railway is the next big investment theme for next 10 years or so and there is not any better name than Rites Ltd. Consultancy is its mainstay as of now which is a high
entry barrier business. Rites is just among the best globally. It wins most of
its bids by competitive bidding. I have seen many instances when Rites had to
be inducted subsequently when MNC consultant failed to deliver on time. But its
consultancy work is not about writing a story...it acts as General consultant
where it undertakes the entire work starting from engineering design, location,
tendering, vendor selection/evaluation, quality control and timely execution.
It is highly technical work. Their domain expertise and knowledge is very
critical for minimum cost variations and timely completion with quality
standards. Their role is very crucial as they have to prepare the cost
estimates and on that basis the bidding is to be done. RITES has been providing
services to Indian Railways/Transportation sector and now to Defence. These
projects are quite complex with very few agencies are having capability to
execute such projects in India.
Its number of employees is same
in last 10 years...some 3100-3200 but revenue per employee is increased from 21
lac to some 70 lac which i think could even beat the best in IT sector. So what
we have now- High entry barrier business with high margins, trading at low PE ratio of 8-9, Profit almost 650
cr (i see this touching 1000 cr in next 2 years), ROE is 25%, dividend yield around 6% which i think will easily touch 10% in
near future. Cash in the books is around 1400 cr. It does not need to spend big
on capital assets so it has big operating leverage which means in the most of
the top-line growth will generate more free cash flows which means much higher
dividends. It is the nominated agency for exports of railway products like
Locomotives of Indian Railways which is again low capital high margin business
and which will grow big. Same is the case with leasing business which will grow
big due to dedicated freight corridor and coming privatization in passenger
trains.
Bharat Electronics Ltd. (
CMP 99, Market cap 24000 cr): I picked this one around 30
(Click here for old post on BEL).
For me this is the proxy for Indian
defense sector. I liked all defense stocks like BDL, HAL etc. But BEL
undertakes the work from all of them including Midhani and ISRO so I decided to
invest only in it. Midhani I also own from 100. Another thing which I like
about it is that it has fairly large non-defense business where I am seeing
high growth. As of now defense segment is around 80% of its turnover but the share of non-defense is growing much faster and it is investing in R&D for non-defense products.
It has some 900 acres of land in prime locations of Bangalore.
Recently HAL has sold some land in the similar area around Rs. 30 cr per acre
which value the land bank of BEL at some 27000 cr when its market cap itself is
at 24000 cr !!! This is one stock where I have invested quite a large chunk of
my portfolio and during covid market meltdown I started picking it at 60-65 and
recently made buying at 90.
It spends staggering 9% of its turnover on R&D. Its turnover this year is 12000 cr and has an order book of 52000 cr. Almost 96% of its turnover is from products developed through in house R&D. Dividend yield is around 4% with around 4000-5000 cr
cash in books. It trades at a PE of 13 which is low if we look at its high ROE of 20%, High cash in books, massive order book, strong focus on R&D, high share of locally developed products, growing share of non-defense revenue and exports...it deserves minimum PE of 20. One of the best pick in Indian defense sector.
BEML ( CMP 636, Market cap
2600 cr): I like it because BEML has significant presence in
Metro rail car manufacturing in India….50% local share. BEML was the first
Indian firm (still the only indian) to start manufacturing of highly complex
metro cars in India. For Metro rail cars, in next 5 years, demand will be for
some 25000 cr in and 70000 cr in next 10 years. 75% is to be procured locally
so BEML is going to get great business. Then export market is the next thing.
The cost of a coach is around INR 9 cr in India while it is around 15 cr across
the globe. BEML’s local content in Metro is 65%. Titagarh also has presence
through its Italian firm. I also hold this at avg of 40.
I see significant economic
measures to be taken by Indian govt on chinese presence in India and chinese
have secured large orders in Indian metro. I can’t say about the fate of
existing orders but new orders will be difficult for them. Plus BEML has one of
the best in defense in India. Its mining equipment division will also see high
growth after a slow period as mining leases are renewed at fast pace. Major
mining sector reforms were announced under Aatmanirbhar Bharat package. BEML has some 70% share of indian earth moving industry. Mining
sector may see high growth in the future and I think large number of auctions
will take place and this will help MSTC greatly which is another pick where we
have invested big. It wins most of its orders like metro in global competitive
bidding which shows its mettle.
The only thing they need to
tackle is the high employee cost which is around 25% of the turnover (BEL has
some 17%) but I think they are already on it as in 2019 they have reduced the
employee count by 500 from 7600 to 7100 and this year the figure is at 6600. So for me this is one of the re-rating catalyst. Another catalyst
is any large near term order from metro etc. Its order book is around 10000 cr and almost 50% is from Metro projects. Its turnover this year is 3000 cr. Almost 70% of its turnover is generated through in house R&D efforts. It has spent 3.4% (104 cr) of its turnover on R&D in 2019-20. This year, BEML has delivered India's first driverless metro cars to Mumbai metro which was launched by PM Narendra Modi. BEML has achieved 65% indigenization level in Metro car manufacturing in India so far and this is going to get better.
BEML has been put on sale which
may spur the big re-rating. BEML also has significant land holdings like in
Bengaluru it has 205 acres of land, in Mysore 530 acres, 2,400 acres in Kolar
Gold Fields and 375 acres in Palakkad. Last time when there was an outcry against
its disinvestment, the value of assets owned by BEML was claimed to be
staggering 50000 cr when its market cap is just 2600 cr!!!
CONCOR (CMP 430, market cap
26000 cr): One of the best play on coming high growth in railways sector
due to dedicated freight corridor.
MIDHANI (CMP 200, Market Cap 3800 cr): One of the best space and defence play in India. It deals in the manufacturing of advanced specific alloys catering to critical sectors like Space, aerospace and defense. Right now the major share of revenues are from Space so we can see that with higher local manufacturing of defense products its order book is going to grow big. It is investing big for capacity expansion and very soon it will see major growth in topline. This is not a stock to be missed.
Hindustan Aeronautics Ltd.
(CMP 900, market cap 31000 cr): I like this one and soon will be putting money
in this one.
(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. reach me at oscillationss@yahoo.in).
