Business - The Cash Advantage

When demand slows down, cost pressures increase and interest rates rise, companies having sizeable cash or liquid investments on their books are seen as safe havens. Not only are they protected from hardening interest rates (which could hamper profitability), they are also in a position to extend their credit cycles and adjust to short-term business hiccups.
But, merely having surplus cash may not really make much sense and in fact, could prove detrimental for shareholders. Says Deepak Jasani, head of Retail Research, HDFC Securities, “Cash lying in the balance sheet for a long time without getting deployed or returned to the shareholders can destroy shareholder value. A two-three year period is sufficient for a company management to decide on how they want to put the cash to use.”
It is also imperative for companies to utilise these resources in a value accretive manner. Says Jasani, “Either the company has to deploy it into its business within reasonable time or return it to shareholders in the form of dividends or through a buyback of shares.”
Companies could also utilise this cash to acquire other companies, foray into other areas or expand their businesses. Ultimately, such moves should lead to enhanced shareholder value in the long run.
The task of acquiring businesses or investing in its own business becomes much easier when there is a significant amount of cash at their disposal.
Highly successful investors like Warren Buffett, typically use the cash on their company’s books to buy good businesses during bad times, as it is only during such times that good assets are available cheap.
To identify companies that have a lot of cash on their books, The Smart Investor crunched numbers of over 1,200 companies. While calculating the quantum of cash and liquid investments, the outstanding debt (loan) payable was reduced and investments in group/associate/subsidiary companies was excluded to arrive at the surplus cash available at the disposal of the company.
Only those companies were considered where the cash and liquid investments as a percentage of their market capitalisation stood at over 20 per cent. Thereafter, qualitative and quantitative factors like past track record, management/promoter profile, company’s standing in the business, positive cash flow from operating activities and future growth prospects were considered to arrive at the picks.
Here is a select list of predominantly larger companies with a market capitalisation of over Rs 1,000 crore (excluding those which have raised money in the form of equity), which stood the test and can be looked at to deliver healthy returns in the medium-to long-term as well as sturdiness during tough times.
Some of these companies have also in the past resorted to measures like special dividend, share buyback, etc, all aimed at enhancing shareholder value. Importantly, these companies are expected to report healthy growth in the coming years.

And, additional triggers could depend on how soon and effectively their managements deploy the cash or return it to shareholders. In case, they take too long a time to act upon, then return ratios like RoCE and RoNW (some key ratios that markets tend to keep track of) could dip and impact valuations.
Bharat Electronics
Bharat Electronics (BEL) was formed with the aim of serving different mechanical and electrical requirements of the Indian defence sector. Since the company is owned by the government of India (75.86 per cent), most of the defence requirements are meet through BEL.
This is also a reason that the company enjoys over 95 per cent domestic market share for strategic electronics such as range of military communication systems, radars, naval systems, telecom and broadcast systems, electronic warfare systems, tank electronics and so on.
Thus, the fortunes of BEL is closely linked with the spends by the Indian defence sector as over 85 per cent of it’s revenue comes from the defence sector.
Historically, the growth in the defence expenditure has been in the range of 6-8 per cent, which is expected to continue on the back of similar growth in the GDP.
Although the growth rates may not be very high, the consistency in defence spending will help the company grow on sustainable basis. The company’s current order book of Rs 9,450 crore, which is over two times its FY08 revenues, providing good earnings visibility.
The revenue over the last 10 years has grown at 12.19 per cent annually and 15.45 per cent annually over the last five years. This also provides consistent cash flow, as a result of which the company has been able to reward share holders by way of dividends. The dividend payout has been above 20 per cent in the past many years.
Also, the company’s cash in hand has grown many fold from Rs 677 crore in FY03 to estimated about Rs 3,000 crore in FY08 (cash profit of FY08 plus cash and liquid investments of Rs 2,081 crore for FY07), which is about 40 per cent of its current market capitalisation. Considering the consistent growth in the business, the stock at nine times FY08 earnings is available at reasonable valuations. Also, as the company is sitting on huge cash, any development with regards to new investment opportunities in the defence sector would be a positive trigger.
Engineers India
Engineers India is one of the leading players in the hydrocarbon space, providing engineering services to companies in the industry such as refining, petrochemicals, offshore oil and gas, pipelines, fertilisers, power, ports, terminals and metallurgy.
The company was primarily incorporated by the Indian government, which currently hold about 90.4 per cent stake, to facilitate development and provide support to companies in the oil and gas segment.
The company now also acts as a preferred service provider for oil and gas companies, many of which are controlled by the government. The company’s growth prospects are closely linked with the capex in the hydrocarbon sector, particularly by the public sector companies.
The company’s revenue in the past have been volatile, however over the last two years the revenues have grown from Rs 581 crore in FY07 to Rs 737.75 crore in FY08, primarily on account of higher capex in the industry. Also a part of this growth is been attributed on account of its efforts to spread its reach in the overseas markets such as Abu Dhabi, Oman and execute several overseas projects.
Going forward, besides the growth from the hydrocarbon sector, the company should also benefit on account of its diversification in other engineering related areas such as highways and bridges, airports, transport systems, ports, water and urban development projects. The company has also formed an equal JV with Tata Projects to undertake EPC work in India and overseas markets in areas of Oil and gas, fertilisers, power and infrastructure.
Engineers India held cash and bank balance of Rs 960 crore in FY07 and another Rs 126 crore in the form of investments in quoted debentures.
This year (FY08), the company’s cash profit works out to Rs 205 crore, which after adjusting for dividend paid, translates into a cash and liquid investment balance of Rs 1,200 crore or about 35 per cent of its market capitalisation. The stock trades at reasonable valuations of 13 times its FY09 estimated earnings.
ICI India
Consequent to the global acquisition of ICI Plc, UK by AkzoNobel NV, Netherlands (in 2007), ICI India is now a 54.33 per cent subsidiary of AkzoNobel. The last two years has seen the company divest some of its businesses (leading to profits of over Rs 500 crore), which has led to the increase in its investment portfolio.
Some of the surplus money was used to buy back shares worth Rs 140 crore (buy-back offer closed on July 11th 2008). Notably, in April 2008, ICI announced the sale of its adhesive business and 67 per cent stake in a subsidiary for Rs 260 crore, which has taken its investment to Rs 1,000 crore (Rs 260 a share) or 53 per cent of its market capitalisation.
Although the company deferred its decision over the second buyback offer in its board meeting on July 17th, 2008, it has not announced any concrete plans on how it will utilise the surplus cash. It’s chairman, Aditya Narayan, though mentioned at the AGM (in July), “the board will continue to explore suitable investment opportunities for utilising the surplus cash to enhance long term shareholder value creation.”
Meanwhile, the past has seen revenues (from continuing businesses) and profit before tax (from operations) grow at a CAGR of about 20 per cent each (over four years) to Rs 1,062 crore and Rs 109 crore, respectively in FY08.
In the recent past though, there has seen some pressure on profitability, thanks to high crude oil prices and a slowdown in economic growth.
For Q1 FY09 and considering the core business alone, even as sales grew 16 per cent, profits grew by only 7 per cent. The numbers are expected to improve as ICI has undertaken price hikes in its solvent based paints (a third of sales) in June 2008, while some hike in emulsions is likely in August, says an analyst.
The longer term story though remains intact given the demand from housing and commercial segments, as well as the investments into infrastructure. For ICI, which has been innovating new products through the use of better technology, it should benefit substantially.
The support of AkzoNobel, the world’s largest player in paints and coatings, should prove helpful. Excluding non-operational income and adjusted for the cash per share, the stock quotes at a PE of 12.3 times its core estimated earnings for FY09.
Ingersoll-Rand
A 74 per cent subsidiary of Ingersoll-Rand Company, USA the company provides a range of solutions spanning the entire compressed air system.
These solutions includes products like rotary screw compressors, reciprocating compressors and centrifugal compressors and products for air treatment (including filters, dryers, etc) among others, which are efficient in terms of performance and cost savings.
The company also offers remote monitoring equipments, which help reduce downtime and service costs, as well as turnkey installations. These products/solutions in the air systems segment are availed by a range of industries including automotive, chemicals, electronics, pharmaceuticals, metals and many more.
Little wonder that the company’s prospects are linked to the growth in the manufacturing sector. That apart, the company also exports its products, while a good part of its total revenue (about 30 per cent) accrues from sales of spare parts, which is largely recurring in nature. For FY08, the same accounted for 20 per cent of the sales.
Last year, the company sold its road development and utility equipment business (in line with its parent’s global strategy) and earned a profit of Rs 212 crore. For this debt-free company, its cash and bank balances doubled to Rs 516 crore (or Rs 163 per share).
Barring the current economic slowdown, Ingersoll-Rand (India), with support of its US parent, is well positioned to benefit from the growing capital investments in the country. At Rs 360, the stock trades at a PE of 16 times its core FY08 earnings (excluding businesses sold and adjusted for the cash).

Maruti Suzuki
Maruti Suzuki, which is facing challenging times, provides an opportunity to buy good businesses cheap. While the past (during FY04-08) has seen Maruti’s sales grow at compounded annual growth rate (CAGR) of 18.6 per cent and net profits at a significantly faster pace of 33.7 per cent, the recent past has been challenging.
Demand has slowed down (as interest rates are up significantly), rising input costs have compressed margins and competition (launch of Nano, etc) is only seen getting stiffer.
But, over the last few years, Maruti has proved its ability in dealing with competition, which provides comfort. Launching of new products, ability to understand customer needs and high-quality after-sales-service have been Maruti’s forte.
Going forward, Maruti has targeted sales volume of 1 million cars (a CAGR of 12 per cent) by FY11 (including a four-fold rise in exports to 200,000 cars), which looks achievable. The company is now in the process of expanding its capacities including expansion of its Mannesar (Haryana) plant.
This plant, which started operations in September 2006, saw its capacity get enhanced from 100,000 units originally to 170,000 units in 2007-08. By October 2008, the capacity will rise further to 300,000 units. Its engine manufacturing facility will also complete by October.
Funding these plans should not be an issue, given that the company generates a cash profit of about Rs 2,300 crore annually and considering the liquid investments it has. With a few new products expected to be launched (A Star and Splash), volume growth for FY09 should be decent.
With expectations of a drop in inflation rate by early 2009, experts say that one can expect RBI to start lowering benchmark interest rates by March 2009. Also, with global commodity prices showing signs of softening, auto companies like Maruti may get some relief.
Nonetheless, barring the rough patch that most auto companies are undergoing, Maruti should do well in the long run. And, as its liquid investments (that currently yield relatively lower returns as compared to its core business) are deployed in the core business (where RoCE is over 20 per cent), expect profit growth to be faster.
MTNL
MTNL, which provides communication services including fixed line, mobile, internet and broadband services in Delhi and Mumbai circles, is an exception in our list of picks considering that revenues and profits from its core business have remained stagnant or declined in the last few years.
These can be partly attributed to the stiff competition and the various constraints it has faced being a PSU. Thus, going forward, while the prospects for the telecom industry remain good, for MTNL, it will depend on how successfully the company can tap these growth opportunities – a challenging task though, given that Delhi and Mumbai are well-penetrated markets with intense competition.
Meanwhile, MTNL has taken steps to expand its operations. This has helped in a steady rise in its customer base in mobile and broadband services in the last five quarters. In mobile services, it recently added 0.75 million lines capacity in Delhi, while 0.75 million lines is being added in the Mumbai circle, which will take its mobile subscriber base beyond 3.44 million (as on June 2008).
However, despite the growing mobile and broadband businesses, the same has not been able to arrest the decline in total revenues and profits. In Q1FY09, too, an increase in staff costs (due to sixth pay commission), besides some decline in mobile ARPUs led to a decline in margins.
MTNL, though, continues to invest in technology and currently provides VoIP, IPTV, and is readying itself for the launch of 3G services. It is also upgrading its cable network and installing next-generation switches, which should help provide additional services at cost efficient prices. The stock, at Rs 101.35, fully reflects the various issues surrounding the company.
While the cash (currently estimated at Rs 65-70 per share; including tax refunds of Rs 1,229 crore received in March 2008 and cash profit less dividends paid for FY08) is likely to be used towards the core business, any special dividends could provide the trigger. Announcements pertaining to merger with BSNL and sale of real estate could improve valuations.
Pfizer India
Pfizer India, a 40 per cent subsidiary of Pfizer Inc, USA makes pharmaceuticals and animal health products and boasts of top brands such as Corex (annual sales Rs 121 crore), Becosules (Rs 96 crore), Gelusil (Rs 46 crore) and Dolonex (Rs 42 crore).
In a bid to realign its operations with its parent, in December 2007 (which is the first quarter of FY08; year ending November), the company sold key brands related to its consumer healthcare business such as Benadryl, Caladryl, Benylin and Listerine to Johnson & Johnson for Rs 214 crore. The sale is in line with Pfizer Inc focus on high growth segments such as CV, oncology, central nervous system and anti-infectives.
The company’s core sales have barely moved over the last five quarters and growth in overall revenues has been driven by sale of assets and consumer health brands.
The company management says that discontinuation of products such as Abdec, Protinex and Pyridium, products that came under price control, regulatory issues (patent protection) and a trade boycott have all been responsible for the muted growth.
To expand its footprint beyond urban centres, the company plans to take its mature products to semi-urban and rural areas where it will be promoted to doctors.
The company wants to promote products and top brands such as Amlogard, Magnex and Magnamycin, which together are clocking a growth of 21 percent, unlike the lower single digit or negative growth for better known brands such as Corex or Becosules.
The company had cash of Rs 480 crore as on November 2007. Considering the revenues from sale of brands, profits in two quarters and the payment of special dividend of Rs 27.50 per share, the company will have cash of about Rs 626 crore (Rs 210 per share) on its books at the end of Q2 FY08.
A key risk for Pfizer shareholders is the presence of a 100 per cent subsidiary of the company in India, which if used as a vehicle to launch patented products could dampen the growth prospects of Pfizer India. If that doesn’t happen, expect a double digit growth in revenues on back of new brand launches, rural push and the strong product pipeline of its parent. The stock is trading at a reasonable 12.86 times its FY08 estimated core earnings.