One of the few low hanging fruits in Indian large cap space, ABNL : My Best pick for 2014

By Manish Bhandari, CEO & Managing Partner, Vallum Capital Advisors

A prolonged economic downturn is test of time for many businesses and their promoters. Many giants fall and make way for the newer leaders with better capital structure, impeccable management bandwidth and operating structure.  One such company is Aditya Birla Nuvo (ABN).  It has revenue of Rs 25,560 crs, EBDITA of 4,142 crs and Net Profit of 1,059 crs in FY13. It has an interesting mix of value creating businesses that represent domestic consumption (telecom, fashion and garments), import substitution (fertilizer, viscose fiber yarn), financial services (insurance, NBFC lending, asset management) along with others. These business lines give it unique competitive advantage in allocating funds across varied businesses and lower cost of capital. It can finance longer gestation businesses, withstand short term earnings volatility while keeping a sight long term goal and value creation.  

ABN was predominantly a manufacturing house till a few years ago. It has embarked on a program to build new economy service sector business, though long-gestations on the back of cash flows from manufacturing and captured that transition successfully. During Year 2005-13, the share of manufacturing revenues dropped from 67% to 28%. Services and consumption revenues now constitute bigger part and reflect future opportunities. The company has painstakingly gained leadership position across business lines and widened the moat on the back of disciplined execution.  

Let’s discuss the key milestones which have defined the entrepreneurial spirit of the company and laid the foundation for robust growth in future.

1. It has successfully built a pan-India telecommunications power house “Idea”.  The telecom business has crossed the regulatory minefield and gained market share of 200 bps in the last two years (16% marketshare) and the competition intensity has reduced, considerably. The company is sole investment vehicle of the group in telecom and has 26% investment in Idea cellular. The sector was marked with high capital investments (Rs 9,000 crs is ABN share) and poor return. However, with the reduction in competitive intensity the RoCE will improve for the company.

2. It has built a high growth fashion and branded garment business, Madura Lifestyle, that generate revenues of Rs 2,200 cr and in excess of 20% p.a return on capital employed. The business was built by acquisition a loss making for considerable period of time. The unique operating structure, stable earnings of the group has led to the business creation over the last 8 years while most competitors have floundered in down turn.  

3. It has built insurance (8% markets share) and asset management (9.4% markets share) businesses with JV partners and the company is among the top five players in market share and profitability. It is one of the prime candidates among twenty six applicants for new banking license to be issued by RBI in year 2014. ABN also has presence in retail broking, wealth management, distribution of financial products and general insurance advisory and it has forayed into Private Equity to cover a large gamut of financial services business. The banking business also gives an opportunity to invest large of capital by the company, generate economic return and stakeholder value.   

Investment phase is over; Harvesting season starts now

While ABN transformed it portfolio and grew new businesses, its market capitalization has grown only marginally. Shareholders have for long complained about focus, low RoE/RoCE generated by the operating businesses and investment structures with long payoffs. During Years 2007-2013, ABN seeded new businesses. Its key businesses are attaining critical mass within their industry segments. Now it is positioned to deploy sizable capital and realize attractive returns. The company has switched gear from investment mode to harvesting now with its three-pronged strategy.

1.          Consolidate segment leadership with bolt-on acquisitions

It has acquired retail format business of Pantaloon for Rs 1,200 crs, employing its management bandwidth to harness synergy and turn around this business. This creates a combined fashion enterprise of about Rs 4,000 cr sales with revenue growing in excess of 15% p.a, synergies of scale and a tight control over working capital. Most of the competitors operate in niches or lack financial capabilities to drive consolidation in the industry.  Hence, the company is well placed to lead the rapid transition of unorganized to organized market. The company is eagerly waiting for government policy guidelines for fertilizer business and is geared up making significant investments in this business. The business has good return over capital employed. 

 2.                   Divesture of non-core business

The company is realigning its business portfolio of low RoCE business and has divested low-margin carbon-black business and redeployed capital in the NBFC lending business which is generating higher return on capital over a economic cycle. It has marked IT-ITES business, which has revenue of Rs 2,400 cr, generating RoCE of less than 9%, for divestment. This will release capital of Rs 2,000 cr which can be deployed in other businesses to enhance shareholder return.

 3.                   Value unlocking

ABN has considerable experience in financial services through by activities in NBFC lending, life insurance and asset management.  The group, with its impeccable track-record, is a key contender for new banking license to be granted by RBI. The financial services businesses will get spun off into a separate structure, thereby unlocking the value of the investments and reducing the holding company discount attributed to the listed company. These demergers and divestures of have created significant shareholder value in cases of conglomerates like Reliance and L&T when their businesses got spun off into new entities. The group has gained considerable experience in financial services over the last decade; a foray into banking sector will establish strong footing in distribution. Inarguably, this also leverage brand of the group which in turn will generate higher economic return than peers.

I believe that market participants are overlooking the last decade’s journey of capital intensive business with competitive advantages.  Sales, Profit after Tax and Book Value have grown at a CAGR 30% over the last eight years. ABN has achieved this with practically minimal dilution of equity. It generated cumulative operating cash flow of more than Rs 15,500 crs which got deployed in various growth businesses as well as in reduction of debt. Overall, the total debt levels are close to 1.0x, much less if we remove the leverage by NBFC. Most of the new businesses have attained a reasonable size, market leadership in their respective industry. I foresee improvement of 150 bps p.a in RoCE for the next 3 years. This is the tipping point of generating superior return over the capital employed in these businesses over the last few years, one of the most power rerating trigger for the company, a fact missed by market participants.

I would also draw attention to one of the underappreciated aspects of corporate governance in Indian companies. With each economic down cycle, the number of companies shrinks which would withstand litmus test of good corporate governance and shareholder value creation. Aditya Birla Group has impeccable track record of transparency, financial reporting and intention towards various stakeholders over last two decades. Globally, Investors have appreciation for global holding companies which have mix of operating businesses and investments such as GE, Berkshire Hathway, Samsung and Sony. The time has come to include AB Nuvo in same hall of fame. 

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