Listed MNCs in India: a good catch, but an opportunity slowly fading

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My March’19 Column Written For Moneycontrol

A basic tenet of long-term investing is to look for high quality listed businesses. This essentially implies 1) they earn returns above the cost of capital (reflected by return on capital employed), and 2) generate strong free cash i.e. they don’t require a lot of capital (fixed assets and/or working capital) to grow revenues and profitability. Those retained earnings can then be utilised either to acquire other companies in the same line of business or diversify. Alternatively, excess capital could be returned to shareholders via dividends or buyback.

But have you ever wondered why would a promoter of such a business list his company as it involves diluting a significant chunk of his ownership to minority investors?

For instance, why is a business like Castrol listed? It generates annual revenues of Rs 4,000 crore. On a gross block of merely Rs 220 crore, (a staggering 18x asset turn) and enjoys a negative working capital, which helps it generate an RoCE of over 100%. Since it hardly needs any capital to grow, it pays out 75-100% of its profit every year as a dividend.

If I was a promoter of such a business why would I divest even a single share? This is true for almost all the multi-national corporations operating in India – be it FMCG companies like Nestle and Colgate, host of high-tech capital goods and fast moving industrial goods or auto ancillaries like Schaeffler.

We analyzed top 40 Indian-listed subsidiaries of MNCs and found that the average fixed asset turns is 6.3x, the average return on capital employed is a whopping 36%, barring five, all are debt-free and net-cash companies while the average dividend payout is 35%. And this brings us back to the fundamental question, why are they listed?

After all, the stock market, primarily, is a medium for businesses to raise capital in order to fund their growth (or retire debt). Accordingly, the majority of the listed businesses should be the ones which are capital intensive like infrastructure companies or ones which constantly need capital to grow, like banks or NBFCs.

If that was completely true, the investable universe for us would have been 1) much smaller and, 2) much poorer in terms of quality from a long-term standpoint.

Keep reading this post on Stalwart Value.

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