| Check returns on capital before investing | |
CLIFFORD ALVARES
While it's no surprise the stock market is increasingly sifting between better quality companies and the alsorans, the extent of the rally's concentration in afew stocks suggests the market is becoming more choosy. While the stock market has surged 13 per cent year to day and also hit an all- time high recently, only six companies in the 30- stock BSE benchmark, the Sensex, are near their all- time highs. As many as 14 are a little more than 30 per cent away from these. Experts say a key change in this rally is that investors are seeking out and investing in quality companies, with lower debt and higher returns. Says Raamdeo Agrawal, joint managing director, Motilal: " In the current environment quality companies are a big factor, those with better cash flows, debt management, and sustainable profits." Try this measure One key statistic which can greatly assist investors is the return on capital employed (RoCE). This ratio has a direct impact on the market capitalisation of companies. The higher the ratio, the better the chance that a stock will deliver higher returns in the longer run. Companies which generated an average return on capital of 30 per cent annually in the past five years have increased their market capitalisations by 89 per cent. Those where the return hovered at 15- 30 per cent, on average, saw market capitalisations surge 38 per cent. Those with a return on capital between zero and 15 per cent saw a decline of 32 per cent. The high returns were generated by adding very little debt as compared to the others (see table: Boom time in cash generators). A recent report by Ambit Capital on the BSE 200 stocks says ₹ 100 invested at the beginning of 2001- 02 in the top RoCE quintile (and rebalanced annually) becomes ₹ 421 by the end of FY13, based on median returns each year. On the other hand, ₹ 100 invested at the beginning of FY02 in the bottom RoCE quintile delivers only ₹ 87 by the end of FY13 (excluding dividends and buybacks). In other words, investors have lost in lower RoCE companies. Many professional investors go by this measure. With a combination of lower invested capital and higher profitability, businesses reap significant advantages and shareholders significant returns. Says Shah: "Superior capital efficiency and a decent growth of real earnings over a period of time will create outstanding value." Why In his book, Of long- term value and wealth creation from equity investing, Bharat Shah, executive director, ASK Group, refers to this quality of businesses as paramount. " This is what software firms enjoyed in the decade of the ' 90s and the early part of the last decade. These businesses were, in any case, outstanding free cash machines, enjoyed exceptional RoCE, had rising margins, along with increasing business volumes and improving pricing. Some of the top- notch software firms were generating outstanding RoCE ( upwards of 60- 70 per cent), along with almost similar profit growth. This is what created a situation in which, in a brief period of four years, firms such as Infosys went up an incredible 140- 150 times." RoCE combines the best parts of the balance sheet and profit and loss accounts, two crucial elements in a company's accounts. If the balance sheet is not strong enough, with lower debt, it will reflect in lower return on the capital employed. If the profits are not adequate or there is no significant profitability, the return on capital will also be lower. Both cases are not ideal for investors to make stock investments. And, both these parameters, lower debt and higher profits, reflect the quality of the management, say experts. Says Agrawal: " A higher RoCE shows the management is of high quality and trying to achieve more efficiency through lesser amounts of capital. These types of businesses do significantly well over time." Other checks Another characteristic of many of these high return companies is ability to pay out better dividends to shareholders. Experts say a high RoCE might be tough for companies to sustain over very long periods if the net worth is expanding. This would result in lower returns. Hence, these companies also have to give out better shareholder returns through higher payouts from profits to investors. Another statistic which can be used is to see how much new gross fixed assets a company is investing in, as compared to its cash generated from operations. For example, if total operating profits earned in the past five years is ₹ 1,000 crore, ideally it should incur new fixed asset costs that are lower than this amount. So, in the past five years, its total of fixed assets should not go up beyond, say, ₹ 800 crore. If it overshoots the cash generated, the company would have to borrow from the market; it also means it does not generate enough cash to pay back shareholders. Take Page Industries, for example. This company's gross block increased by ₹ 115 crore in the past four years but its operating profits after paying interest on its loans added to ₹ 485 crore in this time. This leaves enough surplus for it to distribute with shareholders or expand its capacities further with internal accrual. Little surprise the stock surged 56 per cent ( compounded annual growth rate) in four years. In some years, of course, capital assets could suddenly spike up if a company is taking up rapid expansion; so, cash flows in the first few years could take a hit. But as long as capital invested in the business is at reasonable levels and the cost of capital is kept lower, chances of generating a higher operating cash flow from a business get better. Correspondingly, the return to investors also increases. Investors would do well to find out good high RoCE companies that are sustainable, combined with lower valuations. Companies that can sustain their returns on capital can be seen from the longer term borrowing history. Experts say companies that come to the market for regular capital infusions are not able to keep their balance sheets leaner and efficient. In the initial periods, capital infusion might give a boost to their businesses and earnings growth. Thirty companies which generated an average RoCE of 30 per cent for five years have seen their market cap rise by 90 per cent ENHANCING VALUE |What investors should look for is a combination of higher returns on capital employed, with higher earnings growth. This is the best potential combination for higher possible value creation |On the other hand, higher return on capital and lower earnings growth might maintain the business but won't help value creation. A lower return on capital and lower profitability might lead to value destruction |Experts say by using this measure, along with a lower price- earnings ratio, investors can greatly increase their chances of making winning stock market investments BOOM TIME IN CASH GENERATORS Companies with higher RoCE and decent profit growth increased shareholder value ( in %) M- cap Profit growth RoCE* change (%) ( CAGR %) 30+ 89.5 16.5 15- 30 38.6 6.8 Below 15 - 31.9 - 6.7 *Average for last 5 years as on FY13; Filtered for BS 200 ( Ex- banks & finance) Source: Capitaline Compiled by BS Research Bureau | | Aligning CSR with business strategies | |
Even as the new Companies Act rolls out stressing inclusive growth, there is cynicism and resistance by bigger, richer companies at the manner in which they are being bulldozed to spend two per cent of their profits towards corporate social responsibility ( CSR). " We are already spending more than two per cent, some even 10 per cent. Tap into corporate minds not just their money" for better management of development programmes, is one reaction.
Other reactions vary from " the government has not shown vision in drafting the Companies Act— the framework could have been better" to " laws cannot change the ethics of corporations." The primary role of corporations is to ensure that shareholders gain, but we also want society to benefit. An estimated 8,000 companies will be liable to CSR. The amount garnered for development is expected to be between ₹ 15,000 crore and ₹ 20,000 crore. Corporate houses fear that the mandatory funding will over time be regulated and grabbed by the government to run programmes that are their responsibility. A CSR head, who does not wish to be quoted, says, governments are asking companies to put money into welfare activities like building toilets and providing drinking water, which are primarily their responsibility. It is like an additional tax on the corporates, was another response. The inclusion of support for relief funds like that of the PM and CM raise questions of accountability, political patronage and fear of corruption. Going against the spirit of the Act, the Chhattisgarh government has even announced the mandatory CSR would go into the CM's Community Development Fund. Doubts are being expressed about more money coming into the development kitty — not because the corporate intent is weak, but because many of the companies operate in industrial and urban areas and not in rural outback where development is needed. There is also a possibility that companies putting in money to recharge groundwater and other such extension work, which for many is really a business imperative, will show it as CSR. Companies that work with local communities do so to win goodwill around the workplace rather than because the law demands it. KK Upadhyay, who heads FICCI's CSR division, says neither repackaging of existing programmes nor " compliance" to a business requirement can be shown as CSR. Bringing in machinery for generating clean energy is "compliance not CSR" because efficiency improves energy production as well as profits. Schedule 7 lists several areas in which corporates could invest but Upadhyay gives priority to employment. Just a small percentage of the population in tribal and rural areas is employable because they have neither the skills nor the discipline to work for the stipulated seven to eight hours at a stretch. Skill development, employment generation and management of natural resources are FICCI's area of focus. Mining and manufacturing companies need to ensure employment for local communities. CSR should be part of the business strategy of corporates says a company that deals with milk and nutrition supplements. From CSR it has evolved to CSV ( creating shared values). According to the CSV concept 'for business to be successful it must consider the needs of two primary stakeholders — the people in countries it operates and its shareholders.' As business strategy, there is collaboration with schools and college across the country to create awareness on health and nutrition among adolescent girls. This company has participated in the Science Express Train by putting up an exhibition on nutrition; it has been supplying drinking water for village school children and talking to farmers and women on water conservation. Village women are being encouraged to be financially independent through good dairy practises. The economic growth of 100,000 dairy farmers of Moga who provide milk to the company is reflected in the story of Jitendra Singh who started his association with the company in 1996 with just two cows. Today he owns 78 cows. A bottling company sponsors FIFA ( football) and supports the Olympics to promote health and wellbeing; it supports India's equivalent of the Guinness Book of World Records; programmes in 250 schools; recharges groundwater through rainwater harvesting and improves environment through tree plantation. Under the Women Economic Empowerment initiative, some 5 million women will become small business women selling and distributing the company's beverages. To operate in areas where there is no electricity, they are given solar coolers chilling beverages. To market its popular mango drink, it encouraged farmers to adopt ultra high density farming practises (more trees in less space) of a selected pulpy variety. Combined with drip irrigation, mango yields increased and farmers as well as the company benefitted. To earn credit for gender sensitivity, 15 to 20 per cent of the 50,000 farmers it plans to support will be women. Many of these well thought out CSR activities are indeed good business strategies. The writer is a senior environment and development journalist usharai1948@ rediffmail. com USHA RAI An estimated 8,000 companies will be liable to CSR. The amount garnered for development is expected to be between ₹ 15,000 crore and ₹ 20,000 crore Corporate houses fear that the mandatory funding will over time be regulated and grabbed by the government to run programmes that are their responsibility | | End of tax treaty shopping for India? | |
VRISHTI BENIWAL
Cyprus, a tiny island in the Mediterranean Sea, hardly has anything in common with India, with only 0.01 per cent share in our total trade and Indians comprising barely 0.17 per cent of its population. Yet the European Union country evoked interest from the Indian government to such an extent that the Income Tax law was amended to facilitate blacklisting of Cyprus as a "non- cooperating" jurisdiction. Cyprus, Mauritius and Singapore are the three countries that have a double taxation avoidance agreement (DTAA) with India wherein the right to levy capital gains is not with India while the capital gains tax is nil in these countries. Thus, investors routing their investments into India through these nations don't have to pay tax anywhere in the world, and that is the issue India is trying to address. In the tax treaty with Singapore there is a Limitation of Benefit ( LoB) clause, which restricts benefits under the bilateral agreement only to resident investors who fulfil certain conditions. Some people still find their way to reroute black money stashed abroad through this channel, but Singapore is not that big a problem as Cyprus and Mauritius are for the Indian government. Since the benefits are not limited to resident investors in treaties with these countries, India had proposed to renegotiate the DTAAs. After great reluctance the process started with Mauritius a couple of years ago, but not much headway has been seen, so far. India wants source- based taxation for capital gains so that both foreign and domestic investors in the country are taxed on par on shortterm capital gains, but Mauritius has clearly said ' no' to that. It agreed to put an LoB clause akin to Singapore in the treaty, which was signed about 30 years ago, but India said the way clauses were worded, it didn't serve any purpose. The tax haven proposed more stringent clauses when an Indian delegation visited the country recently. Though the renegotiations may not conclude anytime soon, Mauritius may start losing sheen as the most attractive destination for routing investments into India. Currently, capital inflows from Mauritius account for about 38 per cent of the total foreign direct investment ( FDI) in India— the highest among all countries— followed by 10 per cent from Singapore, 9 per cent from the UK and 8 per cent from Japan. Cyprus accounts for 4 per cent of the total FDI flows into the country. "Singapore is becoming more attractive than Mauritius because there is a fear of the unknown. Investors don't know in what shape the renegotiated treaty with Mauritius would come. In case of Singapore LoB provisions are already established and there is a certainty that if those conditions are fulfilled, treaty benefits would not be denied," says a finance ministry official. This left India with the Cyprus problem. Tax authorities admit while Mauritius has been effectively sharing information even before renegotiation of the treaty, such was not the case with Cyprus. Consequently, India notified it as a ' non- cooperating' jurisdiction last month, making it difficult for investors to do business with Cyprus, as they lost many tax benefits provided otherwise. The tax haven immediately got into course correction mode and agreed to resume treaty renegotiation talks. However, just like Mauritius it has also refused to give India the right to tax capital gains. "This is the end of treaty shopping to a great extent so far as Cyprus is concerned. But other routes are still available to investors. The effort is to effectively deal with that too," said the official. India had thought that blacklisting Cyprus would send a strong signal to other non- cooperating jurisdictions too, but unfortunately that has not happened, so far. Capital gains tax is just one part of the problem. Despite tax information exchange pacts, many countries are not sharing information that could help Indian authorities in trailing tax evaders who have stashed money abroad. Problems have been faced in exchange of information with countries like the UAE, Singapore, Switzerland, Hong Kong, Samoa and Seychelles, but as some of these are our large trading partners compared to Cyprus, tax authorities are wary of taking any action against them, as it could spoil ties. To address the problem, India is becoming part of a global crusade against tax evasion. India is working closely with G20 on formulation of Common Reporting Standards (CRS). This will allow all the member countries to automatically share information pertaining to tax. India is working towards putting in place its IT infrastructure for CRS, which is likely to come into force by 2015. India was ranked the fifth largest exporter of illicit money between 2002 and 2011, with over $ 343 billion sent abroad, according to a recent report. It may be difficult to completely end treaty shopping, not just for India but for any other country. However, the options for tax evaders are certainly getting limited with base erosion becoming a global issue. Options for tax evaders are getting limited with base erosion becoming a global issue Despite tax information exchange pacts, many countries are not sharing information that could help Indian authorities in trailing tax evaders who have stashed money abroad Illicit financial flow estimates for India (in $ bn) Source: Global Financial Integrity ( at bottom of chart) Japan, Netherlands, the UAE, the UK and the US to unearth black money |Section 94A was of information |Negotiation of tax treaties with other countries and renegotiation of existing treaties to allow for better exchange of information and check tax evasion |General Anti- Avoidance Rules notified for those foreign investors who avail of benefits under treaties and the tax benefit in an arrangement is more than ₹ 3 crore |Directorate of Criminal Investigation was created in 2011 to gather intelligence and investigate cases including tax information received from other countries |To prevent shifting of profits out of India and erosion of tax base, select international transactions are analysed every year in accordance with transfer pricing provisions Cumulative 325.98 Average 32.59 | | | | | BRIEF CASEN [1] M J ANTONY | |
A weekly selection of key court orders
Conversion of land use disallowed The Supreme Court last week dismissed appeal of Oswal Agro Mills Ltd against the judgment of the Bombay High Court which had quashed the sanction accorded by the Municipal Corporation of Greater Mumbai for construction of a residential cum commercial complex in its land in Chembur, in the heart of the metropolis. The high court had asked the municipal commissioner to consider the objections raised by the Police Department, Ministry of Petroleum, Ministry of Environment and Intelligence Bureau and the Security Control Regulations issued under the Maharashtra Regional and Town Planning Act. Hindustan Petroleum Corporation Ltd ( HPCL) objected to the sanctions granted since 2006 to Oswal as it feared that it would be a security threat to its refinery built in 1952 over 416 acres and 117 storage tanks, and also because of other industrial units in the neighbourhood which had become congested over the decades. Various authorities considered the issue and ultimately the municipal commissioner granted permission subject to certain conditions. HPCL took the matter to the high court which quashed the sanction. Oswal and the Municipal Corporation appealed to the Supreme Court. The majority in the three- judge bench upheld the high court view. They further stated that the municipal commissioner shall hear all parties before allowing conversion of industrial plot to residential- cum- commercial use. Oswal could use the land for agro- based industries, the majority judgment said. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Tender once accepted is binding The Supreme Court has set aside the judgment of the Calcutta High Court directing the Howrah Improvement Trust to call for a fresh bid for commercial plots after cancelling the earlier one. The high court passed the order on a writ petition moved by an individual, though the offer of the highest bidder was earlier accepted. " The notice inviting tender is no doubt an opportunity given to different bidders to submit their tenders and participate in the tender process but if an offer is made pursuant to the notice inviting tender and the same is accepted and the terms and conditions of the bid documents and the law provide that such acceptance will bind the authority inviting tenders, then the notice inviting tender cannot be cancelled at a later stage," the judgment stated in the case, Dr Nagendra Rai vs O P Singh. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Trial for bounced cheque quashed The Supreme Court last week quashed prosecution for issuing a cheque that bounced because the payee issued notice to the drawer only after 30 days and not within the statutory 15 days. The drawer, who was being prosecuted, moved the Patna High Court arguing that the complaint was not maintainable because the notice was issued late. The high court dismissed and refused to quash the prosecution, stating that the trial had already commenced and witnesses have been examined. Therefore, the trial could not be stopped at that stage. The drawer of the cheque appealed to the Supreme Court. In its judgment, Kamlesh Kumar vs State of Bihar, the Supreme Court stated that even if the trial had started, the prosecution could not be maintained because of the delay in issuing notice. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Self- employed person is not ' worker' A self- employed person trading in paints and hardware cannot be called an unskilled worker and compensation for his road death cannot be calculated according to the minimum wage fixed by the government, the Supreme Court stated in the appeal, Pushkar Mehra vs Brij Mohan. The trader was killed in a road accident. His widow and family moved the motor accident claims tribunal which awarded them ₹ 3.84 lakh, computing his income according to the minimum wage law. The Delhi High Court dismissed the appeal of the widow stating that the amount was more than adequate. On appeal, the Supreme Court awarded ₹ 9.60 lakh and found fault with the courts below for going by the minimum wage fixed for unskilled labour. Chiding them, it said: " The tribunal and the high court should have taken the wages of the deceased to be that of a skilled worker or clerical and non- technical supervisory staff as he was self- employed and running his own business." >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> IPAB ruling on trade name set aside The Supreme Court has set aside the ruling of the Intellectual Property Appellate Board ( IPAB) which had dismissed the petition of the proprietor of Kundan Cables India in a trademark dispute with Balar Marketing Ltd. Kundan Cables was using the trademark Kundan since 1980. It was also supplying its products with that name to Balar Marketing. In 1994, Kundan Cables came to know that Balar had been using the trade name Kundan, and obtained registration in that name. Kundan Cables immediately moved the Delhi High Court for cancellation of the registration. However, the plea was dismissed as the high court had no jurisdiction in the matter. The IPAB had come into being by then and the matter was taken there. The board, however, ruled that the petition before it was time- barred by ten years. On appeal, the board's decision was overruled by the Supreme Court which held that Kundan Cables had pursued its remedy with due diligence and if it had wrongly filed its petition in the Delhi High Court, instead of Madras High Court, the principles of limitation will not bar it from moving the board. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Consistency in arbitration decisions The Supreme Court last week allowed arbitration of disputes arising from a power purchase agreement between Arasmeta Captive Power Co and Lafarge India to go on. The Chhattisgarh High Court had appointed an arbitrator, rejecting the opposition of Arasmeta. The parties disagreed on the terms of the agreement. Arasmeta maintained that the dispute was over billing and should be referred to experts. Lafarge wanted arbitration, according to its view of the agreement. The Supreme Court, while letting the arbitration proceedings to go forward, stated that the high court judge should not have decided disputed questions going into merits. They should be left to the arbitrator. " The part of the impugned order that reflects the expression of opinion on the merits of the disputes deserves to be set aside," the judgment said. The court also rejected the plea to reconsider some of its earlier arbitration judgments, which hold the field. The judgment said that there should be some finality and consistency to the decisions. " It is not apposite to pick up a line from here and there" and ask for review of precedents, the court said and added: " That is most likely to pave one on the path of danger and it is to be scrupulously avoided." | | 'NFRA will enhance auditor independence' | |
How will mandatory auditor rotation and setting up of a regulatory body in NFRA impact the audit industry?
We support mandatory firm rotation, but the universe of companies that it should apply to, should be looked at. My view is, we should try out each and every thing that has the potential to enhance auditor independence — whether it is mandatory firm rotation or joint audits or anything else. But we need to try them out in a small subset of companies, learn from the experience and then enhance the coverage. Monitoring the whole universe of companies can be very hard. One disconnect I have with the Act is the retrospective element to mandatory rotation of auditors, while for independent directors the rotation is prospective in nature. Different standard of " independence" for auditors and independent directors don't make sense to me. Both are pillars of corporate governance, along with the audit committees and the regulators. The National Financial Reporting Authority ( NFRA) is going to enhance auditor independence. To be effective, the composition of the NFRA has to be of truly independent people, who are seen to be credible. Audit is not about number crunching, but about assuring the capital markets that the numbers that are disclosed can be relied on. Auditors have to perform a very important public interest role. Already there is a debate globally as to why not nationalise audits in the face of so many corporate frauds. Whoever sits on NFRA has a great public interest duty, as it is about people's life- saving. Investors want us to apply the highest standard, without that there is no future for the profession. Is there clarity on how the NFRA would get funded? Though the budget for NFRA will come from the Ministry of Corporate Affairs, but I think, the corporate sector should get involved in its funding. In the United States, the listed entities pay a small amount as part of listing fee to fund Public Company Accounting Oversight Board ( PCAOB), which is NFRAequivalent. It will help large Indian companies to attract better investors. With better regulation and governance of auditors, investors will get more comfortable. It will help India Inc when it comes to raising capital. What is your view on not allowing foreign accountancy brands to sign audits in India? This is something that impacts the old Indian ( audit) firms more than the so- called Big Four. If you allow, it will transform the spirit of regulation within the profession. Then the 100odd large Indian audit firms will have a better chance of competing against the Big Four. Do you expect a churn within the audit industry given the mandatory rotation clause? Iexpect a reduction in the number of audit firms that can audit public interest entities. The spend by Top 500 Indian firms on audit is likely to more than double over the next three to five years. Will the new Act lead to improvement in corporate governance practices at the board level? Corporate governance is not about rule making. We have some of the best corporate governance laws in the world even if one goes by our old companies Act, 1956 or Sebi's listing agreement. Having new laws will not achieve anything new. But the question is do we have the capacity to monitor and implement these laws, levy appropriate penalties for deviations, if any. In most times the penalties are either disproportionately too large, or too small. The new Companies Act makes a good start with the role of independent directors and the audit committees. But it is also about creating an environment (in the board room) where independent directors can play their duties to their full extent. It is also about monitoring whether independent directors and the audit committees are working in the right spirit. Lastly, it is also about personal morality and personal ethics. The legislation to have a women director on the board is a good move. For almost all companies the customer base is both men and women. Within a company, anywhere from 25 per cent to 50 per cent of work force is women. There is a capacity issue when it comes to having women on the board. Now, once there is legislation, capacity will follow. But I just hope corporate India does not look towards home to appoint that woman director. VISHESH C CHANDIOK, National Managing Partner, Grant Thornton India LLP, one of the largest accountancy and advisory firms in India, spoke to Sudipto Dey on how the newly proposed audit regulatory body, the National Financial Reporting Authority ( NFRA), will help improve governance standards within the audit community. Edited excerpts: To be effective, the composition of the NFRA has to be of truly independent people, who are seen to be credible | | | | | | |
No comments:
Post a Comment