Six months ago I wrote a column explaining why over 80 per cent of the great companies in the BSE500 self-destruct. This column, which was based on research that I had conducted with my colleague, Gaurav Mehta, said that: “…we can see that once companies achieved great success, they are often consumed by 'hubris and arrogance' - the bonuses, the awards, the press coverage, etc, tends to have a bearing on most management teams' self-perception. Overconfident management teams then make poor strategic decisions which usually involve unbridled expansion and the misallocation of capital. As a result, ROCE and ROE starts sliding and, gradually, financial stress builds up.”
Last month, Gaurav and I inverted this construct and sought to understand why a third of the least successful companies in the BSE500 (the “laggards”) rise to sector leadership over a five-year period. Whilst this research is useful in itself (turnaround plays tend to outperform the broader market by around 15 per cent per annum), there is an even more compelling reason to focus on laggards.
Since over 80 per cent of great companies self-destruct, by implication less than 20 per cent of today's leading companies will be great five years hence. Since a third of today's laggards will be great companies five years hence, the probability of finding tomorrow's great companies amongst today's laggards is much greater (2x greater in fact) than the probability of finding such company's amongst today's leaders.
So how does one identify which laggards will become leaders five years hence? My discussions with companies which have delivered successful turnarounds in India over the past decade (eg. Bata, Eicher, TTK Prestige) and my reading of American turnaround stories (eg. IBM, Chrysler, Xerox) suggests that the following three ingredients are essential for a successful turnaround:
Cashflow conservation: Survival is the key to ensuring an eventual turnaround. Survival entails cash conservation and/or cash generation by selling off non-core assets, cutting unproductive capex and cutting costs.
Change at the top: A successful turnaround requires admission of error. This is easier for a new management team.
A clear, time-bound, focussed turnaround plan: Such a plan should: (a) focus on the firm's core strengths, (b) have a relatively short list of concrete action points, (c) have clearly defined timelines and well-defined metrics to measure recovery, and (d) a well-aligned incentive structure.
Based on these criteria my colleagues and I have sought to identify the most compelling turnaround plays in India. The four turnaround plays that we have identified are:
Ashok Leyland Although demand for medium and heavy commercial vehicles (MHCVs) would remain weak in the near term, we expect a demand recovery in FY15 and 15 per cent volume CAGR over FY14-16. These factors should boost Ashok Leyland's revenues and margin recovery from FY15. The presence of the new CEO, Vinod Dasari (a re-engineering expert with a superb track record at Timken and then at Cummins India), gives us confidence that finally Ashok Leyland has the right man at the wheel.
Bajaj Electricals (BEJ) Whilst BEJ's market leading electricals business continues to perform well, its headache has been the E&P division, which has had a troubled existence since it was created a decade or so ago. The E&P business seems likely to turn profitable from 4QFY14 onwards, due to better execution of new projects, which have been taken at reasonable margins. The new E&P management under Rakesh Markhedkar, who has an almost legendary track record at L&T, Emco and KEI Industries, is institutionalising the monitoring process of each of the new construction sites. The emphasis now is on cash collection versus taking new orders and that change in attitude should drive a turnaround for this business.
Britannia Whilst Britannia's recent management changes (the promoter appears to have taken charge of the business and he has hired a business head from PepsiCo) and margin expansion has excited the stock markets, I am wary of the euphoria. My caution arises from: (a) concerns about whether the recent margin expansion is sustainable; (b) the knowledge that the company has been unable to find competent leadership in the last decade; and (c) the impending entry of Kraft into the Indian biscuit market. That being said, the combination of intensifying competition, Britannia's brand and distribution strengths and the promoters return to the helm does make Britannia look like a juicy takeover prospect.
Bharti Bharti's African misadventure (and the financial stress that it has created) is already part of Indian business folklore. Now, finally, the company seems to be turning a corner under new leadership. Top-level changes (in 2013 Gopal Vittal was appointed CEO of Indian operations and Christian De Faria was appointed the CEO of African business) have led to a change in strategy. This coupled with improving business conditions in India (where, for a change, we have a sane man in charge of TRAI) is likely to lead to a turnaround for this fallen star...
Saurabh Mukherjea is CEO of Institutional Equities at Ambit Capital. The views expressed here are personal.
This article was originally published on April 11, 2014.
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