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RoIC v/s RoCE: The Return Roulette
Re-investment challenges drag RoCE; Stocks at deep discount to NAV
THEME SUMMARY: We have observed distinct inter-relations of RoIC, RoCE and
ASR (annualized stock return) among large-cap metal companies:
1. Superior capital allocation boosts ASR, even if RoIC is modest in some cases
(Tata Steel, JSW, Nalco)
2. RoCE keeps declining due to rising share of CWIP (SAIL, Jindal Steel & Power,
Hindalco) or un-invested capital (Hindustan Zinc)
3. Capital deployment into group companies and/or unrelated businesses
suppresses RoCE and hurts ASR (Sesa Goa, Sterlite Industries).
Stock recommendations: Reiterate Buy on Tata Steel; downgrade Sesa Goa to
Neutral (from Buy); and upgrade Nalco to Neutral (from Sell).
RoCE to keep declining due to rising share of CWIP, un-invested capital
The aggregate RoCE of key Indian metals companies will keep declining though the
aggregate RoIC (pre-tax) is still healthy at about 40%. A large share of un-invested capital
and capital work in progress (CWIP) will drag RoCE though RoIC will not deteriorate. Over
2000-05, the share of un-invested capital rose as margins and cash flows grew faster than
companies could reinvest. Post 2005, Indian metals companies made big investments in
core business. Project execution slowed significantly in FY11 and FY12 due to delays in
receiving government approvals and problems related to land acquisition. Consequently,
the share of CWIP in total capital employed (CE) increased from 11% in FY08 to 23% by
end-FY11, and is expected to rise to 27% by end-FY12. At end-FY11 only 49% of CE was
invested in the core business. This (IC/CE) ratio will fall to 45% in FY12 and FY13.
Superior capital allocation drives equity value faster despite modest RoIC
Over FY07-12 metals companies generated average RoIC of 61% but the annualized
stock return (ASR) was just 16% due to continually declining RoCE. JSPL and JSW Steel
delivered superior ASR due to superior capital allocation and execution despite below
average RoIC. Hindustan Zinc, Sterlite and Sesa Goa generated the best RoIC but ASR
was dragged due to investor concerns on allocation of capital to group companies. High
priced acquisitions dragged the ASR of Tata Steel and Hindalco. Nalco suffered due to
declining RoIC and slow reinvestment.
CLICK LINK BELOW FOR COMPANY REPORTS
Stocks trade at deep discount to NAV
The combined balance sheet of Indian metals companies is strong as, at the end of FY11,
their combined net worth was INR2t and net debt was INR730b, implying net debt-toequity
ratio of only 35%. Barring Jindal Steel, Hindalco and Hindustan Zinc, other metals
companies trade at either their deepest discount or lowest premium to NAV.
SAIL, Hindalco, JSPL, JSW Steel face project execution headwinds
SAIL undertook INR720b capex but execution is sluggish due to inefficiencies. JSPL and
Hindalco are executing multiple green-field projects but slow government decision making,
environmental and land acquisition issues slowed the projects. JSW Steel has been the
best executor of projects but faces shortage of iron ore due to mining ban in Karnataka.
Although SAIL and JSW Steel are trading at 50-60% discount to NAV, valuations still
appear steep due to falling margins. Hindalco's and JSPL's business is strong and their
stocks are attractive at current valuations.
Hindustan Zinc's RoIC improves, capital allocation strategy unclear
Hindustan Zinc's RoIC will improve due to its rising silver production. However, RoCE will
keep declining due to a rising share of un-invested capital. The company has a huge pile
of cash and equivalents but is not able to invest them.
Sterlite, Sesa Goa: Investment in group companies causes concern
Sterlite Industries and Sesa Goa invested large amounts of capital in group companies,
VAL and Cairn India respectively. Sterlite Industries' large investment in VAL is now return
dilutive due to a shortage of bauxite and coal. Sesa Goa has only 12% of capital employed
in the iron-ore business. We downgrade Sesa Goa to Neutral due to a rising risk to
volumes though valuations are not steep.
Tata Steel, Nalco: RoIC improves after years of decline
Only Tata Steel and Nalco will report improvement in RoCE in FY13 due to completion of
high margin projects. Both stocks trade at 50-60% discount to NAV. Tata Steel will
commission INR156b capex in Jamshedpur to increase capacity by 3mtpa. Nalco is
expanding alumina capacity. Upgrade Nalco to Neutral; re-iterate Buy on Tata Steel.
1. JSP: Best allocation of capital led to the stock's stellar performance
JSP was the best performing stock despite generating below-average RoIC over FY07-
11. It was one of the most efficient companies in allocating capital and the only one in the
private sector that did not raise risk capital in the period. JSP generated operating profit of
INR210b and invested INR237b over FY06-11. It ensured IC/CE ratio remained high at
all times. Despite being in a capital intensive business, it kept CWIP/capex ratio below
sector averages. However, this has changed for the worse now due to delays in executing
projects. CWIP is INR100b. IC/CE ratio is deteriorating due to a delay in its Angul and
Tamnar 2 projects, but RoIC is impressive at 32%.
2. Sesa Goa: Impressive stock performance, yet much inferior to RoIC
Sesa Goa generated the best average RoIC of 174% over FY07-11, well above the sector
average of 61% during the period. However, ASR was only 31%, which was still secondbest
in the sector. Sesa Goa failed to reinvest cash flows in the same business. IC/CE
ratio fell from 55% in FY06 to 25% in FY11. This ratio will fall further to 12% and 11% in
FY12 and FY13 respectively due to the acquisition of Cairn India's stake.
3. JSW Steel: Superior capital allocation despite inferior RoIC drives stock
JSW Steel (JSTL) posted superior ASR of 20% despite having the second worst RoIC in
the sector over FY07-11. JSTL has had the best IC/CE ratio at all times due to superior
execution skills and this is crucial to superior stock performance. JSTL remains committed
to superior capital allocation, but headwinds will weaken RoIC and RoCE and drag down
stock performance.
4. Hindustan Zinc: RoCE to decline despite improved RoIC
Hindustan Zinc (HZ) delivered ASR of only 12% v/s RoIC of 121% over FY07-11 due to
deteriorating IC/CE ratio. The IC/CE ratio fell from 59% in FY06 to 33% in FY11 and will
deteriorate to 20% in FY13. HZL generated operating cash flow of INR199b, capex has
been a mere INR77b and dividend payout just 6%. Though HZ generates impressive
RoIC, which is improving due to a rising share of high margin silver volumes, deteriorating
RoCE will be a drag on stock performance.
5. SAIL: CWIP drags down RoCE, fixed costs depress RoIC
SAIL's story is similar to HZ's. The core business generated above-average RoIC of
67% and ASR was just 10%. The share of invested capital fell from 61% in FY06 to 22%
in FY11. SAIL generated post-tax and working capital adjusted cash flow of INR281b
and incurred capex of INR312b over FY06-11. However, INR226b of the INR312b capex
is lying as CWIP and dragging down RoCE due to slow project execution. RoIC will
continue to decline due to rising fixed costs. Although the IC/CE ratio will improve, RoCE
will still decline.
6. Sterlite Inds: Concerns on capital allocation drag down stock performance
Sterlite delivered ASR of 7%, a far cry from its impressive average RoIC of 46% over
FY06-11. It generated operating cash flow of INR279b, of which INR207b was used as
capex and INR73b towards acquisition of Anglo's zinc assets. INR155b of unnecessary
equity was raised, which was largely used to fund capex of associate companies like
VAL. Equity dilution and concerns on capital allocation dragged the stock performance.
Improvement in RoIC due to superior performance of the zinc-lead-silver segment and
higher IC/CE ratio boosted RoCE in FY12, which will deteriorate in FY13.
7. Tata Steel: Low RoIC investment dragged ASR, but the worst is behind it
Tata Steel (TATA) delivered ASR of only 4% but average RoIC was an attractive 27%
over FY06-11. TATA also maintained high IC/CE ratio. Although the average RoIC was
27%, it kept falling from a peak of 74% in FY05 to 60% in FY06 and 5.6% in FY10 before
rebounding to 18.6% in FY11. TATA generated operating cash flow of INR516b, investing
only INR264b as organic capex. It invested about INR491b in the very low generating
RoIC business, which is why it generated average RoIC of 7.7%. INR204b was raised to
fund the acquisition and equity dilution dragged down ASR. There is some weakening of
RoIC in FY12 but it is expected to improve in FY13 due to volume growth in the highmargin
Indian business and a rising IC/CE ratio.
8. Nalco: Low IC/CE, RoIC drags down ASR but return ratios improving
Nalco delivered ASR of only 3% and average RoIC of impressive 43% over FY06-11.
Consistently declining RoIC and low IC/CE ratio dragged down RoCE from 49% in FY07
to 13.3% in FY11. However RoIC and IC/CE ratio are improving due to the start of an
alumina refinery expansion unit.
9. Hindalco: Worst ASR due to equity dilution, declining RoIC; RoCE to fall
Hindalco was the worst performing stock over FY06-11, delivering nil returns. Hindalco
generated operating cash flow of INR243b, of which INR194b was used as organic capex.
A large part of the capex (INR131b) was CWIP at the end of FY11. IC/CE ratio is
declining after peaking in FY09 at 73%.
Hindalco raised INR122b through rights and QIP issues, of which INR117b (net of returns
on capital) was used to acquire Novelis. RoIC will improve by 1.1pp to 16.7% in FY13 on
improved margins in the Indian business, but RoCE will decline by 40bp to 9.9% due to a
deteriorating IC/CE ratio, mainly on project delays.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
RoIC v/s RoCE: The Return Roulette
Re-investment challenges drag RoCE; Stocks at deep discount to NAV
THEME SUMMARY: We have observed distinct inter-relations of RoIC, RoCE and
ASR (annualized stock return) among large-cap metal companies:
1. Superior capital allocation boosts ASR, even if RoIC is modest in some cases
(Tata Steel, JSW, Nalco)
2. RoCE keeps declining due to rising share of CWIP (SAIL, Jindal Steel & Power,
Hindalco) or un-invested capital (Hindustan Zinc)
3. Capital deployment into group companies and/or unrelated businesses
suppresses RoCE and hurts ASR (Sesa Goa, Sterlite Industries).
Stock recommendations: Reiterate Buy on Tata Steel; downgrade Sesa Goa to
Neutral (from Buy); and upgrade Nalco to Neutral (from Sell).
RoCE to keep declining due to rising share of CWIP, un-invested capital
The aggregate RoCE of key Indian metals companies will keep declining though the
aggregate RoIC (pre-tax) is still healthy at about 40%. A large share of un-invested capital
and capital work in progress (CWIP) will drag RoCE though RoIC will not deteriorate. Over
2000-05, the share of un-invested capital rose as margins and cash flows grew faster than
companies could reinvest. Post 2005, Indian metals companies made big investments in
core business. Project execution slowed significantly in FY11 and FY12 due to delays in
receiving government approvals and problems related to land acquisition. Consequently,
the share of CWIP in total capital employed (CE) increased from 11% in FY08 to 23% by
end-FY11, and is expected to rise to 27% by end-FY12. At end-FY11 only 49% of CE was
invested in the core business. This (IC/CE) ratio will fall to 45% in FY12 and FY13.
Superior capital allocation drives equity value faster despite modest RoIC
Over FY07-12 metals companies generated average RoIC of 61% but the annualized
stock return (ASR) was just 16% due to continually declining RoCE. JSPL and JSW Steel
delivered superior ASR due to superior capital allocation and execution despite below
average RoIC. Hindustan Zinc, Sterlite and Sesa Goa generated the best RoIC but ASR
was dragged due to investor concerns on allocation of capital to group companies. High
priced acquisitions dragged the ASR of Tata Steel and Hindalco. Nalco suffered due to
declining RoIC and slow reinvestment.
CLICK LINK BELOW FOR COMPANY REPORTS
Tata Steel :TP: INR693 Buy: Motilal Oswal
Jindal Steel & Power: TP: INR729 Buy: Motilal Oswal
SAIL: TP: INR113 Sell: Motilal Oswal
JSW Steel: TP: INR453 Sell: Motilal Oswal
Sesa Goa: TP: INR288 Neutral : Motilal Oswal
Hindalco: TP: INR226 Buy : Motilal Oswal
Hindustan Zinc: TP: INR183 Buy: Motilal Oswal
Nalco : TP: INR77 Neutral :Motilal Oswal
Sterlite Industries: TP: INR193 Buy: Motilal Oswal
CLICK LINK ABOVE FOR COMPANY REPORTSStocks trade at deep discount to NAV
The combined balance sheet of Indian metals companies is strong as, at the end of FY11,
their combined net worth was INR2t and net debt was INR730b, implying net debt-toequity
ratio of only 35%. Barring Jindal Steel, Hindalco and Hindustan Zinc, other metals
companies trade at either their deepest discount or lowest premium to NAV.
SAIL, Hindalco, JSPL, JSW Steel face project execution headwinds
SAIL undertook INR720b capex but execution is sluggish due to inefficiencies. JSPL and
Hindalco are executing multiple green-field projects but slow government decision making,
environmental and land acquisition issues slowed the projects. JSW Steel has been the
best executor of projects but faces shortage of iron ore due to mining ban in Karnataka.
Although SAIL and JSW Steel are trading at 50-60% discount to NAV, valuations still
appear steep due to falling margins. Hindalco's and JSPL's business is strong and their
stocks are attractive at current valuations.
Hindustan Zinc's RoIC improves, capital allocation strategy unclear
Hindustan Zinc's RoIC will improve due to its rising silver production. However, RoCE will
keep declining due to a rising share of un-invested capital. The company has a huge pile
of cash and equivalents but is not able to invest them.
Sterlite, Sesa Goa: Investment in group companies causes concern
Sterlite Industries and Sesa Goa invested large amounts of capital in group companies,
VAL and Cairn India respectively. Sterlite Industries' large investment in VAL is now return
dilutive due to a shortage of bauxite and coal. Sesa Goa has only 12% of capital employed
in the iron-ore business. We downgrade Sesa Goa to Neutral due to a rising risk to
volumes though valuations are not steep.
Tata Steel, Nalco: RoIC improves after years of decline
Only Tata Steel and Nalco will report improvement in RoCE in FY13 due to completion of
high margin projects. Both stocks trade at 50-60% discount to NAV. Tata Steel will
commission INR156b capex in Jamshedpur to increase capacity by 3mtpa. Nalco is
expanding alumina capacity. Upgrade Nalco to Neutral; re-iterate Buy on Tata Steel.
1. JSP: Best allocation of capital led to the stock's stellar performance
JSP was the best performing stock despite generating below-average RoIC over FY07-
11. It was one of the most efficient companies in allocating capital and the only one in the
private sector that did not raise risk capital in the period. JSP generated operating profit of
INR210b and invested INR237b over FY06-11. It ensured IC/CE ratio remained high at
all times. Despite being in a capital intensive business, it kept CWIP/capex ratio below
sector averages. However, this has changed for the worse now due to delays in executing
projects. CWIP is INR100b. IC/CE ratio is deteriorating due to a delay in its Angul and
Tamnar 2 projects, but RoIC is impressive at 32%.
2. Sesa Goa: Impressive stock performance, yet much inferior to RoIC
Sesa Goa generated the best average RoIC of 174% over FY07-11, well above the sector
average of 61% during the period. However, ASR was only 31%, which was still secondbest
in the sector. Sesa Goa failed to reinvest cash flows in the same business. IC/CE
ratio fell from 55% in FY06 to 25% in FY11. This ratio will fall further to 12% and 11% in
FY12 and FY13 respectively due to the acquisition of Cairn India's stake.
3. JSW Steel: Superior capital allocation despite inferior RoIC drives stock
JSW Steel (JSTL) posted superior ASR of 20% despite having the second worst RoIC in
the sector over FY07-11. JSTL has had the best IC/CE ratio at all times due to superior
execution skills and this is crucial to superior stock performance. JSTL remains committed
to superior capital allocation, but headwinds will weaken RoIC and RoCE and drag down
stock performance.
4. Hindustan Zinc: RoCE to decline despite improved RoIC
Hindustan Zinc (HZ) delivered ASR of only 12% v/s RoIC of 121% over FY07-11 due to
deteriorating IC/CE ratio. The IC/CE ratio fell from 59% in FY06 to 33% in FY11 and will
deteriorate to 20% in FY13. HZL generated operating cash flow of INR199b, capex has
been a mere INR77b and dividend payout just 6%. Though HZ generates impressive
RoIC, which is improving due to a rising share of high margin silver volumes, deteriorating
RoCE will be a drag on stock performance.
5. SAIL: CWIP drags down RoCE, fixed costs depress RoIC
SAIL's story is similar to HZ's. The core business generated above-average RoIC of
67% and ASR was just 10%. The share of invested capital fell from 61% in FY06 to 22%
in FY11. SAIL generated post-tax and working capital adjusted cash flow of INR281b
and incurred capex of INR312b over FY06-11. However, INR226b of the INR312b capex
is lying as CWIP and dragging down RoCE due to slow project execution. RoIC will
continue to decline due to rising fixed costs. Although the IC/CE ratio will improve, RoCE
will still decline.
6. Sterlite Inds: Concerns on capital allocation drag down stock performance
Sterlite delivered ASR of 7%, a far cry from its impressive average RoIC of 46% over
FY06-11. It generated operating cash flow of INR279b, of which INR207b was used as
capex and INR73b towards acquisition of Anglo's zinc assets. INR155b of unnecessary
equity was raised, which was largely used to fund capex of associate companies like
VAL. Equity dilution and concerns on capital allocation dragged the stock performance.
Improvement in RoIC due to superior performance of the zinc-lead-silver segment and
higher IC/CE ratio boosted RoCE in FY12, which will deteriorate in FY13.
7. Tata Steel: Low RoIC investment dragged ASR, but the worst is behind it
Tata Steel (TATA) delivered ASR of only 4% but average RoIC was an attractive 27%
over FY06-11. TATA also maintained high IC/CE ratio. Although the average RoIC was
27%, it kept falling from a peak of 74% in FY05 to 60% in FY06 and 5.6% in FY10 before
rebounding to 18.6% in FY11. TATA generated operating cash flow of INR516b, investing
only INR264b as organic capex. It invested about INR491b in the very low generating
RoIC business, which is why it generated average RoIC of 7.7%. INR204b was raised to
fund the acquisition and equity dilution dragged down ASR. There is some weakening of
RoIC in FY12 but it is expected to improve in FY13 due to volume growth in the highmargin
Indian business and a rising IC/CE ratio.
8. Nalco: Low IC/CE, RoIC drags down ASR but return ratios improving
Nalco delivered ASR of only 3% and average RoIC of impressive 43% over FY06-11.
Consistently declining RoIC and low IC/CE ratio dragged down RoCE from 49% in FY07
to 13.3% in FY11. However RoIC and IC/CE ratio are improving due to the start of an
alumina refinery expansion unit.
9. Hindalco: Worst ASR due to equity dilution, declining RoIC; RoCE to fall
Hindalco was the worst performing stock over FY06-11, delivering nil returns. Hindalco
generated operating cash flow of INR243b, of which INR194b was used as organic capex.
A large part of the capex (INR131b) was CWIP at the end of FY11. IC/CE ratio is
declining after peaking in FY09 at 73%.
Hindalco raised INR122b through rights and QIP issues, of which INR117b (net of returns
on capital) was used to acquire Novelis. RoIC will improve by 1.1pp to 16.7% in FY13 on
improved margins in the Indian business, but RoCE will decline by 40bp to 9.9% due to a
deteriorating IC/CE ratio, mainly on project delays.
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