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MOSL: INDIA INC. ROE (THEMATIC)-A Root and Branch Analysis

INDIA INC. ROE (THEMATIC): A Root and Branch Analysis

Return on equity (RoE) is one of the key strategic metrics used to evaluate the capital allocation efficiency of a company. In this report, we present a detailed study of how RoE has changed over time for India Inc, identify the factors driving this change and its role in market cap creation. As widely known, India Inc’s RoE has undergone two phases over the last 16 years (FY03-19): (1) ‘The Rising Phase’ over FY03-08, where this ratio for BSE500 hit a high of 22.9% (in FY07) and (2) ‘The Downward Phase’ over FY08-19, where the ratio halved to its lowest level of 9.5%. That said, we note that RoEs of India Inc. – excluding public sector banks (PSBs), telecom and autos – have already showed signs of an improvement since FY15 (up 150bp to 14.0% in FY19 from a decade-low of 12.5% in FY15). This could further gain steam with a revival in PSBs/telecom/autos and realization of corporate tax rate cut benefits.

Our ‘root and branch’ study of India Inc RoE reveals some interesting insights: (a) Cyclical sectors are key drivers of India Inc. RoE. (b) PSUs’ RoEs have remained at par with their private counterparts, but their valuation multiples have remained low. (c) A high RoE is desirable, but an improvement in it is key for market cap creation. (d) Mid-caps have a relatively low (v/s large-caps) but highly variable RoE, which leads to its outperformance versus large-caps. (e) Capital structure-led RoE improvement uplifts valuation multiple. (f) Improving RoE and earnings growth is a lethal combination for market cap creation.