TVS Motor Co.’s shares have done miserably in the past three years. Since April 2004, its shares have fallen by 33% at a time when Hero Honda Motors Ltd’s shares have risen by 38%. But looking at TVS’ financial performance in the past three years, the underperformance is justified. Operating profit has nearly halved between fiscal years 2003-04 and 2006-07, although revenues rose by 36.7% during the same period. Earnings per share fell by 52% to Rs2.8 last fiscal, from Rs5.8 in FY04.
With that kind of performance, TVS shares should have done much worse. Instead, TVS shares have become valued more highly in terms of price-earnings ratios. At current levels, the stock trades at about 22 times trailing earnings and 20 times one-year forward earnings. Three years ago, it traded at about 11.5 times earnings. Its current valuations are at a premium to market leader Hero Honda, which trades at 16 times trailing earnings.
So, what makes TVS share tick despite three years of falling profits? The answer lies in TVS’ low profit margin. In FY07, operating profit margin was as low as 3.6%. So, even a slight increase in margins would lead to a huge increase in profits. A one percentage point increase in margin, for instance, would lead to a 28% jump in operating profit. In the case of Hero Honda, which enjoys margins of 11.8%, a one-percentage point increase in margin would increase absolute profit only by 8%. It’s this high operating leverage that has kept investor hopes alive.
Last May, the stock was trading at over 30 times trailing earnings on hopes that new product launches would succeed and benefit of operating leverage would kick in. But cost pressures and intense price competition had quite the opposite effect. With things getting worse for the two-wheeler industry, it would be a while before investors’ hopes of benefiting from TVS’ operating leverage materialize.
Things have gotten worse for the Pfizer Ltd stock, which has been languishing in the past year, owing to uncertainty over the divestiture of its consumer health-care business. The company reported disappointing results for the second quarter ended May 2007 (Pfizer’s accounting year ends in November). Revenues fell by 1.4% to Rs164.7 crore and operating profit dropped 4.4% to Rs35.2 crore. After the fall post results, Pfizer’s shares have underperformed NSE’s Nifty by about 24% in the past year.
Results weren’t exciting in the February quarter as well. Sales had risen by 6.2% and operating profit had increased by 5.3%. In sum, operating profit remained flat at Rs72.6 crore in the first six months of this financial year. Analysts point out that due to the pending divestiture, there’s been a loss of focus in the OTC (over the counter) business, which accounts for about 22% of total revenues and a third of the company’s profit.
Net earnings, however, got a boost, thanks to the sale of the company’s property at Chandigarh for a profit of Rs273.7 crore. For perspective, Pfizer’s profit before taxes in the whole of fiscal year 2005-06 stood at Rs185.4 crore.
What the markets are really interested in at this point is the method through which the consumer health-care business will be divested. The business was sold globally to Johnson and Johnson last year, but in some markets like India, the divestiture is still pending. The best-case scenario for shareholders is if the business is transferred to another company with the same shareholding pattern. This would help them reap full benefits of the hived-off business. What could also happen is that the business is transferred to J&J for a consideration. The worry is that the consideration could be lower than the value the markets have assigned for the business. Until there’s clarity on this front, the stock may continue to underperform.
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