How companies use working capital to boost shareholders' returns

What if a company is paid for carrying out its day-to-day business at no extra cost? It may sound absurd, but that is the case with a few Indian companies.

Out of the total BSE 200 companies, 23 have negative working capital — their current liabilities or payables are higher than current assets or receivables. This essentially means the companies do not have to deploy their own capital or borrow from banks to carry out their routine business activities. “It is actually very good to have negative working capital because this entitles companies to earn relatively better returns on capital and equity. This also shows the operational efficiency of a company. But just this would not be enough. The companies should also have good fundamentals,” says Jeetay Investments Director Chetan Parikh.

Such companies are preferred by investors as they reward shareholders relatively better. The BSE 200 companies have an average returns on capital and shareholders’ funds at about 20 per cent, which is far less than the 32-35 per cent returns generated by companies with negative working capital.

More important, the top ten companies with negative working capital have a dividend payout ratio of 62 per cent, which is far greater than the average 26 per cent of the BSE 200 companies. The dividend payout ratio indicates the proportion of net profit a company pays out as dividends.

Good working capital management also enables companies to easily scale up their business (growth rates) in due course without significant pains. Here are four such companies that had negative working capital in 2009-10, have sound fundamentals, are expected to grow at a healthy rate and can deliver good returns in the long-run:

Bajaj Auto
Bajaj Auto takes 45 days to pay its suppliers, whereas debts are collected within just 10 days. Not only this, its inventory ratio is among the best at 31 times, leading to low conversion time from components to bikes and, further, to sales. This has helped in huge cash savings and enhanced returns.

Meanwhile, Bajaj Auto – which is a leading player in the domestic market and has significant export operations – has guided to produce four million bikes in 2010-11, which reflects a growth of 40 per cent year-on-year. The underlying strong demand and increase in capacity and new product launches by the company should help it sustain healthy growth rates in the next few years.

HOW THEY STACK UP
In Rs crore	Net WC less cash	Dividend payout (%)	ROCE (%)	CMP (Rs)	P/E (x)
Colgate-Palm.	-311	69.8	179.7	850	30.0
Nestle India	-721	81.3	174.2	2,803	39.0
Castrol India	-203	94.1	120.0	464	83.9
Hind. Unilever	-3,289	73.6	106.4	266	31.8
Bajaj Auto	-1,360	38.6	63.1	2,659	24.3
Dabur India	-118	43.0	62.6	200	33.4
Hero Honda Motor	-1,259	32.9	51.0	1,884	16.9
Glaxo. Pharma	-250	54.7	46.0	1,961	36.5
ITC	-671	106.8	43.8	156	33.7
ACC	-1,690	29.0	40.1	843	11.0
WC is working capital; Ranking is based on the return on the capital employed Source: Capitaline

Castrol India
Castrol, which generates 87 per cent of its revenue from lubricants used in automobiles, has grown constantly as a result of growing demand and strong technological support of its UK-based parent BP. Castrol collects money from its customers in just 21 days (on an average), compared to the 76 days it takes to pay its creditors.

Better management of receivables and inventory has led to negative working capital and zero debt in books for the year ended December 2009. Backed by higher demand, analysts expect Castrol’s earnings to grow about 15 per cent over the next two years.

Nestle India
Nestle, which is known for such top brands as Maggi and Nescafe, has maintained its dividend payouts at 70-80 per cent in the last five years, which was possible due to negative working capital, high cash generation and no significant capex. Nestle collects its money from customers in just four days (average collection period), whereas it pays in 52 days to its raw material suppliers.

A low inventory ratio of 11.19 times – or about 32 days of inventory – has contributed to better working capital management. Nestle, which has more than doubled its profits in the last four years, is expected to report an earnings growth of 20-22 per cent over the next two years on the back of higher demand and the launch of new products.

GSK Pharma
GSK Pharma is the third-largest player in the domestic pharma space. It has a strong presence in the acute therapy and vaccines segments, with well-known products like Augmentin, Betnesol and Zinetac. The company has benefited from the support of its parent company, GlaxoSmithKline, which is the world’s second-largest pharma company.

While GSK Pharma is debt free, its negative working capital is on account of better receivables and supply chain management. Led by higher returns on equity, the company maintains a high dividend payout ratio of 50-60 per cent. The company is well positioned in the growing domestic pharma market and analysts expect its profits to grow by over 10 per cent over the next two years.