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Shareholder Value Creation in Steel Industry (An empirical Study)

Submitted in partial fulfillment of the requirements for Master in Management

Studies

(MMS)

2008-2010

SUBMITTED BY

AFTAB SHAIKH

(MMS) Roll No. 06.

Batch: Year 2008 – 2010

H K Institute of Management Studies and Research, Jogeshwari,

Mumbai 400102

MAY 2009 - JUNE 2009

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Student’s Declaration

I hereby declare that this report submitted in partial fulfillment of the

requirement of the award for the Master in Management Studies to H K

Institute of Management Studies and Research is my original work and not

submitted for award of any degree or diploma fellowship or for similar

titles or prizes.

I further certify that I have no objection and grant the rights to H K Institute

of Management Studies and Research to publish any chapter/ project if they

deem fit in Journals/Magazines and newspapers etc. without my

permission.

Class : (MMS – Sem. – IV)

Date : 20th Feb 2010

Name : Aftab Shaikh

Place : Mumbai

Roll No. : 06

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Certificate

This is to certify that the dissertation submitted in partial fulfillment for the

award of Master of Management Studies of H K Institute of Management

Studies and Research is a result of the bonafide research work carried out

by Mr. Aftab Mehboob Shaikh under my supervision and guidance, no part

of this report has been submitted for award of any other degree, diploma,

fellowship or other similar titles or prizes. The work has also not been

published in any Journals/Magazines.

Date 20thFeb.2010 Project guide : Dr. P.K Bandgar

Core Faculty

H K I M S R

Place: Mumbai

Prof. Krishna C. Pandey

Director

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ACKNOWLEDGEMENT

It is difficult to acknowledge precious a debt as that of learning as it is

the only debt that is difficult to repay except through gratitude.

First and foremost I wish to express my profound gratitude to the

almighty Allah and his prophet Mohummed Sallah ale wa salam, (Allah) the

merciful & compassionate with those grace & blessings. I have been able to

complete this work.

It is my profound privilege to express my sincere thanks to K C

Pandey, Director HKIMSR, for giving me an opportunity to work on the

project and giving me full support in completing this project.

I am very thankful to my guide P.K Bandkar for his full support.

Last but not least, I would like to thank my parents & my friends for

their full cooperation & continuous support during the course of this

assignment.

(Aftab Shaikh)

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Table of Contents

Page No.

CHAPTER 1 : 1.1 Executive Summary 01

CHAPTER 2 : 2.1 Introduction

: 2.1.1 Introduction to Shareholder Value 02

Creation (EVA & MVA)

: 2.1.2 Introduction to the Indian Steel Industry 18

: 2.1.3 Literature Review 34

: 2.1.4 Defining the problem 35

: 2.2 Objectives 36

2.2 Methodology 34

: 2.3 Limitations of the Report 37

CHAPTER 3 : 3.1 Analysis & Findings 38

CHAPTER 4 : 4.1 Conclusions 55

: 4.2 Bibliography 56

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CHAPTER: 1

1.1 EXECUTIVE SUMMARY

Traditional measures of corporate performance are many in number. Measures using common bases are Net Profit Margin, Operating Profit Margin, Return on Investment (ROI), Return on Net Worth (RONW), Earning Per Share (EPS) etc. Among these, again ROI is recognized as the most popular yardstick of overall performance. But it is often argued that, in general, these traditional measures fail to identify the true surplus. Economic Value Added (EVA) is advocated as a new measure of corporate performance that focuses on clear surplus in contrast to the traditionally used profit based indicators.

For evaluation of the efficiency of any decision, value creation or value addition aspect is of utmost importance in the present backdrop of corporate governance. Although adopting a holistic approach safeguarding the interests of all stakeholders is being emphasized and rightly so, it should be kept in mind that value creation or value addition aspect is of prime consideration in the assessment of the corporate policy guidelines. If that is not satisfied, wrong signals will be emitted from securities market and the continuance of the operations of the entity will be at stake. In view of the above considerations, in the present paper an attempt has been made to analyze the financial performance of ten India steel companies by using E VA and MVA. The Study is based on secondary data and covers the period of 5 years ranging from 2005-2009. A sample of 10 steel and allied companies selected on random basis among the top steel companies. To analyze the data EVA and MVA technique has been used. Further regression Analysis has been used to study linkages between EVA and MVA From the analysis it is seen out of five years MVA and EVA were negative maximum wealth was destroyed in year 2009 which was due to decrease in price and demand of steel globally as well as there was deep recession all over the world which crashed the market more than 50%.

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CHAPTER: 2

2.1 Introduction

2.1.1 INTRODUCTION TO SHARE HOLDERS

VALUE CREATION

SHAREHOLDER VALUE CREATION: AN OVERVIEW

Creating shareholder value is the key to success in today's

marketplace. There is increasing pressure on corporate executives to

measure, manage and report the creation of shareholder value on a regular

basis. In the emerging field of shareholder value analysis, various measures

have been developed that claim to quantify the creation of shareholder

value and wealth.

More than ever, corporate executives are under increasing pressure to

demonstrate on a regular basis that they are creating shareholder value.

This pressure has led to an emergence of a variety of measures that claim to

quantify value-creating performance.

Creating value for shareholders is now a widely accepted corporate

objective. The interest in value creation has been stimulated by several

developments.

* Capital markets are becoming increasingly global. Investors can readily

shift investments to higher yielding, often foreign, opportunities.

* Institutional investors, which traditionally were passive investors, have

begun exerting influence on corporate managements to create value for

shareholders.

* Corporate governance is shifting, with owners now demanding

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accountability from corporate executives. Manifestations of the increased

assertiveness of shareholders include the necessity for executives to justify

their compensation levels, and well-publicized lists of under performing

companies and overpaid executives.

* Business press is emphasizing shareholder value creation in performance

rating exercises.

* Greater attention is being paid to link top management compensation to

shareholder returns.

Defining Shareholder Value, and – Wealth Creation

From the economist's viewpoint, value is created when management

generates revenues over and above the economic costs to generate these

revenues. Costs come from four sources: employee wages and benefits;

material, supplies, and economic depreciation of physical assets; taxes; and

the opportunity cost of using the capital.

Under this value-based view, value is only created when revenues exceed

all costs including a capital charge. This value accrues mostly to

shareholders because they are the residual owners of the firm.

Shareholders expect management to generate value over and above the

costs of resources consumed, including the cost of using capital. If suppliers

of capital do not receive a fair return to compensate them for the risk they

are taking, they will withdraw their capital in search of better returns, since

value will be lost. A company that is destroying value will always struggle to

attract further capital to finance expansion since it will be hamstrung by a

share price that stands at a discount to the underlying value of its assets

and by higher interest rates on debt or bank loans demanded by creditors.

Wealth creation refers to changes in the wealth of shareholders on a

periodic (annual) basis. Applicable to exchange-listed firms, changes in

shareholder wealth are inferred mostly from changes in stock prices,

dividends paid, and equity raised during the period. Since stock prices

reflect investor expectations about future cash flows, creating wealth for

shareholders requires that the firm undertake investment decisions that

have a positive net present value (NPV).

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Although used interchangeably, there is a subtle difference between value

creation and wealth creation. The value perspective is based on measuring

value directly from accounting-based information with some adjustments,

while the wealth perspective relies mainly on stock market information. For

a publicly traded firm these two concepts are identical when (i)

management provides all pertinent information to capital markets, and (ii)

the markets believe and have confidence in management.

Approaches for measuring shareholder value:

1. Marakon Approach:

Marakan Associates, an international management-consulting firm founded

in1978, has done pioneering work in the area of value-based management.

This measure considers the difference between the ROE and required

return on equity (cost of equity) as the source of value creation. This

measure is a variation of the EV measures.

Instead of using capital as the entire base and the cost of capital for

calculating the capital charge, this measure uses equity capital and the cost

of equity to calculate the capital (equity) charge. Correspondingly, it uses

economic value to equity holders (net of interest charges) rather than total

firm value.

According to Marakan model shareholder wealth creation is measured as

the difference between the market value3 and the book value of a firm's

equity. Thee book value of a firm's equity, B, measures approximately the

capital contributed by the shareholders, whereas the market value of

equity, M, reflects how productively the firm has employed the capital

contributed by the shareholders, as assessed by the stock market. Hence,

the management creates value for shareholders if M exceeds B, decimates

value if m is less than B, and maintains value is M is equal to B.

According to the Marakon model, the market-to-book values ratio is

function of thee return on equity, the growth rate of dividends, and cost of

equity.

For an all-equity firm, both EV and the equity-spread method will provide

identical values because there are no interest charges and debt capital to

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consider. Even for a firm that relies on some debt, the two measures will

lead to identical insights provided there are no extraordinary gains and

losses, the capital structure is stable, and a proper re-estimation of the cost

of equity and debt is conducted.

A market is attractive only if the equity spread and economic profit earned

by the average competitor is positive. If the average competitor's equity

spread and economic profit are negative, the market is unattractive.

For an all-equity firm, both EV and the equity spread method will provide

identical values because there are no interest charges and debt capital to

consider. Even for a firm that relies on some debt, the two measures will

lead to identical insights provided there are no extraordinary gains and

losses, the capital structure is stable, and a proper re-estimation of the cost

of equity and debt is conducted.

A market is attractive only if the equity spread and economic profit earned

by the average competitor is positive. If the average competitor's equity

spread and economic profit are negative, the market is unattractive.

2. ALCAR APPROACH

The Alcar group Inc. a management and software company, has developed

an approach to value-based management which is based on discounted cash

flow analysis. In this framework, the emphasis is not on annual

performance but on valuing expected performance. The implied value

measure is akin to valuing the firm based on its future cash flows and is the

method most closely related to the DCF/NPV framework.

With this approach, one estimates future cash flows of the firm over a

reasonable horizon, assigns a continuing (terminal) value at the end of the

horizon, estimates the cost of capital, and then estimates the value of the

firm by calculating the present value of these estimated cash flows. This

method of valuing the firm is identical to that followed in calculating NPV in

a capital-budgeting context. Since the computation arrives at the value of

the firm, the implied value of the firm's equity can be determined by

subtracting the value of the current debt from the estimated value of the

firm. This value is the implied value of the equity of the firm.

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To estimate whether the firm's management has created shareholder value,

one subtracts the implied value at the beginning of the year from the value

estimated at the end of the year, adjusting for any dividends paid during the

year. If this difference is positive (i.e., the estimated value of the equity has

increased during the year) management can be said to have created

shareholder value.

The Alcar approach has been well received by financial analysts for two

main reasons:

* It is conceptually sound as it employs the discounted cash flow framework

* Alcar have made available computer software to popularize their

approach

However, the Alcar approach seems to suffer from two main shortcomings:

(1) In the Alcar approach, profitability is measured in terms of profit

margin on sales. It is generally recognized that this is not a good index for

comparative purposes. (2) Essentially a verbal model, it is needlessly

cumbersome. Hence it requires a fairly involved computer programme.

3. McKINSEY APPROACH:

McKinsey & Company a leading international consultancy firm has

developed an approach to value-based management which has been very

well articulated by Tom Copeland, Tim Koller, and Jack Murrian of

McKinsey & Company. According to them:

Properly executed, value based management is an approach to

management whereby the company's overall aspirations, analytical

techniques, and management processes are all aligned to help the company

maximize its value by focusing decision making on the key drivers of value.

The key steps in the McKinsey approach to value-based maximization are as

follows:

* Ensure the supremacy of value maximization

* Find the value drivers

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* Establish appropriate managerial processes

* Implement value-based management philosophy

4. ECONOMIC VALUE ADDED

Consulting firm Stern Steward has developed the concept of Economic

Value Added. Companies across a broad spectrum of industries and a wide

range of companies have joined the EVA bad wagon. EVA is a useful tool to

measure the wealth generated by a company for its equity shareholders. In

other words, it is a measure of residual income after meeting the necessary

requirements for funds.

In corporate finance, Economic Value Added or EVA is an estimate of

economic profit, which can be determined, among other ways, by making

corrective adjustments to GAAP accounting, including deducting

the opportunity cost of equity capital. The concept of EVA is in a sense

nothing more than the traditional, commonsense idea of "profit," however,

the utility of having a separate and more precisely defined term such as

EVA or Residual Cash Flow is that it makes a clear separation from dubious

accounting adjustments that have enabled businesses such as Enron to

report profits while in fact being in the final approach to becoming

insolvent. EVA can be measured as Net Operating Profit After Taxes

(or NOPAT) less the money cost of capital. EVA is similar to Residual

Income (RI), although under some definitions there may be minor technical

differences between EVA and RI (for example, adjustments that might be

made to NOPAT before it is suitable for the formula below). Another, much

older term for economic value added is Residual Cash Flow. In all three

cases, money cost of capital refers to the amount of money rather than the

proportional cost (% cost of capital). The amortization of goodwill or

capitalization of brand advertising and other similar adjustments are the

translations that can be made to Economic Profit to make it EVA. The EVA is

a registered trademark by its developer, Stern Stewart & Co.

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EVA Computations

EVA is a measure of value created/destroyed that compares the returns

from operations with the cost of financing those operations. It is the only

performance measure that links directly with the intrinsic value of the

business. Stewart defined EVA as NOPAT subtracted with a capital charge. It

represents residual income that remains after all costs have been

recognized including the opportunity cost of the equity capital employed.

EVA = NOPAT - Cost of Capital * (Economic Capital) ...(1)

Hence, EVA depends on both operating efficiency as well as balance sheet

management. Without efficiency, operating profits will be low resulting in

lower EVA and without careful balance sheet management, too many assets

and too much capital will exist resulting in higher than necessary capital

costs, leading to a lower EVA again (Gopenski, 1996).

As a departure from conventional accounting, where accounting profit is

derived after deducting interest charges, EVA is derived after subtracting

cost of all capital that includes debt, preference and equity capital. Charging

for capital is just the beginning; EVA also eliminates the potential

distortions present in the Generally Accepted Accounting Practices (GAAP)

based accounting. Actually, GAAP is ridden with anomalies that

misrepresent the true economies of a business (Ehrbar, 1999). So, Stewart

recommended a series of 164 adjustments to be made in GAAP-based

accounts to convert the accounting numbers into economic numbers. Many

researchers and EVA proponents generally use between 5-15 adjustments.

Hence, the present study considers the adjustments for non-recurring

income and expenditure, Research and Development (R&D) costs, goodwill

amortization, interest, Non-interest Bearing Current Liabilities (NIBCL),

investments in marketable securities, cash operating taxes, revaluation

reserve. Finally, NOPAT and economic capital have been defined as:

NOPAT = (PAT + non-recurring expenses + revenue expenditure on R&D +

interest expense + goodwill written-off + provision for taxes) - non-

recurring income - R&D amortization - cash operating taxes

Economic Capital = net fixed assets + investments + current assets -

(NIBCLs + miscellaneous expenditure not written-off + intangible assets) +

(cumulative non-recurring losses + capitalized expenditure on R&D + gross

goodwill) - revaluation reserve - cumulative non-recurring gains

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The most difficult component of EVA calculations (as per Equation 1) is to

estimate the total cost of capital, which is denoted as the combined rate of

return expected by both lenders and shareholders. It is the minimum

acceptable return on economic investment or the cut-off rate required for

value creation. This cost of capital has three primary applications and can

be used as:

• A capital charge rate for computing EVA (i.e., value creation);

• A hurdle rate for assessing return on capital employed; and

• A minimum target rate for accepting new projects.

The cost of capital has four drivers namely, after-tax cost of debt, cost of

preferred stock, cost of equity capital and cost of retained earnings. These

drivers are all about the trade-off between risk and return. The greater the

risk, the higher will be the required rate of return, resulting in higher cost of

capital and vice versa.

The overall cost of capital also known as WACC, equals the sum of the cost

of each of the component of capital, i.e., equity, debt and preferred stock,

weighted for their relative proportion in the company's capital structure.

The after-tax cost of debt is simply the bond's yield to maturity times one

minus the firm's marginal tax rate (Abdeen and Haight, 2002). For example,

if a company's yield to maturity is 12% and marginal tax rate is 35%, then

its after-tax cost of debt will be 7.8%, i.e., 12% (1 to 0.35). Since interest on

debt is tax deductible, this adjustment must be made to properly reflect the

true cost of debt component. Further, cost of preferred stock is calculated

by dividing the annual dividend paid to preference shareholders with the

average preference capital. As dividend is not tax deductible but subject to

the appropriation from profits of a company, no tax adjustment is required

in this case. The most critical component in WACC calculation, i.e., cost of

equity is usually defined with CAPM. The CAPM assumes that equity

shareholders require return equal to the return on a risk-free asset (e.g.,

government securities) plus a premium to compensate them for additional

market risk. The equation for the cost of equity is as follows:

where,

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Rj = Expected return on security j

Rf = Risk-free rate

Rm = Market rate of return

= Beta, i.e., sensitivity of the return on scrip j to the changes in market

index

The risk-free rate (Rf) is the theoretical rate of return attributed to an

investment with zero risk. It represents the interest that an investor would

expect from an absolutely risk-free investment over a specified period of

time. In practice, however, no investment is risk-free, as even the safest

investments carry a very small amount of risk. In the present study,

weighted average of annual yield on 364 days treasury bills, as issued by

Reserve Bank of India, has been taken as a surrogate of the risk-free rate.

The risk premium for a given company equals the market risk premium the

return equity shareholders expect over and above the risk free rate denoted

as(Rm - Rf) times a beta coefficient that represents the volatility of that

company's stock relative to the volatility of the market index (Young, 1997),

such as BSE Sensex in this case.

After estimating the individual costs of all the components of capital

structure, the final step is to calculate the WACC by the formula:

WACC = ke × we + kd(1 - t) × wd + kp × wp

where,

ke = Cost of equity shareholders' funds

kd = Cost of debt

kp = Cost of preference capital

t = Tax rate

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E = Book value proportion of average shareholders' funds

D = Book value proportion of average total borrowings

P = Book value proportion of average preference capital

WACC, hence, uses the financing side of the balance sheet in the form of the

targeted debt to capital ratio and provides a basis for weighing the total

cost of capital for the purpose of EVA calculation.

5 MVA Computation

MVA measures the value added by the management over and above the

capital invested in the company by its shareholders and lenders. It is the

cumulative amount by which a company has enhanced or diminished

shareholder wealth. It is the perfect summary assessment of corporate

performance that shows how successful a company has been in allocating

and managing resources to maximize the value of the enterprise and the

wealth of its shareholders. While the EVA of a company is a historical figure

based on the efficiency with which it used the resources at its disposal in a

particular year, its MVA is the market assessment of its ability to create

wealth in future. MVA is obtained by subtracting the economic capital of a

corporation (book value after adjusting for economic anomalies) from its

total market value, i.e., what investors can take out of the company.

MVA = Market Value of the firm - Economic Capital

Hence, the way in which the shareholder wealth is maximized is by

increasing the difference between the company's market value and its

economic capital.

The market value of a firm as represented by market value of its equity is

arrived at by multiplying stock price by the number of outstanding shares

of the firm. Taking share price at the end of the financial year for calculation

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of the market capitalization can be biased. Hence, in the present study, a

364 day average market cap has been taken as proxy for the market value

of equity. Market value of the firm has been taken as the sum of book value

of debt and 364 days average market capitalization. The book value of debt

is assumed to be equal to its market value. The reasons behind this

assumption are:

• Determining the market value of most corporate debt issues is

difficult, as they are not actively traded;

• Debt market values are usually relatively close to book values;

• Such assumption is made to assess the additions to shareholder's

wealth; and

• The market value of an organization's debt is more closely related to

interest rates' movements than to managerial actions that influence

shareholder wealth (Gapenski, 1996).

The economic capital as already mentioned above is arrived at after

adjusting for equity equivalents. In addition to the above, the financial

statement users must also recognize that maximizing wealth (MVA) is not

the same as maximizing market value. A firm can increase its market value

just by raising and investing as much capital as possible, which actually

increases the size of the company and therefore benefits managers. Such

strategy will benefit if capital raised is invested in the projects that earn

positive EVA.

The proposed study aims to achieve the following objectives:

• To define and discuss the measurement of EVA and MVA;

• To calculate EVA and MVA of sample companies after adjusting for

the required equity equivalents;

• To rank sample companies on the basis of EVA and MVA generated or

lost;

• To statistically examine the variations in EVA and MVA figures of

sample companies; and

• To empirically test the strength of the relationship between EVA and

MVA.

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2.2 INTRODUCTION TO STEEL INDUSTRY IN INDIA

CONTENTS

THE GLOBAL STEEL INDUSTRY

THE STRUCTURE OF INDIAN STEEL INDUSTRY

CONSUMPTION OF STEEL INDIA

SUPPLY OF STEEL IN INDIAN MARKET

THE GLOBAL STEEL INDUSTRY

The current global steel industry is in its best position in comparing to last

decades. The price has been rising continuously. The demand expectations

for steel products are rapidly growing for coming years. The shares of steel

industries are also in a high pace. The steel industry is enjoying its

6thconsecutive years of growth in supply and demand. And there is many

more merger and acquisitions which overall buoyed the industry and

showed some good results. The subprime crisis has lead to the recession in

economy of different countries, which may lead to have a negative effect on

whole steel industry in coming years. However steel production and

consumption will be supported by continuous economic growth.

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CONTRIBUTION OF COUNTRIES TO GLOBAL STEEL INDUSTRY

The countries like China, Japan, India and South Korea are in the top of the

above in steel production in Asian countries. China accounts for one third of

total production i.e. 419m ton, Japan accounts for 9% i.e. 118m ton, India

accounts for 53m ton and South Korea is accounted for 49m ton, which all

totally becomes more than 50% of global production. Apart from this USA,

BRAZIL, UK accounts for the major chunk of the whole growth.

STRUCTURE OF INDIAN STEEL INDUSTRY The steel industry in India is concentrated in the east, south and west of the country. The integrated foundries are located in the east, while electric steel is produced predominantly in the south and west. In the future the east will see rapid expansion as more integrated capacities are being built in Orissa and other eastern states due to its raw materials. Although India is now one of the worlds top ten steel producers, its domestic output is insufficient to meet the demand in all segments.

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Imports increased in 2005 by 8% and it is likely that India will continue to import in many segments over the medium term. According to Deutsche Bank Research,1 the three biggest steelmakers in India have a combined output of almost 20 million tons and have a domestic market share of 51%. Their domestic competitors are numerous medium-sized and smallish companies and more mergers can be expected between these companies as these firms need to improve their position with regard to the powerful suppliers of raw materials.

CONSUMPSION OF STEEL IN INDIA Driven a booming economy and concomitant demand levels, consumption of steel has grown by 12.5 per cent during the last three years, well above the 6.9 percent envisaged in the National Steel Policy. Steel consumption amounted to 58.45 mt in 2006-07 compared to 50.27 mt in 2005-06, recording a growth rate of 16.3 per cent, which is higher than the world average. During the first half of the current year, steel consumption has grown by 16 per cent. A study done by the Credit Suisse Group says that India's steel consumption will continue to grow by 17 per cent annually till 2012, fuelled by demand for construction projects worth US$ 1 trillion. The scope for raising the total consumption of steel in the country is huge, as the per capita steel consumption is only 35 kgs compared to 150 kg in the world and 250 kg in China. With this surge in demand level, steel producers have been reporting encouraging results. For example, the top six companies, which account for 70 per cent of the total production capacity, have recorded a year-on-year growth rate of 13.4 per cent, 15.7 per cent and 11.7 per cent in net sales, operating profit and net profit, respectively, during the second quarter of 2007-08. We expect strong demand growth in India over the next five years, driven by a boom in construction (43%-plus of steel demand in India). Soaring demand by sectors like infrastructure, real estate and automobiles, at home and abroad, has put India's steel industry on the world steel map.

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YEAR WISE DEMAND OF INDIAN STEEL INDUSTRY

YEAR DEMAND (in m t) GROWTH IN %

2000-2001 34.444

2001-2002 36.037 4.625

2002-2003 40.471 12.32

2003-2004 43.062 6.4

2004-2005 45.387 5.4

2005-2006 50.257 10.73

2006-2007 58.45 16.3

GRAPHICAL REPRESENTATION OF GROWTH AND DEMAND OF

INDIAN STEEL INDUSTRY

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MAJOR CONSUMERS OF INDIAN STEEL INDUSTRY

Support from dynamic economy

India is the economic region that has enjoyed the world’s most sustained boom. The Deutsche Bank Research Formel-G econometric model forecasts average real GDP growth of 5.5% p.a. for India between 2006 and 2020 O followed by Malaysia (5.4%) and China (5.2%). In all, the analysis covered 34 economies that generate some 85% of global GDP. The growth drivers are population growth, human capital, opening of the economy and rising investment. Despite the sharp increase in India’s population, per-capita GDP – in purchasing power parity terms – should rise by nearly 4% per year until 2020. Since the model does not take sufficient account of the country’s major initiatives in the infrastructure area, average growth until 2020 might turn out to be even closer to 6%. In fact, by the end of the decade India could replace Japan as the world’s third biggest economy after the US and China

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Positive stimuli from construction industry

The steel companies are pinning their hopes largely on the expanding construction industry. The industry is one of the key drivers of India’s economic growth. Up to 10 million new homes need to be built each year until 2030. Strong population growth, rising incomes and decreasing household sizes are forcing comprehensive measures to be taken in the housing sector. The pent-up demand for housing is estimated at around 20 million units by the Indian Construction Association; the Ministry for Urban Development and Poverty Alleviation claims that no less than 31 million dwellings are needed. The hosting of the Commonwealth Games in New Delhi in 2010 should generate additional stimulus for the construction industry and thus boost demand for steel. In addition to the sports facilities, accommodation for competitors and visitors is planned. The government has announced that some 40 hotels with a total of 15,000 beds are to be built. The Indian office market is benefiting from the ongoing off shoring activities of industrial nations. Indian insurers are concentrated in the software development and software product segments. Their second main business area is assuming the responsibility for entire support processes, or business process outsourcing (BPO). These segments still look set for growth.6 Furthermore, the construction sector is benefiting from major infrastructure projects. Capital expenditure is to be focused on road building and the rail network, as well as on the construction and expansion of ports and airports.

Strong growth in mechanical engineering

Mechanical engineering output has increased some 10% p.a. over the past five years. Thanks to the march of technological progress the prospects for domestic suppliers should improve going forward, while import growth is slightly crimped. Demand is greatest for building machinery and plastic-moulding machines as well as machine tools and textile machinery. Since the domestic textile and apparel industry, for example, is focusing further up the value chain, firms have to make numerous investments in modernising and expanding their machinery

24

portfolios Makers of building machinery are benefiting from the large-scale infrastructure projects planned by the Indian government, while machine-tool makers are being buoyed by the upturn in the automobile and auto parts industries for example. Exports by the Indian mechanical engineering industry rose recently by nearly 30% to USD 10 bn. By comparison, German mechanical engineering firms exported products worth close to USD 117 bn, including machinery to the value of about USD 1 bn to India. Germany claims a particularly large share of Indian imports of Woodworking machinery and machine tools as well as pumps and compressors. The demand for foreign machinery comes from customers requiring especially high standards of performance and precision. The Engineering Exports Promotion Council (EEPC) forecasts that Indian exports will be worth USD 30 bn (+32% p.a.) by 2008; nevertheless the volume is still very low by international standards. Booming automobile industry

The automotive industry may consume a relatively small proportion of steel output, but its growth rate is the highest of the most important clients for the steel industry. In India a small but flourishing automobile industry has now developed that sees its future primarily in the budget price segment and views the domestic market and other emerging nations as potential markets.7 Vehicle ownership (cars and trucks) in India at 11 per 1,000 inhabitants are even less widespread than in China with its very low figure of 21. The growth of the Indian automobile industry is being driven by healthy domestic demand. The consumption minded, fast-growing middle class is a major factor. The continuing increase in incomes and low-cost financing facilities are boosting sales. However, it is not uncommon for cars to be used for 20 years (Western Europe: 12 years), with vehicles that have been taken off urban roads often being driven for longer in rural areas. The population’s steadily growing demand for mobility and sharply rising traffic volumes will continue to generate strong demand for cars in the future. At the same time India’s automobile sector is establishing itself as an exporter to international markets. Hyundai, for example, uses the country as an export base for small cars, and Ford manufactures vehicles there for South Africa and other markets. However, competition between

25

automakers has intensified markedly. Whereas in 1995 there were just five carmakers in India the figure has now reached 10. The biggest are Maruti Udyog Ltd., Hyundai Motor India and Tata Engineering (Telco). The Tata group is even trying to gain a foothold in the European market with new models. India currently produces a total of 711,000 cars each year (Germany: 5.4 million).

SUPPLY OF STEEL IN THE INDIAN MARKET Over the past ten years India’s crude steel output rose nearly 7%per year to 55.3 million tons , while global crude steel output increased by

26

4% (Germany managed an increase of just under 1%p.a.) Although India is the world’s eighth largest steel producer, its3%-plus share of global steel output is still very low; it is roughly the same as Ukraine’s share of world steel production. China, the world’s biggest steelmaker, produces nearly ten times as much as India.In 2005 India’s crude steel output of 46.5 million tons was 8%higher than in 2004; only in China was the growth rate considerably higher at 15%. By contrast, production volumes fell in the US and the EU-25 by nearly 5% and roughly 4% respectively. In the first five months of 2006 Indian steel production continued to expand unabated, rising 10% yoy.

GRA

GRAPHICAL REPRESENTATION OF SUPPLY OF INDIAN STEEL INDUSTRY

YEAR SUPPLY ( in m t) GROWTH IN %

2000-2001 32.81

2001-2002 34.7 5.76

2002-2003 38.96 12.23

2003-2004 41.41 6.29

2004-2005 43.278 4.51

2005-2006 46.492 7.42

2006-2007 54.35 16.91

27

We forecast a significant increase in output by the Indian steel industry over the medium term. The entire industry’s contribution to gross domestic product should rise in the coming years to more than 30% – compared to just under27% at present. The growth drivers are the expanding client industries Automotive engineering (production up 16% p.a. between 2000 and 2005), mechanical engineering (up 10% p.a.) and construction (up 6% p.a.).

Company Profile

Tata Steel

28

Tata Steel (BSE: 500470), formerly known as TISCO and Tata Iron and Steel

Company Limited, is the world's sixth largest steel company, with an annual

crude steel capacity of 31 million tonnes. It is the largest private sector steel

company in India in terms of domestic production. Ranked 258th on Fortune

Global 500, it is based in Jamshedpur, Jharkhand, India. It is part of Tata

Group of companies. Tata Steel is also India's second-largest and second-

most profitable company in private sector with consolidated revenues of Rs

1,32,110 crore and net profit of over Rs 12,350 crore during the year ended

March 31, 2008.

Its main plant is located in Jamshedpur, Jharkhand, with its recent

acquisitions; the company has become a multinational with operations in

various countries. The Jamshedpur plant contains the DCS supplied

by Honeywell. The registered office of Tata Steel is in Mumbai. The company

was also recognized as the world's best steel producer by World Steel

Dynamics in 2005. The company is listed on Bombay Stock

Exchange and National Stock Exchange of India, and employs about 82,700

people (as of 2007).

Bhushan Steel

Bhushan Steel is the largest manufacturer of auto-grade steel in India and is

spending Rs. 260 billion to expand its capacity to 12 million tonnes annually,

from the present installed capacity of around one million tonnes.

Financials and management

Gross sales of Bhushan Steel grew from Rs. 500 crore in 2001 to Rs. 4000

crore in 2007. It earned net profits of Rs. 313 crore in 2007 and exported

goods worth Rs. 1,257 crore. Its exports include steel for both the automotive

and white goods industry and the list of countries it is exporting to includes

several developed countries.

Existing plants

The Khopoli plant in Maharashtra was commissioned in 2004 and has been

producing colour coated sheets, high tensile steel strappings, hardened and

29

tempered strips and precision tubes. In addition to these, the Khopoli plant has

recently launched the Galume value added steel (aluminium and zinc coated

sheet) for the first time in India.

At its Sahibabad plant in Ghaziabad, Uttar Pradesh, it has a 1700 mm mill,

which produces the widest sheets in India for the automotive industry. It has

highly automated systems.

At its Meramandali, Dhenkanal plant in Orissa, Bhusan Steel produces hot

rolled coils and has mills for hot rolling. Construction of the first phase is being

carried out.

Bhushan Power and Steel Limited has seven plants at four locations –

Chandigarh, Derabassi in Punjab, Bangihatti, near Dankuni in West Bengal,

and Thelkoloi in Orissa.

Jindal Steel and Power Limited

Jindal Steel and Power Limited is the most valuable private steel producer in

India, with a market cap of $11.8 billion. However, in terms tonnage, it is the

third largest steel producer in India. The company manufactures and

sells sponge iron, mild steel slabs, Ferro chrome, iron ore, mild steel,

structural, hot rolled plates & coils and coal based sponge iron plant. The

company is also involved in power generation.

Jindal Steel and Power is a part of the Jindal Group, founded by O. P.

Jindal (1930-2005). In 1969, he started Pipe Unit Jindal India Limited, one of

the earlier incarnations of his business empire. After Jindal's death in 2005,

much of his assets were transferred to his wife, Savitri Jindal. Jindal Group's

management was then split among his four sons with Naveen Jindal as the

Managing Director of Jindal Steel and Power Limited. His elder brother, Sajjan

Jindal, is currently the head of ASSOCHAM, an influential body of the

chambers of commerce, and the head of JSW Group, part of O.P. Jindal

Group.

On June 3, 2006, Bolivia granted development rights for one of the world's

largest iron ore reserves in the El Mutún region to Jindal Steel. With an initial

30

investment of US$ 1.5 billion, the company plans to invest an additional US$

2.1 billion over the next eight years in the South American country.[1]

Savitri Jindal, the widow of O. P. Jindal, is ranked as the 19th richest Indian

person according to Forbes.

The Jindal family established Vidya Devi Jindal School, a residential school for

girls in Hisar, India, in 1984. Although not marketed as such, it is widely known

to cater to the wealthy through its private location and remarkable array of

activities. The school's student body comprises girls from affluent business

and political families of India.

Ispat Industries Limited

Ispat Industries Limited (IIL) (BSE: 500305), set up as Nippon Denro Ispat

Limited in May 1984 by founding chairman Mr M L Mittal, is one of the leading

integrated steel makers. It has steadily grown into a Rs 9,400-crore company

having operations in iron, steel, mining, energy and infrastructure. It has two

integrated steel plants, located at Dolvi and Kalmeshwar in the state of

Maharashtra. The 1,200 acres Dolvi complex houses the 3 million tonne per

annum hot rolled coils plant., that combines the latest technologies - the

Conarc process for steel making and the compact strip process (CSP) -

introduced for the first time in Asia. The company is listed on Bombay Stock

Exchange and National Stock Exchange of India. It is headquartered

at Mumbai and employs about 3000 people. Ispat Industries was ranked 5th

among major steel companies in India for the year 2008 by Business World.

Hindustan Zinc Limited

Hindustan Zinc Limited (HZL) (NSE: HINDZINC, BSE: 500188) is an

integrated mining and resources producer

of zinc, lead, silver and cadmium. It is a subsidiary of Vedanta

31

Resources PLC. HZL is the world's second largest zinc producer. It's

FY2008 revenues were Rs. 85.47 billion per year.

History: HZL was established in 1966 as a government-owned

corporation.

Operations: Mining

HZL operates the world's third largest open-pit mine in Rampura

Agucha, Rajasthan. Other mines it operates are located in Sindesar

Khurd, Rajpura Dariba and Zawar, also in Rajasthan.

HZL may also the world's lowest cost zinc producer.

Smelting: HZL operates Zinc and Lead smelters and refineries at

Chanderiya and Debari in Rajasthan, and at Vishakhapatnam in Andhra

Pradesh.

ISMT limited

ISMT limited: It is largest integrated specialized seamless tube manufacturer in India. One of the most diversified manufacturers of specialized seamless tubes in the world, producing tubes in the range of 6 to 273 mm OD. One of the most modern alloy Steel plants in India that produces a wide range of alloy steels from 20 to 225 mm diameter. Specialized teams provide end to end solutions to industry-specific customers.

The Indian Seamless Metal Tubes Limited was promoted in 1977 by a group of technocrats to produce specialized seamless tubes in India. Beginning with an installed capacity of 15,000 metric tons per annum, ISMT commenced production in 1980 with the installation and commissioning of an Assel mill in technical collaboration with Mannesman Demag Meer of Germany. Subsequently, in 1990 the production capacity was raised to 50,000 metric tons per annum with the addition of a second Assel Mill. In 1995 The Indian Seamless Metal Tubes limited promoted another company, Indian Seamless Steels and Alloys Ltd. (ISSAL), to produce alloy Steel,

32

the raw material used in the manufacture of seamless tubes, giving ISMT better control over product quality as well as deliveries. In 2008 ISMT added a brand new PQF Mill. With this addition, ISMT’s tube making capacity increased from 150,000 MT/ annum to 450,000 MT/annum. Simultaneously, steel making capacity has also increased from 250,000 MT/annum to 350,000 MT/annum with the addition of a second Ladle refining furnace.

ADHUNIK METALIKS

Adhunik Metaliks was incorporated on November 20, 2001 as Neepaz Metaliks Private Limited under the provisions of the Companies. Act,1956 with its registered office at 14, N.S. Road, Kolkata 700001. Subsequently, the Company converted into a public company pursuant to a special resolution passed on February 18, 2004 and filed the statement in lieu of prospectus as required under the section 44(2) (b) of the Companies Act , 1956. The name of the Company was changed from Neepaz Metaliks Limited to Adhunik Metaliks Limited pursuant toa special resolution passed by the shareholders of the Company at a meeting held on July 22, 2005. As on the date of filing this Draft Red Herring Prospectus, our Promoters hold 5,16,85,642 Equity Shares of our Company representing 80.51 of our pre - Issue issued equity capital and the Promoter Group holds 46,83,770 Equity Shares of our Company representing 7.29 of our pre - Issue issued equity capital. As on the date of filing this Draft Red Herring Prospectus, six of the Directors on our Board represent the Promoters, 1 of the Directors is an executive director and 3 of the Directors are independent directors. In 2007-Adhunik Metaliks Ltd has informed that the Company has acquired Orissa Manganese & Minerals Pvt Ltd as 100% subsidiary.

Electrosteel Castings Limited

33

Electrosteel Castings Limited

Ductile Iron – THE NATURAL CHOICE

Electrosteel Castings (UK) Ltd a wholly owned subsidiary of Electrosteel Castings Ltd, India offers a comprehensive range of Ductile Iron pipes

and fittings for use in the water and sewerage industry.

Offering the end user total versality Ductile Iron provides a broad range of solutions to specific pipeline application or installation demands in both above and below ground applications. The product range covers the diameters 80mm to 1000mm with a choice of jointing types , fitting types and protection systems for use in most applications. Operating under BS EN ISO 9001 Quality Management System and ISO 14001 Environmental Management System products are manufactured in a state of the art facility in Kolkata, India. Quality is viewed as an essential aspect of the product supply and all pipes and fittings are manufactured and tested in accordance with the requirements of both BS EN 545 for potable water and BS EN 598 for sewerage. In addition as a part of the supply package we recognise that occasionally on site unexpected requirements occur that need either a ‘special’ or ‘short lead time’ solution. Electrosteel Castings (UK) Ltd offer both Fabricated Flanged Pipe and Steel Fabrication facilities geared to responding to these demands and assisting our customers in resolving problems.

34

2.3 Literature Review

Most studies dealing with shareholders’ value creation have

focused on comparison of traditional measures (earning, cash flow,

productivity parameters, net present value, etc.) and value based measures

(EVA, MVA as percentage of capital employed, etc.). The purpose of such an

exercise was to identify the most significant explanatory variable that best

measures the shareholder value ; but, the existing literature on the

underpinnings of the share holder value creations is not well developed.

Most companies in India still are in dark about what exactly they are

supposed to do for managing the shareholder but virtually all of them say

the are doing it. The real key to create message a business enterprise has to

earn economic return to its owners for its economic survival. In market-

driven economy, there are number of firms that create wealth whereas

other destroy it. EVA as well as MVA being a value based measure assist

investors in wealth discovery & company selection process. IN the present

study& attempt has being made to explain the application of EVA principles

for the evaluation of companies. It highlights and explains all the elements

that finds in EVA computation like calculation on net operating debt cost of

equity , Cost of preference capital and finally ,EVA.

Thus, the proposed study make an original contribution towards literature

since it is pioneering and comprehensive effort to calculate EVA & MVA of

India’s valuable companies, exactly as per the methodology developed by

Stern Steward & CO.(founders of EVA concept) for a long period . I t helps

strategic investor, academic, researcher, portfolio managers and corporate

decision maker to dig below the surface to interpret the economic realities

of these big business houses. The present study defines and discusses the

EVA computations & outlines the measurement of MVA. It, then, explains

the research design & methodology, and presents the results with

discussions, followed by summary of the findings.

35

2.4Defining the problem

Corporate management has been placed under growing

pressure to implement financial strategies that create value for its

shareholders. Although maximizing shareholder wealth has

become a paramount corporate mission, how this mission is to be

achieved is much less certain. For many years, company

executives and shareholders have relied to standard accounting

measures are not reliably linked to increasing the value of a

company’s shares. This occurs because earnings do not reflect

changes in risk factor, nor do they take account of the cost of

equity capital. So, the conclusions drawn on the basis of such

measures create value is to earn sufficient economic returns to its

shareholders. Two measures of financial performance that

account properly for all ways in which value can be added or lost

are Economic Value Added (EVA) and Market Value Added (MVA).

36

2.2 Objectives

To Study the Shareholders’ value creation in Steel and allied

Industries.

37

2.3 Methodology

The Study is based on secondary data and covers the period of 5 years

ranging from 2005-2009. A sample of 10 steel and allied companies

selected on random basis among the top steel companies.

EVA techniques are used.

MVA techniques are used.

Further, Regression Analysis has been used to study linkages between EVA

and MVA.

38

2.4 Limitations of report

• The project is based only on secondary data.

• Data was available for 5 years only.

39

Chapter 3

3.1 Analysis of Data

Nowadays, investor and portfolio managers are keen to find the ‘best

companies’ in terms of value creation. The purpose behind this is to take

decisions regarding stock selection, portfolio construction and risk

management. The shareholders are always the residual claimants who need

to be satisfied with suitable returns. Without this Business entity is no

longer viable and is not likely to continue as a going concern.

In India, Business Today took an initiative in April 1999 and

commissioned Stern Stewart & Company (Financial consulting workshop

that created the concept of EVA and MVA), to asses the value addition of the

companies followed by many researchers who did many research on

Shareholder value creation. The objective was to look beyond the façade of

traditional measures, like market cap, earning per share and price to

earning ratio so as to investigate weather a company management was

really adding value to its shareholders.

In present study, a similar attempt has been made to identify the financial

performance of selected Indian Steel and related companies based on their

ability to create wealth as indicated by to unique metrics: EVA and MVA.

40

TABLE 1

TABLE: 1 Year-wise EVA and EVA based ranking of sample companies for the period 2009 through 2005 (in crores)

Company Names 2009 2008 2007 2006 2005

EVA Rank EVA Rank EVA Rank EVA Rank EVA Rank

ADHUNIK

METALIKS 34.32 7 12.38 6 2.23 8 2.56 8 1.04 7

AJMERA REALTY -0.21 8 22.59 5 13.12 7 11.33 7 15.68 6

BHUSHAN STEEL 291.81 3 148.31 4 142.93 5 155.62 3 140.18 3

ELECTROSTEEL -15.57 9 7.16 8 -12.28 9 0.62 9 -14.71 8

HINDUSTAN ZINC -545.72 10 -500.20 10 -56.30 10 16.63 6 -40.88 9

ISMT LTD 95.43 6 11.08 7 48.42 6 31.84 5 34.06 5

ISPAT INDS. 597.26 2 -33.37 9 1058.52 1 327.83 1 -216.84 10

JINDAL STEEL 282.52 4 453.11 1 217.09 4 155.02 4 103.41 4

JSW STEEL 725.77 1 260.34 2 289.98 2 -13.17 10 184.83 2

TATA STEEL 263.29 5 164.61 3 242.22 3 317.82 2 242.28 1

Total EVA 1728.88 546.00 1945.93 1006.10 449.04

41

Table 1 depicts the year-wise EVA created by sample of companies for

period of 5 years and their respected ranking for the said period. It is

evident from the table that in year 2009, 7 out of 10 companies reported

positive EVA. The companies gained top three positions were JSW Steel,

ISPAT INDS and Bhushan Steel, respectively where as Hindustan Zinc,

Electro Steel and Ajmera Realty were the worst performer and got the last

three position in EVA ranking. Hindustan Zinc reported negative EVA for

four years except 2006. Tata Steel lost it ranking position from no1 to no5

from year 2005 to 2009.

42

TABLE 2

Above data can be presented in diagram as

follow: (Daigram1)

43

Table: 2 Shows the EVA based frequency Distribution of sample of

companies. The highest wealth destroyer companies were 3 in year

2005and 2009. In 2006 there was only one EVA negative company. On an

average about 22% of companies stated negative EVA through out the study

period. Around 34% of companies generated EVA upto 100 crores, 38%

succeeded into generate EVA between 100 to 499 crores, 6% hand EVA

above 500 crore.

44

Table 3

TABLE: 3 Year wise MVA and MVA based ranking of sample companies for the period 2009 through 2005 (in crores)

Company Names 2009 2008 2007 2006 2005

MVA Rank MVA Rank MVA Rank MVA Rank MVA Rank

ADHUNIK METALIKS -33.12 4 921.80 8 56.29 9 191.40 8 160.98 6

AJMERA REALTY -204.18 6 1517.22 6 2130.84 5 1839.86 4 128.61 8

BHUSHAN STEEL -336.42 7 1019.84 7 967.04 7 -129.02 10 106.36 9

ELECTROSTEEL -834.90 8 101.83 10 -21.80 10 3.95 9 138.86 7

HINDUSTAN ZINC 4546.44 2 10398.09 3 16176.21 1 18677.18 2 5105.45 2

ISMT LTD -192.50 5 278.65 9 533.20 8 1083.30 6 105.24 10

ISPAT INDS. 403.41 3 3155.12 5 995.07 6 1182.10 5 542.30 5

JINDAL STEEL 13167.00 1 28150.54 2 4821.32 3 3997.02 3 1906.18 3

JSW STEEL -3312.08 9 7968.47 4 2790.92 4 676.88 7 1806.93 4

TATA STEEL -9116.33 10 28512.51 1 12151.62 2 19938.31 1 15136.93 1

Total MVA 4087.32 82024.06 40600.72 47460.97 25137.85

45

The above table can be presented in diagram as

follow: (Diagram 3)

46

Table 3 represent the year wise MVA and MVA-based ranking of sample

companies. It is observed that wealth is destroyed in 2009 showing

negative MVA around 70 % of companies were negative. Top three gainers

in 2009 are Jindal Steel, Hindustan Zinc and ISPAT INDS and top three

losers were Tata Steel, JSW Steel and Electro Steel. There was consistent

growth in MVA which tremendously dropped in year 2008-09 to 4087.32

crore as compared to year 2007-08 from 82024.06 crore. The MVA fall in

year 2008-09 was basically because of Global Meltdown and recession in

the global economy which crashed the share market more than 50%

globally.

Table: 4 MVA-Based frequency distribution of sample of companiesNumber of Companies

Year

2009 2008 2007 2006 2005 Total Average % MVA

Negative 7 0 1 1 0 9 1.8 18

0-999 1 3 4 3 6 17 3.4 34

1000-2499 0 2 1 3 2 8 1.6 16

2500-4999 1 1 2 1 0 5 1 10

5000-9999 0 1 0 0 1 2 0.4 4

10000-14999 1 1 1 0 0 3 0.6 6

15000-19999 0 0 1 2 1 4 0.8 8

Above 20000 0 2 0 0 0 2 0.4 4

Total 10 10 10 10 10 50 10 100

47

Table :4 Shows the MVA based frequency Distribution of sample of

companies. The highest wealth destroyer company was observed to be 7 in

year 2008-09. In 2006 there was only one EVA negative company. On an

average about 18% of companies stated negative EVA through out the study

period. Around 34% of companies generated MVA upto 1000 crores, 30%

succeeded into generate EVA between 1000 to 9999 crores, 18% hand MVA

above 10000 crore.

Average of 5 years MVA

48

Table 5:Descriptive Statics

Panel A:Profile of EVA for Entire Sample

Year Mean Median sum Minimum Maximum Std.Deviation Skewness Kurtosis Range

2005 44.90 24.87 449.04 -216.84 242.28 130.53 -0.46 0.74 459.12

2006 100.61 24.23 1006.10 -13.17 327.83 132.12 1.04 -0.47 341.00

2007 194.59 95.67 1945.93 -56.30 1058.52 326.25 2.42 6.56 1114.82

2008 54.60 17.48 546.00 -500.20 453.11 245.97 -0.91 2.94 953.31

2009 172.89 179.36 1728.88 -545.72 725.77 353.90 -0.43 1.16 1271.49

Table 5:Descriptive Statics

Panel B:Profile of MVA for Entire Sample

Year Mean Median sum Minimum Maximum Std.Deviation Skewness Kurtosis Range

2005 2513.78 351.64 25137.85 105.24 15136.93 4705.53 2.60 7.06 15031.69

2006 4746.10 1132.70 47460.97 -129.02 19938.31 7771.47 1.69 1.23 20067.32

2007 4060.07 1562.96 40600.72 -21.80 16176.21 5600.38 1.63 1.59 16198.01

2008 8202.41 2336.17 82024.06 101.83 28512.51 11147.86 1.41 0.53 28410.68

2009 408.73 -198.34 4087.32 -9116.33 13167.00 5651.94 0.95 3.19 22283.33

49

Table 4 provides descriptive statics for both EVA (in Panel A) and MVA (in

Panel B). Here the results have been described as measures of central

tendency (Mean, Median) Measures of variability (Range, Standard

deviation) and measures of shape (Kurtosis and Skewness). Panel A reveals

positive mean EVA for all years but it was less in 2008 as compared to other

years. It was due to huge drop of demand for steel in that year. Almost the

similar behavior is exhibited by median EVA values.The minimum values

are negative , ranging between Rs. -13.17 to Rs. -545.72 and maximum

values being positive throughout are found to be between Rs. 242.28 and

3539.25.

The value range show volatility, i.e, the difference between the

smallest and the largest value. The standard deviation measures the

variation of the data points from the mean value. Here, large standard

deviation values of EVA in panel A indicate that data points are distant from

the mean value and the mean is not representative one. It points the big

difference between EVA values of best and worst performing companies in

each year under study example, e.g., JSW Steel reported positive EVA worth

Rs. 725.76 cr in year 2009, where as Hindustan zinc, in same year, eroded

shareholder wealth and reported negative EVA worth Rs. -545.72cr . similar

behavior of large standard deviation were also observed for MVA (in panel

B) during the entire study period. Further skwness quantifies the extent of

departure from symmetry and indicates trhe direction in which the

departure takes place.

50

Table 6: EVA and MVA of sample companies

(Aggregates, Averages and Ranks)and their Respective Directions

(In Crores) Rank (In Crores) Rank Directions

Company Name EVA MVA

Total Average Total Average

ADHUNIK

METALIKS

52.53 10.51 8 1297.35 259.47 9 E+M+

AJMERA REALTY 62.50 12.50 7 5412.35 1082.47 6 E+M+

BHUSHAN STEEL 878.85 175.77 5 1627.81 325.56 8 E+M+

ELECTROSTEEL -34.78 -6.96 9 -612.06 -122.41 10 E-M-

HINDUSTAN

ZINC

-1126.47 -225.29 10 54903.37 10980.67 2 E-M+

ISMT LTD 220.83 44.17 6 1807.88 361.58 7 E+M+

ISPAT INDS. 1733.39 346.68 1 6278.00 1255.60 5 E+M+

JINDAL STEEL 1211.15 242.23 4 52042.05 10408.41 3 E+M+

JSW STEEL 1447.75 289.55 2 9931.13 1986.23 4 E+M+

51

TATA STEEL 1230.21 246.04 3 66623.04 13324.61 1 E+M+

Grand Total 5675.95 1135.19 199310.92 39862.18

Table 5 provide the aggregate as well as average values of both EVA and

MVA created/eroded by sample companies during the entire study period.

It also provides their ranking on the basis of EVA as well as MVA. Taking

average EVA as the base, the top three wealth creating companies are ISPAT

IND , JSW STEEL and TATA STEEL, where as ADHUNIK METALIKS,

ELECTROSTEEL, HINDUSTAN ZINC. From the MVA perspective, TATA

STEEL , HINDUSTAN ZINC and JINDAL STEEL got top three position in

value creation, where as BHUSHAN STEEL, ADHUNIK METALIKS and

ELECTROSTEEL have been placed in top three value destroyer list. Thus a

mere 8 out of 10 companies steel most valuable companies list boasted

overall EVA during the entire study period. On other hand 9 out of 10

companies reported an overall positive MVA.

Quite obviously, EVA and MVA value of sample companies don’t always

move in the same direction. Thus, the sample features depicting direction of

EVA and MVA are presented in figure 1.

Figure 1

52

It shows around 80 % of the companies have positive EVA and positive

MVA (category A). And around 10% have Negative EVA and Negative MVA

(category B). Conversely , around 10% have Positive EVA and Negative MVA

(category C) whereas, there is no company to represent where EVA positive

and MVA shows Negative value (category D).Of the above category C & D

require some more explanation, that is when MVA does not follow EVA.

Such difference between MVA & EVA often seperates strategic investors

from the value investors & also explains why the market often react to a

corpqarate announcement in a surprising way. Suppose the company has

just announce lay-off of its hubdred R&D employees to improve its cash

flow & firther to enhance its EVA. If the stock market feels that the

employees were not doing useful, the share price will move higher.On the

other hand contrary the stock would drop, If the lay-off has being taken has

the management’s permission about the company future prospects.

Category C (E - M+): Some of the important players falling in this category

are 3M India Ltd., HCL, Infosys Technologies, Satyam Computer Services

53

Ltd., Tata Tea Ltd., etc. Among these, one company, i.e., Reliance Industries

acquired place in the top five wealth creator list from the MVA perspective

whereas, it has got third rank from bottom, when observed through the EVA

angle. Possible reasons of such contradiction might be:

• Companies in this category have gained the confidence of the

strategic investors and hence, their stock is overpriced;

• Markets expect an increase in their EVA. This is based on the

assumption that MVA is the present value of future EVA (Ramana,

2004);

• Huge asset base; and

• Substantial investment being made in the project which cascades not

into immediate returns, but into long-term returns.

Hence, the companies in this category need to achieve a positive EVA by

improving their operational efficiency and balance sheet management.

Moreover, what matters more is that such companies should go for a

substantial capital investment only when they are sure that they can raise

their return on capital employed by upping the utilization of their existing

assets or by stimulating demand for their products and services.

Category D (E+M - ): In the present study, there is no company portraying a

picture where EVA gives positive and MVA reports negative numbers; but

in a market-driven economy, such companies may exist. Possible reasons

for such a situation might be:

• Companies though capable in generating wealth, may have

underpriced stocks;

• Market expects a major fall in EVA that may be due to announcements

of future investments in some projects that don't seem to be

justifiable;

• Improper market valuation techniques; and

• Failure to communicate company's strategies effectively.

Actually, the market price of scrip is not a function of its fundamental

strengths, but of investors perceptions that often have no quantitative basis.

Ramana (2004) has given suggestions that such companies need to build

confidence and awareness among investors and the market about their

wealth generating abilities. To see the signaling effects on share prices,

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companies can also offer benefits like dividend declarations and bonus

issue to its existing investor's base. In addition, an announcement of a hot

new product or an attractive deal can also have influential effects.

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Chapter 4

4.1 Conclusion

The EVA-MVA framework provides a new lens through which the

underlying economies of a business and its contribution to wealth creation

can be viewed. Unless the companies focus on EVA as a metric that can

realistically assess its economic contributions, shorn of accounting

anomalies, they may find it difficult to survive in the long run. The present

study found that almost 50% of the sampled companies representing

India's wealth club undoubtedly destroyed the wealth of its shareholders. It

raises a question on how the paucity of positive EVA in Indian companies

can be declined? In the short run, factors like reduction in the companies'

cost of capital, increase in its return on capital employed, an improved

operational efficiency, hiving off unproductive assets and optimizing the

debt to equity ratio will all contribute to an upswing in its EVA. Thus, the

short-term solution for a high EVA lies in the choice of positive Net Present

Value (NPV) projects and products that are not capital intensive. Moreover,

a consistent high EVA from year to year also results in an increase in the

company's MVA. For this, companies need to focus on growth and financial

jurisprudence simultaneously (BT-2000). The advisors and managers

should seek to link the business strategies to values and values to

performance for the achievement of the objective of value creation. Though

in the last four years, it seems as if Indian companies have paid a greater

deal of attention in improving EVA, yet the metric has not found any legal

backing. It is not mandatory for the companies to calculate their economic

profitability methodically and disclose the same in the audited annual

reports. Ehrbar (1999) rightly claims that corporations will continue to use

a variety of measures to gauge their financial performance, but none will

provide a more accurate measure of wealth creation than EVA. As

companies begin to understand the power of EVA and incorporate it as the

basis for various capital budgeting decisions, performance evaluations and

bonus determination will be on the road to achieve outstanding success.

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Bibliography:

* Pandey I. M. "Financial Management", Vikas publishing house

New Delhi

* Chandra Prasanna "Financial Management Theory and Practice,

Tata McGraw-Hill, New Delhi

Fifth Edition.

* www.Valuebasedmanagement.com

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