Market rewards companies that manage liquidity well: 7 stocks that are proof

The short-term liquidity or cash position of a company play a significant role in determining its financial health. Neglect of liquidity management can land an organisation in serious financial crisis. Short-term liquidity, also known as working capital, is critical for day-to -day operations. It’s determined by the nature and size of business, seasonal variation in sales, change in input or raw material prices and length of the production cycle.

Prudent management of working capital provides several advantages— strengthening goodwill or reputation, better margins due to easy access of discounts from raw material suppliers, and improvement in business health due to enhanced liquidity and solvency. Analysts use different ratios for analyzing the effectiveness of the working capital management and one of such ratio is the cash conversion cycle (CCC).

CCC measures the lifecycle of cash and estimates the number of days in which a company can convert its resources into cash. It is derived using three sub-ratios—days inventory outstanding (DIO), day sales outstanding (DSO) and days payables outstanding (DPO). All three sub-ratios are also expressed in the number of days.

DIO measures the days in which a firm converts its inventory or raw materials into sales. DSO determines the number of days in which a company collects money from its customers for the sales made on credit. Often a company also purchases raw materials or inventory on credit which creates payables outstanding. DPO measures the number of days in which the company is required to pay its suppliers for purchases made on credit. CCC is calculated by subtracting DPO from the sum of DIO and DSO.

Lower the CCC, the better it is, as it implies that the company’s resources are locked into inventory for a lesser number of days. Consequently, it is less dependent on borrowed money for running day-today business operations. The lower ratio is also indicative of strong cash flows and improved liquidity. On the other hand, high CCC levels over a period of time requires investigation as it implies a slower inventory to sales conversion process.

Rising and falling CCC levels over time also influences share prices. CCC for 379 companies with a market cap greater than Rs 500 crore whose financial ratios for 2018-19 are available were calculated for the past four years. There are 24 companies in which CCC has been consistently declining and there are 42 companies where CCC has been consistently increasing for the past four years.

The average return of 24 companies where CCC is declining was 15.1%, 51.7%, and 55.8% in the past two,three and four years respectively. The average return of 42 companies where CCC is consistently increasing was -24.4%, 5.8%, and 12.6% over the same time period. The BSE500 index delivered 0.82%, 20.3% and 23.1% respectively in the same time period. The numbers clearly show that the markets reward companies that are efficient in managing working capital or liquidity.

To look at the future potential of 24 companies whose CCC levels are improving, we considered only those that are covered by at least five Bloomberg analysts and have one year forward price potential of greater than 10%. Let us look at seven such companies whose recent research reports are available.

1. Praj Industries
PE: 21.6
Cash conversion cycle-
Jun 15-16: 79
Jun 18-19: 49
Current price (Rs): 104
1-year target price (Rs): 143
Potential upside: 37%

The company IS engaged in project and process engineering and offers sustainable solutions for bio-energy, critical process equipment, breweries and industrial waste water treatment. A report by Stewart & Mackertich expects strong earnings visibility over the next two years. This is backed by a spur in upcoming ethanol capacities both at the domestic and export level, opportunities in 2G technology space and growing prospects of the compressed bio-gas segment. In addition, the company is likely to witness pick-up in order inflows from the second quarter of 2019-20 and there are prospects of additional export orders from Europe due to the gradual implementation of Renewable Energy Directive (RED II).


2. JK Cement
PE: 17.4
Cash conversion cycle-
Jun 18: 31
Jun 19: 3
Current price (Rs): 970
1-year target price (Rs): 1,160
Potential upside: 20%

This cement industry player manufactures grey cement, white cement and white cement-based wall putty. The company has reported strong standalone numbers in June 2019 quarter with 19%, 102% and 212% yearon-year growth in revenue, EBITDA and PAT respectively. Aggressive pricing across India improved grey cement margins, whereas healthy demand helped white/putty segment in the June quarter. According to a research report by HDFC Securities, the stock is likely to deliver 12% volume CAGR over the next two years driven by probable capacity expansion in the second half of 2019-20. The current valuations are attractive and the healthy pricing and fuel cost moderation will help the company’s EBITDA and PAT to grow at 23% and 39% CAGR respectively between 2018-19 and 2020-21.

3. NTPC
PE: 8.9
Cash conversion cycle-
Jun 18: 41
Jun 19: 26
Current price (Rs): 117
1-year target price (Rs): 160
Potential upside: 36%

This PSU with Maharatna status is engaged in electricity generation and allied activities. In the June 2019 quarter, the company reported a marginal increase in profit which was below expectations of analysts. Performance was hampered as some of its plants ran at reduced capacity during the quarter ending June 2019. SBICap Securities remains bullish on the stock and believes that benign CERC regulations, improving coal supply and the resultant increase in PAF are all good for NTPC. However, dwindling PLF despite the rise in power demand is a concern. The recent price correction has improved valuations and currently the stock is trading at a 47% discount relative to the BSE500 index in terms of Bloomberg’s estimated 12-month blended forward PE multiple.

4. Deepak Nitrite
PE: 11
Cash conversion cycle-
Jun 18: 70
Jun 19: 41
Current price (Rs): 267
1-year target price (Rs): 381
Potential upside: 43%

This chemical manufacturing company manufactures organic, inorganic and fine chemicals. Edelweiss is bullish on the company due to its stellar performance in the first quarter of 2019-20 which is visible from the above-estimates revenue, EBITDA and PAT sequential growth of 4%, 31%, and 44% respectively. Its performance products segment did well due to increase in prices of the intermediate products and traction in the newly launched products. Stable performance in the business segments like basic chemicals and fine and specialty chemicals, high utilisation levels by Deepak Phenolics and diversified and integrated business model with strong demand-side levers offer additional growth catalysts. According to Bloomberg estimates, the company is likely to deliver 12-month blended forward RoE of 26.1% compared to an average 14.5% by BSE500 index.

5. Chalet Hotels
PE: 41.2
Cash conversion cycle-
Jun 18: 212
Jun 19: 81
Current price (Rs): 329
1-year target price (Rs): 406
Potential upside: 24%

The company is an owner, developer and asset manager of highend hotels in key metro cities in India. Analysts are bullish on Chalet Hotels due to its strong brand, promising locations which ensures higher occupancies and improved average room rate, favourable demand-supply dynamics, strong promoter backing and robust balance sheet. In addition, robust operating performance, long-term contracts with established international brands, large asset base of existing properties and land banks and improving cash flows and liquidity are other positives.

6. Tata Chemicals
PE: 12
Cash conversion cycle-
Jun 18: 75
Jun 19: 35
Current price (Rs): 554
1-year target price (Rs): 687
Potential upside: 24%

This chemical company is engaged in basic chemistry, consumer and specialty products. The company has reported good numbers in the June 2019 quarter due to lower input costs. A latest research report by Nirmal Bang states that Mithapur capacity expansion and new demand segment for soda ash due to likely expansion of lithium carbonate market will be the growth drivers for the company going forward. The brokerage house expects the company’s soft input costs will offset any potential slowdown in demand. Moreover, its capex plans are unlikely to strain finances due to the healthy balance sheet.

7. Birla Corporation
PE: 12.6
Cash conversion cycle-
Jun 18: 44
Jun 19: 17
Current price (Rs): 577
1-year target price (Rs): 750
Potential upside: 30%

The company is primarily engaged in the manufacturing of cement as its core business activity and also has a significant presence in the jute goods industry. According to a recent research report by AnandRathi, the favourable demand-supply scenario, cost-saving measures, timely ramp-up of expansions and likely stable cement prices will help the company maintain its profitability. Moreover, the fundamentals are improving as visible from strong revenue in the first quarter of 2019-20, which was supported by strong realisations in the key operating regions, rising share of premium cement and geo-mix optimisation. According to Bloomberg estimates, the company is trading at 12-month blended forward PE multiple of 12.6 times, which is at 25% discount relative to the forward PE multiple of the BSE500 index.


*Stock and index values have been normalised to a base of 100. PE is 12-month blended forward. BSE500 index: forward PE 16.81 times. Price as on 13 Aug. Source: ACE Equity & Bloomberg