MNC titans: Are their premium valuations justified?

Many investors equate growth with success, assuming that a company’s future prospects hinge solely on its ability to expand. This mindset is shared not only by investors but also by companies, many of which prioritize growth at the expense of profitability. However, the capital markets consistently serve as a reality check, proving that in the long run, profitability is essential, and unchecked growth can erode value.

Markets reward companies that generate strong returns on capital, granting them premium valuations compared to less efficient peers. By improving their Return on Capital Employed (ROCE), companies can significantly boost their market multiples and overall valuation.

Growth vs Profitability

Growth and ROCE are two critical metrics for evaluating a company’s performance. While both are important, the key to long-term value creation lies in understanding the distinction between the two and striking the right balance.

For more such analysis, read Profit Pulse.

Growth refers to a company’s ability to increase its revenues and earnings, often through market expansion, product launches, or acquisitions. While growth is generally seen as positive, it can sometimes come at the expense of profitability—even long-term profitability.

ROCE, on the other hand, measures how efficiently a company generates profits from its invested capital. It is calculated by dividing operating profit by total capital employed. A high ROCE indicates that a company is effectively utilizing its resources to create shareholder value.

Efficient capital allocation is crucial to maintaining a high ROCE. While growth is expected, markets place greater emphasis on sustainable growth. Pursuing growth blindly, without considering ROCE, can lead to lower valuations. True value lies in growth that is both efficient and sustainable.

To put it simply: if a company spends ₹100 on capital expenditure, the amount it earns from it determines its ROCE. For example, if it spends ₹100 and earns ₹90, its ROCE would be 90%.

Here are four MNCs with consistently high ROCE, demonstrating that they deserve their premium valuations.

#1 Nestle India Ltd

It’s hard to find an Indian household without a product from Nestle on their kitchen shelves. With iconic brands like KitKat, Nescafé, Munch, Maggi, and Milkmaid, this subsidiary of the Swiss multinational takes the top spot with a 10-year ROCE of nearly 97%. For every ₹100 Nestle India spends, it earns ₹97 in return.

Currently, its ROCE stands at an impressive 169%, far surpassing its closest competitor, Britannia Industries Ltd, which has a ROCE of 49%. Nestle has committed ₹5,000 crore in capital expenditure for capacity expansion through 2025.

The company’s stock price has surged from ₹1,400 in 2019 to ₹2,500 today, marking a 79% increase in five years, with a compound annual growth rate (CAGR) of 12% during this period.

Nestle India is among the top two players in many of its product categories, and its market dominance is a key driver of its high ROCE. With a competitive moat that’s difficult to match, the company leverages its strong brand to charge premium prices while effectively managing costs.

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According to the company's annual report for FY24, India is now one of its fastest-growing markets globally. The report highlights a remarkable figure: six billion servings of Maggi sold in FY24 alone. No surprise, then, that the company posted a substantial sales figure of ₹19,126 crore for the year ending December 2023. This number further jumped to ₹24,394 crore as of 31 March 2024, reflecting a 27% growth in just one quarter.

Nestle's capital expenditure (capex) saw a significant rise from ₹540 crore in FY23 to ₹1,878 crore in FY24, a figure spanning 15 months due to a reporting overlap between the two years. This substantial capex increase reflects the company’s focus on expanding capacities, boosting productivity, investing in new product lines, and enhancing sustainability initiatives across its factories in locations like Moga, Nanjangud, and Pantnagar, among others.

One of the advantages of a high ROCE is that it allows companies like Nestle to reinvest profits into share buybacks and maintain investor confidence through healthy dividend payouts. Nestle India has consistently maintained a dividend payout ratio of over 86%, with a current dividend yield of 0.62%, although lower than Britannia’s 1.23%.

Over the past three years, Nestle has recorded a compounded sales growth of 22%, and over five years, the figure stands at 17%. Ebitda has grown from ₹2,618 crore in December 2018 to ₹4,471 crore in December 2023, reflecting a CAGR of 11% over the five-year period. The company’s profit after tax for 2023 stood at ₹2,999 crore.

Nestlé’s stock currently trades at a P/E of 75x, slightly above its 10-year median of 72x, reflecting its premium valuation.

#2 Castrol India Ltd

At number two is Castrol India Ltd, a 100-year-old leader in the lubricant industry with a market cap of ₹22,534 crore. The company sells over 6 litres of lubricants every second and holds a current ROCE of nearly 57%, with a 10-year median ROCE of 97%.

As of Q2FY24, Castrol had a 51% market share in the lubricant industry, including 39% in the car segment, 28% in motorcycles, and 20% in commercial vehicles. Notably, Castrol also has a strong foothold in the EV segment, supplying fluids to two of the world’s top three car manufacturers.

This market dominance has propelled Castrol’s sales from ₹3,905 crore in December 2018 to ₹5,075 crore in December 2023, marking a 30% growth in five years. The company’s stock has similarly risen, climbing from ₹130 to ₹230 in five years, with a CAGR of 11%.

Castrol India Ltd is primarily engaged in the manufacturing and marketing of automotive and industrial lubricants, alongside related services. The company offers a wide range of oil lubricants and fluids for cars, motorcycles, commercial vehicles, industrial applications, the energy sector, marine use, and IT cooling and data centres.

In July 2020, Castrol’s ultimate promoter, BP PLC, in collaboration with Reliance Industries Ltd (RIL), launched the Reliance BP Mobility Ltd joint venture. BP acquired a 49% stake in the JV by paying RIL $1 billion, with RIL holding the remaining 51%. This partnership has benefited Castrol by allowing it to sell fuels and lubricants through RIL’s existing retail outlets.

As of December 2023, Castrol reported sales of ₹5,075 crore, achieving a compounded sales growth of 19% over the last three years and 5% over the past five years. Capital expenditure increased from ₹2,834 crore in 2018 to ₹3,877 crore in FY23, driven by the launch of Castrol ON (a range of EV fluids for the aftermarket) and the premium Castrol Auto Care line.

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Thanks to its high ROCE, Castrol is nearly debt-free and has maintained a healthy dividend payout ratio of over 79%. Its current dividend yield stands at 3.29%, significantly higher than the industry average of 0.28%. EBITDA has grown from ₹1,071 crore to ₹1,198 crore over the past five years, resulting in a modest CAGR of 2.3%. Profit after tax for 2023 stood at ₹864 crore.

Castrol's stock is currently trading at a P/E ratio of 25.5x, above its 10-year median P/E of 21.7x. Notably, Life Insurance Corp. of India holds a 10.16% stake in the company as of the quarter ending September 2024, according to screener.in.

#3 Colgate-Palmolive (India) Ltd

The third company on the list, Colgate-Palmolive (India) Ltd, is synonymous with confident smiles. With a current ROCE of 97% and a 10-year median ROCE of 85%, the company surpasses the industry median of 77% among peers.

Colgate-Palmolive is nearly debt-free and maintains a robust dividend payout ratio of 97%, with a current dividend yield of 1.3%, higher than the industry average of 0.97%. The company’s revenues surged 27%, growing from ₹4,462 crore in FY19 to ₹5,680 crore in FY24.

Colgate-Palmolive, with a market cap of ₹95,584 crore, witnessed a significant leadership change when Ms. Prabha Narasimhan was appointed Managing Director and CEO in September 2022 for a five-year term.

The company’s stock price has seen remarkable growth, climbing from ₹1,540 in 2019 to ₹3,690 today, reflecting an impressive 140% increase.

Colgate-Palmolive India Ltd is a dominant player in the Indian oral care market, with an impressive 88% penetration for its flagship Colgate brand. Its product portfolio includes toothpaste, tooth powder, toothbrushes, and mouthwash, complemented by personal care products under the Palmolive brand. The company holds a commanding 51% market share in toothpaste, 48% in tooth powder, and 30% in toothbrushes, maintaining its leadership position since the 1990s.

In FY24, Colgate-Palmolive reported sales of ₹5,680 crore, achieving a compounded sales growth rate of 5% over both the last three and five years. Ebitda grew from ₹1,236 crore in FY19 to ₹1,901 crore in FY24, reflecting a CAGR of 9%. The company’s net profit for FY24 was ₹1,324 crore. Colgate-Palmolive's stock is currently trading at a P/E of 71x, significantly higher than its 10-year median P/E of 45.5x. As of June 2024, Life Insurance Corp. of India held a 1.66% stake in the company.

#4 Procter & Gamble Hygiene and Health Care Ltd

Rounding out the list is Procter & Gamble Hygiene and Health Care Ltd, a leader in the feminine hygiene space with a market cap of ₹53,998 crore. With a current ROCE of 112% and a 10-year median ROCE of 79%, P&G Hygiene is a standout in its sector.

The company’s sales grew from ₹2,947 crore in June 2019 to ₹4,206 crore in June 2024, marking a compounded sales growth rate of 7% over the past five years. The strong financial performance has reflected in its stock price, which has risen 45% over the same period, from ₹11,500 to ₹16,635 today.

Procter & Gamble Hygiene and Health Care is a leading player in India’s fast-moving consumer goods (FMCG) sector, specializing in feminine care and healthcare products. The company’s portfolio includes market leaders such as Whisper, the top feminine hygiene brand in India, and Vicks, the country's leading healthcare brand.

The company has expanded its product line with the introduction of Vicks 3-in-1 throat lozenges, while the Old Spice brand has seen positive market reception with its new 0% gas deodorant. These product innovations have contributed to the company’s solid financial performance.

P&G Hygiene is nearly debt-free, with a current dividend yield of 0.64%, which is slightly below the industry average of around 1%. EBITDA has grown from ₹618 crore to ₹970 crore over the last five years, reflecting a CAGR of 9.5%. For the year ending June 2024, profit after tax stood at ₹675 crore, according to screener.in.

The company’s stock is currently trading at a P/E ratio of 80x, above its 10-year median P/E of 74x, indicating a premium valuation. Notably, Life Insurance Corporation of India and SBI Focused Equity Fund are key shareholders in the company.

Crown jewels, indeed?

The four blue-chip companies we've reviewed today have strong fundamentals, particularly in their effective capital utilization. Three of the four consistently maintain healthy dividend payouts, underscoring their commitment to returning wealth to shareholders.

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With increasing capital expenditure and well-defined growth plans, these industry giants continue to maximize returns on their investments. Their high profitability not only enables them to reward investors through dividends but also to enhance market value through share buybacks. Additionally, their low or zero debt levels minimize the need for external borrowing.

Whether they continue to hold their status as crown jewels will be revealed in time, but their track records make them worth watching in the years to come.

Note: Throughout this article, we have relied on data from www.Screener.in and www.trendlyne.com. In cases where data was unavailable, we used alternative, widely accepted sources.

The purpose of this article is to share interesting charts, data points, and thought-provoking insights. It is NOT intended as an investment recommendation. If you are considering an investment, we strongly recommend consulting your financial advisor. This article is strictly for educational purposes.

About the author: Suhel Khan has been a passionate follower of the markets for over a decade. During this time, he served as head of sales & marketing at a leading equity research firm in Mumbai. Currently, he spends his time analysing the investments and strategies of India’s top investors.

Disclosure: The writer and his dependents do not hold any of the stocks discussed in this article.