Turnover ratios help assess the asset efficiency of a company. They are also known as activity ratios and determine how effectively a firm utilises its assets to generate revenue. Some such assets include machinery, inventory and accounts receivables (money owed by customers). Higher the turnover ratios, the better it is. Let’s understand four kinds of turnover ratios—fixed asset, inventory, accounts receivables and total assets.
Fixed asset turnover measures the efficiency of fixed assets such as plants, machinery, etc. The total assets turnover ratio looks at the efficiency of the combined assets of a company. For calculating these ratios, the revenue during a given period is divided by the average fixed assets in case of fixed asset turnover ratio, and average total assets in case of total assets turnover ratio. To illustrate, a ratio of 1.5 indicates that the company generates revenue of Rs 1.5 on every Rs 1 worth of assets it employs.
The inventory turnover ratio measures the management of the inventory (stock of raw materials and finished goods). It shows how many times a company sold its inventory over a defined time period. If a company’s average annual inventory is Rs 2,000 crore and revenue is Rs 10,000 crore, it implies that the company sold its inventory five times in a year. A high ratio indicates that the company is selling its products quickly, whereas a low ratio implies weak sales that could be due to the fall in the demand for the company’s products.
Accounts receivable turnover ratio measures the effectiveness of a company in collecting money for the sales made on credit. It measures the number of times a company collects its money from its clients over a defined time period. It is calculated by dividing the sales on credit by the average accounts receivables. A high ratio implies that the company’s customers pay their dues quickly and indicates its efficiency in collecting money.
We analysed 900 companies with marketcap greater than Rs 500 crore and extracted their fixed assets, total assets, accounts receivable and inventory turnover ratios for the past five years (starting from 2013-14). We filtered companies whose turnover ratios in 2017-18 were the highest in the past four years. We then selected companies with at least 25% growth in all the four turnover ratios between 2013-14 and 2017-18.
Only 10 companies passed through all our filters. The 5-year average point-to-point return of these 10 companies between 26 April 2014 and 26 April 2019 is 1,140.4%. The BSE500 index delivered 81.4% during the same period. The aggregate, year-on-year (y-o-y) net profit growth of these 10 companies stood at 32.1% in the December 2018 quarter—net profit growth of BSE500 fell 31%during the same period.
Let’s look at four of these high turnover companies with substantial one-year forward growth potential, according to Bloomberg consensus estimates:
Manufacturer of ultra-high power (UHP) electrodes, HEG exports 70% of its goods to 30 countries. Factors like environmental clamp down in China and increased usage of environment-friendly Electric Arc Furnace method has affected the demand-supply equilibrium in the graphite electrode industry. Analysts believe that the company is well-positioned to benefit from such structural changes. Demand for UHP electrodes will remain strong and prices are expected to remain stable.
2. Radico Khaitan
It makes industrial alcohol, Indian Made Foreign Liquor, country liquor and fertilizers. Rising disposable incomes, India’s young demographic profile and rapid rural consumption growth will drive its growth. It’s stock is trading at attractive valuations and factors like expansion in the premium whisky segment, ability to raise prices and reduction in net debt will help the company going forward.
Promising companies with high turnover ratios
Stocks of these strong companies are likely to see sharp growth over the next one year.
*Actual growth. PE and ROE estimates for 2018-19. Adjusted EPS estimates for March 2019 quarter. Current price as on 30 April 2019. Data source: ACE Equity & Bloomberg.
3. Maharashtra Seamless
It manufactures seamless steel pipes and tubes. According to a report by Kotak Securities, demand for seamless pipes will remain robust. The latest leading indicators are pointing towards improving trends. These include pick up in orders from the US and Europe, and strong order inflows from ONGC. The brokerage believes that the stock is highly undervalued and is trading at attractive valuations.
4. Ahluwalia Contracts
An integrated construction company, its portfolio includes residential and commercial complexes, hotels, institutional buildings, hospitals and corporate offices. Reliance Securities is bullish on the stock due to the company’s asset-light business model, strong balance sheet, quality return ratios and no equity commitment.