Diversification Strategies and Financial Performance: A Study of Textile Industry

DIVERSIFICATION STRATEGIES AND FINANCIAL
PERFORMANCE: A STUDY OF TEXTILE INDUSTRY
Research Project Report
Submitted to the Punjab Technical university

in partial fulfillment of the requirements
for the degree of
MASTER OF BUSINESS ADMINISTRATION

in
FINANCIAL MANAGEMENT
(Minor Subject: Economics)
By
BAIDYANATH KUMAR
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CHAPTER I
INTRODUCTION
Diversification is a form of growth marketing strategy for a company. It seeks
to increase profitability through greater sales volume obtained from new products and
new markets. Diversification can occur either at the business unit or at the corporate
level. At the business unit level, it is most likely to expand into a new segment of an
industry in which the business is already in. At the corporate level, it is generally
entering a promising business outside of the scope of the existing business unit.
Diversification is part of the four main marketing strategies defined by the
Product/Market Ansoff matrix (Kotler and Keller, 2006):
Ansoff pointed out that a diversification strategy stands apart from the other
three strategies. The first three strategies are usually pursued with the same technical,
financial, and merchandising resources used for the original product line, whereas
diversification usually requires a company to acquire new skills, new techniques and
new facilities. Therefore, diversification is meant to be the riskiest of the four
strategies to pursue for a firm.
The purpose of diversification is to allow the company to enter lines of
business that are different from current operations. When the new venture is
strategically related to the existing lines of business, it is called concentric (related)
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diversification. Conglomerate diversification occurs when there is no common thread
of strategic fit or relationship between the new and old lines of business; the new and
old businesses are unrelated. According to the definition given by Steiner and George
(1969) is followed according to which, diversification is producing a new product or
service, or entering new markets, which involve importantly different skills, processes,
and knowledge from those associated with the present products, services, or markets.
1.1 DIVERSIFICATION IN THE CONTEXT OF GROWTH STRATEGIES
Diversification is a form of growth strategy. Growth strategies involve a
significant increase in performance objectives (usually sales or market share) beyond
past levels of performance. Many organizations pursue one or more types of growth
strategies. One of the primary reasons is the view held by many investors and
executives that "bigger is better." Growth in sales is often used as a measure of
performance. Even if profits remain stable or decline, an increase in sales satisfies
many people. The assumption is often made that if sales increase, profits will
eventually follow.
1.2 VARIOUS TYPES OF DIVERSIFICATION ARE:
1.2.1 Concentric Diversification:
Concentric diversification occurs when a firm adds related products or
markets. The goal of such diversification is to achieve strategic fit. Strategic fit allows
an organization to achieve synergy. In essence, synergy is the ability of two or more
parts of an organization to achieve greater total effectiveness together than would be
experienced if the efforts of the independent parts were summed. Synergy may be
achieved by combining firms with complementary marketing, financial, operating, or
management efforts.
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Financial synergy may be obtained by combining a firm with strong financial
resources but limited growth opportunities with a company having great market
potential but weak financial resources. For example, debt-ridden companies may seek
to acquire firms that are relatively debt-free to increase the leveraged firm's borrowing
capacity. Similarly, firms sometimes attempt to stabilize earnings by diversifying into
businesses with different seasonal or cyclical sales patterns.
Strategic fit in operations could result in synergy by the combination of
operating units to improve overall efficiency. Combining two units so that duplicate
equipment or research and development are eliminated would improve overall
efficiency. Quantity discounts through combined ordering would be another possible
way to achieve operating synergy. Yet another way to improve efficiency is to
diversify into an area that can use by-products from existing operations.
Management synergy can be achieved when management experience and
expertise is applied to different situations. Perhaps a manager's experience in working
with unions in one company could be applied to labour management problems in
another company. Caution must be exercised, however, in assuming that management
experience is universally transferable. Situations that appear similar may require
significantly different management strategies. Personality clashes and other situational
differences may make management synergy difficult to achieve. Although managerial
skills and experience can be transferred, individual managers may not be able to make
the transfer effectively.
1.2.2 Conglomerate Diversification:
Conglomerate diversification occurs when a firm diversifies into areas that are
unrelated to its current line of business. Synergy may result through the application of
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management expertise or financial resources, but the primary purpose of conglomerate
diversification is improved profitability of the acquiring firm. Little, if any, concern is
given to achieving marketing or production synergy with conglomerate diversification.
One of the most common reasons for pursuing a conglomerate growth strategy
is that opportunities in a firm's current line of business are limited. Finding an
attractive investment opportunity requires the firm to consider alternatives in other
types of business.
Firms may also pursue a conglomerate diversification strategy as a means of
increasing the firm's growth rate. As discussed earlier, growth in sales may make the
company more attractive to investors. Growth may also increase the power and
prestige of the firm's executives. Conglomerate growth may be effective if the new
area has growth opportunities greater than those available in the existing line of
business.
Probably the biggest disadvantage of a conglomerate diversification strategy is
the increase in administrative problems associated with operating unrelated businesses.
Managers from different divisions may have different backgrounds and may be unable
to work together effectively. Competition between strategic business units for
resources may entail shifting resources away from one division to another. Such a
move may create rivalry and administrative problems between the units.
Caution must also be exercised in entering businesses with seemingly
promising opportunities, especially if the management team lacks experience or skill
in the new line of business. Without some knowledge of the new industry, a firm may
be unable to accurately evaluate the industry's potential. Even if the new business is
initially successful, problems will eventually occur. Executives from the conglomerate
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will have to become involved in the operations of the new enterprise at some point.
Without adequate experience or skills (Management Synergy) the new business may
become a poor performer.
Without some form of strategic fit, the combined performance of the individual
units will probably not exceed the performance of the units operating independently.
In fact, combined performance may deteriorate because of controls placed on the
individual units by the parent conglomerate. Decision-making may become slower due
to longer review periods and complicated reporting systems.
1.3 TEXTILE INDUSTRY
1.3.1 IMPORTANCE:
The textile industry occupies a unique place in our country. One of the earliest
to come into existence in India, it accounts for 14% of the total Industrial production,
contributes to nearly 30% of the total exports and is the second largest employment
generator after agriculture.
Textile Industry is providing one of the most basic needs of people and the
holds importance; maintaining sustained growth for improving quality of life. It has a
unique position as a self-reliant industry, from the production of raw materials to the
delivery of finished products, with substantial value-addition at each stage of
processing; it is a major contribution to the country's economy.
Its vast potential for creation of employment opportunities in the agricultural,
industrial, organised and decentralised sectors & rural and urban areas, particularly for
women and the disadvantaged is noteworthy.
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Although the development of textile sector was earlier taking place in terms of
general policies, in recognition of the importance of this sector, for the first time a
separate Policy Statement was made in 1985 in regard to development of textile sector.
The textile policy of 2000 aims at achieving the target of textile and apparel exports of
US $ 50 billion by 2010 of which the share of garments will be US $ 25 billion. The
main markets for Indian textiles and apparels are USA, UAE, UK, Germany, France,
Italy, Russia, Canada, Bangladesh and Japan.
The main objective of the textile policy 2000 is to provide cloth of acceptable
quality at reasonable prices for the vast majority of the population of the country, to
increasingly contribute to the provision of sustainable employment and the economic
growth of the nation; and to compete with confidence for an increasing share of the
global market.
1.3.2 CURRENT SCENARIO:
Developing countries with both textile and clothing capacity may be able to
prosper in the new competitive environment after the textile quota regime of
quantitative import restrictions under the multi-fibre arrangement (MFA) came to an
end on 1st January, 2005 under the World Trade Organisation (WTO) Agreement on
Textiles and Clothing.
As a result, the textile industry in developed countries will face intensified
competition in both their export and domestic markets. However, the migration of
textile capacity will be influenced by objective competitive factors and will be
hampered by the presence of distorting domestic measures and weak domestic
infrastructure in several developing and least developed countries.
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The elimination of quota restriction will open the way for the most competitive
developing countries to develop stronger clusters of textile expertise, enabling them to
handle all stages of the production chain from growing natural fibres to producing
finished clothing.
The textile industry is undergoing a major reorientation towards non-clothing
applications of textiles, known as technical textiles, which are growing roughly at
twice rate of textiles for clothing applications and now account for more than half of
total textile production. The processes involved in producing technical textiles require
expensive equipments and skilled workers and are, for the moment, concentrated in
developed countries. Technical textiles have many applications including bed sheets;
filtration and abrasive materials; furniture and healthcare upholstery; thermal
protection and blood-absorbing materials; seatbelts; adhesive tape, and multiple other
specialized products and applications. India must take adequate measures for capturing
its market by promoting research and development in this sector.
The mood in the Indian textile industry given the phase-out of the quota regime
of the multi-fibre arrangement (MFA) is upbeat with new investment flowing in and
increased orders for the industry as a result of which capacities are fully booked up to
April 2005. As a result of various initiatives taken by the government, there has been
new investment of Rs.50,000 crores in the textile industry in the last five years. Nine
textile majors invested Rs.2,600 crores and plan to invest another Rs.6,400 crores.
Further, India's cotton production increased by 57% over the last five years; and 3
million additional spindles and 30,000 shuttle-less looms were installed.
1.3.3 FUTURE PROSPECTS:
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The industry expects investment of Rs.1,40,000 crores in this sector in the post-
MFA phase. A Vision 2010 for textiles formulated by the government after intensive
interaction with the industry and Export Promotion Councils to capitalise on the
upbeat mood aims to increase India's share in world's textile trade from the current 4%
to 8% by 2010 and to achieve export value of US $ 50 billion by 2010 Vision 2010 for
textiles envisages growth in Indian textile economy from the current US $ 37 billion to
$ 85 billion by 2010; creation of 12 million new jobs in the textile sector; and
modernisation and consolidation for creating a globally competitive textile industry.
There will be opportunities as well as challenges for the Indian textile
industry in the post-MFA era. But India has natural advantages which can be
capitalised on strong raw material base - cotton, man-made fibres, jute, silk; large
production capacity (spinning - 21% of world capacity and weaving - 33% of world
capacity but of low technology); vast pool of skilled manpower; entrepreneurship;
flexibility in production process; and long experience with US/EU (European Union).
At the same time, there are constraints relating to fragmented industry, constraints of
processing, quality of cotton, concerns over power cost, labour reforms and other
infrastructural constraints and bottlenecks.
1.4 NEED FOR THE STUDY:
Diversification is one of the most strategic decisions that management take.
Involving significant capital outflows and entry into new products and markets,
diversification have far –reaching implications for the organization’s structure,
systems, processes, and performance. Although not easy to determine top managers
need to take informed view of the likely impact of a diversification decision on long
term financial performance.
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This research will help in examining whether companies classified on the basis
of their diversification strategies differ in their long term performance. Diversification
strategies have been examined to see whether any strategy has produced consistently
good or poor financial performance.
1.5 OBJECTIVES OF THE STUDY:
1) To identify various diversification strategies followed by the companies.
2) To analyse financial performance of the companies classified on the basis of their
diversification strategies.
CHAPTER II
REVIEW OF LITERATURE
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A large number of studies have been conducted on the topics related to firm’s
performance and diversification strategies of different companies. In this chapter an
attempt has been made to present in brief, a review of literature available on the
studies done so far. The review of past studies has been presented in chronological
order to provide a glimpse of work done in this area.
McDougall and Round (1984) examined corporate motives for diversification
and compares the performance of diversifying and non- diversifying Australian
industrial firms. No significant difference appeared in the profitability of the two
groups of companies, and little difference existed in the risk faced by the two groups.
Profitability, however, appeared to be related to the extent of diversification.
Palepu (1985) combined the strengths of the index approach, namely,
simplicity, objectivity and replicability, with the essential richness of Rumelt's
methodology. Using the Jacquemin-Berry entropy measure of diversification and the
line-of-business data, he concluded that firms with related diversification show
significantly better profit growth than firms with unrelated diversification.
Grant et al (1988) conducted a study that investigated the causal relationships
between diversity, diversification and profitability among 304 large British
manufacturing companies that differed in both product and multinational diversity.
Diversity and profitability were positively related up to a point; after that point,
increases in product diversity were associated with declining profitability. The results
showed that product diversification did not increase profitability, and there was limited
evidence that profitability promoted diversification.
Geringer et al (1989) examined potential explanations for performance
differences among multinational enterprises (MNEs). The sample included the 100
largest MNEs from the U.S. and Europe. Diversification strategy was significantly
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related to MNE performance, extending Rumelt's seminal research to international
business. Degree of internationalization was also significantly related to MNE
performance.
Kim et al (1989) studied a sample of 62 multinationals and examined the
impact of global diversification strategy on corporate profit performance by
integrating the product and the international market dimensions of diversification. The
results suggested that the corporate profit performance impact of related and unrelated
diversification varies contingent upon the extent of a firm's international market
diversification. One important lesson of this work is that both business strategy
researchers and managers should review corporate diversification as having distinct
yet interactive strategic dimensions-product and international market-and they would
do well to recognize both the different and the joint effect of these dimensions on
corporate profit performance.
Hamilton and Shegill (1993) confirmed the relative superiority of related-
diversification in terms of the financial performance of New Zealand companies,
companies which are much smaller and less diverse than those which normally feature
in this literature. To facilitate comparisons with other studies, financial performance is
measured in three ways: return on equity; return on assets; and sales growth. Other
independent variables controlled for were company size, risk, leverage, technological
opportunity and industry concentration. The effective rates of protection afforded
manufacturing industries (export subsidies and import tariffs) are also confirmed as
having had some positive bearing on company performance.
Goll and Sambharya (1995) suggested the fit between corporate culture and
diversification strategy influences firm performance. The study examined the
moderating effect of diversification strategy on the link between corporate ideology, a
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component of culture, and firm performance. It was found that the interaction between
ideology and diversification exerts a significant effect on firm performance.
Hall (1995) study addressed several questions: What is the effect of a firm’s
previous performance on its future diversification? Does diversification determine
performance or does performance determine diversification? Results suggested that,
regardless of strategic type, high levels of profitability may be necessary, but not
sufficient requirements for diversification. Likewise, it was found that in certain
situations, superior performance may serve as a substitute for diversification.
Tallman and Li (1996) examined the relationships among international
diversity, product diversity and firm performance. For a sample of large American
industrial multinational enterprises (MNEs), it showed a consistent quadratic
relationship between product diversification and MNE performance but minimal
performance differences across different measures of international diversity.
Bosworth et al (1997) examined the relationship between diversification and
firm performance. They took a sample of large Australian firms covering the period
1989-1994. The result indicated that diversification has negative impact on firm
performance and controlling for firm size.
Pandya and Rao (1998) attempted to verify whether firm level diversification
has any impact on performance. The study found that on average, diversified firms
show better performance compared to undiversified firms on both risk and return
dimensions. It also tests the robustness of these results by classifying firms by
performance class. The results show that among the best performing class of firms,
undiversified firms have higher returns, but these returns are accompanied by high
variance. Whereas, highly diversified firms showed lower returns, and much lower
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variance. Results further show that diversified firms perform better than undiversified
firms on risk and return dimensions, in the low and average performance classes. The
paper concludes that a dominant undiversified firm may perform better than a highly
diversified firm in terms of return but its riskiness will be much greater. If managers of
such firms opt for diversification, their returns will decrease, but their riskiness will
reduce proportionately more than the reduction in their returns. In such firms, there
will be a tradeoff between risk and return.
Bruche (2000) surveyd the discussion of last decades on corporate strategy and
horizontal diversification among strategy researchers and consultants. In the process of
restructuring and privatising the State Owned Enterprises, China faced the choice of
appropriate corporate models in terms of diversity and governance. The paper was
meant as a basis for discussion of these issues, and for a number of propositions on the
particular considerations of diversification strategies in emerging economies (like
mainland China) which are not necessarily the same as in developed economies.
Kakani (2000) used aggregated financial statement and capital market
statement of 240 large Indian business houses over a period of 12 years to study the
performance of Indian business houses’ vis-à-vis their product diversification strategy
before and after liberalization. He found that product diversification is negatively
related to value creation for all the periods of study (viz. 1987-91, 1991-95 and 1995-
99). The study was extended to investigate the precise performance constituents that
drove the above robust results. They found that apart from size and product scope of a
business group, its solvency position and geographical diversification were important
factors affecting its value.
Oijen and Hendrikse (2002) exhaustively studied product diversification and
its financial outcomes. They studied the diversification strategies of cooperatives and
compared them with corporations. They developed hypothesis that predict that
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cooperatives differ from corporations with respect to the extent, type and performance
of product diversification. Data obtained from a sample of 118 cooperatives and
corporations are used to test the hypothesis. They found significant differences
between cooperatives and corporations. Therefore, their main conclusion is that
governance structure does matter for product diversification and its performance.
Elango and Ma (2003) focussed on relationship between diversification and
financial performance of the insurance industry using cross section and time-series
data for the years 1992 to 2000. The findings indicated a U-shaped relationship
between the extent of product diversification and risk-adjusted returns.
Singh et al (2004) focussed on explaining the diversification discount.
However, there is little direct evidence regarding the relation among ownership
structure, corporate governance and corporate diversification. The results in this paper
suggested that agency issues do not account for firms adopting a particular
diversification strategy. Also, the performance consequences of the shift in the
diversification strategy and the subsequent changes in institutional and block
ownership structures are not related to agency issues. In fact, investors seem not to
avoid diversified firms per se. They suggested that observed board and ownership
differences between diversified and focused firms are due to their being at different
stages of corporate evolution.
Colpan and Hikino (2005) found that the nature and magnitude of capabilities
had decisive impacts on the direction of diversification. Their panel data analysis
showed that different diversification paths actually yielded contrasting performances.
The outcomes also suggested that the effectiveness of specific diversification schemes
was contingent on macroeconomic environments. Ultimately, however, only the
commitment to technology, not marketing or finance, ensured long-term profitability.
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Adner and Zemsky (2006) studied the performance implications of corporate
diversification. They found a non-monotonic effect of relatedness on performance:
while greater relatedness increases the competitiveness of diversified firms, it can also
spur additional diversification, thereby eroding market structure and performance.
They elucidated the emergence of heterogeneity in firrm scope strategies. They used
the model to generate data and show how the negative effect of relatedness on market
structure can give rise to spurious inference of a diversification discount in cross-
sectional regressions.
Suresh et al (2006) explored the 'diversification strategy-firm performance'
relationship in the large Indian companies of 1989, and examined it in terms of 'High'
and 'Low' total diversifiers, and 'Related' and 'Unrelated' diversifiers. The analysis
showed, contrary to expectation, that 'Low' diversifiers have higher profitability,
though there seemed to be no significant difference in the profitability of 'High' and
'Low' total diversifiers. The results also indicated that 'Unrelated' diversifiers have a
distinctly lower level of profitability as compared to 'Related' diversifiers, as well as
other companies. An examination of the effect of diversification on profitability and
controlling for other determinants of profitability, showed that 'Unrelated'
diversification explains profitability better than 'Total' diversification and 'Related'
diversification. The paper concluded that the 'diversification-firm performance'
relationship is highly 'context-specific' and the 'industry effects' have had a profound
effect on the 'diversification-firm performance' relationship.
Jang and Lee (2007) investigated the effect of a diversification strategy
adopted by hotel companies on corporate financial performance and stability. Using 36
publicly traded hotel companies, this study analyzed the differences in financial
performance and stability between market-diversified and undiversified hotel
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companies. The results indicated that diversification strategy does not provide profit
growth, but diversification partly improves the stability of performance
Jones (2007) conducted a study that compares the financial performance of all
companies listed on the Australian Stock Exchange pursuing vertical integration,
horizontal integration or diversification in the pathology, diagnostic imaging and
general practice sub-sectors over 2001-2005. Financial ratio analysis indicated vertical
integration is the most profitable strategy. Accounting measures of performance also
showed horizontal integration is profitable.
Rawley (2007) proposed that diversification taxes firms’ existing
organizational systems by altering routines, formal contract structures and strategies.
He tested the proposition that organizational adjustment costs associated with
diversification erode incumbent competitive advantage, using novel microdata on
taxicab firms from the Economic Census. The tests exploited exogenous local
characteristics of taxi markets to identify the impact of diversification on firm
organization and performance. Supporting the contention that diversification leads to
organizational adjustments, the results showed that diversifying firms are less likely to
adopt computerized dispatching systems for their taxicabs and make significant
changes in their formal contract structures governing asset ownership. Consistent with
the theory, diversification is associated with falling taxi productivity. The results
supported the core contention of the paper that diversification taxes firms’ existing
organizational capital.
The above review of literature indicates many of the studies related to profit
performance and its relationship with different diversification strategies. Textile
industry being the second largest employment generator after agriculture in India and
needs researchers attention for growth in this sector. Uptill now no study regarding the
profitability of textile sector is done, this study can be helpful in deciding the
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strategies to be followed by management for profit generation. In this study an attempt
has been made to study the relationship between diversification strategy and financial
performance of some textile companies.
CHAPTER III
RESEARCH METHODOLOGY
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It is imperative to decide upon and document a research methodology
well in advance to carry out the research in the most effective and systemic way. This
chapter describes the research methodology adopted to serve the objectives of the
study in an effective manner. This chapter consists of the following sections:
• Conceptual Framework
• Sample design
• Collection of data
• Tools of analysis
• Limitations of study
These sections are discussed as follows:
3.1 CONCEPTUAL FRAMEWORK
For the purpose of the study, the list of companies in the Textile industry will be
taken from the website of Indiabulls securities Ltd. The list includes 274 companies.
To fulfill the first objective annual reports of the companies were studied to find the
areas in which they have diversified. Companies are classified into related, unrelated,
and non diversifiers on the basis of their diversification strategies. The study took into
account the period of operation from 2002-03 to 2006-07. For evaluation of the
companies in each category following measures of financial performance are
considered:
1) Growth (Compounded Annual Growth Rates i.e. CAGR of total net assets, net
sales, net worth, gross profit, dividends, and market value of equity shares).
2) Profitability (Return on Capital Employed, Return on Net Worth, Gross Profit
Ratio, Operating Ratio, Net Profit Ratio, Cash Profit Ratio, Earning per Share).
3) Risk (Coefficient of Variation in Return on Capital Employed).
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4) Market Value (ratio of Market Price to Book Value of an ordinary share and ratio
of Market Price to Earnings per Share).
3.2 SAMPLE DESIGN
The population for the study was taken from list of textile companies on the
website of India Bulls Securities Ltd. It constituted 274 companies. The sample
consisted of five textile companies, which were selected on the basis of diversification
strategies they followed while the period of study. Then the selected companies were
categorised according to their diversification strategy. These are:
1) Related Diversification: Rajasthan Spinning and Weaving Mills Ltd.
2) Unrelated Diversification: Gravity India ltd., Aditya Birla Nuvo Ltd.
3) Non- diversified: Alps Industries Ltd., Bombay Rayon Fashions Ltd.
3.3 COLLECTION OF DATA
The entire structure of data for the study rests solely on secondary sources of
information. The study was carried out for the period from 2002-03 to 2006-07. Data
was collected from annual reports of the companies and from some websites such as
Moneycontrol.com, Indiabulls.com and Money.rediff.com. The raw data in the form of
various financial ratios for the sample companies was first recorded in a master table
and then subsequent statistical tools for the analysis were applied.
3.4 TOOLS OF ANALYSIS
Analysis and interpretation of financial statements was done to study the
various components of profitability and market of the companies selected, which in
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turn helped in studying the relationship between diversification and firms’
performance. Following were the tools used to analyse the secondary data.
3.4.1 RATIO ANALYSIS
A ratio is a simple arithmetical expression of the relationship of one number to
another. Ratio analysis is a technique of analysis and interpretation of financial
statements. It is the process of establishing and interpreting various ratios for helping
in making certain decisions. Financial ratios indicate the financial position of a
company. These are an important tool to analyse a company’s financial health. For the
measurement of profitability and market valuation of the selected textiles companies,
analysis of appropriate ratios is done.
3.4.1.1 PROFITABILITY RATIOS:
A business needs profits not only for its existence but also for expansion and
diversification. The profitability ratios are calculated to measure the operating
efficiency of the company. Besides management of the company, creditors and owners
are also interested in the profitability of the company. Creditors want to get interest
and repayment of principal regularly. Owners want to get a required rate of return on
their investment. This is possible only when the company earns adequate profits.
Generally, Profitability ratios are calculated either in relation to sales or in relation to
investment. The profitability ratios used in this study are:
RETURN ON NETWORTH
Return on investment is the relationship between net profits (after interest and
tax) and the proprietors’ funds. The two basic components of this ratio are net profits
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and shareholders’ funds. Shareholders’ funds include equity share capital, preference
share capital, free reserves such as share premium, revenue reserve, retained earnings
and surplus, less accumulated losses, if any. Net profits are visualised from the
viewpoint of the owners, i.e, shareholders. Thus, net profits are arrived at after
deducting interest on long-term borrowing and income-tax, because those will be the
only profits available for shareholders (Gupta and Sharma, 2006). This ratio is
calculated as follows:
Return on investment = Net profit (after interest and tax)
Shareholders’ funds
RETURN ON CAPITAL EMPLOYED
Return on capital employed establishes the relationship between profits and the
capital employed. It is the primary ratio and most widely used to measure the overall
profitability and efficiency of a business. Profit here refers to profit after tax plus
interest whereas capital employed has been taken as ‘net capital employed’ i.e., total
assets used in the business less its current liabilities. This ratio is calculated as follows:
Return on capital employed = Profit after tax plus interest
Net capital employed
GROSS PROFIT RATIO
Gross profit ratio measures the relationship of gross profit to net sales and is
usually represented as percentage. It reflects the efficiency with which a firm produces
its products. There is no standard norm for gross profit ratio and it may vary from
business to business but the gross profit should be adequate to cover the operating
expenses and to provide for fixed charges, dividends and accumulation of reserves.
Gross Profit Ratio = Gross profit x 100

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Net Sales
OPERATING RATIO
Operating ratio establishes the relationship between cost of goods sold and
other expenses on the one hand and the sales on the other. It measures the cost of
operations per rupee of sales. It indicates the percentage of net sales that is consumed
by operating cost. Higher the operating ratio less favourable it is, because, it would
have a small margin (operating profit) to cover interest, income-tax, dividend and
reserves.
Operating Ratio = Operating Cost x 100
Net Sales
NET PROFIT RATIO
Net profit ratio establishes a relationship between net profit (after taxes) and
sales, and indicates the efficiency of the management in manufacturing, selling,
administrative and other activities of the firm. The ratio is very useful as if the profit is
not sufficient, the firm shall not be able to achieve a satisfactory return on its
investment. This ratio also indicates the firm’s capacity to face adverse economic
conditions such as price competition, low demand etc. Obviously, higher the ratio the
better is the profitability. But while interpreting the ratio, it should be kept in mind that
the performance of profits must also be seen in relation to investments or capital of the
firm and not only in relation to sales.
Net Profit Ratio = Net Profit after tax x 100
Net Sales
CASH PROFIT RATIO
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The net profits of a firm are affected by the amount /method of depreciation
charged. Further, depreciation being a non-cash expense, it is better to calculate cash
profit ratio. This ratio measures the relationship between cash generated from
operations and the net sales. Thus,
Cash Profit Ratio = Cash Profit x 100
Net Sales
EARNING PER SHARE
Earning per share is a small variation of return on equity capital and is
calculated by dividing the net profit after taxes and preference dividend by the total
number of equity shares. The earning per share is a good measure of profitability and
when compared with E.P.S. of similar other companies, it gives a view of the
comparative earnings or earning power of a firm. E.P.S. calculated for a number of
years indicates whether or not earning power of company has increased.
E.P.S. = Net Profit after taxes – Preference Dividend
No. of Equity Share
3.4.1.2 VALUATION RATIOS OR MARKET TEST
MARKET PRICE TO EARNING PER SHARE RATIO
Earning yield ratio or price earning ratio is the ratio between market price per
equity share and earnings per share. The ratio is calculated to make an estimate of
appreciation in the value of a share of a company and is widely used by investors to
decide whether or not to buy shares in a particular company. Generally, higher the
earning yield ratio, the better it is.
Earning Yield Ratio = Market price per share x 100
24
Earning per share
MARKET VALUE TO BOOK VALUE RATIO
Market value to book value ratio is the relationship between market value of
per share of a firm and its book value per share. Book value per share indicates the net
worth per equity share and the ratio of market value to book value may be used to
analyse its stock market position.
Market Value to Book Value Ratio = Market Value per share
Book Value per share
3.4.2 COMPOUNDED ANNUAL GROWTH RATE
The Compounded Annual Growth Rate of the performance indicators such as
Establishment Expenses, Spread, etc. can be calculated for a period of six years i.e.
2001-02 to 2006-07. The formula for calculating compounded annual growth rate
(CAGR) is:
CAGR = [(Final Value / Initial Value)1/n - 1] x 100
3.4.3 COEFFICIENT OF VARIATION (RISK)
Risk refers to variability or dispersion. It is a complex and multi-faceted
phenomenon. A variety of measures have been used to capture different facets of risk.
The Coefficient of Variation is one relative measure of dispersion. It relates the
standard deviation and the mean by expressing the standard deviation as a percentage
of the mean. The unit of measure, then, is “percent” rather than the same units as the
original data. The formula for coefficient of variation is:
σ
Coefficient of
Variation = 25
(C.V.)
X
3.6 LIMITATIONS OF THE STUDY
1. The accuracy of the research is limited by the knowledge of the researcher.
2. The time factor acted as a considerable limit on the scope and extensiveness of the
study, as the study was conducted for short time period only.
3. The study being based on data available from financial statements of the company
suffered from same limitations that are inherent in these statements.
4. Due to limited availability of data present study was restricted to above mentioned
methods only.
CHAPTER IV
RESULTS AND DISCUSSION
26
4.1 CLASSIFICATION OF COMPANIES
A list of textile companies from website of Indiabulls Securities Limited was
considered for the study. Only three companies met the criterion of sample selection
i.e. they diversified in the time period of study (2002-03 to 2006-07) and two
undiversified companies were selected with the help of simple random sampling
technique. Selected companies were then classified into three categories on the basis
of their diversification strategies as shown in the table 4.1.
4.1.1 The basis of categorisation was as follows:
1. Related Diversifiers: A company has been categorized as a related diversifier, if it
has entered into markets with similar distribution and other marketing characteristics,
or manufactures products using common production facilities and technology, or has
entered into vertically integrated activities.
• Rajasthan Spinning and Weaving Mills Limited forayed into readymade garments
as shown in the annual reports of the company in the year 2003. The similarity of
technology and markets and the extent to which they provide opportunities to
utilize the facilities and resources of one business in the new business helped to
categorize it as related diversified company.
2. Unrelated diversifiers: A company has been categorized as a unrelated diversifier,
if it has entered into markets with different distribution and other marketing
characteristics, or manufactures products using uncommon production facilities and
technology.
• Gravity India Ltd. initially a textile company diversified into information
technology i.e. the technology used and the market being tapped are all together
different from the existing business. The existing facilities and resources were not
used for the new business thus, categorized as an unrelated diversifier.
27
• Aditya Birla Nuvo Ltd. also entered into BPO sector with the acquisition of M/s
TrasWorks Information Services Private Limited in which technology and
marketing channels are different from the existing one. Thus, this was also
categorized as an unrelated diversifier.
3. Non diversifier: These are the companies which neither entered into any related nor
unrelated business during the period of study thus, considered non diversified
companies and were used for comparison purpose in this study.
• Alps Industries Ltd. and Bombay Rayon Fashions Ltd. are the two
undiversified companies taken into consideration for this study.
4.1.2 PROFILE OF SELECTED COMPANIES
RAJASTHAN SPINNING AND WEAVING MILLS LIMITED
The Company was incorporated on 17th October, 1960 at Calcutta. The main
objective of the company was to manufacture cotton yarn, cloth, staple, viscose yarn
and polyester blended yarn. In 1986, the Company received letters of intent for the
setting up of; a 12,000 spindles worsted spinning project and process house for
processing 240 lakh metres of suitings, shirtings, sarees and dress material. In 1987 the
company undertook another modernisation programme under which the latest
autoconers with splicing and electronic yarn cleaning arrangements were installed.
Twisters along with latest carding machines were also installed under this programme.
In 1990 company started an expansion plan under which 6,912 spindles were added in
the Banswara Unit. In 1992 the company undertook expansion of spindles of polyester
viscose yarn at Banswara to increase its installations of P/v spindles from 18,576 to
27,792 numbers. Also another project for manufacture of P/c yarn was undertaken at
Banswara by installing 9,216 spindles. The Company also undertook to install 9,216
spindles at Bhilwara for manufacture of milange yarn. In 1995, the company has
28
entered into negotiations with Dominion Textile Incorporation, Canada, for 51:49
partnership for setting up an integrated 24 million meters per annum high value added
Denim manufacturing facility in Madhya Pradesh. The overall performance of the
company improved due to higher volume of sales, better product-mix and
improvement in techno-economic parameters despite continuous fluctuation in yarn
prices owing to fall in polyester staple fibre. In 1997, the Company entered into joint
venture agreement with Calum Australia Private Ltd. and De Witte Lietaer of Belgium
for manufacture of automotive furnishing fabrics. In 2003 Rajasthan Spinning and
Weaving Mills Ltd. diversified into garment manufacturing segment.
GRAVITY INDIA LIMITED
The Company was incorporated on 13th March, 1987 as a Private Limited
Company under the name and style of Gravity Silk Mills Private Limited. In 1994 the
company was subsequently converted into a public limited company on 28th
September, 1994 in terms of the special resolution passed on 31st August, 1994 under
the name and style of Gravity Silk Mills Limited and was registered with the Registrar
of Companies, Maharashtra, at Mumbai. The Company started its manufacturing
activities in Masat, Silvassa, Union Territory of Dadra and Nagar Haveli in the year
1989 by setting up a project for the manufacture of grey fabrics for suiting and
shirting. In 1997, the company proposes to install one Himson Scragg draw texturising
machine with 216 spindles (Indigeneous) in the existing factory of the company at
village Masat, Silvassa, Union Territory of Dadra and Nagar Haveli for a new project
for manufacture of yarn. The company has taken up expansion-cum-diversification
programme at an capital outlay of Rs.10 crores in year 2000. In 2001, Gravity (India)
Ltd., formerly known as Gravity Silk Mills Ltd., launched a fabric portal. In the year
2003, the company diversified into the information technology field by forming a
29
subsidiary Gravity Infotech Ltd. The company started up its subsidiary unit at Mahape
in Navi Mumbai.
ADITYA BIRLA NUVO LIMITED
The company was incorporated on 26th September, 1956. Formerly the
company was known as Indian Rayon Corporation Limited. The company started
with the manufacture of viscose rayon yarn and fabrics, chemical products,
rubberlined products, bushings and portland cement. In the 1958 the company entered
into an agreement with Von Kohorn International Corporation, Von Kohorn
International (London), Limited and Von Kohorn Eastern Corporation, Limited, who
agreed to design and supply from U.S.A. and U.K. the entire plant and machinery for
the company's rayon factory.They also agreed to supervise the erection and installation
as
Well as the commissioning of the plant. Von Kohorn International Corporation also
agreed to invest jointly with the Financial Development Fund Incorporation, U.S.A. a
sum of U.S. $25,000 in the equity capital of the Company. In 1975 A collaboration
agreement was signed with Ceramconsult Langenthal, Limited, Switzerland for
manufacture of Long Red insulators and high alumina bodies and in year 1976 Jay
Shree Textiles & Industries, Limited was amalgamated with the company with. In
1979, the company received a letter of intent to set up a new industrial undertaking for
the manufacture of 6,000 tonnes per annum of sophisticated insulators at Halol in
Gujarat State.The Company executed a technical collaboration agreement with
Doulton Insulators Ltd., of U.K., for new range of products for 400 KV transmission
line and sub-station insulators and for improving the quality of present range of
products. In 1983, the company received letter of intent to set up a plant to
manufacture 80,000 tonnes of white cement per annum and a technical collaboration
30
agreement with the Onuda Engineering & Consulting Corporatio, Limited, of Japan
was also approved by Government. The plant was commissioned in March 1988. The
company started up a carbon black plant at Remikoot in Mirzapur district of Uttar
Pradesh with an installed capacity of 20,000 tonnes per annum. In 1986, New products
such as flame retardent fabrics, oil/chemical resistant fire hoses and rove boiled flax
yarn were developed and company also undertook to set up a ceramic unit to
manufacture 10,000 tonnes per annum of sanitaryware and 12,000 tonnes per annum
of wall tiles in Uttar Pradesh. The sanitary ware project was proposed to be set up in
technical collaboration with Villeroy and Boch of the Federal Republic of West
Germany and equipment for the wall tiles project were to be supplied by SITI of Italy.
A technical collaboration with Felten & Gujillene Energietichnic GmbH, West
Germany was entered into for the manufacture of condensor bushings, coupling
capacitors and instrument transformers in the same year. In 1987, the company
commissioned the expanded worsted rayon project, machines like radio frequency
drier and auto winding unit with electronic controls were installed. Fancy doubling
machines were also installed to produce fancy yarn.The working of Cotton Spinning
division was adversely affected due to higher cotton price, rise in power tariffs etc. To
rationalise the product-mix the company proposed to convert existing spindles for
production of high value added synthetic yarn. Also fancy doubling machines were
installed for production of fancy yarns. To ensure its competitive edge over others,
the division was upgrading its technology by adding latest machines such as Savio
auto-coners, two-for-one twisters, etc. A new kiln was commissioned in the year 1988
at Halol to meet the growing demand for the company's product range. In 1990, the
spinning and weaving division undertook to further modernise apart from expanding
its installed capacity for worsted yarn by 2,400 spindles. In 1995, The division
undertook to set up 8 continuous spinning machines on parallel yarn at an estimated
31
cost of Rs 36 crores. In 2001, Aditya Birla group flagship Indian Rayon will acquire a
50.35 per cent controlling stake in PSI Data Systems from Groupe Bull, France, for
Rs.71 crores. In the year 2003, Indian Rayon entered into Information technology
sector with the acquisition of TransWorks Information Services Private Limited.
BOMBAY RAYON FASHIONS LIMITED
The Company was incorporated as Mudra Fabrics Private Limited (MFL) on
May 21, 1992. On October 13, 1992 the company was converted into a public limited
company. Subsequently, on September 30, 2004 name of the company was changed to
Bombay Rayon Fashions Limited (BRFL). In March 2005, with a view to consolidate
business of the group, Bombay Rayon Private Limited (BRPL) was amalgamated with
Bombay Rayon Fashions Limited and two partnership firms of the Group, i.e., B R
Exports and Garden City Clothing were taken over by Bombay Rayon Private Limited
and Bombay Rayon Fashions Limited respectively. The Bombay Rayon Group started
in 1986 with the incorporation of Bombay Rayon Private Limited. The Group is in the
textile industry having facilities for manufacture of fabrics, garments, design
development, sampling etc. Presently, the group is engaged in carrying out the
activities of manufacture of fabrics for domestic sale and export and manufacture of
garments for export. In 1998 company started manufacturing facilities for woven
fabric at Sonale in Thane district and group also started the fabric export. Bombay
Rayon Exports was formed for undertaking this business segment. In the year 2003
group turnover reached Rs.100 crores. It started Silvassa unit for manufacture of
woven fabric under Reynold Shirting Private Limited. Garment manufacturing for
exports was also started in the group. Garden City Clothing was formed for
undertaking this business. In year 2004 the company decided to set up an integrated
32
facility for yarn dyeing, weaving, process house and garment manufacturing at the
apparel park in Doddaballapura near Bangalore.
ALPS INDUSTRIES LIMITED
The Company was incorporated as a Private Limited Company under the
Companies Act, 1956 on 11th May, 1972 under the name and style of Alps Textiles
Private Limited and subsequently converted into public limited company vide fresh
certificate of incorporation issued on 2nd Nov, 1994 and was renamed as Alps
Industries Limited on 15 Nov, 1994 and another fresh certificate of incorporation was
issued by ROC Kanpur. Alps Industries Ltd. (formerly known as Alps Textiles Ltd.)
was promoted by Shri K.K. Agarwal a well known technocrat and industrialist along
with his associates. The Company is engaged in the manufacturing and export of home
furnishings and selling it's product range of venetian and vertical blinds, drapery rods,
and other interior decorative and architectural items under the established brand name
of Vista Levolor. The company has entered into an agreement with textile department
of Indian Institute of Technology (IIT), Delhi for providing the technical assistance. In
1975 the company has been awarded by Handloom Export Promotion Council,
Chennai for export of its product for the year1975-76, 1977-78, 1981-82, 1982-83 and
1984-85, and had received State Export award from Government of U.P. for the year
1983-84, 1984-85, 1987-88, 1988-89 and 1989-90. In year 1987 the management
conceived the idea for setting up of plant for manufacturing vegetable dyes, dyeing of
cotton fibre with vegetable dyes and spinning of vegetable dyed yarn, weaving of
fabrics there from and converting into made ups. In 1989 the company achieved
another milestone by entering into the agreement with Levolor Lorentzen Inc.,
presently known as Levolor Corporation, one of the leading manufacturer of window
coverings in U.S.A., to sell and manufacture in India the line of `Levolor' products
33
exclusively. The Company subsequently introduced a new range of Venetian blinds
under the brand name of Vista Levolor. Diversifying into the range of interior
decoratives, the company introduced Aluminium Panels for False Ceiling. The
company setup a research and development wing in 1993 an agreement was entered
into with Indian Institute of Technology (I.I.T), Delhi for sponsorship of research and
development programme of vegetable dyes. The company had established a large
marketing network in India and abroad. The Company proposed to set up a 100 per
cent export oriented unit at Sahibabad Industrial Area, in District Ghaziabad, Uttar
Pradesh.
In 1995 the company has tie-up with Levolor Corporation, USA, one of the
leading manufacturers of window coverings in USA, for manufacture and sale of
Levolor line of products in India. In the year 1997, company had also started business
with new parties in the international market with whom volume of business was
expected to grow further. Sales of Window Covering Division (Vista) had increased in
this year. The Company had launched window awnings and garden umbrellas in
collaboration with Franciaflex Company, France. It was decided to increase the
weaving capacity by installing additional 43 looms. In 1998 the performance of
window covering division (Vista) was adversely affected by the recession in the
domestic market. In this division also, several new product have been added in order
to widen the product range as well as, keeping in mind customer service, several
improvisations were made in the existing products. In 2001 Alps Industries Ltd.
makers of vista levolor blinds had introduced the `Karat' vertical blinds.
4.2. FINANCIAL PERFORMANCE ANALYSIS
4.2.1 Growth in Assets
Table 4.1 Compounded Annual Growth Rates of Assets
34
(Rs.
crores)
Years CAGR
Company
Mar' 03 Mar' 04 Mar' 05 Mar' 06 Mar' 07 (in %)
RSWM Ltd. 373.59 404.01 588.20 712.24 1179.67 25.86
Gravity (India) Ltd. 19.79 21.02 20.31 20.68 21.14 1.33
Aditya Birla Nuvo Ltd. 1438.69 1673.49 1847.09 3771.18 5956.38 32.86
Bombay Rayon Fashions Ltd. 11.70 11.37 73.15 248.35 829.08 134.47
Alps Industries Ltd. 125.89 131.59 192.58 477.38 647.17 38.74
An asset is any owned physical object (tangible) or right (intangible) having a
money value. In other words, assets are economic resources which are owned by a
business and from which future economic benefits are expected to flow to the
enterprise. These assets are meant to increase production capacity of the business.
As shown in table 4.1, the compounded annual growth rate of assets in all the
five companies is positive, this shows a rise in assets of the companies from year
2002-03 to 2006-07. Bombay Rayon Fashions Ltd., which is a non diversified
company had the highest compounded annual growth rate i.e. 134.47 per cent which
was mainly due to the effect of increase in total current assets that increased from
Rs.16.06 crores to Rs.335.55 crores in the five year time period, the current liabilities
of the firm increased from Rs.11.10 crores to Rs.78.49 crores and reduced the impact
of increase in assets to some extent. Rise in total assets in another non diversified
company i.e., Alps Industries Ltd. was 38.74 per cent which was mainly due to
contribution of current assets which increased from Rs.62.29 crores in the year 2003 to
Rs.269.81 crores in the year 2007. Although, current liabilities also increased from
Rs.21.99 crores to Rs.55.26 crores but the percentage increase was substantially less
than the increase in assets.
Similarly, total current assets of Aditya Birla Nuvo Ltd. which is in the
category of unrelated diversifiers also increased substantially from Rs.406.31 crores
(2003) to Rs.1092.96 crores (2007) and the subsequent increase in liabilities was lesser
35
i.e. from Rs.322.20 crores to Rs.593.88 crores thus, showing a compounded annual
growth rate of 32.86 per cent. A related diversified company, RSWM Ltd. had average
compounded annual growth rate of assets i.e. 25.86 per cent as its current assets
increased from Rs.141.09 crores to Rs.266.64 crores and current liabilities increased
from Rs.61.61 crores to Rs.102.48 crores.
Gravity India Ltd., an unrelated diversifier showed the least compounded
annual growth rate of assets i.e. 1.33 per cent due to very marginal increase in current
assets of the firm i.e. from Rs.9.62 crores (2003) to Rs.14.40 crores (2007) and
relatively the increase in current liabilities was quite high, that increased from Rs.2.52
crores to Rs.6.04 crores.
4.2.2 Growth in Sales
Table 4.2 Compounded Annual Growth Rate of Net Sales
(Rs.
crores)
Years CAGR
Company
RSWM Ltd. 445.91 633.41 733.93 959.6 1042 18.50
Alps Industries Ltd. 131.87 152.51 177.87 263 429.14 26.62
The term ‘sales’ is used for the sale of finished goods. It may be cash sales or
credit sales. The increase or decrease in sales should be compared increase or decrease
in cost of goods sold. An increase in sales will not always mean an increase in profit.
The profitability improves if increase in sales is more than the increase in cost of
goods sold.
As shown in the table 4.2, Bombay Rayon Fashions Ltd. had the highest
compounded annual growth rate i.e. 59.16 per cent due to a steep rise in net sales that
36
increased from Rs.47.91 crores to Rs.489.38 during the period of study. The
compounded annual growth rate of net sales of Alps Industries Ltd. was 26.62 per cent
in this five year time period. The total income of the firm increased from Rs.136.56
crores to Rs.456.06 crores due to this increase in sales. Aditya Birla Nuvo Ltd.,
RSWM Ltd. and Gravity India Ltd. had average compounded annual growth rate of
net sales i.e. 18.83 per cent, 18.50 per cent and 17.26 per cent respectively as the net
sales of Aditya Birla Nuvo Ltd. increased from Rs.1443.69 crores to Rs.3420.76
crores in these five years. Net sales of RSWM Ltd. increased from Rs.445.91 crores to
Rs.1042.00 crores and that of Gravity India Ltd. increased from Rs.15.06 crores to
Rs.33.39 crores.
4.2.3 Growth in Net Worth
Table 4.3 Compounded Annual Growth Rate of Net Worth
(Rs.
crores)
Years CAGR
Company
RSWM Ltd. 164.18 179.99 199.34 268.03 304.18 13.13
Net worth or shareholder’s funds include equity share capital, preference share
capital, free reserves such as share premium, revenue reserve, capital reserve, retained
earnings and surplus, less accumulated losses, if any.
As shown in the table 4.3, the compounded annual growth rate of Bombay
Rayon Fashions Ltd. was 167.33 per cent due to increase in equity share capital that
rose from Rs.1.00 crores to Rs.63.00 crores and reserves that increased from Rs.2.63
crores to Rs.420.01 crores. Alps Industries Ltd. had the second largest compounded
37
annual growth rate of net worth i.e. 36.88 per cent, this increase was due to cumulative
effect of increase in equity share capital which increased from Rs.6.20 crores to
Rs.32.51 crores and increase in reserves which increased from Rs.51.01 crores to
Rs.242.65 crores. Aditya Birla Nuvo Ltd.’s compounded annual growth rate of net
worth was 21.69 per cent which was mainly due to increase in reserves which
increased from Rs.1,110.91 crores to Rs.3,031.24 crores Total share capital also
contributed to this increase as it increased from Rs.59.88 crores to Rs.93.31 crores.
RSWM Ltd. had the average compounded annual growth rate i.e. 13.13 per
cent which was due to cumulative effect of increase in total share capital that increased
from Rs.19.88 crores to Rs.60.65 crores and increase in reserves that increased from
Rs.144.30 crores to Rs.241.65 crores. Compounded annual growth rate of Gravity
India Ltd was just 3.13 per cent which was due to increase in total share capital which
increased from Rs.5.99 crores to Rs.9.00 crores. This effect was further decreased due
fall in reserves of the firm that decreased from Rs.3.26 crores to Rs.1.79 crores.
4.2.4 Growth in Gross Profit
Table 4.4 Compounded Annual Growth Rate of Gross Profit
(Rs. crores)
Years CAGR
Company
RSWM Ltd. 19.58 58.27 61.5 112.27 198.4 58.91
Gravity (India) Ltd. 0.735 0.672 0.803 0.481 0.531 -6.30
Gross profit is simply the excess of net sales over cost of goods sold. As shown
in the table 4.4, RSWM Ltd. a related diversifier had largest compounded annual
growth rate of gross profit i.e. 58.91 per cent showing good sales by the firm during
the period of study. This rise in gross profit was mainly due to increase in net sales of
38
the firm which rose from Rs.445.91 crores in the year 2002-03 to Rs.1,042.00 crores
in the year 2006-07. this increase was further enhanced due to decrease in other
manufacturing expenses of the firm which decreased from Rs.17.15 crores to Rs.11.25
crores This effect of increase in sales and decrease in other manufacturing expenses
was reduced to some extent due to increase in cost of goods sold as raw materials cost
increased from Rs.249.12 crores to Rs.630.82 crores. Power and fuel cost also
increased from Rs.49.42 crores to Rs.119.02 crores. Employee cost increased from
Rs.36.74 crores in the year 2002-03 to Rs.78.29 crores in the year 2006-07.
The compounded annual growth rate of Bombay Rayon Fashions Ltd., a non
diversifier was 30.81 per cent due to increase in net sales from Rs.47.91 crores to
Rs.489.39 crores and subsequently there was an increase in cost of goods produced
which reduced the effect of increase in sales. Cost of raw materials increased from
Rs.27.66 crores to Rs.348.78 crores which is a considerable amount. There was also an
increase in employee cost that increased from Rs.0.45 crores to Rs.34.16 crores and
other miscellaneous expenses also increased from Rs.13.81 crores to Rs.29.58 crores
in the period of study. Alps Industries Ltd.’s compounded annual growth rate was
30.62 per cent due to increase in net sales that increased from Rs.131.87 crores to
Rs.429.14 crores. Simultaneously there was also an increase in the cost of goods sold
which reduced the effect of increase in sales on gross profit. Raw materials cost
increased substantially from Rs.89.62 crores to Rs.315.88 crores , power and fuel cost
increased from Rs.4.17 crores to Rs.17.89 crores, employee cost increased from
Rs.8.64 crores to Rs.21.34 crores and other manufacturing expenses increased from
Rs.4.82 crores to Rs.12.37 crores in the five year time period.
Aditya Birla Nuvo Ltd.’s compounded annual growth rate was 21.74 per cent
showing an increase in gross profit due to increase in net sales which increased
substantially from Rs.1,443.82 crores to Rs.3.420.76 crores. Subsequently, there was
39
considerable increase in direct costs i.e. cost of raw materials increased from
Rs.734.08 crores to Rs.1,917.13 crores. Power and fuel cost also increased from
Rs.96.52 crores to Rs.333.75 crores, employee cost increased from Rs.123.12 crores to
Rs.193.22 crores and other manufacturing expenses increased from Rs.58.86 crores to
Rs.103.46 crores in the five year time period.
Gravity India Ltd. had negative compounded annual growth rate i.e. -6.30 per
cent because the increase in cost of goods sold exceeded the increase in net sales
which reduced the gross profit of the firm.
4.2.5 Growth in Dividends
Table 4.5 Compounded Annual Growth Rate of Dividends
(Rs. Crores)
Years CAGR
Company
RSWM Ltd. 2.39 4.39 4.82 6.94 6.95 23.80
Gravity (India) Ltd. 0.06 0.09 0.09 0 0 -100.00
Bombay Rayon Fashions Ltd. 1 1 1 5.9 8.88 54.77
Shareholders are the real owners of a company and they are interested in real
sense in the earnings distributed and paid to them as dividends.
As shown in the table 4.5, during the period of study Bombay Rayon Fashions
Ltd. had the highest compounded annual growth rate in dividends i.e. 54.77 per cent as
dividend paid by the company rose from Rs.0.00 crores to Rs.7.88 crores (in the above
table index one has been taken for the dividends paid in year 2002-03 that were
Rs.0.00 crores) Alps Industries Ltd. had the second highest compounded annual
growth rate of dividends paid that increased from Rs.0.31crores to Rs.2.59 crores.
40
RSWM Ltd.’s compounded annual growth rate was 23.80 per cent, next was
the Aditya Birla Nuvo Ltd with 17.98 per cent compounded annual growth rate of
dividends. Gravity India Ltd had -100.00 per cent compounded annual growth rate as
although, the company paid dividends in initial years but in year 2005-06 and 2006-07
the firm did not pay any dividends and had negative annual growth rate.
4.2.6 Growth in Return on Capital Employed
Table 4.6 Return on Capital Employed

(in per cent)
Years
Company
Mar' 03 Mar' 04 Mar' 05 Mar' 06 Mar' 07
RSWM Ltd. 2.8 5.4 3.52 4.6 4.09
Gravity (India) Ltd. 2.84 2.62 2.58 2.22 2.78
Aditya Birla Nuvo Ltd. 9.43 9.91 76.61 5.91 4.19
Bombay Rayon Fashions Ltd. 15.71 6.67 0.14 0.08 0.07
Alps Industries Ltd. 4.99 5.25 8.49 5.38 5.13
This is one of the most important ratios used for measuring the overall
efficiency of a firm. As shown in the table 4.6, a related diversified company RSWM
Ltd.’s return on capital employed shows a fluctuating trend as initially it increased
from 2.8 per cent to 5.4 per cent and then declined to 3.52 per cent, again it rose to 4.6
per cent and then decreased to 4.09 per cent. Looking at the overall trend during the
period of study it increased from 2.8 per cent to 4.09 per cent thus showing an efficient
use of shareholder’s capital which was mainly due to rise in sales revenues of the
firm .
Gravity India Ltd. which is an unrelated diversifier, initially had increase in its
return on capital employed from 2.84 per cent to 2.62 per cent showing a profitable
initial period but later on this value decreased to 2.22 per cent and finally it again
decreased to 2.78 per cent. The main cause of decline in profitability of the firm was
41
decrease in firm’s net profit due to adoption of faulty strategies. Although the
company showed very good performance in the middle time period but there was an
overall decrease in Aditya Birla Nuvo Ltd.’s return on capital employed that declined
from 9.43 per cent to 4.91 per cent in five year time period.
A non diversifier Alps Industries showed increase in return on capital
employed from 4.99 per cent to 5.13 per cent showing overall increase in profitability
condition and efficient use of shareholder’s capital. In the mid if the time period
company showed its best performance as it had 8.49 per cent return on capital
employed that kept on declining towards the end of the time period. Another non
diversifier Bombay Rayon Fashions Ltd. showed inefficient use of capital as its return
on capital employed declined considerably from 15.71 per cent to 0.07 per cent in the
year 2002-03 to 2006-07 respectively.
4.2.7 Growth in Return on Net Worth
Table 4.7 Return on Net Worth

(in per cent)
Years
Company
RSWM Ltd. 5.32 10.25 9.24 10.1 14.49
Similar as return on capital employed this ratio also reveals how well the
resources of firm are being used. As the table 4.7 shows, the increase in return on net
worth of RSWM Ltd. that increased from 5.32 per cent in year 2002-03 to 14.49 per
cent in the year 2006-07. This shows that firm efficiently used its resources during the
period of study.
Gravity India Ltd. showed gradual decline in its value of return on networth
from 5.3 per cent to 3.89 per cent, showing the decline in profitability of the firm due
42
to decline in its net profits. Aditya Birla Nuvo Ltd. showed fluctuating trend as it
initially its return on net worth increased from 8.99 per cent to 10.36 per cent and then
kept on decreasing till the end time period. Although the net profit of the firm was
increasing during this time period the decline was due to relatively larger increase in
the net worth of the firm.
Among the undiversified firms Alps Industries Ltd. showed marginal increase
in its return on net worth from 9.05 per cent to 11.03 per cent whereas, Bombay Rayon
Fashions Ltd.’ return on net worth declined from 0.30 per cent to 0.11 per cent. Thus,
shows inefficient use of resources by the firm.
4.2.8 Growth in Gross Profit Ratio
Table 4.8 Gross Profit Ratio

(in per cent)
Years
Company
RSWM Ltd. 5 3.56 4.3 5.44 5.77
Gross profit ratio shows the efficiency with which the firm produces its
products. As shown in the table 4.8, gross profit ratio of RSWM Ltd. (related
diversifier) increased from 5.00 per cent to 5.77 per cent. Thus, firm was efficiently
producing its products.
Gravity India Ltd. an unrelated diversifier showed decline in its gross profit
ratio from 4.88 per cent to 1.59 per cent as its gross profit is decline in this time
period. Whereas the other unrelated diversifier Aditya Birla Nuvo Ltd. showed
increase in its gross profit ratio from 10.98 per cent to 12.39 per cent due to increase in
its gross profit.
43
Both the non diversifiers showed increase in their gross profit ratios thus
showing that the firms are following a profit making strategy. Bombay Rayon
Fashions Ltd.’s gross profit ratio increased considerable from 5.4 per cent to 16.66 per
cent and that of Alps Industries Ltd.’s increased from 11.06 per cent to 12.34 per cent
in the five year time period.
4.2.9 Growth in Operating Ratio
Table 4.9 Operating Ratio

(in per cent)
Years
Company
RSWM Ltd. 14.47 10.32 9.09 9.93 10.31
Operating ratio measures the cost of operations per rupee of sales. Higher the
operating ratio, the less favourable it is, because, it would have small margin
(operating profit) to cover the interest, income tax, dividends and reserves. As shown
in the table 4.9, the operating ratio of RSWM Ltd. declines from 14.47 per cent to
10.31 per cent thus showing a profitable condition as it shows that cost of operations
per rupee of sale of the firm goes on declining.
Gravity India Ltd. also showed decrease in the ratio thus, showing a profitable
condition but the other unrelated diversifier, Aditya Birla Nuvo Ltd. showed opposite
trend as its ratio kept on increasing. Its value increased marginally from 15.67 per cent
to 15.91 per cent.
Both the undiversified companies showed increasing trend in operating ratio
thus they were unable to reduce their operating costs with the increase in scale of
operations.
44
4.2.10 Growth in Net Profit ratio
Table 4.10 Net Profit Ratio

(in per cent)
Years
Company
RSWM Ltd. 1.92 2.87 2.48 2.78 4.17
Net profit ratio indicates the efficiency of management in manufacturing,
selling, administrative and other activities of the firm. As the table 4.14, shows
increase in net profit ratio of RSWM Ltd. from 1.92 per cent to 4.17 per cent due to
increase in its net profits from Rs.8.74 crores to Rs.44.07 crores.
Net profit ratio of Gravity India Ltd. decreased from 3.27 per cent to 1.26 per
cent due to decrease in net profit of he firm. Net profit ratio of Aditya Birla Nuvo Ltd.
also decreased from 7.14 per cent to 6.47 per cent, although, its net profit rose from
Rs.105.33 crores to Rs.224.97 crores. This decline was due to subsequent larger
increase in sales that rose from Rs.1,443.82 crores to Rs.3,420.76 crores during the
peiod of study.
Alps Industries Ltd.’s net profit ratio increased from 3.92 per cent to 7.01 per
cent due to increase in its net profit that rose from Rs.5.18 crores to Rs.30.35 crores.
Bombay Rayon Fashions Ltd. showed a considerable increase i.e. 2.28 per cent to
10.99 per cent due to increase in net profit from Rs.1.10 crores to Rs.54.41 crores.
4.2.11 Growth in Cash Profit Ratio
Table 4.11 Cash Profit Ratio

(in per cent)
Years
Company
RSWM Ltd. 11.02 8.84 7.62 7.31 6.93
45
As shown in the table 4.11, cash profit ratio of related diversifier, RSWM Ltd.
is decreasing from 11.02 per cent to 6.93 per cent thus showing a decrease in cash
generated from the sales of the firm.
Similarly in case of both the unrelated diversifiers i.e. Gravity India Ltd. and
Aditya Birla Nuvo Ltd., cash profit ratio was declining thus showed the decline in cash
profits of both the firms.
The non diversified companies showed increase in cash profits as the cash
profit ratio of Bombay Rayon Fashions Ltd. increased considerably from 3.49 per cent
to 12.84 per cent and cash profit ratio of Alps Industries Ltd. increased from 9.08 per
cent to 10.5 per cent.
4.2.12 Growth in Earning per Share
Table 4.12 Earning per Share

(in Rs.)
Years
Company
RSWM Ltd. 4.39 9.2 8.38 11.7 19.04
As shown in the table 4.12, RSWM Ltd.’s earning per share is increasing from
Rs.4.39 to Rs.19.04 as its nets profit increased from Rs.8.74 crores to Rs.44.05 crores
and the number of shares increased from 198.84 lacs to 231.49 lacs, the effect of
increase in dividends paid was negligible. Aditya Birla Nuvo Ltd.’s earning per share
increased from Rs.17.59 to Rs.24.11 due to increase in net profit from Rs.105.33
46
crores to Rs.224.97 crores and number of shares increased from 598.77 lacs to 933.05
lacs. Gravity India Ltd.’s earning per share decreased from Rs.0.82 to Rs.0.43 as its
net profit declined from Rs.0.99 crores to Rs.0.94 crores and number of shares
increased from 60.01 lacs to 90.02 lacs.
Earning per share of Alps Industries Ltd. increased from Rs.7.46 to Rs.9.33
due to increase in net profit that rose from Rs.5.18 crores to Rs.30.35 crores, this effect
was reduced as the increase in number of shares was larger that rose from 61.99 lacs to
325.14 lacs. Bombay Rayon Fashions Ltd.’s earning per share decreased from
Rs.10.97 to Rs.8.64 due to relatively larger increase in number of shares issued from
61.99 lacs to 325.14 lacs in the five year time period.
4.2.13 Risk
Table 4.13 Coefficient of Variation in Return on capital Employed (Risk)
Aditya Bombay
Gravity Alps
RSWM Birla Rayon
Company (India) Industries
Ltd. Nuvo Fashions
Ltd. Ltd.
Ltd. Ltd.
0.99 0.24 31.06 6.86 1.48
As the table 4.17 shows, Gravity India Ltd. had the minimum risk as its value
of coefficient of variation was just 0.24 and Aditya Birla Nuvo Ltd. had maximum risk
as its coefficient of variation was 31.06 among the sample firms. RSWM Ltd., Alps
Industries Ltd. and Bombay Rayon Fashions Ltd. had average risk as their coefficient
of variation was 0.99, 1.48 and 6.87 respectively.
4.2.14 Growth in Market Value of Share
Table 4.14 Market Value of Share

(in Rs.)
Years
Company
47
RSWM Ltd. 19.75 35.53 71.48 118.23 115.98
Market value is the price of share of the firm in security markets. As shown in
the table 4.14 Aditya Birla Nuvo Ltd. had the largest increase in market value as its
market value increased substantially from Rs.93.93 to Rs.996.93. Alps Industries Ltd.
and RSWM Ltd. showed the average movement in market prices. Bombay Rayon
Fashions Ltd.’s market value increase from Rs.6.65 to Rs.30.38 in the five year time
period. Gravity India Ltd. showed a decline in its average market value from Rs.13.6
to Rs.9.98.
4.2.15 Growth in Market Price to Book Value Ratio
Table 4.15 Market Price to Book Value Ratio

(in per
cent)
Years
Company
RSWM Ltd. 0.24 0.39 0.79 1.19 1.01
The ratio of market value to book value is used to analyse its stock market
position. As shown in the table 4.15, market price to book value ratio of RSWM Ltd.
increased from 0.24 per cent to 1.01 per cent thus its market position strengthened
during this five year period.
Market price to book value ratio of Gravity India Ltd. increased marginally
from 0.88 per cent to 0.91 per cent, showing a fluctuating trend and for Aditya Birla
Nuvo Ltd. it increased gradually from 0.48 per cent to 2.98 per cent.
48
Bombay Rayon Fashions Ltd. showed a gradual increase in its ratio from 0.23
per cent to 0.82 per cent and Alps Industries also showed a similar increase, its ratio
increased from 0.16 per cent to 1.05 per cent.
4.2.16 Growth in Market Price to Earning per Share Ratio (Price/Earning ratio)
Table 4.16 Market Price to Earning per Share

(in per
cent)
Years
Company
RSWM Ltd. 4.49 3.86 8.52 10.12 6.09
This ratio help in making an estimate of appreciation in the value of a share of
a company and is widely used by investors to decide whether or not to buy the shares
in particular company. As shown in the table 4.16, Market Price to Earning per share
ratio of RSWM Ltd. showed fluctuating trend as in initial years it increased
considerably from 4.49 per cent to 10.12 per cent but declined in the later period to
6.09 per cent. The overall Price/Earning ratio of RSWM Ltd. for five years showed an
increasing trend thus it was a good company for investors to buy shares.
Price/Earning ratio of Gravity India Ltd. increased from 16.59 per cent to
21.23 per cent during the period of study. Aditya Birla Nuvo Ltd. showed considerable
rise in its price/earning ratio from 5.34 per cent to 41.35 per cent thus, it was a very
good choice for investors.
Price/Earning ratio of Bombay Rayon Fashions Ltd. also increased
considerably from 1.45 per cent to 63.29 per cent and Alps Industries showed an
increase from 1.98 per cent to 9.51 per cent.
49
CHAPTER V
SUMMARY AND CONCLUSIONS
The research project ‘Diversification strategies and financial performance: a
study of textile industry’ was undertaken with the following objectives:
1) To identify various diversification strategies followed by the companies.
2) To analyse financial performance of the companies classified on the basis of
their diversification strategies.
The textile companies for the purpose of study were taken from the website of
Indiabulls Securities Limited. The study was carried out for five years period from
2002-03 to 2006-07. Only those companies were chosen for the study which
diversified either into a related sector or an unrelated sector. The selected companies
were then classified according to their diversification strategy – Rajasthan Spinning
and Weaving Mills Ltd. (related diversifier), Gravity India Ltd. (unrelated diversifier),
Aditya Birla Nuvo Ltd. (unrelated diversifier), Bombay Rayon Fashions Ltd.(non
diversifier), Alps Industries Ltd.(non diversifier). To determine the financial
performance of the firms following measures were used:
1) Growth (compounded annual growth rate of total assets, net sales, net
worth, gross profit and dividends).
2) Profitability (return on capital employed, return on net worth, market
price to book value ratio, market price to earning per share, gross profit ratio,
operating ratio, net profit ratio, cash profit ratio and earning per share).
3) Risk (coefficient of variation).
50
5.1 Findings of the study
Textile sector is growing at very fast pace since last few decades due to increasing
demand and rapidly changing trends. Almost all the sample companies showed
positive growth rates.
1) Bombay Rayon Fashions Ltd. which was a non diversifier showed the maximum
growth rate of total assets which was mainly due to increase in its total current
assets. It also had the largest growth rate of net sales which further leads to
increase in gross profit of the firm which was also largest for Bombay Rayon
Fashions Ltd. and Gravity India Ltd. showed lowest growth .
2) Bombay Rayon Fashions Ltd. had the largest growth rate of net worth which was
mainly due to increase in reserves and equity share capital of the firm during the
period of study and Gravity India Ltd. showed the lowest growth.
3) Bombay Rayon Fashions Ltd. had the highest compounded annual growth rate in
dividends and Gravity India had the lowest growth as company did not pay
dividends in the later period of the study.
4) RSWM Ltd. showed an increasing trend for return on capital employed and return
on net worth. Whereas, Aditya Birla Nuvo Ltd. showed a largest decline in the
return on capital employed and Bombay Rayon Fashions Ltd. showed largest
decline in return on net worth.
5) Aditya Birla Nuvo Ltd. had the strongest market position during the period of
study.
6) According to gross profit ratio, operating ratio, net profit ratio and cash profit ratio
figures for the five years Bombay Rayon Fashions Ltd. is the best performer and
Gravity India was the worst performer.
51
7) Value of coefficient of variation showed that Aditya Birla Nuvo Ltd. is the most
risky of all companies and Gravity India Ltd. is the least risky company.
8) Overall, it was found that non diversified companies showed better financial
performance and unrelated diversifiers showed the worst financial performance
during the period of study.
5.2 Suggestions
1) It has been seen from the research that companies like Alps Industries Ltd.
and Bombay Rayon Fashions Ltd. that did not diversify during the period of study
performed best. So, it is suggested that diversification does not necessarily
improve the performance of the companies. Companies should properly scan the
markets and their own resources before going for diversification.
2) It was also seen that related diversifiers perform better than unrelated
diversifiers due to operational and functional synergies. Therefore, companies
should prefer to diversify in related business.
3) While adopting any diversification strategy, company should keep in mind
their core competencies.
5.3 Scope for further research
The performance of the company can be further explained by
considering the aspects other than financial aspects. The present study was a short
term study due to time constraint. Research can be further pursued for longer period
to evaluate the long term effect of diversification strategies on firms’ performance.
This research was done on textile sector only. Further research can be done on
different industrial sectors or an overall sector wise study can be done to know the
impact of diversification on different sectors.
52
CHAPTER VI
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54

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DIVERSIFICATION STRATEGIES AND FINANCIAL

PERFORMANCE: A STUDY OF TEXTILE INDUSTRY

Research Project Report

Submitted to the Punjab Technical university

MASTER OF BUSINESS ADMINISTRATION

Diversification is a form of growth marketing strategy for a company. It seeks

Diversification is part of the four main marketing strategies defined by the

Product/Market Ansoff matrix (Kotler and Keller, 2006):

new facilities. Therefore, diversification is meant to be the riskiest of the four

strategies to pursue for a firm.

The purpose of diversification is to allow the company to enter lines of

strategically related to the existing lines of business, it is called concentric (related)

(1969) is followed according to which, diversification is producing a new product or

1.1 DIVERSIFICATION IN THE CONTEXT OF GROWTH STRATEGIES

Diversification is a form of growth strategy. Growth strategies involve a

significant increase in performance objectives (usually sales or market share) beyond

executives that "bigger is better." Growth in sales is often used as a measure of

performance. Even if profits remain stable or decline, an increase in sales satisfies

1.2 VARIOUS TYPES OF DIVERSIFICATION ARE:

1.2.1 Concentric Diversification:

Concentric diversification occurs when a firm adds related products or

an organization to achieve synergy. In essence, synergy is the ability of two or more

parts of an organization to achieve greater total effectiveness together than would be

achieved by combining firms with complementary marketing, financial, operating, or

capacity. Similarly, firms sometimes attempt to stabilize earnings by diversifying into

businesses with different seasonal or cyclical sales patterns.

Strategic fit in operations could result in synergy by the combination of

equipment or research and development are eliminated would improve overall

efficiency. Quantity discounts through combined ordering would be another possible

way to achieve operating synergy. Yet another way to improve efficiency is to

Management synergy can be achieved when management experience and

expertise is applied to different situations. Perhaps a manager's experience in working

with unions in one company could be applied to labour management problems in

another company. Caution must be exercised, however, in assuming that management

experience is universally transferable. Situations that appear similar may require

significantly different management strategies. Personality clashes and other situational

differences may make management synergy difficult to achieve. Although managerial

the transfer effectively.

1.2.2 Conglomerate Diversification:

diversification is improved profitability of the acquiring firm. Little, if any, concern is

given to achieving marketing or production synergy with conglomerate diversification.

is that opportunities in a firm's current line of business are limited. Finding an

attractive investment opportunity requires the firm to consider alternatives in other

Firms may also pursue a conglomerate diversification strategy as a means of

Probably the biggest disadvantage of a conglomerate diversification strategy is

the increase in administrative problems associated with operating unrelated businesses.

to work together effectively. Competition between strategic business units for

Caution must also be exercised in entering businesses with seemingly

promising opportunities, especially if the management team lacks experience or skill

become a poor performer.

In fact, combined performance may deteriorate because of controls placed on the

to longer review periods and complicated reporting systems.

1.3 TEXTILE INDUSTRY

generator after agriculture.

delivery of finished products, with substantial value-addition at each stage of

processing; it is a major contribution to the country's economy.

Its vast potential for creation of employment opportunities in the agricultural,

women and the disadvantaged is noteworthy.

US $ 50 billion by 2010 of which the share of garments will be US $ 25 billion. The

Italy, Russia, Canada, Bangladesh and Japan.

increasingly contribute to the provision of sustainable employment and the economic

1.3.2 CURRENT SCENARIO: