Raymond and Other 'For Profit' Companies Who Don't Care about Shareholder Returns - The 5 Minute WrapUp by Equitymaster
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Raymond and Other 'For Profit' Companies Who Don't Care about Shareholder Returns

May 27, 2017
In this issue
» What happens if oil goes to US$ 25 per barrel?
» Are banks sitting on telecom debt time bomb?
» Weekend Market update
» And more...
00:00
Madhu Gupta, Research analyst

When a company grows, shareholders benefit. Ideally, all shareholders will benefit equally (in proportion to their holdings). But time and again, minority shareholders get the short end of the stick.

This happens when promoters, the biggest stakeholders, decide to profiteer at the expense of the hapless minority.

Infosys founder Narayan Murthy made headlines recently when he objected to the exorbitant remuneration of CEO Vishal Sikka at a time when the IT major was facing headwinds in the US market.

Now, you could argue that the CEO steered the company in difficult times and deserves the fat compensation.

But what about the blatant use of power to siphon shareholder wealth?

That's what the promoters of textile company Raymond Limited are trying to do.

They've proposed to sell the company's premium real estate asset in J K House at a discount of more than 90% to the Singhania family, the promoter. A resolution is set for the forthcoming annual general meeting on 5 June 2017.

Institutional Investor Advisory Services estimates the opportunity loss for the company and its shareholders to be more than Rs 6.5 billion.

The Singhania family already pays a low rent to lease the ultra-premium Mumbai property.

When the line between personal and professional begins to blur for the management, it should raise a red flag. The integrity and fairness of the firm are now suspect.

Another company that took shareholders for a ride is Idea Cellular. It set itself up for huge gains when it acquired its own shares through an investment arm of the firm's parent company just prior to the merger announcement with Vodafone. The jump in valuations saw the parent company making a quick buck but in disregard to insider trading guidelines and the minority shareholders. This raises concerns about management ethics.

Such violations may be few and far in between. But what happens when minority shareholders are short-changed in the normal course of business?

Here the Aditya Birla Group's restructuring plan for Grasim Industries comes to mind. With the merger of several unrelated businesses, the logic of synergistic advantage was literally turned on its head, and we saw no benefit to the minority shareholder.

Other examples include multinational companies such as HUL, Nestle and Maruti Suzuki abruptly hiking the royalties payable to their parent companies, compromising minority shareholder interest in the process.

I could go on...

The good news is that increased shareholder activism has resulted the rejection of some of these lopsided management proposals.

In 2014, Maruti Suzuki's parent was forced to change plans to take over a Gujarat plant after institutional investors opposed the move. That same year, Tata Motors had to roll back its proposal to hike management remuneration more than 5% of net profit after three-fourths of the company's minority shareholders voted against it.

Growing shareholder activism is certainly a positive development and can help usher in higher standards of corporate governance and transparency in Corporate India.

But an easier way for minority shareholders to avoid a raw deal is to bet on a good management in the first place.

So what's the profile of a good management?

Warren Buffett, who successfully turned around Berkshire Hathaway, a struggling textile company, has the answer:

  • You're looking for three things generally in a person. Intelligence, energy and integrity. And if they don't have the last one, don't even bother with the first two.

Imbibing the traits of super investors like Warren Buffett can greatly help in identifying companies with strong and ethical managements. My colleagues Rohan and Kunal have brought together the secrets behind the success of great investors in their new ebook - The Super Investors of India.

Get a free copy here.

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02:30 Chart of the Day

Oil at US$ 25 per barrel!

This is the latest prediction by Tony Seba. Well, it's not a name that many are familiar with. So first, a brief introduction. A serial Silicon Valley entrepreneur, Saba was the one to predict solar power boom. It must have sounded outrageous at the time as solar power price used to be ten times higher. Today, it's an undeniable reality.

The subject of his latest prophecy is oil prices. He believes oil price to fall to US$ 25 per barrel by the end of the next decade. Now oil is a capricious commodity that has made many economists look like complete fools in the past. Should we write this one off then?

What Happens If Oil Moves Back to US$ 25 Per Barrel?

We think it's something to take notice of and watch out for. After all, Seba is not going with usual oil demand and supply rhetoric. The reason for his conviction is the technological disruption. He believes the emergence of self-drive electric cars to disrupt the global oil industry. Mind you, these vehicles are not just cheaper to buy, but to run as well.

And it's not a very distant threat. Our in-house auto analyst recently attended the concall of Bajaj Auto. The management specifically acknowledged the disruption coming to even domestic three-wheeler industry - the rise of electric vehicles, and that too in the next five years.

Now that's a real threat, not just to auto industry, but firms like ONGC as well. Does that mean you should stay away from these firms?

Here is Rahul Shah on the subject:

  • The impact on individual stocks like Maruti and ONGC should depend on which value investing camp you are a part of.

    If you are a Buffett-type investor, taking ten-year view of things, you would most likely agree with Mr Seba. You could choose to stay away from these stocks.

    In fact, very few businesses would pass Buffett's stringent requirement for high predictability ten years down the line.

    However, if you are a blue-chip investor taking only a two to three-year view, you could be inclined to invest in these stocks provided their valuations come down to attractive levels. Sure, the odd blue chip will get disrupted and lose money during your this window. But if the stocks are strong fundamentally and priced attractively, you will have more hits than misses.
03:10

The NPA woes of the banking sector is well known. What is less well-known is the concentration of various sectors in the bad loan mess. More than a year ago, we had highlighted the biggest sectoral NPA culprits. Infrastructure, metals, and power topped the list.

However, the telecom sector is not too far behind. The sector is reeling under a debt burden of Rs 2,630 billion!

Spectrum purchased at sky high prices at various auctions is the reason for this mess. It would have been manageable if these companies were generating tons of free cash flow.

But they are not.

As per an article in the Economic Times, annual capex for the sector is about Rs 350 billion. There's also the deferred payments to be made to the government of about Rs 3,090 billion.

If all this was not bad enough, last year Reliance Jio entered the fray and changed the game. Even today its services, though no longer free, are priced much lower than the others. This has put these companies in a precarious situation.

Their revenues have already taken a big hit and the situation will only get worse. FY18 revenues are expected to be about 25% lower than FY17. Operating margins will fall significantly.

The smaller players have no chance of survival. They will either merge with the big boys, or will wind up their operations. But before that process of consolidation is complete, banks will need to be on their guard.

The total exposure to the sector is a staggering Rs 8,000 billion. Will this huge commitment be honoured?

The banks don't believe so. Some smaller players have already defaulted on interest payments.

The banks have now approached the government. Their proposals are familiar and have been made by telcos before.

Tax concessions, the use of spectrum as collateral to avail more debt, easier M&A norms, lower spectrum usage charges, and lower license fees. None of these proposals are a panacea for the sector.

It's a sign of their desperation that banks have approached the government with these proposals. Considering their huge exposure to the sector, we believe banks just cannot risk a situation in which telcos start defaulting on their debt.

04.00

Indian stock markets continued their positive momentum on expectations of a good monsoon and the impending GST implementation. FMCG and Auto stocks rallied as they are expected to benefit the most from GST implementation. After the demonetization hurdle, these sectors are expected to have improved earnings in the upcoming quarters. Pharma stocks continued to struggle due to pricing pressure in global and domestic markets. Indian Pharma companies expect FY18 to be a difficult year in terms of growth prospects due price erosion across geographies. The Sensex ended the week higher by 1.8%.

Brazilian stocks bounced back after the massive sell-off last week. The selloff came after new bribery allegations surfaced against Brazil's president, Michel Temer. Brazilian President Michel Temer hopes to tide the growing political unrest by bringing in political reforms.

The US stock markets posted record highs after a report showed U.S growth to be higher than earlier estimates. The U.S economy grew at 1.2% in the first quarter against the earlier estimate of 0.7%. Healthcare and real estate stocks declined. US Markets ended 1.3% higher this week.

Performance During the Week Ended 27th May, 2017

04:50 Weekend Investing Mantra

"An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Madhu Gupta (Research Analyst).

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