|»5 Minute Wrap Up by Equitymaster|
On This Day - 30 NOVEMBER 2011
It's not cash that is important but how it is used
In this issue:
The answer to these questions is a bit complicated. The companies seem to be increasing their cash holdings but do not have any concrete plan to spend this cash as of now. In the past few months, India Inc has been on a cash raising spree. Public offers, private placements, strategic stake sales, the companies have done it all. And all of it towards one end. To raise the levels of cash on their books.
But the plans for using this cash have not yet been charted out. To understand why this is so we would need to divide the cash rich companies into 3 categories. The first category would consist of companies that have raised the cash for funding their capex plans. Companies in sectors like power and metals would fall into this category. Unfortunately, due to macroeconomic concerns, these companies have put their expansion plans on hold. As a result, the cash that was allocated towards these plans is just lying in the companies' accounts. Obliviously whenever conditions change, the cash would be utilized for the purpose that it has been committed to. When that would happen, is anybody's guess. As a result, investors would do well not to get attracted by the cash balances of these companies and instead concentrate on their business strength and valuations.
The second category of companies is those that are cash rich and plan to go shopping with it. These include companies in sectors like IT, pharma, etc. These companies are the ones that are using the depressed market valuations to scout for acquisition opportunities. These are the companies that investors need to be wary about. Wrongful or expensive acquisitions could actually kill the business rather than adding value to the company. At the same time, being overly conservative and not making any acquisition could lead to underutilization of the cash.
The third category of companies is those that just have the huge cash balances and nowhere to spend the same. These companies may look at rewarding their shareholders with the excess cash. Investors of such companies may see their income from dividends growing period on period. And this adds to the total returns that they receive on their investment.
So the bottom-line is how the company uses its cash. It can either employ increment amounts into its own business to generate higher returns. And if it is unable to do so, then to pay it back to the shareholders. Understanding how the cash would be used is important before making an investment decision.
This is because credit growth in a particular time period is determined by loans sanctioned earlier. In the current financial year, the disbursements for earlier loan sanctions are likely to lead to 16%-18% loan growth. However, poor investment climate, delay in the new project launches, rising interest rates and inflation is drying the pipeline for new sanctions that will lead to slow credit roll out next year. The loan growth next year is expected to hit seven year lows, lesser than the estimated growth of 16%-18% in advances this year. So how does this imply for Indian banks? While a lower credit deposit ratio may bring more liquidity to banks in the short run, if the trend continues, it will be negative for bank's earnings and keep the sector under pressure from rising deposit rates post deregulation of savings deposits.
The company has started the current financial year with a cautious commentary on the company's prospects during the year. However, the management of the company is known for its conservative guidance and early disclosures of the facts. Therefore, all these warnings are being taken just as early cautions. But does it mean that the software sector would sink? Probably not!
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement
Disclosure & Disclaimer: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.
This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.
This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, Canada or the European Union countries, the same may be ignored.
This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.
As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.
Equitymaster Agora Research Private Limited (Research Analyst) 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: email@example.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407