»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:
» Country's biggest investor cuts down investment target
» India's loan growth to decline sharply by FY13
» Rising interest rates to boost small savings?
» IT industry headed for a slowdown?
» ...and more!
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Woody Allen had once said "Money is important, if only for financial reasons". But in today's world of uncertainties, money is gaining more importance. And by the looks of it, India Inc appears to be increasing its focus on this one thing - money. The cash balances of India Inc have burgeoned in recent times. As reported by a leading daily, at the end of September 2011, India Inc (excluding financial companies) had an aggregate cash balance of around Rs 5,707 bn (including short term investments). But the question here is why are they just accumulating cash? What do they plan to do with it? And more importantly, how should the investors look at companies that have such huge cash balances?

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.

What in your opinion is the best way for a company to utilize its cash balance? Share your comments with us or post your views on our Facebook page / Google+ page.

 Chart of the day
Continuing our discussion on the cash balances held by India Inc, today's chart of the day shows the companies that have the largest cash balances as on 30th September, 2011. Interestingly, it is not just the IT companies that make it to the top 5 in this list. It includes companies in heavy engineering as well as mining. It is important to note that the cash balance referred to in this is the net cash or total cash minus total debt on books.

Data source: Business Standard

Over the last one year, the Indian stock markets have been blanketed with dark clouds of gloom and uncertainty. A testimonial of this comes from India's biggest investor, LIC (Life Insurance Corporation of India). The insurance giant has slashed down its investment target for the year by 33%. The company now plans to invest just Rs 400 bn in the equity markets this financial year against the earlier plan of Rs 600 bn. LIC has invested about Rs 200 bn so far in the year and expects the balance amount to be invested in the remaining four months of the fiscal. However, despite the lower outlay, the company has been able to buy as many shares as it did last year. This is because stock prices have fallen significantly since last year. It also attributes the decline in equity investment to a sweeping change in public behaviour. After selling fabulously last fiscal, Ulips (unit-linked insurance plans) are not finding many buyers after the lock-in period was increased from 3 to 5 years. New business premium which indicates the level of growth in the insurance business has declined 20% year-on-year in the April-October period.

The banking sector in India has been at the receiving end of negative news lately. Recently, the global credit rating agency Moody downgraded the outlook for Indian banks. While the Reserve Bank of India (RBI) refused to read too much into it then, there is a likelihood of the worst fears coming true. Rising interest rates, the slack in the economy and the resultant delays in executing projects are likely to take their toll on the loan growth in FY13, sending it to seven year lows.

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.

In order to attract individual investors the government has decided to increase the interest rate and investment limit on the Public Provident Fund (PPF) account. With effect from 1 Dec 2011, interest rate on the PPF account will rise from 8% to 8.6% while the annual investment ceiling will be raised to Rs 1 lakh from Rs 70,000, prevailing currently. Interest rate on savings account in post offices will also increase to 4% from 3.5%. Increasing the interest rate and investment limit will induce investors to invest in these schemes. It will also help government to tide over the shortfall in financing to the annual plan expenditure of states. It may be noted that net PPF contribution from investors is transferred to National Small Savings Fund (NSSF) which loans out the money to states. Slowdown in PPF collections lowers the finance to states from NSSF meaning that they have to look for alternative avenues. Thus, while the current step increases the future liability (higher interest outgo) it can ease liquidity constraints of many states.

The second largest Indian software company Infosys has once again given a cautious signal with regards to the prevailing uncertain demand environment. Last week, Mr V Balakrishnan, Chief Financial Officer of the company, stated that though the company would be able to meet its set target of revenues growth during the third quarter of the current financial year (3QFY11) but it would be difficult to reach the upper end of the targeted growth. He added that the demand environment is worsening by the day. Recently, similar views were expressed by the company's Chief Executive Officer as well. According to him, though clients are not cancelling the projects, but they are delaying the execution of the projects. He also raised the concerns over the allocation of Information Technology (IT) budgets by the clients.

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!

In the meanwhile, the Indian stock market are trading above the dotted line after opening weak. At the time of writing, the BSE Sensex was up by 106 points (0.7%). Stocks in the FMCG and energy space were witnessing gains. However, stocks in the capital goods and realty sectors were witnessing selling pressure. Other stock markets in Asia closed on a mixed note with indices in Malaysia and Indonesia closing in the green while those in China and Hong Kong ended in the red.

 Today's investing mantra
"The fact that people will be full of greed, fear or folly is predictable. The sequence is not predictable - Warren Buffett

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