When the biggest shareholder misuses cash... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

When the biggest shareholder misuses cash... 

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In this issue:
» RBI imposes penalty on banks
» Why domestic savings are not being bolstered?
» Has the dollar rally any steam left?
» Dynamics of the Chinese property market are changing
» ...and more!

What typically are the characteristics of a well run company? One where the management is able to grow the business, improve profitability and more importantly generate ample cash from operations. That is not all. How this cash is utilized also becomes important. Companies looking at expanding capacity and operations might plough this back into the business. Others will return this to shareholders in the form of a healthy dividend. Further, those who have the shareholders' interest at heart will also ensure that this cash is not misused and that corporate governance standards are of the highest order. It goes without saying that if promoters of a company use the company resources to cater to their own extravagances, there is bound to be a hue and cry among shareholders. Indeed, such a company would score quite low on the corporate governance front.

Where do PSUs stand in all of this? Quite a few of these companies are well run by the management and generate good cash. But in many cases, the management does not have much control over how this cash is used, simply because the largest shareholder (read the government) is much more interested in milking the company to fund its own excesses.

Take the case of ONGC for example as highlighted in an article in the Business Standard. The company already has to bear the burden of oil prices being subsidized in the Indian market. This has been going on for quite some time now. And the latest gas price hike appears to be another blow to the company. Indeed, it was stated that the gas price hike meant that ONGC would be one of the beneficiaries. But a gas price hike means that the input costs for consumers such as the power and fertilizer industries would increase. If these sectors are not able to bear higher input costs, then the government has stated its intention of subsidizing them. All of this means that ONGC will be one of the companies bearing this burden.

This is not the only case where the government has been targeting PSUs to cater to their own vested interests. Not long ago, the government had ordered PSUs to dole out higher dividends so as to ease the burden on the fiscal deficit which is of the government's own making. Being the government means that it believes it can get away with such practices without being liable to minority shareholders. And so far it has been able to do so. But it goes without saying that this reeks of bad governance. But is the government listening?

Do you think that the government has been milking PSUs to cater to their own vested interests? Please share your comments or post them on our Facebook page / Google+ page

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01:26  Chart of the day
There is no denying that FY13 was a poor year for the Indian auto industry. As the economic slowdown and firm interest rates took their toll, demand dampened and volume growth was severely hit. But FY14 is proving to be no different. As can be seen from the chart, volume growth in the first quarter of FY14 has been very poor for most segments in the auto space. Indeed, according to SIAM, passenger cars have declined for 8 straight months now, while medium and heavy commercial vehicles (MHCVs) have done worse to decline for 16 consecutive months. And this is likely to continue unless there is a pickup in economic activity. That the scenario has only worsened is highlighted by the performance of utility vehicles (UVs) and light commercial vehicles (LCVs). These two were the star performers in their respective categories in FY13 as volumes for both grew in double digits. But FY14 appears to have turned the tables. For the first quarter, volumes of LCVs declined by 4% YoY, while UV volumes grew by a paltry 5% YoY. Most of the companies expect the first half of this fiscal to be challenging as well, but believe things to start picking up thereafter. But whether this will actually be the case remains to be seen.

*Passenger vehicles, **Commercial vehicles
Data Source: SIAM

There are 26 nationalized public sector banks and 21 private sector banks in India. Although the number of foreign banks operating in the country is 43, barely 6 of them have sizeable retail presence. Given this, the fact that 26 banks in India have flouted KYC norms is worrying. The RBI yesterday imposed monetary penalties on 22 banks for violation of know your customer (KYC) guidelines. It may be recalled that the first round of penalty was imposed on Axis Bank, HDFC Bank and ICICI Bank after the Cobrapost expose in June 2013. The RBI initially drew lot of criticism for denying any money laundering activity on the part of the banks. The fact that banks were flouting regulatory norms was under played by central bank governors. However, subsequent audits have revealed that the malaise runs much deeper. And several entities have compromised on regulatory checks in the pursuit of profits. We are of the view that adherence to KYC guidelines alone cannot sanitize Indian banks. The entities need to step up their overall corporate governance so that the Indian banking sector remains isolated from the systemic risks. Particularly, the kind of risk plaguing banks in the West and in China.

Looks like the RBI has taken upon itself the task of putting the rupee out of its current misery. It sprang a surprise late yesterday. The central bank raised two money market rates by 2 percentage points, thus making Indian debt more attractive to foreign buyers. Besides, the central bank also plans to drain US$ 2 bn from the system through sale of bonds, which will further put pressure on interest rates. This move leaves Russia as the only BRIC nation that has not taken action to tighten liquidity in the system. It should be noted that Brazil and China have already taken measures to tighten monetary policies in their respective economies.

We believe the RBI is right in giving exchange rate and inflation stability a priority over economic growth. The move is of course likely to put pressure on our already strained economic growth. But we believe that we will be better for it in the long term. Keeping rates artificially lower when the fundamentals don't support the same is not the way to take the economy out of trouble. Instead, market forces should be allowed to correct the imbalances by themselves by keeping the interest rates as close to the real inflation in the economy as possible.

There is a big reason behind the Finance Minister's positive comments whenever there is negative news on the economy. You see he does not wish to scare away the foreign capital which is flighty in nature. Why? Because India relies heavily on foreign capital for investment. This makes one wonder as to why we don't focus on increasing savings instead. Won't that be a better option? This is the question being raised by Business Standard. The leading daily has blamed the government's use of financial repression for the failure to boost domestic savings.

Financial repression is a system by which the government channelizes funds to itself. This is exactly what the Indian government does through the SLR (statutory liquidity ratio) by which banks are forced to park funds in government securities. In essence they lend funds to the government at dirt cheap rates. And the government has been using this money to fund its populist programs. This in turn has led to the dismal state of the economy and the raging high inflation rates in the country.

The net result is that the domestic saver who puts his money in the bank deposits, ends up earning nothing on his funds. Therefore it is not very surprising that want-to-be savers get lured by ponzi schemes in an attempt to earn higher and quicker returns. This is a big threat to the financial system. Instead the government could simply start concentrating on rewarding the savers. This would not just help maintain the balance in the financial system but would also provide the much needed funds for boosting investments in the country.

Ever since the US Federal Reserve came into existence a century ago, the US dollar has lost over 95% of its value. In other words, the greenback has lost so much purchasing power. Largely, the dollar has depreciated against major developed world currencies over the last four decades. That is, since the time it exited the Bretton Woods system of fixed exchange rates.

But the outlook for the dollar appears to be changing. The dollar has been gaining strength against several currencies this year. The most recent positive trigger was the likely tapering of the US Fed's quantitative easing program as hinted by Ben Bernanke. A pullback of the monetary stimulus program would push bond yields higher. And this in turn would result in capital flight back to the US.

The other thing is, while the US economy is in no great shape, the rest of the world isn't doing any good either. So in a relative world, the US appears to better off than some major developed world economies. And this is likely to provide strength to the greenback.

China's property market is overheated. And with people's bank of China resorting to monetary tightening, liquidity has become hard to come by. This has changed the competitive landscape in Chinese real estate market. Smaller developers are finding it difficult to operate in such a market. As a result, they are being absorbed by their larger counterparts. Lack of funds is one of the reasons for it. In a tight liquid environment, banks are unwilling to lend to smaller developers who have fewer projects. Instead they prefer to lend to larger developers. Lending to larger developers is less risky since they have more stable cash flows. Further, non- availability of funds has meant that smaller developers have turned to alternate sources of financing. But the interest rates are so high that they are unable to service it. Thus, they are left in a lurch. Taking advantage of this situation large developers have started to feast on them. As per news reports, the value of real estate acquisitions in China has doubled in the first half of this year compared to same period last year.

However, the larger developers have to be cautious here. If they overpay their financial health could be at risk. Also, with property prices in China already being above comfort zone, if prices correct anytime in the near future, the large developers will struggle in making debt repayments. In short, these developers have to be cautious that they do not acquire distress companies/assets while trying to increase their land banks.

The Indian equity markets traded below the dotted line during the first half of the day. At the time of writing, the BSE-Sensex was trading down by about 250 points or 1.2%. While stocks from the healthcare, FMCG, oil & gas and information technology spaces managed to find favour, stocks from rate sensitive sectors such as realty and banking were amongst the top losers. Midcaps and smallcaps were trading weak as well with the BSE Mid Cap and BSE-Smallcap indices down by 1.3% and 0.9% respectively. Stock markets in other parts of Asia were trading mixed with Japan and Hong Kong up by 0.6% and 0.2% respectively, while China traded marginally lower.

04:56  Today's investing mantra
"One of the reasons why looking at return on capital is important is that it keeps you out of the value traps."- Joel Greenblatt
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11 Responses to "When the biggest shareholder misuses cash..."

c v krishnakumar

Jul 17, 2013

The government has been misusing PSUs and PS Banks since ages. They government looks upon them not as independent business entities but as an arm of the government. They are made to locate factories in Neta's constituencies having little regard to backward and forward linkages. At times they are forced to recruit politician's favourites. PSU hotels are not known for customer service because of trade unionism and vested interests. PSU/PSB Boards are packed with incompetent people. That they perform itself is a big thing with the government micromanaging them. Time the government left business of running companies to professionals or sell them off to the highest bidder.

Like (1)


Jul 17, 2013

nice summation of issues of the day. keep going

Like (1)

sunilkumar tejwani

Jul 16, 2013

automobile growth??????? only vested interests in Auto Stocks would be disappointed in the next few quarters. To my mind wrong excise concessions given in the last few years have played havoc with the government finances. The fake economic recession of 2008-09 was utilized for excise reduction & easy finance for vehicles to help automobile industry for obvious reasons. Any sensible government would encourage mass rapid public transport instead of ownership of private vehicles. But alas! we are living in India! Shame on Indian government's misplaced priorities. GOD SAVE THE COUNTRY.

Like (1)


Jul 16, 2013

PSU's are milking cows for the Govt and its BABUS and politicians. Babus have been useing the govt departments, PSU,s in providing vehicles, class IV employees for their personal use without any eyebrows lifted by anybody. BABAUS creat govt expenditure by increasing salaries, allowances without increasing the work culture and than let the expenditure be met from the earnings of PSU. Govt has no business to be in business and worldwide the job of Govt is to look after the law & order on one side and save the nation from foreign invasion be it militarily or economically.

Like (1)

Francis M. Fernandes

Jul 16, 2013

In such cases, Public Sector companies should withhold dividends to majority shareholders for mis-using the majority shareholding. But such action can be taken only on court order. Can this be done?

Like (1)

Subhash Vashi

Jul 16, 2013

Government is not only milking th PSUs but it is milking everything under the sun in India viz PSUs, natural resources, banks, people etc and most of this is done illegally under the guise of legality. As a saying goes in Gujarati : If the government becomes a trader then the people become beggars. This is what is happening in India.

Like (1)

M M Kashyap

Jul 16, 2013

The recent OFS in MMTC by the Government also needs your expert comments in these columns. One wonders why the government is destroying the value of PSUs.

Like (1)

Anant Joshi

Jul 16, 2013

Great Article

Like (1)

Abhay Dixit

Jul 16, 2013

I wonder if SEBI can prevent it so as to protect minority share holders.

Like (1)

sn malhotra

Jul 16, 2013

If the company has large cash it should have solid plans to utilise that within the business. If not there is nothing wrong in distributing the cash as dividend. Yes, if the government has prevented the co from spending it beneficially within the business that would be objectionable

Like (1)
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