»5 Minute Wrap Up by Equitymaster

On This Day - 6 AUGUST 2014
Cash is King. But not for Infosys.

In this issue:
» How Dr Rajan fared in yesterday's monetary policy?
» India's black economy is about 75% of its GDP
» MPs feast in parliament while citizens get culled in food inflation rout!
» How to make 20% returns in gold in 2015?
» ...and more!

00:00
 
Rs 300 bn. This is the amount of cash pile India's IT sector major, Infosys has on its balance sheet as of 30th June 2014. Call it a cash hoard or conservative mindset, the strategy has always been a matter of criticism amongst the analyst community. Until now, the management retaliated with stereotype answers pertaining to inorganic aspirations and took refuge.

However, this time around some minority shareholders who were previously the executives of the company itself have decided to question the policy of piling up cash. In fact, they have also written to the company's board. And have asked it to immediately consider a buyback worth Rs 112 bn (37% of cash pile) to dispose off excess cash.

Management change has been cited as one reason to undergo buyback as it has raised concerns amongst many stakeholders. Till recently, Infosys' cash hoard policy, was not as valuation dilutive as it should have been. The reason was strong management faith. There was a belief that though excess cash was earning meagre returns it was not at the risk of being consummated to reckless activities.

However, an abrupt change in management, with key people leaving and the company having an outside CEO, stakeholder faith may have diluted. Hence, management should indulge in buy back to restore confidence in the company.

Now we certainly agree that if a company is unable to deploy its excess cash profitably it should consider returning the same to shareholders. Cash sitting on balance sheet could earn 8%. But the same if returned to shareholders can fetch higher returns.

However, what slightly amuses us is the demand coming from ex-employees. These are the same people who during their respective stints ignored shareholder demands of returning excess cash themselves. Apart from this, these employees have also accused the company of wealth destruction for hoarding cash.

A demand to return cash now indirectly indicates that the prior management was more financially disciplined. And the current one is yet to build that kind of faith. Hence, needs a makeover via buy backs. However, a comparison between the two managements is too early we believe. And let's keep it aside for the time being.

The bottomline is that Infosys should seriously consider returning excess cash to shareholders. It has made no meaningful acquisitions in the past. And thus high cash is dragging its return ratios. This further strengthens the case of returning the hoarded money. Perhaps, its high time for the management to consider this issue more seriously. Else the valuation discount with its large cap peers like TCS may widen further.

Do you believe cash rich companies like Infosys should return excess money to shareholders? Or should they instead pile more cash to acquire companies in future and grow inorganically? Let us know in the Equitymaster Club or share your comments below.

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01:50
 Chart of the day
 
With Modi Government taking charge, the economic sentiments have turned positive. And the shift is obvious not just in India. The perception of an economic revival has made way abroad as well. This is the reason why the cost for Indian firms to raise funds abroad has come down. As the chart suggests, the average spread over LIBOR for such borrowings has come down by more than 50 basis points in the last few months. In fact, as an article in the Economic times suggests, even the companies with ratings that do not qualify for investment grade are witnessing investor appetite.

This also suggests that one can see a spurt in overseas borrowings as economic sentiments improve further and companies in India plan capacity expansion. While this may support capex plans of the firms, such firms will become highly vulnerable to forex risks. As we have experienced in the past, forex rates can be volatile enough to negate effect of the low interest rates on the ECBs. One must note that earlier in 2008, cheap foreign borrowings lured a lot of companies to expose themselves to foreign debt. However, as the economy slowed down and market sentiments turned negative, paying back the bonds became a tough task. Such debt resulted in stretched balance sheet subjecting India Inc.'s creditworthiness to risk. In some cases, shareholders in such firms burnt their fingers. Hence, as the trend gains momentum again, we believe investors must keep a close watch on such firms and ensure the company's ability to hedge and deal with such risks, in case they materialize in future.

Overseas credit has gone cheaper

02:25
 
Dr Subbarao had large shoes to fill when he vacated the position of the RBI governor. However, it seems that his successor, Dr Rajan is doing an even better job! At least when it comes to communicating the RBI's stance. This is not to undermine the conviction with which Dr Subbarao safeguarded the interests of the banking sector. Sometimes even at the cost of attracting the Finance Ministry's ire! However, the RBI's anti growth perception during his tenure did take a toll on the markets. Now, no doubt it is not the RBI's job to keep the market sentiments in focus. The regulator is better off hedging the risks to the banking sector and fighting inflation. However, it is without doubt that Rajan has done a better job of taking the US Fed's cheap money policies head on. Not just that he has made it amply clear that the RBI will ensure that Indian share markets remain resilient to the Fed's policies. More importantly, inflation control has and will remain the RBI's priority. However, it will take necessary measures to ensure that there is enough liquidity in the system to support growth. These guidances have given enough comfort to investors looking at Indian markets from a long term perspective as well. According to us, investors do not need to read too much into the monetary policies for investment decisions. Especially, as long as the RBI is doing a great job of keeping a close eye on the risks to the financial sector.

02:45
 
Every time an ordinary Indian citizen goes out to the market to buy food supplies, he feels the pinch in his pockets. We read just some days back that tomato prices in Mumbai had crossed the century mark. And prices of other vegetables and food items too have been increasing at an alarming rate. Wouldn't it be amazing if we could get our favourite delicacies at very cheap rates? A bowl of tomato soup and a slice of bread for just 8 bucks... Your favourite matar paneer a meagre 20 bucks... Just 12 bucks for a pudding... And so on... Does this sound like your idea of a utopia, which can probably only come true in your dreams? Well, you can enjoy all that we described above and more. All you have to do is become a member of the Parliament!

Now well, our point was not to suggest that you join politics. But to draw your attention to a dichotomy in our country. On the one hand, we have ordinary citizens paying through their nose and struggling to make ends meet. And here we have parliamentarians who get food at abysmally low costs. So much so that the deficit has to be financed from the budget allocation for Lok Sabha and Rajya Sabha secretariats. So you not only pay a bomb for your food supplies, but you also indirectly, through your taxes, pay to feed our not-so-underprivileged MPs. What worries us most is that the people who run the country have no clue of the misery of the people.

03:10
 
Black money continues to be a menace for the Indian economy. In order to understand the extent of this, a confidential report was commissioned by the erstwhile UPA government, which is now being studied by a Special Investigation Team. As reported in an article in the Hindu Business line, the major areas where black money is prevalent are higher education, real estate and mining. The quantum of black money is huge and this black economy is likely to be around 3/4ths the size of India's GDP. Loopholes in the law, red tapism and corrupt politicians have only contributed to the increase of black money in the country. The burden of this unfortunately has to be borne by Indians in the form of higher taxes. The UPA government, although it did set the ball rolling to curb this menace, does not seem to have succeeded much. And whether the Modi government can bring about a dramatic reversal in this regard remains to be seen.

03:45
 
Gold is what many people believe to be the ultimate safe haven. It is an asset worth holding on to when interest rates are low and one has to preserve one's purchasing power. Therefore it follows from this that gold prices usually rise during a low interest rate regime as people rush into the safety provided by the yellow metal. However, as per a renowned finance portal, the price of gold actually soars in the 12 months before the US Federal Reserve starts raising rates. Thus, with rate hikes most likely to come in the year 2015, this could be perhaps a very good time to buy gold. And there's actually 40 years of data to support this claim. Buying gold just a year before the Fed has raised rates has actually returned 20% on an average for all such periods considered. This is in sharp contrast to a simple 'buy-and-hold' one-year gain of 9% as per the portal.

So, with there being a strong possibility of rates rising in 2015, a 20% gains in gold could be yours for the taking if history is anything to go by. But whether rate hike or not, we do believe that every portfolio should have small exposure to gold. For it acts as a hedge should there be some sort of crisis in the world. Thus, if you haven't bought gold already, this could be a good time to buy it. Besides, there's a chance you could also benefit from the appreciation that precedes an interest rate hike by the US Fed.

04:15
 
The Indian stock markets continued to remain sluggish in the afternoon trading session. At the time of writing, BSE-Sensex was trading lower by 112 points (-0.4%). While the sectoral indices were trading mixed, banking and metal stocks tumbled sharply witnessing maximum selling pressures. Whereas stocks from IT and power were trading in the green. Majority of the Asian markets were trading in the red with Japanese and Indian markets leading the losses. Taiwan market alone was trading positive. European markets too opened the day on a pessimistic note.

04:50
 Today's investing mantra
"When you combine ignorance and leverage, you get some pretty interesting results" - Warren Buffett

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