Equity markets continued to perform well, on the back of continuing optimism that a stable government at the Centre will result in an economic recovery soon. The Nifty currently trades at a level that is 20% higher than the peak level seen in Jan 2008, indicating a break-out from the bearish phase that lasted nearly 6 years. While there is a return of optimism to markets, balance sheet weakness continues to be acute in several pockets.
The recent market recovery has led to a spate of announcements from companies, wanting to raise equity capital. The total QIPs (Qualified Institutional Placements) for which companies have taken permission from shareholders is estimated to have crossed $10 billion, and the number is rising every day. As stock prices rise, it is natural for companies to use the capital markets to raise money, especially companies which have been heavily burdened by debt. Some of the companies, with strong and growing businesses, also need to raise capital to sustain growth.
However, for companies with broken balance sheets, this fund raising may not lead to a lasting solution to their core problem. We looked at the Top 10 companies in India in terms of the size of the debt on their books (excluding banks and NBFCs). These companies have a median Debt / Equity of 1.8x. More interestingly, the median interest / debt for these companies is only 5.7% – note that the Indian government borrows at over 8% currently. Typically private companies which enjoy a credit rating lower than sovereign, are expected to raise debt at higher rates. The median Depreciation / Gross block is 4.8%, indicating assets are being written off over 20 years or more. One can understand that in some industries the depreciation rates can be low, but for the median to be at 4.8% is a bit surprising.
With interest and depreciation, both being likely understated, it suggests that the true equity in these businesses is lower than what appears on the balance sheet. It is a tough situation to be in, and the fund raising from the equity market without substantial dilution of existing shareholders, would not be sufficient to solve the problem. It would be like applying a band-aid to a fracture. Alternative routes, like strategic asset sales would need to be pursued in many situations as promoters wouldn’t want to dilute their stake substantially. As listed equity investors, we continue to stay clear of such situations.
While stock prices have appreciated significantly over the last few months, valuations are not expensive. At least among the stocks in our portfolios, valuations are moderate and in line with historical averages. Needless to say, given the appreciation in stock prices, valuations are not as compelling as they were, say a year back. This is probably a time to be patient, wait for prices to reach your buy points and avoid the broken down balance sheet situations, despite temptation. As the economy recovers, growth opportunities for the companies in the portfolio will improve and for most companies the best years lie ahead. We continue to believe that one should continue to stick with companies with sound balance sheets and that are growing at a reasonable rate.