The Hindu Business Line : Leveraging India Inc's investments

There may be value for patient investors from exposures in select companies with sizeable investments. The ones that make the cut are Tata Investment Corporation, Parry Agro, Ramco Industries, Maharasthra Scooters, Zuari Industries, Rane Holdings, Atul, Indian Oil, Eicher and SRF Polymers.

TO USE a company's cash flow to pick up stake in a group company and thereby indirectly shore up promoter holdings is not the best use of surplus corporate cash, no matter that even the government resorted to this practice. This policy, however, unwittingly turned into an asset for shareholders thanks to the bull phase. This asset has now grown even more, after the recent market rally.

The total value of the quoted equity held as investments by listed Indian companies is now about Rs 1,00,000 crore. This does not include the value of equity held by listed banks and financial institutions. This also does not include the value of unlisted equity, which in many cases would be several times the book value.

Unfortunately, such growth has not automatically translated into a windfall for shareholders. The gains remain on paper and indeed may never translate into cash flows for the shareholders. It is perhaps sensing this that the stock market is refusing to factor in the value of unrealised gains in a number of stocks. This broad-brush approach of the stock market does, however, offer investors an opportunity to hunt for value. Besides, eventually, the increase in value of these assets will get reflected in the form of at least higher dividends if Indian industry keeps growing at a fast clip. In the case of companies with reasonably good growth, the stock price will eventually catch up with the intrinsic value.

Making the cut

The rationale for investing in a company sitting on sizeable unrealised gains is that investors get the core business at a marginal price, if any. Now, it could turn out that the major business is itself is not exciting. In which case, you can extract value only if the business is wound up. It turns out, however, that only a handful of companies are sitting on large unrealised gains, but are also into businesses with reasonable long-term prospects.

In addition, many of these are small companies. There are 32 companies whose market capitalisation is lower than the market value of their quoted equity. Only two of these have a market capitalisation of more than Rs 500 crore. In the case of 35 other companies, the market value of the quoted equity works out to at least 30 per cent of the market capitalisation. Again, only two of these 35 have market capitalisation in excess of Rs 500 crore.

In this backdrop, even if the business prospects are exciting, there are risks from the corporate governance perspective. As such, picking out stocks of value from this segment is a perilous exercise. For instance, your comfort level may be lower when you invest in companies such as English Indian Clays, Sutlej Industries, Vindhya Telelinks, Pantaloon Industries and SPIC, to name a few.

The answer to this question would determine your approach to picking out stocks from this segment. Again, even if we assume a slightly liberal approach to the issue of corporate governance, many a stock will make the cut. Given this backdrop, stocks that were appealing include: Ramco Industries, Atul, SRF Polymers, Parry Agro and Zuari Industries. Except Parry Agro, the profits of the other businesses are growing. In the case of all these companies, the value of quoted equity is more than 65 per cent of the market capitalisation. It may take a while for the value to be unlocked. It is worth a try.

These companies apart, the value of investments was quite high for Indian Oil Corporation and Gujarat State Fertilisers at about 35 per cent. These companies also hold stake in unlisted companies that could prove as valuable. A close look at their investment prospects may be warranted. Also a number of investment companies hold valuable stake in other group companies. These companies are languishing given that the cash flow in the form of dividends is not at inspiring levels now.

A few of these, however, could eventually provide large returns. Attractive stocks from this segment include Nalwa Sons, Eicher, Rane Holdings, Maharashtra Scooters and Balmer Lawrie Investments. In the case of these stocks, the market capitalisation is less than half the market value of quoted equity.

Patience is key

The key to making money from this investment approach is patience. Investors would need to hold on to the stock for sufficiently long periods through ups and down in the stock market cycle. At some point, promoters would be forced to unlock value at least in order to benefit themselves. If investors make money in 2 out of 5 cases, the returns from this strategy would more than commensurate the risks involved.

Risks do exist even if you are a patient investor. For instance, promoters could come up with a preferential allotment dirt-cheap and keep enhancing their stake at the expense of minority shareholders. This did happen in Birla Global Finance. Minority investors could still end up making money if a restructuring that will distribute value to shareholders follows such a preferential allotment.

Market inefficiency in factoring unrealised gains plays into the hands of promoters. At some point, promoters would want to use it for themselves offering other investors a chance to share the spoils. Besides, the size of unrealised gains is too large to ignore for too long.

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