Return
to Story Page
To print: Select File and then Print from your
browser's menu
PN VIJAY
The rise of commodity prices globally has brought in some much-needed sunshine into the hearts of local companies. Right from the beginning of this year hopes of a rebound in Asian economies has led to the hardening of these prices. Asia had been showing double-digit growth in industrial production in the first half of the decade and commodity producers grew because of this.
However, the crash of these economies led to surplus capacities and historic lows of commodity prices. The last six months, however, have shown enough signs that the wheels of fortune have turned. Even though surplus capacities do exist in the system, there is an expectation that such capacities are rapidly finding markets. Both capacity utilisation and prices are showing healthy growth and the bourses have also reacted positively. On the NYSE, International Paper set the trend and Wiggins is doing the same in London. In India too, after a long time, commodity stocks have shown a greater increase in prices than their counterparts incomputer software and pharma.
Most large Indian companies are commodity-players in some form or the other. This is true of steel, petrochemicals, cement, paper etc and even in other areas like tyres, the pricing pattern is really commodity. The shares of scores of such companies have shown a healthy uptrend signifying renewed investor interest in these shares. The big question however is, now that the big undervaluation in the share prices has been corrected, where does one go from here?
This conclusion is based on an analysis of the composition of assets that most of these companies hold. Such an analysis would reveal that a large proportion of the assets of family run businesses is in investments. These are invariably strategic investments made in group companies which have been promoted by the so called flag ship companies. During the days of licencing and MRTP,these entities had to be promoted as separate corporations for various reasons. As families could never bring in resources required, they used their industrial companies to promote other entities. Unfortunately these investments are in most cases not paying off and resulting in reduction in return on net worth. The enormity of this problem will become clear through an example. In a typical large Indian family run business, if the net block is Rs 200 crore, the investment could be as high as Rs 100 crore. Assuming that the net block performs very profitably - due to the rising prices cited earlier - there could be a return on that block of say 30 per cent. But if there is no return on the investment, the overall return on net worth comes down to 20 per cent. On the other hand MNCs have all productive assets resulting in ROCE getting translated into RONW. Unfortunately for outside investors - whether they be institutional or retail - they have access only to the net worth as a whole and hence the returns fromthese companies are available only on a diluted basis. There could of course be the argument that some of these investments are doing well and hence the return from them is not little. However, studies of return on investment have shown the dividends are in fact very little. To add to the problem, our corporate accounting standards are such that companies are now required to show the impact of the diminution in their investment portfolio in their corporate accounts. So if some of these investments are doing badly, there is straight erosion in the net worth. The investment portfolio is not liquid either since a company would not liquidate its strategic investments in group companies, unless it is divesting altogether. My conclusion therefore is that while the present euphoria about Indian commodity companies is to some extent justified, it has to be tempered with the reality of their balance sheets. The baggage, which they carry in the form of their unremunerative investment portfolio, is bound to retardany runaway turnaround in their fortunes. I expect this situation to continue probably for the next five years by which time enough surgery would have been done to make these companies lean and hungry on a balance sheet basis. The author is owner of a private investment banking firm in Delhi and a former country head of Citibank's merchant banking division Copyright © 1999 Indian Express Newspapers (Bombay) Ltd.
------------------------------------------------------------
This story was printed from Net Express located at http://www.expressindia.com.
Net Express provides a portal to India, with news from The Indian Express
and The Financial Express along with sites on travel and tourism, the
entertainment industry, the power sector, the environment and much more.
------------------------------------------------------------