Liquidity injection

The Rs 29000-crore infusion by Unilever could see capital going to assets in need of funding instead of gold and property

By Mohan Sule

Cash can be a blessing as well as a problem. For companies, reserves are primarily a buffer against downturn, when inventories rise, products are slow in moving, customers demand discounts and stretching of the payment cycle, and credit is required to service working capital. RIL used some of its reserves for additional depreciation charges arising from revaluation of its plants and machinery. The market loves companies financing their expansion through internal accruals. For investors, its presence on the balance sheet indicates a healthy operating margin. At the same time, the increasing size of cash pile adversely impacts the return on equity. Consequently, there is clamor from investors to use it to grow the business by undertaking expansion, which would be a cause for capital gain. There is also pressure to share some of it with the shareholders through dividends or as bonus shares. Of late, companies are offering to purchase shares to reduce capital, which boosts earning and invites better discounting. The tendency to dip into reserves is more noticeable during a bearish phase. Besides using this method to support the stock, lack of effective channels to expend is a vital factor in distributing cash. This is not so during a bull run. Besides, the attraction of dividend yield diminishes as stock prices surge. Buybacks and delisting become expensive.

The way a company prefers to consume its cash influences the market’s attitude towards the stock. Those offering dividend, tax-free in the hands of investors, are favored though they may belong to mature industries because of the predictability of their payout. On the other hand, fund-guzzlers are viewed with caution despite the opportunity to buy cheap and scope for appreciation as they mostly operate in the emerging sectors of the economy. For a time it did seem Indian investors were buying into this growth story from the huge response to the Rs 11600-crore Reliance Power IPO, the last of the big-ticket issue before the collapse of the primary market in 2008. Policy paralysis, regulatory overhang and shortage of raw materials have snuffed out the potential of the infrastructure sectors, including telecom, that had lured investors for a while. Buybacks are taken as a sign that growth has peaked and the company does not see many opportunities to expand market share. RIL had to resort to share mop-up to prop up the stock beaten down due to fall in natural gas production. Dell of the US is taking the company private as smartphones and tablets have disrupted the desktop and laptop market. Hindustan Unilever is an interesting case. Parent Unilever is increasing stake in the Indian company to the maximum permissible of 75% to stay listed but triggering speculation that the MNC might go private sometime in future as the margin and revenue come under pressure due to competition. The flawed reverse bookbuilding process mandated by Sebi will ensure investor interest in the stock in the hope of extracting a sumptuous exit price. The shares might even enjoy still steeper valuations, going against the conventional logic that stocks slip after buyback is completed.

What happens to the cash that is returned to investors through the various mechanisms? It will not be surprising if it is deployed in risk-averse fixed income instruments or locked up in gold or real estate. The Rs 29000 crore that Unilever is going to inject into the Indian stock market comes at a different time. There are reasons to believe that some of this largesse might finds its way back into the equity market, which is at a critical juncture. The US Federal Reserve has indicated it might gradually wind up its pump-priming program against the backdrop of return of risk-taking. The Indian market is benefiting from the spillover emerging from the surging Dow Jones Index Average and Nikkei indices. Indians are still buying gold in record numbers despite its declining value. The current account deficit expanded in April 2013 mainly due to higher gold imports. Yet, the difference over the four-and-a-half years since the global market meltdown is that purchases seem to be for consumption rather than for investment. Decent return from real estate looks slim at the current level. On the other hand, cheap sunrise sectors that need capital rather than FMCG counters with stretched valuations could lure investors. Pressure from foreign investors could even prod companies in the infrastructure space to improve their corporate governance and the government to initiate reforms that would allow players easy entry and exit and flexibility in sourcing supplies and pricing. In that sense the cash infusion by Unilever and other MNCs that might be tempted to follow the FMCG giant would be a welcome liquidity injection in the Indian equity market.