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R Ravimohan |
September 19, 2003
The past four to six quarters have witnessed a flurry of good corporate results. Stock markets have risen sharply. What is causing the apparent good performance of various companies in India?
If there are genuine improvements in performance, how long will they last? Are there any risks that need to be taken care of?
There are improvements both at the enterprise level and at a systemic level. Most firms that Crisil rates have done all or most of the following:
- Divested unprofitable assets
- Improved process efficiency (for instance the average consumption of electricity by the cement industry has come down from over 100 kwh/tonne of cement in 1997-98, to about 87 kwh/tonne)
- Reduced working capital
- De-risked their business by reducing pricing mismatches and by having good counter-party risk measurement systems.
These measures have improved their margins, return on investments, interest coverage and gearing.
At a systemic level there has been greater consolidation in virtually all industries.
Almost across the board commodity prices have risen from historic lows, where they were languishing for several years. These prices appear more logically housed in their trend lines now than they were during the past five years.
Almost all industries appear to be in a stronger position than they were five years ago.
This hopefully will reduce the cut-throat competition witnessed in the past and make markets more navigable for the survivors, who are in any case stronger players.
Managements have also by-and-large got a greater appreciation of their standing in the markets.
The financial markets also have a better feel of the business and financial risks under which these companies operate, and are likely to restrain at least the known mismanagements of the past.
Recognising these trends, Crisil has upgraded 13 companies in the first five months of this year.
The credit ratio which measures the proportion of upgrades to downgrades is currently running at 3.50, which presents a much stronger picture than the numbers of 0.78 for 2002-03, 0.11 for 2001-02 and 1.00 for 2000-01.
Is all well? No. The outgoing tide drags everything in its path to the sea; the incoming tide tends to dump all of it back on the coast.
Likewise, the current rally would also bring to market, not very strong companies. Some weak companies that hung in using extraneous tactics, and have not improved their fundamentals, are still around.
The rise in share prices will undoubtedly attract short-term players to cook up schemes to float premium issues that will prove expensive.
There are also likely to be swings, especially in prices, as the recovery is still incipient. What should be done under these circumstances?
- It will also be useful to first understand what can challenge this upsurge. A flashback to 1995-96 will yield two significant challenges -- financial constraints and infrastructural bottlenecks.
Project finance became dear then. All projects that were under implementation suffered heavy damages as funds dried midstream and interest costs skyrocketed.
This could recur, as investment proposals surge. That is because there are now less institutions funding long-term projects, and those that are still engaged in this market will surely be more risk calculative.
- The current short-term liquidity should not be confused with long-term project finance. On the infrastructure front, there has been no worthwhile capacity addition in the power sector.
Urban roads remain clogged, and the water situation has worsened. Telecom and ports have witnessed adequate expansion.
How much load can the financial providers and infrastructure utilities support?
The other concern would be shifting capacities. A lot of capacity has been moth-balled globally. How much of that will re-emerge as prices rise to attractive levels?
- It might be useful to conduct a due diligence on this aspect before taking decisions in investment in massive capacity addition.
Continued emphasis on productivity improvements, creative use of market alliances, increased focus on customer satisfaction, and prudent investments in capacity addition after rigorous analysis of market risks, are important tenets that will serve corporate decision makers well.
- Investors have many more concerns to address. Apart from assessing fundamentals of the companies they invest in, it is important for them to also assess the governance practices of these companies.
In the last round, investor distress caused by mismanagement almost equalled that caused by market developments.
Questionable management practices included accounting misstatements, misappropriation of funds, non-profitable related party transactions, hiding losses and debt in subsidiaries and contingent liabilities and corporate actions that only benefited majority shareholders.
Crisil now provides Governance and Value Creation ratings (Crisil GVC ratings), using a methodology specifically designed to answer some of these concerns.
GVC ratings therefore may serve as a useful additional guide to investors in evaluating potential investment opportunities.
- Investors also got burnt by collusive and speculative market practices.
They might want to check the antecedents of the intermediaries through whom they are entering the market, before developing a trusting relationship.
There are now enough well-meaning professionals in the market who are more committed to fair and transparent dealing. Identifying them could be as crucial as identifying a good stock.
- No investment ought to be made unless the investors convince themselves about the fundamental strengths of the company they are investing in.
No investor needs to be ashamed of his or her ignorance in this respect.
The world's most wealthy investor, Warren Buffet, does not invest in software companies because he does not understand them.
Finally, issues for the regulators. What a fantastic dilemma they must be facing. Here is a market that's faring well after so long. Investors should be happy. But is this for real, or is it another scam in the making?
All the previous rallies since 1990 have ended in massive scams!
How would the regulator tell one from the other? First, this time around the regulatory platform is a lot stronger.
Enough has been done to make information available to investors. Some efforts have also been under way to make investors aware of the risks of investments.
One of the key reminders that regulators would do well to send investors is to keep highlighting the need to make informed decisions and pointing them to the right sources to obtain the necessary information.
Regulators should also send a louder signal by their actions in addition to words. It will be good to follow up on a constant basis on whatever stock price movements cause suspicion in their minds, and openly declare the results of their inquiry.
Constant caution of unexplained movements could be another important service that regulatory agencies can provide.
A good system to track the audit trail in the event of something going wrong would perhaps enable isolation of problem areas, punishment to the guilty and a quick market recovery.
The trick will be to balance the need to ensure that investors are acting rationally and are aware of the risks they are taking, and the need to cultivate the good tidings that seem to have visited the markets after a long time.