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How Do India's Banks Score on Asset Quality?


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There is a lot of negativity surrounding banks & financial institutions (FIs) these days.

Banks are struggling under the burden of bad loans and stringent provisioning norms. It took the wind out of their earnings sail.

They have been battling one challenge after another ever since the 2008 global financial meltdown.

Falling asset quality, digitisation, disruption from new competitors and demonetisation have all taken their toll.

It wouldn't be wrong to compare them to performers juggling balls in a circus. You are bound to drop some eventually. You may end up focusing too much on the juggling and lose sight of things around you.

Despite juggling to the best of their ability, most of the country's banks are not in the pink of health.

Credit offtake has been poor due to over-leverage in the corporate sector, excess capacity, and the economic slowdown. Also, higher provisioning for bad assets has affected profitability.

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But amid all this gloom, should you ignore all banking stocks?

We do not think so.

All these challenges have no doubt tested banks.

But it also brought out the best in them. The cyclical and structural factors still present opportunities for growth and re-rating over the long-term.

The only thing you need to do is find stocks with the best asset quality.

Corporate banks have underperformed retail-focused banks in the last five years. The chart below shows the annualised returns of the last five years.

Corporate Banks Underperform Retail-focused Banks

Retail-focused banks such as HDFC Bank and Kotak Mahindra bank have outperformed.

One of the important reasons for this outperformance is stable asset quality. They could maintain gross NPAs below 1% in the previous five years.

Now, have a look at the table below.

It shows the trend of Net NPA ratio of all the BSE Bankex stocks over the years. The overall picture shows the asset quality has improved.

Net NPAs to Net Advances (in %)

Banks have been facing the unpleasant prospect of seeing a fifth of their corporate exposure turning into bad loans, putting a question mark on the entire sector's profitability.

Even though there are signs of improvement, the NPAs still remain high.

Corporate focused banks such as ICICI Bank, Axis Bank, and SBI are facing serious asset quality issues.

Not to mention, some of these banks had management issues as well. No wonder they not only underperformed retail-focused banks, but also the BSE Bank index as well.

Further, recent tensions in the sector have added to their worries.

On one hand, banks are trying to recover dues using the Insolvency and Bankruptcy Code. On the other, new accounts such as Infrastructure Leasing & Financial Services, Anil Ambani Group entities, Jet Airways, Essel Group, and DHFL are casting a shadow over their future earnings.

Some of these are already in default while others are stressed.

There seems to be no end in sight to mounting bad loan worries for Indian banks.

Owing to these troubles, the housing finance regulator, National Housing Bank, has restrained some entities from lending.

So, the quantum of funds as well as the cost of loans have both shot up.

Smaller public sector banks are struggling to keep themselves afloat.

The few good quality private sector banks are only lending to retail clients, most cautiously.

Banks are Lending Only to the Aam Aadmi

Amid this, it is difficult to expect Indian companies to increase their capacities. Thus, their earnings may not grow at a fast clip.

But co-head of research, Tanushree Banerjee believes there's a silver lining to this cloud.

She noted two important trends in this regard...

  • The stricter credit norms are making corporates less dependent on bank lending for their capex.
  • The new NPA recognition norms and insolvency process could put an end to willful defaults.

Here's an excerpt of what she wrote in the latest edition of The 5 Minute WrapUp:

  • "The cleanup of India's financial sector may be long drawn.

    But it will, once and for all, rid the economy of a big growth hurdle.

    It won't matter if oil prices keep spooking India's consumer inflation.

    It won't matter if domestic interest rates remain steep.

    Indian companies will be in a position to manage their cash flows and debt obligations across cycles.

    The leaner, well capitalised financial entities will benefit the most."

Warm regards,
Rini Mehta



This article (How Do India's Banks Score on Asset Quality?) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/YeKNuScF-MY/detail.asp

Insolvency and Bankruptcy Code Takes a Hit: Boon or Bane?


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Non-performing Assets (NPAs) is the smoking gun of the threat to the very stability of India's banks.

India badly needed a magic pill that would revitalise the system, curing the bad loan problem.

The Reserve Bank of India (RBI) had pointed out the lack of modern bankruptcy legislation in India which was affecting the recovery of loans since quite a long time.

When it comes to resolving insolvency, India's rank is low at 103. This is much below our neighbouring countries.

On both factors - the recovery rate and the time to resolve a bankruptcy - India is slower than its poorer neighbors.

India Slowest in Resolving Bankruptcy

There was a need to revamp bankruptcy laws. Which brings me too...

12 February 2018 RBI Circular

In a bid to stem the lurking rot, the Supreme Court quashed the 12 February 2018 RBI circular on non-performing assets.

Now what was this buzz all about and what does it mean?

In a circular on 12 February 2018, the RBI mandated banks to classify loans of Rs 20 billion and above as 'stressed' if their repayment remained overdue even for a single day.

Thereafter, a window of 180 days would open during which the lenders and the borrower had to agree upon a plan to resolve the default.

If the non-payment problem persisted beyond 180 days, the lenders would get a free hand to take over the firm, sell it or liquidate it under the IBC. Read more about the Insolvency and Bankruptcy Code.

The Timeline of the Issue

  • 4 May 2017 - The government of India issued an order to amend the Banking Regulation Act that conferred powers on RBI to issue directions to banks. It included directing banks to refer NPAs to the insolvency and bankruptcy courts.
  • June 2017 - The RBI issued a list of the 12 largest loan accounts in default. The banks were required to start proceedings under the IBC.
  • 12 February 2018 - The RBI came out with a new resolution framework, to be used by banks before triggering the IBC.

Banks had no choice but to trigger IBC if the loans were not restructured within a deadline.

Finally, the previous mechanisms the RBI had created pre-IBC were all withdrawn.

These mechanisms - Joint Lender's Forum (JLF), Corporate Debt Restructuring (CDR), Scheme for Sustainable Structuring of Stressed Asset (S4A), and Strategic Debt Restructuring (SDR) had all been criticised for being too easy on borrowers.

The schemes allowed for ever-greening of loans, where the banks would pour more money in a company which had already defaulted and were generally considered to be poorly designed.

Now, as per the 12 February circular, the RBI disclosed the top 12 loan defaulters accounting for around 25% of the total bad loans.

As the chart shows, the biggest defaulter was Bhushan Steel with bad loans of Rs 559 billion.

Top 5 Defaulters

The Insolvency and Banking Code was expected to tackle the growing bad loans problem.

Now here's a thing to note...

In case of Tata Steel buying out Bhushan Steel, banks recovered 63% of their outstanding loans, which was very good.

But in case of Alok Industries, the banks could recover only around 16% of the outstanding loans .

Typically, banks managed to recover around 10% of the bad loans in the past. Of course, the Insolvency and Bankruptcy Code led to a recovery rate better than 10%, but it didn't change the state of public sector banks much.

Then on 2 April 2019 the Supreme Court set aside the RBI's 12 February 2018 circular. This restored previous all the previous debt recast options for the defaulting companies. It gave a free hand to banks to explore steps to rescue such companies outside the court.

This came on the back of power, shipping and sugar companies challenging the RBI's February 12 circular which had identified about 30 companies which were stressed. Many of them were power companies.

The effect of the RBI circular fell disproportionately on the power sector. The power sector has some genuine reasons for the high levels of defaulted loans.

Some of the blame for the failure to repay loans was due to government inactions, like the electricity regulatory commissions not updating the price of electricity, change in government policy on coal supply, failure to execute power purchase agreements, and the non-payment of dues by state electricity distribution companies.

Owing to the supreme court's verdict, shares of power companies hogged limelight throughout the day.

The Impact

1. IBC Versus Other Mechanisms:

A recent report by the Reserve Bank of India on the trends and progress of banking in India FY18, showed an interesting comparison on the efficacy of the IBC in improving the recovery rate and in providing the lenders with a better realisation in comparison to the erstwhile regime of recovery.

Recovery by Banks as % of Amount Filed

Also, reasearch analyst, Sarvajeet Bodas had pointed back then, things were about to change for the better. Here's what he wrote:

  • "This is a game changer for India's banking sector. The IBC gave banks the power they needed.

    Earlier, banks had to run after promoters to recover their money. Now promoters are running after banks and looking for solutions.

    As per the RBI's financial stability report, more than 4,300 applications were filed in the National Company Law Tribunal (NCLT).

    With this, banks have sent out a clear message - pay up...or be ready for bankruptcy proceedings."

But now after supreme court's order, banks plan for higher recovery through NCLT cases initiated becomes null and void.

2. Will the Provisioning Remain High or Will It Fall?

Now look at the chart below.

It shows gross NPAs to gross advances of the leading banks in India over the years. There has been a clear rise in NPAs and provisions in all the banks.

With the introduction of IBC, a loan worth over Rs 2.8 trillion, with payments outstanding for 60-90 days, carried the risk of slipping into the category of NPA. This resulted in a surge in NPAs and put additional pressure on the banks to make provisions.

The new framework specifies banks report defaults on a weekly basis in the case of borrowers with more than Rs 50 million in bank debt.

The strict timelines meant that a larger number of accounts would go into insolvency.

Provisions Increased Post IBC Code

The question now is will these banks maintain such high provisions for debt after the Supreme Court ruling?

If not, how will it impact NPAs again?

3. Signs of Credit Growth

The previous attempts to address the issue of bad loans had all failed.

As per an article in The Economic Times, after the code became operational, about 3,300 cases were disposed of by the adjudicating authority based on out-of-court settlements between debtors and creditors involving claims amounting to over Rs 1.2 trillion.

As a result, the credit growth that banks in India posted in December quarter of 2018, at 15.1% YoY, was not just very healthy. It was nearly 2 times GDP growth. But it was also back to the five-year high.

Will Credit Growth Remain High Going Forward?

Ultimately, the total flow of resources to the commercial sector in India, both bank and non-bank, and domestic and foreign (relatable to the non-food sector), have gone up.

These figures tell us the IBC was successful.

As per the reports, total debt estimated to have been impacted due to the RBI circular was Rs 3.8 trillion across 70 large borrowers. These companies will now get the earlier options for restructuring.

What Happens Now?

The IBC code had its own pros and cons. The economy, especially a few sectors, benefited up to a certain extent.

But this came at the cost of power, sugar and other sectors which suffered the most due this circular.

Now you can't deny the fact that, for the IBC to truly succeed, it was important the government let the central bank do its job independently and thwart systemic risks due to the bad loans.

What we truly need is a fair set of rules to set the banking house in order. Now, what the government and RBI does further to correct this remains to be seen.

Warm Regards,

Rini Mehta



This article (Insolvency and Bankruptcy Code Takes a Hit: Boon or Bane?) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/I6va1WStUcE/detail.asp

After Mindtree, Which Companies Are Under Threat of a Takeover?


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Promoters' activities can create quite a buzz in the market.

Promoters are essentially the big boys of companies, the ones with the biggest stakes and the most to lose.

And when news items affect the market price of the company, it becomes even more important to study and deeply analyze promoters' activities and their shareholding pattern.

Mindtree is in news these days for one such reason.

The Mindtree-L&T Saga

L&T is reportedly planning to buy 20.4% stake of V G Siddhartha, the top shareholder in Mindtree. This aggressive move is looked upon as a 'hostile takeover' of Mindtree by the infrastructure giant.

L&T will buy the stake at Rs 981 per share from V G Siddhartha, after which it will have to make the mandatory open offer to the shareholders to buy 26% stake.

How did Mindtree become a takeover target?

Well, Mindtree's shareholding pattern presents a recipe for a hostile takeover in the Indian context.

The promoters of Mindtree, hold a mere 13.3%.

Mindtree's Shareholding Pattern

This Mindtree-L&T case bags a question, are there any other companies under such threat?

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Which Other Companies are Ripe for a Takeover?

A study of 481 listed companies on BSE shows that, 219 companies have promoter holdings above 55%. And in 26 companies promoters hold below 30% stake.

Government owned ITI, Hindustan Aeronautics, MMTC among others have highest promoter stakes above 90%.

Companies with Highest Promoter Stakes
Company Name Promoter Holding (in %) Market Cap (in Rs million)
ITI 90.0 82,300
Hindustan Aeronautics 90.0 238,201
MMTC 89.9 40,800
Housing & Urban Development 89.8 88,284
SJVN 89.5 94,708
MRPL 88.6 129,167
Central Bank Of India 88.0 107,854
India Tourism Development 87.0 23,685
Bank of Maharashtra 87.0 34,170
Corporation Bank 86.8 73,000
Data Source: Ace Equity, Equitymaster Database

Infosys, Mindtree, and PTC India have lowest promoter holding at 12.8%, 13.3%, and 16.2% respectively.

Companies with Lowest Promoter Stakes
Company Name Promoter Holding (in %) Market Cap (in Rs million)
Mahindra & Mahindra Ltd. 21.6 825,853
PVR Ltd. 20.3 74,025
Suzlon Energy Ltd. 19.8 34,259
Yes Bank Ltd. 19.8 571,813
GHCL Ltd. 18.9 22,698
NCC Ltd. 18.1 65,410
IndusInd Bank Ltd. 16.8 1,015,194
PTC India Ltd. 16.2 22,201
Mindtree Ltd. 13.3 154,402
Infosys Ltd. 12.8 3,214,660
Data Source: Ace Equity, Equitymaster Database

A high level of shareholdings has its positives and negatives. It determines promoters' having substantial skin in the game and are willing to give their best, among others.

But our focus today will be on the lower shareholding by promoters.

What's the Problem with Low Promoter Shareholding?

Nothing. Except for a potential takeover.

Mergers and acquisitions are inevitable in the corporate world. Acquisitions can be friendly as well as hostile.

A friendly acquisition is one in which controlling group of the target company sells its shares to another group willfully.

However, if the management of the target company is unwilling to negotiate, the acquirer can directly approach the shareholders of the company by making an open offer. This is known as a hostile takeover.

Limited stakes can drag companies into corporate raids. If the promoters don't own much, they can't do much to stop it.

The Case of L&T Was Just the Opposite Once

As they say, life comes in full circle. L&T itself was the target once.

In its long history, L&T has had to ward off multiple corporate raiders ranging from Manu Chhabria in 1987, to Dhirubhai Ambani, and Kumar Mangalam Birla through the 1990s and 2000s.

Later, everyone including LIC and the government got involved in keeping them away.

L&T has now created a wall. It set up an employee welfare trust which used company money to buy up nearly 10% of the company. This ensured that management had at least 10% of the company.

But look at that table again. Even the prestigious M&M group stock is in the top 10 list!

Can M&M Be a Potential Target for a Hostile Takeover?

If the Mahindra family is breathing easy despite its low holding, that would be because of the solid backing of financial institutions.

LIC is the largest public shareholder with 8.8% stake. Other prominent institutional shareholders are ICICI Prudential Life Insurance (2.4%), SBI Mutual Fund (2.3%), among others.

Widely Held Stakes

Domestic investors collectively own around 22% of M&M. The foreign institutions together hold 33%. The rest is widely held.

Usually, such widely held shareholding makes it humanly impossible for any raider to accumulate shares.

Even HDFC and L&T are two prominent examples of companies without an identified promoter group.

The shares are held by the public at large with the majority stake being controlled by financial institutions.

Corporate raids are tough in India. You can't acquire more than 26% without an open offer to the rest of the shareholders.

You can't as a promoter acquire more than 5% a year through "creeping" buys. If an open offer fails or otherwise, you have rules like you can't own more than 75% unless you try to delist the company. And so on.

You can read all the aspects of takeover in India in this article titled "Takeover Code: The basics."

There are various ways to prevent hostile take overs such as finding a white knight (the way L&T did by bringing Ambani on board when Chhabria wanted in) or creeping acquisitions. And there are many other ways to deal with it.

The Tale of Hostile Takeovers in Indian Corporate History

India's relatively nascent mergers and acquisitions (M&A) space has seen very few hostile takeover attempts in the past.

The first such move was made by London-based businessman Lord Swaraj Paul, who launched a bid in the early 1980s to take over Escorts and DCM, which was thwarted by the Nandas.

Most recently, hotel chain operator EIH managed to get Reliance Industries to buy a stake in the company to prevent ITC from launching a takeover bid for the company.

There have been similar situations not so long ago.

The Raasi Cements and India Cements saga is one of the few successful hostile acquisitions in India till date. India Cements successfully made a hostile takeover bid for Raasi Cements with an open offer for the latter Rs 300 apiece, significantly above the then prevailing share price of Rs 100 on the BSE.

Towards the end, India Cements in total bought out 85% of the shareholding.

Another hostile takeover attempt is from the FMCG space when Emami picked up a 24% stake in Zandu from its promoters Vaidyas (co-founders) at Rs 6,900 per share.

There is also the more recent story of Essel Group's move to mount a hostile bid on IVRCL.

Fear of hostile takeover bids puts the promoters on the edge, which is a positive thing in the context of governance.

But, it may still take some time for such unfriendly takeover attempts to finally result in the acquisition of the target company in foreseeable future.

What Lies Ahead of Mindtree-L&T Battle?

As per the reports, the combination of the two companies will help create an entity with a higher turnover of close to Rs 120 billion, closer to larger rivals such as Wipro and TCS.

The Mindtree management, however, thinks differently.

Creating Synergies?

Given that the takeover has just been launched, it would be too early to make any predictions regarding the outcome.

While the L&T-Mindtree saga will one day disappear into the history books, the lessons will not.

One thing that we must bear in mind is that most companies in India are managed by promoters.

Hence, they are bound to protect their interest and will not relinquish control without a fight.

This means that the company launching such an attack needs to be very clear as to why it wants to go down this route.

Here's snippet from the article on hostile takeovers that Tanushree Banerjee, co-head of research wrote:

  • "In mergers and acquisitions, in general, the acquiring company has to make sure that it pays a reasonable price for the target company. It needs to gauge the synergies that are likely to flow in on making the acquisition such that the payback period is not too long. Many a time, when competition for a particular target heats up, valuations soar. As a result, the company which has finally made the acquisition ends up paying a very high price."

This applies to hostile takeovers as well.

Since these are bound to be fought tooth and nail by promoters, the acquiring company at the end of the day needs to evaluate whether the price paid, and the potential benefits are all worth it.

And as far as minority shareholders are concerned, if they stand to benefit with the change in management, then this takeover doesn't matter in long run.

Warm regards,

Rini Mehta



This article (After Mindtree, Which Companies Are Under Threat of a Takeover?) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/jajTXoCk3RI/detail.asp

MSTC IPO: Should You Bet on This State-Run E-Commerce Player? (Subscriber Feature)


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State-run e-commerce company MSTC Limited is set to launch its initial public offer (IPO) in the price band of Rs 121 to Rs 128 per share.... [Read More]

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The Jet Airways Crisis in 6 Charts


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Do you remember the troubled days at Kingfisher Airlines 6 years ago?

Jet Airways recent crisis reminds you of Kingfisher, doesn't it?

Vijay Mallya's Kingfisher stopped flying in 2012. The airline posted losses, struggled to pay salaries, and had a huge debt pile. This led to its complete closure.

Now, compare that to Jet Airways. Is history repeating itself?

Let's have a closer look at what's exactly going on with Jet Airways. It was once among India's top 3 airlines.

First, its background. Jet Airways was founded by ticketing agent turned entrepreneur Naresh Goyal in the early 1990s after India ended its state monopoly on aviation.

The ownership structure currently remains unclear. But as per reports, chairman Naresh Goyal has agreed to step down.

His shareholding will fall below 20% from 51%. State Bank of India owns 24% and 12% is held by Etihad.

The airline has been losing market share for several years to IndiGo, that is now the clear leader in the domestic market.

Jet Airways Market Share - Then & Now
Jet Airways Market Share - Then & Now

Once a Frontrunner, What Went Wrong?

First was the challenge from the entry of budget carriers. This led to dropping of fares by Jet Airways. Some tickets were sold even below the breakeven cost.

Second, provincial taxes of as much as 30% on jet fuel were added to its expenses.

Price-conscious Indian travelers refused to pay a premium for on-board meals and entertainment.

On a consolidated level, the company has bled in nine of the last eleven fiscals. In other words, it has kept its bottomline in the black in only two out of the last eleven years.

Jet Airways: Bleeding Red
Jet Airways: Bleeding Red

Third, aviation is a tough business.

Despite rapid passenger growth, the cost structures and high competition make it very difficult for airlines to turn a decent profit.

Lastly, the rise in oil prices was a death blow to their earnings.

There is a sense of urgency to rescue Jet Airways given the looming general elections.

With 23,000 jobs at stake, the failure of the bailout plan would send airfares spiraling.

What's the Bailout Plan?

Jet Airways has been in a financial crisis since August 2018, when it began delaying salary payments to its employees.

Jet Airways has been grappling with financial woes and is looking to rejig debt as well as raise funds.

Last week, the airline's proposal to let lenders convert debt into equity was approved by over 97% shareholders.

The bailout plan led by banks and approved by the board of Jet Airways on 21 February, proposed a restructuring plan, under RBI guidelines, to meet a funding gap of nearly Rs 85 billion.

The gap is to be filled through a mix of equity infusion, debt restructuring, SLB (sale and lease back), and refinancing of aircraft, among others.

This complicated arrangement, represents the rescue of one of the country's most visible companies at a sensitive time, with India's general election just weeks away.

High on Debt

Jet Airways defaulted on loan repayments to its banks, casting fresh doubt over the future of India's largest international airline.

The company said it had failed to make repayments to a banking consortium, led by State Bank of India, that were due on 31 December.

It is evident from the chart below that the company is borrowing more to fund its operations.

Thus, its liquidity situation is stressed. The networth of the company is negative since liabilities have exceeded assets.

Its interest costs have been the highest in the December 2018 quarter.

Jet Airways Increased Borrowing & Rising Interest Costs

For now, a Rs 85-billion lifeboat is being readied, but will it end the crisis? Hardly. A more long-term solution will be needed.

How's the Stock's Performance?

At the start of 2018, the stock price of Jet Airways hit a multi-year high.

But as crude oil prices kept rising higher and the overall bull market lost its steam, the stock crashed as much as 80% by the start of October.

Failing to Take Off

The airline posted a loss of Rs 13 billion in the quarter ended September 2018, with liabilities rising further.

This is not to say that the company hasn't created any wealth at all. Here's what co-head of research, Rahul Shah opined on its share price performance:

  • "Those lucky to get into the stock when it was making its multi-year lows have certainly been rewarded with strong gains over the next few months.

    But this is where the problem is. The highs have come just as fast as the lows. There are hardly any 2-3 year stretches where the stock has given positive returns.

    Therefore, for a long-term investor, whose minimum time horizon is two years or more, investing in the counter has been a painful exercise."

So, is it just Jet Airways causing trouble for the sector?

A Look at How Jet's Competitors Are Faring...

Jet Airways' rivals are not faring much better.

The entire aviation sector has been hit by fuel prices woes, depreciating rupee, and debt to fund aircraft purchases.

Their troubles are further worsened by rising pilot shortages.

State-run Air India Ltd is surviving on government bailouts worth billions of dollars.

Spicejet and Go Air are also grappling with their own issues.

Other Indian airlines are struggling too. This includes market leader Indigo, which recently joined the sorry parade reporting a 75% fall in its net profit last quarter.

Hence, it is important to note that certain industries have poor economics compared to others.

Investors would do well to keep this in mind, particularly in the case of aviation.

Investors need to understand the industry dynamics before buying up aviation stocks.

Now coming back to Jet Airways crisis, do you think this bailout package will be able to steer the Jet ship forward? Or will it go the Kingfisher way?

Let us know what you think.

Until next time...

Best Regards,
Rini Mehta



This article (The Jet Airways Crisis in 6 Charts) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/PlF9VniM4vQ/detail.asp

Look for Promoter Pledging in Companies Before You Invest


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Over past few months, you would've come across headlines like these:

Reliance Group shares rise up to 13% after lenders agree not to sell pledged shares till September.

Essel Group pledged Zee's shares to raise funds.

In recent weeks, stock market investors have been hit by sharp swings in prices after news of high promoter pledging, sale of pledged shares by lending institutions, and agreements between the lenders and promoters to go slow on such sales.

Shares of the Zee group have plunged between 15-60%, while Reliance group stocks have dipped 60-80% on such incidents.

Reliance Group & Zee Group Shares' Underperformance

A large number of India Inc promoters have been forced to draw loans by pledging their holdings.

Last week, non-banking finance companies, especially L&T Finance and certain entities of Edelweiss Group, sold 318.1 million pledged shares worth Rs 5.5 billion of Reliance Group, leading to a loss in investor wealth of Rs 130 billion.

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Reliance Communications failed to take necessary approvals from its lenders and the Department of Telecommunications (DoT) to conclude its deal with Reliance Jio. It then opted for insolvency proceedings on 1 February 2019. It's lenders resorted to panic selling of shares in four Anil Ambani-led companies, including Reliance Capital, Reliance Communications, Reliance Infrastructure, and Reliance Power.

As a result, the promoter's stake in Reliance Communications and Reliance Capital slipped below 50%.

What is Share Pledging? And Why Should Investors be Bothered?

Would you ever lend money to a person neck deep in debt? A person who has even mortgaged his house and personal belongings?

Most likely, the answer to this question will be 'No'!

Now consider this situation: Promoters of a company have taken debt by keeping as collateral their controlling stake of the very company they own.

Will you invest in such a company whose promoters have 'pledged their shares'?

No? Well, many investors actually do invest in such companies.

Simply put, pledging of shares is taking a loan against the shares one holds.

Post the Satyam scandal, share pledging is seen as a critical factor in picking up stocks.

What's more, there has been a rise in the value of pledged shares. You can see in the trend below:

Promoter Pledging on the Rise

Now, let us dig into the reasons for pledging...

Promoters, to raise funds for either personal or company needs, pledge their holding shares to a financial institution.

In short, pledging by itself is not illegal or bad. The motive is wide ranging and the intention could be either noble or questionable.

We believe, high promoter pledging can lead to high volatility in the stock price.

Why? Let's explain this through an example.

Let's assume the promoter of a hypothetical company A, decides to pledge 10% of his shares. Let's also assume that when this happens, the price of A's stock is Rs 100 per share.

The bank may set a level, say Rs 80, to which if the price falls, the promoter would need to repay the loan or pledge more shares.

In a few months' time, the price of A dips to Rs 80. At this point, the bank could ask the promoter to repay some loan or pledge more shares.

If the promoter is unable to repay, he could be compelled to increase the pledging to 20% of his total shares. This process could go on till the pledging reaches 100% or the promoter repays the loan.

This is where the catch lies!

If the promoter is unable to pay the loan or pledge any more shares, then the bank has the right to sell the shares in the open market to recover the loan.

A bulk sale of this sort could send the stock price crashing.

Think of how that would affect the shareholding of ordinary investors. Such an event reflects poorly on the promoter as well as on the company because it questions their ability to repay their loans.

Following are the top 10 companies with very high level of promoter pledging.

Top 10 Companies with Highest Promoter Pledging

Here's what Research Analyst & Editor of Hidden Treasure, Richa Agarwal, thinks about promoter pledging:

  • "The promoter using pledged shares as a way of raising capital is okay. However, from a small retail shareholder's standpoint, a high amount of pledging with bad financials could lead to the banks or financial institutions (who hold these shares as a collateral) to dump them to recover their dues. This would then have a cascading effect on the stock price as well, resulting in a huge loss for the shareholder."

What Next?

This makes it clear that promoter pledging can turn out to be a major investment risk. Investors would do well to check this before considering any stock for investment.

We at Equitymaster have developed a stock screener for investors to screen companies which have high level of promoter pledging.

Note that, share pledging is not an illegal activity. However, you must keep an eye out for such data points especially for companies with questionable managements.

For those looking to delve into stocks in beaten down sectors, it makes sense to check promoter pledging before making their decisions.

No matter how attractive a stock may seem, investors must keep away from companies where the debt overhang situation become difficult to assess.

It is better to be safe than sorry. Over leveraged firms with high percentage of pledged shares could very well turn out to be value traps.

Best Regards,
Rini Mehta



This article (Look for Promoter Pledging in Companies Before You Invest) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/84rW1xAdFMo/detail.asp

Chalet Hotels IPO: Should You Bet on This High-End Hotel Chain Owner? (Subscriber Feature)


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K Raheja Group-promoted Chalet Hotels is set to launch its initial public offer (IPO) in the price band of Rs 275 to Rs 280 per share.... [Read More]

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Does Maruti Suzuki's Poor Performance Indicate a Rough Ride for the Automobile Industry?


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With electrification of vehicles catching up fast, the world's economy may change from being oil-driven to dependent on lithium, cobalt, etc.

The introduction of electric vehicles is going to transform the automobile industry in a big way.

In times like these, everyone wants to know 'what's up with automobile stocks?'

Especially looking at the current scenario, nothing seems to be going well in automobile stocks and even the beginning of 2019 is adding more woes to this sector.

Market participants were jolted out of their seats after Maruti Suzuki reported a sharp narrowing of operating profit margin to under 10%. The company's weakening sales volume data have given the impression that the company has hit a rough patch. It looks like it will be a rocky road to recovery.

So, is it only Maruti Suzuki or all automobile stocks?

Both benchmark indices are on a negative trend. One of the reasons for the bloodbath in these two indices can be attributed to the beating automobile stocks have been facing.

All Automobile Stocks in Red
All Automobile Stocks in Red

To investors' horror, the S&P BSE Auto has plunged by nearly 25.3% in past one year. Almost every stock in this sector is on a hotbed.

As you can see in the table above, all the components of BSE Auto index have fallen. Tata Motors and Motherson Sumi Systems have plunged over 40% in past one year. While, Bharat Forge, Ashok Leyland and Maruti Suzuki fell over 30% during the same period.

Underperformance of BSE Auto Index
Underperformance of BSE Auto Index

What exactly happened to the ever-growing automobile sector?

Road Block & Road Ahead...

Year 2018 turned out to be a mixed bag for the domestic automobile industry.

Just like many other sectors, the automobile sector too, was caught up in the tide of the major macroeconomic woes this year.

The year started off with a bang. The industry was motoring along well having digested the cramps of demonetisation and the partial disruption due to the roll-out of GST.

In fact, the passenger vehicle industry grew in the beginning of the year. The sale of passenger vehicles (PV) grew by 7.9% in April-March 2018 over the same period last year. Also, the overall commercial vehicles (CV) segment grew by 19.9% in April-March 2018.

Things went awry thereafter as adverse macroeconomic factors such as rising fuel prices and interest rates took a toll.

Talk of electric mobility also gathered steam during the year with the government and industry deliberating at length on the way forward for India.

Then from taxing conventional vehicles more, banning diesel vehicles in its entirety, to incentivizing only vehicles for fleet or battery technologies, a number of options were debated.

While PV showed growth in the first part of the year, the challenge arose in keeping the trend on account of a high base in 2018. The speed of growth slowed down towards the end of the calendar year across segment with the fuel price increase, domino effect due to non-banking financial companies (NBFC) issues and high interest rates.

The festival season also disappointed the segment with tepid sales of PV's.

However, by the end of the year, there were some early visible green shoots of recovery. Oil prices have softened. Interest rates have also been capped with the RBI maintaining status quo in its quarterly review in early December.

So, Should You Invest or Stay Away?

So, coming down to the final and most important question in your mind, should you invest or stay away from automobile stocks?

One thing we must keep in mind is that not all auto companies will make money over time. And also, you shouldn't stay away from auto stocks altogether.

Even Tanushree Banerjee, Co-head of research at Equitymaster believes that there are businesses in this sector that you cannot ignore. She is particularly talking about the blue-chip auto stocks.

Here's Tanushree:

  • One out of every three household in India is a buyer of their products. They own some of the cult brands in Indian automobile space. They have formidable R&D teams. They have been through several economic cycles over decades. Few have even visited near-bankruptcy in the past and come out successful.

    Yet, some of the biggest passenger car, commercial vehicle, and two-wheeler companies in India have seen a huge dent in valuations in recent times.

    This could be the opportunity long term investors were waiting for.
Bluechip Auto Are Stocks Way Off Their Valuation Peaks

Going forward, while the demand of passenger vehicles has kept growing, there will be challenges like new safety norms and the transition from BS-IV to BS-VI fuel in 2020 that may act as speed breakers.

In preparation for the new regulations, manufacturers may also hold back some new product introductions.

Now while the pessimism surrounding auto stocks keep most of us wary, you must look at the sector with the long-term perspective.

In the long run, India's growing working-age population will keep the demand for private vehicles high.

As far as macro trends are concerned, what you must keep in mind is that what happens in the stock markets is often not in sync with the business realities.

India's automobile firms will do well in the long-term. However, you need to be selective in picking stocks from this space.

Best Regards,
Rini Mehta



This article (Does Maruti Suzuki's Poor Performance Indicate a Rough Ride for the Automobile Industry?) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/aqFwD6bdYLc/detail.asp

Is it the Time to Buy Aviation Stocks as Fuel Costs Fall?


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The past one month was fantastic for Indian aviation stocks like Indigo and SpiceJet, which rose 9% and 8%, respectively. It was only Jet Airways, that declined during the month.

But Jet Airways has been facing another set of issues altogether.

Jet Airways' woes got much worse last week, with the cash-strapped airline defaulting on its loan repayments to a consortium of Indian banks led by the State Bank of India.

This debt default, the airline's first, marks a serious deterioration in its troubled state of affairs that has seen it delaying salaries and aircraft lease payments.

But that's a topic for another day.

Coming back to surge in share prices of airline stocks last month. What was the reason for this industry-wide jump?

Two words: Oil Prices.

High Crude Prices Ground Aviation Stocks

Fuel is the largest expense for airlines. Fluctuations in fuel prices have the single biggest impact on an airline's bottom line in the short term.

Because the cost of jet fuel corresponds tightly to crude oil prices, movements in the price of crude oil affect how much airlines pay for Aviation Turbine Fuel (ATF).

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So, when oil prices go up, airline stocks feel the pinch. When oil prices drop, airlines can make hay while the sun shines and their share prices usually increase.

Best example is 2014 when oil prices dropped by more than 50%. Aviation stocks were flying high that year.

As you can see in the chart below, lower ATF prices resulted in the industry reporting positive operating profit margins since 2015.

With 2016 reportedly being the best year of profitability in over a decade. The ATF prices stayed at multi year lows of Rs 30-40 per litre.

Falling ATF Prices During 2014 Boosted Airlines' Profit Margins

Of course, the opposite is also true.

When oil prices climb, as they did in the second half of 2017, airline stocks tend to underperform the broader market.

That is exactly what has been happening until now.

The sector got an apt New Year present of lower ATF prices.

According to Indian Oil Corp. Ltd, average ATF prices for domestic airlines, at the four metros, have declined by nearly 20% compared to the average for the December quarter. These are the lowest monthly prices in this fiscal year.

In a relief to India's aviation industry, oil marketing companies slashed jet fuel prices by around 15%.

This is the second consecutive reduction in the prices of ATF after around 10% cut in December.

ATF costs has been the major reason to why airlines posted lackluster earnings in Q2FY19. Indigo's fuel cost rose by a whopping 84% in Q2FY19.

The chart below shows how with an increase in oil prices, the net profits of the companies fell during the September quarter in 2018.

Rising Fuel Costs of the Airline Stocks
Poor Q2 Performance as Fuel Costs Rise

However, important to note here is that, its not only oil prices that drive the shares of airline companies. A case in point is Jet Airways and Air India.

Broader economic indicators can also have a big impact.

On top of that, OPEC and Russia recently announced a production cut, which caused oil prices to rise. However, that bump was short-lived.

So, while it seems that lower fuel prices may be likely to stick around through the year after all, it's important to know that the lower fuel price environment is not necessarily a permanent feature.

There is always the risk that prices will inch higher.

Over the past one year, all the listed airline companies in India have underperformed the benchmark index.

It can of course be argued that the very fact that these stocks have underperformed could now turn them into potential future winners. After all, stocks revert to the mean, don't they?

Of course, they do.

But let's first see what co-head of research at Equitymaster, Rahul Shah has to say about it:

  • "But the principle is applicable to companies that are efficiently run, have strong balance sheets and are only victims of an economic downturn or the downturn in the industry. But when companies have negative networth like both Jet and SpiceJet do and also have balance sheets loaded with debt, it is usually a good idea to stay away from such companies rather than invest in the hope that things will indeed turn around one day.

    If they haven't all these years, there's a very small possibility that they will in the future. And one shouldn't bet too much money on a scenario that with little or no upside and the downside that can go all the way to possible bankruptcy."

So, what can we conclude here?

No doubt the capacity has been growing at a brisk pace, the important question whether lower fuel prices will ensure that load factors remain high.

Load factor measures the capacity utilisation of public transport services like airlines. It is used to assess how efficiently a transport provider fills seats and generates revenue.

So, while the trends on demand and load factors are yet to play out, the positive factor right now is that ATF prices have come back to levels where low-cost airlines can generate decent profits.

Also remember, although air travel is becoming the new normal, investors need to understand the industry dynamics before buying any aviation stock.

Best Regards,
Rini Mehta



This article (Is it the Time to Buy Aviation Stocks as Fuel Costs Fall?) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/x9yuRRq-ZBs/detail.asp

Airtel, Vodafone-Idea or RJio - Who Will Win the Telecom Race?


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The giants that ruled a couple of years back went extinction when a new baby was born in this country.

India's richest man Mukesh Ambani's telecom baby, Reliance Jio, was born in September 2016.

With the launch of Jio, India's telecom story was re-written. India's biggest operators, Bharti Airtel, Vodafone India, and Idea Cellular were caught by surprise, and they were yet to gauge what was in store for them in the coming times.

In a matter of just 12 months, the 12 telecom operators in the country, suddenly shrunk to 4.

Small players vanished from the market. Others who survived, started counting days that are left, unless they do something new. They are forced to revisit their strategies, and in most cases, follow the newcomer.

Market Share: Then & Now

The entry of Reliance Jio resulted in a tariff war, which forced even a large corporate house like the Tata Group to exit the industry (In October 2017, Tata group decided to sell its consumer mobile business segment to Bharti Airtel virtually for free).

Following a year-long consolidation, the current stage where the incumbent players, Bharti Airtel, Idea+Vodafone and BSNL+MTNL (Public sector) are hemorrhaging has possibly reached the last lap.

The last lap is running to the pace of RJio.

With the market share divided among several players in 2016, the top 3 players have captured most of the market.

See the chart below.

In terms of subscriber market share, Vodafone Idea has the highest market share of 38%, followed by Bharti Airtel at 29.8%. Reliance Jio stands third with 18.4% market share.

What About the Financials?

Here again, the incumbents have been badly impacted.

In the June 2016 quarter, before new entrant Reliance Jio Infocomm Ltd started steering the ship, Bharti Airtel's India wireless unit boasted annualized revenue of more than Rs 600 billion.

Notably, revenues and profits have fallen almost every quarter since then.

However, in the September 2018 quarter, revenues are showing the signs of growth. Will these players will now go on the path to recovery?

As our research analyst Taha Merchant believes the situation is unlikely to change soon. Here's an excerpt of what he wrote:

  • "Speaking of difficult businesses, the whole telecom business has been an underwhelming story so far. While the telecom subscriber base has increased from 300 million in 2008 to 1.2 billion in 2017, investors have little to cheer. The BSE Sensex has gone up 3.25 times in nine years, but the BSE Telecom Index has not moved an inch from its levels of 2008.

    Telecom companies are straddled with high debt, intense competition, and lack of pricing power. High spectrum costs and regulatory issues have hampered the sector. While consumers have benefited from low costs and new players fighting for their share, investors have suffered."

Subscriber Base Versus Revenues

Among the three leading players, Vodafone Idea has added over 444 million subscribers as on June 2018.

Interestingly, Reliance Jio, which had 215 million subscribers compared with Vodafone Idea's 444 million as of end-September, made a profit of Rs 6.8 billion in the same period.

The third player, Bharti Airtel lost around 64 million users between June 2017 to June 2018 whereas Reliance Jio added 92 million during the same period.

Reliance Jio Surpasses Bharti Airtel in Terms of AGR

Reliance Jio has surpassed Bharti Airtel to become the second largest telecom operator in terms of adjusted gross revenue (AGR) in the quarter ended June.

In India, AGR has specifically become important for telecom companies since the payment made to the government is based on the AGR.

As per the data released by TRAI, Jio recorded an AGR from access services or revenue derived from licensed services of Rs 71.3 billion for the June quarter, while Airtel's AGR stood at Rs 67.2 billion.

The development highlights strong growth of the new entrant and declining strength of the former market leader. RJio had surpassed Vodafone and Idea Cellular individually in the March quarter but lags them now since the two merged to form Vodafone Idea at the end of August.

Rising Debt...

Meanwhile, as Reliance Jio inched closer to Bharti Airtel in terms of revenue market share, Jio's net liabilities have risen at a fast pace.

Meanwhile, debt-to-equity ratio of the incumbents have also remained high. This simply shows the considerable cash burn at the two firms because of the cut-throat pricing in the industry.

Hence, leverage for the sector seems to remain elevated on relentless competition, which in turn is hurting the profitability. Cash flow generation is constrained because of continued capital spending.

Although the dust in the telecom battleground has settled largely, the sector is at the point wherein no clear market leader emerging on key growth metrics and no distinct industry hierarchy in sight.

In the run-up to 5G, the next stage will mark a qualitative transformation and bring stability to the telecom sector.

But that is still some distance away. In the meantime, incumbents will have to dig in and pour more investment to hold their market share.

Best Regards,
Rini Mehta



This article (Airtel, Vodafone-Idea or RJio - Who Will Win the Telecom Race?) is authored by Equitymaster.

Equitymaster is a leading 'independent' equity research initiative focused on providing well-researched and unbiased opinions on stocks listed on the Bombay Stock Exchange.

Click here to Read full Details Sources @ http://feeds.equitymaster.com/~r/eqtm/~3/2vabczawOlk/detail.asp

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