Two of Reserve Bank of India (RBI)’s “dirty dozen” corporate borrowers, which entered bankruptcy process under the National Company Law Tribunal (NCLT) are unlisted companies. The aggregate equity market capitalisation of the remaining 10 as of 20 April 2018 was a little over Rs3,000 crore. Many financial commentators have expressed surprise at the stock market valuations of these 10 companies. Who is buying these stocks? After all, the bankruptcy process will ensure that these stocks goes to zero.

 

Take the example of Alok Industries. The equity market cap of the company on 20 April 2018 was Rs307 crore at Rs3.14 per share. Last week, we learnt that Reliance Industries’ joint bid with JM Financial Asset Reconstruction Co was rejected by the creditors of Alok Industries. Which means that the company will be liquidated.

 

Now, one problem is that liquidation value is that it is almost always going to be far less than money owned to lenders. In the case of Alok Industries, media reports tell us that its liquidation value is estimated to be Rs4,200 crore while claims of lenders add up to more than Rs29,000 crore.

 

If Alok Industries is liquidated, it is certain that all the money will go to the lenders and they will still not get back most of their money. Under those circumstances, how can equity have any value?

 

I often cite such situations in my class by using an image, which I call “Canine Capital Structure.”

 

Canine Capital Structure

 

 

The dog in the end (the equity owner) will have nothing left over for him if all the food in the bucket is taken by dogs ahead of him in the queue.

 

The same logic applies the cases other than Alok. Whether those companies are liquidated or sold to a successful bidder, its almost certain that lenders will not recover all of their money. And if that is going to be the case, then equity can have no value. In liquidation cases, like those or Alok Industries, this is easy to visualize and understand this. Not so, however, if the company is sold. But as other commentators have pointed out it, it will not matter. Dilution will ensure that current stockholders in these businesses will lose almost everything.

 

Incidentally, this particular behaviour of the market participants is not unusual. Indeed, Benjamin Graham wrote about it in the third edition of this book, “Security Analysis”.

 

When a company has senior issues and common stock, and all its securities are of speculative calibre, the common sells too high. This is caused by the speculator’s frequently exclusive interest in common stocks and his preference for low-priced issues.

 

These overvaluations within a company are not so much in a class by themselves as they are vivid illustrations of the general tendency for speculators to buy regardless of price. When there is a senior issue available for comparison, the fact of overvaluation may often be established almost mathematically.

 

(Sanjay Bakshi is an investor and Adjunct Professor at Management Development Institute, Gurgaon.)

The RBI has signalled the prospect of a more hawkish stance on interest rates despite lowering its inflation forecast for the current year at its first monetary policy review of the fiscal earlier this month, according to the minutes of the central bank's latest Monetary Policy Committee (MPC) meeting here released on Thursday.

 

On April 5, the Reserve Bank of India (RBI) maintained the status quo on its repo, or short-term lending rate for commercial banks, at 6 per cent for the fourth bi-monthly review in succession, along with its 'neutral' stance.

 

The released minutes showed that RBI Deputy Governor Viral Acharya is likely to vote for "withdrawal of accommodation" when the MPC meets in June. 

 

"Since the last MPC meeting, I have moved substantially closer to switching from the neutral stance to beginning the process of withdrawal of accommodation. This is in spite of the softening of inflation in recent prints," said Acharya as per the minutes. 

 

"I view the (Inflation) risks as tilted significantly to the upside given the continuing rise in the ex-food-and-fuel inflation. Besides oil prices, my another primary concern is the risk of fiscal slippages, at both the Centre and state levels.

 

"It is important to let some more hard data come in, especially on growth, and allow some more time to let the early skirmishes on the global trade front play out," he said. 

 

As per official data, retail inflation based on the consumer price index (CPI) eased marginally to 4.28 per cent in March, from 4.44 per cent in February, but remained outside the RBI's medium-term target of 4 per cent. 

 

In a repeat of the previous policy review in February, five members of the MPC, including the three external ones and the Governor, voted in favour of the decision, while RBI Executive Director Michael Patra voted for an increase in the repo rate by 25 basis points.

 

The MPC statement after the meeting said the recent volatility in global crude prices has brought considerable uncertainty to the near-term inflation outlook. 

 

"Does it present a persuasive case for an easier/neutral monetary policy stance? It is important to recognise that volatility in the prices of vegetables is obscuring a clearer evaluation of underlying inflation pressures," according to the assessment by Patra. 

 

According to RBI Governor Urjit Patel, the inflation outlook faces several uncertainties emanating from the increase in minimum support prices for kharif crops, volatile crude oil prices, "the staggered impact of revision in HRA by various state governments, fiscal slippages by the Centre and the states and the performance of the monsoon".

 

"I would like to wait for more data and watch how various risks to inflation evolve, going forward. I, therefore, vote for holding the policy repo rate at the current level and maintaining the stance as neutral," Patel said. 

 

External member Ravindra Dholakia also cited several uncertainties around the inflation forecast, as per the MPC minutes. 

 

"There is hardly any evidence on employment growth picking up to a level that would put upward pressure on the wage growth. 

 

"Fears of a trade war among major global players are turning increasingly realistic with likely adverse impact on our exports and costs of production. It may severely affect our growth recovery over the coming year," he said.