Capital investments at a tipping point in India

Capital seems to be the sole agenda dominating company boardrooms at the moment. More than $11 billion has flowed into the stock markets since September 2016 validating BW Businessworld’s July 2016 prediction that the capital market would be in boom. Stock markets have hit an all-time high, but global liquidity is not flowing into corporate coffers yet.

Companies are striving to tap this liquidity flow for new investment plans, including capacity expansions. As capacity utilisation peaks in a growing economy, fresh capital is raised for new investments and the pace at which capital is raised determines the pace at which investments can be made. This is the virtuous cycle that sustains growth. I believe that the capital cycle for expansion is set to take off within the next two quarters.

Leaders and Laggards  

Smart promoters running successful businesses are finding ways and means to capture capital flows coming India’s way. Corporate behemoth Reliance Industries (RIL) and its joint venture partner British Petroleum plan to invest Rs 40,000 crore in the KG basin. Even though this was announced on 15 June, plans must have been in the pipeline for at least six months before the announcement, implying that the company was kicking off its capital investment cycle.

In July, the Aditya Birla group announced that it was restructuring its business. Nuovo, its metal and mining subsidiary, will be merged with Grasim Industries and its financial services arm, Aditya Birla Financial Services (ABFSL), will be spun off into a separate entity and listed separately. The idea, simply put, is expansion to unlock value in the business and to raise capital for this expansion by listing ABFSL. The route enables ABFSL to get listed in the stock markets quickly without having to go through the IPO route.

The beleaguered telecom sector is also witnessing a spate of mergers and consolidations, so capacity may be combined and capital be deployed more efficiently. For instance, the Tata Group is looking to merge its telecom business Tata Teleservices with Airtel. And Airtel has decided to invest in its network after a long gap.

The move comes in the wake of the launch of Reliance Jio, which has hit the profits and growth of companies in the telecom sector, making it extremely difficult for many of them to raise funds from banks. In this competitive environment, which business is most capable of attracting global liquidity?

Many traditional promoters are envious of seemingly upstart companies like Flipkart and Paytm, as they suck in billions of dollars from private equity. The cardinal rule of business has always been that when money is available cheap, raise it. Think about deployment later. Indian businesses follow a herd mindset in raising capital and the leaders of the herd have started moving. Once large conglomerates start raising and investing capital, others will follow suit.

 “This is the best time for Indian businesses to start looking at fund raising,” says HDFC head Deepak Parekh, the godfather of the Indian finance industry. “Global liquidity is looking at India as you can see from the number of international bond issues like the Masala bonds that have happened in the recent past. More companies will tap this market.” Promoters would do well to heed Parekh’s advice as the first movers will get cheaper funds.

The Capital Cycle

Companies need to prepare differently for the capital cycle. Banks are saddled with non-performing assets (NPAs) and defaulters’ lists are making headlines, so credit growth in banks is sure to suffer. Non-performing assets of banks amount to Rs 7 lakh crore, of which Rs 1,75,000 crore is what the top 12 corporate defaulters owe banks. The Reserve Bank of India (RBI) and the government have even started insolvency proceedings against these 12 conglomerates.

Companies such as Bhushan Steel, Essar, Monnet Ispat, Electrosteel, Videocon, the Jaypee Group, ABG Shipyards, Era group, Punj Lloyd, Prayagraj Power and Aban Holdings are in this list. Bank credit growth is at an all-time low. Yes, good borrowers can still access credit from Indian banks. But smart corporate houses are really looking at raising funds through the bond market — both domestic and international.

Amit Chandra, managing director of Bain Capital and non-executive director of Tata Sons, the holding company of the Tata Group, says it is much easier for companies with good balance sheets to raise funds. “Bankers are pretty much unemployed these days as they are chasing the few good ones who are not raising capital,” says Chandra, who has a bird’s eye view of the capital situation in the Indian corporate sector.

While banks can still lend, most large industrial groups or families have one or more companies in the NPA list. Several groups such as Essar, have lost their ability to raise funds from banks. A strategic shift is taking place within companies preparing to lead the capital raising cycle. “Private equity is, and will remain an attractive route for promoters to raise funds,” says Munesh Khanna, PwC lead in corporate finance and private equity practice. “Look at the series of long-term funding that has come into the market from global pension funds in the last six months. These funds are willing to invest in good businesses and capable promoters, the ability to take this funding is in the hands of Indian businesses now,” says Khanna.

Private equity has pumped in more than $11.3 billion into the Indian corporate sector from January to June - a record of sorts - and it has gone into funding expansion and acquisition of assets. Some promoters are capital market savvy, like Puneet Dalmia, who has raised funds from private equity KKR early in 2016 to acquire capacity for his company, the Dalmia Bharat Group, so it may be among the top five cement companies in the country.

While several sectors still suffer from excess capacity, the way promoters look at capacity needs to change. “Promoters need to take a long-term view of both capacity and where it is available. It would be myopic if they do not use the current global liquidity to acquire global capacity,” says a seasoned investor, Vinod Sethi. “While India is growing, there is capacity across the world that is available for a song. Promoters need to think in terms of global capacity in today’s world,” says Sethi.

Another factor plaguing the capital crunch is the risk averse nature of Indian promoters, who have in the past, burnt their fingers in overseas acquisition bids. Several acquisitions in Europe made in the last ten years by the Tatas, Avantha and other groups, went down because of the meltdown of the commodity markets.

“Indian business did take the risk and they are having a tough time offloading it, but now they have become completely risk averse,” Sethi says. “It is almost as if they don’t believe in their abilities anymore. When the world is looking at India for growth, this is not the time to be risk averse,” he adds. As a global investor in both public and private companies, Sethi spends a lot of time studying global capital flows.

Companies such as Mahindra & Mahindra (M&M) are optimistic about expanding capacity overseas and its chairman, Anand Mahindra, is already planning investments in a car plant at the Detroit automobiles hub in the United States. A city like Detroit has seen the worst flight of capital and the crumbling of the auto industry there. Now, there are some signs of recovery there and M&M may pick up incentives for its investment.

Capacity and Capital 

Capacity in several industries are close to their peak utilisation rates, and after implementation of the GST, growth is expected to be higher. Arvind Panagariya, economist and vice chairman of Niti Aayog till 31 August, says that after the initial confusion, GST will actually boost the GDP.

“Even if we take the most conservative estimate of 0.5 per cent every year, it will add substantially to the economy in the next five years,” says Panagariya. While the industry is still waiting for the GST hiccups to subside, some sectors have to plan for expansion.

How they build or plan for adding capacity will also vary this time. Promoters who invested in capacity in the last round (2004 to 2008), have benefited from the surge in capacity utilisation. Some of them have been smarter, like the Dalmia Cements Group that used private equity funding in the last couple of years to buy dormant capacity.

Instead of investing in new cement plants, the Dalmia Group bought out cement plants from promoters saddled with debt. Cement capacity is now reaching utilisation rates of 70 per cent to 80 per cent and has to be created according to regions. Capacity utilisation is rising rapidly in the automobiles sector too and analysts expect capital formation by industry leaders like Hero Honda and Maruti Suzuki.

Smart money is looking for opportunity in the power sector where distressed assets exist. Sajjan Jindal, chairman JSW, passed a resolution on 14 June to raise Rs 21,000 crore to acquire distressed assets in the power sector. The acquisitions will be funded from Rs 5,000 crore raised from non-convertible debentures, Rs 4,800 crore raised via foreign currency bonds and Masala bonds, along with a fresh equity issue of around Rs 7,500 crore.

A situation of sorts is developing in the environment, which some promoters are reading right, even though most tend to ignore. While the twin balance sheet problem continues to plague the economy, the pattern of capital formation in the private sector, is changing slowly but steadily. Heading towards an inflection point, smart entrepreneurs are now looking at alternative routes of funding for expansion.

Fancy Masala Bonds

For the first time in financial history, bank credit fell below 50 per cent of the credit raised by companies. Banks’ share in the flow of credit to commerce was 38 per cent in the last fiscal, down from 50 per cent a year earlier, as per data from the RBI’s Financial Stability Report.

“A lot of credit has moved from banks to non-banks and disintermediation through markets will continue. It is inevitable, this is a natural course and, in my mind, a progressive development for the markets,” Uday Kotak, executive vice-chairman of Kotak Mahindra Bank told a national daily recently.

In the April-June quarter, bond sales worth Rs 1,04,000 crore were arranged by investment bankers. These bonds have mostly been raised for expansion projects and in some cases, to retire high-cost bank loans. The difference in the bond yield and bank rates, now hovering around 100 to 200 basis points, is a substantial saving for good companies.

The bond market has been growing at 15 per cent and is developing fast as an alternative to bank credit. The market has acknowledged the shift in the source of capital and driven up the value of listed NBFCs. Some top NBFCs, like JM Financials, have appreciated very fast. Some are quoting at three to four times their book value, while state-run banks quote at just one or one-and-a-half times their book value. Rating agencies peg the growth of NBFCs at 18 per cent to 20 per cent per annum.

The credit market is shifting, as NBFCs and new instruments replace bank credit. This means that companies need to prepare themselves for alternative routes of funding. The NTPC, NHAI, HDFC and Shriram Transport Finance are some large companies that have used Masala bonds to raise funds this year.

Indian companies and banks have raised $7.6 billion in the first six months of 2017. Spreads at issues — the difference between the bond yield and the benchmark yield during the first-time issuance — have been coming down. Bond yields in most of the developed world are at historic lows, global investors are chasing higher yielding emerging-market debt including India. This, as Deepak Parekh points out, are the best of times for Indian companies to tap the global bond market.

The stock market has already culled out leaders of tomorrow, based on their past performance and management capability. But the real leaders not only in the market place, but for the future, will be organisations that can ride the capital wave. Only if they are ahead of the surf will they be successful, the laggards and the followers have a high chance of being drenched or swerved by the wave.

--ends

This article was also published in Businessworld magazine here https://businessworld.in/article/Capital-Cycle-Now-Ready-To-Take-Off/09-08-2017-123725/

Update to the article on sept 4, 2017:

Two important developments one the the spread between masala bonds and sovereign bonds has further eased making them more attractive for corporates to raise funds. See this report here https://economictimes.indiatimes.com/markets/stocks/news/spread-between-masala-sovereign-bonds-eases/articleshow/60356617.cms

Second , the largest bank in the country State bank of India is also going the bond way doing a $ 3 billion bond to raise long term funds. The banks are now dipping into global bond market to sure up their funds, if the banks can do it, will the corporates wait.

https://economictimes.indiatimes.com/markets/bonds/state-bank-of-india-planning-3-bn-green-bonds/articleshow/60354006.cms