Is cash really king?

Many Indian companies are sitting on a pile of cash. But not all of them have sound finances.
Heres how you can pick the right stocks and enjoy their largesse
India Incs growing cash pile has been under the scanner, of late. Former directors of Infosys
have been demanding that the cash surplus of the company be used to buy back shares to take the
stock price to its right valuation.
Similarly, the Government has been receiving flak for making Coal India shell out a special
dividend that amounted to over 18,000 crore. Of this, around 16,500 crore was pocketed by
the Government.
It is obvious that some of our blue-chips are sitting on large cash balances. Does that mean that
selecting a company based on its cash and bank balance is a good idea?
Many of the countrys top-line companies do have a large cash pile. But not all companies with
large cash and bank balances have sound finances. You need to double-check the numbers to see
if the company is accumulating cash by foregoing capacity addition. Others could be borrowing
heavily despite holding surplus cash reserves.
That said, there is a strong case for investing in cash-rich companies too. The surplus cash can
help fund the companys future expansion without diluting its capital. Some of these companies
might also decide to share some of this cash with their shareholders in the form of dividends.
Looking at a companys cash and bank balance can be one of the checks that you can run while
selecting a stock. We run through the numbers of the last 10 years to give you some takeaways.

Sitting on a cash mountain

It is the fat-cats of India Inc that top the list of companies with the most cash balances and
investments.
A lot has been said about the large cash surplus of the private sector behemoth, Reliance
Industries, and how its income from investments is more than making up for sluggish phases in
core operations. The company tops the list with a cash balance of 37,984 crore and money
parked in investments such as debt, mutual funds and shares of other companies of 61,325
crore towards the end of FY2014.
The Governments favourite cash cow, Coal India, is next with cash balance amounting to more
than 52,389 crore. The Coal India Chairmans recent statement that he is not interested in
earning income from cash surpluses is reflected in the investment portfolio of just 3,775 crore
held by the company.
Among the Tata Companies, Tata Motors has the largest cash reserves with cash balance of
29,712 crore and investments, mainly in mutual funds, of 10,686 crore.
It is obviously the effect of the acquisition of JLR that has turned the fortunes of the company;
Tata Motors cash balance has grown manifold since it took over the company in 2008.
Following close on the heels of Tata Motors is another company that is bearing the brunt of
analysts ire for holding on to surplus cash and not re-investing it for business growth Infosys.
The company too appears to be holding on to the cash for lack of attractive investment avenues.
This is borne by the fact that the cash balance has more than doubled from 10,556 crore in
2010 to the current 25,950 crore.
The other IT majors TCS, Wipro, HCL Technologies feature in the list of top 50
companies with surpluses -- holding between 10,000 crore and 20,000 crore of cash and bank
balances and investments.
The other set of companies that stand out in accumulating cash reserves are the public sector
enterprises. Almost all the profitable PSU companies feature within the top 50. These include
ONGC, NTPC, NMDC and Oil India. But most of these companies are managing their surplus
funds poorly. Most of them have less than half of their surplus funds parked in higher-return
generating instruments, besides bank deposits.
Among the Nifty companies, most feature within the list of the top 100 in holding cash. United
Spirits comes in at the bottom of the list with cash and investments of just 461 crore.
Some of the others in the Nifty basket with low balances are Asian Paints, Dr Reddys
Laboratories, Jindal Steel and Power and DLF.

The last decade

If we consider the cash balances of listed companies with comparable numbers available 10
years ago, it indicates that companies have more surpluses in 2014 than they did in 2004. Cash
and bank balances have increased nine-fold during this period.
Not only do cash balances tell us about a companys finances, they also give us clues about the
health of the economy. There is a strong correlation between the business cycle in the country
and cash surpluses of companies. For instance, in the boom years of FY2005, 2006 and 2007, the
amount held by companies in cash recorded a sharp jump.
But this amount contracted in 2008 following the sub-prime crisis when economies contracted
sharply.
Going by this metric, the Indian economy is not yet out of the woods. For cash balances shrunk 5
per cent in FY2014. This could be a result of tight liquidity conditions that might have made
companies delve into their surpluses.
If we look at the movement in cash balances of individual companies over the last 10 years, it is
apparent that the bigger companies have had to hold on to more cash after 2008.
As the economy began slowing down, companies seem to have put their expansion plans on
hold. Their profits continued to grow, thus resulting in jump in cash surpluses. For instance, cash
held by Reliance Industries was just 4,280 crore in March 2008. This jumped to 22,176 crore
in 2009 and has remained elevated ever since. TCS held 527 crore as cash in March 2008.
This number increased to 12,566 crore by March 2014, resulting in the company paying a hefty
dividend recently, almost equalling its cash holdings, to its shareholders.
Tech Mahindras cash balance increased from 81.4 crore to 2,826 crore during this period.
Why go for cash-rich companies
Blindly picking a company based on its liquid cash balances and investments is not a great idea
since the number could be due to a one-off event inflating it; or worse, it could just be a sleight
of hand.
But if you do the due diligence and pick a company with large cash holding as well as a
profitable business and good management, it can work wonders for your portfolio returns. Here
is why.
Such companies generate enough and more from their operations that enables them to save up a
pile with which future business growth can be funded.

Ready money for expansion

Mukesh Ambani recently announced that Reliance Industries plans to make an investment of
1.5 lakh crore over the next few years to grow its various segments. Not many eyebrows were
raised at this announcement.
Since the company holds cash and investments of close to 1 lakh crore it does not need to take
on large debt or increase its equity to fund this expansion.
The cash reserves with technology companies such as Infosys, TCS and Wipro are also
comforting. It means that they have cash available to buy smaller companies, when the
opportunity arises; since these companies mainly resort to inorganic growth.
There are, however, companies such as Coal India that keep complaining that lack of
infrastructure is impeding business growth but do little to use their surplus cash reserve to
improve the facilities available. Investing in such a company, expecting it to change its colours
in future, is not a good idea.
Hefty dividends
If you belong to the camp of investors who buy shares for the dividends paid to shareholders,
then logging on to some of the companies with large surpluses will help. The companies that are
unable to find suitable venues for investment are likely to reward investors with large pay-outs.
It is the public sector companies that score high on this parameter as the Government tries to
extract its pound of flesh in the form of dividends. ONGC has been consistently sporting a
dividend yield of between 3 and 4 per cent over the last five years. Oil India is another PSU that
has been generously doling out money. The dividend yield for Oil India was 5.87 per cent in
FY13 and around 3 per cent in the preceding three years.
The private sector companies are more miserly in this aspect. Reliance Industries has a dividend
yield of less than 1 per cent over the last five years. Bharti Airtel and Idea Cellulars yields were
less than 0.5 per cent. Piramal Enterprises that is sitting on a pile of money after hiving off its
core operations is one of the rare companies in the private sector that pays hefty dividends. The
dividend yield in FY14 was 9.6 per cent and the number fluctuated between 2 and 3 per cent in
the years before that.
Buybacks, open offers
The arguments in favour of a buyback, when the company does not have opportunities to utilise
the surplus money elsewhere, are many. The company would be better off investing in its own
shares as opposed to investing in the shares of another company.
Making a buyback offer at a price higher than the prevailing market price signals that the
company has confidence in its own prospects and thinks its shares are undervalued. Again, such

actions reduce the number of outstanding shares of a company thus improving the financial ratios
of the company.
RIL has launched multiple buyback offers in its history, backed by its comfortable war chest.
Other companies that feature in the cash-rich list, such as Cairn India, Zee Entertainment and GE
Shipping, have also recently made buyback offers.
Despite many of these offers not going through due to sharp increase in share prices around the
announcement date, shareholders stand to benefit by the increased return on their holdings due to
the increase in stock prices.
If you hold shares in a multi-national company that also holds a lot of cash reserves, there is a
high probability of the parent making an open offer for the shares at a price far above the market
price. The open offer in Hindustan Unilever in 2013 for 22.5 per cent stake in the company at a
hefty premium of over 20 per cent above the stocks market price is a case in point.
Here are the checks you run before you put your money into a cash-rich
company
The balance held by a company in its bank account can give the impression of a sound edifice
but it could turn out to be a pile of rubble if you take a closer look.
Here are a few parameters you can run through before buying that cash-rich companys shares
you have been yearning for.
Operating cash flows
The companies that have large cash surpluses are mainly those that have been generating cash
from operations consistently over the years.
But there are some that do not conform to this trend and are best avoided. For instance, Indian
Oil Corp, despite generating the second highest cash flow from operations in FY2014, IOC
generated negative cash flow in many years over the past decade. Similarly, companies such as
Gammon India and DLF display the propensity to declare negative cash flows.
This shows that even if these companies have large cash balances towards the end of some years,
their operations are not profitable enough to enable them to accumulate large cash reserves over
the long term.
Looking at the proportion of revenue that is held back by the company after accounting for
operational expenses (operating cash flow/revenue) is another measure that can help us gauge the
extent of profitability of the company. Companies such as Bharti Airtel, NTPC, Infosys, Coal
India, ITC and Idea Cellular are more profitable on this parameter with cash generated from
operations of around 20 per cent of sales.

On the other hand, companies from the Tata group appear far less efficient if we apply this
metric. Despite generating large revenues, cash generated from operations for companies such as
Tata Steel, Tata Motors and Tata Power is less than 10 per cent.
Addition to gross block
Some companies could be foregoing investments in their own businesses resulting in large cash
surpluses. You need to avoid such companies too.
Indian companies are expanding their capacities and adding to their assets, but at a sedate pace.
Reliance Industries, for instance, grew its gross block three-fold between 2004 and 2014. The
other topper in sporting strong cash balance, Coal India, did not even double its asset base in the
last decade, showing the PSU giant in very poor light.
Other private sector companies such as UltraTech Cement, ITC, Maruti Suzuki and Larsen and
Toubro have also similarly managed to grow their assets at a rate of between 300 and 600 per
cent in the last 10 years.
The public sector enterprises, on the other hand, have been lagging in asset additions.
PSU companies such as BPCL, MMTC, BHEL and NMDC have shown slower growth in asset
base compared with their private sector peers.
This slow pace of upgradation and capacity additions probably explains the lower efficiency and
productivity of the PSUs compared with their private sector counterparts.
This unwillingness to invest in capacity addition is affecting profitability, which is reflected in a
falling return on equity (ROE) of these companies. Reliance Industries, for instance, had a very
low ROE of 11.7 per cent is FY2014. This number has almost halved from the ROE of more than
20 per cent prior to 2008.
Similarly, Infosys ROE has declined from 36 per cent in 2008 to 26 per cent by 2014. ONGC
too has seen this ratio decline from 25 to 17 during this period.
Debt equity
A company that does show large cash surpluses but keeps borrowing to finance its activities is a
no-no. But fortunately, most of the top-50 cash-rich companies do not have much debt.
Some such as Gammon India, which despite having a cash surplus of 9,045 crore in March
2014, has debt equity ratio of over 19. Essar Oil too held 3,632 crore in hand but its alarmingly
high debt equity should be enough to send investors scurrying from this counter.