BULL RUN SCENARIO: INVESTMENT IN HOLDING COMPANIES

The domestic equity markets have done phenomenally well in the last one year. The first part of the Bull Run which started from August 2013 was on back of measures undertaken by the RBI, including raising import duty to contain gold imports, forex swap window facility, etc. These measures led to the Sensex touching a high of 22,467 in the month of March 2014 from the close of 18,620 in the month of August 2013 – a rise of 20 per cent. Again on May 16, 2014, the markets got signs of the emergence of political stability which led to the equity markets spurting once again by 12 per cent to the Sensex hitting a lifetime high of 27,319 on September 8. In the last one year, except in January and February 2014, the domestic equity markets have been making new fresh highs every month. 

Playing Out a Theme

In the domestic equity markets many holding companies are listed. There are many companies which hold shares primarily of group companies. There are two types of holding companies – some companies have core businesses on their own and also have substantial investments in group companies - examples are EID Parry, Tube Investments, etc. The second category is that of companies whose investments in other companies are substantially more than the investment in their core business or the investment in core business is negligible. The examples in this category are of Bombay Burmah Corporation, Tata Investments, etc. We have taken up about 15 holding companies belonging to the second category to study how they performed in the markets vis-a-vis the broader markets in the last six years.
   
Historically the holding companies never enjoyed optimal valuations on the secondary markets – they always traded at discounts to the value of investment they hold at market prices. The discounts (the gap between enterprise value and market value of investments) to the enterprise value ranged anywhere from 40 per cent to 90 per cent in the past. Moreover, they rarely participated in the overall rallies in the stock markets. For example, for a five-year period since January 2008 to September 2013 (i.e. just before the markets took a solid recovery), while the market-cap of Sensex companies has gone by 10 per cent, the market-cap of about 15 holding companies has gone down by 44 per cent. Despite some recovery in the broader market during the five-year period ending September 2013 (which has seen a turbulent bear phase and also huge volatility), the holding companies’ performance on the markets deteriorated badly.

A Quick Zoom

However, in the last one year, the performance of the holding companies has improved a lot – in fact, while the market-cap of the Sensex companies has gone up by 147 per cent in the last one year, the same has gone up by 305 per cent for the 15 holding companies under our study. The major reason for the booming valuation of holding companies is, in our view, due to changes in the Companies Act. Earlier we had seen a few cases of the promoters of holding companies hiving off investments into separate companies and ultimately taking complete control of those companies at throwaway costs. However, the changes in the Companies Act make it difficult for such promoters to exploit such opportunities.

Market Valuation

In the last one year, the individual stocks of holding companies have gone up substantially for two reasons. One, the value of investments they hold moved up significantly due to the overall Bull Run in the markets. Secondly, the discount (of their enterprise values to the market value of their investments) also narrowed down in the last one year. This time the Bull Run in the market is broad-based and most sectors - barring power and to some extent a few infrastructure companies - participated in the rally in the last one year. Therefore, most of the holding companies have participated in the rally.

As has been observed, most of the holding companies’ stock prices have surpassed the Sensex returns over the last one year, as for example, Bombay Burmah, Summit Securities, Kirloskar Brothers Investments, BF Investments, and Rane Holdings. These stocks have run up more than 180 per cent, 484 per cent, 259 per cent, 139 per cent and 298 per cent respectively.

Valuations and Stock Recommendation

We believe that the valuation gap would narrow down further as it is going to be increasingly difficult for the promoters to unlock any values from the investments in any biased manner in the future. We continue to believe that the Bull Run in the domestic equity markets would continue for another two years. Changes happening at the macro level like arresting inflation at current levels, reducing fiscal and current account deficit, stable interest rates, and policy changes to improve investment climate to revive economy in the long term would help in increasing the growth rates of various industries and we believe the cascading effect will be on the investment values of the holding companies. During a Bull Run the market values of the investee companies would also improve further.

Holding companies typically trade at a discount to the market value of their investments and this can vary between 30-90 per cent depending on business groups. Some of the holding companies may present good investment opportunities on the back of steep discount to the market value of their stake. We have taken into consideration some of the holding companies in the table given alongside and the discount to their investments.

Recent rally has made some of the holding companies expensive in terms of valuations and further narrowed their discounts. However, there are companies within this universe which are trading at attractive valuations, where one needs to be selective considering various parameters - percentage of investment holding or controlling stake in the company, verification of investments into subsidiaries, etc. Based on this study, we suggest that investors should consider accumulating Bombay Burmah Corporation and Pilani Investments. These two holding companies have maximum discounts among those under our study. Between these two companies our strong recommendation is inclined toward Bombay Burmah Corporation based on the following rationale:

• Most of the holding companies are trading at double digit PE; also some of the companies are trading as high as 28x its FY2014 EPS. However, BBTC is currently trading at 9x of its FY2014 consolidated EPS which is dirt cheap in comparison to the other holding companies.
• Currently BBTC’s enterprise value is at approximately 77 per cent discount to the value of its investment in Britannia alone which stands at Rs 8,423 crore whereas the other holding companies of industrial houses like Jindal, Kirloskar Brother Investments, etc. are at much lesser discounts.
• Usually the FMCG market-cap cycle is stable as compared to commodity business where cyclical ups and downs impact the stock prices, thereby affecting the investment values. Since BBTC holds primarily in an FMCG company, relatively speaking there is more stability of its investment values going forward.