A Crisis Can Be A Profitable Opportunity !
Investors adopt different strategies to beat the markets. Some rely on the advantage provided by technical analysis, some bet on value stocks while some are in favour of momentum stocks. Betting on stocks or companies that are facing a crisis situation is one such strategy that can reward investors handsomely. Shreya Chaware discusses the several aspects that investors should keep in mind while attempting to identify investing opportunities in companies that are going through a crisis situation
The recent two to three years for Indian corporates have not been good when it comes to corporate governance. In fact, several cases of mismanagement in terms of corporate governance have emerged in the past few years, leading to destruction of wealth for investors, including companies like Yes Bank, DHFL, Infrastructure Leasing and Financial Services, CG Power, etc. Then have been a few cases of crisis in certain leading companies such as Tata Motors, UPL, Nestle and even Infosys. All of these companies suffered a temporary setback but eventually emerged victorious after underperforming for a certain timeframe. Tata Motors went through a long period of underperformance owing to the woes faced by the whole automotive industry and also due to the internal conflict with one of the biggest investors in Tata Sons i.e. Cyrus Mistry.
UPL, the largest agrochemical company in India, faced a corporate governance issue with allegations by a whistleblower. Eventually, the resigning of the auditor pushed the stocks down by nearly 25 per cent between September 23, 2020 and November 4, 2020. During the same time the Sensex rallied by more than 7 per cent and the market breadth was in favour of the gainers during this time. Such a crisis situation presented an opportunity for investors to enter one of the most fundamentally improving stocks in the agrochemical sector. The company management denied all the allegations and also acted aggressively on the debt restructuring plan which showed the management’s clear intention of focusing on improving the fundamentals of the business.
Investors reacted positively and showed faith in the management. The stock, since its November lows, has jumped by almost 55 per cent while the Sensex has been up by 22 per cent during this period. Investors who were opportunists were able to generate market-beating returns in this counter. If we look at the situation faced by Nestle in 2015, the stock tanked by close to 25 per cent following the allegations that the most popular product and India’s favourite ‘Maggie Noodles’ contained high level of lead and monosodium glutamate (MSG). Maggie was banned by the Indian government owing to the observations by certain FDA laboratories in Kolkata and Uttar Pradesh. Nestle India lost more than `500 crore over the ban, which forced it to destroy more than 37,000 tonnes of Maggi noodles.
However, investors who showed patience and faith in the company’s products and management have been rewarded handsomely as the stock is now up by more than 200 per cent over five odd years. There were signs that the company is managing the crisis very well. Nestle India brought in a new leader to face the challenge – Suresh Narayan who was perceived as the best person to handle the crisis and is more sensitive to Indian bureaucracy than Etienne Benet, who was recalled to join the Nestle headoffice in Switzerland. The company repeatedly explained to the consumers, regulators and investors that Nestle’s roots are in baby food and cerelac and hence it is fanatical about food safety. The management kept on denying the allegations and eventually Nestle was able to regain its entire market share of 57 per cent that it had lost by June 2016.
The Indian noodle market at that time was estimated to be around `5,000 crore. Investors who were watchful of the management’s actions and had a leap of faith in the research and development capabilities of the company as well as trusted the company’s ability to gain back its lost market share in the noodles market in India made excellent returns by remaining invested. Nestle after all was backed by good reputation gained over more than 100 years. These are just a few case-studies which suggest that a crisis situation faced by leading corporates with extremely high-quality management who understand their businesses and clients better than the competitor and who adopt high corporate governance standards at least on a relative basis can be good candidates to invest in even during their difficult patches.
Caution is the Key
That said, it is not always wise to invest in all companies that are in the midst of a crisis. It is observed that the most damaging crisis faced by any listed company is related to corporate governance issue followed by higher debts. Suzlon is a pure example of higher debt which has led to wealth destruction over the years while Satyam, DHFL and Yes Bank are prime examples of corporates with poor governance which led to massive wealth destruction. Investors who showed faith in all these companies mentioned burnt their fingers badly. Hence it is essential to first assess the situation, study the quality of management, spend some time researching the track record of the promoter and examine the salary drawn by the promoters and senior management. It should not happen that the salaries drawn by the promoters keep on increasing while the net profits decline. Such an instance should be red-flagged by investors. Usually, promoters do take 2 to 3 per cent of the net profits as commission.
Conclusion
It is not always easy to invest in a company when it is struggling or is marred with certain allegations. As it is, valuing equity is a tricky job. When you add a few more variables such as corporate governance, quality of management and crisishandling capability the job becomes even more difficult. Hence, proper analysis of the fundamentals of a company under consideration is very important. If a fundamentally strong company with proven cash flow generating business with dominant market share is faced with a crisis situation, investors can probe further investing opportunities. If a company is faced with a corporate governance issue it is best to exit the counter and park your hard-earned money in alpha stocks.
There is no question of exploring investing opportunities in counters that are already fundamentally weak and are faced with a crisis situation. No matter how low the stock prices are, investing in such opportunities can prove to be fatal to your overall portfolio returns. It is important to be able to quantify the damage caused by the crisis faced by the company. Unless and until the quantification is not clear, investors should stay away from speculating. Once the dust is settled and the crisis impact on the bottom-line and top-line is clear, investment opportunities should be explored positively. Just because a crisis has struck a listed company and the stock is down by 50 per cent in the short term does not mean that we have a case for lucrative investments.
It is essential that investors asses if the crisis is manageable by the company. Whether the crisis is manageable or not will depend on the strength of management and also on how strong the balance-sheet is. At present there are two interesting such cases – Future Group and Vodafone Idea. Both the business groups are going through what we can call a crisis situation. Both are unique businesses and the nature of crisis is totally different. Only time will tell if the crisis is manageable by these business groups; however, investors can assess the opportunities by looking at the fundamentals and see if the fundamentals are improving, study the cash flows and take into account the management’s intent to resolve the crisis.
It is important to observe the steps taken by the management and the changes made by the senior management to survive the crisis. So far, Vodafone-Idea has been showing survival instincts and several investors are betting that the company will start generating profits in the coming years. This can therefore be an exciting opportunity for wealth creation. Usually ‘being an opportunist when others are pessimists’ can work wonderfully when an investor is looking at constructing a portfolio or is considering investing in the index when there is a crisis such as Brexit, demonetization, US-China trade war, the pandemic, etc. because the probability of winning is much higher since it is the complete portfolio or benchmark index that one is betting on and not an individual stock.