Is being cash-rich a guarantee to good performance? Apparently not

The performance of cash-rich companies and high-debt companies over the past year has been similar, leading to questions about whether cash is reallya safe haven in troubled times.

The table below shows the performance of two of India’s richest companies in terms of their cash hoards, as well as that of two of India’s high-debt companies.

Infosys and Reliance, which belong the first group, have fallen more than the Sensex, as well as DLF and Tata Steel on a year-on-year basis as of April 2012. Markets are clearly not giving any premium to cash-rich companies even as they punish high-debt companies. In times of economic uncertainty, debt is bad word, while cash is a good word. But the way the markets have treated cash-rich and high-debt companies suggest that cash and debt are both bad words right now.

[caption id=“attachment_294059” align=“alignleft” width=“380” caption=“Infosys has guided for growth below industry projected growth levels for 2012-13.Reuters”]  [/caption]

Cash rich Infosys and Reliance have issues in terms of growth. Infosys has guided for growth below industry projected growth levels for 2012-13, while Reliance is facing falling margins in its refining and petrochemical businesses, as well as scalability issues in its gas output business.The fact is both companies will continue to generate cash every year, adding to their cash pile. But markets do not seem to like that.

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The issues with DLF and Tata Steel are that the economic environment is notexactly conducive to high-debt companies. DLF is facing a slowdown in the realestate market due to inflation and high interest rates in the country, while TataSteel’s subsidiary, Corus, is suffering from an anaemic market for steel inits main market, Europe. These companies are discovering that leverage is becoming a huge drag on profitability, leading to markets punishing these stocks.

Investors want Infosys and Reliance to use their cash to boost shareholder wealth,while they want DLF and Tata Steel to deleverage and improve profitability.What can Infosys and Reliance do with their cash? And how can DLF and TataSteel reduce debt? There is no single answer to these questions and both groups of companies will probably do what they think is right rather than attempt to please the markets.

Reliance, for example, is buying back its own shares for around Rs 10,000 crore,while Infosys has proposed an extra dividend for the financial year ending March 2012. Buybacks and dividends are a form of returning cash to shareholders, but the fact is giving cash back to shareholders is viewed as a sign that companies do not have any great ideas on how to use their cash effectively. Cash earns around 8-10 percent and thesecompanies need to make better use of their cash to improve the overall return on theirbusinesses.

Inorganic growth, new businesses, organic expansions, etc., are someof the uses for the cash they have hoarded.

In contrast, high-debt companies face the problem of a prolonged business slump leadingto issues on servicing and repayment of debt.DLF is selling its non-core assets to reduce debt, while Tata Steel isimproving its efficiency to generate cash flows to service debt. The best thingthat could happen to DLF and Tata Steel is improving business prospects since it will add directly to their return ratios given their leverage.

However, waiting for improvement in the business environment, which could take longer than expected, will increase the pain factor for these companies.

What can investors do?

Investors should be opportunistic while investing in Infosys, Reliance, DLF and TataSteel. Infosys and Reliance will do well if they find good use for the cash they hold or if their businesses look up.In comparison, DLF and Tata Steel will do well if their businesses look up, while a continued downturn will lead to markets punishing them further.

Risk levels in cash-rich companies after a beating in the markets are lower compared to risk levels of high debt companies.

The question is not cash or debt, but the use of cash and business prospects. Takeyour pick.

Arjun Parthasarathy is editor of www.investorsareidiots.com, a website for investors.

[caption id=“attachment_294074” align=“alignleft” width=“323” caption=“Performance of high debt and cash rich company.”]  [/caption]