Lessons from Zee: What to read when investing in a cash-cow firm

ET Intelligence Group: Cash cow businesses are typically considered to be low risk-high reward proposition. However, the recent instances of value erosion in cash cow businesses have revealed a key risk inherent to the way such businesses are run: it is the propensity of the promoters to diversify in non-core areas.The recent debt-related turmoil in India Inc has one underlying theme — unsuccessful diversification into non-core areas, which has been often supported by some cashgenerating all-weather business. Zee Entertainment, Bajaj Electricals, Emami and Eveready Industries are cases in point. The core businesses of these companies continued to do well but their value on the bourses declined in the past couple of years.Even if the flagship businesses are strong, investors can still suffer value erosion due to failed diversification attempt by the promoter group.In worst cases, promoters may even lose control of the cash cow business. The performance of the business could then suffer from the absence of expertise of the company’s promoters. The promoter’s stake in Zee Entertainment, for instance, has reduced to just 5% from 29.3% a year ago. 72340898 Promoter stake in Emami also fell by10% earlier in February to 52.4% as they sold their stake in the fastmoving consumer goods company in a bid to reduce their debt at the group level, which also operates a cement and a hospital business.For Bajaj Electricals, its venture into capital-intensive engineering projects and businesses beyond consumer electrical products led to an increase in leverage and negative cash flows. Rising debt due to loss-making non-strategic businesses and challenges in recovering inter-corporate deposits given to group companies in non-core businesses and corporate guarantees given on their behalf led to value erosion for battery-maker Eveready Industries.An established cash-generating business tends to increase the risk appetite of the promoter or the management. However, the higher confidence to take risks doesn’t necessarily correspond to an increase in the expertise to handle a different kind of business or market. The management becomes more difficult, especially amidst challenging times. Most non-core diversifications, therefore, don’t tend to succeed.Funding of a new unexplored business through cash generated by an established business has been one of the major reasons underlying the pain suffered by several business groups in recent years.While most cash-cow businesses are considered safe haven investments, investors of such businesses need to be vigilant of promoter’s expanding into non-core businesses.Pledging of promoters’ shares, or steady decline in promoter stake, aggressive acquisitions abroad in non-core areas, cash flows turning negative, increase in debt or gradual reduction in the return on capital employed are signs to watch out for. The earliest detection of these tell-tale signs can save investors from loss in their returns.

from Economic Times https://ift.tt/2YbzYxw