Should you play discount in holding company stocks?

There has been a buzz around Tata group companies over the last few weeks. Most stocks have seen a sharp uptick on the back of positive developments in these businesses. This is turning investor attention towards Tata Investment Corp, which owns these diverse businesses. Now trading at a heavy discount to the combined value of its investments, the Tata group holding company seems like a value play. Amid the market uptick since last year, many other holding companies are also available at a steep discount. Are these ripe for picking by discerning investors?When a parent company holds a chunk of shares in other companies but does not have any material operations of its own, it is referred to as a holding company. It derives its income primarily from the returns generated by its underlying businesses. Its value, therefore, is dependent on the value of its investments. However, it is generally awarded valuation that is much lower than the sum of the value of its owned businesses. There are reasons why this discount occurs. One, the volatility in market value of listed subsidiaries increases the risk perception about a holding company’s shares. So the market gives it a lower valuation. Two, investors in a holding company are exposed to multiple businesses, some of which may not be seen favourably. Hence, the parent company is priced lower. Binod Modi, Head – Strategy, Reliance Securities, remarks, “Historically, holding companies have a poor reputation for exposure to different business verticals leading to ineffective deployment of capital. Investors prefer to invest in a pure-play business with strong earnings outlook and RoE.”Third, the market may also assign a discount for lack of ownership control of the holding company in its subsidiaries. The lower the control, higher the discount. Besides, Indian holding companies are typically investment arms of their promoters, so their actions are perceived to align more with the interest of the promoters than shareholders. Finally, the liquidation value of a holding company’s investments is more theoretical than practical. The likelihood of the holding company selling off its investments itself is very low. The realizable value from such sale would typically be lower than its actual worth owing to taxes and other considerations. Given these factors, the holding company discount simply cannot be wished away.87226578As the discounts of several holding companies have increased sharply amid recent market uptick, investors feel these can see a re-rating in the near term. Godrej Industries is now trading at 71% discount to value of listed group companies Godrej Agrovet, Godrej Consumer Products and Godrej Properties. The discount stood at 53% in March last year. Similarly, Bajaj Holdings and Investments’ discount is up from 59% to 67%. Tata Investment Corporation’s discount is also wider, rising from 31% to 48% now. It is pertinent to note that these holding companies also own several unlisted subsidiaries. So the actual discount is likely to be even higher. Interestingly, Grasim Industries’ holding company discount has narrowed sharply to 22% from 52% in March last year. This is on the back of healthy growth in Grasim’s viscose staple fibre and chemicals businesses, apart from strong traction in subsidiaries Hindalco and Ultratech. Besides, investors see value unlocking in the group’s financials subsidiaries positively.Market analysts advise caution before playing the holding company discount. “Holding companies tend to become popular in a bull market when there are no easy pickings left,” says Vikas Gupta, CEO and Chief Investment Strategist, OmniScience Capital. “But you cannot blindly go buy any holding company to play this discount.” Experts say the ‘discount’ can turn out to be an illusion. These seem like value bets, but could be a trap. “The underlying portfolio may be overvalued, so you may end up paying more than what the holding company is worth,” Gupta asserts. Kunj Bansal, CIO, Karvy Capital, sees little merit in pursuing this strategy. “This strategy has never worked in the long run. A shareholder of a holding company will never achieve full realization of underlying value.”However, discerning investors can play the narrowing of this discount in certain circumstances. Investors need to juxtapose the extent of discount with other parameters, before concluding whether the holding company discount is justified or not. A rising dividend payout from the subsidiaries is one factor that can lower the discount. Investors may also target holding companies that are steadily increasing stake in its cash generating portfolio companies.

from Economic Times https://ift.tt/2ZiC434