Desperate times call for drastic measures. Real estate developer DLF Ltd’s sudden decision to buy-back its own shares is a case in point. Raising funds lately has become both difficult and expensive and the better-placed realty firms are those that have tied up most of the fund requirements for medium-term needs. Given this backdrop, it’s strange that DLF has decided to return a large amount of cash to shareholders through a share buy-back.
The right business decision would be to conserve cash, but for now DLF seems to be more concerned about providing a floor for its languishing shares.
DLF shares have fallen about 70% from the high of Rs1,225 in January. The buy-back announcement led to a sharp rally in DLF shares on Wednesday, but on Thursday, the stock gave up about 75% of those gains.
The markets, and DLF investors especially, must be mindful that a buy-back can do little to protect shareholder value if business fundamentals or market sentiment is getting worse. Take the case of Reliance Infrastructure Ltd (formerly Reliance Energy Ltd), which announced one of India’s largest buy-back programmes. When the company announced the buy-back, its shares traded at around Rs1,600 each; when it commenced the buy-back operations, the shares were at Rs1,300. Currently, the stock trades at Rs725.
And compared with many other firms, DLF will be constrained by a high promoter holding of 88.17%. This means that the buy-back cannot be for more than 1.8% of the firm’s capital. A buy-back of such a low proportion will hardly have any impact on the share price.
If anything, the move is a negative one. As analysts at Macquarie Research pointed out to its clients, “In the current scenario of tight liquidity and cash crunch for most developers, we believe that DLF could put the capital to better use by investing in the business itself.”
Gold is getting cheaper relative to crude oil
Apart from shorting the Nifty, buying gold has emerged as the strategydu jour in these trying times. The rationale is simple: Gold is a hedge against inflation and a depreciating currency and investors flock to the yellow metal during timesof trouble.
Since a large part of the rise in inflation is because of higher crude oil prices, it could be worth looking at what happened to gold prices during the oil shocks of the 1970s. Gold was around $65 an ounce in January 1973 and it spiked up to $120 by July that year. The Arab-Israeli conflict broke out in October that year. Gold prices flared up to $150 by January 1973 and averaged $183 by December 1973 and it wasn’t until 1976 that they fell back to below $120.
During the second oil shock in 1979, gold prices rose from $207 an ounce in December 1978 to $675 in January 1980, a level not reached for more than a decade thereafter. In short, buying gold in response to crises would have been profitable for a relatively short window of opportunity.
This time, gold has moved up from around $300 an ounce in mid-2002 to its current level of $900-1,000. The difference is that the dollar has been weak this time and the price of gold is negatively correlated to the US currency. However, gold seems to have weathered the recent concerns about the dollar having found a bottom rather well and is back above $900 an ounce.
A Citi Investment Research update on gold points out that “the forces that have propelled gold for the past five years are firmly in place, and policy prescriptions for the credit crisis seem powerfully and uniformly reflationary. Prices are up in euro, yen, and rupees, a critical credibility test. Gold is below constant-dollar peaks of $1,800–3,000/oz, and has lagged bulk/base metals since the 2001 trough. Appreciation remains muted relative to other metals and oil.” One way of looking at the relationship between crude oil and gold is to consider the gold/oil ratio (i.e. gold price/oil price). As the chart shows, gold is currently very cheap relative to oil.
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