Internal risks abound for Indian stocks

Forget India’s own macro troubles such as high inflationary expectations, rising rates, slowing output growth and policy paralysis. These are well documented and for the most part were reflected in stock prices much before the events of the past 5 days. There are other risks present, mostly at the level of individual firms, which could inhibit a sharp rebound.   

For one, while India’s exports as a portion of national output is still less than a quarter, an increasing number of companies are dependent on overseas earnings. Six years ago, only a fifth of Sensex companies’ revenue came from exports and overseas operations. By fiscal 2010, this share had nearly increased to nearly one-third. This is not purely an information technology firm phenomenon. Even a company such as Larsen & Toubro now looks outwards for up to a third of its income.

Secondly, consider those companies which are already struggling under a massive debt load and have instruments such as foreign currency convertible bonds coming up for redemption. A 22% fall in prices since the November peak means that many bondholders don’t want to convert their holdings into equity and are asking for their money.

Raising funds, which was already tough, has become an Olympian feat now. There are 52 issues worth some $4.87 billion that are coming up for redemption in the next 12 months. Even the merest sniff of a default in a single firm would be enough for investors to fly for safety and cause collateral damage for others.

Thirdly, take the case of those firms whose promoters have pledged shares to raise money. Leave alone midcaps, promoters of some big names in the Indian corporate sector such as United Spirits, Suzlon Energy and Tata Power have pawned as much as 88% of their stock to lenders. Since the fall from the peak, many of these have had to place more and more stock as collateral with the lenders. That also indicates that these promoters don’t have enough money to redeem shares and indicates that they are highly leveraged.

All these problems hit at the very heart of firms’ profitability, which is already under pressure due to rising input costs and interest rates. In short, while stocks may appear attractive when valuations are compared to long-term averages, the very basis for this measure appears suspect.

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