PLEDGED SHARES - STANDING ON THE EDGE OF A HIGH LEDGE

By Ruma Dubey

When you start selling your family gold and silver, especially when all know that you are otherwise leveraged to the hilt and are facing a tight liquidity crunch, surely it means that you have hit rock bottom, as far as your financials are concerned. That is how we view things in personal day-to-day life.

What about companies then? There are many who had borrowed to the maximum limit possible and then they have pledged almost their entire promoter stake – its like silver and gold in the family, right? If then apply the same yardstick, doesn’t it then mean that such companies are indeed in troubled times and we should stay as far away as possible? Liquidity crunch, high working capital needs and difficult macro factors have led to rising pledged shares, a nightmare for companies and shareholders.

Before we go ahead – why are shares pledged? This is the promoters stake in the company and he/she uses it as a collateral to borrow more money from the banks. Money is mainly used to fund financial requirements of the company. The bank keeps a tab on the market value of the shares because if the price falls below the agreed value in the contract, they can sell.

Pledged shares are indeed an indication of the financial health of the company. More the promoters stake pledged, higher is the liquidity crunch and turbulent financials. But BSE, in its report of pledged shares, categorically states that pledging of shares does not necessarily imply that a company or a promoter is under financial stress; banks (lenders) could have sought additional security in the form of promoters’ shares.  At the end of Q3FY18, nine companies had more than 90% of their promoters holding pledged.

The BSE has put out a media release which gives us a pretty good picture of India Inc and pledged shares. As at 28^th Feb’18, out of the total of 5054 shares listed, 3062 companies have pledged shares, up from 2991 companies at end of Jan’18 and 3003 from Dec’17. So more promoters have pledged their shares since Dec’17 till end of Feb/18.

In terms of value of the pledged shares, it declined 7% (MoM) to Rs.2.54 lakh crore mainly due to a sharp fall in the share prices of most companies.

And in terms of holding, promoters of 448 companies pledged between 5 to 30% of their holdings, while 154 firms saw 30-50% of the promoters’ holding being pledged in February. Promoters of 78 companies had pledged 50-75% of their holdings while three firms witnessed their promoters pledging stake between 75 to 90%.

Within a month, we saw two companies where lenders invoked pledged shares. Today, it was IndusInd Bank; it has invoked the pledge on 6 crore equity share of Jaypee Infratech. This is 4.3% stake, held by promoter company, Jaiprakash Associates; it had 89.5 crore shares or 64.44% stake in Jaypee Infratech as of December-end 2017, of which 92.55% were pledged.

Invoking of pledged shares means that the lender has exercised his right on security and the shares have been actually transferred from the demat a/c of borrowers to the demat account of lenders. To that extent the promoters holding has reduced and lender has the liberty to sell the shares at any time and sue the borrower for balance amount.

Then there was Fortis, where Axis Bank and Yes Bank were given the go-ahead to sell the shares pledged by former Ranbaxy promoters -Malvinder Singh and Shivinder Singh. And after invoking their over 25% pledged shares by lenders, the promoters stake today stands at a paltry 0.77%.

Today, companies with high percentage of pledged shares are JSW Steel, DB Corp, McLeod Russel, Max Financial Services, Max India, Reliance Power, Bajaj Corp, Omaxe, Century Textiles, Gayatri Projects, Coffee Day Enterprises,Kwality.

As per a report put out by Kotak Securities, companies whose promoters pledged more than 95% of their holdings are Bajaj Hindustan, CG Power and Industrial, Reliance Naval and Engineering, JBF Industries, Suzlon Energy, IL&FS Transportation Networks and Fortis Healthcare. 

Companies where promoters have pledged more than 25% of their shares, there is rising worry that given the low prices, the promoters might opt to sell out. When stock prices crash, promoters with pledged shares could get margin calls from the lenders with whom they have pledged shares.  Pushed into the corner, promoters have only two options – either repay a part of the loan or get more collateral by pledging more shares.  If they do either, they manage to save the day. But when they are not able to do either, the lender is then forced to dump the shares. This brings down the stock price further.

With probability of interest rates going up, the pressure will mount on the promoters and on the NBFCs.  NBFCs typically fund high risk but at a high interest rate.  There is worry that many promoters might not have the money to pay back the borrowed money and NBFCs might begin to sell off as their cost of funding too will go up.

So should one take this opportunity to buy stocks of these pledged shares as they hit new lows? There is no simple “yes” or “no” answer to this. Just as everyone with the name of Ramalinga Raju is not a thief, not every company which has pledged shares is bad. There are a few factors which should help you decide. Within the pledged shares itself, look for clues of trouble – of the percentage of pledged shares has increased sequentially, then surely it means things have become worse and vice versa for percentage of pledged shares coming down. One interesting fact – DLF for all its debt, does not have a single percentage of promoters shares pledged.

The big question – should one invest in companies where promoting are withdrawing pledged shares? It’s most certainly a positive but not a sole decisive factor. While investing always keep an eye on the size of the company. The bigger the company, the lesser are the chances of the company defaulting on paying the margin money. It is not just the size of the company but also the underlying fundamentals; nothing can be above fundamentals. And by this logic, mid cap and small cap stocks are higher risk. Promoters of many such small companies pledge shares in plenty to raise money but their chances of reneging on their commitment is higher. Pay attention to the percentage of shares pledged. Higher the stake of pledged shares, higher is the risk and vice versa. But above all the bottomline is – simply do not invest in highly leveraged companies.

Catching falling knives is always dangerous; so assess before buying into these highly leveraged stocks.