What comes in, goes out

Cairn India's $800-million loan to promoter Vedanta has yet again raised the issue of corporate governance

It’s a tricky decision whether or not to hold a stock when an excellent image is dashed by corporate governance issues. Investors in Cairn India are facing precisely this dilemma after the company came into the spotlight on July 23 for giving an $800-million loan (commitment for $1.25 billion) to promoter group company Vedanta. Cairn’s share price crashed 10.5% to Rs 308 following the news, raising fresh concerns over the Vedanta group’s corporate governance standards. 

Nitin Tiwari, vice-president, institutional research, Religare, says, “Prima facie, it seems that shareholders’ permission was not taken and notice not given to the markets.” S Subramanian, managing director of proxy advisory firm Ingovern, seconds that thought. “The company has not even made a formal disclosure of this related-party transaction to exchanges. This shows disregard for fair disclosure by the company and merits a full-fledged investigation by Sebi,” he says.

It’s not the first time the Vedanta group has been embroiled in governance issues. Investors had protested the restructuring of Vedanta in 2008 due to shareholders concerns regarding Vedanta’s Zambia-based copper mining and smelting subsidiary, Konkola Copper Mines. Though Vedanta called off the restructuring then, it went ahead in 2012 and merged Sesa Goa, Sterlite, VAL and Malco to form Sesa Sterlite. Minority shareholders of both Sesa and Sterlite had expressed concerns about the ₹66,717 crore gross debt that Sesa Sterlite had to acquire. Further, the ₹19,892 crore gross debt of a ₹2,346-crore, loss-making VAL being transferred to the restructured company sparked investor outrage.

Pumping oil...and money

In the absence of substantial capex, cash reserves have been piling up at Cairn 

In Cairn’s case, the financial impact is actually positive. The company will give the loan using dollar deposits that earned 2-2.5% interest, while the loan to Vedanta at Libor plus 3% will earn relatively higher returns. But that doesn’t mean any great benefit for investors. The Vedanta loan may earn a higher rate and Cairn’s capex plans remain adequately funded, but “this could be negative for stock sentiment as it could preclude upside to shareholder payouts through dividends,” highlights Citi Research in a report. 

In FY14, against an earnings per share of ₹65.2, Cairn had paid dividend of ₹12.5 per share, with a payout ratio of about 22.5%. However, considering the cash (and equivalent) of ₹120.31 per share, which is 38.3% of the current market price, investors had expectations of higher dividend. 

Even if the company does not distribute the surplus cash as dividends, the Street expects it to deploy it in the business, which made return on equity (RoE) of 24% in FY14. This may now not happen.

Cairn India holds some of the best oil assets in India and markets such as Sri Lanka and South Africa. Importantly, hoping that the large part of its capital expenditure is already done, many consumers have invested in the company to gain from future cash flows, which they thought could be used for the distribution of dividend. S Ranganathan, head of research, LKP Securities, says, “We have a neutral rating on this stock. It is being bought only for the cash gains. There is practically no earnings growth in the company.” 

But more than the financial impact, the Street’s fear stems from the way cash is being used — or rather, not used. In its report, ICICI Securities argues, “This [loan] raises a question mark on the utilisation of future cash flows and dividend payout, which will impact the return ratios and shareholder value creation.” This could be true if the cash is deployed in low yielding funds, which will effectively erode shareholder value. Meanwhile, despite good future prospects, issues about the utilisation of the cash and protection of the interest of minority shareholders could remain.