From time to time the stock market gives signals on stocks that are in the danger zone for the purpose of investment. Investors repeatedly make mistakes of buying the wrong stocks at the wrong time without studying their fundamentals. The question I come across is, that this stock is down from its peaks, should I buy it now? People typically buy stocks on tips from anyone, friends, colleagues, brokers or any other source.
The buying is done on the presumption that the bad stocks identified by the market may recover in terms of their stock performance due to some miracle. The theory is that the financial performance may recover in the immediate future and give a sharp recovery for the beaten down stock giving above average returns to the investor. But is it necessarily true always? One needs to check the conditions and scope for such a recovery. Buying a stock because it appears cheap and waiting for it to show improved performance is pure gambling.
For example, recently some companies were identified by the RBI which have contributed to the non-performing assets of Banks. Would you buy them blindly on the hopes of recovery when the market is signifying trouble for them in the time to come.
The Reserve Bank of India recently identified 12 accounts that covered approximately 25% of the banking system’s non-performing assets for immediate resolution under the Insolvency and Bankruptcy Code. The gross bad debt of the Indian banking system as of March 2017 was at Rs 7.11 trillion, which means the 12 accounts that were identified would be responsible for a gross bad debt of about Rs 1.78 trillion.
The 12 accounts are Essar Steel, Bhushan Steel, Bhushan Power, Alok Industries, Electrosteel Steels, Jaypee Infratech, LancoInfratech, Monnet Ispat, Jyoti Structures, ABG Shipyard, Amtek Auto and Era Infra. Some companies are not listed on exchanges which include names like Essar Steel and Bhushan Power.
Bhushan Steel with a gross debt of over Rs 440billion is most likely the single largest exposure that lenders have on their books. Is a recovery possible in terms of financial performance for a company with such a huge gross debt on its balance sheet. The fundamentals will tell the story whether it is in a recovery stage or the worst is yet to come.
For the Company to repay back its debt they would have to sell their products at a rate faster than the industry average growth. This means the assets that are deployed by using all the debt and equity have to churn out revenues for the company after covering all the necessary expenses. When the company would be able to cover their fixed and variable costs there would be money left for the debt repayment and interest payment.
The interest coverage ratio in case of Bhushan steel works out to be 0.35, which means the earnings in this case are able to cover the interest expenses only to the tune of 35% which is alarming. The result is that the company is reporting losses (net profit after tax is net loss) for the Financial Year 2014-15, 2015-16 and 2016-17. Also the interesting trend to be noted is that the losses are increasing on a year on year basis. The net loss for the FY 2014-15 was Rs.12567 million and for FY 2015-16 was Rs.29114 million. The losses for the FY 2016-17 are well in excess of Rs.31000 million.
This shows that the recovery is far and investors should be careful of such stocks for the purpose of investment. Prices of these stocks can go up based on some news flows but for long term investors it is a complete avoid. Bhushan Steel stock price reached an high of Rs.98 in the month of May 2017 from Rs.42 in the month of January 2017. The stock has corrected 40% within a time frame of 3 weeks and still continues to be on the downward trend.
There are many other stocks in the market that have good fundamentals from the point of view of the industry they are operating in and from their financial outlook, which can be invested into. Investors should stay away from speculative and gambling opportunities that the market present and rather focus on stocks with robust fundamentals for the purpose of investment.