#1 Funda | Cash conundrum
Why do some companies like Hero, Maruti, Indigo, IndiaMart sit on huge amounts of idle cash?
Sitting on a large cash balance could either show a poor capital allocation track record given cash yields 4-8% rate (vs 15-20% target ROE), conservative business psyche to take care of uncertainties (esp. for cyclical industries), or an opportunistic step for managements looking for acquisition bets. “Promoters with lots of cash often behave like kids in a candy store. The really good capital allocators demonstrate capital discipline by sitting on cash for a prolonged period of time, waiting for the right opportunity.”
Excess cash on the books may lead some companies to make risky acquisitions. Thus, returning cash to shareholders can be a testimony of the quality of a company’s earnings and will result in more efficient use of capital.
Auto companies - Hero, Bajaj, and Maruti generally keep 15-35% of their market cap as cash reserves. This is because Automobile is a cyclical business with high capex and operating leverage. One down-cycle would lead to a decline in sales leading to cash losses which might be a threat to its existence. So they generally keep large cash reserves to cushion out the impact of downturns. But still, they have come under a lot of investor scrutiny in storing such a stockpile of cash-generating low returns.
Indigo - Keeps huge stockpile of cash given its business model to acquire aircraft in large quantities. Having cash reserves gives it the optionality to make the orders for the fleet whenever required which in the long run would reduce operating costs and result in higher profitability. Also, it operates through a sale and leaseback model which exposes it to some lease rental liability in the future. Indigo has to give a Letter of credit to the sellers during this transaction. Thus some cash collateral needs to be kept with the banks. In a way instead of owning a plane in its balance sheet, Indigo prefers keeping cash in the bank accounts
India-mart - Given the prepaid business model where the revenues are received in advance leads to high cash reserves. Thus, the cash could be ideally used only once the service has been rendered
To sum it up, the reasons for higher cash on books could be: to payout Dividends or Buy Back, Existing Capex and R&D needs (Indigo), New Line of Business or acquisitions (ITC, Maruti), Legal or Statutory restrictions to use cash (India-Mart, Apple), Tide against uncertainty (Auto companies) or Save for the Rainy day.