Three reasons MNC stocks are no longer safe

Three reasons MNC stocks are no longer safe

Investors in India have always sought Multinational Companies (MNC) stocks. But, this is about to change. Until now, these stocks have been viewed as safe investments with assured returns. MNC stocks on the Bombay Stock Exchange (BSE) have consistently fared better than the BSE 500 Index. Over the last year alone, MNC stocks generated returns of 49%, compared to 16% for stocks on the BSE 500 Index , according to a report by Ambit Capital, an equity research firm. For a five-year horizon, the returns stood at 22% and 12%, respectively, the report said. But analysts at Ambit Capital believe that MNC stocks are no longer as ‘safe’ as they once were. 

Here’s why: 

1. Growth in business outside the listed company: To capture business opportunities with big payoffs, MNCs often take the subsidiary route. This means that a private company is incorporated by the MNC to net a higher profit opportunity. This company is a wholly owned subsidiary of the parent company. The local firm, which is the listed company in India, loses the opportunity to earn that profit. For example, Maruti Suzuki expanded its Gujarat plant in 2014 through a 100% Suzuki subsidiary. Maruti was to make payments to this subsidiary towards the cost of production. This means that Maruti only earns some money made from selling or distribution the cars manufactured at this plant. The profits from producing the car go to Suzuki, Maruti’s parent company, through the wholly owned subsidiary. As a result, the Indian listed company loses a part of its earnings and posts lower profits. 

2. Rising competition may erode MNC premium: MNC stocks have done well in the Indian stock market due to two factors: Their USP has been the ability to manage cash better and bring world-class technology and professional management methods to India. MNC stocks are, therefore, traded at a premium. In other words, these stocks are priced at a rate higher than they are worth since many investors are willing to pay more for them. As supply is less than the demand, the price is high. But now, with better governance, India could lower corruption and inflation, creating more efficient competition and a cleaner business environment, in which, Indian companies can thrive. This will lead to lower demand for MNC stocks, which will face competition from well-managed Indian companies. The premium attached to MNCs may erode due to this fall in investor demand. As a result, prices of these stocks may fall, along with the returns on investment. 

3. MNCs may draw cash from listed companies: Another major contributor to the fall in returns on MNC stocks could be the parent company making bigger withdrawals from the listed Indian company. Higher royalty payments demanded by the foreign parent, over a period of time, can lead to lower profits for the Indian listed company. This is the most common way for the parent company to pull out funds from the listed Indian firm. The former may decide on cash repatriation from the Indian company. This practice, though not common, is prevalent today. The parent company may also force the Indian listed company to enter into business transactions on unfavourable terms, where only the parent company benefits.

 Happy Investing

Source:Yahoofinance