18 top holdco shares gain 40% so far this year, twice that of Sensex

Holding company discount in India could narrow in the long-run, says HDFC Securities

Shares of several holding companies (holdcos) have rallied sharply this year amid overall buoyancy in the market. 
A holdco is a company that doesn’t conduct any business operations but holds stakes in other companies, typically belonging to the same group.

Shares of Bajaj Holdings & Investment, which holds stakes in firms such as Bajaj Auto and Bajaj Finserv, have rallied 75 per cent this year.

Meanwhile, RPG Group holding companies — RPSG Ventures and STEL Holdings — have soared over 2.4x.
 
The average gain posted by 18 leading holdcos this year is 40 per cent — nearly double that of the 20.5-per cent year-to-date gain of the Sensex.
Despite this year’s upmove, most holdcos trade between 60 per cent and 80 per cent discount to their intrinsic value or valuing of investments.

Domestic brokerage HDFC Securities is of the view that investing in holdcos can be a good portfolio diversification option.
“Investing in the stocks of holdcos can be a very efficient and inexpensive way of gaining exposure to the stocks of India’s reputable growing business houses. It can generate consistent returns with a margin of safety over a long period of time, as well as portfolio diversity,” say HDFC Securities analysts Amit Kumar and Varun Lohchab in a note.

The duo has compared long-term returns of 18 holdcos to the Nifty. Fourteen, they say, have outperformed the Nifty over two time frames — FY16-H1FY22 (Nifty returns: 16 per cent compound annual growth rate) and FY11-H1FY22 (Nifty returns: 11 per cent).

Since a holdco doesn’t conduct any business operations, what are the triggers for its stock price to move?
The HDFC Securities note has identified three return drivers — appreciation of underlying investment portfolio, narrowing of discounts with market cycle, and event-driven value unlocking. 

The first driver is straightforward. A holdco typically moves lock-in step with the underlying companies while maintaining the holdco discount. The second comes into play, according to HDFC Securities, during bullish market cycles.

“In positive market cycles, when mid-caps rise, holdco discounts narrow and stocks generate returns,” it says.

The third driver pertains to factors such as changes to dividend taxation or one-off events like reverse merger or delisting.

The holdco discount in India is high, when compared to some of the overseas markets like the US and the UK, where it is just between 10 per cent and 25 per cent. HDFC Securities sees the discount narrowing in India as well.

“Over time, Indian holdcos will evolve, attract broader investors, see increased trading volume, and, with increased liquidity and a reduction in promoter holding, discounts will narrow to low levels, comparable to global firms,” it says.

So how does one go about picking the right holdco?

While selecting a holdco stock, one has to compare the prevailing discount to the historical levels and also analyse the holdco’s investment portfolio, say Kumar and Lohchab. Based on their analysis, they think nine holdcos are attractively poised at present.

“The selection is based on two main criteria: solid fundamentals of underlying investments and historically higher holdco discounts. If invested for the long term with an absolute return perspective, this portfolio of nine stocks could outperform the market. The risks involved include a prolonged period of short-term underperformance relative to benchmarks, but overall absolute returns at the end of the horizon will compensate for it,” they say.

Last month, Kotak Securities in a note said large Indian conglomerates (not strictly holdcos) should consider demergers for value unlocking.

“Several Indian conglomerates trade at large discounts to the fair value of their individual businesses in the parent or in subsidiaries. The implied price-to-earnings or market capitalisation (m-cap) of the main businesses in the parent entities appear to be quite low after adjusting for the market value of the companies’ holdings in their subsidiaries or associates,” the brokerage had highlighted.

Globally, the widening gap between holdco m-cap and the sum-of-the-parts value has led to shareholder activism, leading to demergers and splits.

“Majority shareholders of conglomerates with a mix of unrelated businesses may want to reconsider the ownership structure of their companies and/or review their business mix, given that the market is unlikely to accord the fair value of the businesses in the m-cap of the holding/operating company,” say Kotak Institutional Equities analysts, led by Sanjeev Prasad.