Preparing for foreign shocks
There are risks involved when investing in a company which has a substantial presence abroad
Investors face several risks while investing in stocks. But, in many cases, they are not aware of these risks. This can lead to a situation where the investor suddenly finds himself taking a hit because of some negative event. In many situations, this can be a shock as he never thought the implications could be so drastic. It is better to be informed about the situation, so that any adverse development can be tackled effectively.
One such instance is when an investor invests in companies, which rely heavily on revenues from abroad or conducts overseas projects. In some cases, this foreign aspect is not even known, because all attention is on the company's local business. The foreign dealings can range from sourcing of raw material to sale of goods or services in foreign countries but is now increasingly also consisting of foreign fund raising. Each one of these needs to be tackled and considered differently by investors and here are a few situations and examples.
FUNDING
Indian companies are tapping the foreign markets with increasing frequency for their financial requirements. This provides a benefit in the form of a lower cost of funds, as well as ability to raise large amounts under favourable conditions. Companies use both the debt and equity route to raise the required amount of money. There are two types of situations where companies might suddenly find the going tough.
When it comes to debt funds, there could be a negative impact of a change in the country's rating.
If due to some conditions like poor fiscal management or other problems, agencies reduce the credit rating of India, then even though a particular company is strong in its financial position, it might find the debt cost has risen. Even a 0.5 per cent rise on a borrowing of $300 million can lead to an additional outgo of $1.5 million (about Rs 6.8 crore), which can impact performance in the coming quarters. Investors have to realise that for larger and stronger companies this is less of a problem, as the impact can be easily absorbed.
The other situation relates to the country in which the funds are to be raised. For example, if there is a crisis in a particular part of the world or an impact in the financial system, then this would make the funds difficult to obtain. So, if risk appetite disappears, say, in Dubai or Europe, then it could become difficult for companies looking to raise equity from investors in the troubled area.
The financial implication could be on the debt side, too, where the cost of the funds for the purpose of borrowing from these countries would rise, resulting in a higher interest cost for the company, thereby adversely impacting its books.
BUSINESS ACTIVITIES
Companies, including those based out of India, operate on a global level. This means they are either sourcing materials from some other country or selling their products and services across different markets in the world. There are risks in such activities, many of which are often out of the company's control.
Sometimes, tariff wars break out between countries. This could be due to fear of dumping or protection of local industries. In such a situation, there is a higher tariff levied on the import of a specific product from specific countries and this can make the product less competitive, affecting total sales and profits. Textiles, steel, toys and chemicals are just some examples where such situations are witnessed and this can close markets for a company. A reason why investors should consider companies with concentration in one or two markets as a higher risk.
On the purchase side, a sudden shortage of a natural product which is the raw material can suddenly lead to the performance of a company being impacted. For example, if a supplying country suddenly stops export of raw sugar due to local shortages, then companies importing this as a source of raw materials could take a hit. The immediate reaction could be a drop in the business activity, and profits can take a hit as far as the investor is concerned, impacting valuation of the company.
SALES RECOVERY
The business for a company does not end with the completion of production and sales. There is a more severe worry that arises whenever there is a financial problem across some region in the world and this relates to the manner in which a company would go about getting back the amount owed.
Global sales are a good way of diversifying the market and reducing the risk but most of it is done on credit and there is a time period after which the amount is recovered. This can range from one to four months on an average. If there is a problem with a country or a company on foreign shores, then recovering that amount can be a problem. The debtors figure and the classification into the time period for which the amount is outstanding helps in some understanding of the situation. There is some protection in the form of insurance to protect against such credit losses, so this can be some relief for the company as well as its investors.
The writer is a certified financial planner