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Stock Markets: Promoters pledging shares; is it a danger signal?

Saikat Neogi
Stock Market, shares, danger signal, Market news, BSE 500 Index, BSE, Eveready Industries, Lemon Tree Hotel, Orient Electric, Chambal Fertilisers and Jindal Steel, Powser

Promoters are pledging fewer shares, indicating marginal improvement in the financial position of companies. In the three months to June this year, pledged holdings of BSE 500 stocks came down to 2.47% as compared with 2.83% in the quarter ended March this year.

A decrease in pledging of shares over a period time is a good sign for investors. A report by Kotak Institutional Equities Research shows that outstanding promoters pledged shares were Rs 1.73 lakh crore, which is about 1.2% of the total BSE 500 Index's market capitalisation in end-June. Promoters of 112 companies pledged their holdings among BSE 500 Index. Three companies—Reliance Infrastructure, Gayatri Projects and Reliance Capital—have more than 95% of their promoter holdings pledged. Companies in which pledged promoter holdings declined are CG Power and Industrial, Sterlite Technologies, Indiabulls Real Estate, Himatsingka Seide and India Cements.

Pledging of shares, as the Kotak report notes, does not necessarily imply that a company or a promoter is under financial stress as banks could have sought additional security in the form of promoter shares. Whatever be the reason for promoters pledging shares, retail investors must be cautious of those companies where the volume of pledged shares is high.

Why promoters pledge shares

During slowdown, companies resort to pledging shares to borrow money from banks to fund their working capital needs or to fund new acquisitions. The lender keeps the shares as collateral and gives loan to the company. At a time when the economy is slowing down and both consumption and investment are falling, high pledged shares by companies can be risky for investors.

Typically, promoters go for pledging of shares as a last resort. Ideally, they should raise from the debt or equity market, but if they are not able to raise any money from this route, then they pledge their shares to banks. In volatile market conditions, higher volume of pledged shares can be risky as when the price of a share falls, the overall value of the pledged collateral will also fall and will put pressure on the promoters either to repay the loans or pledge more shares as collateral.

Trends in June 2019 pledged shares

The report shows that highest increase in pledged promoter holdings was in companies such as Eveready Industries, Lemon Tree Hotel, Orient Electric, Chambal Fertilisers and Jindal Steel and Powser. Companies in which promoters revoked/creditors invoked entire pledged holdings are GG Power and Industrial, Sterlite Technologies, Indiabulls Real Estate, Advanced Enzymes, etc. Companies in the Nifty 50 with more than 5% of pledged promoter holdings are Adani Ports & SEZ (32.1%), Asian Paints (12%), IndusInd Bank (26.3%), JSW Steel (49.1%), Sun Pharmaceutical (11%), and Zee Entertainment (64%).

What should investors do?

Before investing, an investor must analyse the reasons for the company pledging shares. An increase in pledging of shares could be dangerous to both promoters and shareholders. However, as the Kotak report points out there is a decrease in pledged shares by promoters in the quarter ended June, which is an encouraging sign.

A couple of months ago, markets regulator Securities and Exchange Board of India (Sebi) had tightened the rules for pledged shares. It made it mandatory for companies to disclose reasons for pledging shares if it crosses 50% of the shareholding of the company. Similarly, disclosure will have to be given if it crosses 20% of the total share capital in the company.

Investors must realise that pledging of shares by promoters is not always bad for the companies or the investors. However, if the quantum is increasing then it becomes a worry and investors must stay away from such companies. On the other hand, if the company is reporting increasing cash flow, then pledging of shares is not a major concern and investors can take a measured decision in investing in such companies.