Wednesday, September 26, 2018

In the end, earnings' disappointment will only drag the market

Some food for thought
"The test of a first-rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function."
—F. Scott Fitzgerald (American Author, 1896-1940)
Word for the day
Sibilate (v)
To hiss
 
First random thought this morning
Election season is approaching fast. Beginning with the assembly elections in five states (MP, Rajasthan Chhattisgarh, Mizoram, Telangana) the season shall last for about 7-8months, till a government is formed at the center post general election next year.
I find that it is almost impossible to avoid discussion on politics these days. For one, due to weakness in markets (Financial as well as Real) most people are looking for distractions and nothing is better than politics in these times. Two, political narrative has become very interesting these days, as most parties and groups appear to be in a state of flux. The positioning is changing and so is the strategy.
Going way out of their conventional strategies, BJP appears to be taking the route of minority & SC/ST appeasement. Congress is wooing Hindus and urban middle classes.
To gain some deeper understanding of the present political environment, I spoke to about 100 non RSS BJP supporters coming from various walks of life. I asked them why they would support BJP in next general elections. The answers were as follows:
(a)   TINA
(b)   Modi deserves another chance. We made a mistake by not giving ABV a second chance.
(c)    BJP has forced all parties to care about the feelings and interests of Hindus.
(d)   Congress needs to be stopped at all costs.
(e)    What if Mayawati or Mulayam Singh become prime minister.
No one mentioned any governance issue for their support. Next I shall be speaking to Congress and Mayawati supporters.
Chart of the Day


 

In the end, earnings' disappointment will only drag the market

The markets are perceptibly jittery. In past five years there have been many instances of major correction in the markets. But this does not look like any of those. The price erosion in a large number of stocks, across sectors and market segments, has been deep and sharp. To many it might be reminiscent of the post Lehman meltdown of 2008.
Before I go any further, I would like to make it clear that it is still not too late to make necessary corrections in asset allocation, if someone had been protracting it out of sheer greed or plain lethargy.
In fact, I had been anticipating this for many months now. The market from last week of March had been rather counterintuitive to me.
Notwithstanding with the rhetoric on global trade war, fear of political instability, liquidity crisis etc., I have been maintaining that other things apart it will be the earnings that will disappoint the markets most. Believing my personal observations made during my travels, I never placed much reliance on the optimistic earnings growth assumptions made by analysts. Unfortunately, my fears of earnings disappointment appear to be coming true.
The key premise behind my crude calculations is that the popular analysis is ignoring the structural change in the cost curve of businesses that may lead to persistently lower margins. Costs of resources, compliance, and capital are rising structurally in India. The businesses that have been built upon state patronage, corruption and contempt for compliance norms, shall continue to suffer the deepest pain.
Since the current episode of market panic is driven by the liquidity concerns and anticipated rise in cost of funding, due to rising policy rates locally as well as globally, it would be interesting to analyze the data on Indian corporate indebtedness, finance costs and sensitivity of earnings to interest rates.
I am presenting a sample of data drawn from of all companies (ex financials and banks) listed on NSE having a market cap of over Rs200cr. The date is presented without any comments. Readers may draw their own references or connect with their respective financial advisors to understand the full implications.
 
I have considered it appropriate to highlight "total debt" and not "net debt", because (a) I believe that the companies which are not in the business of finance and have material debt on their books, must be keeping cash in hand because they need it for the business, not because they enjoy holding cash; and (b) there have been many cases in past where the "cash in hand" has been discovered to be only "cash in books of account".
There are many companies where the amount of annual interest expense (net of interest earned) is more than the post tax profit. As interest rates are rising, the earnings downgrade in these companies could be sharper. For a company with present average funding cost of 7%, a 150bps rise in funding cost may result into 20% hike in interest payable (assuming debt remains stable).
The following is an illustrative list of companies where the absolute amount of debt is substantial and interest expense is more than the PAT.
There are many companies whose enterprise value is mostly represented by debt. The market price of the stock of many such companies show a strong correlation with the rise in interest cost and/or the amount of debt. An illustrative list of few such companies is given below.
Disclaimer: While care has been taken to take and present correct data, but it is entirely possible that some mistakes might have occurred. The entire responsibility for any such mistake lies at my door, and I would sincerely regret that.

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Tuesday, September 25, 2018

Not so happy Diwali

Some food for thought

"Adapt or perish, now as ever, is nature's inexorable imperative."

—H. G. Wells (English Author, 1866-1946)

Word for the day

Coup de foudre (n)

Love at first sight.

First random thought this morning
Last week, RSS held its first ever open house in New Delhi. They invited reputed people from all walks of life to join them in comprehensive dialogue. The stated objectives were to (a) clarify RSS's vision on the India of future; and (b) alleviate misgivings about RSS and thus gain wider acceptance for itself in the society, especially the segments of the society that have remain apathetic to it since assassination of Mahatma Gandhi in 1948.
However, the discourse post three day event suggests that the event has raised more questions in people's mind, than it has answered.
The so called "liberals" and "secular parties" are refusing to believe RSS Chief. They are taking the event just as poll campaign of BJP to gain some secular, liberal and minority votes. Some are even interpreting it to be sign of BJP nervousness ahead of key state polls scheduled to be held later this year.
Many feel that RSS is bidding aggressively to gain support of Non-BJP parties for its agenda of cultural (Hindu) nationalism.
BJP, which has so far claimed to be the only legitimate claimant to the political support of RSS workers and sympathizers, might actually feel threatened by this outreach. Especially, if few other parties take Mr. Bhagwat's view at face value and come closer to RSS.
Second, with the kind ease Mr. Bhagwat presented the radical changes in RSS ideology on Hindi, Hindu, Women, 377, etc., it seems to have totally stumped many right wing fundamentalists. They suddenly find the ground below their feet drifting apart.
Besides, it may also motivate many committed RSS workers and sympathizers to look beyond BJP in politics.
I do not know about others, but I drew a lot of comfort from Mr. Bhagwat's presentations and answers. He has categorically endorsed a lot of my views, which I had been sharing with my readers since past many years. This gives a lot of confidence that my thought process and direction is correct.
 

Not so happy Diwali

Last week I made my usual quarterly visit to the wholesale markets of Delhi. I would like to share the following observations with readers, as I believe that these observations may provide some useful clues for review of their investment strategy.
(a)   Most traders indicated that the demand has been poor for past 4months. Traders across trades (textile, chemical, household goods, decorative items, sanitary ware, food, spices, stationary, wood & plywood, et. al.) have significantly reduced their inventory level. Even though the festival season is less than two weeks away, no one is expecting any material inventory buildup for festival demand.
(b)   The primary reasons cited for the poor demand were as follows:
(i)    The consumer demand, particularly from rural and semi-rural areas has been weak.
(ii)   Working capital financing has become scarce and expensive, at a time when the working capital requirement is increasing. The credit cycle has worsened. Banks are reluctant to lend. Only two private sector banks are lending aggressively, taking avoidable risk.
(iii)  Shortage of cash is pinching everyone. The impact is more visible in rural areas and smaller towns.
(iv)   Imports from China are lower. INR weakness vs. USD has impacted demand for dry fruits and confectionary.
(v)    GST glitches are still many and hurtful.
I suspect that we may see the reflection of this trend in the subsequent corporate results. In particular, I find the investors in consumer companies are susceptible to disappointment.
The carnage in financial stocks in past few days may just be a harbinger of the days to come. In my view, it is reasonable to expect - (a) lower margins; (b) poor credit growth; and (c) elevated stress level as new areas of stress emerge.
Consequently, market in its collective wisdom may choose to de-rate these stocks.
I find it pertinent to reiterate the investment strategy shared with my readers in mid July
 You may also like to glance through the following links:

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Friday, September 21, 2018

Nurturing Raktabīja





Some food for thought
"My dear friend, clear your mind of cant."
—Samuel Johnson (English writer, 1709-1784)
Word for the day
Cant (n)
Hypocritical and sanctimonious talk, typically of a moral, religious, or political nature.

First random thought this morning
Three popular business models have caught my fancy in past two decades.
First is the most popular Google model. In this model, the business uses the classical cross subsidization model to build a captive and totally addicted (enslaved if you like that better) customer base, and then exploit these captivated customers at will.
Google first offered an amazing bouquet of free services to all. Once a critical mass of captivated free users was attained, Google started subsidizing the cost of free services through advertisement revenue it earned from businesses who wanted to sell their goods and services to the captivated audience. Now having gained access to the eyes, ears, homes (including bedrooms) pockets and minds of over a billion users, Google is offering a host of services to this enslaved audience.
Second model is the Chinese trade model. In this model, the vendor first engineers a shift in the supply source to itself. The task is achieved by a variety of means, like compromising the interest of environment & sustainability, exploiting labor, evading taxes, offering and manipulating the exchange rates. In the second leg, the vendor engineers the demand for its product by offering lowest prices and easiest credit terms to the buyers.
China first engineered the shift of factories to its land from all over the developed world. Then it copiously funded the fiscal deficit of the governments of its top consumers, helping sustenance of easy monetary policies and abundant credit to consumers. It then flooded their markets with cheapest priced goods to the leveraged customers.
The third model is the most interesting model. It relates to the business of politics. I am not a well read person. With my limited knowledge, I believe that this model has been developed by Mrs. Sonia Gandhi, the former president of the Indian national Congress. Under this model, the leader of the enterprise enjoys all the authority and remains beyond any accountability. All the accountability is owned by the foot soldiers, well trained and conditioned never to challenge the authority of the leader.
All these models, which have defined our economic, social and political behavior in past 10-15years, are facing serious sustainability challenges in recent times.
The voices of concern over Google's hegemony are rising louder in west.
President Trump is seeking to demolish the Chinese trade model completely.
Prime Minister Narendra Modi is held accountable for everything happening or not happening in India, including instances of drains chocking in rains, electricity transformer breakdowns, loss of BJP in JNU elections, etc.
It would be interesting to see how our future generations would be able to cop without free Google, Social Media, Voice Calling and cheap Chinese manufacturing. Greater accountability and less powers may also change the political narrative completely.

Nurturing Raktabīja

The eighth chapter of "Durga Saptashati", one of the most sacred Hindu religious scriptures, is about the annihilation of a mighty demon called Raktabīja by the Mother Supreme.
Raktabīja, a very strong demon, had a boon that whenever a drop of his blood would fall on earth, a clone of his would be born at that spot. Each such clone will be equally powerful and demonic in character. So it was almost impossible for anyone to defeat this demon in a fight. Eventually, the Mother Supreme, along with her many divine manifestations, was able to annihilate the demon, but not before he had caused immense damage to the forces of gods.
I will come to why I am reminded of this story this morning, in a moment.
As per a latest research reports, "India's air conditioner market is poised for solid growth with a CAGR  of over 17% over the next five years." (See here)
International Energy Agency (IEA) in a recent report highlighted that "The growing use of air conditioners in homes and offices around the world will be one of the top drivers of global electricity demand over the next three decades." (See here)
According to a recent IEA report The Future of Cooling, , "global energy demand from air conditioners is expected to triple by 2050, requiring new electricity capacity the equivalent to the combined electricity capacity of the United States, the EU and Japan today. The global stock of air conditioners in buildings will grow to 5.6 billion by 2050, up from 1.6 billion today – which amounts to 10 new ACs sold every second for the next 30 years."
  
Growth in the India’s air conditioner market is anticipated on account of rising demand for air conditioners from residential as well as industrial sectors, extreme climatic changes and emergence of latest technologies in air conditioners, such as inverter technology and smart air conditioners, according to a TechSci Research report.
As per some estimates, Indian electronics market is expected to grow at 41% CAGR between FY14-FY20 to reach US$400bn. Consumer electronics exports from India is also growing gradually, and is already in excess of US$250mn. 
 Some of the key drivers cited for the likely non-linear rise in the consumer durable in general, and air conditioners in particular, are as follows:
(a)   Change in weather patterns. Longer and intense summers, even in some hilly areas and traditional cooler cities like Bengaluru.
(b)   Greater and more predictable electricity supply.
(c)    Rise in affordability, as income levels of middle class households rise.
(d)   Change in air-conditioning technology, motivating replacement demand in favor of modern energy saving air conditioners.
(e)    Changes in trade and consumption patterns. For example, rise in (a) organized retail formats, (b) processed food consumption, (c) office space for ITeS industry and modern manufacturing; etc.
(f)    Modernization of public transport, etc.
The listing of couple of white label electronic goods manufacturers in past one year has enhanced the market interest in this sector significantly; even though the consumer durable market has been witnessing good growth for past few years.
As an "Investor", I am faced with a serious dilemma here.
I can clearly see, that consumer durable market, especially air-conditioning market, is going to grow exponentially in next few years; just like the way motor cycles, mobile phones and single family apartment markets have grown at various point in past 25years.
The dilemma before me is that I see air conditioner as a product which is similar to the mythical demon Raktabīja. For, every few ACs sold may be generating demand for another AC.
No, I am not talking about the vanity issues or household rivalries here. I am trying to highlight a serious sustainability issue.
Each air conditioner installed in a house, mall or factory, generates tremendous amount of heat outside the premises it is cooling. That heat goes on to raise the outside temperature and thus forcing demand for more air conditioners. It is a vicious cycle that shall go on endlessly.
Of course other factors such as rising vehicle population, deforestation, etc. are equally responsible for rising temperature, but I find air conditioners to be more demonic, as I do not yet see anyone highlighting this as a serious concern.
In recent exercise to rationalize the GST rates, the GST council reduced the tax rate for air conditioners. It is for the first time, the government has recognized air conditioners as a non-luxury item. We may therefore see more incentives for the industry, enabling it to grow even faster.
No denying that at this given point in time, air conditioner is becoming an essential household appliance, just like refrigerator or cooking gas.
But the point to ponder is how did it become an essential item, and how would we ever get rid of this!
In the meantime I am wondering "Should I shun AC manufacturers and sellers, just the way I do with the tobacco sellers!" or "Should I seize this opportunity to invest in these firms and make some money so that I can install some air conditioning in my toilet too!"
 

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