India Consumption Story = "FICTION"?

While the consumption story in India has been celebrated by investors and companies have been awarded rich valuation multiples, is there a case to be cautious of the drivers of the story??


India Consumption Story = "FICTION"?  


(Standard Disclaimers apply....:-))

Has CAD affected our longer term foreign inflows??

An attempt at analysing why RBI ended up pressing the FCNR button to give lucrative returns to the foreign investors.

CAD and Long Term Inflows

Thanks

Can we have low inflation and growth together?

My second piece for MoneyLife


Here is the link:

Can India have low inflation & growth together?


( Usual Disclaimers apply...;-) )

Fiscal Deficit - Just a Financial Number??

Have written my first article for MoneyLife.

Here is the link

Fiscal Deficit - Just a Financial Number??

As usual, would love to have your feedback.

Oct-Nov 2013 - Nifty 4500, USDINR 75-80?

I am sure you have had enough bearish calls.
I also know that it is completely in vogue to be bearish on the Rupee and Nifty.Its also clear that Rupee is badly oversold.

The reasons for Rupee's performance and Nifty's decline have been analysed to death.Even a "paanwaala" now knows India's CAD is unsustainable.

So what am I trying to do here? Why add to the already overcrowded bears' county?

I think floating currency rate is a measure of relative confidence. And confidence cannot be overvalued or undervalued but surely can be either built or undermined. Confidence will be reflected by whether capital wants to come and reside in a country or not.

In this world of hyper-volatility, with trillions of dollars floating around it is impossible to mathematically calculate capital flows in or out of a given country.
So this is an attempt to read the market signals and them come to a numerical conclusion for Nifty and Rupee.

This is NOT an attempt to justify any levels for the Nifty or Rupee....its just an attempt to read markets.So no fundamentals here.

At the outset let me warn you, I am a horrible chart reader.Surely not a technical analyst of any kind. I may get this horribly horribly wrong.
I am just trying a different perspective and please take it that way.



So here we go.....

Have a look at the two charts below...

First one is the Nifty....Second is the Nifty in Dollars.....(Src :Bloomberg)

As can be seen, both charts have broken down from very long term triangle formations. If I understand it right, such breakouts, on the up or down side, are likely to lead to fast big moves in the direction of the breakout. In this case it happens to be downside.

The Dollar Nifty is around 78 right now and if charts are any indication,and of course if I can read them right, then it looks like headed towards the 50-60 range. Lets take average of 55. That would mean a cut of around 30% cut. But remember its the Dollar Nifty.

On the Nifty, having broken the lower trendline, if it sustains below it, then next significant support seems to be around 4500. So maybe a cut of around 15%.
That would leave Rupee to fall around 15% to get the Dollar Nifty to 55.

Put two and two together....and you get the title!!

Some of the other technicals that I tried my hand at went horribly wrong. So feel free to neglect this one.....LOL!!!

Time for Asset Kings??

Volatility is making the biggest and best investors and analysts, think and rethink.
Rules and correlations,which would have been blindly adhered to are being shred to pieces by the markets. But as investors and market participants,all of us try to keep our thinking cap on to seek "alpha" as they call it.

What I am writing today is just a continuation from November 2011 linked below.

Manufacturing Opportunity


- Chinese Yuan which was around 7.5 to INR then, is now above 10. At the same time, Chinese wages are now growing fast as the working population of China peaks,a side effect of the one child policy that has been followed for decades.
  
  Simmering discontent on the environment quality amongst the masses is making the Chinese Govt anxious. Just as examples of the havoc that the unfettered industrial growth has caused, the average life expectancy in North China has gone down by 5.5 years over the last 2 decades. Its almost a compulsion to have gas masks on,when moving around in Beijing. China is also not exactly "water rich".
  
  Cleaning up would require lot of money and I would assume shutting down few capacities as well.

- Indian situation has worsened from what was discussed in article above. Consumption continued with no corresponding action to get things made within the country. Manufacturing reflected by IIP has been stagnant for two years now.Naturally CAD situation has worsened and USDINR movement is for all to see.
  
  Moreover if what is understood of the Land Acquisition bill is correct then acquiring land for industrial expansion is hardly going to be a cakewalk.

  The case for existing manufacturing assets to become far more profitable is getting stronger.Rupee depreciation, hopefully reduced Chinese competition and increased Chinese costs should act as tailwinds. Land acquisition problems may act as entry barriers.

  Its been almost two years since that article in November 2011 and all the bearish calls on consumption have not turned out as I thought they would.While its negative side effects are causing distress, consumption itself has not collapsed yet.On the other side, manufacturing companies have not exactly set things on fire.
  
  But given the way things are shaping up I would still bet that these "old sector" manufacturing assets are going to reap a lot of money and valuations are unlikely to remain at the pathetic levels that they are available at today.

  While for the last 3-4 years "asset light" branded distribution companies have been investors' delight, I think "Asset Kings" are set to outperform them over the next few years!!

(Standard Disclaimer : The probability of my opinions going horribly wrong is closer to 1 than zero!!)

Indian 10 Yr @ 9%??

Off late bond markets have seen some volatility with yields going down in expectation of lower inflation and rate cuts and then moving up because of FIIs withdrawing some money from the bond markets.
Yields are still lower than what they were a year back, only off the lows they made recently.

Rupee depreciation majorly caused by this FII withdrawal from the debt market has made it difficult for RBI to cut rates further and yields may have already incorporated that reality.
So now where do we go from here?

Inflation has been coming down last few months, rate cuts from RBI have followed, though not from the banks to the same extent. Finance Minister and Planning Commission have been cajoling the banks into cutting rates further to give a boost to the economy.

I have written before on why I think high, not low, inflation is the way out of the mess that the economy is in. Please find those views here:


High Inflation - Way out??

In fact, I would be tempted to go ahead and bet that markets will force high inflation on us, how much ever we would want it to go the other way.

Have a look at what happened in the bond market.

Govt and RBI opened up to the FIIs in the bond market to cover the huge Current Account Deficit (CAD).The high yields in the Indian market did attract FIIs and they ended up owning 38 bn USD of Indian bonds by May 2013.
The bonds then rallied and yields went down by almost 100 bps. Thus FIIs were sitting on profits.

But at the same time, because of the lower yields, it was not as attractive for FIIs to put incremental money, particularly the hedged arbitrage money. Thus started the initial outflow of dollars from the bonds and it had the corresponding impact on the currency.Currency depreciation started eating away gains and led to more outflows and we had a full fledged depreciating run on the currency.

This round of currency depreciation has caused worries that the lowering trend in inflation might be ending. If that comes out true, in effect, markets would have forced inflation on us through the currency. 
What happened in the bond markets and its after effects on currency were nothing but payback for the borrowing binge we have had for the last 3-4 years.

Lets have a look at government finances.

I am jumping the gun as its early in the fiscal year, but if the early trends in the first two months are any indication of what is coming on the revenue collection for the year, then govt is very likely to overshoot its fiscal deficit target by some margin.That is likely to be inflationary if they continue their spending ways in an election year. 
As I have mentioned in the previous article, linked above, govt itself needs high inflation to meet its revenue targets not only for this fiscal year but for the whole 5 year plan as well.

Overleveraged corporates can repay banks only if there is product price inflation which enables them to make that extra buck.If that doesnt happen the stock markets are not going to be kind. FIIs may withdraw money from there as well. In any case Indian markets have not exactly set the stage on fire with their dollar returns for the FIIs. That may lead to further depreciation and implied higher prices and inflation.

Net net....I think we need high inflation and markets are going to force that on us.
If that happens can the 10 year govt bond keep yielding 7.5-7.6%??

This is a volatile world and surely I can end up looking completely idiotic making these conclusions. There are so many factors like the crude oil prices, QE in US etc which can change the way things are looked at.

But with all that as the background, I would still bet that there is a reasonable probability, more than 50%, that the 10 year govt bond might be yielding more like 8.5-9% in the next one year.
I also think that these higher rates are not going to have any meaningful impact on GDP growth, because that in case may not be much beyond 5%,in my opinion.

Low growth and high inflation might be here to stay for some time...!!

(Standard Disclaimer : The probability of my opinions going horribly wrong is closer to 1 than zero!!)

Something big round the corner..

So confused right now that cant even think of a apt title for this article. Have left that exercise for the end.

Confusion is with what the markets seem to be suggesting.I am talking about the currency and equity markets.As of now USD-INR is 54.8 and Nifty is around 6100. Both looking placed at technically critical points, moves beyond which are generally not the garden-variety ones.

Last 3-4 weeks have seen some interesting movements in the global commodity markets which have significant ramifications for the Indian economy and markets, both currency and equity.
First gold prices have crashed to 1400 $ levels and second, oil prices have also corrected. While oil prices may not have crashed but even 5-7% correction helps.And you never know whats in store!!

Both the above developments are both unequivocally huge positives for the Indian economy. Lower gold prices helps reducing current account deficit and benefits of lower crude prices are also obvious.The other good news,though one-off, is the huge 5 bn USD open offer coming up in HUL by the parent company.

Before all this happened, INR was trending between 53.6 and 54.6 to the USD and the Nifty was around 5500-5600 levels.
Not unexpectedly markets reacted positively to all these developments and USD-INR moved towards the lower end of the range at around 53.6 and Nifty went closer to 5900-6000 levels in Nifty.
But in the last few days, things have changed slightly and the markets are now running in what can probably be called contradicting directions.

In the face of huge FII inflows in the stock markets, Nifty has moved forward and now standing around 6100 levels.But at the same time, USD-INR has made a move in the opposite direction and now stands at 54.8.
This currency depreciation as stock markets are getting within touching distance of the life time highs is what is really CONFUSING!!

I had articulated my opinion on the USD-INR in some previous articles.

Treadmill

60-65 on the Cards

Obviously,environment in which those were written have undergone changes, which are mentioned above.So what to expect now??

Logic would suggest that,given the changed environment,INR should appreciate with external deficit coming down and FIIs pumping in money like never before.I have certain reservations with that thinking. Rupee appreciation would mean all commodities where prices are USD denominated will see downtrend in INR terms.A possible deflation or very low inflation scenario. While that seems anything but negative,in the article below we have discussed the huge negative side effects deflation or very low inflation could PROBABLY have on the Indian economy.

Low Inflation - Good for India?? 

So if INR appreciation does come about,I think there could be huge negative side effects. And the above article has actually not discussed about effect of appreciation on trade deficits.That is unambiguously negative.

So while stock markets may do well, underlying economy and financial systems may come under increasing stress and thus slow down the Indian economy even further from what we are witnessing right now. That in turn would cause corporate profits to suffer and stock markets should logically react negatively to that, right??

But appreciation didnt come, at least not as of now. Stock markets went up and INR depreciated!!!

Confused??!!!

I am not sure this opposing movements can last very long. One of them has to concede and start reversing. So either INR has to start appreciating or stock markets have to start their downward journey.Obviously its difficult to predict if this will happen and in case it happens which market will reverse.
Trade fundamentals dont justify rupee appreciation but fund flows can change the arithmetic.

With so many moving parameters in terms of commodity prices,slowing global growth and crazy money printing leading to humungous fund flows into markets,there are no clear bets.


But I would go with what I think is fundamentally correct. That would be INR to depreciate and stock markets to give up their gains.

Either ways, I think a big move maybe coming....in both the markets.

There is something round the corner....

(Standard Disclaimer : The probability of my opinions going horribly wrong are closer to one than to zero!!)

Pizza Mania!! (Part - 3)

This is third in the series...and the shortest!!

Have already written this....

Pizza Mania Part - 2

(The above article also has the link to the first one)

Jubilant Foodworks today declared the Q4 and Full Year results for FY13.

Since I have already discussed in detail a lot about the model in the previous write-ups, here I just wanted to kind of top it up with something new.

-    The capital expenditure for the company in the last 3 years has been 70 cr, 120 cr and 185 cr for FY11, FY12 and FY13 respectively. (Numbers have been rounded off approx.) And now for FY14, 250 cr is the number being guided for.

      As can be seen,the capex is just ballooning with each passing year.And since there is limit to the number of stores that can be opened in a year, increasing amounts is being spent on non-stores capex. This basically relates to money spent on commisaries/factories to supply to stores in a given region.

      The total expenditure on these factories till date cumulatively would have been maybe 100 cr. This is a rough estimate.And these are supporting the 570 odd stores that the company operates.But now we are talking about spending a similar quantum of money in one year itself!! And this when the store opening in the year would be of the order of 125.Interesting!!

-    The other interesting part of this ballooning capex story is the tax benefits it is generating for the company.Lets see how.

      In FY13, company provided for deferred tax of about 13 cr. Assuming 30% tax rate,the additional depreciation that company would have claimed in the tax books is around 40 cr, which will be over and above the 55 cr already claimed in the accounting books. So company has claimed around 95 cr depreciation in the tax books when  the capital expenditure in the year was around 185 cr.!!

      For FY14 they have suggested a capex of 250 cr. And have also confirmed that there will another deferred tax entry similar to the one in FY13 and probably a bigger one.

      When asked about the deferred tax, it was clarified that the tax books had "leasehold improvement" expenses being shown as revenue expenditure and thus claimed. Clearly the same were being capitalised in the accounting books.

      That also means the profit claimed in the tax books is at least lower by that much i.e. around 40 cr.

      So there is a double benefit.The profitability declared to investors is 'inflated' to that extent and tax outflow is lower to the extent of deferred tax claimed in the books!!

  

In other observations, the Same stores sales growth being guided is lower at around 10%, which is on expected lines given the sluggish economy.

Hope you found the observations interesting enough!!

(Standard Disclaimer : The probability of my opinions going horribly wrong are closer to one than to zero!!)

 

Pizza Mania!! (Part - 2)

This is a continuation of analysis of the Pizza Business of Jubilant Foodworks, which runs the "Dominos Pizza" chain in India.

Here is the link to the previous note.

Pizza Mania!!

The points mentioned in that note broadly stand as were discussed. Just that the analysis in the note was for FY11 and we now have FY12 and also some data from FY13.

This article is to discuss some new aspects.

-  I just happened to go through the latest presentation by Dominos Pizza USA. Almost all international Dominos' stores are franchised out and income for the US parent is in the form of royalty. 

  The interesting thing mentioned in one of the slides was that EBITDA per franchise store in US is in the range of 50000 - 80000 USD annually. The same analysis, if done for the Indian operations gives out an average EBITDA per store number of around 85000 USD. 

  So operations in India seem to be generating more EBITDA per store basis. Admittedly the competition in US Pizza market is much more and population is 1/4th that of India. But the per capita income is US is around 30x that of India. At least, I find it amazing that absolute profitability in India is more than the US and moreover it is growing every year at the same rate as the store sales are growing and that number could be anywhere between 10-20%.
  
  Please keep in mind that INR has depreciated 25% against the USD in the last 2 years. And still the per store dollar profitability is higher in India than the US!!

-  Second interesting point in the presentation was what Dominos' US thought was the potential market size in India. According to the presentation the potential number of stores in India is around 1000.

  I assume the "potential" of 1000 stores in India would have been put in the presentation after their own market research and analysis, which would have been reasonably exhaustive. 

  Jubilant Foodworks has already opened 560 odd stores in the country. In FY13, they are expected to add around 110-120 stores. Going by this run rate and some growth in the store addition number per annum ,we will be very close to 1000 stores in India within 3 years. And I do not think it is unreasonable to expect that the store roll out will slowdown, now that they are getting closer to the potential. With stock trading around 60x FY13 P/E, I am not sure investors will have any appetite for any kind of growth slowdown. 

- Third point I want to raise is about the capex per store. As mentioned in the previous article, it was around 85 lacs per store. In FY12, that number has gone up to around 1.15 cr per store. FY13 balance sheet has not come out yet but some rough calculation from the number that have been declared is that the capex per store has gone up even further from the number in FY12.

  Here again, its interesting that as Jubilant goes into Tier 3 towns to take its franchise forward, it expenses to open the store are going up and costing more than what it was costing in Tier 1 or Tier 2 towns. While the stores in smaller towns are likely to be larger, the jump in capex in FY12, has come more from the machinery side and not so much from the construction side.

  What is also interesting is that the average revenue per store for Jubilant is going up, as more and more stores come up outside the metros. Given the purchasing power difference in metros and outside, that is a intriguing result to end up having.

Hopefully you have enough to chew till I find something more to write about this phenomenon. 

Treadmill

Will try to be make this a short one...

Some opinion on USD-INR have been discussed before...you may want to go through it once...

INR @ 60-65

Just to kind of put the situation as it is right now....

- gold imports have stabilised after the initial fall, which happened on the announcement of the customs duty on gold imports....now that has been raised to 6%. Gold imports may possibly trend downwards for some time from here on.

For the last 3-4 months the avg trade deficit on monthly basis is around 
20 bn USD.

That would make it approximately 240 bn USD on an annual run rate basis.

70 bn USD can be covered by IT/ITES.
Another 70 bn USD can be covered up by private transfers or remittances.

So we are left with 100 bn USD. (Current account deficit - CAD)
Assuming ECBs + NRI deposits will support another 30-35 bn USD...it still leaves 60-70 bn USD to be covered by FII + FDI.

That roughly works out to a required inflow of around 5-6 bn USD per month.
FDI is stagnating and thus will have to be compensated by FIIs.
25-30 bn USD of FII inflows was considered fantastic, but now it seems we will be requiring closer to 50 bn USD just to keep semblance of balance. Or our external debt may shoot up assuming forex reserves are to be maintained at the current levels.

There is a lot of talk about how gold imports are creating serious imbalances in the balance of payments.
Gold imports are at around 50 bn USD. If they are reduced by 30-40%, we will probably save 15-20 bn USD. And correspondingly the pressure on required inflows will also be lower. 
But looking at the overall CAD of 100 bn USD, savings from gold import reduction seem to be of help but not great help.Even after adjusting for the savings on gold imports, we would still be requiring 4-5 bn USD of FII + FDI monthly. That is not going to be easy to manage and this too is just to maintain status quo on the external front.

Sounding like a treadmill..is it??!!

(Standard Disclaimer : The probability of my opinions going horribly wrong are closer to 1 than to zero!1)

Is high inflation the only way out??

In this article I have put forward some data on the Indian banking system sourced from Bloomberg.

Before I do that, its better to put some caveats.

1. Data and numbers are dynamic.These numbers are as of given date and time, liable to change.

2. The data is from the listed space only.

3. All debt is not from Indian banks.A part of it,my guess is 10-12%, would have come from overseas. So please keep that in mind, when inferring anything for the Indian banks.

In the inquisitiveness to get a sense of the leverage amongst the Indian corporates, Bloomberg helped us run a query to come up with companies whose Debt/Mcap ratio is above is particular level.

Debt/Mcap instead of Debt/Networth is to reflect market realities.

Here is a short summary of that query.

                                                                  (debt in Rs. cr.)  
                                                ( "> 20" is a subset of "> 5")
The table above shows the total debt on the books of companies in various brackets of Debt/Mcap ratio. 
As can be seen, companies with Debt/Mcap ratio > 5 have almost 4 lac cr of debt on books.This list has all kind of companies, whether its infra, textiles, metals etc.

Debt/Mcap > 5 should normally raise eyebrows and concerns on the capability of the company to payback, assuming that Mcap represents the ability of the company to run profitably. In fact within that group the avg Debt/Mcap is much higher at 9.3. That should ring alarm bells.
The total debt on the books of companies which have Debt/Mcap > 2.5 is around 8.8 lac cr. 

And this is only from the listed space. Its difficult to estimate the similar number for the unlisted domain, but given that SMEs are a big driver of Indian economy that number MAY not be small. 

Considering total advances of the banking system at around 50 lac cr, above numbers are concerning to say the least.
And of course, this list does not include agri loans or other individual loans, where there is a certain percentage of bad assets.

I am not suggesting that all of these are going to turn into bad assets for banks. Also this is not an entirely new set of probable bad assets.
In fact some of them would have already been recognised as bad.

But surely all of these can be put into the "troubled assets" category.
And for them NOT to turn bad would require a few things to fall in place.

For Example:

- Power companies struggling with coal issues will require some resolution on the tariff as well as the coal supply and pricing front. 
- Metal companies will require their respective commodities to do well in terms of prices for them to be able to earn profits and do well.
- Infrastructure companies will probably require government to pay up dues and then spend lots of money on new projects.

Practically all solutions are highly inflationary.And that is not surprising. 

Inflation is normally the way out of hugely indebted situations, unless you want to go through a period of "depression".
XII Five Year Plan has inherently assumed a 7-8% inflation in the system, almost imperative to fund the kind of spending the government is contemplating.
As Finance Minister prepares his budget for FY14,he cant be hoping for anything lesser. Else he can hardly keep his deficits under control.

As everybody keeps hoping for lower and lower inflation, just wondering if that is what is required.
Wont the debt trap get even further entrenched if prices become stagnant?

The other theory could be, kill prices, lets take 2-3 year pain or maybe longer,and then start afresh. 
But is that an option India can afford given overall demographics and social situation? And what would that mean for the banking system, currency markets and so many others? And how long pain would last is anybody's guess.

I dont have answers to any of these...so I finish with a question...
is high inflation the only way out?

(Standard Disclaimer : The probability of my opinions going horribly wrong is closer to 1 than zero!!)