Crude Oil : What next??

We have discussed Brent Crude on the 10th of January.


Crude Oil - Big Move

Thankfully this was not as horribly disappointing as the call on the Nifty :)
125$ has not been touched yet. But the basic directional call has been proven reasonably fine. So I thought, maybe its not a bad time to see if the call can be taken further.

   Source : Bloomberg


So ATC moves on and has managed to visualise a standard "flag" pattern. That can be seen in the white coloured parallel lines on the chart. "Flag" patterns are supposed to be consolidation moves for a previous move and the slope of the "Flag" is generally opposite to that of the previous move.


In this case that move happens to be the one from roughly 80$ to 125$ for Brent. Then we have now had a one year weekly "Flag" pattern. Brent has now broken out of the downward sloping pattern.


This would suggest Brent is headed for a substantial move, as "Flags" generally are a continuation patterns. The path of Least Resistance also suggests a move up.


But ATC suggests we watch out for the 125-126$ levels for Brent. That is where it had stopped last time. So it will probably find it a little tough to overtake that. (Unless there is Iran war tomorrow). If those levels are taken out convincingly then we might be headed for life time highs.


But technical analysis has ways to fool people and requires expert eyes. ATC surely doesnt have those. Maybe its not a bad idea to just keep seat belts ready....!! 

Pizza Mania!!

Every now and then comes a story which catches everyone's fantasy. Creates frenzy like there is no tomorrow or as if there is nothing else which is good enough to be paid attention to. I dont think it would be an overstatement if I suggest that Jubilant Foodworks is one such story.


(Disclaimer : I have tried my best as far as background work is concerned before writing my opinion/observations here. But would be grateful to readers who find out any mistake and point it out, particularly silly mistakes. They really make one look like a complete idiot. I will be really obliged.It also helps avoid future mistakes!)


For the uninitiated, Jubilant Foodworks runs a highly successful pizza store chain by the brand name, "Dominos Pizza". It has a particular focus on the home delivery business and has set new benchmarks there.
Rising disposable income, favourable demography and changing palates have helped create a story, which could not have been missed by any investor in the Indian markets, domestic or foreign.
Fantastic growth, great profitability and a raging bull market have taken Jubilant Foodworks to dizzying heights, looking eerily similar to the one time favourite technology stocks in 2000.


As I said, no investor would have been left untouched by this story and I am no exception. But writing on such a well discovered story and attracting attention will require that I come up with something that has not been discussed before, or at least I think has not been discussed before. 
I hope what I have written below is ,at least, worth the time spent in reading it!!


-   Dominos had 306 stores as of March 2010 and ended March 2011 at 378 stores. So roughly 342 stores were operational for the year FY11 on an average.If we go by the number of pizzas that were sold, as per the information in the Annual Report, it roughly comes out to a number of 300 pizzas sold per store per day. Going by the growth numbers in the first nine months of FY12, this number should roughly be around 350 for FY12.


  If the company is averaging 350, I think it would be reasonable to assume that the mature stores in cities like Mumbai, Bangalore, Delhi etc would be clocking closer to 450-500 pizzas per day on an average, with stores in smaller towns clocking lower volumes. The stores are open from 11am to 11pm. I think its fair to assume that out of these 12 hours, roughly 10 hours would constitute almost the whole volume with some part of the morning and late afternoon being really slow.


 That roughly means around 45 pizzas in an hour. Company has indicated that roughly 50% of the volumes are towards home delivery and the remaining are dine-in orders.Going by that it looks like a pizza is delivered every 2-3 minutes. So a bike moves out of the store every 2-3 minutes. If there are 2 pizzas per order, it would be 5-6 minutes. I have to say, these numbers are really fascinating and suggest how frenetic a place the store would be.And mind you, these are average numbers, the peak hours would be even more exciting!!!


And can you imagine how it will look once the store volumes grow by another 15-20% next year, which is what the company seems to be indicating right now.




-   As I have said before, Dominos specialises in home delivery and thus has smaller stores. My guess is that the average size of the stores is around 700 sq. ft. (Its a guess, if somebody has better calculations, it would help). The company paid a rent of about 53.6 cr for FY11. If we take the average number of stores calculated above, average size of 700 sq. ft., then some mathematics would conclude that the average rent paid per sq. ft per month is around Rs. 186!! (I pinch myself every time I read that number!!!) 


-  Dominos requires roughly 8 mn Rs. for every new store that they open.Given the modest interiors of a Dominos store, I think its safe to assume that it will not cost more than Rs 1000 per sq. ft. of interiors. They need to have around 25 bikes for the deliveries. So roughly Rs 7 lacs for the interiors and 8 lacs for the bikes. So about 60-65 lacs is spent on the kitchenware, which will include ovens, freezer, cutlery etc!!!  I am sure its worth that much money!!


-  The final interesting observation is the "Sundry Creditors". If we were to compare them with the "Raw Material Consumed", it turns out that they get a credit period of around 6 months!! It is called the "economies of scale"!!


Jubilant had done a successful campaign called "Pizza Mania".
With the stock trading at close to 60x P/E on FY12 , "Pizza Mania" is well and truly on!!!


Enjoy while it lasts!!! :)

NIFTY and INR - Up or Down??

I wrote this in November:

Meltdown

Obviously there could not have been a bigger "sucker" call and my technical and market timing skills leave a lot to be desired. :(

But if I say, the call went wrong on the timing front then do I still stand by the call of a big market fall? Read on....

Lot of things have happened in the last month or so.

- Rupee touched 54 in December, but we had a big rally back to around 50 today. 

- Markets bounced back with a vengeance. FIIs have bought quite a bit, not only in the equity markets but the debt markets as well.

- European problem seems to be dragging on, though the worries seem to have subsided a bit.

- RBI has come out with a CRR cut to boost liquidity.

Those look like a lot of positives.


Rupee appreciating is a positive for FIIs buying into the Indian markets. It adds to their dollar returns. But while INR has appreciated in the last 4 weeks, what I find intriguing is that forex reserves have continued to head down in the same time frame.This is despite all the FII inflows.

European problem may have taken a backseat as far as the equity markets are concerned for the time being, but by no stretch is it being close to getting resolved.


RBI cut CRR, boosted liquidity, but also for the nth time warned the government to control its fiscal position, which looks to have completely haywire.RBI has already done Open Market Operations (OMO) to the extent of around Rs. 70K cr, and the system is still short on liquidity.


So there are positives around but fundamentally issues have not been resolved and are not close to being resolved either.


With all this as a background, I find it difficult to build a case for a sustainable rally in the market. In fact, the shape of the corporate balance sheets in India makes it even more difficult to imagine a bull run.A lot of cleansing is required to build a good base for the markets to head sustainably higher.


So as of now, I continue to maintain my stand. (Hopefully I will NOT end up with egg on my face yet again!!)


- Stock markets will find it tough to rally from here. They might have just finished a big bear market rally. And they should be headed substantially lower from here.


- I had written this on the USD-INR equation


USD-INR

Most the "Drivers below 52" seem to have worked in the last 4 weeks. I will not be surprised if the "Drivers above 52" start making their presence felt.


I finish here. Hopefully I will be able to have a little more confidence when I write next and that is possible only if I get these calls right!!
Wish me luck!! :)

Crude Oil : Big Move Coming??

The amateur technical chartist (ATC) within me has taken control and come up with something. I am sure a simple chart has been converted into something really complex and exotic. But that is what amateurs do, right?? 

               Source : Bloomberg

As can be seen, ATC has managed to draw three channels in the weekly chart of Brent Crude, Yellow, Purple and White. 

Brent has spent the maximum time in the Yellow channel.It has huge deviation on the upside in 2008 and on the downside in 2009. But after having spent some time in the Purple channel, it has managed to get back to the Yellow one.

While it spends time within the Yellow channel, Brent has managed to move within the White Channel for almost the last one year. 

In this one year Brent has broken the lower end of the Yellow channel thrice and every time it has not sustained below the channel.It has taken support at the lower end of the White channel and bounced back into the Yellow Channel, on all occasions except the last where it turned around halfway through the White channel. Purple channel supported the move.

As ATC sees it, Brent is getting squeezed between the lower line of the Yellow channel, which has a positive slope and upper line of the White Channel with a negative slope.

It has been a year since Brent has traded in the range of 100 to 115$, with one exception where it went past 120$.

This one year squeeze will in all probability lead to a big move. Direction - Up or Down?? ATC knows charts dont tell which direction they are going to take. So he goes on to make a guess.

 

In the last one year, every time Brent has tried to move below 100$, it has bounced back helped by channels as elaborated above. ATC applies the theory of "path of least resistance", and comes up with odds favouring a move on the upside with the first target being 125$.

ATC does not bother about fundamentals because that gives a prejudiced reading of the chart. The fundamentals are swinging wildly between a slowdown in Europe/China, saber rattling by Iran and limited spare capacity within OPEC.

Markets factor in all the available news and events, and tell the story through the charts. It is up to us to read it properly. 

I can only hope that ATC has done a decent job of reading it!!

Gold - A Big Fall Coming ??!!

At the outset, I wish you all a Very Happy, Prosperous and Healthy New Year!!

I am back to gold this time. It has been a very interesting 2011 for gold and I thought that a few things were worth mentioning. 

Gold started 2011 at around 1375$ and ended it around 1550$. 11th year in a row of positive returns. That is a BIG bull market. But what happened in the second half of 2011 PROBABLY indicates the direction gold may probably take in 2012. 

What the starting and final quote of the year 2011 for gold does not tell us is that has touched 1920$ in September 2011. Ballooning deficits and money printing central banks had set it up nicely for gold. 

Greece was on the verge of default in September, when gold touched 1920$. 

Soon enough, Italy came with its own version of the problem in November, which was of course, far more serious than the Greece issue. Gold touched 1800$. And a little later in December, the European Central Bank came out with its bazooka, almost.Gold touched 1750$ then. 

Almost everything in the paragraph above is positive for gold. But with each incremental positive news, gold kept making lower price marks or "lower highs" as a technical analyst would call it. Once the positive news flow subsided, gold started dragging down and ended 2011 around 1550$. 

So there is a little more to gold in 2011 than just the 12-13% return it generated in the year start-to-end.

From Greece to Italy and quite a few other nations facing similar problems, gold should have ended the year much stronger. Almost everybody was and is still bullish on gold.The latest survey by London Bullion Metals Association has indicated that people in the trade expect gold to cross over 2000$ in 2012.

But gold prices seem to suggest that we are PROBABLY headed for not a such a great 2012. I will not be surprised if we end up seeing a quote of 1200$ or lower sometime during the year 2012. 

IF, and its a big IF,  that happens, does that signal the end of the long bull market in gold??

Well in December 1974, gold touched 185$ and then went to go as low as 105$ in August 1976. That is a fall of more than 40%. When we are talking of a fall from 1900$ to 1200$, it is not very different.

But August 1976 to December 1979, gold went on to touch 800$!!

So even IF gold does fall to 1200$, we should be careful with our opinions.

All this while, we have been discussing gold prices in USD terms. So what does this imply for gold prices in INR terms. Now that becomes quite complicated because it has to deal with USD-INR exchange rate.

I have discussed that before. In fact it was just the preceding article.

USD-INR Exchange Rate

I found it easier to make a guess for gold prices in USD terms but there is a good chance that I will get it wrong, so I will not even venture into trying to make a guess for gold prices in INR terms. 

Let me know if you can figure it out!!

INR - Up or Down from here??


I have tried to put my views on Indian Rupee on two occasions before this one. For reference,I am putting the links to those discussions below along with the dates. 


INR headed to 50 - 25th Jan 2011

USD-INR Technical Perspective - 12th October 2011

I will use the second of these discussions as my starting point here.
For those who had tightened the belt, the rupee depreciation spree was not a surprise.We have not reached orbit yet, we have only taken off. 
Now whether this take off has enough to propel it to orbit or whether we are heading back to the ten year range is the moot question. Well I do not have the answer, but maybe we can put the probable drivers of the movement in future and try and make an educated guess. 


I will finish off first with my sense of the chartical position right now. What has essentially happened is that INR has broken into a new life time high by crossing the previous high of 52.18 which was set in March 2009. It crossed it with a lot of vigour. Having set quite a few heart beats racing, interventions did come in the form of actual dollar selling by RBI and severe restrictions on market participants (desperate measures, I thought).So broadly what is happening right now is that INR is taking a breather. 


Having made a new life time high, it is basically testing the previous high (this is classical pattern for charts making new highs, particularly life time highs) and as of now has not broken it. As long INR does not start trading below 52 and sustain there, I think its fair to assume that this is a breather and we are getting set for the next round of depreciation after some time.


But how do we decide that it is a breather and that INR will not relapse back to the previous 10 year range.As I said before I do not have an answer for that, but I will put up some drivers for the INR which can drive it below 52 and others which can drive further above 52.


DRIVERS BELOW 52:


- FIIs come in hordes into the stock market, which will probably require global situation to improve.
- Gold imports drop off dramatically (that is responsible for a big chunk of the current account deficit). Possible with the high prices of gold. How about gold exports?? I suspect that may happen if gold prices start dropping alarmingly in INR terms.
- Deluge of money comes in response to the hike in interest rates on foreign currency deposits.
- Crude oil cools off dramatically.
- Finally, Government does some sensible work.


DRIVERS ABOVE 52:


- FIIs pull out money big time. They have hardly sold in the Indian markets as of now.
- Crude oil marches upwards even further.
- Gold imports keep coming.
- Exports crash. First signs were visible last month and lets wait for the follow-up.
- Close to 80 bn USD of short term up for rollover in the next one year.Maybe 15-20 bn USD may not get refinanced.
- Government continues with the screw-up job.


What RBI has done off late is essentially a time-buying manoeuvre. That is not going to solve the basic problem. And it hopes that within whatever time it has bought with these moves, either situation improves globally or at least government starts the process of clearing up the mess.


There are quite a few parameters which can have a dramatic impact on the way the INR moves going ahead. And most of them are inter-connected as well.


So its a tough call.
With a gun on my head, I will put the odds in favour of INR depreciating further in 2012.


(As always, let me make it clear that I am no currency expert. Take these to be the opinions of an amateur currency analyst!!)

Will India export gold??


When India is the largest importer of gold, the title seems out of place. But with gold prices are where they are, is there a possibility that we will start thinking of exports?


Lot of analysis has gone into the effect of gold imports on the trade deficit that India has. Looking at that people have suggested that trade deficit is overstated to the extent that gold is not re-exported in the form gems and jewellery. My rough estimate is that the effect maybe roughly 40 bn USD. That is a big chunk of the trade deficit of around 150-160 bn USD.


People have argued that since gold is more an investment than a consumable, markets (particularly currency market) do not seem to be appreciating the value of the gold that Indians hold, which is estimated to be around 18000 tonnes.


Is the market really discounting such a big storage of gold? And if yes, why?
Generally markets are smarter than all of us put together. So, as of now, I will taking the safer option of being on the market's side.
I will try and reason, why the value of the gold in India is not exactly being appreciated and why currency markets are weakening the rupee when we are the biggest holders of gold globally?


First a little bit of history. Have a look at the following chart. This is gold prices in INR terms over the last 38 years.



Source : Bloomberg


Gold started at somewhere around 520 Rs per ounce (please use the relevant conversion numbers for per tola comparison) in 1973 and today quotes around 90000 Rs per ounce. That roughly corresponds to a return of around 14.3% CAGR over a period of 38 years. That is an astounding number!!!


And this happened when through the 1980s and 1990s, gold was in a severe bear market in practically all other major currencies!!
The major reason for this mind-boggling performance in INR terms is that India has been fiscally profligate country all through out.In fact it was only after 1997 that RBI stopped monetising government deficits.Thus all through out this period INR depreciated against all major currencies. Gold has stood out as a fantastic store of value for Indians as 14.3% CAGR will at least compensate for inflation over the time frame if not do slightly better.That being the case, it should not be surprising that Indians have kept buying gold in the face of ever rising prices.They have experienced that it sustains purchasing power over a period of time and use it as shield against the fiscal attacks that government mounts on them every year.


Looking at the present scenario,it is safe to assume fiscal prudence is not on the radar of the government right now.And as long as that continues, a combination of gold prices in USD and USD-INR conversion ratio will probably continue the mind-boggling performance of gold in INR terms.And it is more likely that Indians will keep importing gold, forget exporting it.


And if ever high gold prices were to attract selling by Indians, it should have happened at least to some extent in the last few years or today. But there are no signs of that yet. We are still importing and in large quantities.


Given the likelihood of gold imports continuing, I think markets are correct in discounting the presence of gold in India.
You do not value the home where you stay, since you never intend to sell it!!

Meltdown Coming??!!





Source : Bloomberg

Indian Consumption Story = FICTION??

In one of my previous articles I have already mentioned why I think the stocks related to consumption in India need to be sold or shorted. In this short note, I will just put a small number work to try and corroborate my point.

Have a look at the numbers below and notice the serious jumps in the sales volumes of most categories.Growth trajectory changed for quite a few of them.But all of that was accompanied by the ballooning fiscal deficit. Or should I say, it was a result of the ballooning fiscal deficit.

Now that the fiscal position of the government is totally messed up, it will probably also mean a serious brake on the growth rates. 

(I have not still forfeited my right to be wrong!!)

I call it the "Fiscally Induced Consumption Tale In Overpopulated Nation" which can be abbreviated to "FICTION"!!!!

Crisis = Opportunity


We ended the last article on the cautious note of every crisis being an opportunity. So I thought maybe starting with the same theme is a nice way to move forward.
As the headline suggests, I will need to define the crisis as well as the opportunity. 
I have pretty much given the contours of what I think is a crisis in a few of my previous articles. I will spend some time on finishing my argument on that and then try and convince what I think could be the opportunity arising out of the same crisis.


Putting my views in short, I think inflation is likely to remain high as long as we keep trying to grow beyond our means. That would essentially mean sustained high interest rates.Deficits of all kinds will exert their own pressure on various economic parameters.
Given the current global scenario, INR depreciation against the USD and CNY is very likely.In fact the crisis should take the form of rupee depreciation.


Thus I think the opportunity exists for sectors which are in a position to take advantage of a depreciating currency. The most obvious candidate that comes to mind immediately is IT sector.But their heavy dependence to the global financial sector is a dampener.


I think the sector which has the potential to make a killing is "manufacturing". 


China has been the biggest problem for all manufacturing setups anywhere in the world. It has now become the biggest manufacturer of the world overtaking USA. Years of cheap credit, labour and government subsidies in various forms (including currency) has meant that manufacturers elsewhere have struggled to compete against Chinese competition, for whom cost of capital is probably an alien concept. Lot of businesses have built models around Chinese outsourcing.
But it looks like things are changing.


- Currency - CNY has started to appreciate. The movement against the USD may not be huge, but the movement against the INR is very meaningful. After having traded on an average of 5.5 to the CNY, INR is now trading at above 7.5. That means a depreciation of above 35% against the CNY in the last 3 years.That should take care of a lot of Indian inefficiencies like infrastructure and labour productivity.
- Wage Inflation - As I have discussed in one of the previous articles, China is ageing fast and wage inflation is likely to be more of a structural phenomenon. 
- Given that we tend to consume much more than what we can produce, deficits flare up and currency is always vulnerable. To balance this situation out, either we start consuming lesser or start producing much more. So manufacturing is the way out of an imminent crisis.


Manufacturing in India is not an easy business. Government policies have ensured that labor,land and capital as well has become difficult to get and whenever you get them, they are expensive.All this has already and will in future continue to take a toll on the competitiveness of Indian manufacturing. 
Currency depreciation, which markets have forced upon us, will act to counterbalance these inefficiencies. It will make exports more viable across the board. Businesses in India which have been built based upon Chinese outsourcing, will find it increasingly expensive to import and sell. That should mean they would turn to Indian manufacturers at some point in time or put some some units themselves.
Given the difficulties in putting up manufacturing capacities in India from land acquisition to clearances, it will not be surprising to see existing manufacturers enjoy some real pricing power.For the past few years, companies built upon the outsourcing model have been highly valued by investors. 
If the above theory is correct, things could change over the next few years.I dont have any individual recommendations to make but I think its not a bad idea to at least do some ground work.


Things can change if the view on currency changes because of collapse of crude oil prices or something similar.But we will take that up whenever it happens.


No country in history has made it big without manufacturing. UK, US or China. As of now, that theory holds unless India proves otherwise and consumes its way to glory!!

Should we accept a lower level of growth?


Recently RBI came out with a report on how inflation impedes growth rates and they also published reports on the threshold level of inflation, from where it starts hurting growth.
Inflation does act as force against growth, but I was just wondering if it is not growth itself that leads to inflation.So inflation tends to act as a self correcting mechanism.But by repeatedly flaring up, as in the case of India, does it raise a red flag on the sustainable level of economic growth that can be targeted?


I dont know the answer but I will try to get a sense.
My analysis is very basic.I am neither capable nor equipped to do some hyper-mathematical regression to come up with a conclusion.

There are "n" commodities that go into making an economy and their weighted price index gives an indication of the inflation levels in the economy.

But I will concentrate on the basic commodities. Almost all other commodities are derivatives of these basic commodities and inflation in these basic commodities is what should generally be the driver of all other inflation.


The following is a table with growth rates for various basic commodities

Let us have a look at them:

Coal – We did well on Coal production before 2010-11. But last year was major disappointment. It looks like it will be worse this year. Looking at the overall scenario as of now, it is fair to asume that we are on are way to higher and higher coal imports.

Natural Gas – We were struggling to satisfy domestic demands and had a lot of hopes pinned upon the KG D-6 gas. It came in 2009-10. But now given recent problems, it looks like KG D-6 will struggle for production and so will India as a country as far as Natural Gas production are concerned. It should not be surprising that there are quite a few plans on the table to setup LNG terminals to enable import of LNG.


Crude Oil – That has been our weakest link in energy. Cairn Energy's find produced a bump in the production but now we are going to struggle again to grow it in any meaningful manner.

Except coal, we were always struggling with other energy sources.It had its own side effects of deficits and inflation but we somehow managed as global liquidity push helped India with capital inflows.
But now it looks as if coal is also going to go the crude oil way.

With limestone in abundance, we managed to get enough of our cement capacity in place.

Electricity - which is almost a derivative of coal in India, has done well. But with increasing problems in coal sourcing, it looks likely to struggle.

Steel has had a good going but even though we have abundant iron ore, we will have to import increasing amounts of coke to sustain steel production growth.

Fertilisers - that has gone nowhere. And no new capacities coming up, is likely to go nowhere.


Besides steel and cement, we will have to imports increasing amounts of all other basic commodities if we have sustain our growth momentum.

So where is the problem?


The problem is that all this leads to increasing trade deficits and we require higher amounts of foreign capital inflows to sustain our external balances.Higher Capital inflows helped us grow fast in the last decade.

But if we are going to struggle to produce enough of these basic commodities going ahead, our problems are going to exacerbate.And what happened in 2008 in terms of currency, inflation and growth shocks will keep coming back.Govt can try to induce growth with fiscal deficits. But given that we are a consumption driven economy, the govt effort leads to even higher trade deficits, inflation and currency fluctuations.And as govt tries to give a boost to a economy slowing because of inherent constraints and external issues, the next crisis becomes bigger.
Have a look at what happened in 2008 and later. The fiscal deficit went from the range of Rs.2 lac cr. before 2008 to more than 4 lac cr. And now this year it threatens to cross 5 lac cr. if we include the various subsidies being doled out.Inflation has been close to double digits for almost 2 years now even though we have not passed the full effect of the crude oil prices.
Rupee is back to 50 to the USD even before FIIs have sold anything substantial in the stock market.This is very unlike 2008 when Rupee did touch 50-52 to the USD, but after a heavy bout of selling by the FIIs.
(That does not necessarily mean that FIIs are going to turn big sellers in the Indian market, but I am just trying to say that the nature of the problem is more serious than it was in 2008.Or at least that is my feeling right now)

Agriculture - We are facing stagnant per capita availability in most agricultural products (except a few). In some cases the per capita availability is going down. This is happening at a time when the per capita incomes are going up. The resultant increase demand for basic cereals and proteins is pushing agri-inflation.As of now this looks like a structural issue, with the agricultural growth not keeping pace with rising incomes and the ancillary infrastructure around agriculture proving to be a bottleneck.Double digit food inflation for two consecutive years has already spilled over to higher wages.

Having put up this argument, it does come to mind that even China imports a lot of what it needs. But they have been able to avoid at least some of these issues.
Its true China imports a lot of the commodities, but I think there are some other differences when compared to India that helps it avoid these issues.

- Firstly consumption as a % of GDP is almost half in China. So they end up exporting a lot of what they import, which is reflected in their trade surplus.So they have current account surpluses instead of deficits. And thus their dependence on capital inflows is much lesser. In fact the trade surpluses can attract more capital in hope of taking advantage of a stronger currency. That this dependence on exports creates other issues is a different matter altogether.

- Secondly the massive infrastructure that they managed to build, a big chunk of which came in the 1990s and early 2000s when commodities were running at their lowest prices in decades.

 
- Thirdly productivity of almost all factors is higher in china except probably capital. It is routinely mentioned that India uses its savings much better.But China has used the capital to put up infrastructure which by definition is “low RoCE”. So they may have used capital a little less efficiently but then they have comparatively lesser inflation and bigger trade numbers.What we save on capital, we pay back I suppose by higher inflation and deficit problems.

Agriculture is probably the common place where both the countries face the same issues. Thus that part of the inflation is common to both.

Looking at at this very basic analysis, I would think there is a big fallacy with the Indian consumption led growth story. 

"We are wanting to consume much more that what we can produce"


What can change around the scenario:
- Collapse in global commodity prices, without having a big effect on the Indian export driven part of the economy. 
- Huge productivity improvements and removal of bottlenecks. (Basically taking advantage of the low hanging fruit)


I am not being critical of anyone, but just trying to put this as an neutral observer.

As of now, I think we would need to accept lower growth till we fix the systems or the commodity scenario changes. Slower growth is surely not acceptable to anyone. 

In that case it looks likely that markets will enforce lower growth on us through inflation and currency. That will be much more painful than a self-controlled slowdown.


There is a famous Indian axiom:
"Chaadar jitnee lambi ho, pair utne hi failaao".


But it is also true that a crisis is also an opportunity.

On that cautious note, I wish all a very Happy Diwali. And I hope everybody has a prosperous, happy and healthy New Year!!

USD INR - Technical Perspective

                                  Source: Bloomberg


USD was in bull market vis-a-vis INR from 1980 to 2002. Then its been a sideways pattern within a range of 40-52.
Only time will prove whether this was a consolidation of the previous 20 year bull market or whether we are going to be in this range for much longer or INR rupee will appreciate thus ending the USD bull market.
As of now I will lean towards it being a consolidation phase.If it breaks above the 50-52 barrier, then we have a renewed bull for USD against the INR.
And if that is the case, as they say in technical analysis, this is unchartered territory and targets are difficult to pin point.
If this analysis is correct, then tighten your belts,we might go into orbit. :)

Should Yuan appreciation be taken for granted?

Exchange rates for the Chinese Yuan has been a contentious issue for some time.Almost everybody other than the Chinese feel that the currency is undervalued. And some feel, by a huge margin.

USA constantly tries to impress upon the Chinese that they need to do more on the exchange rate front and probably to let appreciate Yuan much more and much faster.In fact a bill is being pushed in US Senate to allow USA to impose import duties on countries that undervalue currencies. Cannot think of any other major country, except China, against which this bill can be used, if passed by US and validated by International Law.

Basically its difficult to argue against Yuan appreciation, with all their reserves and trade surpluses across the board.

I am no currency expert, but just trying to put a few points together and see if Yuan appreciation should be taken for granted.

- After the 2008 crisis, Chinese banks, backed by the govt, went on a lending binge, the likes of which have not been seen before.That went onto create a real state bubble, or extend the real estate bubble and money went into projects which probably could not have been justified economically. Inflation came along and wages started to rise.

  Then, starting some time in 2010, they tried to control the bubble and its side effect, putting restrictions on lending, increasing reserve requirements on banks and increasing bank rates.And that is still going on.

  But it looks real estate in China has reached a point, where soft landing is not an option. A crash is more likely.The chickens have come home to roost.

- The low interest rates that are offered to the consumers, has also caused an "informal lending" system to take a stronghold in China. One of the signs of that is that the formal banking system has been seeing its deposit base shrink in the last few months. "Informal lending" offers higher rates to people,but how much of the system is actually legal is not known.

- The Govt has tightened credit through the banking system, for fear of taking the bubble even further. This has only added fuel to fast growing "shadow banking" system. The reserve requirements for banks is at an all time high.Inflation is still to be controlled.

- Given all this if the real estate does suffer a severe downturn, the whole banking system ends up in a huge mess. And the collateral damage on other ancillary industries will also be huge, further adding to the bad assets in the system.

- Lot of local governments in China have been running huge deficits funding questionable projects. some of these deficits are probably of the size same as Portugal or Greece. Local governments earn a significant chunk of the revenue from the real estate industry. Put these two things together, and it smells bad.

- Chinese demographics are turning towards becoming older. Their under-14 population has gone down from 28% in 1990 to 17% in 2010.The flow of new labour to the market has slowed down, one of the structural reasons for the rising wages.The rising wages are causing some other countries like Vietnam or Bangladesh to become relatively competitive. China's scale is not replicable in the near future and thus there is no immediate threat to its place as the world's leading manufacturer. Thus it is very likely that the deflation that China exported over the last 2 decades is unlikely to last.

Moreover with with an aging population, it is not going to be easy to replace export driven growth with domestic consumption driven growth. As is sometimes said "China will become old before it becomes rich".

All this would mean, they have to move towards higher value addition and technology, but that takes time.

- If the US and Europe go through another recession, then Chinese exports will also suffer.

If recession/stagnancy in the developed world combines with a real estate-cum-banking crisis in China, will the government launch another stimulus as it did in 2008?

Given that the present banking system problem and inflation is a result of that stimulus, its very unlikely, though nothing can be ruled out.

Can China be expected to keep appreciating Yuan, which will almost act as an "anti-stimulus"?

Commodities have already come down quite a bit fearing a Chinese slowdown. Thus argument of using currency appreciation as an anti-inflationary tool gets blunted.

Currency appreciation adds to the purchasing power of the domestic consumer, but in the aftermath of a Chinese real estate and banking crisis, a consumption led growth is also unlikely.And so currency appreciation may not serve that purpose as well.

In bad times, trade surpluses will also shrink.

Domestic interest rates are also likely to head down.

If its indeed a big banking bust in China, they might want to print more money and recapitalise the system.

Chinese Yuan is a controlled market, but generally all these factors would add to the depreciation pressure on a currency and not appreciation.

US Dollar and Euro, facing their own issues can get into a money-printing mode, more than what they have already done.Absolutely possible and changes currency dynamics. But then choosing a winner in a currency "race to the bottom" is tough, if not impossible.

I think its time I repeat myself. I am no currency expert. Its just an attempt to look at things with a perspective.

Let me know, if I have missed something very basic.

USDCNY = 6.36 today.

Underwear with holes??


In a recent edition of the DNA, there was an article titled "Underwear stands out as investors lose shirt". They had basically covered the underwear industry and written on the prospects of the industry.


Particular mention was made for Page Inds and the way customer has shifted to brands with Jockey being the most successful of them. The way the company reports numbers will surely make anybody feel that the business is really going great guns.


So I thought I will write down what I have understood from the numbers and otherwise.


- The promoters themselves offered their shares for sale in the IPO in March 2007. They probably got some 50 cr. from the sale of their shares. Company itself raised 50.8cr. from issue of new shares. Not too much to read into. But there was interesting point in all this. Company paid an issue expense of around 8.2cr. If it is for its share of the IPO, then that would have meant a fees of roughly 16% for the money that was raised. Since that number looks unbelievable I think its fair to assume that company paid for the expenses of the share sale by the promoter. Though its a small matter of 4 cr., it doesnt smell good. But anyways the amount is too trivial to be of interest to most.


- Lets have a look at the margin profile of the company:

Before 2006, the average operating margin for the company in the four years before would be around 12-13%. Company did the IPO in March 2007. So investors would have had maximum concentration on 2006 numbers. The operating profit margin changed dramatically in 2006 touching 19-20% range. And since then it has stayed there and thereabouts. That is interesting, isnt it?


- Now lets understand some inventory numbers for the company.In the table below I have just tried to come up with some basic inventory numbers. I have compared the Raw Material Consumed (RMC) in a given year with the year end inventory of the year and computed the inventory in terms of "number of days". I understand that inventory is for the future and not a reflection of the past performance, but here I am more focused on the trend than the absolute number itself.

As can be seen, the inventory has been going up almost one way, except for a dip in 2009. Given that growth rates of the company have remained in the 30-40% range throughout the period, it is very interesting that they had to support the growth with higher and higher inventory in terms of number of days.


- Now let us get onto something even more interesting.

Its just a simple calculation of the cumulative cash flows the company has generated since FY2007. As can be seen, the cumulative "PAT + Dep" number is 201.6 cr. That is for the cash inflows. Now if we add up the cumulative capex and cumulative change in working capital in the same time frame (229 cr.), it turns out the free cash flow generation has been negative. So even though  the profits have multiplied in these years, company has not been able to generate cash.
(Here the working capital changes have been calculated net off cash roughly)  


- Looking at all this, those who know the company might turn around and say how come the company has been paying dividends and has good payouts, when the cash flows were not existent?
Well, the answer to that is reasonably straightforward.

The approximate outflow on account of dividend since the year of the IPO, is roughly 100 cr. The total money raised through IPO and incremental debt in the same time frame is about 132 cr. So basically company has had to take debt to        
pay out the kind of dividends that they have paid. The difference of roughly 30 cr. between dividend paid (100 cr.) and total money raised (131 cr.) has gone to support the cash flow gap that I have explained in the point just before this one.


- And lastly, as of March 2007, promoters held 80.69 lac shares. As of June 2011, they held around 67 lac shares. They have sold roughly around 14 lac shares in the open market in these years at various prices. If I assume average sale price of 700 (CMP:2400), then they would have taken roughly 100 cr. by selling their shares in the market. In this time frame,their average holding of the company would be roughly 65%. So out of the cumulative dividends of 86.5 cr, promoters would have netted around 50-55 cr. And now if I add the share sale in the IPO of 50 cr., the promoters have netted anywhere between 200 cr to 250 cr. in these years.
As the promoters earned this money, the company has ended up with a debt of 115 cr, up from 25.3 cr., inspite of the having raised 42 cr. in the IPO.


I am finished with my numbers analysis of the booming undergarments business of Page Inds.


I just have one question to anybody who is reading this. Not exactly related to all that I have written above but nonetheless I will go ahead.


Have you ever worn an underwear with a hole? Does it last long?

Gold Glitters but gold loans......

Gold loan companies have had their share of limelight in the last 1-2 years. It had to happen with 50% RoEs and similar growth numbers.

But I am just wondering if these are actually such good businesses.

They charge an exorbitant interest rate on what is essentially AAA rated loan since it backed by gold with sufficient margin of safety in case of default.Agreed that gold loans are typically for people those who do not have access to formal sources of funds, but even then, the extraordinary levels of profitability in this business are little hard to digest.

I will try to give some food for thought for the two listed companies in the domain.



Manappuram:

- Gold loans typically have a duration of around 4 months on an average.Interest payment happens monthly. In that scenario Manappuram reports "Interest Accrued but not Due" entry in the "Current Asset" side of slightly more than 4 months. That is almost equal to the average tenure of the loans.Maybe Manappuram collects all the interest together. Highy unlikely though.

- It is only after 2006 that the company started to report such high RoEs. Almost as if they had figured out a magic formula. Numbers before 2006 were not flattering, to say the least. RoEs jumped for 2 years, lot of money was raised and now RoEs are down significantly from what they were at the point of making money. Some bit of it maybe due to the fact the leveraging process is still continuing and may improve later. Money raised in QIPs and placements now form 80% of the networth.I do not find it surprising that the "Accrued interest" entry that I discussed above came about only when the RoEs started to jump in 2006 and not before that.

Muthoot:


- I could not see anything interesting in the balance sheet of Muthoot that can be reported. But I have a more broader question on the business model itself.

They will probably end up roughly 22000 cr of AUMs FY12….

They claim to have an avg tenure of 4 months….lets take it to be 6 months….

That would basically mean they will disburse roughly around 40000 cr  in FY12….since they practically end up with a new book every 6 months….that disbursement figure is bigger than quite a few reasonable sized banks….and its all cash..

And of course similar quantum of collections as well…..

So they would roughly manage 80000 cr of cash in the year…

Just to get a perspective….

For M&M fin/Magma/Shriram…the tenure is roughly somewhere between 2-3 years…..

If we do a similar calculation for these three….the approx cash circulation they are managing is around 40-45K cr all the three added together….

So Muthoot alone does roughly twice the cash volume handling as all the above 3 put together…..when the avg ticket size of each of the three above is roughly 8-10 times that of Muthoot…

The challenge in this type of growth with this model is the same as what SKS Microfinance would have faced…..of course that Muthoot does secured lending is a big difference…..

And in all this to maintain margins….RoEs…..in the face of competition…..(In kerala every village junction has probably 3-4 gold lending shops within a radius of half a kilometre…excluding banks)

Gold prices have helped…value goes up without incurring any additional cost….

The physical enormity of the tasks to be performed boggles my mind....and as I said it is very "SKS-ish".

If Muthoot is managing all this, then they deserve their RoEs.


With the new RBI regulations on securitisation, these companies will probably out of that market. That should hurt RoEs substantially.

Their businesses are leveraged on gold prices. But since it is difficult to predict gold prices, I have not ventured into analysing effects of gold prices on the model. Broadly, rising gold prices favour the business.

A discussion on gold loans businesses should bring the colour "golden" to the mind....but I am more reminded of the colour (ever)"Green"!! :)

Is this the right time to sell/short high flying consumption stocks in India?


First of all, let me make it clear that I am not talking about HUL or ITC. It has got more to do with the likes of TTK Prestige or Page Inds. I will list out my short-selling stocks later.


Short-selling is an art in itself. Not too many in the world have done it successfully in a consistent manner.


So am I bearish on these stories? If yes, why?


- A lot of the growth that these companies have achieved over the last 2-3 years has been a function of government spending. Whether it is the 6th pay commission handouts or the collosal spending otherwise. The large fiscal deficit is a reflection of that. But now the government is itself running on financial resources.The fiscal deficit is still large, but has flattened out. And most of the increase in the deficit is now in subsidies rather direct payouts in the hands of the people. In fact, I dont think it would incorrect to say that the direct payout component will go down moving ahead. These handouts were one of the reasons why the consumer durable industry had such a good time in the last 2-3 years.


- Inflation has sapped the purchasing power of the people. With no government payouts in the offing, discretionary expenditure should see a cut.


- If the whole of Europe is in trouble, particularly the banking industry based there. Than it is very likely that the IT industry here in India will find it tough to grow. That makes it likely that graduates will find it difficult to find campus jobs or laterals may find it difficult to hop. And that might apply not only to the IT industry but also to other export facing industries as well.Generally speaking there could be an environment where there is a bit of scare and loss of confidence. These two things can really dent the psyche and postpone purchases.


- From a stock market point of view, these stocks are very richly valued. They are building in a lot of growth in the next 2-3 years. If the above factors are reasonably correct, then those growth expectations are not going to be met. That should lead to a fall in stock prices.


- There is a uniform consensus that the consumption story in India is going to continue strong, even though there are some indications that it may not be so. 4-wheeler sales are flattening out. Consumer durables did not report good numbers in their peak summer season. This uniform growth consensus, despite a few contrary indicators, has the potential to boomerang if things dont turnout the way people are expecting them to.



I am listing down the stocks that I think should be sold or shorted, in no particular order. I am also noting down the prices as of today in brackets.


- Page Inds (2515)
- TTK Prestige (2573)
- Jubilant Foods(870)
- Hawkins(1524)
- Whirlpool(225)
- Hitachi (162)
- Lovable Lingerie (462)
- Titan(205)
- Zydus Wellness(530)


I may have missed out a few more.


CAUTION: It is always advised, and very wisely so,  that going against the trend in a market is a fool's idea. Even if your thinking process is on the right track, it is famously said "Markets can be irrational longer than you can be solvent".


But trend reversals do take place. And I think there are enough indications for that to happen.
Of course, I can be wrong but then that is a part of being in the market and a part of the never-ending learning process.


Happy shorting!! :)