Extraordinary circumstances need extra ordinary measures

There is this whole debate about Politicians. Can politicians run the economy of a country? Or to be more direct – Can Obama pull out US from the mess?

History tells us that it is possible for politicians to salvage the economies from deep recessions. Take the case of Margaret Thatcher in 1970s. She found that the inflation and unemployment were high and quickly realized that Keysian theory works no longer. She showed her cabinet the book “Road to Serfdom” by Friedrich Hayek and said this is the one to follow. She let the market forces take control. The economy became worse until it became worse. The principles were also accepted and followed by Ronald Reagan.

In the recent times, the right formula for bail out packages is attributed to the British Prime Minister Gordon Brown. When the intelligent economists of US were discussing pumping in public money for absolutely no return, it was Gordon proposed and implemented equity participation of public money. He showed the way to US and other developed nations in economic mess that public money should be spent with potential profitable bets.

I hope Obama and his coterie can repeat history!

Extraordinary circumstances need extraordinary men who take extraordinary measures for extraordinary results.

Profit from Futures

People relate the F in Futures to the F in Fire. Not if it is used in the right way. The strategy I propose here is to invest in futures if you are bullish about the markets. That way you will earn better returns. Here is the analysis:

Suppose you invested Rs 1 lakh in Nifty Index Fund and if you did it on 31st March 2007. The number of units you would have got would be around 26. In one year, you would have made Rs 27,700. Considering 1% management fee, you would have gained Rs 27,400. A return of 27.4%.

Suppose you invested in ONE lot of Nifty futures, the margin would have been Rs 20,000. If you rolled over the series for one full year, you would have gained Rs 37,000. The is after taking into consideration the brokerage, STT and Short Term Capital Gains Tax. The margin at any point in time would not have exceeded Rs 35,000. A clear outperformance of 37% over the index fund. If you buy TWO lots, you would have gained Rs 74,000, a 174% outperformance compared to an index fund . Mind you - I am not even considering the bank interest on the uninvested amount.

The key is to set the exposure you want to take and be within those limits. Discipline is what is required while playing with futures or else the fire will engulf you. Write to me at sshravankumar@yahoo.com incase you need the working.

Better Safe Than Sorry

The financial world is just getting tougher. An asset valued at $80/sh plummets to $2/sh in a matter of a month. Bear Stearns’s balance sheet of $400bn will be severely eroded. This bad news had had immense negative impact on global financial markets. What better example of globalization than a US company going bust in US and liquidating its assets in India. If you peruse through the fund action data for Friday, you will find that Bear Stearns sold huge quantities of stocks like Dabur Pharma, Bombay Rayon, C C construction and CEAT among others erasing significant amounts of Market Capital and Sentiment. What is of concern is the transparency of news flow. Two days back, the CEO of Bear Stearns Alan Schwartz comforts the market that there is no reason to worry which gave a record breaking rup up to the markets. Today, one wakes up to see once dominant investment bank on life support system from fed and fellow friend JP Morgan. No one has an idea as to how many ailing patients we are dealing with. There are rumors of Lehman Bros going the Bear Stearns way and who is it question that until the air clears.

The point I am driving at is the uncertain environment we are in, exposed to whims and fancies of the US markets. Further, what worries is the kind of speculative activity across currencies and commodities. There seems to be no cover to hide. Swiss franc is appreciating fast breaking 1.0 level to US dollar. Yen is appreciating faster breaking the 100 to US dollar and going all the way to 96. Crude getting stronger by the day breaching $110/bbl level. Gold crossing $1000/oz level all the way to $1032. Unless the dust settles the strategy to sit tight on cash seems like a good strategy. Its better to be safe than sorry.

ICICI Bank – Markets react excessively

Markets reacted to the news flash from CNBC-TV18 on the mark to market losses set off by ICICI Bank as if it was a bolt from the blue. Stock was down 9% immediately after the news broke and was significantly down even after the management clarified the situation (though not coherently) closing the day with a loss of over 5%. Even though most of them did not cover this subject in their Q3 earnings reports, the brokerages came out with reports the next day and made it look as a harmless piece of information known to all Toms and all Harrys in the market. But the fact is, the market wisdom was more confused than ignorant of the exposure of the bank in the international markets right from the beginning. Thus reminding all of us that “Markets react. Markets react excessively.”

Markets believed that the bank had exposure of $1.6bn when infact it has $5.9bn. The losses were also ambiguous before the expose. This information asymmetry is what markets reacted to.

Should there be a reason for long term investors of the stock to worry? The credit derivatives subscribed to are from Indian corporates who are not exposed to sub prime crisis in US directly. Also, the investments in UK and Canadian subsidiaries are predominantly in corporate bonds and remaining in government treasuries. More than 85% of these are rated ‘A’ and above. The icing on the cake is that is if these are held to maturity, the write off amounts to the most part may be written back.

Is it a good time to enter? Here is a perspective. The writedowns of $265mn in this financial year works to only Rs7 per share. Not a significant impact. Consider this: For the entire 12 month target price from different brokerages are listed below. The average target price is Rs 1504. Assuming that the foreign subsidiaries would have funding pressure going forward because of liquidity concern in the world and considering no contribution to the bottomline, the target price comes to Rs 1430. This is 60% premium to the current market price of Rs 894. 60% return in 12 months considering worst case scenario!
Citigroup-Rs 1510
JP Morgan-Rs 1628
Merrill Lynch-Rs 1450
Motilal Oswal-Rs 1416
UBS-Rs 1515

Hypocrites???

Consider This:
There are these rich, greedy, supposedly intelligent investment bankers in United States. What did they do? They created complicated structured products which even the Mensa geniuses fail to comprehend. They set up an environment where well groomed - white collared officers loan to people who do not deserve get loans. These people default creating Non Performing Loans (NPLs) that produce a butterfly effect and take the entire credit market with it. The most smartest people cannot still figure out how much could be the bad loans/margin calls/write downs. Fed cut the interest rates at multiple instances. Govt lends billions of dollars of tax payers money. How do we react? We tear our shirts, thump the tables, laugh aloud and cheer the equity markets to new highs.
Now Consider This:
A very intelligent and soft spoken Indian Finance Minister, takes the pain to estimate the agricultural Non Performing Loans. These are neither 'Structured' nor hard sold. These are plain vanilla loans given to hard working souls that toil day in and day out to feed more than a billion inhabitants of this planet. How do we react? We scratch our heads, tear our shirts, beat the tables, cry out aloud and steer the equity markets to new lows.
So much for Hypocracy!

Erasing Loses Overnight!!!

Hats off to Reliance Power management for making an unprecedented move and hope the bonus ratio will justify this eulogy. Well, bonus shares will be issued to non-promoters who hold 22.8 cr shares currently ie 10.1%.

If the bonus ratio is 1:1 then the cost of acquisition for retail will be Rs 215 (down from Rs 430) and if it is 1:5 it is Rs 358. The figures for QIB stands at Rs 225 and Rs 375 respectively (down from Rs 450). Last week, the price seemed to have seen support at Rs 350 and most of the fund managers said that they see value at Rs 340-Rs 350 levels. It is only at a bonus ratio of 1:4 will retail investors just, about break even and any ratio more than that would be a real bonus. At ratio of 1:4, retail investors will lose about 1% while QIB will lose 5%. At ratio of 1:3, Retail sees 5% profit on their allotment while QIBs just break even. As the main reason for issuing of bonus shares is to prevent nominal loses, the bonus ratio could be greater than 1:3.

Calculations:
Cost of Acquisition for QIB: IPO~Rs450, 1:5~Rs 375, 1:4~Rs 360, 1:3~Rs 337, 1:2~Rs 300, 1:1~Rs 225
Returns for QIB: 1:5 ~ -8.5%, 1:4 ~ -5.2%, 1:3 ~ 0.3%, 1:2 ~ 11%, 1:1 ~ 41%
Cost of Acquisition for Retail: IPO~Rs450, 1:5~Rs 358, 1:4~Rs 344, 1:3~Rs 322, 1:2~Rs 287, 1:1~Rs 215
Returns for Retail: 1:5 ~ -4.3%, 1:4 ~ -0.8%, 1:3 ~ 5%, 1:2 ~ 16%, 1:1 ~ 48%

Do I enter now?

Do I enter now?This is the question that is bogging the people irrespective of whether one has lost a fortune in the Jan-Feb correction or one who is sitting outside the market. They would be very few, one in a million, who might have sold in Jan08. He (or She) might be laughing away to glory and I salute him for the foresight. It needs guts to sell when everyone is making money by the loads or atleast that is the perception. However, for not so lucky, the fall has been immense and gave no time to exit.

Coming to the more important question of whether one should enter now. There is no easy answer to this but I believe that there is more pain in left in US economy and as we are coupled with US it is relevant for us. Here are my arguments:

First: It was initially the banks that announced write downs. Now it is the insurers. Just about $200bn have been announced in write downs and there are indications that the figure may be less than half of what we will eventually see. We could hear more from hedge funds across the globe and banks from other countries like Japan and China.

Second: When a finance minister of Germany says that his estimation of write downs is over $400bn I would take him very seriously. Infact he might just be understating.

Third: When Fed is cutting rates so aggressively, one can clearly see that they believe that the pain in US is immense and I think one should respect that. When the President is putting money into tax payers pocket, one can understand the magnitude of the problem at hand.

Fourth: It will take a couple of quarters before the effect of monetary policy is seen in the release of economic data. Unless we see the change in trend of retail sales, housing sales and GDP growth we have no reason to believe that the health of the US economy has improved. Remember, the average of a US recession is about 10 months. In 2001 and 1990 it was 8 months and in 1981-82, it was 16 months. As economists put it, US is still not into a recession but on the verge of going into one.

As Benjamin Graham would suggest, in these kind of markets, one should have 25% of networth in equities and the rest in debt instruments or gold. For those invested in the markets, one strategy is to sell unconvincing stories on rallies to bring the equity level to 25%. There will be enough data points in the course of time to suggest which ones are the screaming buys. When any stock reaches that level, it is the time to make staggered buying. That’s the way to make money.

Ahead of Reliance Power IPO

Everyone is trying to answer one big question today (08th Feb 2008). What should I do on Monday (11th Feb 2008) when Reliance Power is listed? There seems to be two options evolving. One, to be a flipper and move into power stocks. Two, to move out of power sector completely into more lucrative ones like financials, telecom, consumer durables and cap goods. Have a look at how valuations have changed from the close of IPO on 18th Jan 2008 till date (08th Feb 2008). Reliance Energy has come down from 35.9 times to 32.5 times. NTPC from 23.9 times to 20.1 times and Tata Power from 46.8 times to 43.7 times. The valutions though taken a beating do not look attractive at all.

There have been a few people who have been accumulating over the past week as suggested by the delivery volumes. I suppose they are doing with full knowledge. I say this because other indicators do not suggest that to be a wise move. On the F&O front huge short positions have been accumulated in all three major power stocks. These stock prices have taken a beating ahead of such an important listing in the history of the markets. The sentiment on the sector is negative even though most hope for a good listing gains from the IPO. Market watchers suggest the above two strategies - move out of Reliance Power - move out of power sector. For more enterprising ones, short power in F&O.

Piggy back on fund buying??

Tata Sons bought Praj industires at Rs 252 in Sep 2007. The current stock price is Rs 170. Is it a right investment now?Reliance MF buys CCL Products at Rs 291 in Sep 2007. The current stock price is Rs 190. Is it s good time to buy?

One of the favorite ways to make a shopping list is to look at stock prices that are at a discount to the level at which funds have entered. While this may work in many cases, it may also fail in many. This is purely because of market conditions. While in Sep 2007 the mood was gungho with FII money coming, the time horizon funds may be looking would be lower. But once the markets turn bearish as they did now, the business fundamentals of the stock owned kicks in. All the assumptions made earlier will be questioned right from cost of capital to terminal value. Most importantly the embedded stories that are not entirely known to the market. Remember, most mutual funds do not out perform the market. So, should we have faith in their judgement. Though most talk about long term, the reality is that the churning is high in the funds. For all you know you may be stuck with a security dumped by your anchor fund. Hence, it is pertinent for one to understand and have belief in fundamentals of the stock before buying it - be it at a discount or a premium, be it for long term or short term.

Microhooooooooooo.......

Global web search market shares:
Google 77%
Yahoo 16%
Microsoft 3.7%

Points for acquisition:
Expansion of R&D
Gain Operational efficiencies
Opportunity for Microsoft to build its online business (some hope for the loss making internet business with increased inventory)

Points against acquisition:
With slow down the ad revenues might get effected
Intention of Jerry Yang to turn around Yahoo which is coming along on expected lines
Microsoft has no history laying off employees after acquisitions. Will synergies emerge?
Clash of cultures

Possible effect on Aftek Infosys (has 49% stake in a german search firm Arexera), Infoedge & Northgate Tech

Stocks held by stronger hands

I was looking at the stock price movements in two periods. One from 22nd Aug 2007 to 08th Jan 2008. Two from 09th Aug 2008 to 23rd Jan 2008. The first period saw a stupendous rise for the stocks and the later period has seen an equally stupendous fall. I was trying to figure out if there were stocks that were resilent during this period. The stocks which gained in both period will be an obvious choice. Stocks like Amara Raja, Akruti City, Bank of India, Welspun Gujarat and Essar Shipping fall in this category. Just to give the figures, Amara Raja was up 72% in first period and 16% in second period. Akruti stood at 146% and 10%, Bank of India saw 68% and 10%, Welspun Gujarat gained 114% and 4% and Essar Shipping risen 404% and 4%.

There is another category of stocks that have seen huge upward movement but have fall less which indicates that they are with strong hands. Take the case of banking stocks like Indian Bank, Axis Bank, Bank of Baroda and SBI that have gained over 50% in first period but have fallen less than 6% in second period. Some favourite stocks like Indiabulls Financial, Everonn, Shriram Transport Finance, Jain Irrigation, Pidilite, Simplex Infra and Sadbhav Engineering have gone up anywhere between 40 to 170% in first period and fallen less than 7% during the market free fall.

Biggest Sensex Falls

Jan 21, 2008 (Monday): Sensex down 1408 pts (7.4%)
Concerns: US market recession; margin call pressure from domestic investors

May 18, 2006 (Thursday): Sensex down 826 pts (6.76%)
Concerns: Government circular on taxing investment gains; heavy selling by FIIs, retail investors and a weakness in global markets

April 28, 1992 (Tuesday): Sensex down 570 pts (12.77%)
Concerns: Harshad Mehta securities scam

May 17, 2004 (Monday): Sensex down by 565 pts (11.14%)
Concerns: NDA loses election to Congress

Looking beyond flipping

It is a foregone conclusion that Reliance Power is going to be hugely subscribed. Infact, it has subscribed 4 times in 20 minutes of IPO opening with all the bids coming at upper band of Rs 450. It is a no brainer that it is going to list at a huge premium with the current grey market premium quoting at Rs 350. The strategy that many are using is to be flippers on the listing day. Added to that, is it a good idea to short Reliance Power in the futures market. Or is it foolhardy?
Compare the current Reliance Power IPO with Reliance Petro IPO in 2006. Reliance Industries (RIL) gained 16% in a month leading to the IPO start date (Apr 13 2006) and zoomed 31% between IPO start date (Apr 13 2006) and RPL listing date (11 May 2006). After RPL listing, RIL got into a downtrend. It lost 21% in less than a month breaching the stock price it quoted on RPL IPO open date (Apr 13 2006). Even RPL retraced to its issue price of Rs 60 in less than a month after listing at Rs 102. Will it be a similar story with Reliance Power? Doesn’t similar evidence call for shorting Reliance Power after its listing?
A similar comparison can be drawn for peers. When Reliance Industries ran up, ONGC did the same. When RIL cam down, ONGC followed suit perhaps quickly. ONGC gained 8% in a month leading to RPL IPO open date and gained 15% from IPO open date to listing date. What is interesting to note is that, it lost all its RPL IPO driven price in just 9 days. It lost one third of its price in one month after RPL listing. Will NTPC, the closest peer to REL have the same fate. All the ingredients for this scenario are there. REL and NTPC have gained 30% and 16% respectively in a month running to Reliance Power IPO opening today (15th Jan 2008). Is it a decent proposition to short REL and NTPC after Reliance Power listing in the first week of Feb 2008. Just look beyond the listing date and being a flipper.

Tata Nano - People's Car

There are more questions raised than answered by the launch of Tatas’s Nano. Ratan Tata has definitely answered the prayers of millions of people desiring to have a comfortable and safe outing with their families. What are unanswered are the raging debates like: Does auto manufacturers have any role in the development of infrastructure for increased use of their products? Is government doing enough to alleviate the pain of daily travelers? Is it thinking about the elevating aspirations of owning cars by the rapidly growing Indian middle class? Are policies in India too liberal for our auto makers? Are big cars better than small cars? Where will cars be parked when there is not enough commercial space to do business? and many more. Even with these kind of questions bothering in the sub-conscious mind, the innovation from the Tatas is an humdinger.

Tatas have pushed the envelope of current customer demographics wider through the launch. This can be compared to what Dell did with their low cost PC – direct selling business model. CRISIL notes that the market for Nano is families with income around Rs 2 lakhs. It estimates the current market size in India is to be around 2 crore families which will triple to over 6 crore families in just four years. The potential is not only in India but in all emerging markets. PwC predicts that BRIC countries will contribute about 50% of global auto sales and most of them will be small cars. The government of two countries approaching Mr Tata is a vindication of the potential. Even in countries in Europe and Latin America, the sales of Volkswagen’s Gol, Renault’s Clio and Nissan’s Tsuru are upbeat.

Though Tatas have sprung a miracle by producing a car that is 50% cheaper than the existing one in QQ3 of Chevy Auto of China which costs $5000, they should watch out for disruptive models from its peers. We could see serious action from Maruti that sells M800 for $5200, Geely Auto of China that sells Merrie Star and S-RV mini SUV for $5500 and $5780 respectively. Also, Bajaj Auto has already jumped on to the band wagon of developing low cost cars to defend its customer base. Will Tatas capitalize on their first move advantage in the Indian markets? Can Tatas continue to show cost and product differentiation to maintain their sustainable competitive advantage? The Indian auto industry is set for interesting times.

Sources:
http://driving.timesonline.co.uk/tol/life_and_style/driving/news/article316
Tata Nano Impact Analysis by CRISIL Research