Buffett's next destination & more...

Aug 21, 2008

In this issue:
» Power shock for India
» Its averaging time for PEs
» India Inc. to invest US$ 40 bn in FY09
» Buffett's next destination
» ...and more!

  Move over oil shock...
...its power shock for India! The allocation of US$ 193 bn for power sector for the 11th Five Year Plan looks significant enough to display the government's commitment towards solving India's power crisis. However, the same seems to be inconsistent with the growth in demand and power production is unlikely to satiate the demand for electricity this year. As per the recent report of Central Electricity Authority (CEA), India's peak electricity shortage may widen to 18.1% in FY09 from 16.6% in FY08 as demand will outstrip supply in the world's second-fastest growing and second-most populous nation. CEA estimates that the peak demand for power in FY09 may rise to 120,109 megawatts (MW) against the availability of 98,408 MW. As if this were not enough, two of the most industrialised states in the country, Maharashtra and Gujarat will endure some of the highest power shortages of 23.0% and 22.6% respectively. While the government is targeting the power sector to add 78,700 MW of new generation capacity by the end of the plan period (FY12), of which 10,178 MW is to be commissioned by FY09, the power generating companies continue to be dogged by fuel, equipment and labour shortages.

  • Also read - Opportunities in Indian power sector

      The irony of subsidies
    The government is set to approve Rs 220 bn of fertiliser subsidy in cash (and not bonds). The total subsidy bill to be paid to fertiliser companies this year is Rs 1,150 bn - a sharp rise from Rs 120 bn paid four years ago. This second tranche that comes in addition to a provision of Rs 320 billion in Union Budget has been calculated following the hike in global price of fertilisers and addition of complex fertilisers to the concession scheme. It may be noted that subsidies form nearly 80% of fertiliser prices. As part of the non plan expenditure presented in the Union budget for the year 2008-09, the government's subsidy bill including food, fertiliser and petroleum had been hiked by 2.4%. The total amount to be spent on subsidies this year is more than what the government expects to spend in writing off farmer loans as part of the farmer debt relief package.

    On the other hand, the Revenue Ministry has suggested that the government may have to cut subsidies and exemptions to increase tax collections as other options to raise tax rates are hardly feasible. The Ministry has opined that in a scenario where resources can be mobilised through direct taxes alone, the only option available with the government is to eliminate subsidies. It has cited the rationale that subsidies are meant to be provided to promote specific activities and withdrawn after the activities become self-sufficient.

      Its averaging time for PEs
    For private equity firms operating in India, cash is indeed King! Flush with funds that were raised during the easy liquidity period of the past few years, these firms are now going all out to make amends for some of the expensive purchases made during the recent bull run in India. In other words, they are bringing down their average purchase price by snapping up shares from the secondary market of those listed companies in which they already have a stake. Year to date, the Indian stock markets are down around 30% and quite a few companies are trading more than 50% lower than the highs reached during the bull market frenzy. Realising that they may have bought some of the companies at expensive valuations, they are stocking up on such companies to lower the average acquisition price. Among few important examples of such secondary market purchases, Apax Partners increased its stake in Apollo Hospitals to 14.5% as on June 2008, from 12.0% in December 2007. In another instance, Standard Chartered Private Equity, which had 5.5% stake in M&M Financial in March 2008, hiked its stake in the company to 7.9% by June 2008. The fact that these PE firms have little competition from hedge funds and banks that are squeezed for liquidity currently is also helping them buy companies on the cheap. Infact, in other markets like the US the tables have really turned big time. Earlier, most PE firms used to be financed by banks but now these PE firms have taken to bailing out quite a few troubled banks. Needless to say, cash is truly the king especially during troubled times.

      In the meanwhile...
    Asian markets continued to languish in the red today as has been the trend this week. Worries about the upturn in oil prices and lingering concerns over global financial markets, particularly the US, have kept investors on the sidelines. Fears that US mortgage finance giants Fannie Mae and Freddie Mac are on the brink of a government takeover continue to stalk investors. The benchmark BSE-Sensex closed the day with losses of over 3%. While most other Asian markets have also closed lower, the Chinese Shanghai Composite (down 3.6%) was the biggest loser. The European markets have also opened on a negative note.

    The Indian rupee traded near a 17-month low against the dollar (Rs 43.8 per US$) today over speculation that falling stocks and rising oil prices will dampen demand for the currency. According to Bloomberg, global funds have sold a net of US$ 7 bn of Indian stocks in 2008, after making a record US$ 17.2 bn in net purchases in 2007. In the meantime, crude oil prices have climbed 68% YoY boosting fuel import costs.

      Newsprint prices endure Olympic fever
    Profitability of newsprint producers was under considerable pressure in the first quarter of FY09 with an increase in waste newspaper prices to the tune of 30% to 40%. This is in addition to the pressure imposed from inputs such as pulp, coal and power. Prices of the waste newspaper have increased from Rs 7,000-8,000 a tonne in the previous quarter to Rs 11,000-12,000 a tonne in recent times. Even imported waste paper now costs US$ 300 a tonne as against US$ 240 a tonne in the previous quarter. Moreover, the recent strengthening of dollar against the rupee has made imports costlier. The worst affected on account of this are the print media companies (as newsprint accounts 70% of the total cost), which have been witnessing pressure on the margin front. However, the industry believes that the rise in newsprint prices will not sustain as post Olympics there would be a reduction in Chinese demand coupled with capacity additions. Thus by 3QFY09, the cost pressures currently faced by newsprint producers should ease off thereby resulting in improving margins. This would warrant a positive reaction by the stock markets towards print media stocks, which in recent times have been battered.

      'India is critical'
    ...says the largest banking company in the world, Citigroup Inc. The largest US bank by assets that has posted US$ 55 bn (approx. Rs 2.4 trillion) in losses and write-downs in 2008 and cut some 14,000 jobs worldwide, has recently announced a reorganisation of its Asia-Pacific business. It may be noted that Citibank has one of the largest franchises amongst foreign banks in India and owns 11.8% stake in HDFC Ltd.

    Given the growing opportunities in the SME (small and medium enterprises) and consumer banking space, Citibank has clarified that the rationale behind the Asian restructuring is to focus on India and its growing importance for the bank. The bank has also stated it has been retaining profits locally and investing in India to improve the capital adequacy. Thus while the behemoth may have bitten the dust in the West, the growth of the Indian middle class, healthy and growing companies and the government's increasing focus on infrastructure are some of the potentials that are still enticing for it.

      India Inc. to invest US$ 40 bn in FY09
    The RBI, in its August 2008 bulletin, states that Indian private sector companies will invest US$ 40 bn in fresh projects in FY09, a 33% decline from US$ 60 bn they had spent in FY08. Citing the importance of infrastructural activity, the report suggests that infrastructure projects accounted for nearly half of the total investments in FY08, up from 36% in FY07. Nearly 72% of the total investments in infrastructure were in 71 power projects followed by 52 technology parks and special economic zones. Among the states that have been at the forefront of industrial investment, Gujarat took the first place with 22% of the total investments in 100 fresh projects at a total investment of Rs 624 bn; followed by Maharashtra with 12.7% and Orissa with 10.9%. Having said that, since investment is a key indicator of growth plans by companies and fresh investment is essential for sustaining economic growth, the central bank believes that the lower investment planned this year indicates lower growth prospects. The central bank expects the economy to expand by around 8% in FY09 on the back of an 8.8% average growth in the last five years.

      The Japanese market is waiting to be tapped...
    ...especially in the area of healthcare. The land of the rising sun is expected to have the world's largest aged population by 2020. Infact, a report states that people in their 70s and older will account for about 20% of consumption, up from 13% in 2005. This is likely to present a challenge to the Japanese government as public expenditure especially on healthcare is likely to take its toll on the country's public finances. Other developed nations such as the US and countries in Western Europe are not far behind either. According to the US Census Bureau, 20.2% of the US population will be in the 65+ age group by 2030. The rise in aged population in these regions is only expected to put pressure on the healthcare expenditure programmes of their respective governments.

    The Japanese opportunity especially is huge for some India pharma companies. While the pharma market in Japan is the second largest in the world behind the US, prescription of generics until now had not made much headway in the country as they were perceived to be 'inferior'. But this is now changing. Against a backdrop of a rise in the number of elderly people, the Japanese government has realised the need to cut down on costs. Accordingly, the authorities are now introducing a host of healthcare reforms, which will pave the way for a faster entry of generics in the Japanese market. And this will be largely beneficial to Indian companies such as Ranbaxy and Lupin, which have already set shop in this country.

  • Also read - Outlook on Indian pharma sector

      Buffett's next destination
    Two of the world's richest men - Warren Buffett and Bill Gates - are touring Canada these days, visiting the 'tar sands' in Canada owned by Canadian Natural Resources Ltd. (CNRL). With reserves of about 173 bn barrels (1 barrel = 159 litres), the tar sands are said to be the largest oil reserves outside the Middle East. The region's producers plan to spend more than C$100 bn (approx. Rs 4,100 bn) developing the resource and output is expected to nearly triple to 2.8 m barrels a day by 2015. Is CNRL the 'next' opportunity Buffett eyeing? Going by the company's return on equity of 18%, operating margins of over 60% and forward P/E of 9.1 times, maybe! Shares of CNRL rallied by over 7% yesterday.

  • Also read - Lessons from Warren Buffett himself

      Inflation spooks the ghosts!
    Vietnam, Asia's most recent economic tiger, is feeling the pinch of inflation. Everything costs more now - a shoeshine (up 32%), a massage (up 43%), a haircut (50%), a cup of tea (up 100%), fixing a flat tyre (up 100%) and a raincoat (up 208%).

    So much so, that it even costs more to please the ghosts now. Every August, Buddhists in Vietnam offer the starving ghosts of the departed with gifts like food and paper designs of cars, houses, clothes etc. And with inflation climbing to 27 % last month, it costs more to keep the dead happy. As a result, the suppliers of these goodies are witnessing subdued business. Even the living are consuming lesser food, traveling less, delaying purchases and weddings and getting second jobs. Vietnam embraced free markets about two decades earlier and has witnessed a steep reduction in the poverty rate. However, the inflation is reversing much of the good work and people are slipping back below the poverty line.

    There are many reasons for the run away inflation- the worldwide economic downturn, an overheated economy that raced forward without proper safeguards, excess foreign capital, infrastructure bottlenecks and an inadequate education system. While most experts believe that Vietnam will resume on its road to prosperity in the longer term, the ghosts of the dead might remain unappeased for the time being.

  • Also read - Inflation at 2000000%!

      Today's investing mantra
    "I've found that when the markets are going down and you buy funds wisely, at some point in the future you will be happy. You won't get there by reading 'Now is the time to buy'." - Peter Lynch

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