»5 Minute Wrap Up by Equitymaster

On This Day - 29 FEBRUARY 2012
Is Buffett the only hope for India's largest PSU?

In this issue:
» Junk bonds once again luring cheap money
» Will ONGC's share auction help bridge deficits?
» Why World Bank calls China a ticking time bomb...
» Should Americans pay for the govt's fiscal imprudence?
» ...and more!

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Moat. This term is essentially meant to signify competitive advantage when referred in context of stocks. However, it came to be associated with stocks only after legends like Buffett popularized it. But the cash strapped management of India Railways seems to have anchored their hopes of survival on this one virtue. If news reports are to go by, officials of Railway Ministry have approached the value investing legend to save their drowning fortunes. We are not surprised at the official's sheer ignorance about Buffett's strict filters for his value buys. That a history of profitability and transparency come along side economic moat for Buffett's liking appears to have been lost on the Railway management. To top it they seem to have assumed that having purchased a railway network stock in the past, Buffett will be keen to buy more. Even if that means taking exposure to the black hole of Indian politics.

Being the world's fourth largest railway network certainly is not an easily replicable business. To top that manning an employee base of 1.4 million gives it the distinction of being the world's second largest utility employer. However, with its faltering track record in reporting operating profits and poor governance, this PSU behemoth should bow its head in shame. Even the mere accounting prudence of writing off depreciation and lease rents were given a miss during the tenure of last Railway Minister. In the bargain, it ended up earning brownie points over fake surpluses. Now the entity stares at massive deficit next fiscal onwards. Hence, its only hope is for bailouts. The Indian government already has several bailout contenders knocking on its doors. Hence the Railway's novel idea to sell itself as a value buy to the world's most reputed investor. Not that Buffett has not made the mistake of bailing out less worthy entities in the past. But whether it was Goldman Sachs or others, he made sure that he had enough say in the goings on of the company. But Indian Railways is a different story altogether. Embroiled in vote bank politics, the entity, according to us, may least likely appeal to demanding investors. In fact, forget stocks, even the bonds of the firm could come bundled with huge risks.

What is even more frustrating is the government's reluctance in correcting its mistakes. Allowing perfectly good business to bleed due to faulty policies is sheer mis-governance. To top that by encouraging bailouts will be like the last nail in the coffin.

Do you think, bleeding PSUs should be allowed to seek government or non government bailouts without restructuring their businesses? Share your comments with us or post your views on our Facebook page / Google+ page.

 Chart of the day
It is easy to blame Coal India for its plight in operating inefficiencies. But the owner is equally to blame for the sheer lack of long term vision. When compared to the investment on mining exploration in major economies across the world, that in India pales even against its BRIC peers. In fact the investment per square kilometer in India is less than a 10th and less than 3rd of mineral rich economies Australia and Brazil respectively.

Data source: Mint, Ministry of Mining
Excluding exploration for mineral oil

Buffett was bang on when he said that nothing sedates rationality like large doses of effortless money. Rationality of a lot of investors is indeed being sedated. What with the US Fed keeping money ultra cheap. There is nothing else that would better explain the lure for junk bonds where investors have thrown nearly US$ 12 bn in 2012 so far. This is much higher than the US$ 5 bn committed to stock funds and nearly US$ 10 bn to investment grade funds. It should be noted that junk bonds is an area full of land mines and is usually not easily comprehensible to an ordinary investor. Besides, the chance of a default in the case of junk bonds is on the higher side as they usually have faulty business models supporting them. Thus, when it comes to these bonds, one need not really look at the return on one's investments but rather the return of it. The fact that investors are piling onto them is a dangerous one indeed.

It is a well documented fact that what caused the global financial crisis in 2008 was the greed and misuse of capitalism by Wall Street financial firms. The world economy since then has never been the same. Most of the US and Europe are so crippled with recession and too much debt, that a recovery looks a long way off. In the meantime, all hopes are pinned on China to balance the global economy. Especially since it has been growing at a relatively healthier pace. But China has its own demons to deal with. Notably this includes a property market bubble, indiscriminate lending by banks, rising inflation, falling exports and a big income inequality divide. There is more to this. The World Bank has warned that China is a ticking time bomb. And it is quite likely to go the US way because of certain striking similarities between the two. This is that in both the nations a new, powerful Super Rich is aligned with politicians. Who will eventually self-destruct. Most are concerned with fattening their respective wallets and are not really concerned with reforming their respective economic systems. If this is indeed the case, the repercussions that it will have on the global economy will be quite unfathomable.

Inflation is like a termite that eats away everything. Savings. Income. Even investment returns. This is due to the concept of real interest rates. This is the interest rate offered by an asset class less the inflation rate in the country. But what happens when the interest rates are near zero but inflation is not? Well in such a scenario, the investor ends up paying the bond issuer for investing in the latter's bonds. This is exactly what is happening in the US. The real interest rate in the country is actually negative. However, due to the uncertainty in the markets, investors have been flocking to the treasury bonds. The bonds' status of 'safe haven' has attracted one and all. But due to the near zero interest rates in the country, the bond holders are actually losing money by investing in these bonds. Effectively, they are paying the US governments for holding the US treasury bonds. And this is helping the US government in keepings its fiscal deficit at low levels. As ridiculous as it sounds, but the US investors are actually paying their government for meeting its fiscal deficit targets. We wonder who their financial advisor is!

If not for various state elections this year, the Union Budget would have been announced today. With a fifteen day grace period, the Finance Ministry is scrambling to gain some ground on its Rs 400 bn disinvestment target for FY12. In this effort, the government approved a plan to raise Rs 124 bn from an auction of a 5% stake in oil exploration company Oil & Natural Gas Corporation Ltd (ONGC). The government currently holds a 74% stake in the company. It will be offering 428 m shares at a floor price of Rs 290 at the auction.

Earlier this fiscal, the govt. was only able to raise around Rs 11 bn from the follow on offer of Power Finance Corp. Weak market dynamics forced it to put most of its stake sales on hold. Well, we hope that in the new edition of the Union Budget, the Finance Ministry will be able to come up with concrete plans to raise funds and reduce its deficit. The current target of achieving a 4.6% budget deficit is surely a miss. Plugging this mushrooming gap is certainly the need of the hour. But, is Pranab Mukherjee the man of the hour?

Food subsidy distribution mechanism has always been a headache for the government. There have been different opinions on whether the government should migrate to a direct cash transfer mechanism or continue with the existing public distribution system (PDS). Both have their set of pros and cons. In a PDS system, Food Corporation of India (FCI) procures food grains from farmers and then re-distributes them to the needy through fair price shops. This requires adequate warehousing infrastructure. If not then it may lead to a huge amount of wastage, as is the case now. Forging of identity is another problem to tackle with. Many individuals conceal their true identity and get undue benefits. Thus, advocates of direct cash subsidy argue that PDS is increasing inefficiencies rather than reducing it and a switch is mandatory.

However, the direct cash subsidy model also has its own set of disadvantages. It can render the warehouses and employees at the PDS shops redundant. It also faces the same identification issue as PDS. Tracing whether the money was spent for the desired purpose is the biggest concern. Again price variability of food grains in various states will make it difficult for government to fix subsidy rates. Thus, while migration to new system is certainly required it has to be effective. Any decision taken in haste can render the switch ineffective.

Selling pressure in banking, commodity and capital goods sectors has forced the indices in Indian stock markets to shed most of the gains clocked yesterday and earlier this session. At the time of writing, the BSE Sensex was trading 15 points below the dotted line. Indices across other key Asian markets also closed flat to negative. Those in Europe have opened a mixed bag.

 Today's Investing Mantra
"Ignore especially the short-term news. The ebb and flow of economic and political news is irrelevant. Do your own simple measurements of value or find a reliable source." - Jeremy Grantham

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