»5 Minute Wrap Up by Equitymaster

On This Day - 19 MAY 2010
'These evils will outlast us all'

In this issue:
» The impact of Euro crisis on China
» A big relief for SMEs
» Real estate players face the debt heat again
» US$ 50 bn of road projects in the pipeline
» ...and more!

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First came the subprime crisis in the US. Then came the sovereign debt crisis in Europe. The common thread between the two was the poor assessment of risk. As a result, credit ratings agencies invited as much widespread criticism for their role in the financial crisis as no other business ever did. Expert after expert hauled the rating agencies for not being able to assess default risks properly. But the latest comment by Bill Gross of Pimco, the world's largest bond fund manager, seems to be the last nail in the coffin.

As per Economist, Gross has sarcastically compared rating agencies to 'vampires in the dead of the night'! He says that the agencies that fuelled the debt crisis by overrating trillions of dollars of poor debt have had a relatively easy time. This is when money managers and central bankers in the developed world have had to answer embarrassing questions. But by virtue of their oligopolistic business, the rating agencies have escaped unhurt. Calpers, a globally renowned pension fund, has recently initiated court proceedings against the big three agencies with a fraud suit. But Gross believes that despite their wildly inaccurate ratings, the credit rating agencies will outlast us all. This he assumes is due to the lack of evidence available to nail them down. Gross also alleges that a dozen other suits have already been dismissed against S&P alone.

Known for his erudite comments on the financial crisis in the West, Gross seems to pointing fingers at the right people. But unless the regulatory bodies take the case of rating agencies more seriously, yet another crisis may not be too far.

Do you think that the rating agencies will get punished for their role in the financial crisis? Please share your views with us.

 Chart of the day

Data source: Equitymaster

Indian companies rounded off FY10 with reasonably good set of numbers. These were particularly from the stable of metal, automobile and pharmaceutical companies. With lower input costs and higher pricing power these sectors emerged as the top gainers in terms of profit margins. Crisis situation in the developed economies did little to temper their prosperity. As today's chart shows, the profits in the fourth quarter of FY10, showed steady sign of up move despite the crises in developed economies. Most of this was supported by the fact that India's consumption demand remains largely isolated from the fate of the global economy. Going forward, however, investors would do well to keep their eye on long term trends rather than bet on quarterly estimates.

It's all so linked. Definitely so in the world of finance. An event happening in a distant place has curious effects half way across the world. Take for instance the recent sovereign debt crisis in Europe. The Greek debacle has weakened the Euro. That makes China less competitive in Europe, their largest market. Why? You see, China's export juggernaut is based on their artificially weak currency, the Yuan. It takes two currencies to set an exchange rate. With the Euro weakening, Chinese exports have become costlier than before (in Euro terms).

Ironically, it endangers any move by the Chinese to revalue the Yuan upwards vis-a-vis the US Dollar. It may be noted that the US has been putting pressure to relook the currency peg. A demand US makes to increase the competitiveness of its own goods. Another impact of the European crisis is that Chinese exporters are finding it hard to obtain trade finance from European banks. This puts enormous pressure on Chinese companies to finance their working capital needs. Clearly, the European malaise could easily reach China or the US. Through routes not yet fully factored in by observers. The world economy is deeply linked indeed!

Small and medium enterprises (SMEs) can now breathe a little easier. The SEBI has relaxed share-listing norms for these companies. This is by allowing them to disclose their results every 6 months. This is in contrast to the 3 months timeline for bigger companies. Having said that, these SMEs will have to maintain a public shareholding of atleast 25% of the total number of shares issued at all times. SEBI has also issued guidelines with respect to the procedure that these SMEs have to follow if they want to list themselves on the main exchange. Relaxation of the norms by SEBI means that these SMEs can now focus more on their business goals rather than face the pressures of meeting quarterly expectations. A smart move we think!

It is a known fact that the real estate developers stretched their arms beyond their means during the real estate boom. In the greed to acquire land bank majority of the developers leveraged their balance sheet as if there was no tomorrow. But now when the debt repayments are due, all real estate players are facing the heat. Developers believed that the best way to get out of the debt trap was to raise equity. And some of them did manage to raise equity to pay off debt in the recent past. But now even this is going to be uphill task as the investor's appetite for real estate companies has waned. Otherwise what could explain the fact that despite receiving in principal approval from SEBI, majority of the developers having lined for IPOs are yet to launch their offers?

Even the listed entities that were planning for QIPs to repay debt have to cut their issue sizes due to lack of investor interest. We believe that this time around the developers won't be able to fox the retail investor who has already burnt his finger once. The best possible solution to get out of this vicious debt circle is to clear the inventory at a discount. However, will the developers resort to undercutting when the prices across cities have remained buoyant? Only time can tell that. However, we believe undercutting is the best possible solution to deleverage at this juncture.

If road transport minister Mr. Kamal Nath is to be believed, the government is slated to award a huge US$ 50 bn of road projects during FY11. Additionally, he expects private investors to fund as much as 70% of the amount. Private equity players are expected to put in about US$ 18 bn in the sector this fiscal. This comes on the back of a few policy changes that India has seen recently. These are meant to facilitate greater foreign and private equity participation in project SPVs and toll projects. As per Mr. Nath, there is little risk for foreign investors investing in these road projects as traffic is almost assured in India. Further, he is known to have said that that foreign investors can expect a return of 16% to 18% on their investments. With the level of red tapism and land acquisition problems that these projects typically face, we wonder if such a statement can indeed be made with any conviction.

Indian textile companies have had a rough phase over the past two to three years. The demand for their products (majorly exports) was hampered by the economic slowdown. Plus, there was a significant amount of stress on their financials on the back of high interest costs. Companies had taken upon a good amount of debt on their books to finance their expansion plans during this period. These included expansion through the organic and inorganic routes.

Having barely seen some signs of improving demand, the textile companies seem to be at it again. Due to the slowdown, many plants have shut shop across the world. As such, assets are available at throw away prices. Trying to take advantage of this situation, Indian textile companies are again believed to be scouting for acquisition targets in and outside the country. We believe that this may be a worrisome sign as it could add more pressure to the balance sheet of textile companies, most of which already have a high debt ratio. Instead of cleaning up their balance sheets, they will need to borrow more to fund these acquisitions. Plus, with the interest rates expected to rise, there could be additional pressure on their cash flows.

Indian indices like their peers in Asia had a sombre outing today as investors chose to book profits in stocks across the board. Indian stock market are in fact the biggest losers in Asia today, following Indonesia and Singapore. The BSE Sensex was trading nearly 355 points (2%) lower at the time of writing. Stocks and commodities around the world fell today as the Euro traded near a four-year low after Germany banned speculators from some bets against government bonds and banks. The new regulations raised concerns about investors being able to hedge their European holdings or sell assets as the region's debt crisis worsens. Stocks from the banking, auto and commodity sectors were the biggest losers. European markets have also opened lower.

 Today's investing mantra
"You ought to be able to explain why you're taking the job you're taking, why you're making the investment you're making, or whatever it may be. And if it can't stand applying pencil to paper, you'd better think it through some more. And if you can't write an intelligent answer to those questions, don't do it." - Warren Buffett

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