»5 Minute Wrap Up by Equitymaster

On This Day - 24 MAY 2011
Balance Sheet risks lurking for India Inc.

In this issue:
» Unemployment still high in the developed world
» Yields in emerging markets look attractive
» When will China's growth run out of steam?
» Preference for diesel cars is rising
» ...and more!
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Indian companies are still paying a heavy price for their excesses in 2007 and 2008. In those years, the buoyancy in the stock markets and the general perception of well being in financial markets around the world, prompted many companies to raise funds through FCCBs or Foreign Currency Convertible Bonds. The idea was that these bonds would automatically get converted into equity once the conversion price was reached. And in most cases the conversion price was quite high since companies had a mistaken notion that the bull market prevailing then would continue going forward as well. What happened post January 2008 is history. But despite the consequent resurgence in stockmarkets in India especially in 2009 and early 2010, many Indian companies are still witnessing problems on the debt front.

At the height of the crisis, with the stock prices crashing the way they did, the conversion price for the FCCBs began to look quite unattainable. With the meltdown in the markets and the possibility of equity conversion low, companies had to brace themselves to redeem these bonds. This meant having sufficient cash on their books, an option not available for many companies. As a result most had to sell part of their business or liquidate assets to pay off the creditors. What happened to pharma major Wockhardt is a perfect case in point.

Between May 2008 and May 2011 the benchmark BSE Sensex and NSE Nifty index have risen 10% each point to point. But the stock prices of many companies with FCCBs on their books are around 50% below their historical highs. This coupled with high debt on their books and low promoter shareholding is expected to pose problems for conversion and redemption of FCCBs. For instance, as reported in the Mint, for the fiscal 2013, FCCBs worth Rs 220-240 bn will have to get either refinanced or their conversion prices will have to be revised lower. What is more, if all these firms choose to redeem their FCCBs when they mature, the repayment to the bondholders will run up to Rs 301 bn, including a premium of Rs 71 bn. This is more than half the companies' profit in the last four quarters. Refinancing itself will occur at steep costs given the upward trend in interest rates.

Indeed, these instances clearly highlight the need to invest in stocks of those companies which have strong financials with good managements, low debt on their books and abundant cash that will enable them to weather any storm.

Do you think the FCCB crisis serves a lesson for companies and investors? Share with us or post your comments on our facebook page.

 Chart of the day
Problems for the developed world are far from over at least as far as the job market is concerned. As today's chart of the day shows, unemployment rate for most of the developed European countries and the US are either above or closer to the 10% mark for March/April this year. And lesser jobs means that citizens of these countries will be vary of spending. That is why no amount of quantitative easing by these governments will help much unless there is a significant improvement in job prospects.

Data Source: The Economist

Europe is still reeling under a sovereign debt crisis. The US is seeing its debt limit get closer to unforeseen levels. Middle East yet cannot boast of peaceful socio economic conditions. And emerging market equities are oversold with valuations getting closer to historical highs. In such a scenario where do investors looking for relatively safe but high returns put their money? They have found the answer in emerging market debt. With yields in developed nations not moving beyond zero anytime soon, yields in emerging markets certainly look far more attractive. Given the kind of demand that emerging market debt has, the yields could get lower in the longer run. But for the time being developing countries are best poised to cash in on the appetite for debt issuances. Unfortunately, for India, the debt market here lacks depth and is not very mature. However, given the fickleness of short term foreign money, it would be best to keep their access to Indian debt markets limited.

The US dollar has declined considerably in recent times. The loose monetary policies of US Fed have resulted in a decline in dollar's value. Most experts have criticized these policies as they have resulted in erosion of dollar value and led to inflationary pressures. Some experts have also stated that the fall signifies the end of dominance of US dollar as the global currency. However, noted economist Paul Krugman feels that the weaker dollar is just what US needed to cure its employment situation. As per Krugman, the weaker dollar has made American exports more competitive. This in turn has led to a growth in the country's manufacturing sector. All this has resulted in more job creation in the country. As a result, the weaker dollar has actually helped in solving the huge unemployment that the country has been facing since the financial crisis.

When will the Chinese growth engine finally run out of steam? When will the red dragon stop breathing fire? This question has been plaguing the global economy for the past few years.

Developed economies such as the US and Germany manage to only grow at low single digit rates. China, on the other hand has expanded 10.1% a year on average since 1978. In 2007, Chinese Premier Wen Jiabao called the economy increasingly unstable, unbalanced, uncoordinated and unsustainable. And he said the same in 2011. Many including Nouriel Roubini believe that the day of reckoning for China is near. Roubini warns of a sharp slowdown, mostly post 2013. A slowdown in fixed investment would be a major reason for the slump.

But, the Chinese economy has shown to be extremely resilient over the past. It survived the global financial crisis, hot money investments, food inflation over 20%, and protectionism. However, despite the fact that many believe that China has taken over the world, it has a lot of work left. It needs to boost workforce skills, migrate its population to cities from farming villages, and increase innovation. It also needs to provide clean water and sanitation for its billion plus population. China's GDP per capita of US$ 4,200 in 2010 was still only 9% of that in the US. Its standard of living is comparable to Japan in 1954 and South Korea in 1976. So clearly China, like India has miles to go before it can sleep.

Rising prices of fuel has been a matter of serious concern for car users. In order to reduce the pain of high prices, a lot of car buyers are showing preference for diesel cars. The widening gap between petrol and diesel prices has been the main trigger for this. Along with being comparatively cheaper, diesel cars also have higher mileage. In the past few years, sales of diesel cars have grown at a much faster rate than those of petrol cars. Though currently diesel cars have a market share of about 30%, they are set to garner about 50% share in the next 3-4 years. As a result of this changing trend, companies are now concentrating on creating variants of this cheaper fuel. However, it remains to be seen whether this trend can continue for long as it depends a lot on whether the government takes a decision to free diesel from price control.

In the meanwhile the Indian stock markets have been trading in the green today. At the time of writing, the benchmark BSE Sensex was trading higher by 70 points (0.4%). Banking and capital goods stocks were top gainers while realty and metal stocks were trading weak. All Asian stock markets were also trading strong except China and Indonesia.

 Today's investing mantra
"Investing isn't just about probabilities. It's about consequences, and you've got to be prepared for them." - John Bogle

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