Big names don't always translate into gains - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Big names don't always translate into gains 

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In this issue:
» India raises concerns over USFDA audits
» Bad loans plague India's banking sector
» 2G spectrum auctions bother telco investors
» Could Bitcoin be banned?
» ...and more!

00:00  Chart of the day
There is one thing common to crises. They all are eye openers. As the famous saying by Warren Buffet goes, 'Only when the tide goes out do you discover who's been swimming naked'. And the good part about them is that they are precursors to significant corrections.

In this context, an article in Business Standard offers an interesting analysis. The event in question is the global financial crisis in 2008.

The period post crisis led to a rerating for India's most valuable businesses. Those which fell from grace include the likes of Anil Ambani group, Essar Group and Jaypee Group etc. . Thus some of the biggest bluechips in India have been the wealth destroyers. They have seen erosion in the market valuation since the 2008 crisis, as highlighted in the chart below. Even top 20 corporate groups (pre crisis era) have together gained just 4.8% in terms of market cap (CAGR) between FY08 and FY13.

Market value erosion across India's top business conglomerates

Some of the main issues with the big groups were overexposure to cyclical sectors and high leveraging. With sole focus on growth and least regard for the risk management, these companies borrowed heavily at a time when debt was cheap and easily available. However, India's growth story did not unfold as expected and hence such companies suffered. Even when the economic scenario improves, we believe the biggest losers will struggle to make comeback. This is because they will be busy cleaning their balance sheets while the performers will race ahead making the most of the growth opportunities.

Investors have some important lessons from the crisis and its impact. That is, not to get carried away by big names and blue chip stocks. While the latter boast of good track record with regards to growth, balance sheet size and liquidity, what they do not ensure is the robustness of the economic model in bad times. The slowdown that followed the period of crisis exposed some such companies.

It is with this point in mind that we suggest investors to focus on quality of management and strength of balance sheet (rather than size) and attractive valuations. In short, a growing business that does not offer consistent and adequate returns could eventually erode shareholder wealth.

Do you think all blue chips can qualify as good investments? Let us know your comments or share your views in the Equitymaster Club.

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The Indian pharma industry's troubles with the USFDA are well known. It began with two of Ranbaxy's plants being issued an import alert by the US regulator. Since then most of the big players have been given warnings for failing to comply with good manufacturing practices (GMP) norms. The severity of the issue for each company has been different. But is goes without saying that Ranbaxy has faced the maximum brunt for consistent failure to adhere to GMP norms. Because of these issues, the USFDA has also stepped up the number of surprise checks that it would conduct on Indian plants. However, as reported in the Financial Express, India has raised concerns over the way the USFDA has been conducting audits on the plants of Indian companies. It claims that there have been instances when the regulator has not had proper discussions with the companies concerned following audit inspections. Even when clarifications were asked for, harsh decisions were taken before the companies could respond to the queries. India has also questioned the quantum of penalties imposed on some companies declaring them to be too harsh. The commerce ministry has claimed that all of these actions have been hurting exports of Indian drugs to the US. The commerce ministry has brought up the matter with the USFDA. Thus, there are hopes that both the parties come to a meaningful solution to the problem. Indian companies, in the meanwhile, will have to step up efforts to make their plants GMP compliant so that the instances of warning letters and import alerts significantly reduce.

Say you deposit Rs 100 in a bank. The bank typically lends out Rs 80 from the same (average credit deposit ratio is 80%). Against the deposit of Rs 100 the bank maintains networth of Rs 8 (average debt to equity is around 12-14 times). Now if the bank is not able to recover as much as 10% of the loan (Rs 8), it means nearly the entire networth against the deposit gets wiped off. Such is the dire scenario the Indian banking sector is staring at. As per rating agency S&P, the problem of rising bad loans in Indian banking sector is far from hitting the roof. It estimates the stressed assets in Indian banking sector to go up to as much as 12% by FY15. And that could mean several banks finding the capital adequacy ratio (CAR) below the RBI stipulated minimum of 9%. Hit by such a problem, United Bank of India has already suspended all lending activity for an indefinite period. And we would not be surprised to find several smaller banks finding themselves in a similar contagion. Hence investors need to be extremely wary of investments in the sector despite attractive valuations.

Investors in telecom stocks are a worried lot these days. The reason is not hard to find. The 2G spectrum auction currently being conducted by the government has received a very good response. A total of eight telcos are fighting it out for the 900 MHz and 1,800 MHz spectrum on offer. At the end of the seventh day of the auctions, the government would have been very happy with the response. Bids over Rs 580 bn have been received so far after 49 rounds. This is well above the target of Rs 400 bn set by the telecom ministry. The bidding in the 1,800 MHz band which was expected to be fairly rational, due to the abundant pan-India supply, has also heated up. The bids are being made at prices well above the reserve price. In the case of the premium 900 MHz spectrum, bids have already exceeded the reserve price by 70%.

This has raised concerns about high debt levels of these companies. The fear is that telcos will have to stretch their balance sheets to the limit, to fund the acquisition of the spectrum. While only a part payment needs to be made upfront (33% for 1,800 MHz and 25% for 900 MHz), the worry regarding balance sheet stress is quite real. Taking on even more debt to fund the purchase of spectrum will certainly increase interest costs for these firms. This would impact their financials negatively.

Should currencies be under the control of the Government or should they be market determined? This is a debate that's been going on for quite some time now. Needless to say that a nationless currency that answers to the name of Bitcoin is an experiment of the latter kind. And given the way it has risen in recent times, people seem to be losing faith in Government printed money. Bitcoin is not going to have it easy though. Close on the heels of the Chinese authorities banning it, the word is that Russia has also begun to crack down on the virtual currency. When prodded, the blame is put on the role Bitcoin can play in facilitating illicit trade. An article in FT has lauded this step. It argues how we need central bankers and fiat currencies in order to promote prosperity when people behave in unexpected ways.

Really? We would like to highlight to the editor of the article that central banks is only a recent phenomenon whereas trade and commerce have existed since thousands of years. Therefore to claim that Government controlled money is needed to smoothen economic cycles is indeed wrong. On the contrary, Government actions only make the problems worse by interfering in the natural clearing mechanism of the market. Therefore while Bitcoins could indeed be banned, there are other neutral currencies like gold that will never go out of fashion we believe.

After starting the day on a firm note, the Indian equity markets traded in a range bound manner for the rest of the day. At the time of writing, the BSE-Sensex was trading higher by about 50 points or 0.2% , with stocks from the information technology, auto and banking space leading the pack of gainers. Stock markets in other major Asian economies ended on a firm note with Japan, Hong Kong and China up by about 1.8%, 1.8% and 0.8% respectively.

04:50  Today's investing mantra
"You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets"- Peter Lynch
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3 Responses to "Big names don't always translate into gains"

vasant upadhyay

Feb 25, 2014

no sir. big name may not translate in gain always.important is entry point and to decide correct entry point many things may be considered like earning, governance, book value, market perception etc. we jointly can evolve theory. i welcome the comments/ideas


Dr. Arun Draviam

Feb 11, 2014

India did not resort to monetary easing as US did by printing more currency notes. After the financial crisis caused by the US was offloaded in the Europe, through securitisation and credit rating, other countries also resorted to monetary easing in the Euro zone, barring Germany. Even Japan and later China resorted to monetary easing. India did not do any such thing and yet Indian Rupee eroded in value vis-à-vis the USD. Is it something due to policy paralysis at the fiscal level? Was a monetary policy different from traditional economic theory called for and Indian RBI did not dare to go out of the conventional policy? I know I am raising questions than answering them. My purpose is that more deliberations should take place to arrive at a correct conclusion.



Feb 11, 2014

Sirs, You are correct. Big names follows cumulative loss to investers. For example I did purchase RNRL shares. Invested Rs.5000. Later Reliance converted them into R Power. Now the price of R Power is rusted and reduced to 20% of original investment tome. Reliance is really involved in foul play in share market. Though the Co. has earned a marginal profit no dividend has been recommended. This is another foul. How can we believe the so called BIG GUNS ?

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