Chinese shocker! A big steel firm will now sell wine - The 5 Minute WrapUp by Equitymaster
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Chinese shocker! A big steel firm will now sell wine 

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Have you ever imagined the mammoth Government owned steelmaker SAIL to be venturing into cosmetics? How about Hindustan Unilever looking to enter iron ore production? Absurd, isn't it? To use Peter Lynch's terminology, there couldn't be a better example of diworsification than these two. Indeed, most of the shareholders of these two companies wouldn't think twice before selling the stock the day they hear such news.

You would certainly be amused to know that such an event is actually being played out in reality. No, not in India but in the dragon nation China. Yes, that's correct. An article was doing the rounds a few days back about a move being contemplated by a leading Chinese steel firm, Wuhan Iron and Steel Corporation (WISCO). It appears that the firm will debut in the food market soon, with wine and olive oil as its main business. Infact, it will have under its umbrella a total of 38 different kinds of wine and 29 kinds of olive oil!

The reason WISCO is making such a move is that the profit margin of the steel business in China is so low that the company has to do more in non-steel sectors to collect more profits. Infact, WISCO is not the only company to indulge in diworsification. Sticking to the main business, while seeking other industries has become the norm in Chinese steel industry.

Shock and awe aside, this development perhaps points to a much deeper malaise afflicting the Chinese industrial sector. That of overcapacity and below par returns. While this news has only covered the steel industry, if taken in conjunction with other news like an overheated real estate sector and rising inflation, things do appear dire for the Chinese economy. To sum it up, it may not be the western economies that start the next crisis. It could well be the Chinese economy.

What do you think, will Chinese economy start the next crisis or the western ones? Let us know your views or share them on our facebook page.

01:10  Chart of the day
As per the estimates of IEA, China, that generates 70% of its power using coal, is expected to build a staggering 600 GW of coal fired capacity in the next 25 years. To put things in perspective, this is the amount of power that is currently generated in America, Japan and EU put together! The country is also taking huge steps to improve its coal supply. But does it have enough reserves? Not quite. As today's chart of the day shows, while China has reserves to the tune of 120 bn tonnes, its reserves will last the economy all of 38 years if one takes 2009 production into account. The deadline would come even closer if the projected growth in coal fired capacity is taken into account. As far as India is concerned, at 2009 production rate, its coal reserves would last it all of 105 years.

Source: The Economist

The official US CPI (consumer price index) numbers say that inflation is up just 2.1%. But is that the true story? We don't buy that. The reason for this is that the current CPI is unreasonably heavy on housing prices. And everyone knows housing prices in the US have been declining. However, if you take the pre-1980 methodology then the inflation rate is staggeringly high at 9.6%.

But despite this, the US Fed is pretending as if inflation is not a significant concern, but just a temporary hiccup. It seems to be hallucinating a different reality altogether. And it is not just inflation, but the Fed is wrong in its perception of almost every economic reality. While there is every chance of a double dip recession, the US Fed seems quite optimistic about the economic recovery. While it is the Fed's reckless money printing that has been a major factor that has sent commodity prices soaring, it blames other global factors for the same.

Now, either the US central bank is a liar, or it is under the influence of a sedative!

Anna Hazare, a man who was relatively unknown a few weeks back, is now a household name. He has been a social activist for years. However this time his actions struck a chord with the Indian population, which is getting more and more frustrated by crony capitalism and corruption. A hunger strike by this man brought thousands to the streets in Mumbai and Delhi in his support. Kishor Chaukar, executive director of Tata Sons echoes the same sentiment. He states that our society's increased frustration with corrupt practices can threaten to lead to protests akin to the ones seen in Tunisia, Egypt and Libya.

On the power of the people, especially the Indian youth, Chaukar says that "A large number of youth are saying: 'This is enough'. To crony capitalism, they are saying: 'Let's get rid of it'." We believe him when he says that India cannot get rid of its problems in the short term. Indian companies will continue to face ethical challenges and dilemmas for years to come. But, it is definitely an issue that needs to be addressed, before this cancer poisons even the good elements in society.

Stocks of Indian paper companies so far have not really been the apple of the investors' eye. This has largely been due to the capital intensive nature of the industry and the stringent regulations with respect to meeting environmental norms. Also, Indian paper companies could not really match the scale and size of companies in the West and had to deal with a lot of problems on the raw material front. This was because while overseas companies were allowed to have private plantations, the government in India did not permit domestic paper companies to do so. Interestingly, US' largest paper company International Paper acquiring a majority stake in Andhra Pradesh Paper Mills recently has brought the paper industry back in the limelight.

As a result, players such as BILT and JK Paper see the deal, struck at unheard-of price, also hugely pushing up valuations of Indian companies. What makes a case for Indian paper companies is that they have always enjoyed better profit margins and return ratios as compared to their international counterparts. For instance, ROCE for global players is around 4% to 5%, for Asia its around 6% to 7% while for Indian companies it is more than 12%. While the reasons may seem compelling enough, Indian paper companies will have to focus on sustaining a strong performance on a consistent basis if they want to command high valuations going forward.

Equity indices may have bounced back after their lows of 2009, but equity investors are still wary. Such would be the message if one was to rely on the mutual fund data. The Indian mutual fund industry saw a huge redemption for the equity funds. Investors were selling out. One reason for this could be that investors were booking profits as they were cautious especially after seeing the losses of 2009. Another reason that is being cited by the mutual fund companies is that the distributors are not pushing their funds enough. We feel that the latter is probably truer.

Distributors used to push mutual funds to their customers and for this they would receive a handsome fee from the fund houses. However, this payment of distribution fee was indirectly banned by the regulator, which banned the entry fee that the funds used to charge. Part of this entry fee is what was paid to distributors for their efforts. As a result, distributors no longer find it lucrative to push the mutual fund products to their customers. This suggests that funds that were the 'popular' ones in the entry fee era were probably not the ones which were the better performers. They were those which were paying their distributors well. And with the fee being banned, these fund houses are finding it increasingly difficult to lure back their investors.

Meanwhile, Indian markets remained closed today on account of Dr Ambedkar Jayanti. As far as other Asian markets are concerned, most of them closed the day in the red. European markets have also opened on a negative note.

04:55  Today's investing mantra
"The stock market is filled with people who know the price of everything, but the value of nothing." - Philip Fisher
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9 Responses to "Chinese shocker! A big steel firm will now sell wine"

Sonny A. Jacob

Apr 15, 2011

As the market up trend or rally is subject to correction, so is the growth of any country. Economies will slow down or fall after continuous growth, due to various reasons- domestic/global. China knows what maintenance to be done to the machinery otherwise such a hard core communist nation would not have overtaken western super powers in many areas, including industrial production.



Apr 14, 2011

not clear whether the Chinese steel company venturing into wines/edible oils due to slackness in the steel industry--if that is the case,it's a good move. also wud be interesting to know if this steel company is state-owned, otherwise you can be sure Lakshmi Mittal wud be prowling around looking to acquire this unit too!regds



Apr 14, 2011

A good sum up. It seems that both Chinese and US
economies will trouble the world.


Niraj Arora

Apr 14, 2011

"Chinese economy is a big bubble". Many people in the media had been writing about it. We in India love to read and hear such comments. Many stories about China circulates in media and in gossips. China is investing a lot of money in Africa. I am no authority in opining whether WISCO is right or wrong, but the fact remains that China receives highest amount of FDI.
If Chinese economy collapses what would be the fate of Dollars and Euros? Wont there be a world war before the Chinese economy collapses? We can only guess.


Abhay Dixit

Apr 14, 2011

I am sure you have read a book called "Coming Collapse of CHINA" written in around 1996. It had predicted a collapse around 2005-7



Apr 14, 2011

Eq.Masterteam ,
Though I am sure it may probably be a purely typographical error, the spelling that is "Diworsification ",it almost signifies the real state of "Worsification " better still "Divorcification " !!
Just like (in a Dictionary), perhaps the only place anywhere, where "Divorce" comes even before "Marriage " and "Beginning" before the "End "

From the hard goods Steels to the liquid matters/materials "Wine "(38 varieties)
and Olive oil ( 29 kinds) what a contrast to a giant behemoth's dealing matters/materials dealt with by
I hasten to conclude !!



Apr 14, 2011

Economy is like a Ballon:You press it hard at one End, it bursts at the other end! U.S. learned the truth the hard-way: Liberal Housing Finance & creation of complex Mortagages! China will learn when it's strategy of over-Production & capturing forign Mkts bursts on it's face!



Apr 14, 2011

This is really a professional idea. If one sector's though parent sector is not give good profit or giving loss, they it is better to search new lucrative avenues. There is nothing wrong in that. "Chinese shocker! A big steel firm will now sell wine". Wine is lucrative sector and as such steel firm owners have tended towards Wine selling business. One of my friends who spent some years in China told me that whatever playthings/toys are available across the world are manufactured in prisons only; where prisoners render their services round the clock in 3 shifts. So is the optimum use of prisoners as well at China. So diversifying business from steel (due to loss making sector) to Wine (The lucrative sector)is quite natural and professional Chinese move, for there is no anything shocking or shock-giver, I opine.



Apr 14, 2011

Not surprised about this news bit from China. China is the mother of all bubbles said Jim Chanos. But when will this bubble implode is anybody's guess ? Commodity stocks, metals watch out .....

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