Buffett's chemical test - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Buffett's chemical test 

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In this issue:
» Nuclear energy vs. natural gas
» Steel producer's dilemma
» Buffett backs Dow
» Air India's Dubai monopoly ends
» ...and more!

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 00:00    Natural gas sacrificed for nuclear energy?
Charlie Munger, investor and thinker, has often advised thinking about the effect of effects. India's energy policy makers should have listened. They roped in the Samajwadi Party (SP) to salvage the nuclear deal. What they forgot is that SP will bring with it its own agenda in the feud between the Ambani brothers. SP has raised the clamour for windfall tax on private upstream companies such as RIL, Cairn and Essar. SP is also likely to pressurize the government's gas utilisation policy. Currently the policy favors fertiliser companies; it is likely to tilt towards power projects. Interestingly, Anil Ambani's Dadri power plant needs natural gas. These are the first order effects.

The second order effects are what windfall taxes and tampering with the utilisation policy will do to the incentives of upstream oil companies. Chevron's Chairman, David O'Reilly, mentions that windfall taxes were levied in the United States 25 years ago and the US Congress even studied the impact of those taxes at the time. They found that domestic oil production declined more rapidly during that period and the US became even more dependent on imported oil. Given India's dire need for energy security, can we afford to disincentivise hydrocarbon explorers and producers? Moreover, revisiting the utilisation policy would further delay gas production from the KG basin as production cannot be halted once it starts. The Anil Ambani camp would not like to let go of any gas it believes it is entitled to. As a result, the entire production may be deferred.

Clearly it is not just a simple question of nuclear energy but also what it costs us.

Gas utilisation policy
Priority Sector
1 Fertiliser plants
3 Gas-based power plants
4 City gas distribution (CNG and PNG)
5 Fuel oil & naptha replacement
6 Existing industries

 01:11    Inflation goes still higher
The wholesale price index rose 11.89 % in the 12 months to June 28, higher than the previous week's annual rise of 11.63 % leading to a 450-point decline in the benchmark BSE-Sensex. It may be noted that officials from the finance ministry have already said that inflation could march up to 13 % before making a slow descent. It is estimated that steel prices contribute nearly 20% to the inflation numbers.

  • Also read - Inflation, inflation everywhere

     01:30    Input costs put steel producers in a dilemma
    Steel makers had promised the government of maintaining steel prices till the end of July this year. Cost pressures have now gone up significantly to the tune of Rs 10,000 to Rs 12,000 per tonne. Coal is 3 times as expensive. Ferro alloys, freight and logistics costs are also higher. As a result, steel prices have been hiked globally. Indian steel producers may be forced to hike prices to the tune of Rs 4,000-5,000 per tonne. However, the government is unlikely to allow the hikes with the latest inflation numbers touching 11.89%.

     01:55    The mall mayhem
    As per a leading business daily, many malls that sprung across Gurgaon over the last few years have been abandoned or been converted into commercial spaces. It is now feared that several malls in other cities will go the same way. Rough estimates indicate that around 350 malls are set to come up in India. With high levels of saturation in some areas, high property prices and rising construction costs leading to very high rentals, retailers fear that malls are becoming increasingly unviable.

  • Also read - Upsides from here for retailing

     02:17    Buffett backs Dow
    Warren Buffett led Berkshire Hathaway will buy convertible preferred shares to the tune of US$ 3 bn in Dow Chemicals, which will help the latter acquire its rival Rohm and Haas. Dow expects synergies from Rohm's higher margin specialty chemical business when added to its own basic chemicals operations. On conversion of the securities, Berkshire will become Dow's largest shareholder. It may be noted that Berkshire helped Mars takeover Wrigley earlier this year. It is interesting to note that Buffett would get involved in a chemicals operation given his insistence on a durable economic moat. However, he has made large bets even in other areas in the past if he believes low valuations decisively change the odds of success in his favour. Just goes to show that conservative investing is not confined to one dimension only.

  • Also read - Lessons from Warren Buffett

     02.51    Japanese nuclear forays
    As per a leading business daily, Japan is being roped in to construct 12 nuclear reactors costing around 300 bn to 400 bn yen each in South Africa to address the power shortage and help economic development in the region. The plan will have the added benefit of curbing greenhouse gas emissions around South Africa and demonstrating Japanese leadership in combating global warming. An important unstated benefit for Japan is to draw level with China in its diplomatic clout in Africa and subsequently improve the chances of Japanese companies trying to enter the development of rare metals. This is an important development in the natural resources game in Africa in which developed counties as well as emerging countries are now interested. Rare metals are vital for the production of automobiles and cell phones. Interestingly, in its bid to access crude oil reserves, India is also in the race to secure better diplomatic ties in the region but often loses out to China.

     03.29    Air India's Dubai monopoly ends
    The Indian airlines industry is constantly undergoing changes. The latest development is the government approval to Jet Airways and its 100 % subsidiary JetLite to fly to Dubai. While Jet Airways will run daily flights from Delhi and Mumbai, JetLite will run daily flights from Hyderabad and Nagpur. Air Deccan will also be eligible for the same from late August this year, when the airline completes the required five years of domestic operations. While short domestic flights generate losses due to competition induced low fares, very long distance international flights are vulnerable to high fuel prices arising out of spiraling crude prices and weak traffic. A 15-hour trip consumes more fuel for each passenger mile than an 8-hour trip, but the airfare per mile generally doesn't rise proportionally. Hence the airlines wish to operate the heavy-traffic, mid-distance flights to the Gulf countries.

  • Also read - Airlines feeling the heat

     04.05    Sunrise of the DTH industry
    Direct-to-home (DTH) satellite television currently accounts for less than 10% of the cable and satellite market at 7 to 8 customers. Given the large untapped market to be converted into DTH homes, existing players are not about to go easy on the advertising and marketing spends anytime soon. They are dangling all sorts of benefits in front of the consumer ranging from the pledge of superior technology, rates comparable to those of cable, and customized packages, interactive features and free goodies. Clever advertising campaigns are also likely to accompany the marketing efforts. Moreover, the number of direct-to-home (DTH) satellite television players is set to double in the next few months.

    As a result the sector is witnessing massive investments. Dish TV spent nearly Rs 1 bn on advertising last fiscal and is likely to further its budget. Videocon's D2H+ plans to spend more than Rs 1.5 bn. ADAG's Big TV's reportedly has a budget of Rs 2 bn per annum. Interestingly, they all plan to utilize the existing the distribution network of their existing associated businesses to reach out to the consumers. The massive initial capital expenditure reminds us of the early telecom days when players like Bharti Airtel spent heavily to increase their user base paving way for profits even with lower call rates.

  • Also read - Opportunities in telecom infrastructure

     04.57    Today's investing Mantra
    "People calculate too much and think too little" - Charlie Munger
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