Heading back to school - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Heading back to school 

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In this issue:
» Banks' worst fears to come true
» Value trumps growth
» Colgate's unique way to beat costs
» Its back to school for executives
» and more...

 00:00    Banks' worst fears to come true
Bankers seem to be finally waking up to and admitting the fact that loan defaults in select pockets are indeed on the rise on the back of rising interest rates. The worst hit are likely to be the banks that have greater exposure to unsecured and small ticket loans like personal loans and loans on consumer items like white goods and automobiles. India's top rating agency Crisil, had predicted a few days back that NPAs in the retail segment are likely to touch 4% over the next couple of years from levels of 2.7% in March 2007. It seems that loose lending practices followed during the lower interest rate days have come back to haunt the banking sector as more and more consumers are finding it difficult to pay their EMIs, the value of which has gone up substantially in the past few months on the back of record high interest rates. What is more, the growth in the retail segment is also likely to slow down with one banker predicting it to remain in the range of 5%-10% as against a total advance growth of 15%. This further confirms the expected slowdown in the economy, a doubt that had been raised earlier following record decline on auto sales and poor IIP numbers. It also does not bode well for the banking sector that by nature has a risky business model. Debt always outnumbers equity by a ratio of around 10:1 in banks and hence a small mistake on the overall loan portfolio can have a huge impact on the equity value of bank, thus undoing years of good work.

 00:40    Value to outperform growth?
First the bad news! According to a data compiled by Paris based Societe Generale SA and reported on Bloomberg, after trouncing it in 2007, growth investing is well poised to beat value investing again in 2008 and that too, by one of the biggest margins in history since 1980. Now, the good news. The five prior times since 1952 that growth beat value two years in a row, the latter group recovered and won by 17 percentage points annually on average for seven years!

Value investing, believed to be pioneered by Warren Buffett's mentor Benjamin Graham and upon which, Buffett has built his enormous fortune is the type of investing that believes in buying shares that are trading at a significant discount to their intrinsic value.

So, in a sense, it is contrarian in nature and hence, tends to underperform growth investing during periods of excessive mania like the dot com boom in the US in the nineties or the stock market's obsession with power sector stocks in India recently. However, over the long-term, value investing is believed to have a much better track record than growth investing, beating the latter handsomely. The year 2007 and 2008 so far have turned out to be one of the worst periods for value investing. This is evident from the performances of renowned value investors like Buffett and Bill Miller whose funds or investment vehicles are down more than the broader indices. But these veterans are in no mood to panic and believe their time will come sooner than later.

 01:22    In the meanwhile...
Tracking its global peers, the Indian indices traded weak today with the BSE-Sensex benchmark inching nearly 1% lower when it finally shut shop for the day. As far as the US markets are concerned, they ended weak yesterday on the back of fears that there could be more sub prime related skeletons in the cupboards of banks, which would further balloon their losses. The fact that the crude prices receded also did not help matters. Among other markets, while Asian markets closed lower today, European markets are also trading lower currently.

 01:32    SEBI cracks the whip on I-bankers
Investment bankers made hay while the sun shone over them until late 2007, when the primary markets were brimming with activity and every other corporate was bringing to the table new as well as follow-on offering of shares. 2008, however, has not been particularly benign, especially now when the market regulator SEBI has decided to crack the whip on defaulters. SEBI has decided to impose penalties on some of India's top investment bankers for what it considers shoddy work done by them while handling public offerings over the past few years. The regulator has uncovered serious shortcomings in the due diligence process for initial public and rights offerings, besides open offers, carried out by seven investment bankers.

A due diligence process relates to the examination and independent verification of material and financial facts and statements provided by companies seeking to raise capital. However, the busy i-bankers seem to have taken the word "independent" with a large pinch of salt, as the trade off with the i-banking fees was rather lucrative. SEBI, on its part, has taken a grim view of the fact that merchant bankers, who are entrusted with the task of vetting a public issue, have failed to discharge their responsibilities fully, which is detrimental to the interest of investors.

 02:14    Colgate's unique move to beat costs
Alarmed by rising inflation and shrinking margins, producers are indeed resorting to various strategies to cut costs. Latest to jump the bandwagon is India's largest oral care player, Colgate. As per reports, the company has decided that its consumers can live with lesser options in terms of pack sizes, thus enabling it to cut operating costs. In other words, the company has decided to reduce the number of stock keeping units (SKUs) that it dispatches to the markets. It has to be noted that an SKU is a pack size of one product and hence, if 'Colgate Active Salt' is available in six different packs, each is an SKU. This move is a first in recent times by any consumer product company. Colgate is confident of achieving the targeted SKU reduction of 15% well before the deadline although it has refused to divulge the deadline.

Although the company does not disclose the number of SKUs in its portfolio, industry sources place the number anywhere between 150 and more than 200, thus underscoring the significant impact the 15% reduction can have. The company has already informed one of its key suppliers, Essel Propack to stop the supply of packaging of some units. Assuming that the company reduces SKUs at the lower end and the consumer then opts for a high end product, the move is likely to give a boost to its realisations per pack sold. Not to forget, the cost savings on the bulk orders for the reduced number of SKUs. Furthermore, with the company targeting to produce more out of its Baddi plant, it is indeed well placed to ride the current high cost wave.

 03:08    Time please! says the oil minister...
As per a leading business daily, the petroleum ministry has requested the Cabinet Committee on Economic Affairs to grant a 3-year holiday (up to the end of 2010) for the upstream oil companies like ONGC and RIL. These companies had won more than 30 blocks under the NELP V rounds, but have not been able to meet their work commitments due to the shortage of deep sea drilling rigs. It may be noted that much of the new exploration acreage in India belongs involves deep sea exploration and the hire charges for deep sea drilling rigs has shot up 250% over the past 2 years. In fact, the work progress for the blocks under NELP VI is also not satisfactory, but there is still time for the companies to make up as the first phase of exploration for NELP VI ends only in 2010.

Given the extreme dependence on imported oil, the government should do everything in its power to encourage domestic exploration. With the hiccup over exclusion of natural gas for income tax holiday during the union budget and prolonged litigation over KG basin gas, it is high time the government examined the signals it sends out to potential upstream players.

 03:40    Its back to the school for executives
The proof that the global economy is slowing down is showing itself up at some of the most unexpected places, like the stats on number of applications for enrolment at a B-School. As per the Economist, B-Schools, mainly in the US are witnessing a huge surge in applications by executives for full time MBA programmes. Unlike India, where B-school applicants are mainly freshers, in the US, these courses are sought after mostly by working executives. Since taking up a full time MBA means foregoing salaries, executives like to enroll at a time when the cost-income trade off is the most favorable to them. Hence, it can be safely concluded that these executives do not see current times as the most favorable for their paychecks, thus enabling them to make the easy decision of going back to the schools and honing their money making skills. Furthermore, declining asset prices and rising yields on education loans is also not deterring them to hold back their decisions, probably in the hope that when they will come out of B-Schools with their degrees tucked under their arms, their incomes would see a sizeable boost. We too hope that these people learn some valuable lessons in B-Schools on how to run a business and not the financial alchemy of converting 2+2 into 5, an art that has plunged the world headlong into one of the most troubled times in recent years.

 04:19    India corporate debt squeezed in costlier climate
It is common knowledge that the government is on a heavy borrowing programme in order to meet its need for expenses like farm loan waivers and subsidies. What is unknown though is the fact that this heavy borrowing spree is likely to have an adverse impact on corporate bond issuers in India, who are already reeling under high interest rates and contracting liquidity. As per reports, record fund raising by government this year will likely squeeze demand for corporate bonds with a lot of financial institutions unlikely to touch such instruments in the wake of rising inflation that has sent interest rates to record levels. Furthermore, with banks' deposit base rising, they will be forced buy more of government securities to meet the statutory requirement and this will also have an impact on demand for corporate bonds. Infact, some experts predict that even a top rated corporate with AAA or AA ratings will find it hard to raise money at lucrative interest rates. Indeed, tough times lie in store for companies that need access to capital markets frequently.

 04:51    Investment mantra of the day
"The market, like the Lord, helps those who help themselves. But, unlike the Lord, the market does not forgive those who know not what they do. For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments." - Warren Buffett.

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