Are companies geared to deal with geopolitical risks?

Sep 20, 2014

In this issue:
» Who has the most number of billionaires?
» Alibaba debuts with a bang
» Will China ever revert to 10% growth?
» Should India follow the US when it comes to gas pricing?
» ...and more!

We have mentioned in one of our earlier editions of the 5 Minute Wrapup, how geopolitical tensions have increasingly threatened the function of the global economy given that the world is now much more interconnected than it was before.

At present, the major conflicts that are grabbing headlines are Russia-Ukraine conflict and the crisis in the Middle East. These two especially have been closely watched by markets around the world given that it could have major implications as far as crude prices are concerned. The other point is that corporates in today's world are no longer content with doing business in their home countries. They have a strong established presence overseas as well. For example, for many of the listed Western firms, around 20-30% of revenues comes from emerging markets.

Naturally, geopolitical tensions such as the ones we are witnessing now bring some degree of nervousness in case they hamper business operations of companies and thereby dent profitability. One such example is McDonalds, which has had to shut many of its chains in Russia, once the US imposed sanctions on the former.

But are we reading too much into these risks? According to an article in the Economist, that is quite possible. For one, the Middle East, North Africa, Russia and Ukraine together produce just 7% of world economic output. But on a much broader level and not just limited to the current conflicts, multinationals (MNCs) themselves are becoming more adept at absorbing risks. They are not overtly concentrating on one region alone. So problems in one region may not have a significant impact on the overall business as there is a cushion from other markets. Further, there has actually been a positive fallout from the subprime crisis. And that is cop0roations are looking to becoming cash rich to strengthen the ability to withstand shocks.

This is the case with Indian companies as well. Most companies in sectors such as pharmaceuticals, IT, automobiles, auto ancillaries and energy among others have established their presence in markets other than India. These not just include the developed economies of the US and Europe but also encompass Africa, Latin America and Asia. But those who have a wider geographical reach have perhaps withstood the threat of conflicts or regulatory hurdles better than the others.

That is not to say that geopolitical risks should be entirely ignored. In the current context, tensions in Russia could escalate and if the crisis in the Middle East worsens all the more, the impact on crude prices could be worrying. That is why it has increasingly become important for companies including those in India to understand the dynamics of the markets whose potential they wish to tap. Further, should an opportunity not pan out as envisaged, there has to be a plan ready to cut losses and exit and capitalise on other prospects elsewhere.

Do you think that geopolitical risks pose a big threat for Indian companies having operations abroad? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
The people at the top of the income pyramid are often a subject of both envy and fancy. A country's billionaires may not necessarily be as good indicator of economic prosperity as of economic disparity. Nonetheless, it would be interesting to have a look at the billionaire (net worth above US$ 1 billion) stats in India and our neighbouring country China. This year the number of Indian billionaires stood at 100, a 3% decline over last year. China, however, witnessed a 21% jump in the number of billionaires to 190. While Mumbai boasts of 28 billionaires, Beijing has about 37 billionaires. Globally, the total number of billionaires stands at 2,325, a 7% increase over last year.

Who boasts of having the most billionares?

The Chinese dragon is indeed breathing fire. Alibaba Group Holding Ltd, truly a reflection of China's new found economic prowess, finally made its debut in the US stock markets. With close to US$ 22 bn raised, the IPO is already the largest by any company in the US. And if moneynews is to be believed, it easily has the potential to break the global record. And mind you, the timing couldn't have been any better. Investors seem to be drunk with optimism and would be willing to fall head over heels to accommodate any high profile technology behemoth.

Not that Alibaba wouldn't have succeeded in a less bullish market. For like other technology companies where the profits were yet not trickling in when they went public, Alibaba takes home about half of its sales as income. And with China's economic potential far from being fulfilled, the company does have huge growth highway ahead of it. However at a multiple of 29x its expected FY15 earnings, the stock isn't exactly a bargain especially for the value investor types. No wonder some investors are adopting a wait and watch approach.

While we are on China, we know that the dragon nation's growth engine has slowed down. Gone are the days when 10% growth was taken for granted. Slowdown in exports and decline in manufacturing employment and output has slowed down the dragon nation to a ballpark of 7.5%. But this was pretty much on the cards. An economy which is export oriented is likely to witness a slowdown if global demand pips. As an example, China's export growth slowed down from an average of 29%, witnessed during 2001-2008, to about 10% now. Slowdown in global demand post 2008 financial crisis hurt China's export sector. Another factor which hurt China is declining labor force. The share of working age population is gradually declining in China.

So, the question is with such demographic changes, will China ever be able to embrace 10% growth as seen in the past?

Well, this is a difficult question to answer. For one, there has always been a debate on the authenticity of Chinese figures. Hence, one should not attach too much importance to it. Secondly, China has low retirement age. Hence, by increasing the same it can increase the labor force participation and thus growth. While it can tinker with its labor force to maneuver growth, China's exports need acceleration if it were to reach its peak of 10%. And for that the dragon nation has to depend upon global revival which is not in its hands.

Ever since it was announced, the hike in gas prices has been a hot topic with actual implementation proving to be delusional. And the uncertainty continues to cloud the prospects of not just oil and gas but other key sectors such as power and fertilizers sector as well. The gas business in India is beyond the principles of economics, with pricing way out of tune with demand and supply. No wonder the country has not been able to develop its energy market. The players have hardly got any incentive to put their money.

But a nation with ambitious growth targets cannot afford to ignore energy sector, which is an economy's backbone. And since learnings have been few from own experiences, perhaps it is time to learn from the experience of others'. And what better example to follow than US. Following free market and private ownership model, US has lured investors to develop its energy sector. And the success of this model is too palpable in the form of shale gas revolution. And it's not just the producers, but the consumers that are smiling as well. The healthy competition has ensured enough supply of gas, resulting into affordable prices. Now that it is proved regulated pricing approach has failed, it is time to allow free market mechanism to unfold and change the fortunes of the sector for the better.

The global markets ended on a mixed note for the week gone by. The initial concerns over the likely rate hike in the US weighed heavy on the global markets. However, Fed chairman Janet Yellen kept the interest rates unchanged, leading to a rally in the stock markets globally. The other development that led to global markets breathing a sigh of relief was voters decisively rejecting independence for Scotland. The anti-independence 'No' camp garnered 55% of the votes and led to Scotland's first Minister Mr Alex Salmond resigning. Among the global markets, Japanese and US stocks were the leading gainers for the week. On the other hand majority of Asian markets witnessed selling pressure.

Indian indices had a volatile week with the BSE Sensex up by just 0.1%. On the positive side, Chinese president Xi Jingping visit to India has led to the former promising investments of around US$ 20 bn in the next 5 years in India. On the other hand, the ongoing by-elections, which have not been in BJP's favour so far, had some negative impact on the Indian stock markets.

Performance during the week ended Sep 19th, 2014
Data Source: Yahoo Finance, Kitco

 Weekend investing mantra
"Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid." - Warren Buffett

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1 Responses to "Are companies geared to deal with geopolitical risks?"

Niky Kotian

Sep 20, 2014

Indians have always done well under crissis....they are adept at managing companies under unusual political situations

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