Companies resilient to slowdown... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Companies resilient to slowdown... 

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In this issue:
» Did we hear nationalisation?
» The demise of India's first LCC
» Bankrupt but obsessed with baseball
» Nano: Last hurdle cleared?
» ...and more!

00:00 These could allay your slowdown fears
"Investors' preferences for the biggest and most well known companies stem from concerns about a potential economic slowdown, global unrest and liquidity (the ability to easily buy and sell securities). We find this ironic as we believe that many of the companies most likely to be affected by global unrest are precisely the ones whose share prices are rising the fastest." These were the words of Warren Buffett in one of his letters to the shareholders of Berkshire Hathaway. And the converse of this holds true as well. Companies that have been battered in the recent stock market crash need not be the ones that are the worst hit during an economic slowdown.

As the performance of corporate India in one of the most difficult quarters in the past three years gets unleashed, investors are a worried lot. Their fear as to which of their favourite stocks will be able to withstand a hostile business environment leaves them with little choice but to panic. Our analysis of the financials of 200 (non-banking) companies from the BSE A group, however, tells us what exactly investors need to look for to allay their fears. Most companies in this group are susceptible to two primary risks - financial leverage and significant margin erosion. The latter being due to high proportion of fixed costs, be it capital or labour.

In the event of a prolonged slowdown, these risks could even derail companies with reasonably large balance sheet sizes. However, sectors like FMCG that are well hedged against these risks have no reason to lose value.

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00:45 CRR, CAR and more
In an action that speaks volumes of the liquidity crunch facing the Indian financial system, the RBI yesterday cut the CRR (cash reserve ratio, or proportion of deposits lenders need to set aside as reserves) by a further 100 basis points (1%) to 6.5% with effect from October 11, 2008. This measure is expected to release additional liquidity into the system of around Rs 400 bn. This takes the total cut in the CRR in this week alone to 2.5%. Readers would do well to note that the Indian banking system and corporations (especially in the real estate sector) have been severely starved for liquidity on account of the ongoing crisis in the US and Europe. The RBI's moves have also come in on account of the rupee's continued decline (6.3% in the last one month alone) against the US dollar.

Besides the CRR, the RBI has also decided to fund banks that have their CAR (capital adequacy ratio) below 12%. This would make the banks well capitalised to provide for the risks on their books as well as comply with Basel II. Whether the additional funding would stoke inflationary risks, is however, yet to be seen.

01:15 Did we hear nationalisation?
India may not have escaped the global contagion of strained liquidity. But we certainly have much to cheer about. While central bankers in the European and American continent dole out nearly US$ 250 bn each to save the face of their banking industry and even try to nationalise the same, we can be rest assured that at least we are ahead of the curve.

Ironically, the current global situation has made India's measured pace of economic reform look wiser than before. At a time when Western countries are frantically nationalising banking assets, the Indian government's reluctance to sell more than 49% of its state in public sector banks seems to be a wise judgement.

The PSU banks, which control 70% of Indian banking sector assets not just stand well capitalised but also safeguarded from peril of overexposure to risky assets. In addition, the central bank continued to protect the interest of the domestic banking entities while not offering the foreign players significant stakes in them despite repeated requests. A careful control of foreign borrowings by domestic companies limited the dependence of Indian corporates on the global financial system. Thus, once the dust settles, the resilience of India's financial system may continue to draw investors.

01:53 Weak rupee enhances exports, but makes buyouts expensive
The rupee has depreciated nearly 24% against the US dollar in the past 12 months (6.3% in the last one month alone). While this has burnt a hole in the country's trade deficit, it has also proved to be a saving grace in terms of meeting export targets. This is at a time when international trade is witnessing significant pressure.

India's trade deficit widened to US$ 49 bn in 1QFY09 with oil import costs US$ 17 bn higher over last year. Nevertheless, as per latest data, India exceeded the export target of US$ 160 bn for FY08 by US$ 3 bn achieving an overall growth rate of about 29%. This is despite the appreciation of the rupee in the initial part of the fiscal by nearly 8%, eroding the profit margins of exporters.

Having said that, the weak rupee has made the negotiations for Indian companies wishing to shop abroad more combative. The recent examples of HCL Technologies' purchase of UK-based Axon (by outbidding Infosys) and TCS' acquisition of Citigroup's captive Indian BPO have amply displayed the same. While Indian companies try to make the most of their strong balance sheets by cashing in on the discounted valuations, the rupee seems to be spoiling the party.

02:22 In the meanwhile...
The benchmark indices in key Asian markets are giving stiff competition to their European and American counterparts as each of them shed considerable value since the start of the session today. The Indian benchmark BSE-30 index, which closed lower by 2%, infact emerged as the best in the pack. This could be primarily attributed to the RBI's moves and lower inflation (as measured by WPI) number of 11.44% reported today. Crude prices are hovering at a 13-month low of US$ 75 a barrel. The International Energy Agency (IEA) has cut its forecast for oil demand this year by 240,000 barrels per day and slashed its 2009 forecast by 440,000 barrels per day. The IEA now expects global oil demand to total 86.5 million barrels per day this year and 87.2 million barrels per day next year.

02:35 The demise of India's first LCC
It seems that the 3,000 odd Jet employees who have been sacked are not the only ones who are a harried lot. Captain Gopinath, Vice Chairman of Kingfisher Airlines and who promoted India's first low cost carrier Air Deccan, is believed to be unhappy about the alliance between Jet and Kingfisher. He is contemplating buying back Air Deccan, now rechristened Kingfisher Red. The global meltdown has taken its toll on carriers across the world and Indian airlines too have been caught on the wrong foot. Losses are mounting and the alliance between Jet and Kingfisher is expected to synergise costs with a benefit of around Rs 15 bn a year. However, this tie-up is only expected to increase prices and many are of the view that the prospects for a budget carrier like Air Deccan will be brighter in such a scenario. The fact that global valuations have significantly corrected has been touted as another reason for the buyback. However, the going is not likely to be that easy for Captain Gopinath as Mr. Vijay Mallya, who holds 65% share in Kingfisher, does not intend to relinquish his share. Whatever the case may be, troubles just keep mounting for the beleaguered airline industry.

03:08 Bankrupt but obsessed with baseball
Guess what AIG did a week before its multi billion dollar taxpayer-funded bailout. Spent nearly US$ 440,000 on a beach retreat for its top agents. The lavishness does not seem to have stopped there.

The New York Yankees, a professional baseball team based in New York, is now selling luxury suites in its new 'Yankee Stadium' for an unreasonable price. The suites are on sale for US$ 600,000 to US$ 850,000 (approx. Rs 40 million!) a year, which is exorbitantly higher, compared to what other major league teams charge for their luxury boxes. And guess who's buying? The same banks and financial institutions that are supposedly reeling under a severe 'liquidity crunch'. One of them is Bank of America. The justification for its action to spend so extravagantly makes all these seem even more ridiculous. The bank spokesman Joseph Goode has been quoted saying that the value BoA wrings out of its suite - in terms of entertaining clients and rewarding top-performing employees - 'is multiples more than the initial investment.' Unbelievable? Believe it!

03:30 Gone are the days of 'golden parachute'
If you had asked any MBA aspirant in the past six years, 'Why go through the B-school grind?" the most likely response would have been, "I want to study finance. There's lots of money there". Most eyed the hefty bonuses and the golden parachutes (severance pays). Clearly, stories of the mega bucks for the honchos of Wall Street and Dalal Street had trickled down to the young. That is set to reverse now.

As per the Wall Street Journal, the US government's investment in financial institutions will affect executive pay. The US Treasury has recently reduced tax deductions on large salaries. Executives will also have to pay up for bad risks. The stock market itself has come down heavily on them. A large portion of their pay came in the form of stock options. With the stock price s tanking, the options have lost much of their value. All of this will affect the inflow of talent to Wall Street.

Indian stock markets have followed in lock step with their global counterparts. With the stock prices of most financial intermediaries taking a severe beating, executive pay on Dalal Street will also be reset to a more reasonable level. In fact, news is already seeping in that the industry is witnessing a shake out.

04:05 Nano: Last hurdle cleared?
Looks like the Tatas will finally get a chance to focus on what they do best, manufacturing automobiles. In this case, the Nano. This is because the last impediment in the successful launch of the project also seems to have been cleared. The state cabinet has fixed the cost of the 1,100 acres of land allotted for the Nano project at Rs 900 per square meter. This translates into a little more than Rs 4 bn for the entire 1,100 acres and more importantly, it is believed to be slightly higher than the prevailing market price. Although not as big as the Singur flare up, land cost had become a bone of contention between the ruling party and the opposition in Gujarat with the latter alleging that the government has offered the land meant for farming to Tatas at a substantial discount. With that speculation now being put to rest, the company management can heave some sigh of relief. Ironically, the localites were very happy to offer the land to the Tatas as during the great Indian famine of 1899-1900, Jamshedji Tata had donated Rs 1,000 for the well being of animals.

The company will, however, have to shell out a lot more for the land when compared to what the West Bengal government was offering. But it looks like what the Gujarat government has taken from one hand will be returned from the other. In other words, expect the government to give some big concessions for the project.

04:25 Move aside MNC and private sector executives...
With employees of MNC and private sector enterprises no longer being lucrative enough, the government employees have suddenly emerged as a preferred lot of customers for car manufacturers in the country. Courtesy the Sixth Pay Commission arrears, which will see the disbursement of revised salaries to central government employees. Eyeing around Rs 200 bn of liquidity that would be e infused in the system through 32 months' salary arrears for 5.5 m central government employees, several car manufacturers have come up with marketing plans to woo this section of customers. Maruti Suzuki, the country's largest passenger car manufacturer, is running a marketing campaign under which company's institutional sales officers will work with dealers in state capitals to reach out to the government employees. These companies have also tied up with several banks to offer finance options to the government employeyees for their vehicle purchase, at a time when most banks are shying away from vehicle loans.

This move is seen as a smart draw by automobile manufacturers that have witnessed a slump in exports as well as domestic sales in recent months due to lower disposable incomes and high interest rates, which has lead to building up of inventory. Seems like they have a solution at hand.

04:55 Today's investing mantra
"Markets can remain irrational longer than you can remain solvent" - John Maynard Keynes
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