Ranbaxy. Sun Pharma. Who next?

Nov 5, 2008

In this issue:
» Of price and book values
» US gets a new President
» The FD fetish
» To lend or not to lend
» ...and more!!

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 Playing by the Book
That stocks on Dalal Street have been beaten and hammered out of shape is probably old news. But allow us to put some numbers to it. As per an analysis on most actively traded stocks (1,600 to be precise) published in a leading business daily, around 55% of the stocks are currently being valued by the stock market below their book value! What this essentially means is that if one buys into the complete equity of these companies and sells the assets in the open market, one could take home a pretty handsome profit. The study further reveals that the discount to book value increases as the market cap decreases. In other words, there are quite a few mid cap and small cap firms that are trading at a steep discount to their book value.

While the current opportunity to buy into stocks with attractive growth prospects is indeed once in a lifetime, we would like to add that book value could be a misrepresentation of the true value of the company in quite a few cases. For example in companies with technologically obsolete plants, actual book value could turn out to be a lot less than what the balance sheet might imply. In other cases where companies have a lot of real estate bought many years ago, book value could turn out to be a lot more understated. Similar study needs to be conducted on other assets like inventory and receivables. Thus, while investing in a company based on book value, don't just go by the book.

 Democrat Obama is the new US President
The citizens of the most powerful nation on earth have settled a debate on the most turbulent political battle in recent times. After eight long years, a Democrat will finally step into the White House. Barack Obama will take over from George Bush and will become the 44th US President, the first ever African-American to do so. Although the US Presidential elections are one of the most watched global events, the intensity had increased manifold this time around as it coincided with a financial crisis of epic proportions.

Just to put things in perspective, a survey by the International Herald Tribune (IHT) revealed that 6 out of every 10 voters cited the economy as the most important issue during the elections with things like the Iraq war and health care being put firmly on the back burner.

As far as its impact on India is concerned, many experts are of the opinion that irrespective of who moves into the White House, Indo-US relations are only likely to strengthen given the global geo-political climate and economic power shift that is currently underway.

 Few takers for 'Incredible India'
When people start tightening their purse strings, they cut back hugely on discretionary expenses. And what else could be more discretionary than tourism. Despite the rupee shedding one fifth of its value in recent times, slowdown in developed economies has started taking its toll on the Indian tourism industry. Furthermore, terrorism related fear, especially in the after math of the terrorist bombings in big cities recently are also not helping matters. As per a leading business daily, travel firms and hotels in India are expecting businesses to drop 10-20% in the travel season that started in October.

In fact, sensing the trend of negative new bookings especially for leisure travel, most of the companies engaged in such activities have already started tightening their belts. Although these companies are looking at new markets to offset decline from the Europe and US, the overall growth might still be negative. Whoever thought India is immune to global economic slowdown, try asking these companies.

 Another one clashes with the USFDA
Indian pharmaceutical companies have been bogged by a plethora of problems these last four months notably forex losses on foreign currency loans, rise in raw material costs as imports from China became expensive and an unwelcome collision with the USFDA in matters pertaining to corporate governance. But while the former two issues are beyond the control of companies, the latter problem is certainly of their own making. First it was Ranbaxy that paid a heavy price for not meeting the quality standards of the US FDA. Now the latest victim that has drawn the ire of the US FDA is the US based Caraco, the 76% subsidiary of domestic major Sun Pharma. Of course, Caraco has not yet been strictly dealt with as Ranbaxy but the issuance of this warning letter in as many months to another domestic company is worrisome.

Indian pharma companies have made considerable strides in the global generics markets in the past few years and have the distinction of having the highest number of US FDA approved plants outside of the US. While this is noteworthy, somewhere along the way quality has been compromised and unless these issues are resolved quickly and satisfactorily, Indian drug majors could find their reputation in tatters in the future.

 FDs are back in vogue
As cash continues to elude companies, they are now turning to newer and innovative ways to get cash from retail investors. As per a leading business daily, about 37 companies have launched 'corporate fixed deposit schemes' since May of this year. These companies, for their working capital needs, are said to have been offering returns in the range of 11% to 12.5%. This is a higher rate then the 10% to 10.5% returns offered by commercial bank fixed deposits (FDs).

Corporate FDs work in the same way as conventional bank FDs, only difference being that you would be giving your money to a company instead of a bank. Thus a thorough check on the credit ratings and fundamentals of the companies borrowing money is vital to prevent any defaults.

Ansal Housing & Construction, JK Industries, Jagatjit Industries, Jaiprakash Associates, Hudco and Jindal Steel are said to be some of the companies offering interest rates of 0.50% to 1% over bank deposit rates.

 The FDI cheer
All is not bad on the capital availability front. FDI (foreign direct investment) inflows into India for the first six months of the current fiscal have grown by a whopping 137% over the previous year, reinforcing investor's faith in India as one of the most attractive asset classes globally. In absolute terms, the inflows amounted to US$ 17.2 bn as against US$ 7.3 bn recorded during the same period last year.

Construction, housing and real estate and IT were the sectors that attracted the highest inflows for the first four months of the current year. Apart from boosting the confidence of officials especially against the backdrop of a turbulent environment globally, the inflows are also likely to inject that much needed liquidity into the Indian markets. And unlike portfolio inflows, they are unlikely to be taken out any time soon.

 In the meanwhile...
Concerted action by the central banks to prop up money supply and a refreshing change of guard at the White House combined together to send most Asian markets higher in the trading session today. The Indian benchmark BSE-30 index however chose to buck the trend and experienced significant weakness, closing the day with losses of over 5%.

Selling in the Indian markets seems to have been a result of profit booking, especially after a few back-to-back strong sessions. Most European markets are also trading in the red currently. Crude oil also had an off day today as it slid below US$ 68 per barrel in Asia as a global economic slowdown issue once again took centrestage. Gold also met with a similar fate with spot prices falling nearly 1%.

 It is all in the culture
In his 1999 book, "The Lexus and the Olive Tree" Thomas Friedman indicated that the world continues to undergo two struggles - the drive for prosperity and development, symbolised by the Lexus, and the desire to retain identity and traditions, symbolised by the olive tree. Interestingly, this realisation came to him while he was eating a sushi box lunch on a Japanese bullet train after visiting a Lexus factory and reading an article about conflict in the Middle East.

This conflict continues to play out in the modern day world - the world of today facing one of its worst economic and financial crises in decades. And this divide is mostly visible in the way companies in Asia are trying to retain their tradition of preserving jobs while continuing to face difficult times. As against the Western world's actions of firing staff, companies in Asia are resorting to pay cuts while protecting the jobs of their employees.

As against the motive of individual survival that is so predominant in the West, the East shares a sense of collective responsibility. While this might be bad sense in troubled times like these, it might make times easier for Asian firms in their recovery as there will be a lesser need to rehire or train new staff.

 The GDP growth dilemma
It is not just salaries that are being cut. As per India's chief statistician, a surprise fall in industrial production growth rate during the month of July and August is likely to lower India's growth rate to 7% as against the earlier expected 7.7%. However, if the country wishes to still achieve the projected growth rate then the economic expansion needs to be really sizeable in the latter two quarters of the year, a possibility that cannot be denied according to other experts.

As per them, agriculture growth is likely to be robust in the second half and with private consumption also not tapering off, growth in the region of 7.7% for the full year is still achievable. Surely, there seems to be no consensus in sight, except for the fact that the GDP will not outdo last year's robust growth rate.

Note: * Projected

 Lower short-term rates fail to encourage lending
Government bailouts totaling about US$ 3 trillion, interest- rate cuts around the world and unprecedented cash injections by central banks drove money-market rates lower in the past month. However, even all of this was not sufficient to encourage financial institutions to lend.

While nearly 85% of banks in the US tightened lending standards on loans to large and mid-size companies in the past three months, Indian banks went shy on retail and mid corporate loans. Global banks, which are still in the stage of re-evaluating the interest rates for covering the incremental risk in the changed scenario, are unwilling to pass on the rate cuts to the consumers.

However, on the Indian shores, the Finance Minister's successful arm twisting of the government held banks may force the latter to compromise on their business interests (in terms of margins and NPAs) to yield to the government's demands.

 Today's investing mantra
"For years the traditional wisdom - long on tradition, short on wisdom - held that inflation protection was best provided by businesses laden with natural resources, plants and machinery, or other tangible assets. It doesn't work that way. Asset-heavy businesses generally earn low rates of return - rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses." - Warren Buffett

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