Shahrukh Khan to the rescue - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Shahrukh Khan to the rescue 

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In this issue:
Hedge funds lose US$ 64 bn of assets
Indian Hotels gets Rs 250 m of insurance claim
Kishore Biyani seeks to challenge FMCG majors
IIP growth down to 15-year low
...and more!

Well, if you were thinking that Shahrukh Khan was going to rescue the stock markets, we are sorry to disappoint you. This rescue is about emotions as against numbers. The deplorable terror attacks have instilled fear in our minds. We are going out to restaurants and to movie theaters less often. In fact we are told that the restaurant business, at least in Mumbai, has see a decline of anywhere between 20% and 40%.

Movie theaters are crying out for an audience... the other day on the radio, a film critic who was reviewing the latest three releases mentioned that all the theaters he visited were more or less empty! But this may be about to change. This year's biggest film release hit the screens today. And with Shahrukh Khan in the lead, it is sure to tempt people into the theatres. Maybe that will just help in kicking off the fear. And we hope so. Go on Shahrukh, deliver the biggest hit of the year!

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The letter to shareholders written by the chairman of a leading engineering company in its FY08 annual report has an intriguing sentence. It goes like this - "...we have been able to maintain ROCE at 20.6%, and grow our EVA by over 51% to Rs. 834 crore. I am, therefore, pleased to propose issue of 1:1 bonus shares, subject to your approval." This rhetoric seems void of any substance.

The underlying tone is such that it seems to be attempting to create an impression on an investor of the company that - 'Dear investor, your company is doing so well that we as the management of the company have decided to reward you. We shall do that by giving you bonus shares!'

But how exactly does this 'reward' work out for the investor? Instead of one share he will now have two, with the combined value of the two shares equal to the value of the one share he owned initially. So we wonder why is a person in such a responsible position trying to induce excitement by making a bonus sound like something more than a stock split?

The RBI governor Dr. Subbarao in a recent speech on the global credit contagion explained the relation between the crisis and the globalisation of trade and labour. In a very interesting remark in his speech, the governor called the 'NICE' era as the prime culprit for the global recession. Ironically, the 'NICE' era - a term coined by Mervyn King, governor of Bank of England - referred to the period of greed across global economies that ultimately led to the creation of several asset bubbles.

First, there was the globalisation of labour. Emerging Asia added nearly three billion to the world pool of labour as it integrated the world through the 1990s. What this did was to reduce production costs at the aggregate level and increase Asia's comparative advantage. While the Asian economies (particularly China and to an extent India) piled up trade surpluses, these were mirrored by current account deficits in the US. The resulting imbalances that generated easy liquidity and low interest rates encouraged under-pricing of risk and deterioration in credit quality. Thus the 'non-inflationary consistently expansionary' (NICE) era fooled market participants into believing that the benign economic conditions were here to stay while the underlying value of assets kept getting eroded. Yet another instance of market punishing the ones enamored by greed.

The failure of the US automobile industry bailout plan has dealt a severe blow to the fortunes of the Big Three auto companies in the US - GM, Ford and Chrysler, who were looking for the bailout plan to pass to help them survive. "Millions of Americans, not only the autoworkers, but people who sell cars, car dealerships, people who work on cars, are going to be directly impacted. It's going to be a very, very bad Christmas for a lot of people," writes CNN. The industry that defined the US industrial strength is now facing a bleak future, with the Big Three staring at bankruptcy. The failure of the bailout plan is also expected to lead to a surge in US unemployment, which is already at its highest in fifteen years.

Atleast some degree of promptness is being seen to come to with the recent terror attacks in Mumbai. Within two weeks of the attacks, the insurance industry has started disbursing the claims made by Indian Hotels against its terrorism insurance cover. The Indian Terrorism Insurance Pool released the first payment of Rs 250 m for the claims arising on the iconic Taj Hotel in Mumbai. Though the final assessment of the claims is yet to be done, considering the huge damage caused, the first payment would be a small percent of the total claim. Both the Taj and the Oberoi Group have a sum insured of around Rs 10 bn. A quick redemption of the claims would aid the companies to accelerate the restoration project and reduce the loss of revenue.

Meanwhile, another major hospitality player in India, ITC, is looking at acquiring hotels at attractive valuations after recent corrections. The company is open to purchasing new properties from the cash strapped realtors as well as existing properties in the three to seven star spaces. The hotel segment currently contributes around 5% to 6% to ITC's revenues. With World Travel Organisation expecting Indian tourism demand to grow at 8.8% (CAGR) over the next ten years (from 2005-2015) , this move would benefit ITC in the longer run as the long term prospects of the Indian hotel and tourist industry continue to remain strong. Further, the company would also benefit from de-risking from the uncertainties in the tobacco business.

Ranbaxy's ordeal just got bigger. As if getting an import ban on 30 of its products in the US market is not enough, IMS data has revealed that the company has lost 45% of prescription in the US market. This is a huge blow to the company given that US is a major market and contributes around 23% to its revenues. Readers would do well to recollect that the US FDA (Food & Drug Authority) had issued a warning letter to Ranbaxy with respect to two of its manufacturing plants at Dewas and Poanta Sahib, as they failed to meet the quality standards.

The management's reiteration that the US FDA has issues with the process and now with the quality of products as such, does not seem to have done much to revitalize its sagging sales from this market. Meanwhile, there seems to be no signs of a quick resolution of this issue yet in the near future. The silver lining is that Ranbaxy has been increasingly focusing on the emerging markets where generics are branded consequently earning higher revenues and profits to reduce dependence on the US although the latter continues to be an important market. The problem is that any negative action from the US FDA could pose problems for Ranbaxy in other markets too. Certainly, the country's largest company by sales, is not in an enviable position right now.

For many of us who are only aware of the brutally capitalistic side of US Inc., this is something that may also let us appreciate the human side of some of its members. There have been a few big companies in the US like Nucor and Lincoln Electric that have a long history of not laying off even a single staff member under the garb of cost cutting. While the stance is indeed welcome, the severity of the current crisis, which many believe is next only to the depression of the 1930s may present before these companies one of their sternest tests ever. So, have they passed the test? It has been a case of so far so good.

Remaining firm in the face of enormous pressure on revenues, they have started adopting other measures like redeploying people to other areas, conducting training sessions or classes and even asking staff to go on extended holidays. Employees are willing to make even more sacrifices if it means keeping their jobs. Some companies opine that besides resulting in some meaningful cost cutting, these policies are also going a long way in making their employees more loyal and hard working. We hope other organisations are listening.

Meanwhile, as margins in the retailing business get thinner by the day, it is time for retailing companies to arm twist the FMCG majors. And taking the lead in this cause is the owner of one of the largest retailing companies in the country. Mr. Kishore Biyani, is seeking support from rival retailers to challenge the might of Hindustan Unilever, Cadbury, Britannia and other confectionary, food and fast moving consumer goods (FMCG) companies to bargain for higher margins. The founder of Big Bazaar, Pantaloon and other chains of retail stores (under Future Group) across the country thinks that if retailers collaborate they could collectively bargain for a better price that will help sustain profitability in the slowdown.

Sourcing, including back-end operations and supply chain management, is an important part of the retail business that provides retailers scope to save on cash by pooling purchases or collectively bargaining with the FMCG companies. According to Mr. Biyani, some retailers account for about 3% to 6% of an FMCG company's turnover and collectively their purchases could rise to as much as 10%, giving them a higher bargaining power.

The ongoing credit crisis is changing the financial habits of the average American in a profound manner. As per CNN Money, obtaining debt has become difficult even for eligible borrowers. With interest rates shooting up, it has also become expensive. Homes of a more than a million Americans have been foreclosed, shifting the debt away from homeowners. The result: US household debt has fallen for the first time ever.

Moreover, Americans are saving more and spending. With massive job cuts all around them, Americans have less to spend. But 70% of the US GDP is made up by consumer spending. That means, ironically, lower spending is aggravating the unemployment scenario.

That's not all. Tumbling housing and stock market prices are taking a huge toll on the average American's net worth. In fact, his wealth has witnessed the largest decline in 57 years. This doesn't help spending either. When home prices soar, investors rely on their newly created wealth and forgo savings. It's the exact opposite now.

The 5 Minute WrapUp:Consumer Leverage The 5 Minute WrapUp:Net Worth in Decline
Image source: CNN Money

Politicians are after all...politicians, wherever they are! On November 4, when the US citizens chose Democratic Senator Barack Obama as their future president, the Governor of Illinois - Mr. Blagojevich had the responsibility of selecting a successor to Mr. Obama. The federal investigators have now alleged that the governor tried to 'sell' the seat in return for political and financial gain. The agency also revealed that Mr. Blagojevich's campaign fund faced more than US$ 500,000 in legal bills from the federal inquiry and that he owed more than US$ 900,000 on homes in Chicago and Washington DC. According to the New York Times, the government affidavit has records of Mr. Blagojevich complaining that he needed to earn much more than his US$ 177,000 a-year governor's salary and also weighed the option of appointing himself to the Senate seat, to reap even better opportunities.

As global markets continued to remain under the gloom of the failure of auto bailout in the US, the Indian markets managed to breach the dotted line in the latter half of the session and close marginally higher. This was despite the fact that the IIP data (index of industrial production) released today were rather disappointing and markets across Asia closed lower. The industrial output has declined for the first time in fifteen years. That's when an average stock analyst was half his/her age! Well, the output has declined by 0.4% YoY during the month as against a 12.2% growth recorded in October 2007. A large part of this decline can be attributed to the 12% YoY dip in the country's exports. The European markets have also opened lower today.

"A pin lies in wait for every bubble and when the two eventually meet, a new wave of investors learns some very old lessons." - Warren Buffett. This time, it was the turn of a tribe whose members call themselves hedge fund managers. As per Bloomberg, the global hedge-fund industry lost US$ 64 bn of assets in November 2008. The market decline contributed to US$ 18 bn in net losses, while investor redemptions accounted for the remaining US$ 46 bn.

The hedge fund assets, which had peaked at US$ 1.9 trillion in June 2008, lost most of the corpus due to distress selling and the rollback of debt-funded investments over the past two months. While the global economic crisis continues to erode funds, investors in the poorly 'hedged' funds seem to have more to lose as the largest economies in the world such as US, Europe and Japan fall into simultaneous recessions for the first time ever since the Great Depression.

04:52 Today's investing mantra
"Value stocks are about as exciting as watching grass grow. But have you ever noticed just how much your grass grows in a week?" - Christopher Browne
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