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Mr Tata: 'Man of Steel' or Soft Touch?

Dec 12, 2016

In this issue:
» Crude oil prices up 35% in 5 months. What next?
» Will demonetisation root out corruption from the real estate sector?
» Market roundup
» ...and more!
Richa Agarwal, Research analyst

India's epic boardroom battle at Tata is gaining intensity with every passing day. Since Mistry's ouster, there has been lot of mudslinging. And the country's most trusted group's sheen has faded.

But recently, the newspapers had something positive to write about Mr Tata. He's been hailed as the saviour of the UK Steel industry.

You see, last week, the Tata Group announced a ten-year commitment of one billion pounds to save thousands of jobs at its steelworks in the UK. In doing so, Mr Tata reinforced the group's philosophy: 'In a free enterprise, the community is not just another stakeholder in business, but is in fact the very purpose of its existence.'

This is in stark contrast to the 'selfish capitalist' image of other Indian corporates as they lay off thousands in a day. The bleeding hearts among us may appreciate the group's benevolence. But how should minority shareholders see this decision?

Here is some context.

Around the same time Mr Tata was crowned 'Man of Steel', we received a letter from him. It was addressed to the shareholders of TCS and sought support for the removal of Mr Cyrus Mistry.

This was amid allegations from Mr Mistry that Tata Steel's UK operations are earning negative returns and pose a risk to the whole group.

As if to address these concerns and to justify the ten-year commitment, the letter said:

  • We exit the business only when we believe it is unviable. In every situation, our capital allocation decisions are always based on maximizing long-term shareholder returns, viz. return on capital employed, return on equity and free cash flows. So, there has always been, and will continue to be, a strong alignment of interests between us and the minority shareholders.

This begs some serious questions...

How long should the 'long term' be when throwing good money after bad? Is this a bet on Mr Tata's ability to turnaround? Or some loss aversion bias? Or is Mr Tata a victim to sunk cost fallacy? And shouldn't viability be a parameter to enter the business...and not just an afterthought when business decisions go wrong?

As you can see in the chart, Tata Steel's UK operations, and a lot of other projects, offer little to support the group's claim regarding the interests of minority shareholders.

Tata Group: Some Losing Propositions

How would you as a minority shareholder react to this?

We will speak only from an investing standpoint. Do not be blinded by the halo the media wants to put around leading corporates with social causes. The real reflection of an efficient and competent management is cash flows and returns.

Unfortunately, inexperienced investors often forget to price in the inefficiencies when valuing these big companies. And they end up overpaying for the visible 'brand' and the management.

For us, corporate governance is non-negotiable. But the management's good intentions cannot overshadow skilful execution and disciplined capital allocation. That's why management interaction is mandatory for every small-cap stock we recommend.

If the management does not walk the talk, the company does not make the cut.

Junior Bluechips not only make the cut...these are our highest-conviction small-cap picks. Furthermore, we believe the managements of these small companies could offer their large-cap peers some serious lessons in capital allocation and execution.

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Amid the demonetisation saga, there's another important development that India needs to be concerned about: the rise in crude oil prices. Crude oil prices, which stood at around half the price of a bottled water during the start of this year, are showing signs of turnaround.

Crude oil prices have increased by about 35% in just five months. From trading near US$40 per barrel in August 2016, they're now up to almost US$ 55 per barrel. But the story doesn't end here. Going by the recent developments, crude oil prices could firm up in the near term.

What are the triggers? First is the Organisation of Petroleum Exporting Countries (OPEC) deciding to reduce production by 1.2 million barrels per day starting January 2017. Second is the non-OPEC producers recently agreeing to reduce output by 5,58,000 barrels per day.

The above agreements are made in order to ease the global supply glut and bring in a revival in crude oil prices. If that happens, India will be at the losing end in the settlement.

Ever since June 2014, the Modi government has received a huge tailwind from falling crude prices. The crash in crude oil prices helped the government keep the fiscal deficit and inflation level in check. Also, the government captured most of the gain by raising excise duties on petroleum products multiple times. The petroleum subsidy fell from Rs 969 billion in 2012-2013 to Rs 300 billion in 2015-2016.

With the rise in crude oil prices, the above trend could be reversing. Higher prices would mean a rise in the current account deficit and inflation levels. The situation has also been highlighted by the Reserve Bank of India (RBI). In its monetary policy statement last week, the RBI stated that crude oil prices may firm up in the coming months and could be a risk to the year-end inflation target.

So while India's oil-producing companies may benefit from this development, the economy as a whole could witness some bumps in the ride ahead. As my colleague Kunal Thanvi wrote in one of the recent editions of The 5 Minute WrapUp...

  • We think prices at petrol pumps could rise. This will have a pass through effect on inflation. When consumer spending normalises post demonetisation, we should all be on our guard for rising inflation.

Speaking of demonetisation, the move has indeed been a big shocker for the real estate sector. It's one of the biggest losers of the demonetisation drive. The reason: Business here has for long had one of the highest proportions of black money involved.

In the 25th November issue of The 5 Minute WrapUp, we explained how demonetisation could trigger a subprime crisis in India.

  • Unlike stocks, with real estate, there is no concept of intrinsic value. The lack of clarity on 'intrinsic value' amid the cash crunch could lead to a long down cycle.

    If that happens, related sectors won't be spared.

    We already have 60% of the banks burdened with non-performing loans that are at historic highs. The banks and NBFCs may claim that their loan to value ratios are within limits. But most of them are over exposed to the realty sector thanks to the system of dual financing. With sector already reeling under the bad debt crisis, this could be the proverbial last straw to break the camel's back.

    In fact, the banking and real estate sector crisis could lead to a domino effect that topples other sectors...and ultimately, the economy.

    Layoffs, wage cuts, project delays, bad debts, a consumption slowdown...prepare for a long, vicious cycle. Our worst fears may yet come true.

    If this sounds farfetched, remember that it was a house price correction that led to the subprime crisis in the US that still haunts the global economy. While mortgage-backed securities may be less severe in India, black money has created a similar bubble in housing prices.

So, there is no denying that the months ahead could be times of chaos and uncertainty for the real estate sector. Furthermore, demonetisation alone cannot weed out the corruption in the real estate sector.

As an article in Firstpost states, demonetisation by itself is powerless to arrest the corruption that grips the sector, and keeping it flowing with black money.

One way to weed out the corruption here is to make processes such as stamp duty and permission clearances more time-bound. Another way is to bring in more transparency at the ground level transactions. A transparent approach backed by regulatory implications could wipe out the bribery and black money transactions in the sector. Unless the underlying sources of corruption are targeted, the real estate will remain mired in corruption.

That said, the correction in prices of real estate stocks could also offer some bargain buying opportunities for investors. In fact, Rohan Pinto and his ValuePro team just recommended a stock from the real estate sector. And considering how different this company and its management are from typical real estate businesses, I am pretty confident of their long-term vision. The team believes even Buffett would consider buying this stock.


In the meanwhile, the Indian indices have extended their downtrend during the noon trading session tracking mixed cues from global peers. Sectoral indices are trading on a mixed note with auto and FMCG stocks leading the losses, while metal and PSU stocks are in demand.

The BSE Sensex is trading lower by 135 points while the NSE Nifty is trading lower by 53 points. The BSE Mid Cap index is trading down by 0.7% while BSE Small Cap index is trading down by 0.2%.

04:50 Investing mantra

"When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst) and Ankit Shah (Research Analyst).

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1 Responses to "Mr Tata: 'Man of Steel' or Soft Touch?"


Dec 12, 2016

we have seen in the past that M/s TATA had layoff employees to meet the crisis. In late 90's several employees were shown the door as early seperation scheme.At beginning of this century steel sector come to good cycle we call it china effect L.N.Mittal was acquiring various steel co's
hence to avoide such situation TATA sons acquired steel company in europe which was not a profitable bussiness just to increase their size so that Mittal steel should not thinks to acquire tata steel.Where was the humanity touch while shoeing the doors to Indian employees.


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