»5 Minute Wrap Up by Equitymaster

On This Day - 13 NOVEMBER 2015
The Threat to 'Make in India' that Nobody Wants to Talk About

In this issue:
» Should investors make most of the sharp decline in stocks of pharma majors?
» Share pledging on the rise
» ...and more!

A few months ago, my colleague Ankit wrote about automation and robotics. We are concerned about this trend. Not because we're against it. We are strongly in favour of manufacturing firms improving productivity in this way. Clearly, robots are the way to go.

But what about the labour force? About 13 million people enter the work force every year in India. Most of them do not find jobs in the formal sector. Most of those who do, find jobs in India's vast services sector.

This is problematic. Compared to manufacturing, services don't provide as much of a boost to income levels in a country that's moving away from agriculture. We have known this fact for long. And this is what concerns us.

The UPA government's attempts to boost India's manufacturing sector did not yield positive results. The Modi government came to power with a promise to solve this problem. The proposed solution: 'Make in India'.

Over the last one and a half years, many MNCs (General Motors and Foxconn in particular) have decided to set up shop in India under the 'Make in India' banner. They have committed to invest large amounts of money. Some of it has already begun to flow in.

Does this mean that India's on the cusp of a manufacturing boom? Unfortunately, this story is not so simple. The global trend towards automation and robotics is very real. And make no mistake; it will impact India as well.

Think of it this way. If a global manufacturing firm sets up a big plant in India, which of the following two options will they choose? Will it employ a large number of people in that plant or will they use robots? There is good reason to believe they would choose the latter.

Recently, McKinsey Global Institute and Bank of America have released detailed reports on this topic. Their findings are grave. McKinsey believes that most people involved in high-wage high skill jobs (in manufacturing as well as services) perform many redundant activities. These tasks are ripe for automation. If employees don't adapt, they could become redundant.

Bank of America goes even further. It believes robots could take away up to 45% of all manufacturing jobs within a decade! Even worse, this would add up to a stunning US$ 9 trillion in 'savings' in labour costs. Just think about that for a minute. Employees around the world will never get their hands on that money.

The demand for automation is rising rapidly in India too. It has already begun in the software sector. India's large IT firms are no longer hiring employees the way they were five years ago. Nothing will stop India's manufacturing sector from getting in to the act as well. In our travels, we have already seen this trend in many manufacturing plants.

The costs of robots fall every year. At the same time, their complexity is on the rise. It won't be long before cheap robots will be catering to the needs of a wide range of manufacturing firms. Bank of America thinks the auto sector has already crossed this threshold.

We believe this will prove to be major challenge to the government. Will 'Make in India' be successful if a large number of people remain unemployed despite a manufacturing revolution? There are no easy answers to this question. It makes people very uncomfortable. But we believe it is high time that everyone starts thinking along these lines. India's demographic dividend is at stake.

What do you think? Will 'Make in India' create an employment revolution along with a manufacturing revolution? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day

  • Sun Pharmaceuticals has declined by 16% in the past two weeks. It now trades at its 52-week low price.
  • Dr Reddy's declines by more than 21% in in the past two weeks.
Its not very often that you get to hear such type of news. After all, they are related to amongst the biggest and best run companies in India. And that too in a sector that has enormous growth potential. And such sharp price corrections are enough to grab the attention of long term investors.As it turns out, the strict norms of the US Food and Drug Administration (FDA) has not even spared the Indian healthcare majors. Today's chart of the day indicates the price movement in the top five stocks (by market capitalization) forming part of the BSE-Healthcare index.
Sharp correction in pharma majors - A buying opportunity?

Trying to get a better understanding of how bad the situation really is, I sent a mail to my colleague (who tracks the healthcare sector) to get her views on the sharp correction in these stocks; and whether the problems are temporary in nature.

This is what she had to say:

    "The big pharma companies are believed to be the cream of the Indian Pharma sector. These companies have witnessed sharp growth in the past. While they continue to develop niche molecules and have quite a lucrative portfolio to launch in the coming years, the regulatory challenges have become one of the biggest risks for their growth.

    The regulatory landscape in the pharma space is increasingly becoming stringent. Most of the pharma companies in India have received negative observations from the USFDA regulators across their manufacturing facilities. What's more, if the regulator believes the compliance issues to be more serious, stricter steps could be taken. We have already seen this happening in the case of Dr Reddy's - the company received a warning letter on its three facilities. In the case of Sun, an OAI (Official action indicated) was issued.

    Since the regulatory consequences are very difficult to predict in such cases, the biggest risk is, the time taken to clear the issues. Therefore, investors should take a call on case to case basis, rather than just buying the beaten down ones. One should keep in mind some factors like revenues and profits contributed by such facilities, management's past track record to deal with such events, whether there are any other back up facilities.While most of the big pharma companies have quite a comfortable debt position, one should however, avoid those companies which have high leverage as well as those undergoing compliance issues. And most importantly, one should limit exposure to such stocks."

Share pledging in India is on a rise. The Economic Times, referring to a report by Ambit Capital, has reported that overall share pledging has increased to 4.5% in September 2015, from 4% a year ago, for companies forming part of the BSE-200 index.

Cash strapped companies have seen this data point worsen significantly over the past quarter. For instance, companies such as Jindal Steel, Reliance Power and Dish TV have more than 20% of their shares pledged (as a percentage of total holding) as of September 2015. As research done by the business daily indicates, this data point rose by 7.5% to almost 10% for these companies on a quarter on quarter basis.

Share pledging is not an illegal activity per se. However, we recommend investors keep an eye out for such data points, especially whose managements are questionable. In fact, we give a high weightage to this data point in our internal scoring system - Equitymaster Risk Matrix - which we display in our recommendation reports. A high promoter pledging makes a stock score poorly on our matrix.

There are a bunch of stocks from the commodity space that seem long term value buys at the moment given that their stock prices are trading considerably below their respective book values. However, it would only make sense for investors to make sure that such checkmarks are well looked into before making buying decisions. Not matter how attractive the stock may be, we would suggest investors to keep away from situations where the debt overhang situation become difficult to assess. It would be better to be safe than sorry as over leveraged firms with high percentage of pledged shares could very well be a value traps.

Indian markets were trading below the dotted line at the time of writing with the BSE-Sensex trading lower by about 220 points or 0.8%. Weakness was seen in stocks from the mid and small cap space as the respective indices were trading down by 1.4% and 0.8% respectively. Stocks from the information technology, auto and capital goods spaces were least favoured today

 Today's investing mantra
"There are two kinds of businesses: The first earns 12%, and you can take it out at the end of the year. The second earns 12%, but all the excess cash must be reinvested - there's never any cash. It reminds me of the guy who looks at all of his equipment and says, 'There's all of my profit.' We hate that kind of business." - Charlie Munger

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