RBI helps mitigate subprime

The private sector banking stocks have taken a beating post rumours of sub prime exposure of Indian banks. The issue came to the forefront in the parliament where it was announced that ICICI bank had suffered marked to market losses on credit derivatives.The stock has fallen 40-50% from its all time high and the negative outlook on banking stocks continues to persist among investors and analysts alike. However the situation cannot worsen from here on given the stringent norms RBI had in place for overseas portfolio investments by Indian corporates. RBI's regulatory forbearance in the banking and financial services sector through a cautioned liberalisation process and a calibrated removal of capital controls has really paid rich dividends for the Indian economy in the wake of the ongoing sub prime crisis globally. RBI's stringent norms on issuing fresh licences to open banking branches abroad and its norms on capital controls exercised through the FEMA act has insulated India from the subprime contagion. The mint street giant deserves all the praise from the Indian public at large for its persistence in what were until recently, in the wake of globalisation, termed "retrogade policies" by various economists. Their cat calls have collapsed along with various investment banks and hedge funds in the aftermath of the global credit crisis. Kudos to RBI for its appreciable act of monetary management.

Inflation heats up the economy

The wholesale price index rose 6.68% in the week ended 15 March 2008, surging from the previous week's rise of 5.92%. The rate is highest since 27 January 2007, when inflation was 6.69%.The week-on-week rise in inflation was seen across all major heads of the WPI with primary articles seeing the maximum rise of 233 basis points.Inflation in primary articles have gone up by 376 basis points within a span of just six weeks. Inflation in the fuel group has spiked by 100 basis points in just a week's time taking cues from the global surge in crude oil prices. Inflation in manufactured products has also surged to its 49 week high of 6.27% in the week ended 15th March 2008 and has moved up by 206 basis points in the first two weeks of March.The headline inflation crossed the tolerance level of five per cent set by the RBI for 2007-08 in the week ended 23 February 2008 itself. It is now within striking distance of 7%.

Based on the above data one can decipher the following :
1. There is a need to augment production and productivity in wheat,rice, edible oil and pulses as the rise in prices of these imported products has been a major driver of inflation in India.The country would be able to insulate itself from rise in global commodity prices only if it becomes self sufficient in the respective commodities.

2. Rise in commodities prices and inflation have become global worries. The price rise in commodities is putting pressure on inflation and thereby curbing growth.For growth to happen in India, we need lower interest rates but with the RBI having a hawkish monetary stance and with the government clear in its agenda on curbing inflation even at the cost of growth, it is highly unlikely that interest rates will come down in the near future.

3. Indian voters are known to be merciless when punishing governments unable to deliver on the price front and things are only going to worsen as the Budget and Sixth pay commission recommendations will result in increased disposable income in the hands of the consumer, which may result in higher inflationery pressures.

4. Lower interest rates are necessary to spur investment activities in the country and at current levels,there is a definite slow down in production and capacity addition plans of Corporate India.The IIP date has also not been encouraging.These supply side pressures are also contributing to rise in manufacturing inflation.Though imported inflation has been a major driver as reflected in the surge in prices of primary articles and fuel prices, domestic factors like high interest rates that have been ruling in the economy over the past one year have also resulted in significant supply side pressures along with demand slowdown.

In this scenario, the best bet for the government would be to reduce tariffs further, better supply-demand management, spur investment activities aimed at self sufficiency, cut back on wasteful spending and refrain from fuelling inflationary expectations.

Titagarh Wagons IPO : Dependant on Railways

Titagarh Wagons is a reputed private sector wagon manufacturer. The company is primarily engaged in the manufacture of railway wagons, bailey bridges, heavy earth moving and mining equipment, steel and iron castings. Railway wagons constitute 89% of the order book of the company and therefore the revenues of this company are historically dependant on one segment i.e: manufacturing of rail wagons. Wagon manufacturing business contributes to 79% of the total income of the company. Wagon manufacturing and demand is a need based activity that arises based on traffic volume and replacement of wagons. The company plans to use the IPO proceeds for expansion and modernisation.There are plans to enter into other segments of wagon manufacture, such as EMU and passenger coach manufacture.

Strengths :
* Strong Investment pipeline of Indian Railways to the tune of Rs.375 billion, demand estimated at 20000 wagons for FY 2008-09. Carrying capacity of railways to increase 40% over the next four years which would mean additionla investment in rail tracks and wagons.
* Plans to upgrade to stainless steel coaches from 2010-11 an opportunity for private wagon players
*PPP investments to the tune of Rs.1,00,000 crore in freight corridors, terminals,logistics and infrastructure in the coming fiscal in railways will propel demand for wagons. Dedicated freight corridors coming up in the different parts of the country will entail the need for high capacity and high payload special purpose wagons to handle bulk cargo. The company with its value added services is well positioned to capitalise on these opportunities.
*Wagon leasing scheme implementation by railways will ensure replacement demand for wagon manufacturers
*Total Order book stands at Rs.753 crore which is 2.65x FY 07 sales and indicates good visibility of earnings going forward.
*The company has just begun exporting wagons to Africa.Its still in the process of exploring relationships with customers in foreign markets. This may emerge as a potential revenue stream going forward.
*The special projects division (which concentrates on value added services to railways and supplying defence equipments as well as nuclear power plant equipments )and the heavy engineering division, though forming miniscule portion of revenues as on date have scope to add to the topline and are steadily pursuing orders from DRDO and Nuclear Power Corporation.
*Realisation per wagon has been improving over the last few years with the reduced dependance on railways albeit the company sells to Indian railways at a significant discount compared to private sector customers.Even adjusting for the free raw materials supplied by Indian railways, there exists a huge subsidy incurred by the company on its sales to Indian railways given the highly competitive bidding prices for wagons. The realisation from private players cross subsidises the margin losses on sales to railways.

Weakness:
*Dependant on a single segment namely wagons and also on Indian Railways policies.
* Competition is significant in the industry with the presence of players like Texmaco, BESCO, Hindustan Engineering, Bharat Bhari Udyog Nigam. With the Railway Ministry deciding to approach international companies for wagon design, the possibilities of competition intensifying in the wagon manufacturing segment is quite high.
*Significant Pricing pressure with resultant negative impact on margins buttressed by increase in raw material costs and inability to pass on the same to Railways, the latter being a monopoly player in India.
*Acquisition of Cimco Birla, a loss making wagon manufacturer, though the same auguments the capacity, operational and financial turnaround seem unlikely at the moment. The same factors apply to the acquisition of the loss making heavy engineering division of Hyderbad Industries.
*Indian Railways have a budgeted investment of Rs.750 billion to ramp up their own infrastructure and are also setting up a new wagon manufacturing plant in Kerala
* Change in Indian Railways procurement policy of wagons to favour the public sector undertakings can adversely affect the financials of the company. The company is not the exclusive supplier of wagons to Indian railways. Therefore supply to Indian railways shall vary from year to year.
*As far as orders procured from Indian railways are concerned, the terms and conditions of the order include free supply of raw materials of high value like wheel sets and bearings. This cushion is not available to the company in case of private customers and the company will be exposed to vagaries in the movement of raw material prices to the specified extent. The cost of wheel sets have risen exponentially over the last few years and constitute 30-35% of the selling price of a wagon. The item as a raw material is also in short supply globally and as a result has a profound impact on the operating margins of the company.The impact of raw material prices on the bottomline of the company assumes significance in the wake of the company placing greater emphasis on orders from private players. The share of Indian railways in the revenue of the company has shown a steady decline over the years.
* Production delays in the past on account of delayed procurement of raw materials like wheel sets have resulted in the company paying liquidated damages to both Railways and private customers to the tune of Rs.2.5 crore.
* Titagarh Steels, one of the group companies is also manufacturing certain wagon related components produced by this company resulting in conflict of interest and may result in loss of orders and revenue in future.

Financials :

*Sales of the company have grown at a CAGR of 43% over the last five years and profits have grown at a CAGR of 51% over the same period.

* Raw Material costs constitute 70-75% of the total revenues of the company. The company has maintained its operating margins at 18% over the last couple of years and PAT margins at 9% over the same period. Margins have shown significant improvement from 2005 after the company started assembling wheelsets at its own plant in Uttarpara. The company has also been aided by free supply of raw materials from specific customers including Indian railways.

*Operating margins and PAT margins are higher than its immediate peer company Texmaco but the latter has a much higher market share and a better track record and a much diversified business model. Texmaco is setting up Asia Pacific's biggest wagon hub in West bengal and commands 30% market share in the wagon manufacturer's segment vis a vis Titagarh Wagons at 18%. The order book for Texmaco also stands higher at 2000 crore at more than 3x FY 07 sales.

Valuation :

Titagarh Wagons discounts its trailing 4 quarter FY07 earnings at 38x at the lower end and 43x at the upper end of the price band of Rs.540-610. If we annualise the half yearly earnings for the six month ended Sept 2007, the PE works out to 24x and 27x forward EPS of Rs.22 for FY 2008.

The only listed peer company being Texmaco is trading at 24x FY 08 earnings after the steep correction in the stock markets. Based on the current volatile market conditions, the pricing appears to be stiff and investors would have been more comfortable with a 20% reduction in the price band to leave something in the form of listing gains on the table. Therefore it is advisable to apply for this IPO at the lower end of the price band. Investors would need to moderate their expectations of major listing gains from this counter, however, stocks like these with good fundamentals and earnings visibility are a definite long term hold.

New Initiatives in Railway Budget 2008-09 that shall affect the Wagon Industry
1. Setting up of dedicated freight corridors and privatising the same to container operators shall increase the demand for wagons from private players
2.All coaches of Rajdhani, Shatabdi and Suburban rail coaches to be made from stainless steel. This initiative shall benefit wagon manufacturing companies that upgrade to meet this requirement.
3.Railways has set a target of 20000 new wagons, 250 diesel and 200 electric locomotives to be manufactured internally/ sourced from private manufactureres
4.Wagon leasing scheme to be operative from 2008. This will ensure continued demand for wagons
5.Railway capex plan for Rs 375 billion for wagon procurement, Rs.750 billion for improving internal infrastructure holds a lot of promise for private manufacturers
6.PPP model to be pursued aggressively by railways and out of the total planned investment of railways to the tune of Rs.2,50,000 crore, 40% of the same is to be harnesssed through PPP model and throws up new opportunties for wagon and locomotive manufacturers.
7. Plans to set up a new wagon manufacturing unit in Kerala is a negative for private wagon manufacturers as it indicates the increasing emphasis of railways on internal manufacturing of wagons and locomotives.

Will IPL be a huge success?

IPL (The Indian Premier League) - the term that has become synonymous with wealth and valuations. The total value of the league is pegged at $2 billion (Rs.8000 crore) and come April this event assumes significance marquee value among advertisers, broadcasting companies and viewers alike. Definitely the format has been well thought out by its showman Lalit Modi and definitely the hype and hoopla surrounding it will find its right answers with the show at the various cricket stadiums by the game's elite. The success of the format is assured with the presence of the best players from different teams of the world albeit a few unwilling to participate in the first format citing their own reasons. Even the valuations, Iam sure, will increase manifold by the end of the first saga of the league with more sponsors and celebrities pitching in for the various zonal teams based on their performances in the league. Individual players will find fresh contracts getting signed under different endorsements and its all money sloshing around everywhere. But for all this to continue into the future, sustaining spectator interest is the biggest objective in the hands of the BCCI. Yes, agreed, with the likes of Sachin tendulkar, Ricky Ponting, Mathew hayden, Andrew Symonds, Dhoni, Yuvraj, Bret Lee and the array of stars ready to play, pulling in the crowd should be a walk in the park for the authorities. But with a player ratio of 7 Indians:4 foreigners , the Indianness in any team is lost. Now with 4 foreign players of star value and 2-3 Indian players of respectability, there's more than enough for the spectators to chew but the passion and the fervour that you associate with a spectator watching a match that India plays will definitely be missed. Crowds will come on weekends to watch good entertainment but these crowds will only get to see balls getting thumped around the dusty grounds of our country. There will be no nail biters, humdingers, people who generally flock to the stadium with intense passion to watch even a test match would prefer to watch these fast food matches on Tv. Without a complete Indian XI, will the crowds of the respective zones/cities be able to identify with the foreign players as one amongst their own is a big question in the minds of sports analysts. Branding and cutting edge marketing would definitely try it's best to address such issues.
All said and done, as far as the stock markets are concerned, one will soon find these teams jostling for space among the "A" category stocks by listing themselves on the exchanges. For eg. If Chennai Super Kings does extraordinarily well and clinches the title for the first tournament, Iam sure Indian Cements, the franchise that owns Chennai would not think twice before spinning of this team into a separate corporate subsidiary and getting it listed on the bourses. Each player of Super Kings would be given shares in the company just like ESOP's and that will be a great incentive for players to do well in future to improve the valuations.
The same kind of format can also be explored for Cinema in the case of big budget movie releases of SRK or a Rajnikanth. There should be a futures market for movie tickets of cinemas to be released at a future date. Just like an option, the ticket prices can be traded on based on developments at each and every stage of movie making. Contracts can be designed to begin from the date of movie launch until its release or say a week after its release. A positive verdict at the box office can push premiums up even further. This can also be thought of as a financially innovative product by the cine industry as it also leads to financial deepening and better price discovery for producers and distributors. These kind of exotic products are much better than the other form of exotic derivatives like CDO's (collateralised debt obligations) and CDS (Credit Default Swaps) which have only led to financial disaster world over.
Have i set anyone thinking???

Markets may fall further from current levels

Today March 14th 2008
Nifty closes at 4623.6
Sensex shaves off close to 770 points to close at 15357 points
India being a high beta market, any major fall in global indices gets magnified and exacerbated to a larger extent in our country. As they say when it rains, It pours, thats the exact description for the manner in which we are falling down like nine pins into a bottomless pit each day. All the stories of India having been decoupled from global cues have been thrown out of the window, all the more supported by the domestic institutions and sovereign wealth funds who are sitting on huge piles of cash and are unwilling to invest at current levels even if they see value and enough margin of safety(MOS) to their investments.

The fortunes for the week ahead look pretty bleak. Every relief rally that has happened ever since the lows of Jan 22nd have been pure short covering rather than any new buying emerging in the markets. Even as i stare at the F&O data for today fresh short positions have been initiated on the Nifty and the bellweather stock Reliance Industries which only indicate a further fall tommorrow whatever be the global cues. Even thought the Nasdaq and DOW seem to be hovering around a slightly positive territory at the moment, we can expect profit booking to emerge at every high on the Nifty. The technical trading levels for tomorrow are expected to be rangebound between 4690-4801 on the upside and 4527-4402 on the downside. The nifty needs to convincingly close above 4812 for a intermediary bullish trend to emerge on the cards.

An analysis of the present situation is provided below:
1. Markets are in a state of confusion over the earnings momentum going forward and are taking cognisance of the fact that there may be downgrades in a few sectors. Growth may slowdown in cement, banking, commodities and real estate. In case of the cement sector, incremental supply to the tune of 60 million tonnes is coming in as against an incremental demand of 35-40 million tonnes in 2009. This would definitely result in fall in pricing power for cement companies. The demand supply gap would get narrowed down completely by 2009. As for the real estate sector, though there has been tremendous supply of real estate over the past few years demand has toned down due to rising interest rates. We have already observed prices in the NCR (national capital region) fall by 15-20%. Banking stocks especially the PSU banks are a great buy at current levels provided we have enough clarity on the loan waiver scheme and the reimbursement of the same to the banks in the form of oil bonds. The positive side of this loan waiver is that the banks are cleansed of all their past NPA's in one go. However, whether this step by the finance minister will result in more defaults from multiple sectors is something only the future will decide. But all said and done at a price to book value of 1.1-1.3x banking scrips do look attractive. Steel as such is getting into a bearish mode with disappointing resultsfrom Corus. If we strip the consolidated results into standalone factions one would find that the numbers from Corus have been a clear thumbs down and if that’s the tone set going forward, it will definitely have a rub off effect on all other steel counters.

2. Global cues with crude oil touching $110 per barrel, over the top commodity prices and the collapse of Carlyle group due to losses in the fixed income market are not at all comforting signs.

3. The exposure of Indian corporates to the credit derivatives market, foreign currency and commodity hedging are still unclear and the cracks are beginning to show up with ICICI and L&T being the first casualties to these exotic derivatives.

4. Neither the Railway Budget nor the "Aam aadmi" Budget of PC had anything much for the corporate world to cheer about. Markets like reforms and there was no mention of it in the budget. When the economic survey document promised so much on privatisation/divestment and deregulation, not an iota of the same was discussed in the budget leaving us all exasperated enough to remind us that the latter shall always remain a non event as far as our country goes. On the contrary the Short term capital gains tax on share trading was hiked to 15% to bring it in line with DDT (Dividend Distribution tax). The objective of the same, though welcome, being investors should develop discipline and hold on to their investments for the longer term, the timing of the levy has been vicious that too when the markets are at an all time low. Some thought process could have gone into the same to bring about this provision after a level of sanity had returned to the markets. As a result of this provision, we expect more sell offs from HNI and other short term traders prior to March 31st as the provision comes into effect from April 1st onwards. The provisions on STT being now directly allowed as a deduction against income rather than against the tax liability as a rebate is also a negative for the markets as it forces the arbitrage players out of the market and will reduce volumes in the momentum counters.

5. IIP (Index of Industrial production) numbers have been dismal at 5.3% as against anestimated 7.7%. This clearly points to a Q3 slowdown if the IIP nos have to be believed. The poor show on the manufacturing and capital goods front has put immense pressure on the markets. Investors are being scared away from pumping fresh money into the markets.

6. GDP estimates are also getting lowered down to 7%. Though the structural growth story continues in India, it has been hampered by cyclical pressures and with both the government and RBI focussing on giving top priority to inflation management rather than maintaining or improving growth, its difficult indeed to achieve a 10% growth as aimed by this UPA government.

7. Though most of the capital goods companies have maintained a positive stance on theirorder book position, their capex plans will definitely get affected going forward with credit spreads having widened all across the globe. Debt doesn’t come cheap anymore and this will hamper most of the expansion plans of Indian companies. Even M&A deals may get affected what with most PE firms and investment bankers having burnt their fingers in the subprime crisis. Loan syndication is a difficult task henceforth. The primary market in India too has not been supportive with the dismal response to two heavyweight IPO's like Emaar MGF and Wockhardt hospitals forcing them to withdraw their offers.

8. The impact cost of trading has become so high that even a small short position created by an FII triggers or accentuates a bigger fall in the markets. The trading is so lacklustre at the moment that dealers are busy enjoying their favourite past time during trading hours. I for one saw my broker watching a Rajnikanth movie on Sun TV today....Can anyone imagine such a scenario prior to Jan 21st. The situation is pathetic to say the least.

As far as the markets are concerned with all the negatives crowding around, the only saviour can be a good show on the advance tax numbers by Corporate India that would be released next week, a little bit of help from FED in cutting interest rates further and a stellar outperformance in Q3 results from the core sectors which however seems highly unlikely.

Most of us belong to the "sunrise" investing generation which has not seen long periods of market volatility or a bearish phase of the likes of 1992-2002. Having seen a continuos secular bull run from 2002 to 2007 , we lack the patience and conviction that a rakesh jhunjhunwala or a ramesh damani posessed to emerge out as "Dhandho investors".

Rupee appreciation to stop here!!

1. Broadly because the exports and services sector have already been hit badly by the onslaught of rupee appreciating close to 12-13% year on year.
2.This year is an election year with the polls looming large prior to Nov 2008 and the government cannot afford to have interest rates at high levels which might alienate middle and lower class vote banks
3. Inspite of the Interest Rate Differentials between US And India we havent seen significant inflows from FII's even after a number of fed rate cuts
4. Yen has started to appreciate against Dollar and all other major currencies of the globe and this is going to result in major Yen carry trade unwinding which will only put pressure on the rupee to decline