Welcome 2009!

At the outset a very Happy New Year to one and all. 2008 has been one forgetful year from all perspectives. Globally, we witnessed the biggest and the strongest disappear from the world stage (Bear & Lehman) and these were, for all we knew legacies of 75 year or more. Then nearer home we saw giants like China facing massive job losses and decline in GDP growth (though officially no ones dare talk about it in the mainland) and hoping that the storm passes quickly.

Closer home in India, we saw our worst nightmares come true. Stock markets crumbling, loan rates spiking, EMI’s getting out of hand, negative home equities, job insecurities and not the least terror attacks. And we definitely know deep inside that the terror attacks were not the last one we will see. And we also know that we have not done enough so far to bring the perpetrators to book (but lets not get into that debate right now).

Time to get serious about that asset allocation decision

Why an asset allocation decision important and is it easy to implement it in the current environment? First, we have no doubt that in this environment (which we expect will continue in 2009) it is extremely important to know when and where we need to invest our hard earned money. Second, despite it not being easy to have a strong asset allocation strategy, which will be fool proof, it can be the only way to capital preservation if not earn some positive return on the money.

It also becomes imperative because, with all the volatility in asset classes witnessed in 2008 (remember gold which has never been so volatile in the past has seen amazing swings during 2008) we need to put our money in a diversified basket of assets; distributed of which is on the basis of weights that are likely to make a meaningful hedge and an opportunity to earn a return when asset classes perform.

What does the crystal ball tell us!

If we had one, we wouldn’t have told the world what it told us. But jokes apart, we continue to believe that individuals should take all the opportunity to invest and lock the returns the fixed income markets presents us. These are truly golden times and we might not see double digit returns on fixed income instruments, fixed deposits and term notes after 2009 and therefore people should not waste time in thinking of locking in at rates provided by banks on FD’s.

More importantly, this is also a great time to SIP your way through the cream available in the stock market. We mean that though it is quite early to make a selective stock bets and it would be akin to finding ‘needle in the haystack’, it is truly a time to broad base your investments in the stock market. Great gems are all dispersed on the floor and let’s not waste time to pick one individually and painfully. Let’s sweep the floor.

It’s a great time to invest in systematic investments plans (SIP’s) of select mutual funds. For one you get to participate in the broad market, second it is a classic buy at lows and more units over a longer period in time.

Go for Gold!

Why gold and that too at top you might ask. Gold is an excellent hedge against inflation (which is going to come down over the near future) but that’s not the precise reason to buy into it now. It’s our classic Indian trait of saving for a rainy day, is what we mean. Try to collect it in physical form and in low quantities. For one, it will remain illiquid and mostly locked in the vault, second it will build over time and you will tend to forget about it (which is the classic case of long term investing-Buy and hold).

We are sure that when the unforeseen time does come (God forbid), you can reach for the vault instantaneously.  

Halleluiah!

But for now, its time to pop up the Champaign, celebrate our existence and pray for people who laid lives defending our country so that we may live another day. And yes, hope that almost definitely 2009 will be much better year as compared with 2008. Let’s start this year by thinking forward, learning from our mistakes and remember that the collective forces that drive the markets can make the most seasoned of fund manager/investor a very humble / helpless of persons within a short span of time.

Until then. Keep the faith.

Prepare for a smooth take off!

Wow! What a year it has been. We started at the 21000 (or thereabouts) on the Sensex in January 2008 and now we stare with questions such – Is there a bottom? It can’t pierce 8000 levels and of course the all familiar; how low can it go?

We are absolutely awed by the way things can turn in the stock markets and yes, we must admit, it can be a humbling experiance to us. We also believe strong in the idiom – keep it simple stupid (the KISS principle) cause no matter where you enter in a stock, if you enter the right stock (right business model, strong franchise and transparent management), it will all come back one day.

Meaning, imagine you invest a company at its 52 week high and the stock tanks 50% or even 70%, what would you do? If the answer to the question we put before (Is the business model right…) is affirmative, believe it will all come back one day. You will need to be patient. The fact of the matter should be that if you had the courage to buy it at the levels you bought it, you should be buying it even more at the current price.

At this moment all we can quote is what Peter Lynch said “If you believe that this business will be around after the next 20-25 years you shouldn't bother what is the current stock price is.

Its Déjà vu all over again!!

That’s what Yogi Berra, famous for his often very subtle quotes (on second thoughts of course) had said no so long ago. Now we don’t profess and don’t want to beat our drums with a trademark “we told you so” attitude, but nevertheless it does not stop us from just drawing your attention to what we wrote just few months ago in our earlier post.

We had a definitive feeling that this would happen (the Bond rally) and was the only way stocks could rally. Only, as mentioned in the post, we thought the government could be a little lethargic (as always) to step in and help the market. We were wrong.

The Bonds have rallied and how. It’s been an incredible 30% on the gilt funds in only two months! Wow, we say with a dazed look. But if what we said is indeed coming true, what is in store in the next coming months?

Happy New Year 2009?

At the outset, we can certainly tell you that it’s going to get a little rough as we head into 2009. What does that mean? That the situation is not going to turn around (for equities) like a bond rally for sure. Buyers are not going to return in droves to buy real estate, nor will car buyers flood showrooms. People will continue to stash their cash into bank vaults and “saving for the rainy day” will remain the mantra for the next few months.

We believe it will not be until there is any meaningful turnaround happens in the corporate earnings. But the first indications could come from decline in interest payouts of corporates over the next 2-3 quarters.

Next could be the outperformance of the "safety net" stocks or the ones like high dividend yield, stable cash flows - consumer staples and pharma/healthcare and finally growth stocks. Within the growth bandwagon too, we could see the last coach (realty sector) of the train not coming good until 2 years from now.

To summarise:-

• we are indeed in the middle or the last leg of the bond rally
• typically it has been witnessed that stock rally starts 6-9 months after the bond rally completes
• the cycle normally upturns with the value picks / absolute bargains starting to outperform

While we go into 2009, if you are thinking of entering the stock market, it would be akin to coming to the airport 3 hours before you flight takes off. For one there will be no one around, second you could end up first in the que, you could end up with the choicest of seats (we hate tele-check in) and yes when you know that its a large aircraft (like the A-380) you would be sure that you will almost certainly enjoy the flight and it will be a smooth and a perfect take off!


So stay tuned...

The name is BOND !!!!!!!!!!!

While we continue to write on Indian equity markets (which are our forte) we have chosen a misnomer in the title nevertheless. In addition, we strongly believe in following what our mentors have preached. For instance, Peter Lynch maintained (albeit mockingly) that “people who trade bonds do not know what they are missing”.

This time, however, we are departing from writing about our favorite asset class – equities. We are writing about Indian BOND market. Also, we’ve not forgotten that over a “long term horizon and on average equities outperformed bonds most of the time”.

So why are we even thinking about them leave alone write and put forth a case. The point worthy of mention here is that equity markets outperform bonds on average and that there could be that occasional period where bonds outperform equities in the past and can happen in future as well.

Is this that time when bond markets will overtake the equities over a short time in the future?

Let us see. For starters, we know that these things do not happen only occasionally and the last time that happened in India was just 5 years ago. For records, Indian bond markets returned whopping 18% (this is not a typo) in 2003-2004 period as compared with 6-8% return from equities.

What could then be the ingredients of a bond market rally the?

1. Plateau experienced in the rate environment (monetary policy of the central bank) after a rate tightening environment as a result of many MACRO factors (inflation etc.).



2. View from the central bank that interest rate plateau is certainly choking growth (given inflation is under control) and there exists a scenario to decrease the rates to stimulate demand or growth.



3. Existing bond paper would be much sought after as bond prices would rally as effects on interest rate stimulus will be only seen 2-3 quarters down in line.
   
   

   Are we then saying that now is the time to invest in bond markets and bond funds in particular?

   
   
   1. It looks like some of the ingredients mentioned above certainly could come through over the next few quarters. What could be the factors that would make this possible? Let's see.
   
   
   2. For one, we are in an inflationary environment, with runaway prices on commodities (agro and otherwise), high fuel prices and resultant liquidity tightening by the central bank (the RBI).
   
   
   3. This would mean that if the situation continues for another couple of quarters then we could end up witnessing rate hikes, albeit modestly. This could in turn impact commercial lending rates and further slow down credit growth visibly(Banks are seeing these early omens - March 2008 Earnings). Another obvious impact of higher rate environment is on the corporate sector, by putting strain on the cash flows by way of higher interest bills each quarter(This could lead to rating agencies showing some concerns).
   
   

   What could be the impact on the GDP growth?

   Well, obviously pressurized corporate sector would borrow lower than before, postpone projects and concentrated on protecting the bottomline. This would visibly impact each one of us adversely. Slower GDP growth than witnessed over the past 3-5 years would not go down well with the government as well and this could be a trigger (There are sell side forecasts of low 6% range to optimistic 8% range).
   

   What would the government do?

   For starters, not much in an election year (2009) and therefore sacrifice growth over inflation control. But not for long, according to us. Which ever party heads the next government in 2009 will start to push reforms, provide more fiscal stimulus and look to push the GDP growth to same levels which we already saw, 9-10% real growth. The caveat in all this could be the government formation by a predominantly one party. Can that happen – lets see.
   

   So what?

   This means by mid-2009 we could witness the same situation we saw in late 2003. Rate cuts, loose monetary policy and ample liquidity. The impact of which will be favourable on the corporate sector and another equities rally. But not before late early 2010.
   

   Then what could be in store in the Bond markets by then?

   
   
   1. As a result of rate cuts, easy monetary policy in early-mid 2009 we could see bond market rally
   
   
   2. Investors would flock to Bond market as a result of weak prospects of performance in the equity markets in 2009 strengthening the rally
   
   
   3. Bond market could end up beating equities market by a whopping margin.
   
   

   Are there holes in this thesis?

Yes but not many.Firstly we could be wrong in purely timing the cycle (late 2008-2009).

Secondly, we do not know how the corporate sector could behave. For instance, if the corporate sector borrows from outside (ECB route- RBI may increase the limit of ECB) then the anticipated slow down will not pinch the GDP and equities would perform much better and RBI could increase rates further. We see this possibility unlikely, given the bottom of the rate cycle in the west.
And lastly, we could be very early on this prediction and therefore limit the returns from the bond markets.

However, the good part is that we have time on our side.


Until next time!

Caution: Sharp turn ahead!

When we started writing in late 2007, we had said that 2008 could be full of uncertainty (refer: Ab kya hoga?). At that moment we did not know and did not have an iota of conviction where we could end up after 2008. At this juncture, however, we believe that 2H 2008 could be far more correction oriented(bumpy ride) than most people think it will. The reason for this ‘pessimism’ could be in what we are seeing lately on the macro front and its effect on the corporate performance has still to show up, according to us.


What’s up with the Sensex?

There are umpteen articles published recently comparing our markets with those of the rest of the emerging markets. The BRIC economies which had a spectacular run in the last four years have all corrected recently, but the arguments put forth are that the Sensex is amongst the cheapest of the lot, in terms of valuations. For the record the Sensex trades at around 16-17x FY09 earnings compared with other emerging economies which trade more than this multiple.
For one, Sensex companies have had a spectacular run in the last four years making them from ultra cheap in 2003 to overvalued by early 2008. For instance, the erstwhile (consolidated) Reliance Industries Ltd. was trading around 16-17x 1yr forward earnings in 2004, while now it trades at around 22-23x 1yr forward earnings. Sure it has corrected from 28x it was trading in early 2008. But we believe that to make an entry into Reliance Industries, we still have time on our side, right through 2008. This is true for most of the Sensex companies.

Secondly, sector wise we think that it would be prudent to move away from high beta sectors (read; rate sensitives, high growth, high multipliers), to defensive yield oriented and low beta sectors.

Thirdly, we believe that the near term could throw up certain sectors which could end up gaining from the current slowdown. Counterintuitive you might say. We meant in terms of relative performance.

Slippery when wet!!

Its like running while wearing rubber gripped shoes on a concrete surface. When the surface is dry the rubber provides grip and powers us forward. But what if we hit a patch with water on the surface. Just can’t imagine that, can you? The same, we argue, is that case with rate sensitives, high capex sectors, and ultra growth movers. A little lower octane (capital) provided than before can slow these sectors more than a few percentage points.
As a result of the successive liquidity squeeze, which in all probability does not seem to be over, the octane for certain sectors suddenly has been cut.

Real estate, banking, capital goods, construction, autos and manufacturing in heavy industries are the ones which could have visible lack luster performance in FY09. This situation could get complex as a result of commodity inflation, resulting in another set of industries such as Metals, cement, transportation & logistics and processing companies getting margin squeeze.

We believe that it is indeed a time to get defensive, albeit move into a watch mode from here. This situation could persist for maybe a year before the next leg of performance by the heavyweights of capital consumption.

The formula (if we can call that) to get over this trying phase is to look back at those sectors which display a secular demand which is devoid of economic cycles. FMCG, F&B companies, Pharma, IT and related services and of course medical care.

These stocks will display continued growth, could be available cheaper than those stocks in the cyclical sectors and could assure you decent returns which may not be provided by cyclical or growth stocks in this period of pain.

One could therefore look at stock such as ITC, Indian Hotels, Apollo Hospitals, PVR, and TCS.

Therefore, if the hare is resting bet on the tortoise.

Picking beaten angels - Part II - LMW (BSE: 500252)

Amongst all the clutter and noise at present in the market, we believe that there are companies which are plugging away slowly, beaten down more than necessary due to market pessimism and worthy of mention as a result of attractive fundamental story. LMW or Lakshmi Machine Works, (BSE: 500252; NSE: LAXMIMACH), is one such name. Below, we present our case:

Investment Rationale:

Lakshmi Machine Works Ltd (LMW) is a Coimbatore, Tamil Nadu based textile machinery manufacturer. LMW is India’s largest and world’s third largest textile machinery manufacturer. LMW is a 40 years old company and sold almost 2.3mn spindles in 2007 with almost 60% of the domestic market. Swiss based Rieter is world’s largest textile machinery manufacturer and has a long association with LMW. LMW acquired the technology to manufacturer textile machines from Rieter’s only. In 1999, both the companies called off their collaboration, but Rieter still continues to hold 13% in LMW and has its own production unit in India as well. Before we start narrating the entire script, here are the following major pillars of our investment thesis:

1. Orders of Rs.4500 Crores in hand, leading to a sales visibility for next 2 years.
2. Gets 10% of the order as advance from the customer, leading to negative working capital
3. Debt free with a cash of ~ INR 600 Crores at FY 07 end
4. Gets 1.75% of the textile machinery bill amount as subsidy from GOI under the EPCG scheme. Sales of textile machinery to 100% textile EOU are considered to be deemed exports.
5. Stable OPM of 17-18% and PAT of 11-12%
6. Implementation of VAT in TamilNadu is saving Rs.2.5-3 Crores every month for the company
7. Exploring other major Asian textile manufacturing hubs like Pakistan and Bangladesh
8. Textile Up-gradation Fund Scheme (TUFS) has been extended till 2012 by GOI

9. No price change since June 2005 with iron & steel, aluminum, brass, copper and pig iron as the biggest raw materials
10. Invested ~Rs.400 Crores in last few years to double the production capacity to 3.5mn spindles in 2008 from 1.8mn spindles in 2006
11. No plans to expand the capacity going forward

One Immediate Trigger

Voltas provides presales, order booking and installation services to LMW. In its latest results announced by Voltas, the company has gone on record saying that “Textile Machinery division achieved 20% growth in equipment sales”. Applying the same logic to LMW, the company should post the same growth in its textile machinery business also leading to Rs.2000-2100 Crores of sales in FY08 with Rs.1682 Crores of sales in FY08.

LMW is scheduled to announce its results on May 19, 2008.

Indian Textile industry – Key Facts

1. Accounts for 14% of industrial production and 4% of GDP
2. Employs approx 35mn people, second largest after agriculture
3. India’s textile exports in 2006-07 - $17B. Target to export $50B by 2012
4. India’s expected domestic textile market in 2012 - $50-60B
5. Installation of 38.8mn spindles (21mn supplied by LMW) out of which:
1. 29.8mn are active
2. 10mn are waiting to be scrapped
3. 15mn are fit for modernization
6. 6. India’s textile machinery market (3.9mn pa) is second largest after China (7mn pa). Pakistan is third largest with 1.1mn spindles pa.
7. 7. India is expected to add 3.5mn – 4.8mn – 5.4mn spindles every year under worst, base and best case scenario till 2012 to reach its $50B export target.

Business Profile

1. More than 4 decades old
2. Sold 2.33 mn spindles in 2006-07, with ~60% of the Indian market
3. Third largest textile machinery manufacturer worldwide with Rieter of Switzerland and Schlafhorst of Germany bigger than LMW
4. Long-term association with Rieter has helped the company to learn the technology with 90% of raw material and components locally procured. Reiter holds 13% of LMW. Reiter has its own production unit in India.
5. Large localization helps the company to sell the products at 15-20% less than its global peers.
6. Invested Rs.410 Crores in last 2 years to increase the capacity from 1.8 mn spindles in 2006 to 3.5 mn in 2008.
7. Takes 10% of the order as advance, leading to negative working capital. Similar amount on Rieter BS seems to make this a worldwide phenomenon.
8. Increased capacity and improvements in production has helped the company to decrease the delivery period to 10 months from 18 months.
9. Worldwide textile machinery demand peaked in 1HFY07. LMW is expected to end FY08 with an order book of Rs.4500 Crores as against Rs.5400 at Q2FY08 end.
10. Plan the production at the beginning of the quarter by getting an approval from the customers.
11. Irrespective of the date of arrival of the order, the customer is charged at the time of delivery of the machinery.
12. The pricing is done as per the prices prevalent at the time of delivery, as per the competitor’s rates and the market conditions. Due to this practice, the margins are expected to remain stable going forward.
13. The company has been following the current pricing rules since last 40 years and has never faced any issue with any customer.
14. No price hikes since June 2005.
15. The company gets 1.75% of the bill value machinery sold as exports or to EOU’s as benefit under EPCG scheme from GOI. The company previously used to share (50:50) the benefits with the customers but now has stopped the practice.
16. Implementation of VAT in Tamil Nadu is helping the company to save Rs.2.5 Crores - 3 Crores every month.
17. Holds investments worth Rs.60 Crores. JV with Rieter had sales of Rs.121 Crores and PAT of Rs.9.85 Crores in 2006-07. LMW has invested Rs.12.5 Crores in the JV.

Product Profile

1. Textile Machinery Division – 90% of the sales
2. Machinery tools & Foundry Division – 10% of the sales.
3. As the technology in the machinery tools division is highly guarded by some of the world major’s, the sales mix is not expected to change dramatically going forward.

Shareholding Pattern

Association with Voltas is strategic as the same provides presales, order booking and installation services to LMW. Voltas charges 3%-4% of the bill amount as commission.

We would like to resist from giving any projections considering the uncertain economic environment we are in. Also as per our philosophy, is it what he have that matters and not the uncertain future.

Conclusion

LMW with its leading position and strong order book is a strong defensive investment available at cheap valuations. We expect the company to do well in future and the share price to mirror company’s financial performance.

Sasken Communications – UPDATE… (BSE: 532663; NSE: SASKEN)

Wow!!! We like this! While the prices of real estate in Bangalore have stabilized, why has Sasken communication gone up in Value?
For starters, the stock is up > 60% since we last wrote about it last month. Yes we agree that the stock was close to 80% down from its 52wk high, but what the heck!
Wasn’t it a golden opportunity to average out to a decent price and maybe exit at the next up move if you felt skittish? We hear people screaming out “Falling Knife” and won’t fall for that one. Well that’s where those who test the business model WIN.

IT is the next in thing…
Well, we are not saying this. Its’ the GURUS who are saying it. We always maintained this ever since we starting writing on it late in 2007. (Refer: Ab kya hoga?)

We believe that the long term IT story is pretty strong. Margin may come under pressures, business model will change, and the sector will look more like cyclical over a decade from now and probably there will be a shakeout with some bruised and battered companies.
The trend could also change, slower growth, more controlled performance, steady dividends and yes acquisitions. Finally there will be winners.

Let get fundamental…

1. There are a few things that we look at in a company when we invest into it (at least this is the philosophy that we believe in).
2. Is the company in a domain in which it has a first mover advantage?
3. As a result has the company able to maintain a top slot in the sector?
4. Are there catalyst that we dethrone the company in the near future?
5. Is the business model in for a fundamental change in the future/is threatened by forces (external or internal)?
6. Is the company favorite / dumped by the street for a longer lengths of period in time (in simple terms – valuations)
   

The results are good or bad?

Sasken reported Q4FY 2008 numbers yesterday and while we see them in the comfortable, the street seems to be reiterating its SELL mantra. We believe that the street has got it right as far as next 2-3 quarters are concerned.

Citi (analyst Surendra Goyal, a good friend of ours) has a SELL report in the market reiterating very valid concerns in the short term. But we disagree with him certain macro fears he puts forth.

Metrics would continue to drag, performance might be subdued and risk could look overwhelming. We believe the opportunity might come over a longer period (12-18 months) is

1. Telecom space (where the company operates) improves as a result of continued penetration in the domestic and Asian markets. We would see revenue growth steady and continuous
2. Margins hitting bottom and then reverting back to saner levels of higher double digits (possibly mid-teens).
3. Employee costs stabilizing over the next 18 months as a result of overall lackluster employment opportunities

Sasken for now has done two important things to keep nervous investors some comfort.

a) Given a 40% dividend on a INR 10 FV share. This translate into a dividend yield of little under 3%, so this is a positive, a minor one you would say. But we conclude a positive nevertheless.
b) Sasken board has approved for a buyback upto INR 40 crores, an authorization for buying shares upto INR 260 / share. CMP at around INR 144. We believe that even though this also will not really lift EPS materially. The signal from management at the moment is the company is undervalued. We believed this for the last 3-4 months.

Time to speculate, then?

Well we believe that there will be lots of activity in this counter from now on. The triggers are the buyback, dividend stripping and bullish traders getting in the make a quick buck while the undertone is positive.

The safety net is therefore stronger than before. However, we think that investors should look at this counter only for a fundamental story rather than a speculative opportunity.

Easier said than done.

We think we could see this counter moving up nicely to around INR 220-240 effortlessly. So a good 40-50% from here in the next 3-6 months. Over a longer term however, we continue to maintain that the upmove could be a lot more painful than it appears. Investors who entered this counter at various levels starting at INR 300-400 price band have caught a falling knife and made a few deep cuts to themselves.

But were they intelligent enough to buy some more when it reached INR 86 (all time low) a few weeks ago?

We don’t know that for sure.

Until next time….

UPDATE: Gold fever - It still ain't what it used to be....

Gold: Is it a Consolidation phase ($900-$950 level) or things are really going wrong?

What is going on behind the scene?

Gold still remains the best bet in precious metals. Gold has given an annualized return of 46.28% YTD and around 40% annualized since we wrote our first thesis and recommendation on gold (see article date January 21, 2008). Gold roared to a lifetime high of $1,030.80/ troy oz. on March 17, 2008 but then tumbled to a two-month low of $872.90 in early April in a broad commodities sell-off. It has bounced since then and stood around $935 an ounce on April 15, 2008. There has been increasing media reports and speculation about future of gold. In our opinion, the concerns like, “is the bull run over”, “has gold seen its golden season”, are baseless and we have reasons for our strong view. Many on the street are also arguing that the shining in gold was due to the increased money flow in the commodities complex (Commodity ETF’s/funds), however we think this remains one of the factor but certainly not the underlying one, gold has its own reasons supporting the price movements.

The answer to the first question in the headline is affirmative and second question is negative.

Recent concerns/factors working for gold:

1. Strong fundamentals: Increasing supply concerns from South Africa:

Gold still enjoys the case of strong fundamentals where demand is still more than supply (see our previous analysis "Gold: its ain't the fever what it used to be Jan 2008")

South Africa (SA) is one of the top producers of gold. In terms of 2007 mine production it accounted for around 11.1%, Just behind China which enjoyed 11.3% (see production chart). Lately SA is having growing imbalance between the power consumption and generation. As a measure of regulation and in order to control things, SA govt. is controlling all the power allocation to all the business’s which primarily includes gold mining. As per last update, SA govt. is now allocating around 90% of the power which the mines used to consume earlier. This is regardless of which mine is producing how much in terms of efficiency and cost, hence even if the producer may want to allocate 100% or more of the power to some low cost and more efficient mines and keep certain high cost mines closed , it has no option but to suffer on rising costs for non-efficient mines.

As per experts and power industry consultants the power problem is a structural problem on account of lack of build up of new generation facilities coupled with increased usage and bad weather, hence the situation might take around 2-3 years to get fully normalized. Major gold producers like Gold Fields, Anglo American (400,000 ounces shortfall) have already announced reduced production guidance on account of power shortages.

Source: http://www.goldsheetlinks.com/production.htm
Source/further readings supporting the thesis: 2007 world gold production fell marginally and 2008 output to stabilize – GFMShttp://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=50465&sn=Detail

2. Renewed demand from Asia particularly India: Seasonality

Though there is no denial of the fact that demand was subdued in India and China due to high gold prices, the fact remain that gold is the party essence for every celebration in India. This time the pullback is attributed to or rather spurred because of the wedding season (ending May 2008) and The Akshaya Tritiya festival (May 7, 2008). Jewellery demand may see a major spur due to these two reasons. We have studied the data from 1970 for gold demand and came to the conclusion that gold does have seasonality factor. The first and fourth quarters are the periods when there was rise in gold price on account of higher demand, while the second and the third quarters were seen as quiet or flat demand during the particular year. Having said that, the analysis is based on normalized data and we have removed specific outliers to improve data quality.

Source/further readings supporting the thesis:
Indian demand keeping gold markets alive
http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=50690&sn=Detail
Return to gold by Eastern jewellery markets means price may have bottomed
http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=49719&sn=Detail
Citigroup warns of waning gold investment, seasonal slack - but positive long term
http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=50688&sn=Detail

3. IMF sales – a perspective. The gold for sale is different from the rest!

The recent announcement from the US Treasury on 25th February, approving in principle the proposal for the IMF to sell some of its gold reserves, marked a reversal of policy and generated a knee-jerk reaction in the gold market, with prices dropping by $10 to close at $938 that day.
It looks as though any sales by the IMF will be restricted to 400 tonnes used in a previous sale and repurchase agreement – and in any case would be made within the existing CBGA sales Agreement. The market is right to remain unfazed!

This looks very much like the gold that was used in sale-and-repurchase transactions with the IMF in 1999 and 2000. In these transactions the IMF sold gold to Brazil and Mexico at prevailing market prices and then immediately accepted it back at the same price in settlement of financial obligations of those countries to the IMF. While the net effect on gold holdings was zero, the gold thus accepted was entered onto the IMF's books at the prevailing market price rather than the official price of SDR35/ounce. In accordance with the IMF Articles the equivalent of SDR35/ounce from the proceeds of the sales was retained in the General Resources Account. The increase in the value of the gold held on the balance sheet was deemed to offset the liabilities of Mexico and Brazil to the IMF.

There are three things which needed to be noted in this regard as observed by Crockett Committee:

Firstly the undertaking-sale of gold-should be qualified in important ways that limit its impact on the gold market. In the first instance, the amount should be limited to the 400 tons I mentioned, without envisaging any additional sales.

"Secondly, the sale should take place within the existing Central Bank Gold Agreement, that is to say it would not be additional to sales already programmed by central banks, but would be accommodated by reductions in the amounts of gold that the central banks might sell under the Central Bank Gold Agreement.

"And thirdly, we have emphasized that the sale should be undertaken in a very careful way in terms of their periodicity amounts and manner of sale such as not to disturb the market.

Source/further readings supporting the thesis:
IMF sales – a perspective. The gold for sale is different from the rest!
http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=48222&sn=Detail
Swiss Central Bank gold sales – further analysis
http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=49939&sn=Detail

Picking beaten angels : SREI (BSE:523756, NSE:SREINTFIN)

In our quest to provide timely advice to investors, we have been putting in a lot of time and efforts off-late to find out value stocks. Recent market crash has given us some opportunities in finding beaten angels and one such angel we believe is SREI (BSE:523756, NSE:SREINTFIN)

Why we like SREI
With 25% of the construction equipment financing market, SREI is India’s largest private NBFC with over Rs.6, 500 crs of assets under management. A 50:50 JV with BNP Paribas will help the company to aggressively expand its business with having access to low cost funds and to expand on its Project financing business.

With net NPA of approx 0.3%, strong management, domain expertise, expected BV of Rs.60 for FY08 and Rs.75-80 for FY09, SREI is available at 1.75x FY09 expected BV. We believe that last 20 years of knowledge in the equipment financing business will help SREI to make a formidable entry in Project Financing business.

With the additional kicker of QUIPO, SEZ, Ports and Roads projects which we have not included in our estimations, we believe SREI is attractively priced at the current valuations. The allotment of 2.5 crs warrants by promoters to themselves at Rs.100 per share is a big positive. We expect the stock to trade at 2.5x FY09 BV in the next 9-12 months.

Let’s dig deep

SREI is India’s largest construction equipment finance private NBFC located out of Kolkata. The company holds 25% of the India’s equipment financing market with IDFC, ICICI Bank and few other players sharing the rest. Promoted by the Kanoria family, the company has a 2 decade history behind it.

SREI has assets more than Rs.6, 500 crs under management and its activities include financing of construction equipments, equipment leasing, project finance and renewable energy equipment financing. SREI has floated subsidiaries for merchant banking, syndication services and forex services. Currently more than 90% of the revenues and profit comes from the equipment financing business, but project finance and equipment leasing are expected to contribute significantly from FY08 onwards. Now we will discuss all the businesses in detail:

1. Equipment Financing
Equipment expenditure is estimated to be 20-25% of the construction outlay which is estimated to be 40-45% of the infrastructure spending. While the government has plans to spend $250bn on infrastructure in next 5 years, the opportunity is just too big for SREI.

The company raises money from all available sources including banks, bond markets, public deposits and multilateral agencies. With an average borrowing rate of 8% in FY06 and 9% in FY07, the company’s operational expenses are just 2% due to its high ticket size transactions. With average yields of approx 13%, the company also maintains an interest rate reset clause in all the agreements to take care of the rising interest rates.

At 3QFY08 end, SREI had Rs.6, 500 crs of assets under equipment financing. This is up from Rs.3, 500 crs at FY07 end. For an effective utilization of its assets, SREI frequently utilizes the route of securitization. As SREI book the income over the life of the asset and not at the time of securitization, it maintains a conservative approach and provides a smooth sales pattern. Now we will discuss the major step taken by the company to make it big in the business.

A 50:50 JV with BNP Paribas
Considering the expertise developed by SREI, BNP Paribas and SREI has formed a 50:50 JV for the equipment financing business. Under the terms of the agreement, the equipment financing business will flow from SREI into the JV and BNP will introduce Rs.775 crs as their contribution. Out of this Rs.775 crs, approx Rs.375 crs will flow to the parent company which they will utilize to grow the Project Finance business which is mentioned below.

The JV will help SREI to have access to low cost funds and to utilize the world-wide expertise of BNP in this business. At the same point in time BNP will get access to the growing Indian equipment financing

Competition from banks is a major threat to SREI for the business, but as the banks are not willing to lend money to small contractors, the area where SREI operates and specializes, it is difficult for banks to make any sizable impact.

SREI intends to have a Net worth of Rs.800 crs and with a leverage of 8x-10x, the company aims to build a book of Rs.6, 000- 8, 000 crs from its current Rs.4, 400 crs (post securitization). The company in first nine months of FY08 has been disbursing loans of roughly Rs.300 crs per month.

2. Project Financing
SREI is trying to make big into project financing business where the Net Interest Margins (NIM’s) are lower in the range of 2.5% to 3.5%. The projects would specifically be in the infrastructure space only, as the company has good understanding of the same.

With getting Rs.375 crs from JV and roughly Rs.250 crs of cash infusion by promoters over a period of 1 year by converting the warrants into shares, the company plans to have a Net worth of Rs.800 crs for the business. With a leverage of 8x-10x, the company again aims to build a loan book of Rs.6, 000 – 8, 000 crs over a period of 2-3 years.

SREI is in serious talks with many parties for the project financing, but will announce the actual details only after the completion of all formalities.

3. Stake in QUIPO
QUIPO Infrastructure Equipment Limited (QIEL) is India’s largest renting out construction equipment company. SREI holds 17% of the company and it is supported by Construction Industry Development Council (the apex industrial body formed by the Planning commission and the Ministry of Surface Transport, Government of India).

SREI is in talks with other shareholders of QUIPO and intends to raise its stake in the company. In last few quarters, SREI has raised its stake to 17% from 15%. The estimated value of QUIPO is Rs.1, 500 crs and SREI stake of 17% can be valued at Rs.235 crs.

Positives
1. Excellent asset quality – With its gross NPA less than 1% and provisioning exceeding 80%, the asset quality is comparable to that off HDFC and IDFC. With its excellent track record, we can assume the management to deliver best results in this aspect.
2. BNP Paribas association – We expect that SREI would be able to increase its NIM as they would be having access to low cost funds from BNP. With its predominant position in the infrastructure equipment financing business, growing Indian economy and steady relationships with its clients, the opportunity is huge for the company.
3. Low tax rate – The Company is expected to have its tax rate at 9%-12% over the next 3 to 4 years as it keeps on paying MAT.
4. Strong Book Value – SREI had a book value of Rs.47 at FY07. We expect the same to increase to Rs.58-60 at FY08 and Rs.75-80 at FY09. We have not factored in any of the money infusion by promoters at Rs.100 and any major appreciation from the project financing business.
5. Warrants allotment to promoters – In Nov 07, the promoters allotted 2.5 crs shares to themselves with a conversion price of Rs.100 per share. On April 1, 2008, promoters converted 72 lac warrants into shares. After the entire conversion, the promoters holding will go up to 35% from its current 20.1%.

Take off - Point

One of the biggest deals cracked by the company was of recently allocated Rs.25, 000 crs Ganga Express Highway project. SREI is the sole advisor to the UP government for the project. The company is going to play a key role in project management and advisor for the project. The advisor fee of roughly 1% of the project cost is to be shared between SREI and UP government. SREI will receive its share of Rs.100 – 125 crs over a 5 year period. We believe that if SREI management can figure out some mechanism to get the entire amount upfront through some bill discounting route that will add a one time Rs.6.5 to the book value.

Other Major Initiatives
1. SEZ – SREI is developing 2 SEZ’s, one auto SEZ where SREI holds 89% of the equity and another one in collaboration with QUIPO where SREI holds 50%. Both the projects are close to 1000 acres of land development and involve hundreds of crs. As there is substantial time involved for the cash flows to happen, we have not included them in our calculations.
2. Road projects –SREI under one of its subsidiaries has got 7 road projects worth Rs.4000 crs and 950 kms where SREI holds anywhere from 26% to 49%.
3. Port project –SREI is developing a port in Rewas where the initial capex is as high as Rs.4000 crs and the project is expected to be profitable at the net profit level post 2014. Again we are not including the same into our calculations.

Pressing the button

We believe that SREI with its strong fundamentals, strong domain expertise, JV with BNP Paribas, low NPA and strong management is available at reasonable valuations. We expect SREI to trade at 2.5x-3x of its FY09 BV in next 1 year. We expect an appreciation of 50% from the CMP of Rs.140 in next 9-12 months time frame.

Sasken CT Realty Ltd.

We know anything with a suffix - realty, developers, real estate has been shunned over the past few weeks in the markets. But we have a deal for investors, or rather a game...
Suppose you were asked to play a game which in which INR 5,000 is deposited into your account. If you win (of course after a length of time during play) you could win big time. You could get twice, thrice or even four/five times worth what you bid. Incase you lose, however, you will get the INR 5,000 deposited into your account and nothing else...

There will be NO catch in this game. No you would ask, who the hell will sponsor such a game. Well, for one, there are enough people willing to give away free money in the market. Especially the stock market. Anyways, lets get back to out game.

Is it possible to find such an investment in the market. I think we have found one. It's name is Sasken CT (Realty) Ltd.
Weird, isn't it? What do you get when a cross a IT company with a real estate player. The idea would, according to market pundits, would be a disaster. We are no pundits. Coming back to Sasken CT Realty.

This company is a IT (rather a communication vertical player) company, which according to us is available for free in this market. Please explain, you would say.

Let's therefore get our arms around what we mean....

The background:
1. 52 Wk high @ around > INR 500 sometime in mid-2007
2. 52 Wk low @ INR 86.5 on 19 Mar 2008 (could be tomorrow, day - after.....)
3. Revenues - 9M FY 2008 - 412 crores with a operating margin of 4.5 %
4. Revenue mix - US constitutes only around 30% of FY 08 mix EMEA > 50%
5. Cash flow positive.
6. Has net cash of around INR 10 crores
7. Enterprise value - INR 240 Crores
8. Institutional holding @ 30% with average price of acquisition > INR 300 (holding period >1 Yr)

We'll stop at that. You can buy this company tomorrow @ INR 240 crores from the market. Keep this datapoint in mind.

We looked at the Q3 FY 2008 income statement and balance sheet. Go ahead and take a look:

http://www.sasken.com/results/Q3FY08/Sasken_Q3FY08_Media_Release.pdf

Break - up value of this company:
Net Cash - INR 10 crores
Receivablies - INR 112 crores
Land - INR 180 crores ( two buildings - 1. Domlur, which is close to city center & 2. on route to Electronic city). Combined sq feet of > 5,25,000 and we value it at INR 3500/sq ft
Total value - > INR 300 crores

We would like to discount this value by 10%. Even after this, we have INR 30 crores surplus.

So the deal is, forget IT man - lets buy it break it up and make cash instantly without having to worry about running and understanding the business, you see.

However, we believe that, Sasken with all the people who run it are more than capable to generate a long term sustainable multi million $ profit enterprise.

We believe that the street has gone overboard in taking a very pessimistic view (resulting from the US slowdown) on some valuable companies and here we would like to twist the term of Alan Greenspan. We call this kind of moments as - Rational Antipathy. Or simply put - Seeming display of rationality in hammering the good guys...

Financial analysts would go only by numbers, so let us throw them in as well - Sasken trades at
1. 0.6 x PEG with a 7.5 x 1 yr forward Price / Earnings
2. 0.5 x Price / Sales (or INR 130 sales per share)
3. 4.5% Dividend Yield (We've now started of talking about dividend yield on IT companies.....When was the last time that happened)
4. 0.6 x Price / book (or INR 140 BVPS, we really like this - our original premise of selling the land.. Wow)

To quote Warren Buffett, "We simply attempt to be fearful when others are greedy
and to be greedy only when others are fearful."

Are you ready to play this game, and yes we can rename this company to Sasken CT Realty Ltd. by appointing the best lawyers and consultants and paying them their worth.

Are you game???

P.S: If you are still digesting what it's all about - BSE ticker 532663.

Gold fever. It ain’t what it used to be!

Producers Removing Hedges

In 2007, most gold producers (E.g. Newmont, Barrick etc) removed their gold hedges in anticipation of a rise in gold prices, which came true in the last quarter of 2007, witnessing a substantial increase in gold prices, although top-line gains of these companies were affected and offset by higher operating costs, still the highest operating cost was around $400-500 per ounce which still leaves a decent margin on a price of $800 gold.

Production more difficult, limited supply and consolidation underway

Since the depletion of gold mines is more rapid then the other conventional mining assets like base metals, Gold producers are constantly pushed to acquire new assets. Although prices remained elevated, key producers remain under huge pressure to increase reserves and lower production costs. It should be noted that in most cases there has been no new discovery of precious or base metals, the reserves were lying there for years, just uneconomical to produce because of the low prices.(refer table/charts below.)

Gold fever. It isn’t what it used to be!

We look back on the last time gold hit $850 (1980) with even gold teeth going into the melting pot. Not this time though, as many feel the metal has much further to go yet on its upward path. The hype and hoopla that accompanied gold's record-breaking rise the last time around is probably missing this time partly because although there is plenty of risk around, including high oil prices, there is little 1970s-style doom saying.

Though the price of gold seems very high today, the record $850 an ounce it hit at the London fixing on January 21, 1980, translates in today's money to more than $2,150 and therefore we can say that we are comfortable at these levels (inflation adjusted).
(Refer to http://www.mineweb.com/ for more details)

If that’s the case, why is gold falling now?

The only reason gold peaked recently ($918/ounce), coming back to $880 levels, is a result of current scenario in which the market for gold-specific factors that have been acting unfavorably. There have been two price drivers have become less supportive.

First, central bank selling has picked up for some parts of the world, and second, speculation is underway.

Having said that; a strong recovery in physical demand (particularly from India & China) and positive external drivers outweigh the two gold specific factors for now. Hence in our view the gold prices are likely to maintain their upward momentum in the months ahead.

More room for upside

We anticipate that gold prices will continue to increase on account of a weak U.S. dollar and concerns about inflation. Gold is up approximately 30% for the year, with a year-to-date average price of $760 per ounce. Notably the 5-yr return on gold was a total of 140%. We expect a weak global economic growth, increase in inflation fears, a flight to quality for safe haven and other market concerns with the broader economy which will in turn support for higher gold prices. Historically it has been seen, that a US FED easing cycle results in money flowing into commodities especially oil (a.k.a.black gold) and precious metals.

Some of the charts to support the thesis:

World Consumption Pattern

Gold – a tool against Inflation

Gold – a bet against dollar

Charts Source: http://www.reliancemutual.com/

Some of the recently listed articles for gold outlook http://www.mineweb.com/mineweb/view/mineweb/en/page33 http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=44725&sn=Detail http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=44725&sn=Detail http://www.gold.org/value/stats/statistics/investment/index.html

IT Sector – IS Bhav Main?

The sector is falling, rupee is rising, wages are going up, taxes are just 2 years away, US is getting into a recession and EU might just follow. The list is endless, but point is: What an investor should do now?

All those guys who had bought IT stocks at the higher levels with the expectations that it will further go up, are probably wondering what to do now. Can things go bad from the current status? Probably yes. How much more? We don’t know.

All the fund managers and analysts are saying that IT is a contrarian call at the current levels. We tried to do some digging around the statement and the results were quite interesting. The delivery based volume on NSE in TCS and INFY has gone up substantially in last 1 year. The chart below (Blue – TCS, Purple – INFY) goes on to show that delivery %, which used to move between band of 50%-60% in 2006, has now been moving in the range of 60%-70% in 2007.

With relatively stable total quantity traded, increase in the % of delivery proves that the traders and punters are not playing, and only people with serious money are involved right now.

Lets talk a bit about fundamentals - Bloomberg consensus estimates shows an INFY EPS of Rs.108.86 for FY10 assuming the tax rate of 25%. Let’s make the tax rate 35% then our EPS is Rs.88. So the PE is 16.8 FY10. Is that expensive? Kindly note that this PE is less than 1 PEG. If INFY, TCS, Wipro, Satyam, HCL can sustain a +20% EPS growth rate, then these stocks are trading at a steal. So can we buy now?

As wise people say, that it is always the darkest before the dawn. Whether it is 3 am or 3.30 am before the sunrise of 5 am, we don't have an answer. So if the pain is endurable, then let’s jump.

As Lance Armstrong says....Pain is temporary, failure is permanent.

Caveat Emptor!!

Literally “Buyer beware”.

The Indian stock market continues to be in the push-pull mode with research houses split between where to invest in 2008. While the general tone of the market seems to be bullish, with research houses almost unanimous in putting Sensex targets around 23-24,000 by the end of the year 2008, the individual stock recommendations seem to be in disarray.

Everything in today’s market is up for sale. We believe that the situation is quite similar to one witnessed during the annual exhibition sale of wares by small traders/hawkers. During these sales, where a large number of buyers are visiting stalls of traders, one tends to play oneself to the mob psychology. We loosen our purse string to things we would not have bought in ordinary course, or unassumingly pay a price for an item which is not worth half of what we ended up paying.

This is precisely what’s happening in the current market scenario, we believe. Every time we loosen our purse string to buy a new idea, hot tip or the next growth company, we need to very careful of what we are buying. Like always, it is easier said than done.

What we said was evident with investors rushing to invest in mid-caps stock a few weeks ago as if there was no tomorrow, resulting in stock prices shooting by 40-100% in select mid-caps. Over the past week, however, the same stocks have pulled back around 20-30% and we believe that a very small percentage of investors have made money during this period.

5 questions to ask before you buy a mid-cap stock

1. Do you really understand or made efforts to understand the business model?
2. Have you done a gut check on the recent reported numbers by the company?
3. Did you bother to check 3-4 basic valuation ratios of the company at the CMP?
4. Have you decided the time horizon till which you will hold this ticker?
5. Will you buy more of the stock if it tanks 35% or more after you bought?
   
   If the answer to ALL the above questions is a thumping YES than go straight ahead with your investment, else take time out and ponder a little more because the stock markets always opens in a few hours after they closes.
   
   And always remember the golden words 'Caveat Emptor'.