Decoding the Indian markets - Bull or Bear?

Indian markets have shown a lot of volatility in recent times. The market rallied 15 percent (about 2,650 points) in 15 trading days between 28 August 2013 and 19 September 2013 on account of the fading threat of US military attack on Syria, steps announced by the new RBI chief Mr. Raghuram Rajan to address depreciation of the Rupee and liquidity constraints and also the dovish stance by Fed which postponed the anticipated QE taper and thus resulted in an increase in FII investment into Emerging Markets (EMs) like India. FIIs made Net Equity investments of Rs.11,138crs in September (till 19^th September 2013) as compared to a net outflow of Rs. 6200crs in August 2013.

However, markets lost nearly 400 points on 20 September 2013 on Mr. Rajan’s decision to hike repo rates by 25bps and the blood-bath continues. So where exactly is the market headed and what are the factors to watch out for?

Well to address this let us rewind a bit and look at the concerns the markets were facing pre- the rally – CAD issues, depreciating rupee, economic slowdown, inflation worries, debt burden for corporates, policy paralysis and low visibility on core- policies owing to the looming elections. The Rupee regained some of its lost luster from the historic lows of 68.80 per dollar reached on 28 August 2013, benefiting from Mr. Rajan’s measures (including enhanced limits for exporters to re-book cancelled forward exchange contracts and a swap window to swap foreign currency deposits,etc) and renewed interest in EMs owing to Fed postponing the taper. However, India’s other macro-economic concerns remain, the impact of which will play out in the upcoming corporate results session which is expected to be disastrous.

In view of all these factors, I believe that while the Fed taper postponement might lend support to Indian markets as capital gets reallocated to EMs, markets are still likely to remain highly volatile in the next few months owing to risks related to the impending taper, weak fundamentals, impending elections and lack of visibility on implementation of pro-growth policies.  Moreover, in addition to RBI policies, even Government support in the form of policy implementation will be a key factor for the up-turn of India’s economic and investment cycle. 

I believe, the markets are likely to move in an uptrend post elections since the new government, whichever be it, will be under a lot of pressure to deliver. It is likely that we will see the resurgence of the new investment cycle once we start seeing policy implementations aimed at structural changes in the country. However, until all these macro-factors play out, the markets are more likely to be a Trader’s market rather than an Investor’s. Also, there is a high possibility of markets correcting further if the Fed tapering occurs before we see any structural changes in the Indian economic/policy scenario. Till either of these happen, the market may continue to be a ‘Defensives’ and ‘Export oriented’ market in the near term as has been the case during historically weak periods and periods of a stronger dollar respectively. Additionally, there might be some interest in stocks which are 'Monsoon plays' in the near term owing to a good monsoon session. However, I believe that the core India-centric ‘Cyclicals’ will start gaining traction only after visible improvements in the economic and policy space.

Will Mallya have the last laugh?



Everyone seems to be talking about Kingfisher Airlines Ltd. (KFA) and Vijay Mallya these days…on how hopeless KFA is and how Mallya will possibly have to sell his other assets to raise money to appease KFA lenders and keep the airline operational. But is this really the end of ‘Good Times’ for ‘King’ Mallya or are we jumping the gun in labeling him as a goner? Let’s look at the facts:

Once amongst the top domestic carriers in India, grounded flights, layoffs etc resulted in KFA’s market share dipping from over 15% in 2011 to 3% in July 2012and spiraling losses for the company. The airline cut down its operations from 66 aircrafts in 2011 to 12-13 in 1H 2012 and now only 7 are operational. Financials pose even a more grim picture. As of FY 2012, the company has a debt of Rs8,030cr (short term debt is 2,335) + over Rs 1,300 crs in current liabilities in addition to payables to airport operators and exchequer. Increasing loss for the company during the year just adds to the gloom.  According to an August 2012 study on ‘Analysis of Indian carriers Q1-FY13 performance’ published by The Centre for Asia Pacific Aviation, KFA requires about $600mn by October 2012 and a further $400mn over the next 12-18 months to save the company. As the 17-member banking consortium led by State bank of India (SBI), which loaned about Rs.7,000crs to KFA seems to be closing in, the key question on everyone’s minds seems to be- Where does this leave Mallya?

One positive for Mallya seems to be that after a long drawn wait, the government has finally opened up FDI in aviation of upto 49% in the second week of Sept 2012. This opens up one avenue for Vijay Mallya. But with the current state of the airline (high debt, huge losses, minimal mkt share, curtailed operations) it will hardly be a surprise if foreign players are averse to investing money in KFA. Just for the sake of simplicity even if we assume that some player is ready to invest in money at current market price of Rs14.45 it will still raise about Rs572crs. At a higher price of Rs20-25 the amount raised would still be between Rs800-1000crs, quite below the required levels.

Another option would be selling non-core assets such as Mangalore Chemicals and Fertilizers Ltd. (Mangalore Chemicals). Vijay Mallya has a stake of about 30% in this company. At CMP of Rs14.45 the stake is valued at about Rs.177crs, far less than the required amount. Even if we assume that the stock price increases considerably, the stake sale would not garner enough by itself to meet KFA’s obligatory amount.

For that matter, the yields from both the above measures combined (FDI in KFA plus a stake sale in Mangalore chemicals) would still be significantly below of the amount required by KFA or Mallya in the near term.

In case KFA is unable to raise the required capital in time lenders will resort to selling of non-core assets (as is being currently planned) as well as corporate guarantees of United Breweries Holdings Ltd. (UBH) will be called upon. UBH itself has Rs2,122crs in debt compared to Rs4,710crs in assets and of these assets 20% are invested in KFA. With limited scope for repayment of its own debt or KFA guarantees, stake sale in holdings seem to be only option out. We have already discussed how selling of non-core assets will not yield sufficient capital and FDI is also not a viable option (atleast till Mallya injects some capital into his airline), hence the remaining option is selling stake in United Breweries Ltd. (United Breweries) or United Spirits Ltd. (United Spirits).

Let’s look at both these avenues in terms of risk that Mallya faces. Currently about 7.56% shares or 10% of promoter’s stake of United Breweries is pledged. Compare this to United Spirits where 97.32% of UBH’s stake of 18.03% and 100% of Kingfisher Finvest’s stake of 9.69% is pledged. In short, 98% of promoter’s equity is pledged. In case of any event default in debt servicing, 98% of promoter’s stake in United Spirits will be at risk- a possibility of Mallya ceasing to be the controlling stakeholder of the company. In view of this we believe that United Spirits can better serve as the vehicle to drive mallya to safe shores.

A positive way of looking at solving the current crisis would be…. at current market price of Rs1,147.7, the United Spirits’ pledged amount would be valued at Rs4,085 crs. Hence, selling of stake in United Spirits could, I believe, create a win-win situation for all concerned. As per news reports, Diageo Plc (Diageo), the world’s largest spirit company, is looking at buying a stake in United Spirits. It is looking at a valuation of Rs1,200-1,300 per share while United Spirits is looking at a Rs1,400-1,600 price level. Diageo is also willing to retain Mallya as the chairman for life even if it gains a majority stake in United Spirits. At the above mentioned price range of Rs1,200-1,600 per share, even a stake sale of 15% would yield Rs2,354-3,139crs, there by solving Mallya’s near term worries. It would also leave him with a remaining stake of 13% in United Spirits, to enjoy the future growth of the company, as well as allowing him to continue as the chairman of United Spirits. United Spirits stands to benefit from synergy and new avenues of growth and funding brought to the table by global giant Diageo. With respect to Diageo, apart from the anticipated 15% stake from Mallya, the company is also expected to raise another 10% from other investors making it the largest shareholder in United Spirits and giving it a foothold in the key market of India which is expected to grow by 5-6% in volume terms, the fastest in emerging markets as India benefits from growing population and per capita income levels (Source: International Wine and Spirit Research).

With the required cash in hand Mallya can appease the lenders in the upcoming KFA lenders meeting (to be held in 1H Oct 2012), draw plans to restructure the airline and work on getting an FDI partner for KFA at better valuations.

The United Spirits stock has increased about 22% in the past 1 month and 134% Ytd while United Breweries has risen about 26% in the past 1 month and 84% Ytd. The KFA stock has increased about 55% in the past 1 month (Ytd: -31%). Additionally, UBH has increased about 35% in the past 1 month and 121% Ytd.

In view of the above mentioned factors I believe that the United Spirits stock could surge higher from current price levels either due to speculation on the stake sale or  re-rating due to change in fundaments (in actual event of a stake sale). Consequently, we could see further upside in the KFA and UBH stocks from current levels in the near term.  The good times remain for Mallya..for now...

Please note: The Current market Price (CMP) is BSE last traded price as of 25 Sept 2012. 1 month and YTD figures courtesy google finance. Picture courtesy google images.

  

Wipro ADR trading at a premium of 50% to domestic stock!!

Yups you read right! The Wipro ADR (ratio 1:1) is trading at a premium of 50% to the domestic stock. Lets look into the why’s of it, how investors stand to benefit and the possible way forward.

Considering the ADR and local stock are for the same company, ideally they should trade at similar prices, adjusted for exchange costs. However, it is found that most of the ADRs generally trade at a premium or discount to the local. The reason for discrepancy in prices of ADRs and local stocks is many-fold. Various reasons are demand for the stock (ADR) in foreign market, limited supply of ADR and difficulty in conversion of local shares to ADRs. ADR’s of Indian companies command a premium to their domestic counterparts due to demand mainly from Exchange traded Funds (ETFs), as it is easier for foreign investors to take exposure in Indian companies via the ADR route rather than going through regulatory approvals in India. Preference for trading in local markets also plays an important part. The premium is also due to difficulty in converting common shares to ADRs, which makes it difficult for arbitrageurs to execute trade.

Coming back to the Wipro ADR. Back in January 2007, the ADR was trading at an average premium of approximately 20%. The premium was totally eradicated in March 2008. However, since then the premium again started widening, reached 58% in October 2008 and peaked at 80% in Dec 2008 before reducing to a premium of 30% in May 2009. Over the past 1 year the ADR has traded at an average premium of 48%. So how does one benefit from this discrepancy in prices? The answer is arbitrage. One way would be buying the stock from local market, converting it into the various levels of ADRs and then selling these in the foreign market. Investors in local shares also benefit in a sponsored ADR program by tendering in their shares.





Going ahead, the Indian finance ministry’s recent mandate at requiring a minimum public shareholding of 25% in listed companies may play a vital role in reducing the Wipro ADR premium. As of March 2010, Azim Premji and family held approximately 80% stake in the company, which would require them to dilute the stake by around 5%. The ideal option in this case would seem the ADR route considering they would get a premium for the shares issued there. This may in-turn result in increased ADR volumes and subsequently reduced premium for the Wipro ADR in times ahead. Reminds me of the saying…if possible…’Make hay when the sun shines!’

Stocks mentioned here are: ADR ticker: WIT US, Domestic ticker: WPRO IB

Current Global Economic Scenario: Problems and possible solutions

The global financial meltdown has resulted in depressed economic conditions worldwide. The crisis which surfaced in July 2007 in US spread to other parts of the world leading to stock market crashes followed by long period of stock market volatility, credit crunch, failure of a number of leading financial organizations and rising unemployment. The impact was seen across the world be it the US, Japan, European countries or developing nations. Although governments across the world stepped in and announced a number of stimulus packages to help economic recovery, the crisis is far from over. According to the mid-year report by United Nations (UN), the global economy is expected to dip by 2.6% in 2009, with weakness extending in 2010 if the stimulus packages fail to fan economic recovery. Further, the report states that developing countries are the worst hit due to the recession as although they have been badly hit by rising capital costs, capital reversals and falling world trade, 80% of the global stimulus package (amounting to US$2.6 trillion) is concentrated in the developed world. So what should be the all encompassing solution to this problem? Are the measures being taken by governments across the world enough or do we need to make some additional efforts? The solution seems to be in restoring the financial system, the backbone for any kind of economic growth. In addition, proper alignment of the fiscal stimulus is needed with a view to global development and not concentrate on development of individual nations. Corrective actions need to be taken to ensure the fundamental problems giving rise to this kind of situation (regulatory or otherwise) are dealt with and resolved.

Emerging markets: have they really decoupled from the rest of the world

To answer this question one would have to look at what exactly is decoupling. Decoupling, as has been defined in the traditional sense, means the ability of emerging countries to grow without any stimulus from developed countries, primarily the United States. The April 2009 World Economic Outlook by International Monetary Fund (IMF) seems to support this phenomenon. According to the April 2009 World Economic Outlook by IMF, emerging market and developing countries outgrew the advanced nations in 2007 and 2008. Further, the report expects advanced economies to contract by 3.8% y-o-y in 2009 (United States to contract by 2.8% y-o-y) and growth is expected to remain flat in 2010. This compares with a +1.6% y-o-y and +4.0% y-o-y growth estimated for the emerging market and developing countries in 2009 and 2010 respectively. The world economic conditions have since improved, and the forecasts are expected to improve when IMF comes out with its revised forecast in autumn, but what remains the key take-away here is the fact that emerging market growth has outperformed the advanced countries in the past and the trend is expected to continue going forward.

World output growth 2007 – 2010

Source: IMF, April 2009 World Economic Outlook


Given the above facts is it prudent to conclude that the decoupling has indeed happened? And if indeed it has then what are the factors behind it?

Economic liberalization and globalization have been the key words in the world economic scenario for the past two decades and has let to a number of benefits, especially for the developing economies in the form of increased economic activity and improvement in the standard of living. Improved economic conditions and standard of living in turn has driven domestic demand within the developing countries, a form of shield for the developing countries from the broader negative happenings across the world - decoupling (although not in entirety).

Considering the base of decoupling itself lies in globalization how long can the emerging markets/developing nations continue to grow when the advanced nations are reeling under economic weakness. It is possible in the near term for the developing countries, especially India and China, to grow based on strength of domestic demand and mitigate the impact of global weakness but the long term success of any economy in today’s world of globalization is linked and entwined. The plummeting of equity indices around the world, including those of the emerging markets, post the financial crisis in United States is proof of the growing dependence of nations on one another. Prolonged global crisis would mean declining exports, drying- up of foreign investments and reduced cross-border lending. Reduced investments and exports would mean liquidity issues even for domestic companies, reduced economic output, rising unemployment, slowdown in the domestic economy and rising deficits. Besides, with reduced inflow of money and rising deficits, implementing fiscal policies would become very difficult for governments of developing nations. Thus to say that emerging markets have decoupled would be jumping to conclusion too soon. Having said that it would also be impertinent to totally ignore the strength of some of the emerging countries, particularly China, where government stimulus and spending is almost on par with some of the developed nations and is driving demand growth not only domestically but even in some sectors of the United states. So instead of arguing over if emerging economies have decoupled, a better idea would be to accept that a few of the developing nations are coming into their own, and if not dependence of emerging countries on the United States, in future it could be dependence on United States and China or dependence on China instead of United states. For now the dependence continues to exist and it is not only of the developing nations on some other nation but dependence of economies on one another, be it of the developing nations or of the developed nations.

-Shazia Naik
(Dated: 04 July 2009)