Connecting the dots…

Deciphering the Big Picture !

It has been a  year since this new government took office . Govt. unveiled a massive media blitzkrieg   to morph this  milestone into a mega event . Hi-pitched  adulations marked the anniversary celebrations.    But , on the ground , growing disillusionment in the broader corporate and investment world has taken much of the sheen off the celebrations  . Campaigns such as “Make in India” which is sweeping in scope , but short on specifics , have only added to the confidence woes . Rarely any govt. had taken oath amid   heightened expectations like the current government .   With reality falling far short of initial expectations , hope has given away to a mood of  despair .

Is the shine really off or should the  blame rest on myopic short-term view   . Is the consensus view of investment community missing the wood for the trees . Behind the growing impatience for a quick turnaround , savvy investors shouldn’t fail to fathom the larger footprint that is being laid out.  Much of the investment and business community complain that there is too much of piecemeal legislations and reforms that do not add up to any bold big picture  . That is barely the case if one moves beyond the surface . Digging deeper , one can see the deft designs behind the seemingly unconnected reform measures .

Let us start with what ails India’s macro that mars it  from achieving its long-term growth potential . Every time when we hit a cyclical peak of 8 to 9% GDP growth , we seem to be hitting a speed breaker in the form of inflation that puts India  back on a slower saddle . Inflation is a structural issue for India . It arises from supply side constraints in land , labor and capital (cost of capital) . If one addresses inflation issue structurally ( not cyclically  by raising interest rates) , it can structurally change India story. This is precisely what the new govt. attempts to do over time by systematically eliminating supply side challenges in land , labor and capital .

The key focus areas for this govt. have been easing land acquisitions , shifting savings from real-estate and gold ( thro’ the proposed domestic money laundering bill and the gold monetization scheme ) , rigorous auctions of natural resources ( taking discretionary power out from state and hence black money generation)   , proposed changes to labor acts ,  subsidy reforms ( effective implementation of direct benefit transfers   ) , higher allocation to rural infrastructure , capping MSP (min support prices) and  cutting allocations to free dole out schemes such as NREGA etc . All these have one common thread running across , which is addressing supply side constraints thereby structurally eliminating inflationary pressures from the economy . If successfully executed , this will go a long way in reducing cost of capital ( by structural low interest rates by lower inflation and from shift of savings to financial assets) , increasing supply of land and labor to productive areas and putting higher purchasing power on rural segment ( by wage and job growth ) .

This may not be a very bold and loud picture , but certainly a sensible big picture that can put the economy into a  sustainable  high growth orbit . As much as it is economically wise , it is also politically shrewd one   . Low inflation and rural wage growth  are  proven prescriptions for winning elections in India   . But not everything is as  rosy as it seems  . Any structural shift will need adjustments that will be painful in the short-term . Current one is no different with delayed recovery on the ground till reform measures take hold  .

For investors , understanding this big picture is critical for their  investment choices . Retail investors have to move beyond their favorite gold and real estate to capitalize on the emerging theme .  Financials and rural based themes will emerge as key opportunities for investment ideas . Markets in its myopic mood can not see beyond few quarters and hence its disillusionment .  When market loses traction on worries on immediate earning growth , it throws a brilliant opportunity for long-term investors who keep their eyes on the big picture .  It is time for bottom-up stock picking to create long-term wealth from the structural shift that is being clinically crafted by this politically  savvy government . Interesting times ahead !!.

ArunaGiri . N


Divide and Conquer !!

Value Unlocking by Spin-offs….

One plus one is rarely two in the investing world . That shouldn’t come as a surprise for seasoned stalwarts of schizophrenic markets. Sum of parts  larger than whole – is the gaining wisdom in the whimsical world of finance.  Spinoffs in much of the  cases miraculously magnify the valuation so as to yield juicy returns for investors.

As savvy investors know , value unlocking in listed space  needs a catalyst . Corporate actions such as buy-back , open offer , delisting , mergers and demergers act as the required catalysts for rerating in mispriced stocks . Of all these , the most profitable one by historic data is the catalyst in the form of demerger . Spinoffs and subsequent listing of demerged entities have generated handsome returns for investors .

For the parent company , rationale for demerger can be many and can well be beyond the limited objective of value unlocking . Needs such as strategic sale , differing funding profile , sharper focus , promoter’s funding needs  etc could be some of those drivers  . Take the case of Crompton Greaves which is in the process of demerging its consumers business . This demerger is primarily driven by the promoter’s ( Avantha Group) need for raising funds for its power and infra ventures vide its plan to exit from its consumers business . Or take the case of Polaris which demerged and listed  its product business “Intellect” recently in the market . The funding and return profile between IT services and IT product businesses are vastly different . While Polaris’s IT services business is in a mature phase throwing cash year on year with stable growth , its product business is in investment phase with significant needs for regular cash infusion . This mis-match in return and funding profile underscored the need for demerger in the case of Polaris.

Irrespective of the underlying rationale for demergers , historic data over past few years shows that the demergers in majority of  the cases  , resulted in sizable rerating for both parent and off-shoot units  . As per one of the studies , of the top 11 demerged companies by market capitalization , almost 60%+ of them have delivered “2x – 7x” returns over the event cycle . Intellect design ( from Polaris) , Orient Cement ( from Orient Paper) , NRB Industrial bearings (from NRB) , Marico Kaya ( from Marico) , Star Ferro ( from Century Ply) , Gulf Lube ( from Gulf Oil) are some of the stellar performers that created significant value creation from demergers.

Interestingly , demergers define much of  the deft portfolio strategies that value investors rely for cash management during market tops . When value is scarce during market tops , value investors vote for special situation based arbitrage opportunities to eke out the extra returns while conserving the cash at the same time for the rainy day    . In Buffett’s parlance it is called “work-outs” . Demergers tops the work-outs during market highs with its attractive arbitrage returns profile .  The added kicker in demerger based arbitrage strategy  is that the inefficiency in the price discovery process of the demerged company ( mis-pricing during the listing process )  can many times morph the resultant company into a deep value opportunity for value investors  . Understandably , nothing is seen in the  horizon that can  dent the dazzle in the demerger themes  for times to come !.

Market Musings

Wobble while waiting… 

The wait is long and not over yet for the earnings to show up on the ground . The ongoing earning season offers no comfort either for a quick turnaround  . As the market waits for the earnings to catch up  , its vulnerability to shocks have risen manifold . Tax tantrums on MAT (for FIIs) ,  pains in rains and political grid-locks have only worsened such risks . Given the elevated level to which the valuation has vaulted  over last year , global gyrations if any can wreck a wobble during this protracted wait . Markets have ample  reasons  for such gyrations in the coming months . Impending fed rate hike cycle , potential Greek exit , hard landing in china or any reversal in crude story etc could trigger such global gyrations. Not to forget the risks from reversal in Rupee’s one way run so far . Surging FII inflows have so far kept the rupee on a robust wicket , defying the fundamentals that warranted weaker one . It is a familiar fact that the Indian currency has appreciated significantly on a trade weighted basis , impacting the export competitiveness .Fickle FII flows  on  delayed earning    cycle  is  a  serious  threat  to  Rupee in the coming months . If tapering traction in FII flows over last few weeks is anything to go by , it could be a rocky ride for rupee in the near term .

For investors , it is a classical early stage scuffle between valuation that has gone up on hopes and earnings that is yet to catch up on ground . This tussle is a typical of what  happens in early stage of every economic recovery cycle .  Nothing to get nervous about , but to welcome it as a window for deployment ( nibbling) during this dull phase . It is a typical pattern  of “long-term gains at the cost of short-term pains”  in such stage of the cycle . Since markets never adjust in orderly fashion , the ride will have its nerve wrenching moments . Seasoned investors understand these nuances and will welcome such a  fiery ride for distress prices , instead of fretting about temporary portfolio losses during these volatile times . Of course , one needs to have a cushion of cash to capitalize on such wild swings . Portfolio managers and investors who have conserved cash will come out as winners from this wobble-in-the-wait   . Risk to such a cautious call is that if there is any  sudden surge in FII sentiment (hence liquidity) , it  could trigger a sharp rally defying the weak medium-term  fundamentals . While this is unlikely given the lull earnings season and the impending fed tightening   , it can’t be completely ruled out .  Interesting times ahead .