Bluffed in the Budget

Today was the second budget that I listened. Last time I did not bother to understand it too much, this time I decided to check the numbers. Before I Delve into what has been presented by the FM, here is a small table that will help make matter simple

The FM is projecting a petroleum subsidy of Rs 23,640cr. If I do a backward calculation assuming that given the inflation scenario the government does not increase the prices of the petroleum products going further point 1 gives the scenarios

Item	Petrol	Kerosne	Diesel	LPG
Consumption Quantity (MMT) in 2011-12	15.2	9.3	66	14.8
Current market price	58.37	12.32	37.75	316

1. Now doing a quick math on the above figures, assuming that the government bears 77% of the total subsidy and the upstream bears 33%, the crude price has to be $76/bbl and the prices of these products should not be marked down if crude is to fall to those levels.
   On the other hand if I assume the crude price of $92 which I think is reasonable to assume in FY11-12 the total subsidy bill comes about Rs.98000cr. Now if the government is to provide only 23640cr that is too less at 24% of the subsidy. If the government does that then upstream companies, downstream companies everyone will be paying out huge money and it would be really difficult for the OMC’s to even show a profit figure. The third possibility is he is banking on plugging the leak i.e containing subsidy payouts by ensuring that only the needy get the subsidy through the UID project. I would assume it to be the right step, but assuming that it will happen in 1 year timeframe is like buying a stock with PE of 500!!. Huge expectations!. For as simple as taking approvals for setting up a power plant where you require approvals from just 5-6 agencies takes years, just imagine opening an Indian Rural Facebook with so many districts, panchayats etc


2. On the gross tax receipts Rs.9,32,440 an increase of 25% over the estimates of 2010-11, without too much changes in the tax structure and allowing the exemption to the common man which according the FM will lead to lower tax receipts of Rs.11500cr means he is expecting way too much from corporate profits. I mean how is that even possible, on one side equity markets is punishing companies due to inflationary scenario and our FM comes and says that he is expecting corporate profits to grow upwards of 25%. I don’t think that is possible.


3. For the above kind of growth to happen, credit should be available at reasonable rates, RBI has been tightening monetary policy has raised the key policy rates by nearly 150bps and can raise it further if it does not stop here. The borrowing gets expensive, capital plans get shelved, how does our FM expect the economy to grow by that much amount


4. This year the government received a bonanza in terms of 3G auctions, I say this because all the telecom players have made their not so ugly balance sheet into Altman Z balance sheets. This is not going to happen in the next year. I mean if government expects to come up with 4G then we might expect some payout but again that is not happening, even if it happens, we will need to find a whole new hosts of operators to pay the money.

I think the targets set by the FM are overly optimistic on the backdrop of no reforms and the rising crude prices and higher fertilizer subsidy payouts. FM has been able to deliver what he has promised, this statement is borrowed from one of the speakers on CNBC, but this one looks like he has raise the bar too high for himself. All can I say is best of luck Mr. FM. Hope to see the number s you put out actually being hit.

The market falls

I came across an interesting graph today.. the market falls greater than 500 points. Since it was for the first time that i actually felt the market going down as this time i was Invested rather that other times when i was just an observer. I took the market fall snapshot also.

Getting Squeezed

There are some companies who are dependent on just a single company for a bulk of their revenues. I had invested in one such company some time ago but did not realize this concentration risk. I had bought the company as the market was not factoring in the increased capacity that the company would have. When I look back I realize that capacity addition cannot be the sole reason for buying, as the margins that the company makes on that incremental capacity might be very different. The company I had bought was Hitech Plastics, the company derives 80% of its revenues by selling plastic containers to Asian paints. Now if Asian paints wants to protect its margins in an rising input cost scenario, the first place they will cut their margins is where they have the highest bargaining power and that will be guys who are solely dependent on them and hitech fell in that category.

Next consider the case of a company called Shah Foods which is basically a bakery company, the company does contract manufacturing for Britannia biscuits. The company is 100% dependent on Britannia for its revenues and the company in its annual report acknowledges the fact that they have been trying to diversify its revenue base, and the demand from Britannia is highly erratic and irregular. Their financial performance speaks of the same.

Next the most recent example which actually prompted me to write this article, Mphasis derives 80% of its revenues from HP and yesterday in the results reported by the company there was a mention of the company giving price cuts to its parent company. Now people are questioning the corporate governance issues, but is it not a matter of lack of pricing power and bargaining power rather than corporate governance? It simply shows the solutions being provided by the company to HP are not differentiated and there are other competitors who are willing to provide the same service at a lower cost. Had the company’s product being in-substitutable, the price cut would not have happened as the possibility of switching from one service provider to another involves a lot of costs and effort and time.

Had the company not taken a price cut, HP might have moved to some other solutions provider, the revenues would have taken a further beating and hence the profits. There are numerous companies that take a price cut to push their products, but the fact here is accentuated by the fact that the cut is taken for a customer from where 80% of revenues come, this leaves the company vulnerable to further price cuts since it bulged once, it might bulge once again.

After my learning’s from Hitech I have decided not to invest in companies which are hugely driven by one customer and even if I would invest it would be at a huge huge discount to the multiple that other firms are trading at in the same space.

Mr. Porter said it long ago, look at the bargaining power with buyer and suppliers.

Compounding Machine

Value investing has the same definition but everyone chooses different stocks. The field is huge. But i like the concept of "Compounding Machine" brought about the manager of Akre Focus Fund

1. have durable pricing power
2. have real prospects for growth
3. are not natural targets of regulation
4. require only modest amounts of capital to operate efficiently
5. are run by people of the highest integrity
6. duplicate what happens at the company level at the per share level
7. have an opportunity to reinvest all the excess profits at above average returns

This model of great businesses, great managers, and great reinvestment

opportunities has the potential to create a great “compounding machine”.

Hyderabadi Biryani - Tasted really Bad

Hyderabad Investing sucks!! That is how my experience has been investing in companies based out of Hyderabad. The companies are among the worst in terms of communication of information to shareholders. I guess as Dilios say’s in the movie 300 “We did what we were trained to do, what we were bred to do, what we were born to do”.
The Hyderabadi Companies can replicate the above line with a small word at the end which says ‘-SCAMS’.
The premise comes from two companies that I ended up investing and from other examples that we all are aware of, Ramalinga Raju. Below I will write about the two companies

1. Premier explosives:A company based out of Hyderabad, whose website seems to have been updated ages ago. None of the phone numbers given on the website leads to the company. Even if you try calling the agents, most of the numbers are out of service and one number luckily got a response, a guy picked up the phone, but alas, he did not have the head quarter number.
   
   The problem with the company is the company has been maintaining its gross margin over the past quarters, which is a good sign as the raw material price rises have been passed on to the end consumer which is 90% times coal India. The worry is the employee expenses which have been travelling at the speed of light. On exactly the same quarterly sales as last quarter, the Q3FY11 results show that employee expenses have increased by 28%. In Q2 and Q1 the Y-o-Y increase was 19% and 25%. I fail to understand what has the company been doing without increasing the sales which is leading to such dramatic jumps in employee cost. I had asked the same questions to the management in the HOPE that would reply, but as it turns out that my hopes are based on FALSE EXPECTATIONS. I Have not received any reply from the company till date.


2. Nagarjuna Agrichem The name speaks of its Hyderabad origins, but I somehow got invested in the company due to two good years of growth the company witnessed where it made EPS of 40 rupees each year. But alas!! I was caught at the wrong part of the cycle. Anyways that is my mistake. The company had a plant shutdown for the DECEMBER quarter for 2 months and there was no investor communication!! Can you beat that!! I guess No!! Tata chemicals even if they close the plant for 15 days, they send out a notice to the exchanges. Well that’s the difference!!

I face a dilemma whether to book losses on these stocks or not. For the second one I will wait till the next year. On the first one, if the management replies to the emails that I have sent them after Q3FY11, fine, otherwise that would be my first BOOKED LOSS.

One more thing I was reminded of after the recent market correction is

“Markets go up the stairs, but come down the elevator” – warren buffett