Monday, May 19, 2008

Cutting out of KRBL

I had bought KRBL at 139 a month ago and sold it at 119 last week. This is a very interesting stock as it illustrates the risk that govt can expropriate wealth that capitalists might consider theirs. Some people get govt to transfer public assets to them at low value - witness the real estate deals and how FSI's get increased and tax status changed after the deals have been stuck. Others can't stop govt from stealing what is theirs by passing taxes that are 'legal' - after all the government decides legality.

Basmati is an interesting commodity. It is probably the only commodity which India has marketed well enough that it is now a brand. It has also fought hard to make sure other pretenders from Vietnam etc don't steal the brand. India and Pakistan are the largest producers with India accounting for the lion's share. 90% of Basmati production is exported, as the rice is expensive (3x-4x price of normal rice). India exports about 1mn tonnes, at $1000/ton, this is export earnings of $1bn - 4000 crore for the rural economy. Not bad.

KRBL is the largest basmati rice miller and exporter in India. Surely - one would have thought -with rice prices shooting up throughout the world, this company should benefit. And with the stock at 4x Fwd P/E, this should be a multibagger. At least, this is what I thought.

Export taxes: Well, I was wrong. Rice prices are going up and feeding into inflation, so the govt has come up with an export duty of Rs 8000/tonne (or Rs 8/kg) to prevent exports. Last I remember, Basmati was selling for Rs 80/kg, so this is a 10% tax. This will reduce exports of Indian Basmati, which will then get sold locally pressuring domestic rice prices.

Now one can argue that it is all in the interests of the common man, so govt has done a great job. It is making sure that some capitalists dont benefit at the expense of vast majority of poor people. I disagree with this. I think this tax will hit Basmati supply in India - the very outcome that the govt wants to avoid.

Thin margin business: The margins are thin for millers (5%-7% PAT margins), so a 10% tax can effectively destroy their economics. So they will be forced to raise prices, which will hit export demand.

How elastic is the export demand? Some people will argue the following to justify price hikes can be absorbed without impacting demand: a) Basmati is a brand of which India produces the lions share, b) It is the rich man's rice, so price elasticity is less, (c) Indian basmati is anyway more expensive than Pakistani variety, and (d) there is a supply constraint of rice globally.

I dont think thats the case. I think argi commodities have high price elasticities and are almost perfectly substitutable. Besides, if export demand doesn't slacken and domestic rice prices remain high, govt will again increase export taxes. So there is going to be a big demand impact.

Long-term supply reduction: As exports take a hit, millers will dump rice domestically, which will cause a fall in domestic Basmati rice prices. So thats good for the common man.

But what about next year? Millers won't again procure the same quantities of Basmati paddy that they did this year - after all export demand will be down. Some farmers will switch to other crops.

More importantly, this will give an opening to Pakistan, Vietnam and other countries to capture market share in the international Basmati market. If demand is there, and India is willing to fulful that only at exorbitant prices, demand will find other supply sources. The longer the Indian govt persists with this tax, the more likelihood it is that Pakistan takes away the market.

Of course, the govt will say that this is a temporary tax, and as soon as rice prices normalize, this tax will go away. I just look at HPCL and BPCL and think that it might not turn out to be the case.

This tax reduces incentives to create supply. Indians won't buy a lot of Basmati at the price it normally sells, and govt wants to discourage exports. How can govt incentivize people to produce something if they end up losing money in the process?

3 comments:

VIRAM said...

HEY DUDE PRICE OF BASMATI RICE HAS UP BY 20 RUPEE 1 KG. AFTER IMPOSING 8/PER KG DUTY.NOW PRICE IS 105 PER KG SUPREME BASMATI RICE.RATE IS EX DELHI.

Value Architects said...

Your assessment is not correct.
Basmati guys age inventory for 12 months before exporting. The crop on which they are sitting is 12 months old - when the prices of paddy were Rs 18/kg. Presently the prices in the market are $2000/T, ie. Rs 80/kg. This is after inclusion of export duties. Infact after export duty, further scarcity has lead to further hike in prices.

"I dont think thats the case. I think argi commodities have high price elasticities and are almost perfectly substitutable. Besides, if export demand doesn't slacken and domestic rice prices remain high, govt will again increase export taxes. So there is going to be a big demand impact."

1)In order to impose Export tax, you got to account political ramification by the importing nations - Saudhi govt is already pressuring india to remove cess.
2)Basmati is not substitutable - India & pak enjoys a natural moat - due to their geography.
3)Indian mkts dont have capacities to swallow the export-supplies of basmati. Rice and basmati are not-subsitutable.
4)Presently, indian farmers are moving from other crops like sugarcane towards basmati - which is fetching them higher prices. Presently they are making nearly Rs35/kg from sale of basmati paddy.

You may find more on this at my blog.

PENNY STOCK INVESTMENTS said...

Nice stock