Deflation and Commodity prices

Sometimes I really wonder why bulls on everything else are perma-bears on commodities and commodity stocks. That such high return ratios for commodity stocks cannot be justified. I don't think they realize that if commodity prices were to collapse, we will get outright deflation. The only thing holding the world up right now are high commodity prices.

That makes me wonder - all this recession and not even one scare of CPI deflation (not asset price deflation)!! Or is that a 2010 story?

The simple reason to invest in EM's is - there is structural inflation here. Somewhere like Brazil, where we get 7% inflation and an appreciating currency - if one can time the currency swings right - is the best. Economic theory would suggest currency depreciation in an inflation heavy country. What we see is currency depreciation in potentially -ve inflation countries and appreciation in +ve inflation currencies due to capital flows. This is such a better way to generate returns.

Jagran Prakashan

I recently purchased Jagran Prakshan. Publisher of Dainik Jagran newspaper in North India. Reasons:

a) My hunch is - ad biz in India is going to rebound much more strongly than anybody anticipates. Last year, media companies reduced ad rates as ad buyers stepped back fearing a recession. So media companies faced a volume AND price decline. Advertising is like real estate and commodities in that respect - volume and price both go up and down at the same time.

Now, the thing is - India continued to grow at 6%. This year, ad buyers are back - real estate, IPO, financial services are getting back on their feet. Media companies are now seeing more volumes, but they haven't pressed the button on prices. Sooner or later, they will.

b) Analysts are modelling just volume growth and not pricing growth - at least for Jagran. That will prove a bit conservative - maybe a bit too much.

c) The biggest swing factor for newspaper EPS is the newsprint prices. Currently they are rock bottom. This has benefited Jagran. If they go up substantially, this will be -ve. What I am hoping is that they don't go on a rocket fire here.

d) It can easily do Rs 5.5 EPS this year, if newsprint prices remain within bounds. So the stock is trading at 19x. While it might look high, remember that Indian consumer staples are trading at 25x. They are unlikely to beat consensus estimates - while a consumer discretionary (media) can.

e) Will Indian newspapers go the way of their US counterparts? There are a couple of analysts who argue that they do not structurally like the newspaper industry, considering what is happening to newspapers in the West. What they forget is that newspaper circulation peaked in US in 1984. Till 2000, newspapers remained in fine shape. There is zero threat of Internet to the local language newspaper industry in India - till the time Internet content is predominantly English.

Disclosure - Own Jagran.

So here is how it is now. Consumer - Jagran, Godfrey Phillips, a little bit of GSK Consumer. Financials - Shriram Transport, Crisil. Manufaturing - FAG Bearings. A little bit of this and that. Biggest risk is in Crisil - Moody's (MCO) chart gets scarier by the day.

Excise duty cuts - what happens when they reverse?

I looked at Godfrey Philips numbers in a bit more detail, considering I have mentioned it a few times now. The profits of the company almost doubled yoy in 1Q, which is very unusual. I thought there might have been some dealer inventory movements, and only after looking at 2Q will a clearer picture emerge.

In 1Q10 (June qtr), there is an excise duty reduction of close to 16 crore. Considering PBT is 82cr, this is almost a 20% boost to profits. Now this is a non-recurring item. My guess is that company had already paid excise duty on some goods on which it was able to claim the benefit when government reduced excise duties some time back - I might be wrong here.

So one can knock off 20% of 1Q earnings. Also, like other Indian companies, 1Q has higher "other income" as (fixed maturity plans) FMP's mature. If we exclude both of these, 1Q EPS is higher by 25% yoy. Full year EPS should be somewhere between Rs 120-130 excluding the excise tax benefit - Rs 140-150 including it.

The relevant question is - what happens when government again increases excise taxes? Like a lot of other Indian companies, GP hasn't passed on excise duty cuts to consumers, thus capturing incremental margins. Would companies be able to increase prices to offset any excise duty increase by govt to retain 1Q profitability? I doubt that they can do that in one quarter - such price increases will be spread out over a longer term. This is a big risk for some Indian companies. Surprisingly, no one is talking about this. Something to keep an eye on.

Disclosure: Own GP. Positions might change at any time.

Godfrey Philips starts producing Marlboro

This article came out in Economic Times on 9th Sep. I don't think in any other country Philip Morris has let a partner take control of the manufacturing and distribution of Marlboro. This might not make a huge difference to GP's bottom line today, as Marlboro's share in India is really small. But nonetheless, it is a positive.

The stock is trading at less than 9x EPS - if we were to annualize 1Q10 EPS. Now, it is possible that there were some dealer inventory movements etc. in the first quarter, which boosted 1Q earnings. So we will need to wait till 2Q earnings to really figure out the pattern here. Still, the company has gone into new markets (West Bengal and Tamil Nadu) and launched Marlboro. The second largest tobacco company in India is available at less than 10x, when all other FMCG stocks are trading at 25x. Stock might go down if equity markets swing around, but to me this one is for keeps.

Disclosure: Own GP

The Step Function and the Punchbowl

Markets have the ability to create the reality they believe in. Asset prices go up - for whatever reason - and problems get solved. Since March, this is what is happening.

The world moves in step functions. When asset prices are in a x to y range, the impact on sentiment and consumption is completely different from when asset prices go into y to z range. Just maybe, we are now taking another big step and moving into a completely different zone - where the blue sky is indeed the limit. Interest rates are 0, inflation is low and growth is accelerating. Will central banks take the punchbowl away now that the party has started?

Shriram Transport Finance

LIC Housing Finance is on a tear. I had sold it late July - my rationale was that the stock wont do anything till 2Q earnings unless company does a QIP around 650. Seems like thats what they did today - selling stock at 658.

So now, here we have a company trading at 10x PE and around 2x PB. 3 years back, the company was a basket case on account of souring loans. Has the culture of the company changed that much that it will not be making bad loans today in its hyper charged growth environment? Don't know, but I will not bet on the culture change thing in LIC. Maybe the stock goes up 50% to close the valuation gap with HDFC. But this stock will give me sleepness nights. It is in 2011-2012 that we will really come to know how smart LICHF was in 2009.

My preference is with Shriram Transport Finance. Trading at 12x PE, 3x P/B, quasi monopoly in commercial vehicle lending. The company survived the CV downturn of last 18 months without too many scratches => they know how to lend to this segment profitably. Having seen the downturn, they will be managing risks carefully. The stock is expensive compared to LICHF, but the lending biz is probably much better quality. In banking, numbers can be very deceptive, so it is better to pay up for a good quality lender.

Disclosure: Own Shriram Transport Finance

Some nice one-liners

Hanlon’s Razor: Never attribute to malice what can be adequately explained by stupidity

At times of crises, sacred cows turn into hamburgers.

Apollo Hospitals

Barrons had over the weekend a story on medical tourism (subscription required). It had mentioned Apollo Hospitals in that context, besides a host of Singapore and Thai providers. Now this is a theory that has been around for a decade, and indeed the Indian hospital companies might have benefited in the past few years because of this. And they might benefit more if US insurance companies start reimbursing patients for more procedures carried out in India. But this is just the sideshow story.

The real story is the shabby public health infra in India, and the opportunity for private players. If we look at what Fortis is paying for Wockhardt, Apollo would look a no-brainer. But then, we know that Sardarji screwed the Japs with Ranbaxy, and the money is burning a hole in his pocket. So we shouldn't take it as an indication of what a hospital is really worth.

What I like about Apollo is that the stock is not very volatile. Its correlation with the market is non-existent. So it is a relatively good stock to rotate into out of the more risky stuff. One can also think about it as a long-term investment - if one believes in the Indian hospital story. It is a capital intensive biz. And with Apollo, numbers are always an issue, like for a lot of other Indian companies. The saving grace is that the hospitals are there for everyone to see.

Disclosure: Own Apollo

India car exports beat China

Very interesting article on Bloomberg. Auto stocks have run up, but some auto comp stocks are still ok. It seems like not a lot of Indian brokerages are covering them now - they gave up on these companies post the meltdown last year. There might be interesting plays here. I own FAG Bearings.

WSJ: Weak Back-to-school sales spell trouble for holidays

WSJ is out with an article today on weak back-to-school sales (subs reqd). Now who knows what it means for holiday sales - but people will extrapolate. And one can expect more noise, more articles, and more confusion around holiday sales as Sep grows into Oct. This is probably going to be one big factor which keeps global markets on its toes - which is why I took money off some of the riskiest names I had last week.

Unfortunately, these stocks - Nilkamal etc - are up 10% since then. Indian mid-caps/small-caps are still running strong even though the bigger indices have turned. Probably these are the best stocks to long-short. They don't rise until the large caps are well and truly up (see May 2009), and they don't fall till the large caps have been taken to the cleaners.

Whats up with Berger Paints?

This chart is very strange. At 1:30 pm yesterday, the stock popped up, and has since being going up straight on volumes that are much higher than it usually trades. Is there some insider info out there? Is this company getting sold or something? If some fund house has suddenly become interested in this stock and is buying it at whatever price, the traders at that fund should be fired. Running up a stock 25% is no way to buy the stock. If I find out who the fund house is that is buying the stock, I will never ever buy a fund from that company.

Berger Paints

Exiting Berger Paints. Stock is now 17x-18x EPS. While cheaper than Asian Paints, it is no longer a no brainer. I have moved some of this money into Godfrey Philips - at 10x PE, it is a very cheap tobacco stock.