Friday, July 31, 2009

Godfrey Phillips

The second largest cigarette company in India reported a great 1Q10, like VST. Cigarette's biz operating profit went up by 45% as the company took price increases. It recently got the Indian distribution for Marlboro, and has launched in new territories (West Bengal and Tamil Nadu). Even after the run this week, it is trading at 10x (and possibly below).

A trivia: Lalit Modi, the IPL head honcho, is the son of K.K.Modi (GP promoter)

Disclosure: Own Godfrey Phillips, VST and Philip Morris International, though position might change at any time

GSK Consumer Healthcare

Like other FMCG companies, GSK Consumer reported very strong results. There are four big MNC owned FMCG companies that are investible in India - Hindustan Unilever, Nestle, Colgate and GSK Consumer. Others like P&G are not good long term buys, because the parent companies have 100% owned subsidiaries through which they are launching new products. These four are launching all the new products through these listed companies.

Unilever is barely growing its volumes - growth there is being led by pricing. The other three are growing very well on volume and pricing. Unilever, Nestle and Colgate are all trading in 25x-30x PE band. GSK is trading at 18x-20x. If GSK keeps up the growth momentum it has shown in the last several quarters, I wouldn't be surprised if the valuation gap closes. This is what has happened with Colgate over last 2 years vs Nestle.

Disclosure: Own GSK, positions might change at any time.

Edelweiss, Motilal, IndiaInfoline

Edelweiss Capital didn't really have the same kind of qtr like Motilal Oswal or IndiaInfoline. For the other two, PAT and rev jumped almost doubled qoq. For Edelweiss, qoq growth was 50%. YTD, Edelweiss stock has underperformed Motilal and IndiaInfoline - does this qtr have a clue as to why?

It appears that Edelweiss had lower broking rev growth than others, which would imply company lost market share. Part of it might have to do with the nature of clients. Edelweiss had probably more hedge fund clients (it is the largest derivative broker) than the other two, and they got wiped out last year.

The question is - is there something structurally different about Edelweiss that it might not grow as fast as the other two? Edelweiss has a huge prop trading book (40% of its revs are from arbitrage trading), while the other two are pure brokers. Is this book as scalable as broking revs? Besides, Motilal and India Infoline also have a huge retail broking network, while Edelweiss is primarily institutional, so this might reduce the long-term acquisition potential of Edelweiss. Why will any foreign broker acquire an arbitrage trading group?

One thing is sure - valuing Edelweiss on PE is strictly not correct, as its arbitrage business requires capital and is more appropriately valued on PB. The ROE's on this book are in low teens - so that warrants a discount to pure brokers.

I had bought Edelweiss couple of weeks back on the theory that if Edelweiss delivered the same kind of growth as other two, it is the cheapest amongst the lot on PE basis (10x PE vs 15x for Motilal and 20x for IIFL). That has turned out to be incorrect - Edelweiss didn't have the same growth. So I sold Edelweiss today. It is unlikely to outperform the other two from here. Market will need better 2Q results - better relative to competitors - to do that.

Next time - I will pick up one of IIFL or Motilal. Brokers are the best way to play beta. IIFL is a very good company but also very expensive and loved by everyone. Motilal might be a more intriguing play.

Thursday, July 30, 2009


Regal's attendance growth again lagged the market, and by a wider margin this time. Company keeps driving ticket prices higher, which has an adverse impact on concession revenues (which is where theatres make their money). This implies Cinemark should once again have better attendance growth than industry. Lets see. At least I picked the right one here.

Not in case of Mastercard vs Visa. I picked Visa, and Mastercard has outperformed Visa by close to 20%.

I bought a share of Berkshire Class B. It is underperforming the market this year, which is strange considering the bear case on Berkshire is around the index put options that Buffet sold at market peak in 2007. I would have expected higher beta here.

Now I own both Microsoft and Berkshire :) WSJ had a pretty positive article on Microsoft today.

Tuesday, July 28, 2009

Some Nice Quotes

From Howard Marks letter to be found here:

Einstein: Not everything that can be counted counts, and not everything that counts can be counted

Keynes: A speculator is one who runs risks of which he is aware and an investor is one who runs risks of which he is unaware

Investors face two risks: a) The risk of losing money, and b) the risk of missing opportunity. Investors can eliminate one or another, but not both

The words of late Amos Tversky aptly represent my view: It's frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what's going on

Torrent Power and Adani Power

I bought some Torrent Power as a speculative play on the potential success of Adani Power IPO, which has opened today. Torrent Power will have more active generational capacity soon as Sugen comes online than Adani Power will have by 2012, with plans to add as much as Adani in the future. Besides it controls distribution in Ahmedabad and Surat - so I am assuming both Adani and Torrent are close to the Gujarat govt. If Adani Power gets valued at 20K crore post listing, Torrent Power will look so cheap in comparison at only half the market cap :) That is the level of my detailed analysis.

Of course I am willing to overlook here the small fact that one needs to view Torrent Power's numbers with suspicion. But then, is Adani any different?

Another way to play Adani Power IPO is to subscribe to it. But then, by the time listing happens in 3-4 weeks, the world might have changed. Investors in Reliance Power IPO in Jan 2008 didn't really enjoy the ride as the stock listed in Feb and the Sensex was on its way to 10K instead of its way to 40K. This way, if things were to turn suddenly, I can exit.

FMCG Margin Expansion

Certainly I got it all wrong in April on FMCG margins - margins have been the biggest surprise of this recession. Volume growth has been so strong that companies haven't had to cut prices. Commodity and media deflation has reduced costs. As a result margin expansion has been very strong, much beyond even the most bullish expectations. So profits have zoomed up 60%-70%.

1Q11 (June 10) would certainly be a very tough qtr for FMCG companies. 2Q10 (Sep 09) might continue the trends of 1Q10 (June 09). Volume growth is unlikely to suddenly break down barring a shock.

Monday, July 27, 2009

Verizon-Verizon Wireless and ABI-Inbev

The situation at Verizon and Anheuser-Busch Inbev is remarkably similar. Verizon's cash cow is Verizon Wireless, where it owns only 55%. However, it fully consolidates VZW. Similarly ABI owns only 61% of Ambev, which is the real cash cow. ABI too consolidates ABV.

The fully consolidated businesses at both companies - wireline in case of VZ, and ex-Ambev biz in ABI, is where the disproportionate amount of consolidated debt is. So looking at consolidated debt/EBITDA for both these companies is wrong, unless one adds the market value of the minority stake in subsidiaries to debt.

Similarly, the FCF yield for both these companies is vastly over-estimated. Analysts estimate ABI is trading at 10% FCF yield. That's incorrect. ABV doesn't pay off its entire FCF as dividends. So, the consolidated FCF looks much better than the real economic benefit to ABI. The real FCF yield is closer to 8% than 10%.

In Verizon's case, the FCF yield is even more exaggerated. Wireline biz doesn't generate any FCF today due to FiOS capex. The reported FCF is all from wireless, so it needs to be multiplied by 55% (VZ stake in VZW) to come to VZ's real FCF yield today.

Both VZ and ABI have to figure out ways to tap into the cash flow of their subsidiaries - VZ to fund its dividend (its wireline biz can't fund the dividend on its own today), and ABI to reduce its leverage. The best solution is if it happens in a way other than a dividend from the subsidiaries. If VZW or ABV pay a high dividend, the consolidated debt picture at VZ and ABI will look much worse, as there will be cash leakage to minority shareholders in the subsidiaries.

Asian Paints and ICI

Asian Paints - the largest paint company in India, has reported pretty staggering 1Q10 results. EBIT is up 66%!! While paint sales are up 17%, EBIT margins expanded from 15.7% in 1Q09 to 22.0% in 1Q10 in paints.

ICI India - the third largest paint company in India - also had a similar qtr - EBIT jumped 45% as sales grew 7% while paint EBIT margins expanded from 6.9% to 9.4%.

There are quarterly fluctuations in paints industry depending on dealer inventory and timing of festivals (particularly Diwali), so yoy rev growth on a quarterly basis can fluctuate. Like other FMCG categories, paints industry also probably benefitted as commodity costs fell (oil is their biggest raw material item) and media costs deflated.

Asian Paints has cut prices recently. It is unlikely margins remain this high in the industry. On that matter, I think it is very unlikely margins remain this high for FMCG companies on a substainable basis going forward - company after company has benefitted from media deflation. Stocks like HLL and Colgate are now priced at 25x-30x on all-time high margins.

Now it is true that Indian media has created a lot of inventory in the past couple of years. So some of its woes are justified. But before competing on price, FMCG companies (like HLL) will step up advertising and promotion expenses.

On ICI, company's market cap is around 2000 crore, and cash is 950 crores. Unfortunately, company has now started lending cash to Akzo Nobel India's subsidiaries. Even if it is at arm length's basis and company earns 10%, I am not investing in the stock as 50% of the company earns 10%. This is the biggest risk of investing in MNC subsidiaries in India which hold excess cash (case in point was Novartis).

On Asian Paints, the company has voluntary decided to take prices down by 2% odd. Historically, it seems that company wants to operate at a high teens margins - if margins expand beyond that, it cuts prices. As the industry is consolidated (AP, Berger, ICI and Nerolac control 70%) and everybody else follows AP price points, there is no danger of anybody else initiating a big price war. The volatility of the profit pool in this industry is lesser than in others like soaps, where Godrej Consumer is very happy at having a massive qtr, but won't do anything on price till a price war breaks out. So if Godrej Consumer is trading in line with Asian Paints (both at 25x PE - isn't it amazing!!!), there is a relative valuation mismatch.

Saturday, July 25, 2009

Crisil and ICRA Earnings

Crisil reported CY2Q09 on expected lines. Ratings biz continues to grow driven by bank loan ratings requirement of Basel-II. Research is not growing, as Irevna's outsourcing biz has stalled. EPS growth from cont ops at 12% is in-line.

ICRA continues to grow faster than Crisil as it is a pure play on Indian ratings. In FY1Q10, its EPS jumped 72%.

However, the sequential picture is much different. Crisil's rating revenues went up from Rs597mn in CY1Q09 qtr to Rs 607mn in CY2Q09 qtr. ICRA's rating revenues, on the other hand, declined from Rs 288mn in FY4Q09 to Rs 201mn in FY1Q10 - that's a seq decline of 30%. Thats very strange.

Both companies are at 18-19x, but it is quite irrelevant. The relevant issue is what SEC does with these companies. Seems like RBI in India is very happy with the way these companies are.

Also note, Berskhire sold some Moody's last week.

Disclosure: Long Crisil

Disclosure: Sold LICHF as NIMs compressed drastically. Stock is not going anywhere till 2Q earnings now, unless they do a QIP at Rs650. 2Q earnings will be in Oct, which is a long time away.

FAG Bearings and SKF

FAG Bearings (505790.BO) is the subsidiary of the german Schaeffler group (the group that got into trouble last year for buying Continental). It is also a bearings company, like SKF India. Like SKF, they don't talk - so there is not enough information out there.

FAG and SKF had quite contrasting qtrs. FAG's rev is now growing yoy at low double digits, while SKF is declining at low double digit. This might be because FAG is largely automotive bearings, which might have seen a revival with the revival of domestic auto industry. SKF, on the other hand, is also heavily in industrial bearings, which are still to revive. QoQ, SKF is seeing growth, but still not yoy.

However, the story at margins is completely different. SKF's margins have bounced back - this qtr EBITDA margins are at 13%, up from 8% in CY1Q09. FAG margins, on the other hand, have declined from 19% in CY1Q09 to 15% in 2Q. FAG's margins have always been much higher than SKF historically - FAG has been in high teens, while SKF has been in low teens.

Considering both these companies import a lot of what they sell in India, one could have expected margin expansion in 2Q as rupee has appreciated from 1Q to 2Q. That has happened for SKF, not FAG.

FAG is trading at 10x PE on 2Q margins of 15%. If the margins bounce back to high teens (Maruti, Bajaj and Hero Honda are all now making tons of money, so their suppliers should also benefit), it is trading at 8x PE. That doesn't mean that stock will go up - it can easily trade at 5x PE too, like it was not that long ago.

From a little bit of what I have read, it seems like bearings is not a commodity industry. Auto manafucturing is an intensely competitive industry - anybody can make a car. But there are only a few big companies in the world that can make bearings.

The big question with SKF and FAG India is not about their long-term top-line growth prospects. It is about margins, and specifically this - how much money will their parent companies let their Indian subsidiaries make? The Indian subsidiaries import from 100% owned subsidiaries of the parent companies, so there is a transfer pricing issue. As a minority shareholder in the Indian subsidiary, we can get beaten over.

Still, I have gone ahead and purchased FAG. So far, the parent company has played fair. Now the parent company has a huge debt load and might play unfair. But FAG India makes only $20mn of profit every year. Playing unfair here won't make any dent in Schaeffler's billions of debt. I plan to hold this for some time, but it is a risky bet.

Disclosure: Own FAG

Thursday, July 23, 2009

Philip Morris International

Raises guidance to $3.10-$3.20. 2Q EPS is 0.83. Unless EM currencies appreciate even more from here, it is unlikely 2009's guidance gets raised much more beyond here. 1H EPS is $1.56, so if we assume similar performance as 2Q for rest of year - i.e. 2H EPS of $1.69, we come to $3.19.

Both PM and BAT have mentioned Korea as a growth market. PM mentions in its press release:

"In Korea, the total cigarette market was up by 2.8%. PMI’s shipment volume surged 17.9%, driven by market share increases. PMI’s market share reached 13.7%, up 1.9 points, driven by strong performances fromMarlboro, up 0.8 share points, Parliament, up 0.7 share points, and Virginia Slims, up 0.2 share points."

Must be bad for KT&G. It might be one of the companies that one of the big 4 (PM, BAT, IMT or JTI) acquire next.

Wednesday, July 22, 2009

LIC Housing Finance

From a cursory glance of LIC Housing Finance, Gruh and HDFC, it seems that spreads have compressed sequentially. Is it a 1Q phenomenon or something else? Or is it that all these companies as well as banks are aggressively competing with each other right now, reducing the spreads.

Because HFC's can lever up their entire equity (they dont need to keep and SLR), they have an attractive biz model in India. Question is the spreads and the NPLs. And of course, what multiple the market decides to give these biz on a particular day.

Disclosure: Own LIC Housing Finance.

Tuesday, July 21, 2009

Coca cola earnings

From Coca-Cola earnings.
  • Russia’s unit case volume declined 9 percent in the quarter, reflecting the impact of a continued challenging macroeconomic environment. Russia is struggling - this might impact PM and BAT due to downtrading.
  • Unit case volume growth in Northwest Europe was partially offset by weakness in Spain and Eastern Europe due to significant macroeconomic challenges in those regions.
  • Strong unit case volume growth of 6 percent in the quarter was led by a 6 percent increase in Mexico, a 5 percent increase in Brazil and a 6 percent increase in Argentina. Latam is up 6% on volumes in 1H - thats good news for the other beverage companies.
Mexicans are just behind Americans in per capita consumption of carbonated drinks and obesity rate is ahead of US - amazing for a developing country.

Ron Paul singles

This is funny (from today's WSJ):

Mr. Paul, an obstetrician and two-time presidential candidate, considers the Fed to be unconstitutional. He sells "Audit the Fed" T-shirts on his Web site, and his movement has a small but deeply committed following: Supporters even have a dating Web site in his name, "Ron Paul Singles," where users seek others displeased with the Fed.

Sunday, July 19, 2009

Comment in Barrons

This is a good statement in this week's Barrons.

In coming months, Kass says the fear of being out will overcome fear of being in. Kass believes the March low of 666 on the S&P 500 might mark a generational low, but please don't mistake Kass -- or us -- for bulls. Huge bull rallies inside bear markets are hardly unusual. The long-term market headwinds haven't gone away, he notes. In addition to the macro concerns Roque cited, Kass lists an elevated savings rate, which lowers consumption; spreading wage deflation; the devastation of the construction and real-estate industries, once big job creators; and a reduced securitization market, a former growth engine, as factors that will weigh on stocks for years. "These issues raise the specter of a fragile recovery and a double-dip both in the economy and stock market next year," he says. Kass sees a "lumpy and inconsistent" market for the next few years, with substandard to negative returns.

Saturday, July 18, 2009

Hindustan Unilever struggles

ET has an article today on how HUL is struggling in all its business lines, whether it is soap or toothpaste. In its previous conf call, HUL clearly mentioned that without market share, profitability is impossible in the long run. Colgate is reporting blockbuster results by having sales growth while at the same time cutting ad expenses. Ad expenses are down as ad rates have taken a big hit in the last year - both because of excess media inventory as well as reduced ad expenses by other industries which are struggling (financial services etc).

HUL doesn't seem to be suceeding so far in whatever they are doing to stem their share loss. Is a more aggressive HUL here? They can either cut prices or increase ad and promotion expenses aggressively, or both. Or they might not do anything despite what they say - which would be good news for Godrej Consumer and Colgate.

Zee reported results two days back. Their subscription revenues are now more than ad revenues - that is something I didn't realize would happen so soon. Ad revs are down massively yoy, and that is probably the case for a lot of media companies right now in India. Can there be a sudden ad upsurge in India?

What is a good media play in India? Problem with Zee is that it is not what it seems - it will be investing in DishTV and WWIL whenever they run into problems.

Friday, July 17, 2009

Indian Company Earnings

I will start writing down my one-line thoughts on earnings of various companies to help me later on 1-3-5 years down the line if I happen to look at them again.

1. Colgate: EPS jump of 40%!! From Rs 5.3 in 1Q09 to Rs 7.5 in 1Q10. Ad and other expenses have come down, while Colgate hasn't cut prices (I recall reading they actually increased them during the qtr). If investors annualize this, it is Rs 30 EPS for FY10 vs consensus at Rs 25. Stock at Rs 645 is 21x. Suddenly it ain't so expensive anymore (this is India)!! Nestle is at 28x, and right now Colgate has the highest EPS growth amongst all.

Question is - how long can margins expand?

2. SKF India - Sales down 15% yoy while EBIT is down close to 50%. Even when commodity prices have cooled off. Is it mainly because of the trading biz - importing heavy bearings into India and selling it here - which might have been hurt very badly by rupee depreciation. After all auto has recovered. Or is it that while auto is important, overall industrial growth is more important for this company. Company doesn't talk and analysts dont cover it - so this is all guess work.

3. VST: EPS has gone up 250% yoy - but a better way to look at it is probably sequentially this time around. What has happened to this company in the last year is actually quite amazing. This is the 3rd largest cigarette company in India. In 1Q09, its biz collapsed as Indian govt increased the excise duty on non-filter cigarettes by 2x-5x. VST had a high share of volume from non-filter segment. Suddenly the company found itself without a biz. So it did a very smart thing. It launched the same cigarettes in filter category - at a higher price. I guess its customers came back. So suddenly, its profits have zoomed up and have been going up every qtr for the past 4 qtrs - much much higher than under the old tax regime. At least that is my guess - no analyst covers this stock, and the company doesn't talk.

Right now, it is trading at 6x-7x PE. The company pays out most of its earnings as dividends. Disclosure: Bought stock today. This is high risk as the stock has always been cheap. I am betting some people will get attracted by a 10-15% dividend yield next yr.

4. India Infoline: Brokerages are minting money - no surprise there. QoQ profits have doubled. But stock is at Rs 132. Annualizing 1st qtr, we get Rs 6 EPS. 22x PE for a broker is a bit too much - even if they dont have any balance sheet risk and they exist in this great country with a wonderful future called India.

Thursday, July 16, 2009

Wednesday, July 15, 2009

Calpers sues rating agencies

Article in NYT. Basically Calpers investment managers outsourced their decision making to somebody else. When they got ripped off, they are suing. The question to ask is - is Calpers relying on its own brains today in its fixed income investment process, or are they still relying on rating agencies.

Something to watch out for. I am basically betting that nothing will change.

Tuesday, July 14, 2009

SEC's Schapiro Eyes Credit-Rating Firms

WSJ (sub reqd) has an article today on what the SEC is doing with credit rating agencies: "Securities and Exchange Commission Chairman Mary Schapiro is set to tell Congress she has directed her staff to look into ways of preventing debt issuers from shopping around for the best credit ratings".

What that means is - the credit rating system as it exists today will continue to exist, with a few tinkers here and there. Rating agencies are govt created monopolies with unregulated pricing power.

Ratings are a way for investors to outsource the blame of their stupidity on others (the rating agencies). HSH Nordbank investment managers would have told their superiors - "But I invested in AAA" - and they wouldn't have been fired. Such a cool way to protect the downside and get the bonus on the upside.

This is worse than tobacco - in tobacco everyone now knows the harm caused by the product.

Disclosure: Long Crisil.

Russia - the world's third largest beer market

After China and US, Russia is the world's third largest beer market. Russia and Ukraine are also in the top 5 for smoking. Seems like the former USSR's population made a virtue of vice.

Friday, July 10, 2009

Is 2009 a rerun of 2008?

The indices have behaved strangely similar so far. Fall in Feb, rally starts in March (Bear Stearns in 2008), topping out in June. Further out - struggle till Aug end, and rollover in Sep and Oct?

Except that Shanghai keeps marching higher. That is very different between 2008 and 2009. In 2008, Shanghai kept going lower and lower.

Crisil and Rating agencies

Crisil is 51% owned by S&P, and is S&P's subsidiary in India. It is the biggest player in Indian domestic ratings business, but is not a pureplay on it. Only 20% of its biz is domestic ratings, another 20% is outsourcing revenue from S&P global, almost 40% is financial research outsourcing (Irevna), while the rest is consulting and advisory revenue. As ratings has a higher margin than other revenue streams, the contribution at the EBIT line is different: domestic ratings - 35%, S&P outsourcing - 25%, research oursourcing - 40%. Stock is currently at 15x CY09 earnings, so depending on one's view of Irevna, it is either cheap or expensive. It is one of the stocks in India that I have continued to hold since 2007. If one is bullish on India and infra spending, then either Crisil or Icra (Moody's sub, and this is purely domestic ratings) are probably a good bet.

One of the most surprising things since the financial crises exploded in August 2007 is that while various parts of the financial industry - banks, brokers, insurance companies - have seen their business models and ownership structure change irreversibly, the rating agencies continue to exist and do what they have been doing for the past 100 years. There are some half-hearted proposals here and there to change the way rating agencies work, and there are some shorts now (Einhorn) targeting rating agencies. But there doesn't seem yet to be a regulatory or legislative urgency to change anything the way ratings system work. The question is: if equity markets can work without ratings, why can't debt markets?

Recently, BIS published a report titled "Stocktaking on the use of credit ratings" (hat tip: Prof Verma). What is clear is that ratings are used more pervasively in the US than in any other country. If Fed was to decide that it will stop using credit ratings in its decision making process and instead recruit a team of inhouse credit specialists (for e.g. to figure out eligible collateral for TALF), that would be a death sentence for the rating agencies.

If this team of inhouse credit specialists were to make their ratings public, it would become an FDA style agency for the credit markets. This is what rating agency bears say should anyway be the case, because today we have govt. designated monopolies earning non-regulated returns.

There is however, a very big risk with a govt owned rating agency. If the ratings of the govt agency turned out to be bullish or faulty - and they will at least once in the next 100 years - then investors will go the US govt to be reimbursed. So, if Fed decides to set up a team of inhouse credit specialists, its recommendations would likely remain private.

What is the benefit of rating agencies to investors? Maybe rating agency help reduce costs - in the sense that not all bond funds, banks etc have to hire smart credit analysts to buy bonds. However, that is extremely undesirable as we can see. Ratings create a false sense of security.

Net net, till the regulators decide to do the hard work of analysing bonds and loans to calculate the capital cushions of various financial institutions, I don't think rating agencies go away. Having more NRSRO's won't reduce S&P and Moody's dominance in the next 2-3 years. What can certainly change is the way these companies are compensated. That is something that doesn't seem to be happening today, but it can change anytime.

Tuesday, July 07, 2009

Telefonica and DT should swap O2 Germany for TMobile UK

Everybody is speculating how TMobile UK might be paired with one of Vod, O2 or Orange to consolidate the market. One analyst speculated Vod acquiring T-Mobile UK and giving DT its underperforming Turkey biz (Telsim) + cash. DT has a stake in OTE - a Greek mobile provider. So this will give DT a way to expand its Balkan footprint.

There is another attractive combination for DT. That is with Telefonica. It can sell TMobile UK to Telefonica (O2), and acquire O2 Germany from Telefonica. O2 Germany is ranked fourth in Germany where EPlus is executing very well. Telefonica will be better off consolidating the UK mobile market, and DT will be better off consolidating the German market. The synergies in such a transaction will be far higher than in any other combo, and for all the players - including the ones not participating in the deals. Vodafone will benefit because not one but two of its main European markets (UK and Germany) would get consolidated.

Monday, July 06, 2009

Egyptian Pound conundrum

I am going country by country to understand Vodafone better. Vodafone is the second largest mobile operator in Egypt. Egyptian pound is pegged to USD. The country also seems to have an independent monetary policy - overnight lending rate is 10.5%. Foreigners can invest in Egypt stocks. How is that possible? A country is pegging its currency, following an independent monetary policy, and allowing capital flows? If investors get confidence the peg will be maintained, the easiest way to make money is go long Egpyt and benefit from the 10% inflation. Currency carry traders must really love Egypt. Something is not right in the way I understand the situation.

HKD is pegged, but then HK doesnt have a independent monetary policy - HK follows Federal Reserve. Yuan is pegged and China has an independent monetary policy, but it doesn't allow capital flows. INR is virtually floating freely, so India has capital flows as well as an independent monetary policy.

Why is this important? Well, if Egyptian pound were to devalue, Vodafone's estimates will get cut. There is a similar risk with Telefonica, which has benefitted a lot because of the Venezuelan peg.

Sunday, July 05, 2009

The New Paradigm for Financial Markets, by George Soros

I am currently in the middle of this short fantastic book by George Soros. I haven't read any of his other books except the first few pages of Alchemy of Finance in 2003, from where I picked up the concept of reflexivity (i.e. prices can impact fundamentals and earnings). This is Soros's paradigm for financial markets:

"Instead of being always right, financial markets are always wrong. They have the ability, however, both to correct themselves and occasionally to make their mistakes come true by a reflexive process of self-validation. That is how they can appear to be always right."

Some other key points are:

a) While the methods of scientific enquiry have proven successful in physical sciences, it is incorrect to use them to the same extent in social sciences - because of inherent uncertainty and indeterminacy.

I recently read an article arguing that financial markets collapsed because economics doesn't use some superior mathematical techniques that have been used elsewhere for sometime. Many people argue that better risk management techniques will make sure a crisis like this doesn't recur. That is incorrect - because risk is also a function of leverage, and not merely the volatility of the underlying cashflows. An inherently more risky financial product is less risky when bought with no leverage. Conversely, if people believe in "a great moderation in the volatility of inflation" (Greenspan and Bernanke) - and by implication cashflows, they will lever everything up more - so the system ends up with more risk. Uncertainty in participants actions makes the future indeterminate in social sciences. Light, on the other hand, doesn't change its speed.

b) The Enlightment tradition focuses solely on the cognitive function and not on the manipulative function. "The philosphers of Enlightment put their faith in reason, they saw reality as something seperate and independent of reason, and they expected reason to provide a full and accurate picture of reality". This philosophy has served physical sciences well for centuries. In security analysis, this is equivalent to constructing a DCF and a WACC to figure out the price.

"The postmodern approach goes the other extreme - by focusing on the manipulative function and treating reality as collection of often conflicting narratives, it fails to give sufficient weight to the objective weight of reality". In security analysis, this is the equivalent of saying all DCF is non-sensical. Or something similar to what the world leaders are attempting right now - "lets talk our way out of this recession."

The truth lies somewhere in between. Sometimes, financial theories work - and sometimes they do not. The trick lies in identifying the turns. Because "the behavior of markets is best regarded as a historical process". A long-term investor might not get the same prices when theories start reworking as when they stopped working. The movement of prices during the chaotic period might have irreversibly changed the fundamentals - like US regulators panicking on seeing financial stocks falling and seizing WaMu etc.

Where I disagree with Soros is when he extends this theory to politics. Soros gives the example of the Bush administration as following the dangerous post-modern philospohy, and how it not merely recognized that truth can be manipulated, but promoted the manipulation of truth as a superior approach. But haven't politicans done this throughout history and in all countries. Goebbels did it in WWII. Even De Gaulle was manipulating when he kept insisting "I am France (Je suis la France)" - when France was under German occupation and De Gaulle was living in UK.

The difference between politics and economics is - while it well accepted that politicians manipulate, it is not recognized that markets can be manipulated as well. Because the manipulators are we ourselves. The manipulation might be passive and not active because no one person controls it. But to the extent that the biases of thousands are able to turn imagination into reality through the market mechanism, it indeed is manipulation.

Friday, July 03, 2009

Verizon Wireless and Vodafone

I am sticking by the prediction I made one year back - that the biggest M&A deal over the next four years will be a Verizon takeover of Vodafone. By 2010 end, Verizon Wireless will be levered at 0.5x debt/EBITDA. There is hardly anything left in US to acquire. VZW can't expand abroad under the partnership agreement with VOD. The best thing would then be for VZ to acquire Vodafone and become a global wireless operator.

No sell side analyst talks about it - this is completely original.

Disclaimer: Own Vodafone

Cinemark Holdings

I had purchased Cinemark (CNK) at $8.90 at the end of April when Swine flu broke out in Mexico. 20% of CNK's EBITDA comes from LatAm (mainly Brazil and Mexico), so the fears were justified at that time.

1H09 has been spectacular for US theater exhibitors with box office gross up approx 13% yoy. In 2H09 though, they will face difficult comps from The Dark Knight, which was released in July 2008. And come 1H10, they will face difficult comps from a great 1H09. So the question is - what should one do? Here is a list of the +ves and -ves:

  • Dividend yield of 6.5%, FCF yield of 12% are good. This is not a declining biz - volume (attendance) is up high-single digits this year. That might fluctuate yoy and might be -ve next year, but it doesnt look like this industry is in secluar decline.
  • 3-D might really happen. If Avatar is a big success, it might just change the dynamics of the entire industry. Dreamworks is quite bullish on 3D. 2010 might not be a down year if 3D takes off in a big way.
  • There was a lot of concern over the past few years that DVD's will destroy the theatre industry. Investors were afraid that if the studios are able to collapse the time gap between theatrical release and DVD release of a movie, consumers will prefer to buy a $20 DVD than spend $40 for a family trip to the movie theatre. After this year, theatres might have more negotiating power against the studios.
  • Cinemark seems a better operator than Regal or AMC - its attendance growth/screen is constantly higher than Regal and AMC.
  • 2Q earnings might be above consensus because of higher attendance growth translating into better margins. Real and MXN strengthening would help - offset by the biz lost in these markets because of the flu.
  • Hey, it is an emerging market play :)
  • Difficult comps.
  • Company levered at 3x Net Debt/EBITDA. If 2010 is a down year, and investors extrapolate that down year into the future, then the company might be forced to do something on its capital structure - like cut dividend or raise equity. Regal has cut its dividend.
  • Studios might turn up the pressure on theatres to shorten the DVD release window now that they are in real trouble because of falling DVD sales
  • Studios are cutting on their movie slate. It is possible to have a higher box office gross with fewer releases (like 2Q09) - but one never knows.
  • Maybe consumers get bored of 3D by 2010. So it turns out to be all capex with no returns. Though after watching Monsters vs Aliens in 3D, my reaction was - I don't mind paying a bit extra for the 3-D experience.
I think I am going to hold on till earnings.

Thursday, July 02, 2009

1H09 Performance

It has turned out to be quite good in the US portfolio - what with markets going up and not. 10% YTD in 2009 (indices are up 1%-2%). I am now 10% below the peak in Oct 2007. I am playing it conservatively - these are my savings after all. The biggest money losers since Oct 2007 have been the UltraShorts (SKF and SMN). If I do a sleight of hand and convert dollars to INR - my currency of consumption - than I am up 10% or so in the past 2 years. A lot of people told me in June 2007 to convert dollars into Rupees as Rupee was at 40 on its way to 30. So I can justifiably claim I have generated some alpha for myself.

I will now start running a proper portfolio for the Indian markets too. Kotak Securities has such a bad user interface that I never bothered to do anything systematic. Sometimes, the interface doesn't work during market hours. Then, they calculate profit and loss from the cost basis and not on YTD basis, so it is quite a task to figure out YTD performance. Most frustratingly, they link the brokerage account to my bank account from which money gets debited or credited for each transaction - so it is extremely difficult to figure out the average invested amount over a period of time itself. As a result, I have multiple brokerage accounts, and I have no idea of my IRR.