Getting wages indexed to a labour index

There are several amazing things about the great recession:

a) Margins remained strong throughout, and will now go through previous cycle peak. Companies have squeezed labour costs hard.

b) Commodity prices have zoomed right back, even in commodities like oil which have near-term oversupply dynamics.

Traders in commodity pits have turned out to be the saviours of commodity exporting nations. Had it not been for their speculation, it is entirely possible that commodity prices would have been lower, and commodity consumers benefited at the expense of commodity producers. In case of commodities like oil, one can argue that traders are looking through near-term supply-demand imbalance and looking 3 years out.

What I have been wondering is - suppose labor costs were similarly linked to some wage index on the exchanges. Wouldn't the wage costs also have jumped - which is the right thing to have happened if corporate profits are booming? Now there will be political issues with such a construct. In a downturn, wage costs might also fall below what is considered acceptable. But maybe, leftists should just think about this idea.

Sugar stocks get pounded

Stocks like Shree Renuka and Dhampur have been absolutely crushed. Next time to buy these stocks will be 2014. It is pretty amazing - to say the least.

Emerson Radio

This one is interesting. MSN announced a special dividend of $1.10 on March 2. That day, stock was at $2.27. Today, it is at $4.64. I saw the announcement two days after it was announced. The stock was at $3.47, and I debated whether I should purchase it. Too bad I didn't do something on impulse.

Company is some sort of distributor of electronics, and it seems they make money. 2009 was a pretty good year for them for some reason.

The blog is back

After a brief hibernation.

I calculated my carbon footprint here. The results are quite shocking. The key reason is the number of flights I take. I guess it is absolutely necessary that Boeing and Airbus come out with their new planes. Another technology that will help is video conferencing (Cisco and Polycom). This is something which is quite here and now. Maybe Cisco should encourage regulators to put a carbon tax on long-distance flights. Cisco might also benefit from attempts to make utility grids more smarter. Can Cisco become the new climate evangelist?

Can GM seeds reduce carbon emissions? Due to higher productivity of these seeds, one can argue that total farmland area can reduce and still lead to higher food grain production. Farming is one of the biggest carbon emitters. It will also probably use lesser water, fertilizers, pesticides etc. Monsanto might also become a climate evangelist. That will be really interesting.

CIT

CIT emerged out of bankruptcy yesterday. There is no balance sheet yet out there. Heck, people don't even know what the share count is - for that you need to read the bankruptcy filing 8-K.

Total share count = 200 mn

Share Price = $28

WSJ is saying that $11bn of debt has been wiped out. That is on top of $5bn of pref and equity interests that have been wiped out. So in total $16bn has been wiped out - on a book of $64bn.

The books have to be restated at fair value. Even if there is a 15% write off of the book, so that $10bn of loans are written down, there should be tangible book value left. And after that, because there wont be any more provisions to take, CIT will report eye-popping earning numbers. This is like the Wells Fargo - Wachovia situation from a year ago.

Blue Dart

The company's operating margins are expanding again. As this is a very high operating leverage business model, and considering in 1H09 the company was hit badly due to operating leverage, next year might see a steep jump in EPS. I have purchased this stock.

So far, the Indian portfolio is up some 80%-90% odd this year.

IGK vs ING stock

A tale of two cities. ING announced 7.5bn Euro capital raise. The hybrid security is up 11%, while the stock is down 11%. Such a cool long-short.

Another good long short pair might be MO-RAI.

FAG Bearings

Very bad results. Margins have taken a massive hit. Stock is down 5%. Company doesn't talk to investors - so difficult to figure out what is really going on. Company is on track to do a Rs 40 EPS - 12x PE, which is not dirt cheap. I used to think this is trading at 8x-10x PE, assuming Rs 60 EPS for full year. Point to note with this company is - revenues go up sequentially. 3Q08 was a sharp jump over 2Q08, so yoy 3Q09 is down quite massively. This doesn't seem to be a seasonal business.

Considering 20% of my India portfolio is in this stock, I want to exit it. But considering it is so illiquid, I will need to figure out a better time to exit.

NRB Bearings is up 8%. It also reported numbers today. 1H profit is 8.5 crore. If we annualize it, we come to 17 crore. Market cap of FAG is 300 crore. So it is trading at 15x. FAG is still cheaper.

I hope this is the bottom of margins. Hopefully Schaffler group is not screwing us - the minority shareholders of FAG.

Mark Twain's quote

It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so.

Selling out Godfrey

Selling out Godfrey Phillips. 1Q10 earnings had a excise benefit of 16 crore, as well as other income of 24 crore (vs 10 crore in 1Q09). Remove these two items, and core profits grew 20% instead of doubling. So 2Q10 profits should be down sequentially - quite massively. This is probably not what the market is looking for right now.

Excise Duty cuts continue to help

Exide Industries - the big battery manufacturer in India - reported Sep 09 earnings earlier this week. The crucial bit is this - gross sales went down by 5%, but because excise duty rate is lower this year, net sales were the same. Company reported a 50% jump in profits. But if one were to assume the same excise rate as last year, profits would have jumped by 25% - aided by lower commodity prices (lead).

It is possible that the reversal of excise duty cuts will be a big headwind for profit growth next year - especially in the manufacturing sector. Most analysts will probably take this year profit numbers and project growth on that. That might prove to be really wrong.

Disclosure: No position in Exide.

People not shaving as much!!

From Barron's article on Energizer past weekend:

Trouble is, consumers aren't trading in their razors and replacing their blades as often as they used to. "A lot of people you see around aren't shaving as much as they used to," P&G CEO Bob McDonald said recently.

That is very strange indeed.

Verisk Analytics

Verisk Analytics had its IPO last week. Barron's mentioned over the weekend: "The company's business bears resemblance to the likes of Visa and the Chicago Mercantile Exchange - once-cooperatively owned, low-capital-intensity, high-margin growth businesses. There are also similarities to current market darling MSCI, a data and risk-modeling leader." What that implies is a biz growing topline in low-double digits and expanding EBITDA margins leading to a high teens EPS growth rate - what Visa and MSCI promise.

Verisk has two segments - Risk Assessment (52% of revs) and Decision Analytics (48% of revs). Decision Analytics is growing much faster. Risk Assessment has grown its topline at 4% over last four years (from $450mn in 2005 to $525mn in 2009E by annualizing 1H09). Decision Analytics, on the other hand, has become 2.5x between 2005 and 2009 (from $197mn in 2005 to $481mn in 2009E by annualizing 1H09). Some part of that growth has come through acquisitions - between Jan 2006 and June 2009, Verisk acquired 10 companies, 9 of which were in Decision Analytics segment.

Now one can focus on the low teen growth rate, high (and expanding) EBITDA margins in the low 40's, and low capex (low single-digit capex-sales) and get excited. But the most crucial element in this story is probably acquisitions.

a) Six month ended June 30, 2009 revs - $503.7mn. Six month ended June 30, 2008 revs - $437.7mn. Increase of 15.1%. Ex acquisitions, rev grew $50mn, or 11.5%. Positive.

b) FY2008 revs - $893.6mn. FY07 revs - $802.2mn. Increase of 11.4%. Ex acquisitions, rev grew $52.8mn, or 6.6%. That's not encouraging.

c) FY2007 revs - $802.2mn. FY06 revs - $730.1mn. Increase of 9.9%. Ex acquisitions, rev grew $24.6mn, or 3.4%. That's definitely not encouraging.

The problem with acquisition led growth is - acquisitions don't come cheap. Verisk acquired a company XactWare in 2006 for $188mn. Additional contingent payments of $98.1mn and $62.9mn were paid in April 2008 and May 2009 as XactWare achieved certain financial results. XactWare had $63mn in revs in 2007 - now its revenue run rate should be $90-100 mn. to have triggered the contingent payments. Clearly, XactWare's performance has been much beyond whatever the initial expectations were - so it is a success. But equally clearly, Verisk has till date been sharing that success. And if an acquisition doesn't succeed, then Verisk shareholders carry the bag.

Can this company grow revs in low double digits on an organic basis? Because if the organic revenue growth is mid-single digits, and the company pays up for acquisitions to get to double digit revenue growth, then that is quite different from what Visa and MSCI are all about. 2009 has so far been a great year on organic revenue growth. But is there something one-off - like a major contract or pricing increase, which will slow down pricing growth in future years?

It is entire possible that under the old structure, the company didn't pass regular price increases to its owner customers. As an independent company, the company will be more focused on profits. So we might see much higher organic revenue and profit growth going forward.

Verisk has around 200mn shares outstanding - 113mn Class A, 67mn class B, and 24mn stock options at strike price of $9.38. At $26, the company is valued at $5.2bn. We don't know the consensus EPS estimates right now. 1H09 PAT was $90mn. This number includes some one-time expenses like IPO expenses and pension costs. Still, it seems like the stock is already valued in the mid 20's multiple on FY09E EPS and low 20's on FY10E EPS.

I doubt that bullish broker reports once the silent period is over will be enough to catapult the stock into the low 30's anytime soon - assuming markets don't rocket another 20% by that time. But it will definitely be a very interesting stock to follow.

Disclosure: No positions in Verisk, but might change at anytime.

Converting paper profits into real money

Over the last few months, I have cut out and then got back in a few times. It might have been better to buy and hold since April - the profits would have been more - but the periodic profit taking has enormous benefits psychologically.

But now, I am cutting out on all the positions I have even a little doubt on. The ones left in US portfolio are Berkshire, Philip Morris (best play on dollar weakness), Cinemark, Long CTSH - Short Infy, and a few odd here and there. The ones in India are Jagran, FAG, and GSK Consumer, and a few others here and there.

After this, I am close to 40% into equities.

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