Sunday, September 21, 2008
Rakesh Jhunjhunwala is India’s most successful investors; one of the stock market’s most successful stories. The sometimes maverick, often mercurial but always a respected voice. He is a wealth creator and a man who anyone who enters the stock market wants to be.
Q: You are the first Individual Wealth Creator we are chronicling. I am curious to know, what does the term mean to you?
A: I don't know when I started on in life, I had some ambitions. My parents never liked the idea that I should go to the stock market. I started life financially with just USD 100 or only Rs 5000 and my first thought was that when I went to the markets, I had just come from Chartered Accountancy; used to earn Rs 150 a month. So my first concept in life was that I should be financially independent. I never started with the idea that I will be a great wealth creator and I will have some great wealth or anybody will know me. I thought I must be able to earn my daily bread. I loved the markets. I thought India was in a very initial stage and this would be one of the places which will develop and the opportunity would be huge.
Q: Do you also find it odious sometimes because you are a wealth creator in your own right and I don't think you have taken on the mantle of leading a lot of people with you. But you get that. A stock that you would pick up will be picked up by others. They would want to know why Rakesh bought it - why he is buying so much or why he wants to buy more?
A: I think these are all misconceptions. When you buy stocks, you should be ensured that other people will buy stocks. Then only you should buy the stocks. I have a different concept in life. If a stock is beautiful, the suitor will come. If a girl is beautiful a suitor will come. If a stock is beautiful, a suitor will come. So I don't search for suitors when I buy the stock.
Q: Tell me where you have to be the most patient with the market?
A: I think my greatest patience with the market was in 2001 September to April 2003. That was because I was a lone bull. I wrote an article in the Economic Times in June 2002 that India is on the threshold of a structural secular bull market and people said, he has bought stocks and he is caught and now he is asking us also to come into the cage. People didn’t just believe what I thought or what my opinion was. That was a testing period.
Q: Did it bring confidence down to its knees for you?
A: You have your conviction and I always staked what I could afford. So say, when markets went down in August 2002, I had no problems there. In spite of my opinion, I did not stake so much that if markets did not go up in the manner that I thought, I would be on the roads. I was well-off absolutely. So you know it was a trying time. But then there was a great dividend; the kind of bull market we had - 3000 to 21000.
Q: And you really rode it didn’t you? There are so many terms people use about you - The young tiger, pin up boy of the bull market, India’s Warren Buffet. Do you find it pointless? Do you find it flattering? How do you take it?
A: I don't know. I have learnt two things about the press and wives. When they something – don’t react.
Q: Are you the same guy that you were? Are you the same guy you were 15-years back?
A: Why are you asking me? Ask my friends, if I have changed in any way.
N Jayakumar, CEO, Prime Securitie says, “As earthy as it comes, he is as raw as it can be and he is as direct as it can hurt. He is all of this and I think at the end of the day it is not because he is a wealth creator, he is all of this, but he has been that since the time I have known him and he has just remained much of the same.”
Q: Is It tough to be tight with people from the same community - the stock markets? Can you be close to some one who is part of the same?
A: I am close to a lot of people from the stock market. Actually, my best friend and whom I consider my guru, Mr. Radhakrishna Damani - he is from the stock market. Actually he has taught me so much in life and we are the best of friends. We can discuss anything. We go on holidays together. We’ve done so many things together and my other friends - they are from the stock market. Also let me not pretend. I don't have much interest in life other than the stock market.
Did you know:
The name of Rakesh’s organisation is actually a combination of his initials and his wife’s initials. So, Rakesh plus Rekha equals RARE Enterprises. As Rakesh says, she is the only one he likes being answerable to.
Samir Arora, Helios Capital says, ” I am very impressed with Rakesh not because he has done so well in the stock market which itself is very impressive but to have done that without raising any controversy, without creating enemies, which is a problem in India for successful people.”
Q: You are very much into the individual behind the business. Who runs it and how well it is run. Tell me how carefully you look at that when you look at a business that you wanted to be a part of?
A: I look at the situation. I look at the possible outcomes and then I think what could be the outcome? For example, when I invested in Titan, my thinking was, can Titan become India’s largest specialist retailer? That was the question I asked myself. Will it always occupy a 50-60% share in branded jewellery? Will it always remain a leader in Indian watch industry? Will it enter into other areas of retailing? I asked myself all these questions and the answer I thought was yes.
So this is the basic analysis I did. Then I went to the office - Titan office was like a young advertising agency. So I thought marketing is in their blood. I met their management team including their Managing Director. I was thoroughly impressed by them. I took the decision. I put my life behind it.
Q: What impressed you?
A: Their sheer approach. The Managing Director told me that the task is difficult. But we'll overcome it. We have to suck the capital and increase the profits and that's what they have done. So, when I take a decision there are three-four matters that I consider - opportunity. I am from the investment thought which says nobody can be bigger than the opportunity. Second, I look at the competitive ability. In a capitalist society, you cannot deliver product and make a profit unless you do it in a competitive manner and competitive does not mean the most expensive. Then I look at scalability. Scalability is very important. When I invested in Pantaloons, the biggest idea was can ten stores become five-hundred? It was written behind a Maruti -- when I grow will I be a Mercedes? Great are the challenges of scalability.
Then what I look at is valuation. It’s important what you buy. It is more important what price you buy. Somebody bought Hindustan Lever at an Index of 2900 - the price was Rs 320. When the Index was 7000 - the price was Rs 145. You bought Hindustan Lever - best quality company, best pedigree and everything and I made lot of money by buying United Breweries and McDowell’s at a valuation of Rs 200 crore. There was no corporate governance. People told you you’re down the drain. I made five-times my money in two-years.
Q: Sometimes there are tough lessons to learn as well? Just on the subject of valuations, you would be watching the media space and there are a couple of howlers over there by way of stock performance, for example, MiD DAY (Multimedia) - have there been more tough lessons to learn?
A: Every mistake teaches you a lesson. There is always a risk in investing in midcap stocks because if they succeed, the gains are huge. If they don't succeed and scalability does not come, then the losses are also huge. I don't regret having invested in MiD DAY because I always allocate my assets and I don't do it in a planned manner. I don't put more than a certain percentage of my wealth in incomplete situations. So, I might have made a mistake. The decision is tough, but okay, the good comes with the bad.
Atul Suri, Rare Enterprise says,”I have known Rakeshji for over five-years and I have traded on his behalf. I use technical analyses but not once has he interfered in a single trade of mine and that is very special. For a very accomplished trader to see a different approach in trading and not interfere with him and that really comes from the basic thing I have noticed in him is that he respects other disciplines also to the markets.”
Q: You're very patient, though?
A: What is the choice?
Q: The choice is to book out.
A: Well, its not that I’m not booking out because I’m afraid to take a loss. I’m not booking out because I still think there is reason to believe that things can change.
Q: Were you surprised Rakesh - could anybody have seen where we are right now in January this year?
A: I have made presentations to show in October, that this is going to be an unprecedented fall. And I have reasoned out how much is the lending to subprime, and that this problem cannot be stopped by reducing interest rates. The American bull market has come to an end. It may be a long correction.
I’ve made these presentations in writing. I have them on record. I don't say I foresaw the failure of any particular organisation but I thought it'll be very tough and I didn't rule out in my mind that some organisations can fail.
Q: Is there any question in your mind that we as well are in a bear market?
A: In India?
A: What is a bear market, what is a bull market, I don't know. Numerically - surely, since we have broken the last lows that we had in August 2007, we'll have to term it as a bear market. But I don't think the long-term Indian stock bull market has ended. I think it’s in interruption mode.
This bull market is based on two factors. One is economic growth of India, which I think is based on factors that are irreversible, whether democracy, whether skills, whether demographics, whether cultural factors. They are irreversible. I think India’s economic growth will always trend upwards.
Then it is based on the platforms that we have created to attract money into the Indian markets -- the trading strategies, the regulation and the under-exposure of Indians to equity. I will surely say that it’s an interruption. How long? Nobody knows.
Q: You've been cautious, though, Rakesh, right till since last Samvat you've been striking a cautious note?
A: If the Index instead of going from 3,000 to 21,000 had gone from 3,000 to 13,000, and then back to 11,000 - would that not have been a bull market? Then it would have been termed a bull market correction. So at levels, where you saw the participation, the valuations, you saw what was coming in the Western world, you saw the sheer corporate greed in India; you saw the senselessness with which people in India just wanted to buy anything. They were all indicators - so what is wrong in being cautious?
Q: Are you feeling better about all those indicators? Do you think things have cooled down now?
A: I think now we've begun to reverse slowly. Now things will be overdone but that’s the way markets are. As I told you, markets are like the weather. Whether you like it or not, you have to bear it.
Q: There is courage of conviction as well, to be a wealth creator? If someone were to sit you down and ask you, do you think that over the next five years, Indian equities is still the place where you'll see the most significant wealth creation, would you say yes?
A: I would think so, as far as Indian assets are concerned. I don't have much knowledge about global assets. My good friend Mr. Shankar Sharma has said, equity has one quality - it is always an asset which trends upwards. India will remain in a phase of very good economic growth for the next 30 years.
Q: Do you feel we will have to be a lot more patient with it though, this time around?
A: As I told you markets are like women, you have to be patient.
Q: No, but you know we've had a fantastic run. We've had the mother of all bull runs in the past three years.
A: I disagree with you.
Q: You do?
A: The mother of bull runs is still to come
A: In my opinion, yes. But it could start after one-year. It could start after eighteen-months or after six-months. But the next high and the next bull market will be far bigger and have far more participation and far more excesses than we had in the last one-year.
Ramesh Damani, Member, BSE says, “He is so free with his information. He will willingly share with you his ideas. He will willingly share with you his investment style or his thought processes with the market and there is almost leisurely number of young men or Turtles as we call them on the street who’ve benefited enormously and handsomely from his advice including myself. Earlier in my career he really helped open my eyes, showed me how to dream and allowed me how to take position with the market. So above all, we respect that – the ability to share that information in a business that is so secretive - he is an open book, always willing to help.”
Q: Do you see a lot of people who are part of the stock market, returning back some of the wealth creation? I know that you have a Jhunjhunwala Foundation. You're actually actively part of a lot of NGOs and you donate significantly amounts over there. Is that an important part of being a wealth creator for you - to spread it as well?
A: I cannot forget my late father, who has never asked me ever that what is your wealth? The only thing that he would ask is how much charity have you done this year, and are you going to continue it or not? So, I’m making my own efforts towards some good social cause that I’m supporting. I’ve built a Home for 400 boys in New Bombay. God has given me one daughter and I’m going up 400 children. I cannot give them absolutely what I’ve given my daughter but I’ll send them to English medium schools. I’ll see that they have all the needs of life and I want to bring them to a stage where they can get good jobs and they can contribute back to the Home.
I think the greatest wealth is giving the person ability to learn. Then I’m supporting lots of causes with children like girls' education. I'm supporting other small causes for street children. We're building a temple in Lonavala. It is my target in life. This year by budget is Rs 10 crore, next year it should be Rs 12.5 crore and on my twenty-fifth wedding anniversary, which is on February 21, 2012, the gift I want to give my wife is - I’m going to give Rs 500 crore to her foundation.
Q: Is this a bigger high than being part of the stock market?
A: I don't think it is a high. It is a duty. To donate and to help others are very good attributes.
Urmila Jhunjhunwala, Rakesh Jhunjhunwala’s Mother says,” When he was a little boy, whenever our friends used to come, he used to tell them which shares are good to buy.
Rekha Jhunjhunwala, Rakesh Jhunjhunwala’s Wife, says, “I think the market is only first priority for him. His first wife is only market. When he started, he had nothing, absolutely nothing. Everyone used to say, what will you do in stock market? But he wanted to do that only.”
Q: What's your biggest faith?
A: Myself. I am confident of myself and I don’t rely on anybody.
Q: What's the big dream for Rakesh Jhunjhunwala - the wealth creator because we have had entrepreneurs who say I want my business to go to XYZ level, I want my turnover to double, triple, four-times?
A: I have two-three dreams in life. The first dream is that when I die and only truth of life is death, how many people come to my funeral and say, a good man has died. That is the greatest ambition in my life. Second thing is I want to earn the greatest wealth of the world in the most legitimate manner; practical legitimate manner and leave the largest part of it to charity.
Q: Favourite trade – long or short?
Q: Rank the following companies on a scale of 1 to 10:
A: I would rank it 2.
Q: Answer the following questions with just bullish or bearish:
Q: The S&P 500.
Q: The Indian bond market.
A: I expect the yields to go down. I am bullish on the bond market.
Q: The Nifty 50
A: I am bullish.
Q: If you weren’t a man of the market, what would you be?
A: I never think about it because being man of the market is so good and exciting.
Q: The worst advice someone has ever given you about the market.
A: You can never earn money in the market. You will go bankrupt.
Q: And the best advice someone has ever given you about the market.
A: Be careful. Be responsible. It’s fire.
Q: You have told me what you want to be remembered as. But what's the one piece of advice you would give someone who wants to get into the stock market?
A: First advice is respect the market. Have an open mind. Know what to stake. Know when to take a loss. Be responsible.
Shareholders can retain their exposure to the stock of Cummins India, a leading manufacturer of diesel oil engines in the country. Recent events such as the softening in the prices of steel and pig iron (its main inputs), depreciation of the rupee and reversal of import octroi levied earlier are likely to provide near-term relief to Cummins. The coming quarters may also see the company benefit from price hikes carried out by the company last quarter.
At the current market price of Rs 312, the stock trades at about 16 times its likely FY-09 per share earnings. While the valuation does not appear unreasonable given the company’s strong balance-sheet and return ratios, the risk of moderation in growth, as a result of uncertainties on the demand front (linked to the slowing economic growth), does not make a strong case for fresh exposure to the stock now.
The recent cooling off in the prices of commodities such as steel and pig iron, which form a significant input for the company, would provide it with the much-needed relief on the margin front.
In the last two quarters, the company’s performance had come under the scanner as the operating profit margin had dipped due to the mounting pressure on the raw material front.
The OPM had dipped to about 11 per cent in March ‘08 quarter but improved to 13.3 per cent in the June quarter.
March quarter, however, was exceptional as the company had to shell out extra money following the unexpected increase in import octroi from 3 per cent to 7 per cent by the Pune Municipality that quarter.
This has however been reversed, positively impacting margins with immediate effect. The recent fall in oil price also bodes well for the company.
On a more sustainable basis, the price hikes of over 2-3 per cent that were carried out last quarter by the company may also help Cummins maintain its overall margin performance from hereon.
For the June quarter, Cummins reported 30 per cent growth in sales and 38 per cent increase in profits.
Cummins India caters primarily to three user segments — power generation, industrial and automotive. The power generation segment, which made up over 45 per cent of the total sales in FY-08, has been its key revenue driver over the last couple of years.
But considering the perceptible slowdown in the growth of its user industries such as IT, realty and retail, the growth for Cummins is likely to be riddled with many challenges.
While the demand for gensets may remain robust given the continuing power deficit in the country and the buoyant spending in the telecom sector, it still remains to be seen whether its main user industries would continue spending on developing infrastructure when faced with a slowing growth scenario themselves.
Cummins’ industrial segment, which caters to construction and earth-moving equipment, compressors and pumps, may also see lower growth in the coming quarters.
The mining segment, which continues to remain on a strong footing, may be an exception even as the demand from other segments such as construction may remain uncertain under a high interest rate scenario.
The industrial segment contributed to about 15 per cent of the total sales last year.
However, amidst all the noise of a slowing demand scenario, Cummins appears best-placed among its peers to weather the slowdown given its diverse portfolio and balanced exposure to various user industries.
Exports, which contributed to over 30 per cent of sales, may continue to remain strong for Cummins. It may also get a lift from the recent depreciation in rupee, which will make its exports more competitive and strengthen Cummins India’s position as the global sourcing hub for Cummins Inc, its parent company. The other growth driver for the company may come from the compressed natural gas (CNG) segment.
Although insignificant at present in terms of its contribution to the overall revenue pie, this business holds potential to develop into a significant segment for the company in the next couple of years. It has already, in a joint venture with Tata Motors, supplied 600 buses to the Delhi Transport Authority.
That the Delhi Government has further floated tender for introducing 2,500 more CNG buses offers more growth opportunity for Cummins, which has a virtual monopoly in the lean burn natural gas fuel systems (each engine is worth around Rs 3-4 lakh).
With most cities looking to move towards cleaner and greener modes of transportation, this segment holds tremendous growth potential.
Another factor that speaks in favour of the company is its zero-debt status and healthy operating cash flows.
This especially appears significant in the current market scenario when some of its peer companies are struggling with the increasing interest burden.
"We are assessing the current market situation and closely monitoring the trading pattern. We will wait for a couple of more days before taking any decision."
Before a sharp recovery today, the domestic benchmarks fell over 10 per cent in four trading sessions on the back of massive short selling.
The share of the largest private sector bank, ICICI Bank, was hammered on news of its high debt exposure to Lehman Brothers. The stock fell over 20 per cent this week and touched a 52-week low of Rs 515 on the Bombay Stock Exchange on September 16.
The last week, the existing financial system was put to the severest of the test and it almost snapped before change of rules midway through the game, gave the regulators some breathing time to fix the leaking taps.
The Fed gave up its resolve not to come to the rescue of the ailing financial institutions, after AIG seemed to be sinking the whole ship. While Lehman filed for bankruptcy, a rope worth $85 billion was thrown at AIG and suitor was found for Merrill Lynch in quick speed time. And sensing that even that was not helping, Uncle Sam threw his smashed hat in the money market mutual fund ring as well. And then announced his mega plan of buying distressed assets from the banking systems, contours of which could be chiseled over the weekend.
But the remedy that really helped the markets get a much deserved breather was the banning of shorts by SEC till October 2. These are some of the other important global events that happened last week.
Þ The 3-month U.S. dollar London Interbank Offered Rate, or LIBOR, saw its biggest one-day jump in 9 years.
Þ The Dow slumped to its lowest level since October 2005 as lending between banks around the globe nearly ground to a halt
Þ The US treasury three month bill were yielding 0.02%, their lowest yield since World War II, indicating the investor anxiety to buy safety at any cost. The rise in Gold also indicates that. All the world's bourses are at multi-year lows. The Yield has since improved.
Þ Gold too spiked as investors panicked. But retreated after investors took note of the Government's resolve to loosen its purse strings.
Þ The California Public Employees' Retirement System will not lend select financial stocks to short sellers.
Þ The New York attorney general has called for an investigation into the short selling of some prominent financial companies, including Goldman
Þ In Russia, officials’ suspended stock-market trading for two straight day as the Russian government promised to inject $20 billion to halt a collapse in share prices. The market rose 30% on Friday, their highest ever one day rise.
Þ In China, government officials directed purchases of bank shares and encouraged companies to buy their own shares in efforts to prop up a falling market.
Þ Britain's stock market regulator on Thursday banned short selling in financial companies and said it might extend the ban to other sectors. The move followed the Securities and Exchange Commission's curbs on the practice that went into effect Thursday morning.
Þ France decided to monitor shorts sales more closely.
World's largest bail out is on
In what could be the biggest intervention in financial markets since 1930, the US Federal Government is working on a sweeping series of programs to address the ongoing turmoil in the US and the global financial markets.
The contours of the package would be known by the time the markets open on Monday for the next week.
The new initiative could be on the lines of ‘Resolution Trust’, which was put in place following the Savings and Loan crisis in the late 1980s. The government created the trust to manage mortgage-related assets owned by defunct banks.
Appreciating the fact that the genesis of the problem are the toxic assets in financial companies, the idea is to buy these from the ailing owners at discounted prices, hold and nurse them to health and then offload it back to the market.
Don't count the chickens
Þ As companies deleverage, their earnings will reduce. Even if the ailing companies are able to find Oriental white knights, they will be unable to make the extra-ordinary profits. There will be write backs but no real earnings.
Þ The financial-services industry's share of total American corporate profits rose from 10% in the early 1980s to 40% at its peak last year.
The central bank is taking on a potentially big risk.
The loans that the Fed makes through its discount window via banks, are non-recourse loans. Bernanke may better say his rosary everyday.
Lessons from 1987
History tells us that while RTC was set up in 1989 to tackle the crisis, the markets took one year to bottom out and the housing market took an additional two years to bottom.
So if you are thinking, that the mechanism M/S Bernanke and Paulson are putting in place, will wave a magic wand over the financial woes and the markets will sky rocket, think again.
The buoyancy could last a few sessions, but once the shorts are allowed to be back in the system or another branded cookie crumbles, the markets would be back on their beaten track heading south.
Domestically, we expect 4550 to be a crucial resistance for the markets. Markets are unlikely to runaway to higher levels and we expect derivatives expiry to close around 4250 levels.
For those of us who had only a nodding acquaintance with Wall Street, news this week has been bafflingly littered with the big Wall Street names. Lehman Brothers filed for bankruptcy, the venerable Merrill Lynch was taken over by Bank of America and AIG, bailed out by the US Fed.
So, how has the housing crisis in the US impacted Wall Street? What were the repercussions on the Indian markets?
The (sub)prime crisis
Taking advantage of the housing boom in the US, mortgage banks disbursed loans to many sub-prime (less credit worthy) borrowers.
To compensate for the risk undertaken, these loans were given at higher interest rates. To raise more money, banks packaged these loans into securities and sold them to investment banks.
These highly leveraged positions paid off as long as the housing market continued its upward move, with rising property prices.
When recession set in, borrowers began to default. The banks seized properties and foreclosures rose. But, by then, the fall in the housing market was so steep that the foreclosed properties were difficult to sell.
The mortgage banks began to make huge losses on the outstanding loans and foreclosed assets. In the process, investment bankers who bought securities based on these loans too were hurt.
Bear Stearns flagged it off...
Bear Stearns, the US mortgage giant, was the first of the large investment institutions to fail on sub prime related issues, after it declared losses on mortgage lending in March 2008. Unable to sustain operations, the institution was sold to JP Morgan Chase.
Many other small and mid-sized firms in the US too declared losses on sub-prime mortgages. This triggered a lowering of interest rates by the US central bank- the Fed- to ease the credit crunch in the economy.
Following the Bear Stearns episode, there were similar problems at Fannie Mae and Freddie Mac, the two other mortgage giants of the country. This prompted the Fed to infuse $200 billion to shore up these institutions.
Just when the markets thought the worst was over, came the news of Lehman Brothers’ filing for bankruptcy on huge mortgage-related losses.
And even before the market could absorb this shock, came similar news from Merrill Lynch and AIG (US’ largest insurer). The stock markets plummeted. As the week drew to a close, the US Fed, with other central banks, assured the markets that the impact of the credit crunch would be contained.
Bailouts have been put together for the troubled banks with AIG taken over by the Fed and other investment banks in takeover talks with the stronger firms. The names that you just read are not of some neighbourhood bankers. All are renowned global bankers which served some of the largest corporations, governments and high net worth investors worldwide.
Also, several banks of other nations have invested in funds of these bankers.
Impact on the Indian market
FIIs, who are the key source of liquidity in Indian stock markets, continue to dominate , with sizeable holdings in many stocks. A weak stock market also makes foreign PE (private equity) funds hesitant to bring in money. In a scenario where the cost of borrowing is already high, poor foreign inflows (both FII and FDI) worsen the funding situation making fund availability tougher for corporates.
Given the size of FII holdings in stocks, bulk selling by foreign institutions has the potential to severely impact individual stocks as well broader markets. The Sensex lost 6 per cent off its value on the day the Bear Stearns collapse came to light.
But Lehman had already liquidated a significant part of its India holdings when its troubles came to light. However what worsened the initial falls this week were fears that other foreign institutions that run similar risks may also sell their holdings.Banking stocks were in the limelight, as they are most vulnerable to the credit crunch. A leading domestic bank that had exposure to the bonds of the Lehman Brothers faced tough times last week. Until reports clarifying that the bank expected recovery of the investments made came in, rumours had triggered huge selling in the stock.
The Banking Index too was in the red until the Finance Minister gave the assurance that the public sector banks had limited exposure to Lehman’s assets and that the Indian financial sector was well-placed to handle the crisis.
Lessons from Lehman
Are there lessons for Indian investors from the events on Wall Street? Here are a few. If the housing collapse in the US was triggered by ordinary borrowers being unable to repay loans, interest rates back home too have been rising. The Indian housing market has been showing signs of slowdown with property prices correcting in many markets. This should set the alarm bells ringing for borrowers, as also bankers. As banks become more cautious in offering credit to individuals, it is time for us to take stock of whether we have enough of a safety margin on our borrowings, be they home loans, credit cards or any other kind of credit. Stock market investors obviously should brace for choppy markets ahead!
Investors with a two-year perspective can consider buying the stock of Yes Bank at the current price (135.65). The bank trades at 3 times its June 30 book value and 20 times its FY-08 earnings; at 15.8 times its FY-09 earnings and 2.4 times the FY-09 book value.
Yes Bank is among the youngest and the fastest growing private banks in India. The stock trades at a premium to ICICI Bank and at a discount to private sector rivals such as HDFC Bank and Axis Bank.
The bank has high quality assets, small exposure to the retail segment (2 per cent), comfortable capital adequacy, high proportion of core non-interest income to total income and strong growth in advances and deposits in the current challenging scenario.
However, a relatively small proportion of low-cost deposits and limited branch network are curtailing the company’s retail banking growth opportunities.
Yes Bank is aggressively foraying into retail banking for deposits, while retail advances are not the focus. Its loan book is divided between corporate (57 per cent) and small and medium enterprises (41 per cent).
This loan mix holds the ability to weather the current high interest rate scenario with limited threat of slippage. Until 2007, the bank had no slippages, but in FY-08 and the Q1 of FY09 there has been an increase in delinquencies.
The 51 per cent earnings growth in Q1FY09 was much slower than the four preceding quarters when the earnings grew over 100 per cent. Yes Bank’s balance-sheet and advances have grown by 130 per cent (compounded annually) in the last four years ended March 2008, whereas the deposits grew at 170 per cent (annualised rate) in the same period.
The high growth in the past is partly attributable to the effect of a low base.
The going can get tough from hereon. In the recent quarter, the bank posted a deposit and advances growth of 45 per cent.
The deposit base declined sequentially as the bank has shed high-cost deposits but improved low-cost Current Account Savings Account (CASA) deposits. After phenomenal growth in FY08, with total income growing at 112.9 per cent, the June 2008 quarter saw a decline in growth. The bank’s net interest income grew at a healthy 122 per cent. However, the slow down in non-interest income as a result of decline in “income from financial markets” tempered the growth of the total income to 37 per cent in the June quarter.
Segments such as transaction banking, financial advisory and third-party product distribution have grown at a good pace to boost ‘other income’.
Improving net interest margin
Comparison on a sequential basis suggests that the bank has managed costs well, with cost of funds remaining flat at 8.4 per cent, despite hikes in CRR and repo rates during the quarter.
This may have been achieved through an improvement in CASA (at (8.9 per cent) by 96 per cent over the year. Improvement in gross yield on advances from 11.2 to 11.5 per cent (PLR was hiked during this period) helped in propping up the net interest margin of the bank to 2.88 per cent.
A Rs 22-crore provisioning was created for the bank’s mark-to-market loss in the available-for-sale bond portfolio. There was increase in gross NPA to Rs 21.3 crore and net NPA to Rs 17.4 crore, amounting to gross NPA/gross advance of 0.21 per cent and the net NPA proportion of 0.17 per cent.
The provision cover is low at 18 per cent but the bank is confident of recovering these advances. The bank has said that there has been no further loss in forex derivatives in the quarter in addition to the provision it made in the previous quarters.
The capital adequacy of Yes bank stands at 15 per cent after recent capital raising of Rs 564 crore. This will help the bank increase its asset base with ease this year. The credit-deposit ratio of the bank at 80 per cent is high but may come down as the balance-sheet expands.
While the bank’s balance-sheet may see lower growth, it may nevertheless grow at a rate superior to its peers, given its aggressive moves in opening retail branches, targeting SMEs and also building corporate relationships. Yes Bank has 100 branches mostly in large cities and it is likely to add 17 more (it has already received licences to open these branches) this fiscal year, but in future the bank may have to look towards semi-urban and rural areas to continue growing at these rates.
Yes Bank also plans a foray into asset reconstruction business by the end of this year; this can boost its ‘other income’. The bank intends to increase its SME clientele to 1,000 by FY-09 and plans to add 5,000 customers under its Urban-Micro Finance programme.
The recent PLR hike to 17 per cent will cushion the bank from increasing cost of funds and maintain its net interest margins in the current quarter but there could be more slippages as the advances grow. The FII exposure of 28 per cent as of June 2008 exposes the stock to the risk of institutional liquidation.