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Wednesday, March 30, 2005
Tisco: The price rise effect
Come April, steel prices are expected to rise further. While Tisco has already announced a hike in prices by about 20% for its long-term customers, the others are expected to follow soon. However, the quantum of price hike by the other players will not be as steep as that announced by Tisco owing to the fact that they have been increasing prices periodically.
It must be recollected here that Tisco had refrained from raising steel prices in August 2004 in wake of the high inflation, which had then hovered at over 8%. In fact, it had reduced prices by Rs 2,000 per tonne to aid the noble cause of reigning in the country's inflation!
However, this did not affect the company's profitability, as the company continued on its path of costs reduction and enhancing its realisations by improving its product mix, thus helping it to absorb the impact of the price cuts announced then. These are vindicated by the fact that the operating margins of the company were at over 43% in 9mFY05 while its realisations per tonne also was higher.
It must be noted that unlike other steel companies, Tisco is in a significantly advantageous position considering that it meets all of its iron ore requirements and a bulk of its coal requirements internally. This has enabled it to insulate itself from the adverse impact of increase in input costs, in comparison with other global and domestic steel majors, who are forced to pass on the steep rise in input costs to consumers. The rise in average steel prices over the past few quarters must be considered in the backdrop that prices of steel inputs like iron ore (up around 150% YoY), coal (up around 200% YoY), coke (up around 125% YoY) and scrap (up around 230% YoY) having skyrocketed.
So, considering that Tisco has managed to increase profitability substantially in FY05 despite reducing prices, will the price hike for the new fiscal i.e. FY06 improve profitability further? Well, not exactly. This is because the price hike announced by the company is effective for its long-term contracts, which as per a company presentation made sometime back, constitutes to about 15% to 20% of the company's total sales. This is considering only the annual and half-yearly contracts of the company. Even if we consider the quarterly contracts, the price hike would cover another 8% to 10% of its contracts, taking the total to about 25% to 30%. Thus, the remaining portion of its sales would be governed largely by short-term price movements, which we are not very bullish on.
Further, it must be noted that the long-term contracts entered into by companies for assured supply of steel at an assured price (irrespective of the spot price movements), are generally made at a price lower than the spot price. Our cautious view on steel prices is also supported by our interaction with steel user-industries who have indicated that steel companies, unlike a few quarters ago, are now more willing to enter into long-term contracts. This is an indication that steel prices are nearing their peak. All these are probably the reasons that have not seen any major action in the Tisco stock despite the announcements.
However, while we will be revisiting our Tisco numbers soon (post a management meet) to incorporate the impact of increased steel prices, a back of the envelope calculations reveal that even based on optimistic assumptions (price realisations would be higher by about 10% YoY in FY06 and operating margins would hover in the vicinity of 45%), the EPS and book value per share would be around Rs 75 and Rs 195 respectively. This means that at the current levels of Rs 420, the stock is trading at a price to earnings multiple of 5.6 times our FY06 expected earnings and 2.2 times its FY06 book value.
Now, while the stock looks attractive in terms of P/E valuations, this is a typical characteristic of any commodity stock. During peaks or close to peak prices, the company's earnings are robust. But sustainability is always a question. It is therefore, pertinent for investors to look at what is in store for the sector in the year forward. With China increasingly giving indications of meeting it steel requirements internally, the threat of increased supplies and consequent pressure on steel prices is all the more evident. Further, considering our valuation parameter for steel stocks i.e. price to book value, which in the current phase of the steel cycle seems apt at 1 time to 2 times, the Tisco stock is currently trading above the upper band of the valuation parameter.
Amidst the possible upside potential in the near-term, we believe that the downside risk is more important. Since commodity cycle cannot be timed to perfection, it may not be worthwhile to extend the downside risk. To that extent, we advise caution.
Tuesday, March 29, 2005
Are you a braveheart ?
News is BAD.. Bears are BACK.
Here is Sharekhan's Braveheart Strategy
Lose your horns
The toughest thing to say to bulls is to ask them to lose their horns. For that's their raison d'être. The bulls would be happier if bears just never came out of hibernation. But unfortunately for the bulls the bears resurface every time they go into hibernation. So for the bulls, it is not so much a matter of IF the bears would come back, as of WHEN the bears would come back. And after three long years the tables have turned again. Yes, the BEARS ARE BACK!
Click here
Sunday, March 27, 2005
Hindu Business Line Recommendations
Buy >> Coramandel Fertilizers
Sell >> SKF India, Goodlass Nerolac
Hold >> Alfa Laval, Tata Tea
Saturday, March 26, 2005
Fed Rate Hike - Indian Implications
The US Federal Reserve has yet again affected a 0.25% hike in its overnight rates, which now stand at 2.75%. This is the seventh quarter percent hike since the Fed started raising rates last June in its pursuit of tiding in the rising inflation. However, while the central bank kept the measured tone intact, it indicated that it is growing more concerned about the inflation. Give us a break, Mr. Greenspan. That does sound stale now!
In his recent testimony to the US Senate Banking Committee, Greenspan had hinted at a further hike in interest rates, citing reasons like improvement in the US economic fundamentals and low savings of consumers. He had further indicated that the rise in rates would continue to be 'gradual' (read measured) and that it was an 'imperative to restore fiscal discipline in the United States to help narrow the huge trade deficit.'
While not much should be read into this ¿measured¿ rate hike as this seems a repeat of what the Fed has consistently maintained in the past year, Indian investors should note that these are few of those times when Greenspan has confessed that the problem of high deficit is a consequence of the extensive liberal policies of the Fed with respect to interest rates in the past 2 years.
In the recently held 'Advancing Enterprise 2005 Conference' in London, Greenspan had owned up that the fall in US interest rates since the early 1990s has supported both home price increases (the asset bubble as it is termed) and, in recent years, an unprecedented rate of existing 'home turnover'. This combination has then led to a significant rise in debt on account of home mortgages. What Greenspan meant from the latter (home turnover) was that the sharp rise in home prices has created capital gains for owners, which become realised with the subsequent sale of a home. A large proportion of this money is then used to purchase another home and the remaining part is used for 'consumption' purposes. This has been the chief perpetrator of the rising US personal dissavings. And so the Fed decision to now raise interest rates at a faster clip to reign in the bubble.
A case in point was the minutes of the meeting of Federal Reserve (held on December 12, 2004) that were released a couple of months back. Some accompanying facts of the minutes led to investors across the world panicking in belief that the faster rise in the US interest rates will lead to the 'hot' FII money reversing its flow, back towards the relatively safer US treasury bills and bonds.
The minutes of the aforesaid meeting indicated that the US economy expanded at a moderate pace in the second half of 2004, with both consumer and investment spending remaining robust. However, while core inflation remained subdued, prices rose slightly higher than in 2003. This was much owing to the indirect effects of higher energy prices. It was also indicated that the recent depreciation of the US dollar against key currencies was also putting pressure on inflation, thus increasing risks of a faster rise in prices going forward.
These key details of the Fed meeting led market participants to believe that the US central bank might raise interest rates faster than in the past, thus increasing risks of re-allocation of FII money back to US equities in 2005. Apart from that, the fact that economic policies across the globe are now more integrated than ever before, investors seemed to have believed that in light of the US Fed raising interest rates at a faster pace, central banks across the world would follow soon.
So, what should Indian investors do?
In light of the concerns that have been mentioned above with respect to a faster rise in US interest rates and FII flows reversing their direction, thus leaving local investors in the lurch, we suggest that investors should not bank on just FII inflows to drive markets to new highs. Economic theory suggests that a country cannot sustain a GDP growth that is much higher than the prevailing interest rates as it leads to high inflation and overheating. Given the fact that the US interest rates still lie at 2.75% as compared to the GDP growth of around 3.5%, there is a case in point for the Fed to raise rates fast, at least till the 3.5% levels.
As for Indian investors, given the sharp rise in stock prices over the last two years, they have to be cautious when it comes to investing in equities at the current levels. Apart from the fact that return expectations have to be toned down, investments should be made on a staggered basis.
Source : Equitymaster
Thursday, March 24, 2005
Low volatility points to some big moves in investment markets!
Many commentators have recently pointed out that volatility in both the bond and stock markets around the world has been unusually low and that from the current low levels of volatility big market moves will emerge.
Financial pundits also expect these moves in the financial markets to be likely on the downside. And while I tend to agree that volatility will sooner or later rise, an increase in volatility does by itself not necessarily imply that rising volatility will lead to market sell-offs.
As an example, extremely low volatility in the bond market gave, in early 1987, way to a sharp sell off in bond prices and a rise in long term bond yields from 7.14% to 10.23% (bond prices bottomed out a week before the October 19th stock market crash).
Conversely, low volatility in April 1998, was followed by a sharp rise in bond prices. 10-year government bond yields fell from 7.11% to 4.11% and bottomed out, in September 1998, in the wake of the LTCM crisis.
So, all low volatility is suggesting is that a 'big move' is coming but it does not convey the direction of the next big move. Now, in the case of the stock markets around the world we have record low volatility and in the case of the US, the VIX volatility Index is hovering near a ten years' low.
In fact world equity implied volatility is at present far below the average volatility of the last 10 years. So, all we can say is that within the next few months a large stock market move can be expected, either up or down.
But the question is obviously whether an upward or downward move in stock and bond markets is more likely. For equities, most indicators do seem to suggest that the next big move will be on the downside.
Financial institutions have a record low level of cash hence there is little buying power left. Insiders continue to sell heavily. The public and fund managers are very bullish about the prospects of equities - a contrary indicator, which would rather point to a sell-off in equities.
Liquidity tightening
Moreover, global liquidity has been tightening. Earlier in the year, I showed that money supply growth had been decelerating. My friends at Gavekal Research compile a global monetary indicator that suggests tighter global liquidity, which is usually not very favorable for investment markets.
In the eyes of the American Federal Reserve the US economy appears to be sound (it is not - just look at GM) and, therefore, the Fed is likely to continue to raise short term interest rates - that is unless the US economy weakens suddenly once again badly.
Therefore, we should assume higher short term interest rates and tighter liquidity for the foreseeable future, which should not be good for equities.
Admittedly, the S&P made a new recovery high in the first week of March, but strength was concentrated in energy and basic material stocks while financial shares are underperforming. Usually, when financial stocks are under-performing while oils are strong the market is in the last stage of a bull market.
In addition, stock markets appear to be - after their recent renewed strength - to be overbought. This would especially apply to emerging markets, some of which had almost vertical upward moves. At the same time corporate bond spreads are at record low, suggesting widespread complacency about risk.
So all in all, as far as stock markets are concerned it is more likely that rising volatility will give way to possibly severe market downward moves.
For bonds the picture is murkier, since bullish sentiment on bonds is rather leaning on the bearish side. Still, bonds would seem to be vulnerable as either economic growth could surprise on the upside or as 'visible' inflation accelerates.
By 'visible inflation' I mean inflation that would show up not only in asset markets like housing, equities, art, and commodities but would manifest itself in a sharply higher CPI figures, which are at present kept through statistical anomalies artificially low.
Bonds to fall
Therefore, I lean toward the view that the next 'big move' in bond prices, given the risk of higher inflation and higher short term rates will rather be toward the downside. Needless to say that rising short and long term interest rates would not be favorable for the housing market.
I have pointed out to the vulnerability of sub-prime lenders before. Robert Prechter recently produced a figure of a sub-prime lender index, which measures the stock market performance of several sub-prime lending companies.
In fact, all financials including Fannie Mae, and mortgage, credit card and sub prime lenders, and providers of financial guarantee products such as Capital One Financial (COF), Countrywide Financial (CFC), Accredited Home Lenders (LEND), New Century Financial Corp (NEW), MBIA Inc (MBI), MBNA (KRB) appear to be rolling over. JP Morgan Chase (JPM) - heavily exposed to derivatives - is also not performing well.
As observed before, strength in oil stocks and weakness in financial stocks is usually not a particularly favorable omen for the stock market. In addition weakness in the shares of mortgage lenders is not a positive indicator for the housing industry. We are short some of the financial shares mentioned above and are looking to renter the homebuilders from the short side on any sign of weakness.
As can be seen from above figure, the S&P Homebuilding Index has risen ten-fold since 2000 and seems to be getting extremely overextended. This particularly in view of the weakness in financial stocks I highlighted above.
What about industrial commodities? There is a close correlation between Foreign Official Dollar Reserves (FODOR) and Crude Oil Demand (the same correlation exists between Foreign Official Dollar Reserves and industrial commodity prices).
FODOR growth has been decelerating, which confirms the tighter liquidity argument I made above. And since there is a close correlation between oil demand and industrial commodity prices, I would expect under normal conditions oil and other commodity prices to ease in the near future.
I am saying under 'normal conditions' because oil prices could rise much further if geopolitical tensions increase. In particular, US air strikes on Iran and Syria have become a distinct possibility and could lead to soaring prices. I also admit that copper prices have recently broken out on the upside from their yearly trading range.
Grains look promising
However, the breakout is not very convincing and might turn out to be a false breakout move. As a side, I may also add that when FODOR growth slows down, the US dollar tends to strengthen. So, whereas I remain wary of industrial commodity prices I maintain my positive stance toward the grains, about which we wrote a month ago.
Wheat, corn and soybeans have all strengthened recently and we would use any weakness as a buying opportunity.
I have mentioned before that since October 2003 all asset markets including equities, bonds, art, commodities and real estate have been inflated in concert. At the same time volatility and bond spreads have been coming down to almost unprecedented lows while sentiment among investors is either very bullish or at least extremely complacent. This would suggest to me that risks have been rising and that the next 'big move' in asset markets could be to the downside.
Finally, we should not forget that January was a down month for the stock market in the US, which is usually quite a reliable indicator for the market's direction during the year. So, while I am not ruling out some recovery potential for the US stock market until mid April, limited upside potential could give way, at any time, to a sharp increase in downside volatility.
Thus, the high risks in buying US stocks and other extended asset markets (real estate in the US, and industrial commodities) at this point would, in my opinion, hardly justify the very limited near term upside potential that might still exist in the asset markets.
Marc Faber
Shopping Time !
500 points down and more predicted ! Now thats what I call Shopping time !
Here is a list of stocks I will probably research and buy (again).
In no particular order..
- ONGC
- ITC
- Sesa Goa
- Avaya Globalconnect
- Geometric Software
- Alfa Laval
- SBI
- ICICI Bank
- Container Corporation
- Exide Industries
- Nicolas Piramal
- ABB
- Reliance
- Finolex Industries
- Rico Auto
- Pricol
- Shanti Gears
- Mphasis BFL
- Karur Vysya Bank
- Jammu and Kashmir Bank
- Canara Bank
- Visualsoft
- Bongaigaon Refineries
- Blue Star
- Subex Systems
- Asahi India Glass
- GNFC
- I-Gate
- Infosys ( Planning to attend the AGM )
- Mahindra & Mahindra
- MRPL
- Navabharat Ferro Alloys
- Upper Ganges Sugar
- Balrampur Chini
- NTPC
- Pfizer
- Glaxo Pharma
- Shyam Telecom
- Indian Hume Pipe Co. Ltd
Disclosure: I hold shares in all the companies listed above if thats the disclosure that you want.
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