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Fund manager with top brokerage in Mumbai. Ivy educated for whatever its worth. Need to remain anonymous given institutional constraints.
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  • India. Reforms. Really?

    As predicted, the Indian government has started its divestment drive. The Indian government is behaving like the corrupt and bankrupt zamindar in a Tagore novel, who has to go to an older lady of the night, instead of the younger fresher one, because that is all it can afford. As outlined earlier, this is part of its plan. It is talking up the markets, announcing reforms that can never be developed on, and then selling its paper. It will recover Rs 40000 cr. from divestment and Rs. 30000 cr. from spectrum auctions. They say, the money will be applied towards the deficit. In reality it will be used to fund further sops and giveaways in the next budget. The deficit will be kept at 6 % of GDP and they will take their chances with the rating agencies like S and P later. (SELL ALL STOCK).

    Much has been made of the "burst of reforms" unleashed by Finance Minister Chidambaram in recent weeks. The stock market has rallied and animal spirits it seems are back. Everybody's babbling about how the UPA, after eight years in power, has found religion ie "reforms".

    The market is now at 21 times price to earnings (trailing twelve month free float adjusted as per the National Stock Exchange). Once more the mood swings violently. More interestingly the India VIX , the fear index is at 3 year lows of 15. This is usually an indicator of complacency, and historically such lows have signified a massive sell off. The combination of the stretched price to earnings and the VIX means the market is ripe for a big sell off. My two bit as an Ivy educated fund manager in Bombay who has worked internationally on some of the world's major structural adjustment and economic reform programs.

    In reality, the reforms amount to bureaucratic tinkerings with percentages - of a sort that only tax mavens and accountants can comprehend. Witholding taxes go down by a percentage point or two. FII margin percentages change. Service tax percentages for insurance companies change. Now an attempt's been made to increase the percentages foreigners can hold in insurance and pensions. (This last will never pass through Parliament given the unanimous opposition to it). Blah Blah Blah.

    The Indian economy, in fact, requires Parashurama's ax and not the surgeon's scalpel. The reference is to the mythical woodcutter of Indian mythology who wields a massive axe when needed. Wholesale violence will have to be committed on large areas of India's economy with Parashurama's axe, if we are to resume a decent growth rate.

    The government had no choice but to unleash this wave of tinkering and call it "reform". It is trying to keep the capital markets buoyant because it needs to sell or "chipkao" (i.e. stick, as we say in the business) close to Rs 40,000 crores worth of equity. This with spectrum auctions, hopefully plug the budget deficit a little by March. More crucially, it will also free up resources for massive election giveaways in next March's budget. This is especially needed if the Food Security Bill -Madame Sonia's chosen strategy for reelection - is to be passed.

    Real reforms for India will not happen for a long time. These include financial sector reform, and an end to the financial repression signified by the statutory liquidity ratio. Privatization of the banking system that's put an end to the ridiculous spectacle of 75 % of the banking system being owned by the government in a market economy. Bankruptcy and exit laws will have to be introduced. Labour market liberalization and the freedom to hire and fire labour will have to be allowed.

    The collapsed state of Indian cities will have to be addressed by building 30 to 40 cities to accommodate massive rural urban migration. Land acquisition which is impossible now will have to be addressed. This list does not even include the sector changes required in mining and real estate and infrastructure and banking and power and sugar, and so on and so on. None of this is happening ever, it seems.

    Everybody's babbling in the media about how crucial the February budget is going to be for the UPA because it will be packed with big ticket sops like the Food Security Bill. Remember game theory however. It is crucial to take your opponent's reaction into account. The Opposition also knows that the budget will be crucial to the UPA's reelection chances ! Why then will they allow the UPA to present the budget at all. Especially when they have the numbers and the government is already on life support and in a minority. !!!

    The government therefore, will, in all likelihood, fall in November-December, during the winter session of Parliament. Elections will take place in March-April as India needs the school system for a general election. This will allow the Opposition the chance to deny the government's attempt to pass a budget full of sops and giveaways. The February budget will consequently be a vote on account. This scenario will suit all parties except the Congress and hence it will happen.

    Is the market discounting the possibility that in a few weeks, all these guys PC, Montek etc. will be gone ? Is it realising that this whole reform effort is a sham that will be exposed in a few weeks when the govenment falls ? Looking at the way its going up, I think not.

    The logical conclusion also is that this is the high point of the markets move this year. India has gone from having the most incompetent FM (Pranab) to the most cunning FM (Chidambaram). The later is deliberately doing all he can to talk up markets to implement his plan. There is little need to oblige him and his plans of using the stock market as a financing vehicle, by buying high and losing one's hard earned capital.

    Oct 17 3:03 AM | Link | Comment!
    I have received various private queries on real estate. Boarders will recall that I called the bottom on the sector about a month back. I shall summarise the argument for why real estate stocks are the classic contrarian play for 2011. Before I begin, patience, gentlemen, is the key. In particular, don’t bother about today’s and tomorrow’s price movement. Also don’t make the classic retail blunder of selling after making 10 or 15 % when a 100 % upside looks likely. Also please do not buy the smaller counters in the sector. Buy only the blue chips in the sector. Top picks are India Bulls Real Estate, HDIL, Orbit and Unitech. They are the ones that have the both the value argument, and the volume to attract massive FII buying, which is happening as we speak.
    Donald Trump one of the world`s leading and most astute real estate developers is investing in Indian real estate for the first time. Mr. Trump will be in Mumbai to announce a new project. “I think India has amazing long-term potential. The country is going to be one of the greatest places in the world to buy real estate,” says the real estate magnate in an exclusive interview in GQ India’s forthcoming issue. PLEASE SEE ATTACHED STORY.
    The disconnect between the real estate market and the scripts is growing by the day. Real estate has more than recovered from the 2009 slump. Looking at recruitment ads, we sees that there is shortage of people from civil engineers, to karigars and bricklayers. A housing and construction boom is on. Yet the scripts are trading at 52 week lows. ( BTW, Unitech promoters have hiked their stake yesterday in their company. Insiders buying shares, and raising stakes, is one of the most bullish signs in a sector.)

    The slump in real estate stocks is ironic, because real estate is the biggest beneficiary of 9 % GDP growth. It is also the biggest beneficiary of the Indian demographic story. After all, you are born, then you finish school and college, then you find a job and get married. Then what do you do ? You buy a house for your expanding family.

    Valuations are astonishing. Many of these stocks are trading at 50 to 60 % discounts to their net asset values (NYSE:NAV). Now the NAV calculation is simple. If I take all the land and flats under construction and sell them, then pay of all the debts on the company’s books, I get the NAV. Consequently, most company shares should sell AT OR CLOSE TO, THEIR NAVs. Instead they are trading at massive discounts. The market is behaving as though some sort of nuclear bomb has gone off on these company’s properties. ( In fact, if there was a market for corporate control in India, it makes sense acquiring these companies, breaking them up, selling their assets and paying off their debts, to realize value).

    Consider the following companies stock prices and their NAVs. IB Real current price of 130 vs NAV of 280. HDIL current price of 185 vs NAV of 370. Orbit current price of 80 vs NAV of 180.  To trade at their NAVs implies a 100 % upside in these stocks from here. Remember the NAV itself is subject to upside revision particularly for IB Real, HDIL and Orbit.
    A panic bottom was reached in late November due to the socalled “scam”. This was nothing but a bunch of mid level managers at banks getting paid by middlemen to facilitate loans. These middlemen are called loan syndication agents (LSAs) and the industry if full of them. The mistake this time was that the LSAs  bribed mid level managers to facilitate paperwork, a common Indian practice. As a result, blue chip real estate companies have lost 50 % of their value in weeks !!  This is a disproportionate result. Notice also that not a single real estate company, let alone a blue chip one, has been named in the scam.

    There is also short term earnings momentum due to the base effect. Many of these companies reported lousy earnings last December, so earnings growth just due to the base effect will be considerable.

    Real estate companies with substantial presence around Mumbai will benefit particularly from the final clearance to the Panvel airport project, - and the transharbour link - done a few weeks back by the Environment Ministry. Land prices are already rising substantially in anticipation.  The price on India Bulls Green, a 20 mln sq ft project in Panvel has doubled almost from 2200 psf to 4000 psf, a gain in potential sales of 4000 cr on a mkt cap of 5000 cr. ! Imagine India Bulls current NAV upside from current levels of Rs 280 with this project. Also imagine future upside as Panvel becomes a suburb like Santa Cruz. After all, the IB Real city project is four times the size of Nariman Point. Astonishing !! Please see the attached story from the Business Standard.

    The stock according to Motilal Oswal should do 16 per share earnings, leading to a multiple of 9 vs a market trading at 21 times.  This is comfortable, actually dirt cheap given the upside. In India Bulls Real Estate's case the undervaluation reaches bizaare proportions. The company has a listed power subsidiary and IB Real's stake in the subsidiary is worth 100 per share.  The current price is 135. So I get the entire real estate business with all the upside outlined earlier at 35 per share !!

    Other beneficiaries are HDIL and Orbit.

    The real estate sector interests me currently because it is a genuine contrarian investment. Genuine contrarian investing is tough, dangerous, and for most people, psychologically impossible. That is why it is so hugely profitable, and practiced by all the great masters of investing. It involves buying from the crowd what the crowd hates, and selling to the crowd what the crowd loves. There are two basic requirements and I shall consider them with regard to the RE industry. First, there has to be overwhelming strong consensus, either positive or negative, about a sector. With regards to real estate, there is overwhelming strong negative consensus. There is not a single brokerage or analyst who is positive about the sector, and all are heavily underweight. The entire sector has become a dog.

    Second, that strong consensus has to be supported by “weak” reasons. This is an important, and profound, point that deserves detailed explanation. In contrarian investing, a weak reason is not a weak reason per se. It is a reason that so widely known, that it is already “baked into the price”. Thus in real estate, “interest rates are rising and this will affect demand for housing” . Also, the “scam may make banks more cautions about lending” to the sector. These are all valid reasons. But because the whole world and their grandmothers are talking about it, it is already in the price, which is why the price is so low. Hence in contrarian investing, this is a weak reason.  A weak reason may also have no basis in current reality. One reason cited is that "these companies have very high debt levels" . This is yesterday's story and downright wrong.  I note that India Bulls Real and HDIL have debt equity ratios of less than 0.3, as compared to conservative cyclicals like TISCO or TELCO that have debt equity ratios in excess of 1.0. !!

    Two things can then happen. Firstly, the sector becomes vulnerable to positive news surprises that will suddenly cause the price to flare up. This could be an earnings surprise. Or FDI changes in real estate/retail. ( I note that Indian inflation concerns due to a faulty retail sector supply chain are reaching very high levels. The government as per press reports is considering further liberalising FDI in the retail sector to allow major retail chains to invest. These chains will demand large amounts of property in major metros).   Secondly, valuation considerations start to predominate when prices fall so low. Fund managers looking for alpha and seeking to deploy excess cash, realize their stupidity and start buying in. This generates momentum, and trend followers pile in, and we have a full blown rally.
    Jan 03 12:19 AM | Link | Comment!
  • Indian stocks - I'm forever blowing bubbles, Pretty bubbles in the air

    Are we entering the bubble zone on Indian equities ?

    The Indian stock markets are on a dream run.  Up almost 160 % since March 2009 (ie) in little over a year.  The trailing twelve months pe multiple is pushing 26 according to the National Stock Exchange web site.  Only twice since 1998 when the NSE was founded and the data was first published, have we seen this.  In February 2000 at the height of the IT mania, and in December 2007 at the previous bubble peak.   On both those occasions we peaked at 27 times and then crashed.  We are getting there folks on valuations.   Please verify the data from the NSE s web site (Indices and then Statistics)  by following the link and punching in the relevant periods.

    Your basic Fed Funds model is also out of whack. The risk free interest rate on the long bond in India – the 10 year GSEC - is pushing 8 %.  The earnings yield on the stock market, - the risky asset - the reciprocal of the pe ratio, – 1/26 – is less than 4 %.   The risky asset should yield a lot more than the risk free asset if investors are to be compensated for the risk they are taking. Instead it is yielding 4 % less.  Peter Lynch’s immortal advice –    When the yield on bonds exceeds stocks by 5 % , sell stocks and buy bonds”.  We are getting there on this too.

    All this would not matter if there was real growth in corporate earnings.  But the advance tax payments by the top 100 corporates – a good proxy for the market  - was up 13 % only in the September quarter. Not a good augury for profit growth in this quarter, especially with the market at 26 times earnings.  Please follow this link for the article.

    The IPO market is the hottest it has been since 1995.  Another sign of the top in place perhaps.   September featured a week which was the best since 1995 with 15 issues hitting the market.   "This will be the busiest week in the Indian primary market history after 1995. Even during the red-hot bull market of 2007, no single week featured 11 IPOs".  So says  SMC Global
    Securities Equity Head  Jagannadham Thunuguntla .  The IPO pipeline to March is scheduled to raise USD 25 to 30billion, with the largest – Coal India – scheduled in mid October.  Please follow the link to read the article.

    And how is the real economy doing ?   Core sector growth was up a little over 3 % according to the latest figures from the government.  3 % !!!  With the market at 26 times earnings. !! Please follow the link to read the article.

    And on the price level.  The primary articles index  is up 18 % according to the latest data,  literally close to text book definitions of galloping inflation levels ( which is 20 %) . Please follow the link to read the article.

    And the RBI Executive Director Mr. Mohanty,  is calling yet again for rate hikes.  Please follow the link to read the article.

    Finally on to insider selling, also a sign that markets are getting dangerously overvalued.. Indian insider selling, Bloomberg tells us, is at the highest it has been since the previous top in December, 2007.  Please follow the link to read the article.

    All this doesn’t matter in the face of a tidal wave of liquidity surging into Indian equity markets.  Last month – September 2010- w as the best month ever  for foreign inflows into  Indian equities. ( almost USD 8 billion). Someone, somewhere is buying Indian paper like water, and like there was no tomorrow.   And without regard to any of the facts above.   ETFs, hedge funds, sovereigns, it doesn’t matter.  And canny local investors, who know no other market than India, and therefore know it well, are all too happy to sell to the foreigners. September 2010  had one of the largest outflows from domestic institutional investors. (DIIs).  Basically the foreigners (mainly indexed money)  bought,  and the local guys sold to them.

    Optimism is rampant and the local brokerage community is making the usual soothing noises to keep the party going. One specimen, Raamdeo Agarwal of Motilal Oswal, still insists the market is trading at 17 times forward earnings. Recall from the NSE data that the market trades at 26 times its most recent past twelve months earnings.  For it to trade at 17 times forward, it   would mean an implied earnings growth of 47 % ! But most recent advance tax growth is at 13%.  The numbers simply don't add up. Recall the immense conflict of interest among brokers and investment bankers. They have to sell USD 25 billion worth of paper in the next few weeks and months ( as noted in the article above) . Hence the soothing noises.

    At some point the above facts will kick in, and the tidal wave of liquidity will end.  Just make sure that when the music stops, you have a chair to sit on.   We heading for a crash, folks.   And a big one at that.

    Disclosure: Exiting Indian markets
    Oct 03 2:19 AM | Link | 1 Comment
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