Outlook Money

Most of last week saw pretty flat and listless trading in Indian equities, but Thursday's surge ensured that we saw another week of gains in Indian stocks. With the Nifty now at 5728, and the Sensex back above 19000, Indian equities are now at their highest since end April.

This enthusiasm about equities is a global phenomenon, and European equities have risen in 8 out of the last 9 sessions, while the Dow is flexing its muscles at 12700+. However, there are many reasons to be a little circumspect about sustained bullishness. Just yesterday, many of our financial newspapers said that the fall in global commodities is good for us; which is true, especially in the case of crude oil. The drop in Nymex crude, to just below 90 dollars was extremely welcome. That, however, turned out to be a knee-jerk reaction to the release of 60 mn. barrels of oil coordinated by the International Energy Agency (IEA). By last night, Nymex crude was close to 99 dollars.

Movements of 10% in either direction, within a few weeks, make it extremely difficult to set one's course - whether as an equity investor, or as a policy maker. Indian policy makers, in their desire to control everything, make their lives ever more difficult, and a little more buoyancy in international crude oil will have us - once again - scratching our heads as to how to pay those import bills, not to mention funding the deficit.

Deficits, too, are not uniquely an Indian phenomenon, and most of this week, the attention was on Europe, where, in quick succession, Portuguese debt got downgraded, the ECB raised interest rates, and then said that it would ignore ratings in its willingness to accept Portuguese bonds as collateral. This led one Tweeter to say - I am going to turn my baby's diapers in for a loan of 1 bn., and a more sober, but equally exasperated netizen to say that the whole money construct is now a house of cards. Nobody knows who is holding what, since it doesn't suit governments to put a reality-based value on anything.

This last sentiment is the reason, possibly, that gold and silver have recovered so smartly from their recent lows - gold had been beaten down almost 100 dollars an ounce, from its all-time high of 1575 to 1480 last week. But this week, it surged back up 50 dollars - roughly half-way, to rule at around 1530 as we go to screen this Friday morning.

World economics may not rule Indian equities over the next two weeks, as we are now heading into the thick of earnings season. HDFC will be announcing numbers this morning, even as reports filter in about a slowdown in transactions in Mumbai, India's largest market. Meanwhile, in Greater NOIDA and NOIDA extension, controversies about the mode of allotment have put several projects into jeopardy, and lenders, HDFC included, are holding back on sanctioning fresh loans. Against this backdrop, it will be interesting, not just to study the HDFC numbers, but also to analyse the comments that accompany them.

Happy Earnings season!

On Pg 1:  builders have been ordered to return land to villagers, following a court order that the acquisition of land by the Greater NOIDA authority was illegal. This will push many builders and their financiers over the edge, but I feel much more empathetic towards those who have bought flats in these buildings - an estimated 20,000 owners/investors. Knowing how our typical builder operates, its going to take them years to recover their investment.

This development highlights how far away our nation is from the rule of law - in a well-functioning state, the administration guarantees title; once a transfer of land is approved by the registry, the title is effectively guaranteed by the state. In India, firstly, the registration process only certifies that a sale has taken place, and if the seller's cousin approaches the court 5 years later to say that the land belonged to their grand-father, and the seller did not have clear title over it, the hapless buyer's title is in question. But, under Mayawati, the state has found ways to swing even further away from any norms of governance - the state's very acquisition of land was illegal!

On Pg 3: property registrations in Mumbai dropped 30% in June (Y-o-y). The slowdown in India's most expensive real esate market comes even as Sajjan Jindal buys a 3-storey bungalow on Mumbai's Napean Sea Road for Rs. 400 crore. Mumbai property sales have been slow all of 2011, and every month has seen lower sales than in the corresponding month last year; June, however, racks up the sharpest drop.

Every day seems to bring new disturbances to the global investing scenario.

June sales figures for cars flagged the sea-change in the outlook for this sector.

In 2010, automobile stocks had out-paced the market; between July and December, the BSE index for the sector soared from 8200 to 10500. Year-on-year gains in sales for major producers were running at 30%. Though it should be apparent that such gains are not sustainable, valuations in the sector did not acknowledge this, and market leader, Maruti, for example, saw its share price test Rs. 1600 in November.

Since then, the bull run in crude oil, the consequent increase in petrol prices, and hardening interest rates have all contributed to a lowering of sales growth. In June, Maruti sales logged  negative growth - partially, no doubt, due to labour troubles in its production facility; however, two other dynamics are worth understanding - firstly, the increased competition in the compact car segment which has been Maruti's mainstay. From Fiat to Ford, virtually every major international car manufacturer has been offering up worthy competition to Maruti. Toyota's highly competitive Etios and Liva are now convincing auto analysts that the days of Maruti's dominance are now over. Secondly, Maruti has focused on petrol engines, and many buyers believe that, if you need to buy a diesel drive car, the Europeans are much better. As the gap between diesel and petrol pricing has widened, this perception has furthered damaged the pricing for Maruti shares.

On June 22, Maruti's share broke below Rs. 1100 for the first time in a year. Though they recovered somewhat during last week's bullishness, Friday saw renewed selling of Maruti's shares; in the absence of some positive developments, it seems likely that Maruti's shares will test new lows in the weeks ahead.

It's been an excellent week for equities, beginning last Friday, with the Nifty putting on 327 points - over 6% - between the close of trading on June 23, and June 30.

The markets began getting perky when the government bit the bullet after a year of discussion, and increased prices of diesel, LPG and kerosene. As I wrote earlier this week, the price corrections were mild, and will not do a great deal to set right the huge losses of the Oil Marketing Companies. They will do even less for the fiscal fortunes of our government, since it has given up tax revenue by way of import duty on both crude oil and petroleum products. However, I get the sense that much of the relief came from the thought that our government can actually take decisions: rather than appoint committees and cancel meetings.

Simultaneously, international crude oil prices also corrected, when the IEA (International Energy Agency) coordinated a release of 60 million barrels from strategic resevres of various stakeholders in consuming countries. This does nothing to alter the supply-demand balance, but it was perhaps necessary to flex muscle in the face of OPEC's stubborn refusal to enhance production.

Other international sentiment has also helped hugely, as the Greek crisis seems resolved -  for now. Stocks in all the major markets have been rising this week, and European stocks have had their most most bullish 4-day run in the last 9 months.

With risk in the 'ON' position, money has been coming back to Indian equities, which is always a major determinant of our price levels. With commodity prices dropping, and a benevolent world sentiment, could the bullish trend in Indian equities continue? Yes, unless of course commodity prices, oil especially, reverses. The second, and related, issue iis going to be the pace at which inflation falls off - the hike in diesel prices has just taken place, and needs to work its way through the system. It is estimated that higher prices of diesel and other fuels will impact our price indices by just under 1 %.

More immediately, we are going into the earnings season once again, and a great deal will depend on what numbers we see. It seems unlikely that the market leader, Reliance, will report inspiring results, and I am not too optimistic that the IT majors will report numbers that justify even higher PE multiples. Auto manufacturers' share prices will be guided by the latest sales numbers, which will appear today; with the increased competition, I doubt if individual numbers will give much reason for cheer.

Money seems to be stacked behind the FMCG companies, which have had a stellar run in the last week. The BSE FMCG index was at an all-time high yesterday; plastics, edible oils and sugar prices have moderated significantly since early May, so the market has been extremely logical in bidding up these stocks. With even a modicum of support from the international situation, this is likely to be the winning sector over he next quarter

For the last four trading sessions, the flotilla of Indian equities has been on a great cruise, aided by winds of global optimism.

The Greek vote supporting austerity measures yesterday meant that its government will receive bailout funds; this sent European stocks up by 1.5 to 2%; over in the US, housing numbers are not looking quite as weak as they have been doing for a while, so the Dow is now firmly over 12000 once again.

The downside for our markets of all this is that crude oil, our Achilles heel, is firming again. Last week, it looked like WTI crude in New York would slump below 90 dollars. Now, it is at 95. With Brent crude closer to 110, the Indian crude basket is expensive, and the recent price hike in diesel, kerosene and LPG is in danger of being much too little, much too late.

Our fiscal position continues to look bleak, and in another two weeks, we'll be looking at a fresh set of inflation numbers, which partly factor in the recent fuel price hikes, and may set the tone for the next RBI pronouncements on interest rates.

From an investor's point of view, I think the likely dynamic of the next few months is most negative for the auto sector, and would advise a continual lightening of positions of shares, especially of four-wheeler manufacturers.

I spent two days in Hardwar, the "gate to God" at the foot of the Himalayas.

All of 203 km from Delhi, it took me 7 hours to drive there, with a stop of under half an hour. That's an average speed of 31.2 km/h; forget using the train - firstly, its not much faster; secondly, in the summer season, you can't get tickets unless you book 3 months in advance, or you have connections.

The 'demand' for pilgrim visits to Hardwar is astronomical - the hotels, lodges and ashrams begin a good 7 km before 'Har ki Pauri', and cater to tourists at prices ranging from zero to Rs. 5,000 per night. The diversity of lodgings is truly astounding, international chains like Country Inn and Suites, national chains like Ginger, and regional groups like Leisure Hotels; local entrepreneurs climbing up the value chain, with marble lobbies, air-conditioning and roof-top cafes; and holes-in-the-walls, where you can barely get a sniff of the river, but the open gutters are pretty ripe, thank you very much.

The civic amenities, on the other hand have nowhere near kept up with demand, either in quality or quantity - the parking lots are over-flowing, the vehicles allowed to park in higgledy-piggledy fashion, and the unpaved surfaces turned to slush; the roads are pot-holed and narrow; the gutters choked with uncleared refuse, and in 5 kilometers of walking, I didn't see a single garbage bin.

If you talk to a person in the administration - whether railways, roads, or municipality about such issues, the typical response is that they can't deal with the numbers. An entrepreneur's response to a parallel situation would be - "Wow! Demand is fantastic. We're ramping up supply."

This diametrically opposite response the same dynamic is the reason India cannot cope with high-growth. Aside from all the monetary and financial issues in our economic policy, the fact that so much of our growth is constrained by governmental monopolies over infra-structure is going to be our biggest constraint.

A  piece* in yesterday's Economic Times signals severe cash - and reporting - pressure at DLF, India's largest real estate company.

Essentially, it suggests that over 75% of the reported sales by DLF during 2010-11 never took place! That is a truly amazing statistic, and even though my own number crunching shows a lower number, it is still huge. Sales reporting was done on the basis of 'percentage completion'. This is like Soviet accounting - production is equal to turnover - irrespective of whether the stocks rusted in a corner of the stock yard, and with a total disregard to eventual price realisation.

Looking at the skeletal balance sheet on the DLF site, it would seem that there have been some very 'interesting' changes on the company's balance sheet between March 31st 2010 and March 31st 2011:

1. 'Stocks' have gone from Rs. 12481 cr. to Rs. 15039 cr., an increase of roughly Rs. 2500 cr.

2. 'Other current assets' - a convenient grab-bag, have gone from Rs. 4684 cr. to Rs. 7890 cr., an increase of over Rs. 3000 cr. A look at DLF's annual report for 2010 shows that the ET has it right - this includes 'unbilled receivables' - note below.** 

For a business with sales recorded at Rs. 9000 crores, over Rs. 3000 crores has appeared by way of an increase in unbilled revenues. This is a whopping amount; if the unbilled receivables are not converted into cash soon, DLF is going to have a whopping cash management problem on its hands.  

Meanwhile, between year-end 2010 and year-end 2011, Rs. 5500 crores worth of investments have dwindled to under 1000 cr., a diminution of Rs. 4500 crores in financial assets, while loan funds have gone up by over Rs. 2000 crores.

This all looks like deep distress.

*Real estate: Experts doubt 'percentage completion' method of revenue calculation by builders - The Economic Times

** Here is the relevant revenue recognition policy from DLF's 2010 annual report:

" Unbilled receivables disclosed under Schedule 11 - “Other Current Assets” represents revenue recognised based on Percentage of completion method (as per para no. 7a and 7b above), over and above the amount due as per the payment plans agreed with the customers."

"India's primary culture is agriculture", was our in-sarcasm when I was at the Delhi School of Economics, underlining the inability of a nation to leverage modern agricultural techniques into a relative independence from the cycles of weather.

 Did the prospect of a revision in the Mauritius tax arrangements actually cause yesterday's plunge in Indian stocks?

 Greek tragedies take a special place in theater - everyone know that they end in a disaster. Right now, the investing community is trading in the timing of that disaster. Will the ECB bail Greece out for a week's worth of loan roll-overs, or two? In the longer term - if a couple of months can be called longer-term - the cost of decades of Greek fiscal mismanagement is going to be paid by the European bankers who under-estimated the risk of lending to its government.

Since April 2010, our central bank has raised interest rates 9 times, and the repo rate has gone from 5.25 to 7.25%. But, with inflation still somewhere between 9 and 10%, the hikes are not nearly done, a fact RBI underlined yesterday in the text of its policy review.

 The financial crisis of 2007-2008 saw governments and central bankers moving closer together as they acted to bail out bank balance sheets. In my view, this was always a dangerous move.

 My posts have been erratic, due my mother's ill-health. She passed on, quite peacefully, last Friday, and has left us with the satisfaction that she lived a full life.

 A couple of weeks ago, the State Bank of India reported results under a new Chairman, Pratip Chaudhuri, who took a stiff new broom to doubtful old loans. The resulting provisions knocked a hole in SBI's numbers, and sent the stock tumbling 8% in one session.

Yesterday, Reserve Bank deputy governor, KC Chakrabarty came out with a (barely) veiled criticism of Chaudhuri's move, "When bank chairmen change, profits tend to fall. Things should not turn topsy-turvy if bank chairmen change."

Mr. Chakrabarty is addressing the wrong end of the broomstick - firstly bad loans should not have been made in the first place; it is well known that 2 major causes are cheap money and interference from outside the bank, aside from the risk inherent in making loans; secondly, if bad loans have been made, they should have been recognised earlier. In fact, it appears as if such a move had been mooted one quarter earlier, but " the bank management persuaded them (auditors) to believe that possibly it should be feasible to get a favourable dispensation from the RBI", Pratip Chaudhuri has said.

In other words, assessing  the quality of a loan does not depend on the view of bank management, or of the auditors, but rather on the view of the RBI. So much for good management and non-interference. Mr. Chakrabarty's latest statement underlines the sense that his mandate is about cutting the feet from under bank management, rather than good banking practices.

 Indian equities rallied sharply on Friday, sending bears scurrying for cover. The Nifty was up 1.18%, and the Bank Nifty was up 2.43%.

 Yesterday's food price number reinforces the fact that the Reserve Bank of India is way behind the curve.

 Real estate major DLF slumped to a 2-year low yesterday, and announced that it was looking to sell 'non-core' assets worth Rs. 6-7,000 crores to help strengthen its balance sheet. Another big player, Emaar MGF, is reported to be in talks to sell a Gurgaon residential project to US real estate player, Tishman Speyer for Rs. 1,000 to 1,200 cr.

 Released late last evening, quarterly numbers from DLF show a company reeling under the burden of its debt.

Though turnover is up substantially over the same quarter last year - from Rs. 1994 cr to Rs 2683 cr - DLF's profitability has shrunk to one-third: profit before tax (PBT) is down from Rs. 742 cr. to Rs. 231 cr. Significantly lower tax provisions have prevented the reported net profits from getting as deeply affected, and the company has been able to declare an EPS that is only 20% down, from Rs. 2.51 to Rs. 2.03. 

The tax provision, at only 7% of net profit, is not explained; though I am sure such a low provisioning has been carefully vetted by the company's tax experts, subsequent quarters should see tax payouts at a higher level, and unless there is a substantial turn-around in the real estate business, DLF's EPS will be under further pressure. With interest rates hardening, it is going to be a while before this sector sees the ability to increase margins, so one should be prepared for much lower earnings from DLF. This, of course, makes even the current price of Rs. 218 for the DLF share extremely rich. At some point, investors with deep pockets and long investment horizons will buy real estate stocks for their "land banks"; however, that time is still several quarters away.

Meanwhile, DLFs  borrowings continue to mount, and currently stand at Rs. 27,000 crores. Servicing these debts is proving more and more difficult for the business: last quarter, financial costs were just under 40% of profit before interest and taxes; this quarter, the same ratio is up to 67%, an alarming number by any standard.

What is true of DLF would be true of many players, large and small, across the real estate sector - they are loaded with debt, and unable to clear inventory at the pace and prices required to service debt and equity. Expect further trouble for shareholders of these stocks.

 The world is going through one of its cycles of risk aversion, this time prompted by deepening fears about sovereign debt in the Eurozone. Up until recently, the main concern has been with Greek and Portugal, but as the downgrading of Spain, and most recently Italy, has begun, the worries are moving from the periphery towards the center, from relatively small economies to larger ones. A couple of weeks ago, it was the dollar that was plummeting; over the last 10 days, it has been the Euro, which threatened to drop below 1.40 to the dollar. In response, gold hit a new all-time high in Euro terms, at 1080 per ounce, though the dollar price, at 1515, is still 4% off the peak of 1575.

The risk aversion has meant that there are few overseas buyers for Indian stocks. Indian investors, in any case, have been increasingly wary of Indian equities ever since the 2008 crash. The combination of attitudes meant that Indian equities dropped almost 2% in yesterday's trading, taking 12 of our 50 leading (Nifty) stocks into the region of 52 week lows. 

Real estate stocks continue to be among the hardest hit, but are marginally higher than their February 2011 lows. Banking, power and capital goods also lost close to 3% each yesterday, the CG sector being particularly hard hit by extremely weak numbers from BHEL, India's pre-eminent manufacturer of power equipment.

European stock indices lost between 1.5% and 2% yesterday, and the Dow looked set to follow last night. Losses did get trimmed towards the end of trading, and US markets ended down just over 1%. But the mood remains sombre, as investors watch for further recognition of Eurozone risks.