Archive for August, 2009

Quick Nifty PE post

4 comments Written on August 31st, 2009 by
Categories: Uncategorized
A quick take on the Nifty P/E and EPS growth till now:

(Click for a larger image)

At the 4700 levels we are at a P/E of 20.94, which translates to an EPS of about 223. This is an EPS growth, over the same time last year, of a NEGATIVE 5.89%. (We were at 236.57 last year; that was another lackluster 7% growth from 2007. Take a look at the flattening EPS chart of the Nifty:

(Click for a larger image)

We've been flattening on EPS for a while now. In fact, TWO years ago, in 2007, the Nifty EPS was 221.06 - speaking tomes; even the Nifty then was at the 4500 levels. Two years and we haven't gone anywhere; on the Index OR on the Index EPS. The 9% and 6% GDP growth hasn't quite impacted our Earnings Per Share, it seems.

Posted in Uncategorized

SoS: Rollover, Crappy Performance and A Holiday

2 comments Written on August 27th, 2009 by
Categories: ShortOnly
Rolling over all positions from the Short Only strategy as is. No change in my outlook from a fundamental perspective, though I'm close to stop losses on everything. Performance has been pathetic, with a negative 3%; good learning on what might work and what might not. Useful to stick on, and to work closely with SLs.

Also I'm taking a short break, heading over to Nainital with my wife and son. Will be back Tuesday, and hopefully will get thoughts better organised so I can post more frequently. Apologies for dragging out posts and the innumerable mistakes that are left unedited.

Posted in ShortOnly

BDI drops 30% in Aug, Nat Gas at Seven Year Lows, Copper Climbs

3 comments Written on August 25th, 2009 by
Categories: Uncategorized
Amidst glorious stock market movements and fantastic upturns, it's evident that any negative news is going to be looked at with scorn. Still, it's worth mentioning that the Baltic Dry Index has been taking a toss in the recent weeks.

Courtesy Stockcharts.com.

The BDI has fallen to 2437 as of yesterday, down 30% from the 3500 level it was at the end of July. From a June high of 4250 this is nearly 50% down.

It's a combination of two things: Vessel supply is going up, with 806 more ships adding to dry-bulk fleets (14% more in dead-weight tons).

Of more concern is China's dramatic reduction in buying raw materials. China's been stockpiling a lot of raw material - like iron ore and coal - which has caused port congestion in both China and Australia. This has eased off and Chinese demand is down.

China records it's GDP as based on production, not consumption - so if they get iron ore and make steel, that's GDP regardless of whether someone out there is using the steel. Plus, the stockpiling will have helped them convert a good amount of their US Dollar Hoard into something more useful. That it's stopping can only mean they've reached their limits and that demand internally isn't quite picking up to keep purchasing.

Another product that's not doing very well is natural gas.

At a price of $2.92 per MMBTU, we're fairly close now to Anil Ambani's asking price from RIL - the RNRL deal was struck at $2.34.

That aside, the chart is telling. Crude holds, but Nat Gas falls? Nat Gas is at or near a seven year low - I repeat, a seven year low. (Nitpick: the low was actually two trading ago) Natural Gas has some huge supply pressure - new drilling techniques have opened shale gas fields in the US. A harsh winter can change things, but the scene is interesting - crude sticking on, gas making long term lows.

Good news: Copper has risen to $2.93, which is a rapid move up from the lows earlier this year. That's good - Copper has a substantial industrial use and isn't quite as speculative as crude.

But some say these times could come to an end. China's copper stockpiling was a reason for the heady rise; and in August, their imports dropped 15%.

As an aside, going long Nat Gas and short oil or copper looks like an interesting reversion trade.

Posted in Uncategorized

HDFC issues 4000 cr. debentures, 300 cr. worth warrants

7 comments Written on August 22nd, 2009 by
Categories: HDFC
HDFC is looking to sell a 4000 cr. non convertible debt issue to institutions. There are two parts - two year debt of 2000 cr. at a yield of 7.15% annualized, and a 2000 cr. issue at a yield of 7.85%.

These are zero coupon debentures - meaning you don't get paid during the tenure. In this case you get a lumpsum principal plus "premium" at the end. The premium is such that your yield is at the rates mentioned. HDFC will really be paying out Rs. 296 cr. for the 2 year debenture and Rs. 508 cr. for the 3 year debenture as total interest.

From an interest outgo basiss, that's about 800 cr. in three years; 317 cr. for the first two years, and 170 in the third. They need to make at least that much to pay for the loan.

In addition, HDFC is issuing warrants - that give you the right to buy an HDFC share at Rs. 3,000 anytime in the next three years, for an upfront non-refundable payment of Rs. 275. This sounds like an American stock option, and it is. So can it be valued that way? Using the Black Scholes model, a three year term with a 3000 "strike" price and a current market price of Rs. 2440, I get a valuation of Rs. 375. (Volatility of 25% assumed)

(Note: Black Scholes is a notoriously unreliable model for valuing long term options - it either overstates or understates prices dramatically. The implicit assumptions of volatility and distribution are totally wrong as observed. The basic underlying assumption of Black-Scholes is that markets are efficient; any observer will tell you that is bunkus. Specifically, you might see "efficiency" work in the short term, but over a long term the model simply doesn't apply)

Still, HDFC gets 300 cr. it doesn't have to pay back, for issuing these warrants. They'll dilute just 3.5% - consider that there is a 4.5% dilution with the total outstanding stock options remaining and another 1% from FCCB conversion. (Heck, that's a lot of dilution - but different story).

They will use the money to buy out 3% of stake in HDFC Bank. HDFC had paid 400 cr. as an advance last year for buying 4000 cr. worth stake at Rs. 1520 per share - this is valid till Dec 2, 2010. Current HDFC price is at 1480 - but if they choose not to buy shares they lose the 400 cr. advance. So they have to pay out Rs. 3600 cr. to say hello to the 3% extra share in HDFC Bank.

While this is good for HDFC bank, the share of HDFC in it goes up from 19 to 22%. That's not much really - a rough calculation shows that even if HDFC Bank grew 20% a year, HDFC's extra stake will only give it Rs. 80-90 cr. a year as increased profit share.

HDFC benefits from the warrants it sells - the 300 cr. it receives can be used to pay for the first year's interest on the debenture. Since it's borrowing to buy HDFC bank shares, it can't really generate cash from that avenue (and it plans to NOT sell HDFC bank shares at all) - so where do they get the money to return this loan after two/three years? I don't know. Maybe they'll borrow again. Scary strategy, that. What if the lenders say F.O.?

Now the extra interest outgo is about 30-40 bps (0.3% to 0.4%). (Of a total borrowing of 80,000 cr. the extra interest is 300 cr.) That may not sounds like a large amount, but they had a net interest margin (inflow minus outgo) of only 2.1% or 210 bps. This extra 30 bps will hurt, from 2011 onwards.

But their prospects are good, no doubt? Well, they have a higher cost of funds than, say, banks. Their insurance and mutual fund subsidiaries are not going to do well in the next few years, considering new tax laws, lowered commissions to agents and higher competition. The new tax law may hurt housing too - tax exemptions are due to go away in 2011, and that will hurt prices. (Housing is where HDFC makes its core money) There is likely to be a revision of NHB provisioning too - current levels say 90 day delinquent loans need to provision just 10%, upto 15 months of delinquency (!!!). Even at 50 months or more of non-payment, the provisioning needs to only be 50%. These rates will change once loans go "underwater" - a situation we haven't quite seen yet, but I believe we've overbuilt enough to see it in the next few years.

The other point is price. HDFC is valued at more than 30x past earnings (it had an EPS of 78 in FY 09, and an EPS of Rs. 19 in Q1 FY10). It's price to book is close to 4 - while most regular banks are quoting at close to book values (p-to-b of 1 or less). It's dramatically overpriced. (It's a good trading stock though - has decent volatility)

You and I can't subscribe, so I won't even talk about what I would do. Still, one has to have some direction. At a 7.5% yield the debentures look pricey - why would I go there, when L&T Finance or a Tata Capital gives me a 10% yield? And the warrants - if I think the equity is overpriced the warrants are a joke. But there are enough takers for the issue, apparently. When the music is playing you have to dance, no?

Posted in HDFC

Another Gilt Auction devolves

No Comments » Written on August 21st, 2009 by
Categories: Gilts
RBI's 12,000 cr. auction today was undersubscribed - meaning, not enough buyers - to extent of 912 cr., or 7.6% of the auction amount.

This devolves on the primary dealers - who will need to pay up. Funny thing is - the 7 6 year bond, a 2015 gilt, wasn't subscribed (short 591 cr.) even with a cut off yield at 7.10%. Just a few weeks back, bidders got in with a 10 year bond at 6.90% yield. (Which, btw, was also 321 cr. short of subscription, at a 7.30% yield) A few weeks, and the appetite for government bonds has degraded dramatically.

Some say it's because corporate credit is reviving, so people would rather lend to corporates at a higher yield. Of course, when as a government you swear to rescue anyone and everyone, obviously money will run to the higher interest rate - after all, if safety exists everywhere, why lend to the government. The moral hazard hits back.

But that may not quite be true. Banks dropped 130,000 cr. into reverse repo - meaning they really have no other use for the money.

Another common grouse was that RBI always sold illiquid bonds. But the benchmark 2019 bond is one of the most heavily traded; even that was undersubscribed.

It's not even like people are ditching bonds like mad. Just yesterday, the RBI tried to buy back bonds - last year's benchmark 10 year, the 2018 bond - at a yield of 7.28%. See, that's a couple basis points off the yield as RBI sold today - very well worth the effort of a year's wait less - and definitely in the "yield curve". Yet, the RBI couldn't buy enough at that yield - the buy-back only got them bonds worth 5,411 cr.

So it's not panic, yet yields are dropping like crazy; just the last few days have seen benchmark yields move from 7.01% to 7.30% - a fairly large move for an otherwise non-volatile bond. Bloomberg says there's no appetite for govt. bonds anymore. But someone forgot to tell the RBI; it's selling another 12,000 cr. next friday.

Being the regulator and watching so much money flowing into rev. repo every day, the RBI could hike the Statutory Liquidity Ratio (SLR) back to 25% (it had reduced SLR to 24% earlier, to help a bad liquidity situation). This extra 1% is about 28,000 cr. that the banks will need to buy SLR securities, government bonds being the most liquid of that variety.

The government's panic pushing of these bonds could be a sign of things to come; things you and I don't know about. Conspiracy theories abound - inflation will rise, so will interest rates, and the government will have to pay more. Or, a big bank or FI will go under, liquidity will drop and there won't be money to chase those bonds. Or, they need the money before swine flu goes berserk and they're afraid to touch your money then, so give it to them now please. Conspiracy theories are only fun if you have illegal substances to go with them.

Posted in Gilts

Gilt Fund – Getting out half – yield at 7.18%

5 comments Written on August 20th, 2009 by
Categories: Gilts
I've been holding on to the gilt fund for a while and I'm sick of it - the yields are going up and prices are falling. At 7.18% it's the lowest I've seen for a while, and I am getting out of half my position. Why am I leaving half in there? Just a feeling there's going to be a better time in the next week.

I've made a miserable 4% gain in about 9 months - nothing to write home about. Luckily I won't pay any taxes on it - all of the money has come in as dividend.

Last week, the auction of 12,000 cr. devolved on primary dealers - meaning, not all of it was subscribed. 285 cr. of a 7 year bond and 630 cr. of a 11 year bond didn't get subscribed. A lot of bond sales have happened by the RBI lately, like most other governments, and the spirit is to sell even more while the going is good. Well, the going doesn't seem to be as good anymore.

What will be interesting is the impact of a bad monsoon on yields - with even lower revenues from the after effects of a bad monsoon, the deficit balloons further. At some point we will need to monetize it - meaning, the RBI will buy bonds directly (or, like in the US, slightly indirectly). Monetization breeds inflation - a fear that is currently not on the radar.

Still, this is all the expected result - nearly everyone in the market thinks of the deficit monetization as a conclusion. Yet, I've seen markets behave in really odd ways - will there be something different this time? Time will tell.

But I'm getting out when I still have a profit; hopefully it won't make me regret it by turning around right now!

Posted in Gilts

Restarting SoS: ICICIBank, HDFC, RelInfra, Nifty

4 comments Written on August 17th, 2009 by
Categories: ShortOnly
I'm restarting the Short Only Strategy. After a pretty good bull run, there seems to be some weakness. I think I may be too early; this of course has no money involved (it's "virtual") so I would not recommend that anyone try this at home without protective equipment.

Going short, virtually, on Nifty. It's showing the sort of weakness I haven't seen for a while - and world markets are softening too.

HDFC - it's raising 4000 cr. using bonds, and I think the current valuation is rich. A 25-30 P/E for a finance co. sounds high - and it has the highest price to book in the pack. There is no solvency issue - it's a valuation problem.

That applies to ICICI Bank too - at a 20 odd P/E and a literally flat EPS for the last two years, it needs to show enormous growth just to stay there. It has shown signs of "trading income" based growth in the 1st quarter, but the main businesses of advances and fees declined - so, valuations being high, and the technicals showing a breakdown, it's time to short.

Lastly, Reliance Infra. Again a little rich in valuation considering anything new and good will go to Reliance Power. They may eventually absorb Rel Power - like RIL did to RPL - but till such time I'm suspicious of paying this much for a utility business.

Everything's on with a 15% stop loss - must exit if it rallies back that much. And are there reasons for a rally? Of course - we have the great statistical recovery going on and money's sloshing around equity markets, so a rally cannot be ruled out. And if there's price inflation - something that is traditionally good in the short term for stocks - there is likely to be upward revisions in stocks too.

(Current Status)

Note: No current personal positions matching the above. And this is not advice. This is not anything for the folks that get really anal about this kind of post. I am not a financial advisor. And in case you think I might be right - I've just been terribly wrong in this post - I thought the market would rise (before it fell) but it gave me no ijjat.

Posted in ShortOnly

New Tax Code: EET Regime and Tax Saving Schemes

19 comments Written on August 13th, 2009 by
Categories: IncomeTax
The new Direct Tax Code is out (full draft) and proposed to cut taxes dramatically starting 2011. From a current slab of about 1.6 lakh, 3 lakh and five lakh (10%, 20% and 30% rates) - the new slabs will be 1.6 lakhs, 10 lakhs and 25 lakhs.

The flip side of it? Most deductions are out, and it's a simplified bill. The lower rates will encourage compliance and weed out complex avoidance schemes.

But there are tons of online sites that talk about all the stuff in the code. Let me focus on one thing: the EET regime.

EET refers to Exempt-Exempt-Taxed. Upto 3 lakh a year starting 2011, certain investments - and I think by this they mean insurance, ELSS mutual funds, PPF and so on - will be exempt from tax in the year of investment. Then, as they grow in size, the growth is also exempt. Finally, when you withdraw the money the entire amount is added to your income and taxed.

Currently we have EEE - insurance and ELSS funds are exempt at entry, exempt on growth and exempt on exit. The limit is only 1 lakh a year.

Still, 2011 is hajaar far away - two more financial years away, in fact. Why should you bother? Because the EET regime changes a few things.

Investing money in tax saving instruments now will be taxed on exit - because they will exit only after 2011 (lock in is three years, minimum). So if an insurance agent tells you to buy an insurance policy because it's tax-saving, he's pfaffing - you will end up paying tax when you exit.

(This doesn't apply for PPF apparently; the tax code has a grandfathering clause that lets any accumulated balance in PF accounts as of March 31, 2011, stay untaxed even afterwards)

But it may still be worth it. A person earning 8 lakhs today will pay 30% tax on the 1 lakh invested. Should he get scared of EET and ditch? Well, he will get 70K today, out of that 1 lakh. But if he held for three years, and say there was zero growth, he will get 1 lakh in 2012, at which time let's say his income is 12 lakh. The 1 lakh he gets then will be charged at 20% only, a 10% saving. (It may not be much, but there is a saving)

But in all the participation in insurance and Mutual Funds should reduce today, even though the tax code only gets valid in 2011. At least till 2011, because one can get a better deal investing in a PF instead. Not very positive in the short term for MFs/Insurance companies.

Another impact of the tax code will be that interest on housing loans may no longer be exempt from tax. I'm not sure about this, though. And STT will go - which means long term cap gains tax is back.(sell all long held stocks and buy them back in March 2011!)

Posted in IncomeTax

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